How to Use it to your Advantage and Stay Compliant with CRA
If you are the owner-manager of a corporation, understanding the concept of the shareholder loan is essential to running your business. Below I will explain what a shareholder is and how to use it. After reading this article, you will become familiar with potential tax traps and how to avoid them.
We will discuss the following topics:
- What is a shareholder loan?
- What are the tax implications of the shareholder loan, and how to use it to your advantage?
- How to avoid problems with the CRA
What is a shareholder loan?
In general, the balance of your shareholder loan represents the total owner cash drawn from your company minus the funds you have contributed.
Your shareholder loan will appear as an asset or liability on the balance sheet. If you contributed more cash to your company vs. what you drew out, the shareholder loan would be a liability on the balance sheet. When your owner’s cash draws exceed contributions, the shareholder loan will be an asset on the balance sheet.
Various types of transactions will affect the shareholder loan account. A few examples are:
CASH CONTRIBUTIONS
If the shareholder deposits cash into the company bank account, the money can repay this money to the shareholder tax-free at some point. The company owes the shareholder this money, and the balance will appear as a liability on the balance sheet called “due to shareholder.”
PAYING FOR COMPANY EXPENSES WITH A PERSONAL CREDIT CARD
It is common for owner-managed companies to pay for company expenses with a personal credit card. This type of transaction is treated like a cash contribution. The company gets a tax deduction that the shareholder can reimburse at some point.
CASH WITHDRAWALS
If an owner draws cash from the company bank account, not dividends or salary, they are considered a shareholder loan and debt owed to the company. The total draws will appear as an asset on the balance sheet called “due from the shareholder.”
PAYING FOR PERSONAL EXPENSES WITH COMPANY FUNDS
We often see company owners pay for some exciting things using their company funds. For example, a family trip to Mexico paid for on the company credit card is not tax deductible. When this happens and happens often, the transaction is treated like a cash withdrawal. The company cannot deduct the expense, and the amount will become a debt owed back to the company.
We advise all our clients to pay for personal expenses with a personal credit card. You will have accurate bookkeeping records and spend less time explaining questionable transactions to your accountant or bookkeeper.
What are the tax implications of the shareholder loan, and how to use it to your advantage?
Many clients ask, “how do I pay myself from the company? And the typical answer is dividends or salary. However, you do not have to designate cash draws as dividends or salaries until fiscal year-end. In the meantime, you treat cash draws as a shareholder loan.
In many start-up companies, the owner puts more cash into the business than they take out. Therefore, the running balance of the shareholder loan at fiscal year-end has a credit balance and appears as a liability on the balance sheet. Meaning the company owes the shareholder money. If this is the case, the owner does not have to declare any draws as dividends or salary and can take the shareholder loan balance out of the company tax-free at year-end.
Suppose the running balance of your shareholder loan is in a debit position, which appears as an asset on your balance sheet. In that case, you typically declare the amount as dividends or a salary. Depending on your tax situation and business/personal goals, dividends or salary, or a combination of both, will be discussed with your Tax Accountant to determine the best method for you.
Shareholder loans provide opportunities for tax planning. At RGB Accounting, we will assess your tax situation to determine the timing of dividends or salary that will minimize the amount you pay for personal and corporate tax combined.
How to avoid problems with the CRA
You may be thinking, “why don’t I repay the shareholder loan right before fiscal year-end, then borrow it again in the new year?” CRA is aware of this technicality and placed rules to prevent you from doing this. So, do not even think about trying it!
There is one final option if you owe your company money at the end of the year. You have one year from your fiscal year-end date to pay it back as a direct repayment, salary, or dividend. But be careful since your shareholder loan will be reported to CRA as an asset on your balance sheet at fiscal year-end. By reporting your shareholder loan as an asset on the balance sheet for two consecutive years in a row, you signal a red flag to CRA that you may not have included your shareholder loan as personal income.
Summary
The shareholder loan is a helpful tool for tax planning and cash management between the owner and the company. Used correctly, the timing of cash draws, dividends or salary can be advantageous.
Contact us today if you are looking for expert advice on shareholder loans. We will get an in-depth understanding of your specific situation and make sure you are set for success!
Other related articles:
- Do corporate loans count as taxable income?
- Beware of using your corporation’s income to pay personal expenses
- Incorporating your business in Canada
Source: CRA
