Last updated: Aug. 11, 2022
As Canadian interest rates continue to soar, the idea of taking out a loan from your corporation at no or low interest may be increasingly appealing.
But, before you start using a shareholder loan account, it’s important that you understand the associated tax impact and implications. While shareholder loans may initially look attractive to many small business owners, they may not be a good fit for your individual situation.
If you’re considering taking out a shareholder loan, here is what you need to know before you make that decision.
What are Shareholder Loans?
A shareholder loan is an amount that you, as a shareholder owe to your corporation.
Typically, a shareholder is paid from the corporation through either salary or dividends. Dividends are paid from after-tax corporate profits and taxed at a personal level. Salary payments require source deductions to be paid in a timely manner (i.e. CPP and income tax must be remitted to CRA usually by the 15th of the following month).
Shareholders may use corporate funds for personal uses throughout the year, outside of the traditional salary or formal dividend arrangements. These amounts are considered loans from the corporation to the shareholder. This money has not been taxed at a personal level, so must either be repaid by the shareholder within a certain time frame (i.e. typically a year), or must be included in the shareholder’s personal income. .
A shareholder loan can be made to your own company, a company related to your company, or a partnership of which your company is a member. The company can give shareholder loans to any shareholder of the company and any person connected with the shareholder of the company. Check out the Canada Revenue Agency website on who are connected shareholders.
How can you use Shareholder Loans?
There are four common uses for shareholder loans: two that are considered “due from shareholder” loans and two that are considered “due to shareholder” loans.
Due from Shareholder
If you withdraw money from your incorporated business and it is not designated as salary or dividends paid to you, it is considered a loan from the company to you, the shareholder.
Another common “due from shareholder” loan takes place when company money is 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. Be aware that these types of loans are subject to special rules such as requiring repayment to the corporation within a year.
Due to Shareholder
If you pay for company expenses using personal funds or loan money to the company, this is considered an owner contribution and is reflected on the balance sheet as a debt owed (liability) by the company; the company will need to pay the owner back at some point.
What are the tax implications of Shareholder Loans?
Before taking out a shareholder loan, there are several tax implications you need to be aware of. The most important is the shareholder loan repayment rule. The basic rule is that the amount of the shareholder loan will not be included in your taxable income if you repay the loan within one year from the end of the fiscal year of the corporation.
For example, assume you own shares in Company A, and Company A has a fiscal year-end of December 31. If you borrowed money from Company A on December 1, 2021, you need to repay the loan by December 31, 2022.
Tax income impact of Shareholder Loans
If you don’t repay the loan within that time, you must include the unpaid amount in your taxable income and pay income tax on it.
Also, if you didn’t charge an interest rate on the loan, you must also add interest rates equal to the prescribed rate to your taxable income. The prescribed rate is currently 2% but is subject to revision every quarter. This interest is considered a taxable benefit to you, as a shareholder, and it reflects a benefit you received (i.e. a loan) due to your role as a shareholder. Taxable benefits are included in your personal taxable income.
Exceptions to the Shareholder Loan rules
You can take out a shareholder loan for a longer period in certain circumstances. For example, if your company’s business is to give out loans, and the shareholder loan is made in the ordinary course of the business, then as long as the terms of your shareholder loan are similar to that of any unrelated borrower, you don’t need to repay the amount within one year and you won’t run into any tax issues.
You can also take out a shareholder loan without the time limit if you purchase a motor vehicle for company use or if you purchase a principal residence for the shareholder, this can include a house, condo, cottage, or mobile home. There are certain conditions which must be met in order for this to apply (i.e. must have a legitimate repayment plan with a reasonable time frame, etc.)
There are several other tax-saving strategies you may want to consider. Check out our free 37-page toolkit that includes 10 key strategies you can use before the year-end to pay less tax.
What to know before taking out a Shareholder Loan
Remember, your corporation is a separate entity from you; therefore, corporate funds and personal funds must be kept separately. You should also keep proper paperwork and structure your shareholder loans correctly to avoid any issues at tax time.
However, one of the best ways to safeguard yourself from potential problems with CRA is to speak with a tax specialist and make sure that the right paperwork in a place, such as clear tracking of the transactions made through the shareholder loan account, so it’s clear to CRA that you will or have paid off the loan, and that you keep paper records of repayment.
If the loan is to a related party, you should consider a separate and detailed loan agreement to protect your rights and the rights of the borrower.
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