Businesses and their owners often have intertwined finances. While we encourage all business owners to keep their personal finances separate from their business finances, it is sometimes tricky. Your business may have a short-term cash flow crunch, and you use personal funds to tide it over. Perhaps you need short-term cash financing, and a salary or dividend is inappropriate. You may consider a shareholder loan in this instance.
What are Shareholder Loans?
Shareholder loans are loans made from the corporation to a shareholder. For shareholders, this is another type of cash inflow from their business to their personal funds. You might see it on your balance sheet as “Due from Shareholder” or “Shareholder Loans” in the liability section. Typically new shareholder loans are initiated in one of two ways:
- Withdrawing cash from a company account
- Using the corporation’s funds for personal expenses, maybe using your business credit card for personal expenses.
Shareholder loans are meant to be a form of short-term financing only. They should not be treated as compensation or a benefit for shareholders through the corporation. Unlike dividends and wages, they do not trigger tax liabilities when issued. As a result, the CRA has specific rules regarding the treatment of shareholder loans.
How does the CRA treat Shareholder Loans?
The CRA recognizes that shareholders might take short-term cash financing from their own businesses. However, they have strict and prescriptive rules around managing shareholder loans between the corporation and its shareholders. The big picture is that the CRA does not want to see preferential financing terms between shareholders and their businesses. In the eyes of the CRA, as long as you pay the shareholder loan back before the due date, it is not a form of compensation or income.
When is a shareholder loan due?
According to the CRA, the deadline for repaying shareholder loans is within 12 months of the end of the fiscal year in which you take out the loan. For example, for a business with a December 31 year-end, a shareholder who took out a loan on January 2, 2XX2, would have to pay it back by December 31, 2XX3.
If the shareholder does not meet the deadline, the CRA considers it to be income for the shareholder personally. As a result, they would be taxed based on their personal income tax rate.
When is the interest on shareholder loans due?
The shareholder should pay back any interest on shareholder loans within 30 days of the end of the fiscal year, as per the CRA. Suppose the shareholder does not pay the interest. In that case, there should be a taxable benefit for the interest amount at the prescribed rate included as other income on their personal tax return.
How can you repay shareholder loans?
There are generally three ways to clear out shareholder loan balances to your corporation: pay it back, take it as a salary, or as a dividend.
Pay it back.
The most straightforward approach for your financial records is typically to repay the funds to the company account, including any remaining interest.
Consider it a salary.
If you work within the business and receive regular wages, one approach would be to classify the shareholder loan as a salary. As a result, the loan amount would be treated as income and taxed the same as other employment income.
Classify it as a dividend.
Another approach to dealing with the shareholder loan can be to classify it as a dividend to the shareholder. The shareholder will not have to pay it back to the business. But it will be included as dividend income to their personal taxes.
Are there any exceptions for the repayment of shareholder loans?
In many cases, you may be an employee of the company and a shareholder or owner. As a result, in some instances, the shareholder loan may instead be an employee loan. If this loan was for a house or a car, the due date for shareholder loans might not apply. Instead, you may classify the loan as an employee loan. However, it is crucial to ensure that the shareholder-employee is not receiving preferred benefits because they are shareholders. If you have any doubts, be sure to loop in your tax accountant for advice before taking on such loans.
Best Practices for Shareholder Loans
- Keep track of shareholder balances – Shareholder loans are often not just one cash outflow. If there are ongoing payments between the corporation to the shareholder, track all withdrawals and repayments.
- Document any shareholder loans – It is essential to document all shareholder loans and repayment terms to provide a paper trail if necessary.
- Charge at least the prescribed loan rate for the quarter – The CRA has prescribed rates for each quarter for various transactions, including shareholder loans.
- Repay the interest within 30 days of year-end.
- Clear balances before year-end as appropriate – remember to repay any loans before their due date to avoid including them as income on your personal taxes.
- Consult a tax accountant if you need – Your tax accountant can guide you through these transactions to ensure you comply with any CRA rules.
CONSULT THE BUSINESS ADVISORS EDELKOORT SMETHURST CPAS LLP IN BURLINGTON FOR EXPERT TAX ADVICE
Dealing with shareholder loan and tax regulations is essential for small business owners. At Edelkoort Smethurst CPAs LLP, our skilled team of tax experts is ready to tackle all your business and personal tax obligations while optimizing for all possible deductions. Let our trusted accountants give you the peace of mind of knowing that your taxes will be filed accurately and on time. Get in touch with us online or by telephone at 905-517-2297.