Saturday, April 21, 2012

Shareholder Loans - treatment by Canada Revenue Agency

Shareholder Loans

It has been widely common for the business owners to use their sole manager/director status to simply take funds for living from the corporation. Or, make the corporation pay for their personal expenses like home renovation or visa bills. Not wishing to declare it as personal income, but rather say that it was a loan that will be paid back later. On the other hand, the employed person would have paid those same expenses from his/her personal salary. It is obvious that the difference between those two would be that the employee has paid personal taxes, pension and employment insurance contribution, before receiving his/her net pay. Therefore, on average, 100k annual salary will give you a 60k net pay. The business owner, taking money directly from the business bypasses the source deductions, and receives access to the whole 100k. By The CRA rules, simplistically stated, If the company earns 250k net, and then pays the salary 100k, has 150k net income and needs to pay tax on 150k (16.5% for small business in Ontario). Then the person receiving 100k salary needs to pay personal income tax.(40-45% or more), and that is precisely what the average business owner is reluctant to do. For the same reason the CRA has concentrated its attention and developed a sophisticated set of laws and regulations to help enforce tax law in that area.

In particular, Section 15 of the Income Tax Act (ITA) outlines the CRA's position on loans advanced to shareholders/directors. The idea is that any benefit provided by the company to the shareholder/director shall be included in his/her taxable income. S. 15(2) deals with "shareholder debt" saying that where the shareholder, or any person connected to the shareholder received a loan "amount of loan or indebtedness is included in computing the income for the year of a person";

There is, however, a gesture of goodwill on the part of the ministry, saying in 15(2.6), that the above does not apply when "loan or indebtedness repaid within one year after the end of the taxation year of the lender" if it can be seen that " the repayment was not a part of series of loans or other transactions and repayments"

Home Purchase Loan

There might have been a home purchase loan from your corporation, that is allowed by the CRA, for the term of 5 years, with the renewal option. Should be" acquired for the sole purpose of acquiring right to inhabit a dwelling where the dwelling is for the habitation of

(a) the individual by virtue of office or employment the loan is received or the debt is incurred

(b) specified shareholder of the corporation by virtue of whose services the loan is received or the debt is incurred, or

(c) a person related to a person described in (a) or (b)"

Saying therefore, that you must be an employee or a shareholder, providing actively services to the corporation.

The loan must bear interest, and its principal does not have to be included in income of an individual, for the amount not exceeding what was actually paid for residence purchase during the year. S. 80.4(1); 80.4(7). The loan must be taken for the term not exceeding 5 years, and the "prescribed" interest rate must be paid.

Automobile purchase loan option is also available, shall it be received for the reason of employment, as opposed to shareholdings.

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