The Benefits And Risks Of Your Shareholder Loan Account
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What Is A Shareholder Loan Account?
A shareholder loan account tracks money borrowed from or lent to a company's shareholder. Balances can be either payable to the shareholder (if the company owes money) or receivable from them (if the shareholder owes the company).
Basics Of A Shareholder Loan Account
A shareholder loan account tracks things such as the shareholder paying for business expenses, the business paying for personal expenses, draws to the shareholder during the year, and contributions the shareholder makes to the business.
If the shareholder loan account is in a credit balance (liability on the company balance sheet) it means the shareholder can withdraw this amount from the corporation on a tax-free basis as it was contributed to the corporation with after tax dollars, which prevents double taxation.
However, if the shareholder loan account is in a debit balance (asset on the company balance sheet) it means that either the shareholder needs to repay the balance to the company or receive it as income on their personal tax return by having the company issue a T4 or T5 to the shareholder.
It is important to remember that tax still needs to be paid on draws from the corporation, so shareholders should take this into consideration and plan for taxes when drawing money out of the corporation during the year.
Rules And Exceptions Of Shareholder Loans
Section 15(2) of the Income Tax Act (ITA) states that the amount of the loan must be included in computing the income of the person (shareholder or someone that does not deal at arm's length with the shareholder) in the year the loan was received. However, there are some exceptions to this rule, some of the more common exceptions are listed below.
- Any loan to an employee shareholder of the company as long as they are not a specified employee of the company. A specified employee is someone who does not deal at arm's length with the company, such as a shareholder that owns 10% or more of the issued shares or a family member of the shareholder. ITA section 15(2.4)(a)
- Where the loan is to an employee of the company or their spouse or common law partner for the purpose of acquiring a home. ITA section 15(2.4)(b)
- Where the employee receives a loan for purchasing previously unissued fully paid shares of the capital stock of the lending company or a company related to the lending company. The shares are to be held by the employee for the employee's benefit. ITA section 15(2.4)(c)
- Where the loan is to an employee of the company for the purpose of acquiring a vehicle to be used in performing their duties as an employee. ITA section 15(2.4)(d)
- This is the most common exception. The shareholder loan is repaid within one year of the end of the fiscal year the loan was taken. ITA section 15(2.6)
- It is important to note that paying the loan back at the end of the fiscal year then taking out a new loan in the same amount at the beginning of the new fiscal year does not satisfy this requirement. This is considered a series of loans or other transactions and repayments by CRA and is viewed as a continuation of the original loan. Issuing a T4 or T5 to clear the balance in the shareholder loan account is not considered a series of loans or other transactions and repayments.
It is very important that an agreement is prepared with details of the interest and repayment terms of the loan and that the repayment is within a reasonable period. A reasonable period would be comparable to what an arm's length borrower could obtain from a lender for a similar loan. Otherwise, CRA could deem this loan to be income in the hands of the borrower in the year it was issued.
In addition, if a shareholder takes a shareholder loan for any of the exceptions in ITA 15(2.4) it needs to be in their capacity as an employee. This means that all employees would need to have access to these benefits for the shareholder to be able to receive these types of loans. If employees don't already have access to these benefits, it makes it difficult to prove that the shareholder is acting in the capacity of an employee.
The following table shows how ITA 15(2.6) works and when ITA 15(2) comes into effect.
Notes:
(1) The shareholder loans the company money in the first year in business. When the shareholder loan is in a credit balance the shareholder can withdraw this amount without tax implications as it was loaned with after tax-dollars.
(2) In 2021, the shareholder withdraws $20,000 from the company leaving the shareholder loan account in a debit balance at the end of the year. There are two options here, the shareholder can be issued a T4 or T5 for $15,000 to clear out the debit balance, or it can be left as a debit balance and be paid back to the company in the following year, or a T4 or T5 can be issued in 2022.
(3) In 2022, the shareholder withdraws another $10,000 from the company increasing the debit balance at the end of the year to $25,000.
(4) Even though the debit balance has increased to $25,000 in the second year, only $15,000 of the debit balance is from the prior year, therefore only $15,000 needs to be either paid back by the shareholder in 2022 or have a T4 or T5 issued for $15,000 that would be reported on the shareholders 2022 personal tax return. This would satisfy ITA 15(2.6), and ITA 15(2) would not come into effect.
If, at the end of 2022, the shareholder didn't pay back $15,000 and didn't report the $15,000 as income on their 2022 personal tax return either as a T4 or T5, then ITA 15(2) comes into play as the loan no longer meets the exception in ITA 15(2.6). The shareholder would need to amend their 2021 tax return and include $15,000 in employment income. This would result in additional taxes for that year as well as interest on the tax that wasn't paid. Additionally, the company would not be allowed to deduct the $15,000 as an expense in 2021, which results in double taxation.
ITA 20(1)(j)
If the shareholder loan is repaid after 15(2) has come into effect, and it has been included in income the year the loan was taken, then ITA section 20(1)(j) states that the shareholder can include the repayment as a deduction of income in the year the repayment was made.
If the repayment isn't a series of loans or other transactions and repayments, then the repayment can be reported on line 23200 of the shareholders personal tax return in the year of repayment.
Interest On Shareholder Loans
Loans From A Shareholder
If a company borrows money from the shareholder and the loan is in a credit balance these are typically interest-free loans.
However, if a shareholder wants to charge interest to the company, there should be an agreement in place that details the interest and repayment terms. In this case, interest expense would be recorded in the company, and interest income would be reported on the shareholders personal tax return.
Loans To A Shareholder
ITA 80.4(1) states that when there is a loan to a shareholder, interest needs to be paid by the borrower on the loan. The interest rate is the prescribed interest rate (5% per year as of Q2 2023) posted by CRA at the time the loan is made. The interest payment needs to be paid within 30 days of the end of the year, or it becomes a taxable benefit to the borrower.
For example, if a shareholder took a $10,000 loan from the company on January 1, 2020, and were still outstanding on December 31, 2020, the interest charged on the loan would be:
$10,000 x 1% x (366/366) = $100
Taxable benefits would be reported as follows:
- Employees that receive a taxable benefit have the benefit reported using code 36 on a T4 slip.
- Shareholders that receive a taxable benefit will have the benefit reported in box 117 on a T4A slip.
If a loan is greater than 5 years, the prescribed interest rate at the beginning of the loan is used for the first 5 years and is then updated to the prescribed interest rate in effect after each 5-year period.
How The Shareholder Loan Account Can Affect The Lifetime Capital Gains Exemption (LCGE)
The LCGE allows an exemption of capital gains tax on the sale of a qualified small business corporation. The exemption for 2023 is $971,190 (2022 was $913,630).
One of the eligibility requirements for the LCGE is that at least 50% of the fair market value of the company's assets were used in an active business, primarily in Canada, for 24 months prior to the sale of shares. This means that a shareholder loan account in a debit balance over the two years prior to the sale could potentially disqualify a shareholder from claiming the LCGE and cost thousands or even hundreds of thousands of dollars in additional tax when they sell their corporation.
Frequently Asked Questions
What type of account is a shareholder loan?
A shareholder loan account is a balance sheet account.
Is a shareholder loan a liability or an asset?
If the shareholder owes the company money, it appears in the assets section. If the company owes the shareholder money, it shows up in the liabilities section.
When does a shareholder loan have to be repaid?
In Canada, a shareholder loan taken from a company should ideally be repaid within one fiscal year to avoid tax implications. If not repaid within two consecutive year-ends, the Canada Revenue Agency (CRA) may consider the loan a taxable benefit and need to be reported on the shareholders' personal tax return.
Summary
Shareholder loans are great for meeting the short-term financing needs of a shareholder. They can borrow at low-interest rates and have time to either pay back the loan or include it as income on their personal tax return either in the year of borrowing or the year after. However, shareholders must be careful when loans are taken for specific purposes.
Eligibility criteria must be met, and documentation must be in place to ensure the loans are valid and acceptable to the CRA. A shareholder loan that is not maintained by either repaying the loan on time or having the shareholder report withdrawals on their personal tax return could cause the company and shareholder(s) significant and unnecessary tax implications.
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Disclaimer
This article does not fully go into detail about all circumstances of the shareholder loan but provides an overview of some of the more common situations that arise. As each shareholder loan is unique, an accountant should be contacted to discuss your situation.
