- A shareholder loan is any fund that is borrowed from or contributed to a corporation by its shareholder
- Shareholder loans do not have to be repaid until the end of the subsequent (next) fiscal year
- When strategically planned, shareholder loans can provide strong opportunities for tax planning
- There are many advantages to shareholder loans including tax deferrals, income splitting, and employee incentives
As a shareholder of an incorporated business you should consider the possibility of issuing shareholder loans as a tool for tax planning purposes. A shareholder loan is an agreement to borrow funds from your corporation for a specific purpose. In essence, it’s a form of remuneration similar to salary and dividends where funds are withdrawn from the corporation without the source deductions.
In this article, we’ll go over what a shareholder loan is and some of the benefits that it can bring.
What is a Shareholder Loan?
A shareholder loan is an agreement to borrow or contribute funds to and from your corporation for a specific purpose. In general, the balance of your shareholder loan represents the total you have withdrawn from your company minus funds you have contributed.
Shareholder loans may be classified on a balance sheet as “Due to Shareholder” if you have contributed funds, or “Due from Shareholder” if you have withdrawn funds. Your shareholder loan will appear on the balance sheet as either an asset or liability. If you contributed more cash into your company vs. what you draw out, the shareholder loan will be a liability on the balance sheet. When your withdrawals exceed contributions, the shareholder loan will be an asset on the balance sheet, since the corporation has loaned more than it’s received. As a rule of thumb, you generally want to contribute more than withdraw as a shareholder.
What are some tax benefits of Shareholder Loans?
Shareholder loans can provide opportunities for tax planning purposes. If used correctly, the timing of cash draws, dividends or salary can be used to your advantage. When you take out a shareholder loan from the corporation, you are not required to report it as personal income on your personal tax return for that fiscal tax year. For example, if the year-end for the corporation is December 31, 2021 and you borrowed from the corporation in June of 2021, you have until December 31, 2022 to repay the shareholder loan.
A loan to a shareholder must be returned to the corporation by the end of the next fiscal year to ensure that the amount will not be taxed with penalties. This is primarily to prevent the abuse of shareholders loans; without this rule a taxpayer could repeatedly withdraw amounts as loans from his or her corporation without paying any tax on the transactions.
You must repay the loan within one fiscal year. In case, carry-forward high withdrawal balance (debit balance), CRA will include the full amount borrowed to your personal tax income and deny any deductions in the corporation through salary expenses with interest and penalties. The shareholder loan account should carefully be monitored through the year. Speak to FShad CPA Professional Corporation for further guidance and strategies to better manage the account.
A shareholder loan may also be granted to family members that are actively involved in the corporation to take advantage of the tax deductions for the year the loan is repaid. For example, if you issue a shareholder loan to a family member with a low-income, they would have one year to repay it at the prescribed rate. If it’s not paid within the year, it would be included in their income, and then deducted from their income in the year the loan is repaid. If done strategically, it would be repaid at a time that their income is higher in order to maximize the effect of the total tax deduction, thereby reducing the overall income tax paid.
Another unique advantage of a shareholder loan is that it can be paid out to employees of the corporation in order to acquire a vehicle or a home, as permitted by the Income Tax Act (ITA). This is a huge incentive for employees to work for a corporation, and serves as a great way to strengthen employee relations and loyalty by providing access to lower interest rates that wouldn’t be offered by other financial institutions.
A shareholder loan, if strategically used, can be very beneficial for you and your stakeholders, but to ensure compliance to the requirements of the CRA, the most important aspect of a shareholder loan is the documentation of any terms and conditions. Wherever required, it’s best to speak to an accountant to complete the agreement and execute a Shareholder Loan properly.
FShad CPA Professional Corporation can help you navigate the steps for drafting and finalizing your Shareholder Loan agreement, as well as provide consultations if you’re considering issuing one.
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FShad CPA Professional Corporation
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This publication is produced by FShad CPA Professional Corporation as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors. Your use of this document is at your own risk.