6 Tax Traps to Avoid: Shareholders Loan to a Corporation
What Is A Shareholder Loan?
A shareholder’s loan to a corporation is one of those things that isn’t immediately intuitive. It’s not an actual bank account, and it’s not like accounts receivable, where you can run a list of transactions in the account.
In a nutshell, a shareholder loan is the running total of money or assets you’ve put into your company and cash or assets you’ve taken out of your company.
As a business owner, it’s essential to know what’s going in and out of this account. There can be significant tax implications whether you owe the company or the company owes you.
- Four Types of Transactions In A Shareholder Loan Account
- What Are Shareholder Loan Best Practices?
- What Happens If I Have Shareholder Loans Due From My Corporation?
- Charging Interest on a Shareholders Loan To A Corporation
- What Happens to My Shareholder Loan If I Close My Corporation?
- Tax Trap #1: Double Taxation
- Tax Trap #2: A Series of Loans and Repayments
- Tax Trap #3: Interest Benefit
- Tax Trap #4: Other Shareholder Loan Benefits
- Tax Trap #5: Fancy Planning
- Tax Trap #6: Closing Your Corporation
Four Types of Transactions In A Shareholder Loan Account
Four basic transactions flow through a shareholder loan account. At the end of the year, the sum of these transactions will cause your shareholder’s loan to a corporation to be a receivable (owed by you to the corporation) or a payable (owed to you from the corporation).
Types of transactions that cause you to owe your company money
- Using company funds to pay for personal expenses or using company assets for personal use. These include any costs paid by the company that aren’t business-related. The most common personal expenses I see are haircuts, dentist fees and personal use of the business vehicle.
- Withdrawing assets – this could consist of cash and other assets. The most common “other assets” I see removed from a company are vehicles and equipment.
Types of transactions that cause your company to owe you
- Using personal funds to pay for company expenses. These include any costs paid by you on behalf of the company. It could consist of anything from loan payments, vehicle purchases, or office supplies.
- Cash injections – this is where you deposit cash directly into the company. Shareholders usually make these deposits to ensure the company has cash for operating expenses.
What Are Shareholder Loan Best Practices?
Keep it simple
Business owners often use corporate funds to pay for personal expenses (think groceries and dental). These kinds of transactions flow through your shareholder loan account and the bookkeeping for these items can become very messy.
For example, say you’re a restaurant owner, and you purchase personal groceries with your company credit card. It could become complicated to sort out which grocery items relate to your personal use and which relate to business use.
To keep things simple, I recommend taking regular amounts from the company for personal income and keeping business and personal items completely separate. These regular amounts would be treated as dividends or salaries, paid annually, monthly, or quarterly.
Keep good records
If you deposit cash into your company, make sure you keep documents proving the transfer came from you. Otherwise, the taxman might consider those transactions to be revenue to the corporation and assess tax in the corporation and assess you tax when the corporation repays you.
Likewise, keep receipts for business expenses (whether your business is incorporated or not), so you can prove that they are legitimate.
Regularly review the transactions in your shareholder’s loan account
Your bookkeeper or accountant may use the shareholder loan account to record those bank and credit card transactions that don’t have supporting receipts.
Given that there can be adverse tax consequences to getting your shareholder loan balance wrong, it’s essential to review your shareholder loan account at least annually to ensure that the items flowing through it belong there.
What Happens if I have Shareholders Loan Due From My Corporation?
Unlike owing money to your corporation, there are few tax consequences to your corporation owing you money.
As a shareholder, you can loan your corporation as much money as you want with no tax implications. The loan is not considered income to the corporation, and no GST applies. You can withdraw the funds at any time, in any amount, tax-free.
Another way to increase the shareholder loan to your corporation is to pay for operating expenses or buy assets on behalf of the business.
Charging Interest On A Shareholders Loan To A Corporation
You’re not required to charge interest on a loan to your corporation.
Most shareholders choose not to charge interest for two reasons:
- Administrative – it’s just another thing to keep track of, and there isn’t much benefit
- You would need to report the interest income on your personal tax return, and you probably pay a higher rate of tax personally than in your corporation
When would you want to charge interest on a shareholders loan to a corporation?
When your corporation has multiple shareholders, it may make sense to start charging interest.
For example, when one shareholder contributes more funds than the others, interest is one way to compensate them for this difference.
What Happens to Your Shareholder Loan When You Close Your Corporation?
When you close or windup your corporation, you may be able to write off the balance that your corporation owes you.
Writing off your shareholder loan can be tricky for tax purposes. You may be able to write off your loan as a capital loss. You can only use capital losses to offset capital gains on the sale of other assets.
Alternatively, you may be able to write off your shareholder loan as an allowable business investment loss; you can use these losses to offset all types of income.
Tax Trap #1: Double Taxation
Paying tax is never fun. Paying double tax is even worse. Avoid double taxation by repaying your shareholder loan from your corporation on-time.
Tax rules allow you to owe money to your corporation for two fiscal year-ends. The balance should be repaid or included in your income during this period. If it’s not, tax rules require that you add shareholder benefit to your income.
A shareholder benefit isn’t deductible like salary, and it doesn’t allow the same tax credits as dividends. This means your corporation pays tax on the income it earns, and then you pay tax on the shareholder benefit. This may not sound like a big deal, but it will end up costing you.
Say you withdraw $150,000 from your corporation and have no other sources of personal income. If you take that $150,000 as dividends or salary, you and your corporation will have a combined tax rate of 35%. If that same $150,000 is outstanding for more than two fiscal years and you are required to add it to your income as a shareholder benefit, you and your corporation will have a combined tax rate of 46% or $16,500 more tax to pay.
With a little planning, you can avoid double taxation.
Tax Trap #2: A Series of Loans and Repayments
At this point, you may think it’s a good plan to repay the balance before the end of your corporation’s fiscal year and then withdraw it again in the next year. Voila! No shareholder benefit, no dividend, no salary and no tax bill! Well, not quite.
The government is way ahead of you on this one. There are tax laws in place to expressly limit this “series of loans and repayments”. If the government thinks you’ve engaged in these types of transactions, they will include the balance in your income as a shareholder benefit.
Tax Trap #3: Interest Benefit
Say you’ve taken a shareholder loan from your corporation and plan on repaying it within the two fiscal years, but not right away. That’s great! There’s just one more thing to be aware of: the interest benefit.
Your corporation has loaned you money, and the government assumes you would pay interest if you borrowed the funds from a third party. Therefore, you’re getting a benefit by not having to pay interest to someone else.
This means you need to calculate your “interest benefit” and include it in your income each year that your shareholder loan balance is unpaid.
Tax Trap #4: Other Shareholder Loan Benefits
Say you don’t have a balance in your shareholder loan account. Now you need to think about non-cash benefits.
Yep, you read that right. You can have benefits for which you didn’t seem to receive anything. One of those non-cash benefits is the interest benefit noted above. But suppose you use a company asset for personal use, like a vehicle or residential property. You’ll need to figure out what benefit you received and include it in your income.
Tax Trap #5: Fancy Planning
Right about now, you’re probably wondering if there is any way you can use corporate cash without taking a tax hit. There are a few options:
- You may be able to take a shareholder loan from your corporation to buy a residence or purchase shares of the corporation. These are both risky options, not that they’re illegal, but if they aren’t properly structured and documented, you could end up with a significant shareholder benefit (see double taxation above)
- You could temporarily fund a purchase of a new house while still owning your old home. You may plan on buying a new house before you sell your old home. If you have sufficient cash in your corporation, you may be able to take the money out temporarily to fund a deposit on the new house. When you sell your old home, you repay the amount you took out of the company. Be careful, though! If you don’t repay the loan within a specific period, you will need to add it to your income.
- There are other options, but they’re highly specific to each situation. Give me a call if you’d like to discuss!
Tax Trap #6: Closing Your Corporation
Say you need to close or wind-up your business, but have a shareholder loan from your corporation. In this situation, you have still received a benefit from your corporation, and the corporation needs to clear it out upon wind-up.
Assuming there are no other assets or debts in your company, you will add the shareholder loan balance to your income, usually as a dividend.
Check out this article from Tax Tips for a technical summary of the tax implications of a shareholder loan from your corporation.
Unincorporated Businesses And Shareholder Loans
You don’t need to be concerned about your shareholder loan account if your business is unincorporated even if you have a separate business bank account.
For tax and accounting purposes, you and your business are the same legal entity, so there is no need to record transactions flowing between you and your business.
You’ll need to track your revenues and business expenses; that’s it.
Have questions about your shareholder loan? Get in touch with me!