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.
Looking For Professional Help?
If you’re looking for advice or tax planning services, you can contact me directly through my professional tax practice.
Related Articles
- Income Splitting Using Loans To Your Spouse
- Specified Shareholder
- Employer Loans To Employees
- Income Splitting With Loans To Your Spouse
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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.
IF you loan ur own company $10000.00 to invest in MF & the markets go down & the 10000.00 would become worth 9000.0
& providing that this company has other source of funds.
If u sell the MF at loss would u recover from the company
10000.00 or 9000.00 ? & who would claim the capital loss?
Hello Mishmish,
I assume that you mean that you are the shareholder of a corporation that has $100,000 invested in mutual funds that have been sold or redeemed for $90,000.
The shareholders and corporation are separate taxpayers and file separate tax returns. Therefore, if the corporation sells its investments at a loss, the loss can be used by the corporation to offset any capital gains it had earned in the current tax year. If there is any excess losses after gains have been offset, they may be carried back and used against the corporations gains in the prior three years or carried forward indefinitely.
The corporation cannot pass its losses to its shareholders.
I hope this helps.
The principal residence rule includes a reference to purchasing new shares. What is the definition of new shares. May I take a loan from the company to purchase my business partner’s shares without it being considered income?
There is no reference to purchasing new shares and the principal residence exemption I am aware of. You’ll have to provide a link to where you have seen this.
@NJC,
It means that the company can lend the shareholder money in order to buy new shares in the corporation, but only if they are also an employee.
Is it possible to use the shareholder loan (in capacity as an employee) to pay down the existing mortgage on a principal residence? Or does it need to be used only on a new purchase of a principal residence?
My understanding is that it must be used to acquire a principal residence and not replace an existing mortgage. We’d have to obtain a ruling from the CRA to confirm.
Sorry if this is a little off topic but if a corporation owes only one of two shareholders money can dividends to this shareholder be used to reduce this amount and not be included in income, while still being included in income of the other shareholder?
@Cindy,
What you are saying is that a shareholder lent the corporation money in the form of a loan. Repayment of this loan is simply a repayment of debt from pre-tax dollars. It is not a dividend.
@Laura,
The way the CRA looks at this situation is whether the allowance paid to the employee is reasonable or not. The CRA considers that if you pay your employee’s an allowance that do NOT EXCEED the amounts in the following CRA link, that the allowance would not be taxable.
http://www.cra-arc.gc.ca/tx/bsnss/tpcs/pyrll/bnfts/tmbl/llwnc/rts-eng.html
If you pay based those per KM rates (or less), the payment is not taxable to the employee. The employee then has two choices: Accept the payment as a non taxable benefit but do not deduct the operating costs themselves or claim the payment is unreasonable, include in their income and deduct the actual operating costs allowed under the Act.
Based on an analysis I did a couple of years ago, that even at current gas prices, the maximum allowances set by the government are more than sufficient to cover the costs of fuel, insurance and operating costs of most standard automobiles.
I created a corporation to purchase a rental property, I loaned the corp. $100,000 interest free. The corp. is paying me back $2,000 a month.
My Question.
1. Does the corp. declare the $24,000 as a expense from the revenue on the tax return.
If the $100,000 was truly a loan, it would be a liability to the company and it’s repayment would be a reduction of the liability and not an expense. Only interest payments the company made would be an expense.
Your receipt of the $24,000 would be a non-taxable return of your capital. Had the company paid interest on the loan, the interest would have been interest income to you.
If you gave the company $100,000 and received shares in return, then the $24,000 is an after-tax distribution of retained earnings (it is not an expense) and is a taxable dividend to you.
I suspect you are aware but it bears mention, that unless the corporation employs more than 5 full time employees, that the rental income will be deemed to be Specified Investment Business income and taxed at the investment income tax rate for corporations: Federally this amount is 34.67% and the provincial rates range from10% to 16%. This means that the tax rate on the income received by the corporation may be higher than the top personal marginal tax rate in most provinces. In addition, it adds additional reporting and compliance.
Can money that was lent to a corporation to buy a building be secured by registering a mortgage on the title of the building that was purchased by the corporation? The money was lent by the shareholder and parents of the shareholder
Hello Patricia,
You are asking a legal question and I am not a lawyer.
In regards to shareholders “lending” money to a corporation to cover its operating costs, if the corporation dissolves and there is an outstanding shareholder loan amount, does that loss have any benefit to the shareholder’s personal taxes? For example, a shareholder lends $5,000 to the corporation to cover operating costs and the corporation dissolves from lack of business and cannot payback the $5,000 to its shareholder, is that $5,000 “loss” able to be claimed anywhere on the shareholder’s personal taxes??
Thank you!!!!
The rules are rather complex, but generally, if the company qualifies, then yes.
A taxpayer who invests in the shares or debt of a small business corporation may be able to claim an allowable business investment loss against all sources of income.
The company must be a small business corporation (SBC) which is defined in s.248(1) as a CCPC where all or substantially all (which meant 90%) of the FMV of its assets are used principally (i.e. 50% or more) in an active business in Canada by the corporation itself or a related corporation.
To be able to report the loss as an ABIL, the corporation must be a SBC at the time the loss is realized.
The ABIL is ½ of the loss.
Hi Tax Guy,
I love your Q&A blog!
I have what appears to be simple questions but I’m sure they aren’t.
A corporation has a shareholders loan that needs to be cleared and I plan to clear it by cr shareholders loan and cr retained earnings. I think a T5 needs to be filed before or on Feb 28, 2011 for that amount of dividend, right? Do I have to withhold taxes or source deductions in respect of the dividend paid? Would this be eligible dividends? All income is active business income. Is this dividend eligible for a dividend refund? The dividend will be paid to an individual shareholder. How does RDTOH get triggered for a dividend refund? I think $1 of dividend refund is allowed for every $3 of dividend paid but I’m not sure.
This question relates more to bonus payable than shareholders loan. In order for a bonus payable to be deducted, it must be repaid within 180 days. Does this bonus have to be paid in one lump sum amount or can it be paid here and there in different amounts but the total of the payable was paid within 180 days (dr bonus payable and cr cash)? How will this affect the source deductions? There is no set pay date. So I’m not sure what amounts of taxes or deductions to use to file the T4, which is also due Feb 28, 2011. This is confusing… I tried reading the IT bulletins to get a better understanding but I’m at a loss.
Your help would be greatly appreciated.
I wouldn’t say you have “a” question, but rather several! And it may take me a couple of days just to answer them!!
Here are some general answers to some questions: No, you don’t withhold tax on a dividend payment, but you need to make sure that the corporation has enough cash on hand to pay it’s taxes (dividends are paid from after-tax dollars).
You can only pay eligible dividends if the corporation has a GRIP balance.
The RDTOH, is calculated when you file the T2.
A bonus is a bonus. The payment of which affects payroll taxes and that is a whole separate topic. But for T4 purposes, the payment is included on the T4 in the tax year paid.
Normally, when I’m presented problems like this, I have to take a step back and ask myself “what is the objective here?” or “what are we trying to achieve?” Often these questions help you identify the specific problem or issue that needs to be addressed.
Then list the potential variable factors that can affect the outcome.
Here is an example:
Problem: Corporation has excess cash.
Question to be answered: What is the most tax-efficient way to pay the excess cash out to the company stakeholders? (bonus payment or dividends).
Interested parties: The shareholders, lenders, the CRA, and any user of the financial statements.
Variable factors:
* The small business deduction limit.
* The 180 day rule for bonus payment.
Thank you for the quick reply.
Does the company have to have cash to pay a dividend? What if the scenario is like this: shareholder pays his personal expenses using the company’s bank account, so dr shareholders loan and cr cash. To avoid any taxable benefit under section 15 at the end of the year, and there is a retained earnings, can I just book at the beginning of the next dr dividends paid (or retained earnings) and cr shareholders loan to clear out the account, and then issue a T5?
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