Quarter 1 - 2002 CABusinessAdvisor.com Newsletter
Keith Anderson, BComm, CA∑IT
10260 112 Street
Edmonton, AB T5K 1M4
Phone: (780) 447-5830
Loans From Your Corporation May Be Taxable
If, as an owner/manager or shareholder, you are considering making loans to yourself from your company, it is imperative to talk to your Chartered Professional Accountant. If the loan is not properly structured, the costs may be more than you bargained for. Employees and owner/managers often receive loans from their employers/companies. However, because these loans are not always tax-free, you may inadvertently trigger some very adverse income tax consequences.
If the loan is interest-free, or bears interest at less than CRA's prescribed interest rate, there is a taxable benefit for the difference between the prescribed rate and the amount of interest paid on the loan. To reduce the benefit, you must pay the interest (preferably with a personal cheque) within 30 days from the end of the year.
Shareholder Loan Rules
If the person receiving the loan is also a shareholder, this interest benefit is usually a minor concern. The Income Tax Act contains rules that prevent certain shareholders from receiving loans from their companies. Fundamentally, the purpose of the shareholder loan rules is to prevent shareholders from withdrawing funds from their company without paying taxes. If these rules were not in place, shareholders would continuously advance funds to themselves in the form of loans and never repay them. These loans would, in effect, be tax-free, thus eliminating the personal tax required to be paid on salary or dividend payments.
Loans Repaid in One Year
A loan that is repaid within one year from the end of the corporationís taxation year in which it was made is not taxed in the hands of the recipient. If the entire loan has been included in the individualís income, any interest benefit included in a previous yearís income should be reversed. Otherwise there is double taxation, once for including the loan in income and again for the taxable benefit. Many owner/managers are not aware that if the loan is included in income they can receive a deduction for subsequent repayments. However, if the loan and repayment are considered as a "series of loans and repayments," CRA not allow the deduction. This latter rule generally applies when the shareholder only made a temporary repayment of the loan with borrowings occurring again shortly thereafter.
The rules have allowed corporations to loan money to individual shareholders in certain limited cases.
Non-taxable loans include those made:
With the exception of loans made in the ordinary course of business, the borrower must also be an employee of the corporation. In addition, each of these loans must have bona fide arrangements for the repayment of the loan within a reasonable time and the loan must be received by virtue of the individuals employment and not because of the individuals shareholdings. In other words, to qualify for non-taxable status, similar loans must be made available to other employees who are not shareholders or related to shareholders. In cases where the shareholder is the sole employee, this may be impossible to substantiate. In these cases it is imperative that proper planning with your Chartered Professional Accountant be implemented.
These rules can be used to your advantage. In some cases, it may make sense to loan funds to your adult children to be used for post-secondary education. Your children would include the loan into income in taxation years where their tax bracket rate is very low. When your children repay the loan, the amount repaid becomes a deduction on their personal tax return. Usually, this is done in taxation years where your children are in a high tax bracket rate.
Careful planning with a Chartered Professional Accountant is warranted. Contact Keith Anderson, BCom, CPA, CA-IT, CITP at (780) 447-5830 if you need advice.