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Shareholder loan taxation

Shareholder Loan Tax Treatment in Canada

Shareholders of a company can withdraw money from a corporation through various methods including salary, dividends, management fees, and shareholder loans. The intention of this guide is to provide a detailed description of shareholder loans in simple layman terms.

What Is a Shareholder Loan?

Each option to withdraw money from a corporation has specific benefits and tax implications. It’s important to understand each of these to determine if taking a shareholder loan is the right option for you.

The Canadian Income Tax Act lays out the guidelines for these shareholder loans in Subsection 15(2). Shareholder loans allow shareholders to extract funds from a corporation with the intention that they will be paid back later. This is a much different approach from the other withdrawal methods such as salary and dividend payments which do not require repayment.

Who is Eligible for a Shareholder Loan?

According to Section 15(2), the following entities are eligible to withdraw money from a corporation if they meet the following criteria:

  • Shareholders of a particular corporation – Includes individuals or partnerships that own shares of the corporation. Corporation residents in Canada and partnerships made up entirely of corporation residents in Canada are excluded.
  • Connected with a shareholder of a particular corporation – This includes people who are connected to the shareholder such as a spouse or other family member. Section 15(2.1) specifically excludes foreign affiliates of the corporation.
  • Member of a partnership, or a beneficiary of a trust, that is a shareholder of a particular corporation – While entire partnerships or trusts can request a shareholder loan, individual members or beneficiaries of those partnerships or trusts can also take out a shareholder loan.

Tax Implications of Shareholder Loans

Like any withdraw or distribution from a business, it is imperative that consider the tax implications of this decision. The most advantageous feature of a shareholder loan is that the loan recipient can borrow the money tax-free for a short period.

This tax-free period outlined in Subsection 15(2.6) is based on each corporation’s fiscal calendar. A loan taken during a fiscal year must be repaid before the end of the following fiscal year. The portion of the loan that is not repaid by this deadline will be included in the loan recipient’s income and taxed accordingly.

For example, Mark is a shareholder of a Canadian corporation and decides to take a loan of $10,000. The company’s fiscal year runs from April to March. Mark takes the loan in August of 2020. This means that he has until the end of the following fiscal year (March of 2022) to repay the loan. In this scenario, there are three common potential outcomes:

  1. Full Repayment – If Mark fully repays the loan before the deadline, nothing is added to his taxable income.
  2. Partial Repayment – If Mark pays back $8,000 of the loan before the deadline, the remaining $2,000 is added to his income and taxed accordingly.
  3. Failure to Repay – If Mark doesn’t repay the loan at all, the full $10,000 is added to his taxable income.

While this is a simple and straightforward example, there can be very complex tax implications depending on each individual’s situation and income levels. It is highly recommended that you consult with a tax professional or tax attorney before making any financial decisions related to shareholder loans.

Exemptions From Income Inclusion for Shareholder Loans

Many exemptions are built into Subsection 15(2) that would allow people the ability to avoid having to claim the loans as income at all. These exemptions include:

Employee shareholders – Subsection 15(2.4a) states that shareholders who are employees of the company can take a loan for any reason and the loan amount will not be added to the employee’s taxable income. Employee shareholders are no longer eligible for this exemption if they own 10% or more of the company’s issued stocks (called “specified employees” in the Income Tax Act).

Purchase of a dwelling – Subsection 15(2.4b) allows for employee shareholders or spouse or common-law partner to take a loan to purchase a dwelling or stock in a cooperative housing corporation acquired for the sole purpose of rights to inhabiting one of the company-owned dwellings.

Stock purchase – Subsection 15(2.4c) allows employees to use the loan to purchase additional stock in the company or other related corporation.

Vehicle purchase – Subsection 15(2.4d) states that the loan can be used to purchase a vehicle for use in performing duties as an employee of the corporation.

Future Tax Benefits for Shareholder Loans

While the ability to borrow money tax-free is one of the key benefits, shareholder loans can also be used to reap other tax benefits if leveraged strategically. After a past due loan is added to your income, any future payments will reduce your taxable income during that year. If you expect to have an increase in taxes in the future, you can choose to pay back the loan at a later date and reduce your tax liability at a higher rate.

For example, Mike’s son goes to university and elects to take a shareholder loan to cover living expenses. Since he is a student, he only has limited income from part-time jobs. He could choose to not repay the loan and pay the tax while his marginal tax rate is low. Mike’s son could then pay off the loan several years later after he has graduated and secured a better paying job. Since the loan payments are tax-deductible, the tax savings would be higher than the original tax amount paid.

Need Help From an Expert?

If you’re thinking about taking out a shareholder loan, let one of the experts at Valley Business Centre help. For over 30 years, our team has been providing comprehensive bookkeeping, payroll and tax services to our clients in Whistler, Squamish, the Sea to Sky Corridor, and metro Vancouver BC areas. We’ll give you the peace of mind you need to make confident financial decisions.

Disclaimer

This article is written for informational purposes only. It is current at the date of posting and changes to laws and regulation may result in the information becoming outdated. It is not intended to provide legal, tax, or financial advice. It is recommended that readers get advice from a tax professional before making any financial decisions.

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