Shareholder loan

Owners of privately held corporations might be tempted to withdraw the extra cash in the corporation as a shareholder loan rather than reporting a salary or a dividend.

The Income Tax Act has specific rules about shareholder loans. Since corporations often pay tax at preferred rates, the concern is that owners could take money out of their corporation without paying personal income tax on it.

Subsection 15(2) of the Income Tax Act prevents the tax free withdrawal of corporate funds as loans to shareholder (or a person that does not deal at arm’s length with the shareholder). The loan should be included in the income for the year in which the loan is received. The shareholder may be an individual or a partnership.

One exception to the above rule is repayment of the loan within one year. Pursuant to subsection 15(2.6), there is no income inclusion if the loan is repaid within one year after the end of the corporation’s taxation year in which the loan arose.

Consequently, if a shareholder owes money to the corporation on two consecutive fiscal year-ends, the loan must be included in the shareholder’s net income for tax purposes. It also should be noted that a series of loans and repayments will be viewed as one continuous loan. This prevents the shareholder from paying the loan off just prior to year-end and then borrowing the money again just after year-end so the loan does not show up on the balance sheet.

A repayment of the loan should be accomplished through declaring a salary or dividend. If a salary is declared, the amount has to be “grossed up” to take payroll withholding into consideration. For example, if the loan is $10,000, this is the net amount after deductions. Let’s assume the deductions are $4,000, the salary that needs to be claimed would be $14,000.

If the intention is to repay the loan through declaring a dividend, it needs to be documented in the corporate books. Additionally, if there are other shareholders, they may also be entitled to dividends.