Shareholder loans are a standard business practice that gives shareholders the flexibility to borrow from their corporation when they need cash. While these types of transactions are not uncommon, shareholders need to be aware of the potential tax consequences that result when the shareholder has a balance owing to the corporation. In this article, we will explore the basics of shareholder loans, their tax benefits, and other important considerations.
Under the Canadian Income Tax Act (ITA), there are complex rules surrounding the tax implications of shareholder loans. These rules are covered under Section 15 of the Act, which establishes the basic principle that a corporation is a separate legal entity. Section 15 is one of the fundamental provisions in the ITA as it addresses the relationship between a corporation and its shareholders. Its main objective is to discourage shareholders from using corporate assets, such as borrowing from the corporation, as an indirect means of gaining economic benefit. Before we delve into the tax implications of shareholder loans under the ITA, let's look first at what a shareholder loan is and when it arises.
A shareholder loan is an amount that a shareholder owes to their corporation or money that they have contributed to the corporation. It's a short-term loan that can be converted to a form of remuneration, much like dividends or salary. Shareholder loans can also go the other way, where an owner lends money to the corporation. Shareholder loans are specified as either "due from shareholder" or "due to shareholder," depending on the specifics. In simpler terms, you have the option to either loan money to your company or borrow from it through a shareholder loan.
A balance in the shareholder loan account represents the cumulative total of all shareholder loan-related transactions that are going on at any one given time. Shareholder loan accounts can have both a debit balance as well as a credit balance.
Due from Shareholder
A "due from shareholder" is represented by a debit balance and is reflected in the balance sheet as an asset. This balance is the amount of money a shareholder withdraws from the company that is not designated as salary or dividends. In such a case, the amount becomes a corporate loan to the shareholder.
Another common scenario where a "due from shareholder" loan takes place is when company funds are used to purchase a personal item. In both situations, corporate funds have been borrowed for personal purposes and personal tax has not been paid on those amounts.
Due to Shareholder
If you pay for company expenses using personal funds or loan money to the company, this is considered an owner contribution. Hence, a "due to shareholder" is represented with a credit balance and is reflected in the balance sheet as a debt owed (liability) by the company to the shareholder. The company will need to pay this balance back to the shareholder at some point.
Generally, shareholders are taxed on any amounts received from a corporation. Based on Subsection 15(2) of the ITA, if you are a shareholder of a corporation and you receive a loan or otherwise become indebted to the corporation, the amount of the loan is to be included in computing income of the shareholder, unless the loan meets certain exceptions. The same tax treatment would also apply to anyone who was non-arms length with the shareholder such as their spouse, children, and siblings. To avoid income inclusion, there are a number of exceptions in the ITA.
If a shareholder or a taxpayer connected to the shareholder can establish that the loan obtained from the corporation meets one of the following exceptions, the loan will not be included in the shareholder's income.
The most common exception is if the shareholder loan is repaid within one year after the end of the taxation year of the corporation in which the loan was made. However, this exception will not apply if the shareholder loan repayment was part of a series of loans and repayments. This means that if a shareholder repays the loan by the due date and borrows a similar amount shortly after, the Canada Revenue Agency ("CRA") would view this as part of a series and would include the full principal amount of the loan in the income of the shareholder.
The purpose of this rule is to prevent business owners from providing themselves or other shareholders with long-term loans that effectively allow them to use corporate funds for personal purchases while deferring their tax obligations. For illustration purposes, let's look at an example.
Joe has a corporation with a year-end of December 31. Joe takes out a shareholder loan from the corporation for $100,000 on September 10, 2021. Joe has until December 31, 2022, to repay the loan to fall within the exception noted above. If Joe does not repay one year after the year-end (December 31, 2022), CRA will include the shareholder loan in his taxable income for 2021. If the loan is repaid at a later date (i.e 2023), the shareholder loan repayment allows Joe to claim a deduction in his personal tax return for 2023.
This exception applies to a debt that arose in the ordinary course of business of the corporation of lending money (for example, banks and loan companies) to one of their shareholders. For this exception to apply, bona fide arrangements were made for repayment of the loan within a reasonable time at the time of the loan.
Non-specified employee
If the shareholder is an employee that owns less than 10% of the corporation’s shares of the corporation, they are considered to be a non-specified employee, and the loan is not included in their income under subsection 15(2.4) of the ITA. In addition, the loan can be used for any purpose to fall within this exception. The two criteria that must be met to meet this exception are:
a) you received the loan in your capacity as an employee of the corporation rather than in your capacity as a shareholder and;
b) at the time of the loan, bona fide arrangements were made to repay the loan to the corporation within a reasonable time.
Specified employee
To make things more complicated, the above exception applies differently if you are a specified employee. A specified employee is one that owns more than 10% (either direct or indirect) of any class of shares of the corporation.
Hence if you are a specified employee, the above exception will only apply to you if the loan is going to be used to:
In addition, the specified employee will still need to meet the condition of receiving the loan because of employment and not shareholder status and showing repayment arrangements that are reasonable and well documented. Further similar benefits should be provided to non-shareholder employees in the same position and with similar responsibilities, to ensure they have access to loans of similar amounts and under similar terms and conditions from their employer.
Another exception deals with shareholders that are Trusts, but that is beyond the scope of this article. If you require advice in this specific area, reach out to our professional tax accountants.
If you meet the exceptions or the loan is repaid in time so that there is no income inclusion, you may still have a deemed interest benefit that is taxable to you if the loan is non-interest bearing or low-interest-bearing. Interest on shareholder loans is payable at the prescribed rate of interest in effect with the CRA at the time. This interest is considered a taxable benefit to you, as a shareholder, and thus must be included in your personal taxable income for the time the loan is outstanding. The current CRA prescribed rates on shareholder loans can be found on their website.
1. Keep corporate and personal funds separate
Since the corporation is a separate legal entity, you should keep personal and company funds separately.
2. Keep track of shareholder loan account
One of the most common issues when it comes to shareholder loans is improperly tracking and recording shareholder loans, which can lead to missed expenses and personal income tax implications. To avoid tax problems with CRA, it's important to keep clear and accurate records of all shareholder loan transactions. Thus, ensure that all shareholder loan transactions are accurately documented and clearly distinguishable from other transactions. This is especially important when making repayments of shareholder loan, so it's clear to the CRA that you will or have paid off the loan, and that you keep records of repayment.
3. Repay shareholder loans within two corporate year ends
To prevent any tax problems with shareholder loans, it is important to repay the principal balance through the shareholder loan account within two corporate year ends.
4. Avoid a series of loans and repayments
As per subsection 15(2) of the ITA, the repayment exception is only met if the repayment was not part of a series of loans and repayments. When repayments are made just before the end of the year and an equal amount is borrowed shortly after, it is considered a series of loans. In such situations, the CRA does not consider the original shareholder loan to be repaid on time and hence the amount is included as taxable income to the shareholder.
5. Establish a clear bona fide agreement
It is crucial to have a well-defined loan agreement in place that outlines the terms and conditions of the shareholder loan. This agreement should include the loan amount, interest rate, repayment schedule, and any other relevant details. By clearly documenting the loan terms, you are demonstrating to the CRA that the funds received were indeed a loan. If a shareholder loan is not properly documented, or the repayment guidelines are not met, there is a risk that the CRA may consider the loan as income to the shareholder.
6. Clear the shareholder loan balance before year-end
You can also avoid a shareholder loan issue altogether by clearing the debit balance in the shareholder loan balance account before year-end by paying a salary, bonus, or dividends to the shareholder.
Q: Is a shareholder loan considered a liability?
A: Yes, a shareholder loan is generally categorized as a liability or debt for the party that receives the funds. In the event that the shareholder borrows money, it becomes their personal debt. On the other hand, if the business borrows funds from the shareholder, it becomes the company's debt.
Q: When does a shareholder loan have to be repaid?
A: A shareholder must be repaid within two corporate fiscal year ends. For example, if Joe takes out a shareholder loan from the corporation for $100,000 on September 10, 2021. Joe has until December 31, 2022, to repay the loan.
Q: Can a shareholder loan be forgiven?
A: If the loan or debt to a shareholder is forgiven, the forgiven amount will be included as income in the shareholder's hands in the year of forgiveness, as per subsection 15(1.2) of the Income Tax Act.
If used properly, shareholder loans are a great tool for tax planning and cash management. They offer shareholders the opportunity to withdraw funds from the corporation without triggering a tax liability. However, there are complex rules in the Income Tax Act that should be considered before you take any money out of your corporation to avoid negative tax consequences. Further, proper documentation and written agreements are essential to avoid ambiguity and ensure that the shareholder loan is not considered income to the shareholder. If you are looking for an accountant in Hamilton who can provide professional guidance with shareholder loans or tax planning initiatives, please contact us.
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Disclaimer
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.
