Essential Facts about Shareholder Loans for Incorporated Small Business Owners

 There are three primary ways in which you, as an owner-manager, can  withdraw funds from your corporation.  You can pay yourself a salary, you  can declare a dividend or you can borrow money from the corporation.  When  you borrow money from your own corporation the Canada Revenue Agency  (CRA) has put into place strict rules as to when you have to repay the loan.    This is essentially to ensure that the owner-manager does not avoid paying taxes indefinitely. 

The basic rule for shareholders loans is that they must be paid in the fiscal year following the year in which the loan was taken.  For example, if your fiscal year end is December 31 and you borrow money in 2011, then it must be repaid before December 31, 2012.  Failure to repay will result in the loan amounts being included in the shareholder’s income in the year in which the loan was taken, which in this case would be 2011.  The loan must also not be considered to be a series of loans and repayments eg. Repaying an amount at the end of 2011 only to borrow again in early 2012. 

One of the more common ways to reduce or eliminate a shareholder loan is to convert it into a salary, bonus or dividend.  Since this gives rise to taxable income, it is not considered to be a series of loans and repayments. 

There are exceptions which allow shareholders’ to take out loans for longer periods:

 

  • Purchase of a dwelling (a house, condo, cottage, mobile home and even a houseboat J).  The dwelling does not have to be located in Canada nor does it have to be a principal residence as long as the shareholder dwells in it i.e. no rental property.  Repairs and improvements to an existing dwelling do not qualify for the exception.
  • Purchase of shares in the corporation
  • Purchase of a motor vehicle
  • Trade debts i.e. amounts sold by a corporation in the normal course of its business as long as it is on the same terms as other customers
  • Loans to spouses of employee-shareholders in certain cases
  • If the corporation is in the business of lending money eg.  A financial institution

 

Keep in mind that, with respect to loans made to shareholders for the above purposes, a taxable benefit may arise for the shareholder if market rates of interest are not charged on the loans. 

It is important for small business owners to understand that, although they may borrow funds from the corporation, they must repay these amounts  by the end of the following fiscal year either via a direct repayment or via salaries or dividends.  If not, the amount of the loan will be included in your income for the year in which the loan was taken, which can result in significant taxes payable as well as interest and penalties.

For more information see CRA Interpretation Bulletin IT-119R4

Ronika Khanna is a Montreal accountant who helps small businesses achieve their financial goals.  To receive regular updates of articles pertaining to small business, accounting, tax and other topics of interest to business owners you can sign up here.  You can also follow her on Facebook or Twitter.

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