Owning a corporation allows business owners to plan taxes and use money most efficiently. A corporation is a separate legal entity from the owner. As a business owner, you can withdraw money from the business as a shareholder or as a salary in the capacity of an employee. In both cases, you pay personal income tax on these withdrawals. However, there is a third way that can help you withdraw money from the business temporarily without any tax implications. This way is shareholder loans.   

Understanding how shareholder loans work is essential for harnessing and making the most of their power.

How Do Shareholder Loans Work in Canada?

There are two ways business owners can use shareholder loans:

  • “Due to Shareholder” where you give a loan to the company
  • “Due from Shareholder,” where you take a loan from the company 

The workings of both loans are very different. Let us first understand the easy one.

Due to Shareholder

A business might need additional funding for a new project or to pay suppliers. In these cases, the owner might inject their savings into the industry as a loan, and the shareholder becomes the creditor. The company will record this inflow on the liabilities side as due to Shareholders.

This transaction has no tax implication, and the company can repay the loan to the shareholder tax-free. However, any interest paid by the company to the shareholders is taxable in the hands of the shareholders. 

No hard and fast rule exists on when the company should repay the loan. If the company doesn’t repay, you can forgive the shareholder loan and write it off. In such a scenario, the money injected into the business would be considered an investment, not a loan. And investment is subject to losses.

Due from Shareholder

Just as shareholders can loan money to the corporation for business purposes, they can also borrow money from the corporation for personal reasons. The company will record this outflow on the assets side as Due from Shareholders.

This loan will have no tax consideration for up to one year. During this year, the shareholder must repay the loan in full to avoid tax implications. For instance, a shareholder who takes a loan in July 2023 has to repay it by June 30, 2024. The interest paid on the loan is taxable.

If the shareholder fails to repay the loan, they must report the outstanding loan amount as taxable income in their income tax return and pay the corresponding tax. However, if the shareholder repays the loan later, they can deduct the repayment amount from their taxable income in the year the loan was repaid. But if they repay the loan and then take another loan, this deduction will not apply.

If a shareholder doesn’t repay the loan within a year, the company can forgive the debt and write it off in its books. A forgiven loan becomes the shareholder’s taxable income.  

Exceptions To Shareholder Loans

However, there are a few exceptions to the shareholder loan tenure. A shareholder can take out a loan for a more extended period,

  • If the company is in the business of giving loans
  • If the loan amount is used to buy a motor vehicle or house.

In both scenarios, the loan should have a legitimate repayment plan with a reasonable time frame.

Things Shareholders Should Consider When Taking a Loan from a Corporation

Shareholders can use this loan facility to access low-interest or no-interest cash to invest in real estate, stocks and other ventures to earn money. They can repay the loan from these earnings or skip repaying the loan and realize that money as taxable income in the tax returns.

However, you should ensure the shareholder loan is well-documented with a detailed loan agreement stating the loan amount, terms, and conditions. 

The Canada Revenue Agency requires corporations to give shareholder loans at the interest rate prescribed in the Income Tax Act. If no or low interest is charged, the CRA may impute interest at the prescribed rate and impose tax on it. 

Shareholder loans are a powerful tool if planned and documented correctly. 

Contact Black and Gill LLP in Etobicoke to Help You Use Shareholder Loans

A professional accountant can help you document and record shareholder loans effectively and maximize this tax-free limited-period cash flow. At Black and Gill LLP, our accountants and tax consultants can provide services such as planning, accounting, and documenting business transactions tax-efficiently. To learn more about how Black and Gill LLP can provide you with the best accounting and tax planning expertise, contact us online or call us at 416-477-7681.