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Tax Benefits of Shareholder Loans

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Inclusion isn’t all upside down when it comes to taxes. As in most areas of Canadian law, corporations and their shareholders operate as separate individuals for tax purposes. The Canadian Tax Code devotes a lot of space to try to achieve “integration,” a principle that the same activities should be taxed equally regardless of whether or not they are conducted through a company. For example, company directors, who pay all business profits as salaries or dividends, end up in tax accounts very similar to what they would have if they ran the business in person.

While the integration can provide significant opportunities to defer taxation or income distribution for several years, taxpayers who are late or do not keep their records may eventually pay tax on all of their corporate and individual income. While the skillful use of incorporation can allow people to defer taxes and protect their assets, incorporation is not the other way around.

Section 15 of the ITA deals with certain transactions between companies and their shareholders – including loans and shareholder benefits – that companies should keep in mind when managing their finances.

Shareholder Loans

Corporations maintain an account that records loans to and from their shareholders. If at the end of the year, the shareholder owes the company money, the shareholder must claim that amount as income. However, if the shareholder repays the loan in the future, he may request a deduction for the same amount under paragraph 20 (1) (j). If the shareholder repays the loan before the end of the year, they may also be required to include interest on their income if they have received a reduced-rate or interest-free loan.

By keeping a record of payments and keeping an eye on interest, you must keep your documents to a bookkeeper and you know also that shareholder loans can be an effective tool to compensate shareholders, where the loan balance is declared as a dividend throughout the year.

Shareholder Benefits

However, shareholder benefits should almost always be avoided. If a company grants a “benefit” to a partner other than those that involve the use of specifically authorized instruments such as dividends, salaries and loan repayments, the shareholder must include the value of that benefit in his or her income. The “benefit” is deliberately broad, including, among other things, shareholders who take money from the company, do not pay for the company’s services, or let the company cover their own personal expenses. As for the company, it cannot claim an adequate deduction – which results in “double taxation”. Accounting firms can help you achieve everything that can save you more.

The Excise Act, the legislation governing GST / HST in Canada, contains similar rules to limit self-employed shareholders. If so, the company may be required to pay sales tax, even if it never collects it from its shareholders.

A typical example of this problem is a tightly controlled company that pays the expenses of its shareholders. If the company is verified, the CRA is likely to reject not only the expenses requested by the company but also value the same amount of the shareholder benefit. As a result, both the company and the shareholder pay tax on the costs. You should contact an accountant for more information and benefits.

Where the CRA monitors small businesses to assess whether they have reported all their income, this second level of tax can make a huge difference, especially since penalties are also taken into account. For example, if a director reports that his company pays him $ 95,000 in salary in a given year, the CRA can audit the company and determine that his revenue has not been sufficiently reported by $ 50,000. For businesses in Ontario and a resident, the tax document collects 37.16% federal and individual provincial tax combined with 12.5% ​​corporate income tax (49.66% total). In addition, the CRA can impose a fine of 50%, resulting in a tax rate of 74.5%. With HST and GST gross negligence fines, adding another 16.25%, the CRA would collect a combined tax of more than 90% of the price of the undeclared sales sticker! The CRA can then use the same transfers of corporate assets to its operators to justify the transfer of all this tax to them personally.

These additional tax layers also increase the resources and time needed to counter any assessment; although some or all of them can be resolved jointly, the taxpayer must still file several objections or appeals in court.

Therefore, the companies involved should be especially vigilant in keeping airtight books and records. For example, keeping detailed sales records with numbered items can prevent unannounced income checks, while keeping a record of who had a business lunch and who they talked to can prevent both unauthorized food and entertainment expenses and personal judgment.

Taxpayers who want to minimize taxes may notice the frequent and often promoted use of corporations by wealthy Canadians to save taxes. They might consider buying a cottage or other property through a company, believing that this could limit their exposure to capital gains tax on the sale of their property. However, owning property for personal or semi-personal use under a company name can mean both for the benefit of the shareholders (use of the house without rent) and for the alleged income for the company, which will create a tax document for both companies and a shareholder with no significant benefit.

Conclusion

Aside from the risks of double taxation, in certain circumstances, companies could simply lose their tax advantages. For example, companies called “personal service firms” may require various expenses available to other firms.

If you are considering integrating your business and hope to do so tax efficiently, or if CRA is threatening to evaluate shareholder benefits, contact a reliable tax consultant and have all your concerns addressed.

Salman Rundhawa
Salman Rundhawa
Salman Rundhawa is the founder of Filing Taxes. Salman provides valuable tax planning, accounting, and income tax preparation services in Toronto, Mississauga, Oakville, and Hamilton.

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