It is no secret that the Canadian interest rate is skyrocketing by the day. Taking out a loan from your corporation or loaning money to your corporation is an appealing option. You can borrow or lend money at a low or no interest rate.
The shareholder loan or “shareholder advance,” as it is known, is appealing. But before your leverage it, there are a few important details to know, especially associated tax impact and implications.
Shareholder advance is a good way to tackle certain situations but may be flawed in some situations. When you want to decide to take out a shareholder advance, here are a few things to know.
Shareholder Advance
In simple terms, shareholder advance is the money you loan to your corporation or money you withdraw from your corporation. When shareholders are paid, they are paid through salary or dividends. Any money you take from the company that is not under salary or dividend can be considered a shareholder advance.
What to know
According to the Income Tax Act, a shareholder can take a loan from the corporation and not report it as personal income on their personal tax return for that fiscal tax year.
The shareholder is expected to return the loan to the corporation before the end of the next fiscal tax year. That way, the loaned amount will not be taxed.
According to CRA (Canada Revenue Agency), for the loan not to be considered income, the corporation must charge interest at a given rate to the shareholder who takes out a loan.
When taking out a shareholder advance, it is also important that all agreements are well-written and documented. Also, the terms of repayment should be well documented. Proper documentation helps you avoid any problems at tax time.
How shareholder advance is used
Owner Cash Withdrawal
One of the ways the shareholder advance is used is when the owner (shareholder) withdraws money from the corporation. If the money is not categorized as a dividend or salary, it becomes an advance to the shareholder from the corporation.
It can also be referred to as “due from shareholder.” The amount becomes a due the shareholder owes the corporation.
Owner Cash Contribution
This is the direct opposite of the “due from shareholder.” When a shareholder deposits money to the corporation to cover certain expenses, it can be regarded as the owner’s contribution. It means that the shareholder has loaned the money to the corporation. And the corporation is expected to refund the money later.
It can be referred to as “due to shareholder.” That is because the corporation has a due to pay the shareholder.
Buying A Personal Item
Another way a shareholder advance can be classed is when a Shareholder uses company funds to purchase a personal item. These items can include a principal residence or a vehicle.
Benefits Of A Shareholder Advance
With the shareholder advance, shareholders can withdraw the money from the corporation without activating any tax liability. It gives room for more planning opportunities.
Tax Income Impact of Shareholders Advance
If the loan balance is not repaid within the stipulated time, the outstanding will be included in the shareholder’s taxable income. Meaning they must pay income tax on it.
If the initial loan weren’t charged at any interest rate, the given interest rate would be added to the taxable income.
Tax Implications of Shareholder Advance
The most important shareholder advance implication to know is the repayment rule.
Repayment rule: The repayment rule allows shareholders to avoid adding the loan amount to their taxable income. That is, if they can repay the loan before the end of the corporation’s fiscal tax year.
Exceptions To The Shareholder Loan Rules
You can take out a loan without the fiscal tax year time constraint if you buy a vehicle for the corporation’s use or buy a residential home. Even with this exemption, there must be a proper repayment plan with a viable timeframe.
Also, as a shareholder, you can avoid the fiscal tax year time constraint if your company is involved in the loan business. The shareholder advance can be taken out like the regular loan given to any other customer. Provided the shareholder advance has similar terms to that of a regular borrower, you won’t run into any tax issues and can avoid the fiscal tax year time constraint.