Have you ever used a business credit card to pay for an expense in which a portion relates to personal use? Or have you taken a loan from your company to cover short-term personal cash needs? If these scenarios sound familiar to you, you need to monitor the shareholder loan balance to avoid adverse tax consequences.
The Shareholder Loan Tax Rule
Generally, when a shareholder borrows from the business and and does not repay the outstanding balance within a year, the loan will be included as income on the shareholder’s personal tax return in the year the loan was made. The “loan” here may not necessarily be cash withdrawn from the corporation. It can also be a payment made by the business on your behalf. Under the current shareholder loan tax rule, funds withdrawn from the corporation as a loan are not taxable in the hands of the shareholder. The shareholder could legitimately take funds out of the corporation indefinitely without reporting it as income. To prevent this, the Canada Revenue Agency (CRA) imposed the shareholder loan tax rules to treat the loan as a benefit to the shareholder and tax the outstanding balance as income if it is not repaid within one year after the end of the taxation year of the lender in which the loan was made.
Deemed Benefit Rule
In addition to the shareholder loan tax rule, a corporate loan made to a shareholder may cause a deemed benefit to be received by the shareholder under the tax regulation unless the interest paid on the loan is equal or greater than the prescribed rate set by the CRA. The prevailing interest rate is updated every quarter.
Putting Things Into Perspective
Suppose you recently borrowed $30,000 from the business and the company has a December 31 year-end. If you repay the loan by December 31 of the following year (i.e. one year after the end of the tax year of the lender in which the loan was made), you are not required to report the loan as income on your personal tax return. Also, be mindful that if you borrow a new loan to repay the original loan, the CRA may see this as a continuation of the original loan and you would still be required to report the $30,000 as additional income.
If you repay the loan within one year and successfully avoid the income inclusion, you may still be subject to tax under the deemed benefit rule if the interest paid is less than the CRA’s prescribed rate. For example, if you paid $100 interest to the business, you are required to include $500 of interest income as a deemed benefit ($30,000 x 2% = $600 – $100 = $500).
Alternative Ways to Reduce Shareholder Loan Balance
Besides direct repayment of the loan, the outstanding balance can be reduced via payment of salaries, bonus or dividends from the corporation to you. The payment must be paid or recorded in the company’s books before year-end to be used to offset against the outstanding balance. If you choose either one of the alternative solutions, there are important timing issues you need to consider. If the shareholder loan is settled against salary payment, income taxes and any applicable Employment Insurance (EI) premiums or Canada Pension Plan (CPP) contributions must be remitted to the CRA by the remittance due date. For most businesses, this is the 15th of the following month in which the salaries are paid. A corporation with a December 31 year-end would need to remit payroll tax by January 15. If a bonus is accrued, the business must pay the bonus within 180 days following the corporation’s year-end. In the case of dividend payment, T5 slips must be filed no later than the end of February of the following year.
With so many different variables to consider, the shareholder loan tax rule can be quite complicated. If you notice a shareholder loan amount on the company’s balance sheet, consult with your tax accountant to ensure both you and your business are fully compliant with the CRA.