Many Canadians operate their business through a corporation.Though the finances of small business corporates are directly linked to the finances of their owners-managers,the concept of a separate legal entity prevails. Therefore, it’s important to remember that corporate funds are not personal funds and should not be treated as such, for it can result in serious adverse tax consequences.
What is a Shareholder’s 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 either 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 as “Due to Shareholder.” When your owner’s cash draws exceed contributions, the shareholder loan will be an asset on the balance sheet as ‘’Due from Shareholder”.
The following transactions affect a Shareholder’s loan:
Cash Contributions
If the shareholder deposits cash in the corporation bank account, it amounts to a loan to Corporation and adds to “Due to Shareholder” as a liability on the Balance Sheet.
Cash Withdrawals
If the shareholder withdraws money from the corporation, it amounts to a loan by the Corporation and adds to the “Due from the Shareholder” as an asset on the Balance Sheet.
Business Expenses paid through Personal Funds
Suppose the owner-manager pays for corporation expenses from his personal funds. In that case, it amounts to the owners’ contribution to the business and is added to the Due to Shareholder account on the balance sheet.
Personal Expenses paid through Business Funds
Similarly,if the owner with business funds has purchased personal items, it adds to Due from the Shareholder’s account,i.e., kind of loan from the corporation.
Ultimately,your shareholder’s loan balance will appear as assets or liabilities on the corporate balance sheet.It’s considered a liability(payable) of the business when the company owes it to the shareholder.On the other hand,it will be shown as an asset(receivable) when the shareholder owes it to the company.
TAX IMPLICATIONS
Now let us discuss the tax implications of a Shareholder’s Loan in a corporation.
Like any withdrawal or distribution from a business, it is imperative to consider this decision’s tax implications.
As an owner-manager of a corporation, you can compensate yourself by way of salary, dividends, management fees, or a shareholder loan. Though generally, any distribution from your company is subject to taxation, each type of distribution has different tax implications and needs to be appropriately documented.
Shareholders may take a loan from the corporation and are not required to report it as personal income on their personal tax return for that fiscal tax year. A loan to a shareholder must be returned to the corporation by the end of the next fiscal year to ensure that the amount will not be taxed. The portion of the loan that is not repaid by this deadline will be included in the recipient’s income and taxed accordingly.Interest is payable on shareholder loans at the prescribed interest rate in effect with the CRA. Therefore, all loans must be adequately documented in a written agreement or documented as a corporate resolution that defines the repayment terms to the corporation.
While the ability to borrow money tax-free is one of the key benefits, you need to ensure that you always pay the loan back on time to show that it was a loan and avoid income inclusion.
Need Help?
If you are thinking about taking out a shareholder loan and are not sure of the tax implication,let us at Rav Bhatia CPA Professional Corporation help you.We have been providing comprehensive bookkeeping,payroll and tax services to our various clients. We’ll walk you through the best decisions you will ever make for your business and grow substantially with our expertise and advice on tax planning and financial management.