Shareholder loans are a common 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.
Under the Canadian Income Tax Act (ITA), there are complex rules surrounding the tax implications of shareholder loans. The purpose of these rules is to ensure individuals do not try to take funds out of their corporations on a tax free or tax-deferred basis.
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 the income inclusion, there are a number of exceptions in the ITA.
Loan repaid within one year
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 repayment was part of 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 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 long term loans that effectively allow them to use corporate funds for personal purchases while deferring their tax obligations. For illustration purposes, lets 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 repayment allows Joe to claim a deduction in his personal tax return for 2023.
Another point to note is that for the shareholder loan not to be considered income, there must be interest charged by the corporation to the shareholder at a prescribed rate on the loan amount. To see the current CRA prescribed interest rates on shareholder loans, click the link here.
Shareholder employee exception
Another exception applies where:
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.
To make things more complicated, the above exception applies differently if you are a specified employee vs a non-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.
If you are not a specified shareholder employee, you only need to meet the above conditions under a) and b). Thus you can use the loan for any purposes and still fall within this exception.
If used properly, shareholder loans are a great tool for tax planning and cash management. 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. If you have any questions about shareholder loans, please contact us.
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.