The following article originally appeared in Tax Topics 2548.
The Canada Emergency Business Account (“CEBA”) is a federal support program for businesses and non-profits that are struggling with the pandemic. The program provides government-backed loans to eligible borrowers with non-deferrable expenses. Nearly 800,000 applicants have received CEBA loans, and $32 billion has been disbursed through this program. Initially, the CEBA provided a loan of up to $40,000 of which up to $10,000 is forgivable if the loan is repaid by December 31, 2022. The CEBA was recently expanded to provide an additional loan of up to $20,000 of which up to $10,000 is forgivable under the same repayment terms.
There are immediate and future tax consequences of receiving a CEBA loan. The CRA has published two technical interpretations that discuss its views of how the forgivable portion of CEBA loans should be treated for income tax purposes (2020-0861461E5 and 2020-0862931C6). Based on these documents and the relevant provisions of the Income Tax Act (the “ITA”), this article provides a summary of the key income tax implications of receiving a CEBA loan.
Income Inclusion When Loan Received
Paragraph 12(1)(x) of the ITA includes any government assistance in income from a business or property if the assistance is otherwise not included in income. It is the CRA’s view that the forgivable portion of the CEBA is an amount that is described under subparagraph 12(1)(x)(iv). Accordingly, based on the value of the loan received, the total forgivable amount must be included in income in the year the loan is received by virtue of paragraph 12(1)(x). This income inclusion is required regardless of whether a loan is eventually forgiven, but an election and/or a deduction are potential remedies. For example, if a business receives the entire $60,000 CEBA loan in 2020 and subsequently repays the loan after December 31, 2022 (i.e., nothing is forgiven), the taxpayer must still include the $20,000 forgivable portion in income in 2020. However, if a taxpayer enjoys the loan forgiveness by repaying the loan in a subsequent year, there is no further obligation to include an amount in income since the income was recognized in a prior year.
Election to Reduce Income Inclusion
Although the forgivable portion of a CEBA loan is included in income in the year that the loan is received, a borrower can avoid this income inclusion by electing under subsection 12(2.2) of the ITA. The election can be made where a taxpayer receives an amount that would be included in income by virtue of paragraph 12(1)(x) in respect of an outlay or expense (other than an outlay or expense for the cost of property) that is incurred before the end of the following taxation year. These conditions would likely be met since the purpose of the CEBA is to provide borrowers with capital to pay their employees and other non-deferrable expenses. A taxpayer can elect under subsection 12(2.2) to reduce the amount of the expense by up to the amount of the CEBA loan that is otherwise included in income. As a result, the deductible expense is reduced by the elected amount and the income inclusion under paragraph 12(1)(x) is equally reduced.
The election must be made with the tax return for the year in which the outlay or expense is made or incurred. For example, the CRA states in document 2020-0862931C6 that a corporation could avoid the income inclusion under paragraph 12(1)(x) by filing the election with its income tax return for its 2020 taxation year to reduce the amount of allowable non-deferrable operation expenses incurred in 2020. Similarly, a corporation could avoid the income inclusion under paragraph 12(1)(x) in its 2020 taxation year by filing the election with its income tax return for its 2021 taxation year to reduce the amount of allowable non-deferrable operation expenses incurred in 2021.
No Forgiveness: Deduction Upon Repayment
The forgivable portion of the loan will not be forgiven if the taxpayer does not repay the loan by December 31, 2022. When the taxpayer eventually repays the forgivable portion of the loan after this date, they can offset the prior income inclusion by a deduction under paragraph 20(1)(hh) of the ITA in the year of repayment. The deduction is allowed if the amount was repaid in the year pursuant to a legal obligation to repay an amount that was included in income by virtue of paragraph 12(1)(x) or that reduced the amount of an expense under subsection 12(2.2). For example, say that a taxpayer borrowed the maximum $60,000 CEBA loan in 2020, so the $20,000 forgivable portion was included in income for 2020. If the taxpayer repays the entire loan in 2024, no amount of the loan is forgiven due to the timing of the repayment. However, the taxpayer would deduct $20,000 under paragraph 20(1)(hh) in 2024.
The timing of the paragraph 20(1)(hh) deduction can be complicated if the loan is not entirely repaid in a single year. For example, if a taxpayer borrowed $60,000 in 2020, repaid $40,000 in 2024, and repaid $20,000 in 2025: should the deduction for $20,000 be made in 2024, 2025, or should it be prorated between the two years? According to the CRA’s comments in document 2020-0862931C6, the timing and amount of the deduction depend on the intent of the parties.
Where the intent of the parties is that any amount reimbursed by the taxpayer will be applied first in repayment of the portion of the loan that was initially forgivable, the taxpayer could claim a deduction under paragraph 20(1)(hh) with respect to the amount reimbursed in the taxation year in which the reimbursement is made, up to the amount included in its income pursuant to paragraph 12(1)(x). However, if the intent of the parties is unclear in this regard, the CRA stated that the deduction under paragraph 20(1)(hh) should be prorated as follows:
Deduction under 20(1)(hh) = amount reimbursed in the taxation year x (portion of the loan that was initially forgivable ÷ outstanding balance of the loan on January 1, 2023)
When the loan is fully reimbursed, the total of all prorated deductions under paragraph 20(1)(hh) in respect of the loan will equal the income initially included under paragraph 12(1)(x).
Based on this guidance, when CEBA repayments are made after 2022, taxpayers may consider consulting the loan agreement and/or their lender to determine the intention regarding repayment. Ideally a taxpayer would want the repayments to first apply to the initially-forgivable portion, if the lender allows it. However, the intention with respect to reimbursement may already be established in the written terms of the loan that have already been agreed upon by the borrower and the financial institution. If the repayment terms will delay the offsetting deduction for borrowers, will financial institutions alter the terms of their existing CEBA loan agreements to allow their borrowers to obtain a better tax outcome? That is probably asking too much. In either case, borrowers can only offset the prior income inclusion once the loan is repaid fully or partially, depending on the intention of the parties.
Debt Forgiveness Rules
According to CRA document 2020-0861461E5, if the loan is settled for less than its principal amount (minus the forgivable portion), the debt forgiveness rules under section 80 of the ITA can apply in the year of settlement. The rules would apply in respect of the portion of the loan that was not otherwise included in the taxpayer’s income under paragraph 12(1)(x) when the loan was received. The debt forgiveness rules would reduce certain preferential tax attributes of the taxpayer such as loss carryforwards.
The forgivable portion must be reported in the tax return of a CEBA recipient in the year the loan is received. However, an election to reduce the amount of expenses and the income inclusion under subsection 12(2.2) can be filed with the tax return for the period in which the expenses were incurred if doing so would benefit the taxpayer. A deduction is available when the loan is repaid without forgiveness, but the rules are uncertain. Last, there could be additional consequences if the federal government further modifies the CEBA program as pandemic-related disruptions continue.