Have you ever used a business credit card to pay for an expense in which a portion relates to personal use? Have you taken a loan out of your company to cover short-term cash needs such as buying a house or a car? If these scenarios sound familiar to you, you may be at risk of violating the shareholder loan rules under s.15(2) of the Income Tax Act.
Shareholder Loan Rule
Generally, when a shareholder takes a loan out of the corporation and does not repay it within a year, the loan will be included as income on 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 The "loan" here may not necessarily be cash withdrawn from the corporation.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 in the form of a payment made by the corporation on your behalf. Under the current tax rules, funds withdrawn from the corporation as a loan are not taxable in the hands of the shareholder.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 incurring adverse tax consequences. To prevent this, the Canada Revenue Agency (CRA) imposed a rule to treat the loan as a benefit to the shareholder and tax the amount 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 rule, a corporate loan made to a shareholder would cause a deemed benefit to be received by the shareholder under s.80.4(2) of the Income Tax Act unless the interest paid on the loan is equal or greater than the prescribed rate set by the CRA. The prevailing interest rate is 1% and is updated every quarter.
Putting Things Into Perspective
Suppose you borrowed $30,000 from the corporation on September 1, 2017. The corporation has a December 31 year-end. If you repay the loan by December 31, 2018 (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 an income on your personal tax return. However, if you borrow a new loan to repay the original loan, the CRA sees this as a continuation of the original loan and you would be required to report an additional income of $30,000.
If you repay the loan within one year and successfully avoid the income inclusion of $30,000, 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 corporation, you are required to include $200 of interest income as a deemed benefit ($30,000 x 1% = $300 – $100 = $200).
Alternative Ways to Clear Shareholder Loan Balance
Besides direct repayment of the loan, the balance of your shareholder loan can be cleared by payment of salaries, bonus or dividends from the corporation to you. The payment must be paid or recorded in the books of the company 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 by the company sin accordance with the appropriate remittance period. For a regular remitter, this is the 15th of the following month in which the salaries are paid. A corporation with December 31 year-end would need to remit payroll tax by January 15. If payment of bonus is to be made, the corporation must pay the bonus to you 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 the year.
The rules surrounding shareholder loan are complex, and professional advice is recommended when withdrawing funds from the corporation. It is critical to monitor the shareholder loan balance continuously to avoid any adverse tax consequences.