Hannah, a young maiden, is the sole director, president and shareholder of Acme Services Ltd. a very successful purveyor of explosives. In honour of her biggest customer, she incorporated Wiley Coyote Holding Ltd. (“WileyCo.”) which then purchased a vacant lot in a remote location of Vancouver Island. Over the next two years Hannah built a cabin on the lot. WileyCo. paid for the cost of the construction. Hannah lives part time at the cabin. She enjoys sitting on the porch sipping lemonade but Hannah spends a lot of time around explosives so you’ll understand it when I say that the cabin looks more like a bunker than a grotto. The result is that there is no real rental market for the cabin so it’s all good, right?
No it’s not good Hannah. When a corporation confers a benefit on a shareholder, the amount or the value of the benefit must be included in the income of the shareholder. It is common knowledge that dividends are taxable income but where some people get tripped up is in the conferral of “non-cash” benefits from the corporation to its shareholders.
So what is the value of the benefit Hannah received? The courts have generally taken two approaches to determining the value of the benefit received. The “Usage Approach” and the “Return on Investment Approach”.
Under the Usage Approach the amount of the benefit is based on the fair market value of the benefit received. The CRA says that where corporate property is made available to a shareholder and a rental market exists, the value of the benefit is the fair market rent minus any amount that the shareholder paid the corporation for use of the property.
The fact that there is no existing rental market for the cabin will not save poor Hannah. Where no rental market exists the courts can apply the Return on Investment Approach. Here, the court looks at what the corporation invested in the property and determines what a reasonable rate of return would be on the corporation’s investment. In Hannah’s case, the court could impose an artificial rent for the cabin based on the corporation’s costs to purchase the lot, construct the cabin and maintain the cabin. The courts expect, and rightly so, that corporations are in business to make money.
So what are Hannah’s taxable benefits? In this case Hannah failed to pay rent to the corporation for her use of the cabin. The amount of artificial rent that Hannah should have paid to the corporation for the period in which Hannah occupied the cabin is considered a taxable benefit to Hannah. The consequence can be harsh. The value of the benefit received is added into Hannah’s taxable income. For example, if we assume that Hannah pays personal income tax at the top marginal rate of 43.70% and the value of the benefit she received was $5000, Hannah would be required to pay $2,185 in additional tax for her use of the cabin even though she did not receive any cash with which to pay the tax.
Hannah made a mistake by holding the cabin in WileyCo. She failed to consider that corporations only hold assets to make money. By putting her cabin in WileyCo, she lit a fuse. When she failed to pay rent for her use of the corporation’s property, boom went the dynamite.
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.
