There is a misconception that when a shareholder borrows money from their corporation, the loan can remain outstanding indefinitely without any income tax consequences. This is generally not the case, unfortunately; however, there are various tax-efficient ways to repay or offset the loan.
What happens when I withdraw money from my corporation?
From a tax perspective, if a shareholder withdraws money from a corporation for personal use, the corporation is considered to have loaned those funds to the shareholder. Where there are bona fide terms of repayment, individuals who are employees of the corporation may be able to receive these loans without any adverse tax implications so long as the funds are used to either:a) Purchase a property to live in;
b) Acquire shares of the corporation from treasury; or
c) Purchase a vehicle for business use.
However, the position held by Canadian jurisprudence and the Canada Revenue Agency (“CRA”) is that where the individual is both an employee and a shareholder of the corporation, the assumption is that the loan was received by virtue of the individual’s shareholdings and the exceptions above do not apply.
Shareholder loans that are not repaid within one year after the end of the corporation’s taxation year must be included in the individual’s income and are subject to tax. For example, if a corporation has a December 31, 2021 year-end, any shareholder loan must be repaid by December 31, 2022, regardless of when the funds were withdrawn during 2021. The repayment can also not be withdrawn from the corporation immediately after, as it would likely be considered a series of loans and repayments and not a true repayment of the original loan. It should be noted that if an individual must take the amount of the unpaid loan into their income, any repayments made at a subsequent date will generate a personal tax deduction at that time.
In addition, the shareholder loan must carry a reasonable interest rate. Zero-rate interest loans or loans which carry interest at a rate below the CRA’s prescribed interest rate (currently five per cent) will result in a taxable benefit being included in the individual’s income for the period the loan is outstanding.
I’ve borrowed from my corporation and the one-year repayment date is approaching. What can I do?
There are a few ways a shareholder can avoid the full-income inclusion of an outstanding loan. The simplest manner would be to repay the loan before the end of the one-year. Often though, the individual has used these funds and they are no longer available for the repayment.
The shareholder loan can be offset by business expenses paid for personally by the individual. For example, if the individual purchased an asset that is used by the business of the corporation, maintained a home office, or had an automobile that they used for business purposes, any related expenses that have been paid for personally can be used to offset all or a portion of the outstanding shareholder loan.
Another option to avoid the adverse tax consequences of a shareholder loan may be to declare a salary or bonus to the individual sufficient to offset the outstanding loan. While the salary or bonus would be taxable to the individual, the corporation would be entitled to a corporate tax deduction for the amount. For the salary or bonus to have been considered paid by the end of the year for a corporation with a December 31 year-end, the related payroll source deductions must be remitted to the CRA no later than their due date.
Alternatively, the corporation could declare a dividend to the individual to offset the outstanding shareholder loan. The dividend would not be a taxable deduction to the corporation but the personal income tax rate on the dividend would be lower than the tax rate on a salary or bonus.
Finally, more creative tax planning could also be used to avoid the full income inclusion on an outstanding shareholder loan. For example, an asset (i.e., non-registered investment portfolio) could be transferred to the corporation. Assuming the investments have an accrued gain, the original cost of the investments could be used to offset the shareholder loan outstanding. More aggressive types of tax planning- including a “capital gains strip” - may also be available in certain circumstances to mitigate the consequences of a shareholder loan approaching the one-year repayment deadline.
Regardless of a taxpayer’s method of repaying a shareholder loan, careful attention must be given to ensuring that repayments are made in a timely manner, or the appropriate action is undertaken to avoid a full income inclusion.
This article has been prepared for the general information of our clients. Please note that this publication should not be considered a substitute for personalized advice related to your situation.
Updated on May 4, 2023 to reflect CRA’s current prescribed interest rate.
