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.
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{ 33 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?
@ 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,
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: 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.
@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).