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.
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.
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