Do corporate loans count as taxable income?

When shareholders or employees borrow money from a corporation, that money is generally considered taxable income. But this rule, like many CRA rules, has exceptions.

Many shareholders and employees borrow funds from their corporations for many different reasons or end-uses. Unfortunately, many end up with significant taxes owing because they did not understand the tax ramifications of their loan.

The Canadian Income Tax Act (ITA) contains specific rules regarding the tax treatment of shareholder loans.

Essentially, these rules are designed to ensure individuals do not try to take funds out of their corporations on a tax-free or tax-deferred basis.

As noted below, with some specific exceptions, if you receive a loan from a corporation you are an employee or shareholder of, CRA will include the loan amount in your income for that tax year.

The situation is the same for anyone connected to you who receives a loan from the corporation – the amount will be included in their income. A connected person is someone who is non-arm’s length, such as your spouse, children and siblings.

Fortunately, ITA rules for shareholder loans include some exceptions. If you meet these criteria, you could get a tax-free loan from your company.

The shareholder loans rules do not apply if:

• You are an employee of the corporation but not a specified employee. A selected employee usually owns at least 10% of any one class of the corporation’s shares; and
• You received the loan because of your employment with the corporation as opposed to your shareholder status; and
• You have made bona fide arrangements to repay the loan within a reasonable timeframe.

In addition, whether or not you are a specified employee, you can borrow tax-free from your company as an employee if you intend to use the loan for any of the following: 

• to buy or refinance an owner-occupied home; 
• to purchase newly issued shares in the corporation or a related corporation, or 
• to acquire a vehicle to be used for business purposes. 

However, the loan must be because of employment, not shareholder status, and arrangements must be made for repayment in a reasonable time.

Regardless of the end-use of the loan, if you repay it within one year of the end of the taxation year in which your corporation made the loan, you’ll always avoid personal tax on that loan. Note, though, that this is not the case if you borrow one year, repay the loan the following year, and then re-borrow the exact amount and repay it the next year. CRA usually will not accept such a series of loans and repayments as onside.

Repayment of Shareholder Loans

Suppose you have a shareholder loan that does not qualify for special exemptions. In that case, you have until the end of the corporation’s tax year after the year in which you received the loan to repay it without tax ramifications.

In a situation where the shareholder rules do apply, and your loan is deemed to be income, if you subsequently repay the loan, you can deduct the repayment.

For example, if a $10,000 loan is added to your taxable income one year, and you pay off that loan the following year, you will reduce your taxable income by $10,000. However, if the repayment relates to a series of aforementioned transactions, the repayment may not be deductible.

Deemed Interest Benefit

If your situation falls within one of the exceptions to the shareholder loans rules and the loan is made at low to no interest, you may be assessed a deemed interest benefit. Usually, the benefit is equal to the prescribed rate of interest computed on the loan amount in each year it is outstanding. CRA sets the prescribed rate of interest quarterly every year. It is currently set at 1%.

Never will the shareholder loans rules and the interest benefit rules both apply in one scenario. So, if your loan is not eligible for tax-free status and the amount is included in your income, you will not have a deemed interest benefit even if the loan is interest-free.

If you received a low-interest loan from your employer, the amount of the deemed interest benefit would be reduced by any interest you paid on the loan, but the interest must be paid within 30 days of the end of the calendar year. For example, if you receive such a loan in July, make sure you pay any interest on or before January 30, the year following.

Loans for Home Purchases

If the corporation makes you a loan as an employee to acquire a home, the taxable benefit, based on a 2% rate, can be locked in for up to 5 years. So, if you receive a $100,000 loan, the annual taxable benefit on your T4 would be just $2,000. If you paid this interest to the corporation, there would be no taxable benefit at all.

You can use your loan to purchase just about any housing, including an apartment, a duplex, a condominium, a mobile home, a share of a coop housing project, a trailer or houseboat, even a vacation home.

It’s much more difficult for owner-managers than non-shareholder employees to take advantage of home purchase loans from their companies. Often, CRA will not accept that the owner-manager is receiving the loan because of employment rather than shareholder status unless loans of this nature are generally available to other unrelated company employees.

Suppose you are a business owner who borrows funds from the company to pay personal expenses throughout the year and contributes personal money to the company at different times. In that case, you need to pay close attention to your shareholder loan balance at all times. 

CRA specifies that if you owe your company money on two consecutive year-end balance sheets, you must include the principal loan amount in your net income. CRA will view a series of loans and repayments as one continuous loan.

From a tax perspective, it could be better to issue a bonus or shareholder dividend rather than borrowing from the company and run the risk of having the borrowings included in personal income by CRA.

The bottom line is that if you’re planning on borrowing funds from your corporation, make sure you seek the prior advice of your tax or accounting professional. Knowing the tax implications before you act could save you a significant amount of income taxes.

Don’t hesitate to contact RGB Accounting by phone at (416) 932-1915 or by email at [email protected] if you need help with this matter. We’ll be pleased to assist you.

Source: www.fbc.ca ​