Section 15(2) – Shareholder Loans – How to Get Cash from Your Corporation Tax-Free

If you own an incorporated business, you likely know that you can withdraw funds out of your corporation by taking salary, dividends, or a shareholder loan.

Out of the three, shareholder loans are probably the most misunderstood and often misused by most shareholders. This can lead to an unintended tax consequence for which you may not be aware of.

Now, what is a shareholder loan?

You might know this as a “Due to Shareholder”, or “Due from Shareholder”. Or, simply it is you as a shareholder using your company’s bank account for your own needs. It is quite common for bookkeepers and accountants to record
transactions to a business owner’s shareholder loan without the owner realizing. That is why it is a good idea to learn when and how shareholder loans are used.

If as an owner withdraw cash out of your business and it is not a dividend or salary, it becomes a loan that you as an owner owe to your corporation. Generally, you need to repay the amount owing in the taxation year following the year
the loan was taken. This will also apply if someone you deal at non-arm’s length (ex: your spouse), uses that money for their own need.

If this amount is NOT repaid, a T1 adjustment must be made to include the income in the year it was withdrawn. Subsequently, CRA will reassess that tax year which can result in additional taxes and interest owing for
which you are unaware.

For example: Jack borrows $200,000 from his corporation JackCo on January 1, 2020 and the year-end for JackCo is December 31, 2020. In this case the entire loan amount must be repaid to JackCo by December 31, 2021. As
mentioned above if the amount is not repaid by December 31, 2021, it will be added to your personal income for the 2020 tax year.

Additionally, the shareholder must pay interest on the loan at the rate equal or greater that the prescribed interest rate set by the CRA. The interest payment must be made no later than 30 days after the end of the year. If you use this
loan to produce income, then the interest payment for you becomes tax deductible.

Since most loans shareholders take from their corporation is interest-free or low-interest, we will use the prescribed intertest rate set out by CRA for the example above. Using the prescribed interest rate of 1%, the interest amount will
be $2,000 ($200,000 x 1%). If this amount is not repaid by January 31, 2021, it will be added into your income for 2020.

Series of loans made to shareholders:

What if you received the loan from your corporation, repaid the full amount of the loan and then immediately after the repayment, you received a new loan. This strategy makes it sound like you have beaten the CRA and will not have to pay
any tax. Well, not so fast!

If you repay a loan and immediately borrow from your corporation after repayment, the CRA will consider this a series a loan and will essentially deem it to be the same loan. Therefore, you cannot use this strategy to avoid the tax.

Let’s discuss some exceptions and some tips on how to borrow money from your corporation the right way:

Money Lending Business

if the loan was made through a money lending business and the repayment terms are set, the amount does not need to be added to your income in the year it was withdrawn if it remains unpaid past the one-year period.

Employees who have more than 10% of shares:

The loan must be provided to purchase a home, newly issued shares in the business or a car for business purposes.
There must be an agreement in place for repayment in a reasonable time frame.
The loan must be given with respect to employment and not their shareholdings in the company.

Employees with less than 10% of shares:

There is no restriction on the purpose of the loan. However, it must still be provided with repayment terms and because of employment.

Tips:

Always repay the loan within one year of borrowing (this way you will avoid having it included in income)
If you cannot repay the loan, take a salary or dividend. Ensure that the proper T4 and T5 tax forms are filed on time.
Document the reason for the loan, and set out the repayment terms using a Directors Resolutions

As a business owner there are many options on how you want to extract money from your business. Whether its salary or dividends, contact us to find the best solution that keeps the most money in your pocket!