How Shareholder Loans Affect Your Income Tax

by Tax Guy on February 12, 2011 Print This Post Print This Post

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 after 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 Lenders Rule - 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 and are 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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{ 120 comments… read them below or add one }

Ken Dey August 29, 2008 at 2:21 pm

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.

Reply

Tax Admin August 29, 2008 at 6:46 pm

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.

Reply

Lynda MacPherson January 27, 2009 at 11:15 pm

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?

Reply

Tax Admin January 28, 2009 at 9:53 pm

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.

Reply

Caragh September 24, 2009 at 7:38 pm

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?

Reply

pratima puholoo August 20, 2010 at 4:54 am

how to account the shareholders loans written back in accounting? is it of a capital nature?

Reply

pratima puholoo August 20, 2010 at 4:55 am

please advise me?

Reply

Tax Guy August 20, 2010 at 5:01 am

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.

Reply

Tax Guy September 25, 2009 at 7:12 am

@ 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.

Reply

Paul October 13, 2009 at 2:05 pm

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!

Reply

Tax Guy October 14, 2009 at 11:40 am

@ 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.

Reply

Mark October 15, 2009 at 10:31 am

Are these shareholder loans interest free?

Thanks!

Reply

Tax Guy October 15, 2009 at 10:54 am

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.

Reply

Mark October 15, 2009 at 11:47 am

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?

Reply

Tax Guy October 15, 2009 at 7:09 pm

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.

Reply

manny October 18, 2009 at 12:51 am

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

Reply

Tax Guy October 19, 2009 at 12:18 pm

@ Manny

Only the interest you receive is income. Otherwise the infomration in this article does not apply in your case.

Reply

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