Understanding how a shareholder loan works and how to to use it if you run a business is completely underrated in our opinion. Most business owners are not aware of the tax implications that can arise by using a shareholder loan. This article will help you understand the following.
- What a shareholder loan actually is
- How to use a shareholder loan
- Understanding your shareholder loan balance
- Shareholder loan problems with the CRA
- Avoiding tax problems with CRA
What is a Shareholder Loan?
You see your shareholder loan as either “Due from Shareholder” or “Due to Shareholder”, one is owed to you and one is due from you. The shareholder loan balance signifies any funds that you have contributed into the corporation (“Due to Shareholder”) or any funds that you have withdrawn from the company (“Due from Shareholder”).
Most business owners use their shareholder loan account without really understanding how it works or why there is a balance. If this is the case ask your bookkeeper or accountant why it is there and how it came to be there, they will explain why.
How is a Shareholder Loan Used?
Now we’ll look at some common ways a shareholder loan is used.
If a shareholder withdraws money from their business for personal use, and it is not designated as a dividend or salary, it creates a loan that the shareholder will have to pay back. This is called “Due from shareholder”.
Let’s use an example to explain this better. If Anthony purchased a lawnmower and used the company credit card, this personal expense used company funds. The transaction would be recorded in Anthony’s shareholder loan account as a loan from the company to Anthony and he would need to repay it.
If a shareholder contributes money into the company to cover an expense that should be borne by the company, this means that the shareholder in effect loaned the company money. This creates a “Due to shareholder” and the company will have to at some point pay the shareholder back.
An example of this would be if Anthony is at Staples and purchases a printer for the business. This business would now owe Anthony for the amount he paid as the printer is strictly used for the business.
Understanding Your Shareholder Loan Balance
Your shareholder loan balance will either appear on your balance sheet as an asset (Due from shareholder) or a liability (Due to shareholder).
The total balance is a sum of all shareholder transactions at a given time. If you have deposited more money than you have taken out, that is a liability to the company. If you take out more money than you have put in, that is an asset to the company. For strictly tax purposes, it is safer for the company to owe you money than you to owe the company money (See next section).
CRA Tax Problems with Shareholder Loans
If a shareholder withdraws money and this money is designated as a shareholder loan, and it is repaid within one year from the end of the taxation year of the company, this amount will not be included in the shareholder’s income. However, if the shareholder fails to repay this amount within one year AFTER the year-end, the full value of the loan is now included in the income of the borrower. The one-year rule helps the CRA prevent business owners from just taking out money as shareholder loans tax free forever.
This is why it is essential from business owners to understand shareholder loan balances. It can help you avoid paying larger personal tax bills and help with tax planning.
Avoiding Shareholder Loan Tax Problems
There are a few ways that this shareholder loan problem can be resolved.
AS A SALARY
Being a shareholder can also mean being an employee of the company. If you have taken money out of the company, you can declare it as a salary. This creates a tax deduction for the company and you now include this amount in your employment income. By doing this you will have to deduct payroll deductions so you won’t be getting the full amount you originally took out as a loan.
AS A DIVIDEND
By simply declaring that the amount you took out was originally a dividend, the shareholder loan goes away. If you decide to declare a dividend, there is no payroll deductions needed but you still need to include the dividend amount as income so you will be taxed personally.
REPAY THE LOAN
This is the most obvious and simplest method of getting rid of the shareholder loan. Just pay it back and be done with it. This avoids tax problems and you won’t be taxed personally for taking it out (if it’s done within the one-year rule).
You can’t, however, repay it at the end of the year and take it out again at the beginning of the year. There are rules the CRA has put into place that take those types of situations into account.
Shareholder loans allows shareholders a ton of flexibility into how they want to withdraw money from their company. It also grants a lot of flexibility into how they can possibly pay it back (or not pay it back). Make sure you always understand where your shareholder loan balance is and what the repercussions are for where it sits.
If you need a more in-depth discussion about anything that we’ve gone over today (shareholder loans, taking a dividend, paying a loan back, etc.) drop us a line. We enjoy going over this stuff.