If you are the shareholder of a corporation, the use of shareholder loans from your corporation can be an important tax saving or tax deferral device. However, the Canadian Income Tax Act contains many provisions relating to the tax treatment of shareholder loans which are designed to prevent their abuse by shareholders.
The general rule is that if a shareholder loan is repaid within one year after the end of the corporation’s taxation year in which the loan was made, and as long as the repayment amount was not a part of a series of transactions or loan repayments, then the loan is not included in the income of the borrower shareholder. If you don’t repay the loan within the one year after the year-end, then the full value of the loan is included in the income of the recipient back to the date of advance.
So what is a shareholder loan anyway? A shareholder loan for the purpose of tax treatment by the CRA represents any funds that you have received from the corporation (other than reported items such as salary or dividends). This includes taking cash from the company or purchasing personal items with company funds.
The tax problems occur when a company makes a loan to a shareholder over a period of more than a year. If, for example, you are a shareholder and you withdrew $50,000.00 from your company and didn’t pay it back for more than a year, the CRA would consider that loan to be income to the shareholder. However, the CRA does not allow the corporation to deduct that $50,000.00 like it could if it was paid as a salary. This results in double taxation on the $50,000.00.
In addition, if you didn’t pay interest at the prescribed rate or greater, then the value of the interest payments that you should have paid will be deemed to be a shareholder benefit and taxed as income in the year(s) during which the loan was outstanding. The payment of interest must be made no later than 30 days after the the end of the year. If the loan is repaid before the end of the year, any unpaid interest will still be a deemed a shareholder benefit if it is not paid within 30 days after the end of the year.
There are a few exemptions from the application of the taxation on shareholder loans but they are complicated and will require you to consult with a tax advisor. The easiest ways to avoid shareholder loan problems and the double taxation mentioned above are to repay the loan within the one year after the year-end, or take the money as salary or dividends.
Whatever you do, make sure you keep accurate records and that you properly structure and document the shareholder loan.