If you are the owner-manager of a corporation, understanding the concept of the shareholder loan is essential to running your business. Below I will explain what a shareholder is and how to use it. After reading this article you will become familiar with potential tax-traps and how to avoid them.
I will discuss the following topics:
- What is a shareholder loan?
- What are the tax implications of the shareholder loan and how to use it to your advantage?
- How to avoid problems with the CRA
What is a shareholder loan?
In general, the balance of your shareholder loan represents the total owner cash draws from your company minus funds you have contributed.
Your shareholder loan will appear on the balance sheet as either an asset or liability. If you contributed more cash into your company vs. what you draw out, the shareholder loan will be a liability on the balance sheet. When your owner cash draws exceed contributions, the shareholder loan will be an asset on the balance sheet.
There are various types of transactions that will affect the shareholder loan account. Below are a few examples.
CASH CONTRIBUTIONS
If the shareholder deposits cash into the company bank account, this money can be repaid to the shareholder tax-free at some point. The company owes the shareholder this money and the balance will appear as a liability on the balance sheet called “due to shareholder.”
PAYING FOR COMPANY EXPENSES WITH A PERSONAL CREDIT CARD
It is common for owner-managed companies to pay for company expenses with a personal credit card. This type of transaction is treated like a cash contribution. The company gets a tax deduction and the shareholder can be reimbursed at some point.
CASH WITHDRAWLS
If an owner draws cash from the company bank account which is not dividends or salary, they are considered a shareholder loan and debt owing to the company. The total draws will appear as an asset on the balance sheet called “due from shareholder.”
PAYING FOR PERSONAL EXPENSES WITH COMPANY FUNDS
We often see owners of the company pay for some interesting things using their company funds. For example, a family trip to Mexico paid for on the company credit card is not tax deductible. When this happens, and it happens quite often, the transaction is treated like a cash withdrawal. The company cannot deduct the expense and the amount will become a debt owing back to the company. We advise all our clients to pay for personal expenses with a personal credit card. By doing so, you will have accurate bookkeeping records and spend less time explaining questionable transactions to your accountant or bookkeeper.
What are the tax implications of the shareholder loan and how to use it to your advantage?
Many clients ask, “how do I pay myself from the company? and the answer is dividends or salary. However, you do not have to designate cash draws as a dividend or salary until fiscal year-end. In the meantime, you treat cash draws as a shareholder loan.
In many start-up companies, the owner puts more cash into the business vs. what they take out. Therefore, the running balance of the shareholder loan at fiscal year-end has a credit balance and appears as a liability on the balance sheet. Meaning, the company owes the shareholder money. If this is the case, the owner does not have to declare any draws as dividends or salary and the balance of the shareholder loan at year-end can be taken out of the company tax-free.
If the running balance of your shareholder loan is in a debit position, which appears as an asset on your balance sheet, you typically declare the amount as dividends or a salary. Depending on your specific tax situation and business/personal goals, dividends or salary or a combination of both will be discussed with your CPA to determine what method is best for you.
Shareholder loans provide opportunities for tax planning. At Argento CPA, we will assess your tax situation to determine the timing of dividends or salary that will minimize the amount you pay for personal and corporate tax combined.
How to avoid problems with the CRA
You may be thinking, “why don’t I repay the shareholder loan right before fiscal year-end, then borrow it again in the new year?” CRA is aware of this technicality and placed rules to prevent you from doing this. So, do not even think about trying it!
There is one final option if you owe your company money at the end of the year. You have one year from your fiscal year-end date to pay it back. This can be repaid as a direct repayment, salary, or dividend. Be careful doing so since your shareholder loan will be reported to CRA as an asset on your balance sheet at fiscal year-end. By reporting your shareholder loan as an asset on the balance sheet for 2 consecutive years in a row, you signal a red flag to CRA that you may not have included your shareholder loan as personal income.
Summary
The shareholder loan is a useful tool for tax planning and cash management between the owner and their company. If used correctly, the timing of cash draws, dividends or salary can be used to your advantage.
If you are looking for expert advice on shareholder loans, contact us today. We will get an in-depth understanding of your specific situation and make sure you are set for success!
Discuss your specific needs and challenges. Book a one-on-one strategy session with our experts today!
