Shareholder Loans with Corporations
06 Aug 2019
Kasim Tanvir, Accounting Associate
Olivia Fei, Tax Associate
Shareholders often advance or withdraw funds from a corporation. For accounting and tax purposes, this transaction gives rise to a shareholder loan account on the company books. A transaction whereby a shareholder advances funds to provide capital for the business is routine. However, shareholders should be wary when withdrawing funds, and those withdrawals exceed the original amounts advanced to the corporation.
In this situation, unless the funds are taken out as salary or dividends, the shareholder now owes money to the corporation.
Owners may "borrow" money from their corporation in order to avoid personal tax on the funds withdrawn. To prevent this from occurring, the government has introduced a series of complex shareholder loan tax rules.
In general, if a shareholder loan balance has been outstanding for more than two consecutive fiscal years of the corporation, including the year in which the funds are originally withdrawn, the amount outstanding will be taxed to the individual borrower as ordinary income in the year that such funds were withdrawn. the shareholder would not only be liable for the personal income tax on the amount withdrawn, but also interest if the tax was not paid for the year of withdrawal. On the other hand, the corporation cannot deduct the amount to reduce corporate taxes, creating a double tax situation.
To mitigate any double taxation, the shareholder may eventually deduct any repayment of the borrowed funds on their personal tax return. However, this does not necessarily mean the shareholder will recover all of the tax originally paid.
For example, the shareholder may have been subject to a 53% income tax rate at the time the funds were borrowed, and a 20% income tax rate at the time the funds were repaid. In this case, the tax payment is at 53% rate, whereas the tax recovery is only at a 20% rate. Therefore, 33% of the income tax paid would not be recovered.
Another drawback to borrowing from a corporation is that the shareholder could be subject to an imputed interest benefit, if the loan is interest-free or at a rate lower than the Canada Revenue Agency prescribed interest rate (2% in 2019).
The shareholder loan rules are also applicable to any person that is related to the shareholder who borrows funds from the corporation, this would include a spouse or child of the shareholder, even if they do not own any shares in the corporation.
It is important to note that the new Tax on Split Income ("TOSI") rules are also applicable to shareholder loans. Therefore, shareholder loan income splitting strategies are generally no longer available.
Borrowing funds from a corporation is still an option to overcome short-term cash flow needs. However, in order to avoid any negative income tax consequences, it is ideal to repay the loan in full within one year from the corporation's fiscal year-end date in which the funds were taken. another option is to declare a dividend to clear out any outstanding shareholder loan balance. In any event, it is always recommended to consult with your tax advisor in order to identify the best options based on your specific situation.