If you own your private corporation and borrow money you should consider the income tax consequences.
The Income Tax Act contains a series of rules that may have income tax consequences for the person receiving the loan from the company. In the context of this article, the term loan means any form of debt the shareholder or family member has to the corporation. The term shareholder should be taken to mean the shareholder of the corporation or members of the shareholders family.
These rules exist to prevent shareholders of private companies from taking out a series of back-to-back loans and avoid personal income tax altogether.
General Tax Rule For Shareholder Loans
The general rule is that your shareholder loan must be repaid within one year from the end of the corporations’ tax year then the loan will not be taxed in your hands.
You may be able to have the loan outstanding for longer that 12 months depending on when the loan was taken out and the corporation’s year end. However, caution must be taken as missing the repayment deadline can have some unwelcome tax consequences.
3 Exceptions To The Shareholder Loan Rules
There are three general exceptions to shareholder loan provisions under the income Tax Act.
1. One Year Rule – As outlined above, if the loan is repaid by the shareholder within the year after the end of the corporations’ tax year, the loan is not included in income.
However, the loan cannot be a series of loans and repayments. On the other hand, if a current loan account is maintained in the corporation for a shareholder during a tax year and the year-end balance is repaid from salary or declared dividends the CRA will generally not consider these transactions as a series of loans or repayments.
2. The Lenders Rule – If the corporations’ business is lending money or the debt is from the normal business activities then the loan is not considered a shareholder loan, provided standard arrangements are made for repayment and are maintained.
3. Principal Residence Rule – If the shareholder is also an employee and a loan is advanced to purchase a principal residence, new shares in the corporation, or a vehicle to be used for business purposes then the loan is not considered income (more details at lendgenius.com). In addition, the loan must be advanced due to employment and not due to shares held and standard arrangements are made for repayment are made and maintained.
Repaying A Shareholder Loan
When the loan is repaid that was previously included in income for tax purposes, it may be deducted from income of the year of payment.
Before you take a loan, be sure to discuss the matter with your accountant. If the loan is not properly structured, the costs of the loan could be substantial.
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The information in this article is for general use only and should not be considered advice or a recommendation.