One area of confusion that some clients can have is why there are strict rules about borrowing money from the company that they own. The Canada Revenue Agency (CRA) has developed a set of rules strictly regulating how an individual can borrow money from a company that they own.
These rules have been put in place to prevent individuals from continually borrowing money from their company rather than taking a salary and paying tax on this salary. For example let’s say and individual owns a business and are able to pay themselves an annual salary of $100,000 and this goes on for 20 years. Each year individual would have to pay approximately $25,000 income tax, meaning they would net $75,000 per year, and over 20 years net $1,500,000. If these rules were not in place the individual each year could “borrow” $100,000 with no intention of paying it back and over 20 years net $2,000,000 at which point they could dissolve the company and never repay the loan.
To prevent shareholders from using this potential loophole, the amount of the shareholder loan will be included in the shareholders income in the year the loan is made if the initial loan is not paid back within one year of the year-end of the year in which the loan was made.
I know that’s just confusing accounting talk…. Here’s an example to help clarify the rule.
Let’s say Mrs. X borrows $100,000 from her company on September 15 2011, and her company’s year-end is December 31, 2011. If Mrs. X does not repay the $100,000 to her company by December 31, 2012, the $100,000 will be included in her personal income for 2011.
After the loan has been included in income, if the loan were to be repaid by the shareholder, they would get a deduction for the repaid amount in the year of the repayment.
If the repayment of the loan is a part of a series of transactions in which the debt remains, then the loan will still be included in the shareholders income. In the example above this would mean that if the loan was repaid in December 2012, and then taken out again January 2013, this would not count is repayment prior to December 2012 and thus would still be included in Mrs. X’s income.
There are a few exceptions to the rule, but these are very rare cases and there are strict specific rules around these exceptions. If the shareholder is also an employee the following loans can be made in certain circumstances:
These above loans are only allowed if they are repaid in a reasonable time in accordance with bona fide arrangements and if this type of loan was made because of the employment relationship rather than the shareholder relationship.
All in all shareholder loans are a complicated matter and a constant juggling act with many business owners. This is one of the main items that your year-end accountant monitors to ensure that it is compliant with tax regulations. This is one of the areas in which business owners are least informed, and thus can get themselves in trouble with the CRA which can lead to prior year reassessments resulting in significant tax, penalties, and interest owing to the CRA.
If you have considered borrowing money from your compnay you should contact your Chartered Accountant to ensure that it complies with tax regulations. If you have any questions related to shareholder loans or if you need assistance with any tax or accounting needs please contact us at firstname.lastname@example.org , 604 510-0156, or visit our website at https://wattsca.ca
Disclaimer: The information in the blog is for general information only and is not intended to be a substitute for professional advice. Each person’s situation is unique, and a designated professional accountant can assist you in using the information on this blog to your best advantage. The author of this blog strives, but does not guarantee, to provide information which is current and accurate. Due to the nature of the information, it should not be relied upon for decision making without talking to a designated professional accountant. By obtaining information from this blog, you fully release Steve Watts, Chartered Accountant of any liability that may arise from using this information.