Understanding Shareholder Loans and Their Tax Implications in Canada
Shareholder loans are common practice in the world of business in Canada. Owners often make withdrawals from their company, both for legitimate business expenses but also for personal expenses like home repairs, dining out, or transportation. Some, however, may be caught off guard by the eventual tax implications if you fail to understand the rules and plan wisely.
How can you ensure these loans remain a good financial resource while reducing the tax burden? In this blog, we will unravel some misconceptions around shareholder loans and recommend some smart strategies to minimize end-of-year taxes.
What is a Shareholder Loan?
A shareholder loan is money given by a corporation to a shareholder, or to someone who is closely related to the shareholder. By the same token, a shareholder loan can also be money that is contributed to the corporation by a shareholder. In the latter case, when the corporation owes the shareholder money, there are usually no tax implications.
When money is given to a shareholder, however, there are tax implications that should be considered. If certain conditions are not met, the loan amount may become a taxable amount to the shareholder. This means the individual will have to pay tax on the full loan amount because CRA now considers it “income” to the shareholder.
Shareholder loans can serve as a practical solution for swiftly securing short-term financing, and offering advantages over conventional bank loans in terms of accessibility and flexibility. Shareholder loans not only streamline the borrowing process but also enhance the collaborative financial dynamics between the company and its shareholders.
Repayment of Shareholder Loans
The process of settling shareholder loans requires careful consideration. Paying back the loan directly to the company within a one-year timeframe is possible but be careful if money is withdrawn again: this could be considered a ‘series of loans and repayments’ which may have tax implications.
Alternatively, shareholders can opt to repay their shareholder loan through the use of dividends or bonuses. This method, distinct from a straightforward cash repayment, helps shareholders avoid falling into the potentially costly trap of a ‘series of loans and repayments’.
The emphasis with shareholder loans should be on managing cash flow and minimizing taxes through dividends, bonuses, timely loan repayment, and other strategies. This is where your accountant can advise you best.
Three important guidelines to follow:
- Properly document the shareholder loan: The terms of the loan, including the amount, interest rate, and repayment terms, should be clearly laid out in writing.
- Ensure interest is charged: The loan must bear interest at a rate that is at least equal to the CRA’s prescribed interest rate at the time the loan is made. The prescribed rate is set by the CRA on a quarterly basis and is currently at 6% for January 1, 2024 to March 31, 2024.
- Pay interest: Interest should be paid on the shareholder loan in accordance with the terms of the loan, as documented. This interest on the shareholder loan must be paid within 30 days after the end of the year. In the absence of this, the interest (6% as of first quarter of 2024) will be considered a ‘shareholder benefit’ and added to the shareholder’s income.
Shareholder Loans in a High-Interest Rate World
In years past, shareholder loans have been a great short-term financial resource for owners: a smart alternative to bank loans and lines of credit. After all, when interest rates were just 1%, a loan balance of $200,000 had minimal financial impact. Today the situation is different. The Canada Revenue Agency (CRA) prescribed interest rate stands at 6%. That means you will end up paying considerably higher interest on that shareholder loan come tax time.
The key to minimizing the tax impact is foresight. You’ll want to calculate your loan repayment obligations and the potential tax owing to avoid surprises at the end of the year. That’s why it’s essential to consult with your accountant and engage in thoughtful planning when dealing with shareholder loans.
Shareholder Benefits: what’s taxable and what’s not
Shareholder benefits come in various forms, and it is crucial to recognize them to ensure compliance with the tax act.
Any shareholder loan not repaid – as well as any benefit conferred on a shareholder – must be reported on the shareholder’s personal tax return.
Some common shareholder benefits include:
- Car allowance: If a corporation pays for a car used by a shareholder, there may be a taxable benefit. Even if the vehicle is used primarily for business purposes, the portion used for personal matters must be reported as a taxable benefit on the shareholder’s personal tax return.
- Housing and lodging: If a corporation owns a property, such as a cottage, and a shareholder uses it for personal purposes, it results in a taxable benefit. Renting out the property to others while occasionally using it personally can also trigger this tax liability.
- Travel expenses: Travel costs for business are generally deductible, including costs associated with business meetings, conventions, trade shows, etc. If, however, a spouse or family member accompanies the shareholder on a business trip, only the business portion of the expense may be deducted in the company.
Shareholder Loan Strategies to Reduce Tax Liabilities
To help manage cash flow and avoid unexpected tax liabilities, it is recommended to take a proactive approach. Here are two strategies to consider:
- Utilize Capital Dividend Accounts: The Capital Dividend Account (CDA) can be a valuable tool for shareholders to reduce their overall tax burden. By issuing tax-free dividends you can balance money taken out of the corporation, thereby reducing your tax impact. It would be important to contact your accountant to identify if there is a capital dividend account in which to draw tax free money from the corporation.
- Transfer Personal Assets into the Corporation: In some instances, shareholders can opt to transfer personal assets to the company to offset their shareholder loan(s). Be sure to consult your accountant on whether this may be possible in your scenario.
Some final advice
When it comes to shareholder loans, the most important thing is to plan wisely for the tax implications. Decide ahead of time whether these loans will be repaid using personal funds or assets, or through employing a strategy using dividends or bonuses to minimize the tax burden.
Shareholder loans can be a valuable resource for business owners in Canada, but they come with various tax implications that must not be overlooked. It is crucial to understand when a shareholder loan becomes a benefit and how to address the associated tax liabilities. With thoughtful planning and the assistance of a knowledgeable accountant, you can navigate the complexities of shareholder loans and minimize your tax burden while making the most of your business resources.