A visitor to Canadian Tax Resource recently asked the following question:
“Is it allowable to issue an interest free loan to a director of a corporation by the corporation for the purpose of the director purchasing a residence or using it to pay down a residential mortgage?”
A corporation may from time to time advance funds to a shareholder or members of the shareholders family in the form of a loan or indebtedness. The Income Tax Act contains rules that may have income tax consequences for the person receiving the loan. In the context of this article, the term loan means any form of debt the shareholder or family member has to the corporation. The term shareholder should be taken to mean the shareholder of the corporation or members of the shareholders family.
General Tax Rule For Shareholder Loans
The general rule is that when a corporation advances a loan to shareholder, the full value of the loan is included in the shareholders income in the year the loan was made. Now keep in mind that there is an anti-avoidance provision that prevents establishing loans through related corporations. For example:
John Smith owns 100% of ABC Corp. and ABC Corp. in turns owns 51% of EFG Corp. If EFG Corp. lends John funds, the value of the loan may be included in Johns’ income for tax purposes.
These rules apply even if the corporations are not residents of Canada.
3 Exceptions To The Shareholder Loan Rules
There are three general exceptions to shareholder loan provisions under the income Tax Act.
1. One Year Rule – If the loan is repaid by the shareholder within the year following the end of the corporations’ tax year, the loan is not included in income.
However, the loan cannot be a series of loans and repayments. On the other hand, if a current loan account is maintained in the corporation for a shareholder during a tax year and the year-end balance is repaid from salary or declared dividends the CRA will generally not consider these transactions as a series of loans or repayments.
2. The LendersRule - If the corporations’ business is lending money or the debt is from the normal business activities then the loan is not considered a shareholder loan, provided standard arrangements are made for repayment are made and maintained.
3. Principal Residence Rule - If the shareholder is also an employee and a loan is advanced to purchase a principal residence, new shares in the corporation, or a vehicle to be used for business purposes then the loan is not considered income. In addition, the loan must be advanced due to employment and not due to shares held and standard arrangements are made for repayment are made and maintained.
Repaying A Shareholder Loan
When the loan is repaid that was previously included in income for tax purposes, it may be deducted from income of the year of payment.
If you are a small business owner and are considering shareholder loans or are concerned about the tax implications of certain transactions you may have with your corporation, you should consult with a tax professional. The information in this article is for general use only and should not be considered advice or a recommendation.
Summary
In addressing the readers question, it would appear that if the corporation advanced a loan for the purposes of purchasing a residence for personal use and bona fide repayment arrangements were made and adhered to, the loan would not have income tax consequences.
What Accounting Software Do You Use?
If you are looking for an easy to use bookkeeping software package to help keep track of money coming in and going out, you should try QuickBooks Canada now. QuickBooks helps you quickly easily keep track of your business. Compare QuickBooks Canada Software. Click Here to Start.
Did you find what you were looking for? If not, consider searching our site. Otherwise please feel free to ask a question by leaving a comment below.
If you post a question or make a comment below, please ensure your question is on the topic of shareholder loans.
Related Articles
- Who Is Required to Pay Canadian Income Taxes?
- No Income No Tax Return?
- Deductions From Employment Income
{ 84 comments… read them below or add one }
Thank you very much for your prompt and informative response. Could I impoose on you to provide me the section of the Income Tax Act or Interpretation Bulletin, etc that would apply to this subject.
The relevant sections of the Income Tax Act is section 15. The interpretation bulletins are IT-119R4 Debts of Shareholders and Certain Persons Connected with Shareholders and IT-421R2 Benefits to individuals, corporations and shareholders from loans or debt. You can access these bulletins from the CRA website at http://www.cra-arc.gc.ca/menu/ITSC-e.html.
Is a shareholders loan considered to be a situation where the shareholder lends the company money, or is it a situation where the company lends money to the shareholder/director?
Shareholder loans are situations where the company lends funds to the shareholder. Typically small corporations will lend funds to their shareholders and if not structured correctly, these loans can be included in the shareholders income and taxed.
I’ve lent my corporation money from a personal LOC. My accountant has booked the repayments from my corporation as a shareholder’s loan.Now I have to claim it as income when really it is just repayment of a loan. Is this correct? Would this be considered as normal business activity?
how to account the shareholders loans written back in accounting? is it of a capital nature?
please advise me?
Hello,
I’m not sure its clear what you are asking. This site is about Canadian income tax.
If this concerns a Canadian corporation, the loan to the sharholder is a balance sheet entry.
@ Caragh:
The shareholder loan rules are designed to address situations where a corporation lends money “to” it’s shareholders.
In your case, you have “lent” money to your corporation. This type of arrangement is not income but rather a way you invest in the business.
I am self employed and pay myself dividends as income.
I am purchasing an investment property under my personal name.
I would like to use the shareholder loan vehicle to put the down payment on my investment property. Or would it be better to pay myself a dividend (which I would then pay tax on). Is there a way to do a loan and then pay back the company within a year?
Can you suggest an appropriate approach to avoid as much income tax as possible?
Thank you!
@ Paul:
A shareholder’s loan is not a investment funding mechanism, but rather a set of anti-avoidance rules designed to keep small business owners from taking money out of their business in the form of “loans” and avoid paying tax.
If you are buying a principal residence and are an also employee of your corporation you may be able to borrow to buy a principal residence. Be aware that you may also need to extend this privilege to other employees of your company.
The best advice I can give on this matter is to discuss your plans with your accountant.
Are these shareholder loans interest free?
Thanks!
The company lends you money and 100% of the loan is taxed in your hands as income. The rate of interest is irrelevant in this case.
If the loan is for under points 2 and 3, the minimum interest will be deemed to be at the prescribed rate.
What about point #1 (One Year Rule), where shareholder loan is payed back within 1 year?
I understand that this loan (if payed back within one year) is not included in income. What about the interest on the shareholder loan – does this need to be reported as shareholder (loan recipient) personal income?
The interest, if equal or greater than the prescribed rate would not have any tax issues for the shareholder. Under the prescribed rate would be a taxable benefit.
I’ve lent my corporation money from my personal savings. The corporation is making monthly repayments to me. Do I have to claim this as income? Also does the corp claim this as income and then as expense?
Could you point me to a link on the CRA website.
Thank You
@ Manny
Only the interest you receive is income. Otherwise the infomration in this article does not apply in your case.
Our mother has loan my brother funds for his company, which is set up as a shareholders loan. I nor my mother are shareholders in this company. I am wondering how my brother will go about paying her back. It was quite a large some of money. Also he had the check may out to the company and not his name. Why would he do this? To protect himself or our mother?
The loan on his company was for 3 years. Will our mother have to wait that long to receive her money?
@ Mary:
The article above deals with the situation where a company lends a shareholder money. This scenario is not a shareholders loan but rather your mother appears to be creditor of the company.
As a creditor she is entitled to a share of the assets of the company if the company defaults on the loan. She should speak to a lawyer to understand the implications of her investment.
Let’s say you borrow money from your corporation in 2008. You have until the end of 2009 to pay it back without including it in income correct? If you do not pay it back by the end of ’08, it would have to be included in income. Would the amount be included in your 2008 income and you would be reassessed? Or would it simply be included your 2009 income even though the loan was made in 08?
@ Jim:
The rule is that the repayment must occur in the year following the corporations’ year-end to avoid an income inclusion.
Assume the corporations’ year end is June 30th and the corporation extended a loan to you on July 2, 2008.
The corporations’ tax year is July 1, 2008 through June 30, 2009. You must repay the loan no later than June 30, 2010 to avoid being taxed.
If the loan is not paid by this time, then it is included in your 2008 income and you must file an amended return.
Can my corporation of which I am a shareholder advance me a loan (which is secured by a mortgage on ordinary commercial terms) to purchase a vacation property, without the loan being included in my income?
I’ve read this is possible, but I am not sure if it applies only to principal residences, or can also be used for vacation properties.
@ Andrew – Yes you can use a loan from the corporation to buy a home, but to avoid the loan being included in income, it must be used to buy a principal residence.
What happens to outstanding shareholder loans if the corporation “goes under”?
@ Casper:
Unless the loan is repaid, it is ultimately included in the shareholders income. The loan is a note receivable that is either collected or converted to an expense.
Who would collect on a shareholder loan if a company goes under?
I’m sorry if the above question is off topic but, can you direct me to a forum where I might find the answer?
@ Casper – If the company “goes under” it becomes insolvent. Either it gets court protection from its own creditors or it is wound up. In either case the loan to the shareholder would become due under its original terms. The liquidator or administrator would be responsible for collections and would use the funds to satisfy the company’s creditors.
I’m not sure why a shareholder would pay back the loan. The choice is payback the full amount to the company to pay its creditors or keep the proceeds and have it taxed in the shareholders hands.
If a corporation gets a bank loan and lends it to the shareholder (s/h) to buy a principal residence, is the interest paid to the bank deductible?
Does the s/h have to make monthly payments to his corporation for this loan? If so, interest only or both principal & interest? If not can the s/h just include a taxable benefit for the interest?
Does housing loan need to be for max. of 5 years at CRA’s prescribed rate for s/h loans?
Thank you,
@Dominic: Possibly. In order to deduct interest expense, the funds borrowed must be for the purposes of gaining or producing income. The corporation would extend the loan to the individual and claim the interest as income. So the corporation would incur a deductible expense.
1 more Q – If the company has $50,000 in the bank, and borrows $200,000 on the building it owns, which is mortgage free, and the shareholder loans to the company $250,000 from money he gets from a line of credit on a rental property that he owns………Then the company would have $500,000 of available cash.
Can the s/h take this $500,000 amount as a s/h loan to buy a principal residence? The principal residence will cost more than $500,000.
Also, would the s/h now have a separate s/h loan of $500,000 for his house and also would his corporation owe him a separate amount of $200,000, which he loaned it and thus, he can take it out tax-free whenever he wants.
Thanks again. Your previous answers were great.
@Dominic: It seems like a lot of work with little real benefit. Your accountant will certainly earn his keep in the process and I question if there is any tangible benefit.
Why would you lend the company money only to turn around and lend it back to yourself? If it there is any benefit, I would suspect it may be denied under the general anti-avoidance rules.
I have a shareholder loan from 2008. My accountant suggested that I pay it back personally for a week and then take another loan. Wouldn’t this be considered a series of loan and repayments. If the CRA discovered this. What would be the consequences. Would I have to include the loan in my the 2008 income or would there be deemed an interest benefit.
@John – Not necessarily. Paying out a loan and taking another does not necessarily mean a series of back to back loans. A series is generally restricted to repayment of a loan before the end of the year and the same (or substantially the same) amount is borrowed again shortly after the end of the year.
If the loans can be reasonably be considered to have been repaid from salary, bonus or dividends received, then the repayments are not considered a series. Typically, the repayments are applied to the oldest loans first.
Take a look at paragraphs 28 and 29 of this CRA document.
I incorporated my business June 2007 and have one customer. I am an IT business analyst, paid through my corporation and have been using the money from my corporation for personal use. I have not filed my corporate and personal taxes for 2007, 2008 and 2009. I have however sent instalments to Revenue Canada because I collect GST — they have given me until March 31 to file my 2007 GST/HST return — I don’t have a problem with this.
To file income tax returns (personal & corporate) I have to choose a method of payment. After reading your article, thank you, dividend & salary method are out because of the government penalties for filing T5 and remitting payroll late. Am I correct in my assumption? Filling a T5 for 2007 and 2008 will cost me $5,000 not to mention that I will also have to pay a penalty for 2009.
So my only option is to categorize that money I have been taking from the corporation from 2007 as a loan. I have 100% ownership of the company and the sole director. Please advice, I am desperate and really stressed over this. I am a procrastinator, and it has cost me greatly throughout my lifetime.
Thanks in advance.
Emilly
@Emily: It never pays to procrastinate with the CRA! From a purely business perspective, it always makes sense to take advantage of discounts and freebies and to avoid interest and penalties unless they will generate you revenue.
Your situation is that you have used funds from the corporation and face a dilemma: Claim the funds as dividends and the corporation pays a penalty for late filing a T5 or claim the funds as salary and pay a penalty for late filing payroll.
The shareholder loan may provide some reprieve but these ultimately must either be repaid fully (and not be a series of back-to-back loans) or be included in your income. If there is a balance in the loan account after one year, then it must be included in your income.
I would strongly urge you to hire someone to look at this and make the filings for you. The cost will save you many headaches and avoided other surprises (you need to be carefuly if you have a corporation).
I have a dilemma on my hands here. I recently filed my husband’s 2007 taxes (he and his ex split in 2007) and together with her he owned a business. In 2007 he received payments from her towards his buy out of the outstanding shareholder loan he made to the company. In 2008 he received the balance payment as well as compensation for lost income over the next several years. The company’s accountant issued a T5 dividends payment statement for 2008, including all of the payments in one lump sum. Of course this creates a huge issue for 2008 taxes. I didn’t include the payment he received in 2007 on his income tax, because they were included in the 2008 T5. Now Revenue Canada has chosen his 2007 return for an arbitrary ‘audit’, which isn’t an issue since I have all of the supporting documents. However I am concerned about the 2008 T5 and how to actually deal with it, since the funds received were used to start a business outside of Canada.
I’m not certain I fully understand the events. Your husband and his ex owned a business. Your husband had loaned the company money. Therefore, the company owed your husband money?
You stated she paid him out for the loan. The repayment is not taxable.
Dividends can only be paid to shareholders, so the T5 should reflect actual or deemed dividends from the company (not the ex).
If the ex bought his shares, there would be a capital gain or loss on disposition. If the company redeemed the shares it would be a deemed dividend.
I hope this helps.
do you do telephone consultations
I do not do telephone consulations but am happy to address question either via the comments (open forum) or via the contact form (above).
Hi
This has been partially covered above, but I think not fully.
I am a incorporated medical professional in Ontario.
Can my professional corporation loan me money, with interest (a bit above CRA set rate so that the corporation is at an advantage), to purchase a new principal residence (we are looking to move)?
My corporate accountant says now, a colleague’s of mine says yes. Do you want to be the tiebreaker?
I have a significant amount of capital saved in my corporation, and figure it would be a good way to access the cash and in the end pay interest to myself not a bank.
Hi Danny,
You can use a shareholder loan to acquire a principal residence. You may want to ask your accountant his/her reasons why. There may be an extenuating circumstance. Although, I can’t think what it might be.
thanks for quick reply
so my corporation can loan 200K to me at the current CRA set interest rate (something like 1.6%) and I can set up a repayment schedule over the next 5 years?
must say – it seems a bit too good to be true, but in essence a pretty good deal for the corporation given the current investment interest rates out there
D
Hello Danny,
Generally, the value of a loan to a shareholder is taxable in the shareholder’s hands as income. However, if a loan is made to the shareholder to purchase a residence then the loan is not taxable. There are some rules that must be adhered to: First, the loan must be extended because he is an “employee” of the company (not a shareholder) – ITA 15(2.4)(e). Second, bona fide arrangements must be made to repay the loan (i.e. a repayment schedule).
The first requirement may be the sticking point: You may need to demonstrate or be prepared to make available similar loans to employee’s of you practice. This is really a personal business decision you must make, but it is doable depending on how many arms-length employees you have.
Further, as long as the loan is at the CRA prescribed rate or at market rates, then there is no taxable benefit.
I hope this helps clarify the situation a little better.
Thanks Tax Guy.
Yes my husband loaned the company money, he re-mortgaged his house to purchase the company. When he and his ex split, the company repaid him his investment, (set up in their books as a shareholder loan) and paid him what amounts to a severance package, for lost future income over the following few years. They had set up a payment schedule for the ‘buy out’, part of the payments were made in the later half of 2007, and the balance in the spring of 2008. In Jan 2009 the company issued a T5 for the full amount paid to him as a dividends payment.
He has taken those funds and set up a new business as a US based corporation, because he intends to move out of the country.
Would our best bet in this case be to claim the LCGE on the amount, or use the new business and claim the funds spent as business star-up costs?
AGB:
The repayment of the loan is not taxable so I assume the company is redeeming its shares, which results in a deemed dividend and generates a T5.
To use the LCGE, his ex would need to buy his shares and certain other conditions must be met: Cash & non-active assets less than 10% at the time of sale, that he held the shares in the 2 years preceding the sale and at least 50% of the assets were employed in an active business in Canada in the two years preceding the sale. Otherwise it’s not available.
Thank you,
He meets all of the mentioned qualifications. He and his ex purchased the company (a franchise of a Real estate company) in 2005. The purchase of the company from him, entailed purchasing his interest in the company. Of course more than 50% of the assets purchased were used actively in the business.
The T5 issued (for 2008) is for the entire amount of the buy out, agreed upon price and includes his repayment of his portion of the shareholder loan (actually partially repaid in 2007)he made to the company, as well as deemed lost income potential for the next three years, and his exiting clients.
In this instance I would think that the best course would be to claim the LCGE. The income was not claimed in 2007 (due to circumstances I filed his 07 return in Feb of this year, and knew that the T5 included the total sum of everything paid in 2007 and 2008. Now I am not sure of the year end of the company, or if this would be a factor.
Hello AGB:
If a T5 was issued, there is no way to claim the LCGE. The T5 reports dividends received from a corporation including deemed dividends. If the payment was, as you say, a buy out and repayment of a loan (debt), then the accountant for the company needs to make adjustments to the T5 and report the transactions appropriately.
I would strongly suggest you hire someone to file and amend these tax returns. They can work with the company’s accountant to ensure the appropriate filings are complete.
Thank you for your help. I will pass this all onto an accountant. Revenue Canada is at the moment reviewing his 2007 tax return.
thanks Tax Guy
I think my issue needs further clarification
I am medical professional (ie. an MD providing medical service) that is incorporated.
I have no arm’s length employees (my only employee is my wife who manages the books).
After discussing shareholder loans with a few people (including my corporate accountant who has >100 physician clients), I would have to prove that such a loan was made in my capacity as an employee and not as a shareholder – and with no arm’s length employees this is essentially not possible.
I also find it odd that none of the documentation regarding advantages of becoming incorporated as a medical professional includes shareholder loans for the purchase of a residence.
I assume it may be that this has just not been challenged yet, and the CRA’s position is a matter of interpretation. Perhaps a tax lawyer’s opinion would help?
D
Hello Danny,
Despite the requirement to demonstrate that the loans would be extended to other employees, your situation is common in that you are the only real employee. There is some evidence to suggest that the CRA would look to other medical practices to see if loans have been extended.
Given the grey area, I would suggest obtaining an Advance Tax Ruling (ATR) from the CRA. The ATR is a letter from the CRA confirming their position on the proposed trnasaction.
Hi Tax Guy
Is there any way that a shareholder loan can be made to for something other than a house? I don’t get why this is limited to a principal residence.
Like many others I’d like to borrow from my company and pay the loan back at a reasonable interest rate (T-bill rate). This is so much more attactive than paying interest to a bank for a loan, or adding $100k to my salary and then paying the taxes on that.
Thanks in advance,
Howard
Howard,
Loans to shareholders are easily used to avoid paying dividend or a salary. If you are considering borrowing from your corporation, it is advisable to work closely with your accountant.
Thanks for the reply and the warning Tax Guy.
I’m not looking to avoid paying taxes as such. I am trying to build up the money in my company as I may need to have that money there for future business purposes. I also don’t want to pay myself a large salary.
I would like to know if there is a way to set this so that I can borrow the money, and pay it back just like a regular loan over 3-5 years.
cheers,
Howard
Hello Howard:
Probably not. The only exceptions to the income inclusion rules are for the acquisition of a residence, purchasing new shares of the corporation, or for an automobile used to perform duties. It is possible to extend general loans if that is the business of the company (i.e. you have a lending company).
I am a newbie-If I was taxed by the government for a shareholder loan that I received and I do not repay it, would that then be recorded in an expense account as wages or bonuses or equity or how do I record it in the company records?
Hello Carina,
You would initially record the loan as an asset (dr. Loans to Shareholders). When it is no longer a loan and payable, you cr. Loans to Shareholders and Dr. Salary Expense (or something similar).
I own a Corporation which I am sole owner. I have just agreed to owner finance a purchase of my business. I have invested my own personal money into the business that was not repayed. Is there a way, that I can take this money on a monthly agreement and not be taxed? Somebody told me that I need to have a NOTE for my CORPORATION to give me the income personally. Do you know what they are referring to?
The amount you invested in the business is a capital investment. When you sell the business, I presume it would be for more than what you paid for it and the difference is profit. Therefore, you get your investment back, plus your profit. The profit is a capital gain and is taxable when realized.
If you are financing the purchase, you may be able to spread the capital gain over 5 years.
Essentially to self-finance the sale, you personally transfer the corporation to the new owner and take a note back that specifies terms of payment.
In a guide I found on how to use GnuCash to run a small business, the writer’s company pays him shareholder loans throughout the year, and then he repays the loans using a dividend payment at the business year end. Is this a valid practice? The guide is here, it may describe things in better detail:
http://www.linas.org/mirrors/www.aerospacesoftware.com/2003.06.21/GNU_Cash_for_Business_users_Howto_Guide.html
Hi Bryan,
In a nutshell, yes. You can draw funds from the corporation using shareholder loans and provided you clear them before with a dividend payment, then you avoid full taxation on the loan.
You should have your books set up by a professional and receive some coaching.
Bryan,
If you would like some help, please feel free to contact me.
Hi Tax Guy,
Looking for advice on this topic:
1) I, my wife, and daughter are all shareholders in my company, but I am the only employee
2) My wife is being extended a $200k promissory-note backed loan from the company in order that she can provide a $250k mortgage to our daughter to buy a condo (balance of mortgage funded from wife’s personal savings).
3) daughter is buying a $300k condo ($250k mortgage plus $50k down payment from her savings)
4) Wife will pay the company annually the CRA quarterly prescribed rate interest rate, plus 10% of the prinicple loan amount in each of the next ten years
5) daughter pays wife the mortgage payments on a pre-set payment schedule (mortgage interest will also be at CRA quarterly prescribed rate interest rate)
6) company will claim interest payments from loan to wife as interest income
7) wife will claim difference between interest received from daughter and interest paid to company as interest income.
Can you identify any obvious downsides to this strategy?
Thanks
The loan to your wife may be deemed a shareholder loan and included in income. I would suggest you get an official opinion from your accountant before attempting this transaction.
Hi Tax Guy
I just wanted to follow-up on the issue of a professional corporation with a sole employee taking out a shareholder loan.
I spoke with the CRA tax rulings director about this issue. According to him, the CRA has no official stance. There appears to have been no rulings for or against a sole employee (who is also the director and shareholder) taking a shareholder loan. He stated that he thought it was not ‘on their radar’. He did acknowledge that it was a very ‘gray’ issue, and if someone was audited they would have to prove that the loan was given to the person as an employee, not a shareholder. He thought that for a medical professional, this would be relatively easy given he/she is the only employee that provides an income to the corporation, and there are not employees outside of ‘arms-length’ – but nevertheless, he was quite frank (and a bit sheepish) in stating that he really didn’t know how it would be viewed if ever audited – and he understood my accountants hesitation to go ahead with a share-holder loan to myself.
So – I still don’t know what I will do (haven’t found a house yet), though I think that for the person that commented recently on this thread or a similar one that their wife (who is within arm’s length) may be given a shareholder loan, I would be very cautious – as it would be very hard to prove that this was offered as an employee (ie. not a shareholder), as one would have to prove that the same was offered to all employees that are not at arms length.
it is all very complicated
D
Hi Danny,
If your prof corp would, in future make a mortgage available to an employee manager, then why not extend the mortgage to yourself.
I would prepare some documentation to place in the corporate minutes stating that the corporation may, from time to time, extend loans to employees for the purpose of purchasing a principal residence. You might also state that such loans would only be extended insofar as the corporation was able to extend such loans. This is the documentation indicating the loan is available anyone.
Then you enter into a written employment contract with your corp. The contract states your minimum annual salary for any given year. This establishes that you are an employee.
Be sure you pay yourself the salary stated in the contract.
Finally, have a lawyer draft and establish the mortgage. Your bank may do this for you and may be in a better position to administer it for you.
Then make sure you move into the new home and occupy it.
Danny, this should work, but I cannot say it “will” work if you are audited. This is because of liability but I may be able to recommend someone for you
If the corporation lends money to 2 employees so that they can purchase a principal home, What is the minimum interest rate that can be applied for the repayment? Is there a maximum time frame before this loan becomes an income to the employee?
Sami,
What does this question have to do with loans a corporation makes to its shareholders?
You appear to be asking about taxable employment benefits and it particular mortgages made to employees which is addressed in this article: http://blog.taxresource.ca/employee-loans/
Equal partners divorce and husband sells his share to ex for $50.00. The division of other marital asset equal a substantial amount which he agrees to take in payments so that she does not have to sell house (personally owned by them) or the business.
However at the next tax year he receives a t4 . The T4 amount is the total for a shareholder loan that has gone thru the books under his name. Some of which was fine except for the agreed payments for the personal division of assets.
Does the copy of the $50.00 sale of shares not prove that it is not a buy out for the business?? Should the payments not go under her shareholder loan as it is a personal pay out??
CRA taxed heavily and it is past the employee complaint stage.
Options?
I’m not entirely clear on the situation and the relationship between these items. What exactly is the issue?
Who is being taxed and for what?
Was the $50.00 sale at fair market value?
What was the shareholder loan for? Who was it extended to? If the company lent your husband money and he didn’t pay it back, then it will be included in his income.
I believe the shares were sold at this amount as it was determined that the debt on the company basically nutralized the worth. They ( husband and wife) did pay out personal items such as mortgage and such which he had no complaint about being taxed on as income under the share holder loan in his name. Both husband and wife as equal partners did this. However, when it came to paying out the personal marital assets the wife (who retained the business and home) paid out the exhusband and the put those payments under the ex husband’s shareholder loan. Essentially he then had to pay tax on the worth of his personal items the wife wanted to keep.
Your husband drew funds from the business as a shareholder loan and did not pay the loan back. The sale of shares does not affect this nor does the relationship between you and your husband have any effect.
No, he didn’t take a “loan” from the company. His ex-wife and ex business partner paid him out of his share of the marital assets (not the business shares) by putting through the books her payments to him as “his” shareholder loan. Therefore he is taxed on it as he would not pay back the business for being paid out for his half of the home and such.
Our arguement is that if she used the business to pay her ex out of the division of personal assets then she should have put it through “her” shareholder loan. Right??
Tax Guy:
my friend owns his own business (really, it’s not me, but it’s a true story)
Upon a recent Rev Can audit, he was assessed with a $90,000 ‘shareholder’s benefit’ for a loan to his girlfriend to finance her house. Actually, the $90,000 bought out her private mortgage.
Rev Can wants to tax him on the full amount in the year it was lent out, plus tax him on the prescribed rate of interest each subsequent year.
His business pays a much higher rate of interest on his mortgage, which provided the funds to buy out her mortgage. Rev Can will not allow the original transaction to be an investment, which was the intent of buying out the mortgage (with a guaranteed pay back of higher than prescribed rate, but lower than the rate which he pays).
Rev Can says that the interest paid on that portion of his mortgage can not be deducted as business expense, and that he must take an owner’s withdrawl for the benefit of the interest. Since their is a significant difference in the amount of interest paid on his mortgage, and the prescribed rate for the same principal amount loaned to his girlfriend, we are having a discussion on how to balance the transaction.
example. interest paid on loan amount is approx $9000, but prescribed rate is less than $1000.
Rev Canada will not allow the write off of $9000 interest, but says that should be the owner’s withdrawl. Yet, prescribed rate of less than $1000 should be the amount he personally realizes as a taxable benefit. How does he account for the other $8000?
How does he go about paying this loan and getting it off his books? Can he, such as the gnucash post above, take a withdrawl/owner’s loan, and then repay the loan with it? He has sufficient owner’s equity to do so.
thank you.
The loan was included in his income for tax purposes and he can deduct it if he pays it back. His girlfriend would have to get a mortgage from a financial institution and use the proceeds to payout the mortgage extended from the company.
Thanks for your response, and yes, we understand that he can claim the expense against his personal income when he repays the company.
The real issue at this point is the accounting.
If he can not claim approx $9000 of his mortgage interest as an expense, but should be realizing approx $1000 as personal benefit, how does that transaction compute on the books? I’m old school accounting, and can’t seem to understand the balance of debits and credits….
credit interest expense of $9000. CRA says the opposite end of that transaction is to debit Owner’s withdrawls, yet says under the current rates, he should only realize about $1000 as personal income… so, where does the other $8000 go??
Other than selling the house, and repaying the loan, or getting a conventional mortgage on the house and repaying the loan, are there other alternatives?
WHAT IF they were to move into the house together, as their principal residence? At that point, would the loan be interest free to him, as owner? Thus, realizing the tax savings of writing off the full $9000 in interest to the business, and not being taxed on the personal end?
And if that worked, what documentation would he need to provide to CRA?
It almost seems like a double tax hit for him… he loses the write off of interest to the corporation and gets taxed on the benefit personally. (even though they are at different rates).
thanks for your response.
Jeff,
Here is what I am seeing:
The corporation lends the shareholders girlfriend $90,000 in the form of a mortgage. The funds are used to payout the girlfriends’ old mortgage.
The company has a $90,000 “Mortgage Receivable” on its books and the payments received from the girlfriend would be a blend of “Interest Revenue (a credit)” and a credit of “Mortgage Receivable”. The offset of the payment would be a debit to cash. This mortgage was extended at the prescribed rate.
In order to extend the mortgage to the shareholders girlfriend, the company itself borrowed $90,000. This would be reported on the company’s books as “Mortgage Payable.” The payments may would credit cash and debit interest expense and mortgage payable. This loan was at a rate that was around 10%.
The CRA comes back and says:
a) The mortgage granted to the girlfriend was deemed to be a shareholder loan for $90,000 and was included in the shareholders income.
b) The interest payable on the loan the company borrowed from the bank is $9,000. The CRA denied the deduction from the company’s income.
There does not appear to be any bona-fide reason for these transactions and I would agree with the CRA’s assessment. Borrowing money at a significantly higher rate than what the company would charge is not a reasonable business decision and would create an illegitimate tax deduction.
As it stands now the company owes the bank $90,000 and is itself owed $90,000 from the girlfriend.
This situation is extremely messy and due to liability concerns, your friend will need to engage a public accountant to help resolve the issue. The cost of the accountant will save more headaches than its worth.
This is related to an outstanding loan on the corporation books from a shareholder. The shareholder has since sold his shares…what happens to the loan outstanding….is it now payable to the new shareholder?….there is no intention of repaying the loan to the old shareholder… is it deemed to be the new shareholder loan to the company and as such the new shareholder can be paid as a repayment of loan from the company? ….. and if not how do we clear this amount on the corporation books?
A former shareholder lent the company money, sold his shares and the loan was not repaid by the company.
A loan is a legally enforceable contract between the lender and the borrower. Unless the lender assigns the loan to another party, it is still enforceable by the original lender. The loan would not be “assigned” to the new shareholder.
The reality is that the loan cannot really be removed from the books unless it is repaid to the lender or it is forgiven by the lender. If the loan is forgiven, there will be tax event to the company.
Other options may be available but are far too complex to write here.
Sorry I can’t be of much help.
Thanks for your quick response. You have been a great help as your answer puts it all in perspective and confirms my understanding of the situation.
I do apologize but your written information is very unclear and I cannot make any sense of the information. If ownership of the company moved from your husband to you, then there should have been no transactions or entries made on the books of the company.
A transfer of ownership is a transaction between the buyer (you) and the seller (your husband). It has no accounting implications from a company perspective and no entries should have been made on the books.
If your husband had taken funds from the company prior to the sale of the shares, this would have been deemed a shareholder loan and taxed as income to him.
At this point, I would strongly suggest you “hire” CGA, CA or CMA in your community who can help you understand this. I am afraid I cannot provide any further assistance.
I will reword this, sorry about the confusion.
Mr an Mrs Smith owned a shop. They then divorced in aug 2005. The shops debts equalized the equity that Mr. Smith would have had in it so he “sold” all of his shares to the now Ex Mrs Smith for $50.00.
All other items in the marriage were considered personal as they included the house, car and other shared items not relating to the business.
Mr. Smith agreed to a buy out of the personal items for $10000.00. As ex- Mrs Smith did not have the money he agreed to take payments for $1000.00 for 10 months. She paid it which ran into the 2006 year.
However in Feb of 2007 Mr. Smith received in the mail a T4 for $15,000.00. When he did his taxes he had a huge amount to pay CRA as min tax had been taken off of the T4 from the “shop”
Upon Mr. Smith’s investigation he discovered that Mrs. Smith put his personal pay out of marital assets thru the books as a shareholder loan under Mr. Smith.
How can this be?? If Mr’s Smith wanted to pay him from the “shop” shouldn’t it have been under the ex- mrs Smith share holder loan?
Mrs. Smith’s argument is that it was his equitable value for his share in the shop and not for personal items.
Their agreement for the division of asstes is very vague other than the dollar amount and payments.
CRA told Mr. Smith to do an “employee complaint” which was declined as the books looked in order as they just look for the math to add up.
Notice of appeal has now been filed and it will go to court. Mr. Smith is gathering all info on mortgage and such to show CRA that this was not his shareholder loan.
Any other suggestions? I hope this makes it clearer.
Facts:
* Divorced in 2005.
* Mr. Smith sells his business shares of Mrs. Smith for $50.00
* Mrs. Smith will pay Mr. Smith $10,000 over 10 months as an equalization payment for assets.
* Mrs. Smith pay’s Mr. Smith using the business account.
* Mr. Smith is issued a T4 for the payments (why $15,000 and not $10,000) that was included in his taxable income.
The business paid Mr. Smith. It’s taxable income. The business probably should not have been used to pay Mr. Smith.
You need to hire an account to help you resolve this.