CRA raises Prescribed Interest Rates in 4th Quarter of 2013 for Low or Interest Free Employee Loans

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interest

For the first time in several CRA announced today (Sept 23, 2013) that effective the 4th quarter of 2013 interest rates used to calculate employee taxable benefits on low interest or zero interest loans is rising from 1% to 2%.    While not many employers actually service employee loans anymore these days, one thing has become very clear to me over my many years of payroll experience – most employers don’t realize what actually constitutes as a loan to their employees.  A loan comes disguised in many formats and most employers are offering them unknowingly to their employees at a zero interest rate.

So what does constitute an employee loan you may ask…well look in places you never thought of before:

  • a cash advance is money lent to an employee and typically is considered an interest free loan
  • an overpayment to an employee that is not recovered immediately is an interest free loan

Many employers worry about the undue hardship a cash advance or overpayment recovery will have on an employee but what they don’t realize they are putting themselves in jeopardy of fines and penalties should they be audited by the government.  Let’s break this down into bite-sized pieces.

a)  the employee is in possession of company money that is to be paid back to the employer

b)  the employer agrees to a payment term – typically without interest or very low interest rates

c)  the employee takes from several weeks up to several months to repay the funds

The end result is the employee has now incurred a taxable benefit for the zero or low interest money.  What does this all mean?  Because the boss did not charge the prescribed rates for the loan made to the employee, the employee “saved” the amount of interest they would have been charged had they gone to a financial institution.  The employee will have to make CPP (Canada Pension Plan) contributions and pay additional income tax on the difference of the interest he paid vs. what the current prescribed interest rates.

In the example below, the employee was overpaid $5,000 in vacation pay.  They made an arrangement with the employer to repay the funds $100.00 per month until the money is repaid.  The employer agrees not to charge interest on the overpayment.  The employee will incur a taxable benefit for a zero interest loan.  The calculation is as follows:Interest Rate

In 2013 the employee will incur a taxable benefit of $294.00 which is included in their total annual remuneration in box 14 and also in the information box 36 for low interest or interest free loans.  That’s not all.   The employee will receive a lesser net pay because they will have to pay CPP and income tax on the interest savings they received.

I am of two mind sets with this common dilemma.  One, the employee is enjoying money that doesn’t belong them; they should repay it right away to avoid the taxable benefit.  Two, it’s not their fault that the company messed up their pay.  They should have the opportunity to repay over a period of time.  I would say no more than 2 pay periods is the longest repayment plan I would offer to keep them from incurring an interest free or low interest loan and to keep you out of hot water.  No promises on the hot water though.  If you are audited this could come back and haunt you.

Here’s to helping you understand what’s in your pocket.

Until next time.

 

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