Essential Facts about Shareholder Loans for Incorporated Small Business Owners

How Can A Shareholder Withdraw Funds From A Corporation

There are three primary ways in which you, as an owner-manager, can  withdraw funds from your corporation.  You can:

1. Pay yourself a salary,

2. Declare or pay yourself a dividend or

3. Borrow money from the corporation. 

You are allowed to borrow money from your own corporation, however, Canada Revenue Agency  (CRA) has put into place strict rules as to when you have to repay the loan to prevent owner-managers from using loans as a means to indefinitely defer personal income taxes on funds withdrawn from the corporation. It is therefore important to account for the money that is borrowed from the corporation and ensure that you pay it back in a timely manner.

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When Must a Shareholder Loan Be Repaid?

When you borrow money from your corporation or lend money to the corporation, the account (unsurprisingly) is called a shareholder loan account. The shareholder loan account is also referred to as:

• Shareholder Loan Receivable to Due From Shareholder

• Shareholder Loan Payable or Due to Shareholder

In this article we are focusing on the shareholder loan receivable or due from shareholder which is when the shareholder loan borrows money from the corporation.

The basic rule for shareholders loans receivable is that they must be paid in the fiscal year following the year in which the loan was taken. 

For example, if your fiscal year end is December 31 and you borrow money in 2023, then it must be repaid before December 31, 2024.  Failure to repay will result in the loan amounts being included in the shareholder’s income in the year in which the loan was taken, which in this case would be 2023. 

The loan must also not be considered to be a series of loans and repayments i.e.Repaying an amount at the end of 2023 only to borrow again in early 2024. 

The best way to clear out a shareholder loan balance is to pay a salary, bonus or dividend.  Since this gives rise to taxable income and eliminates the shareholder loan for the previous year, it is not considered to be a series of loans and repayments. 

What Are the exceptions That Allow Shareholders to Borrow Funds For A Longer Period?

According to CRA, there are exceptions which allow shareholders’ to take out loans for longer periods: 

• If a loan is made in the ordinary course of the corporation’s business eg. they are a financial institution that makes loans as part of their business and as long as the terms of the loan are similar to an unrelated borrower

• Purchase of shares in the corporation or a related corporation (this does not apply to unrelated corporations)

• Purchase of a motor vehicle for use in the employee’s job

• Trade debts i.e. amounts sold by a corporation in the normal course of its business as long as it is on the same terms as other customers. Usually these are settled within 12 months.

• A final exception specifically include the purchase of a dwelling (a house, condo, cottage, mobile home and even a houseboat ) The dwelling does not have to be located in Canada nor does it have to be a principal residence as long as the shareholder dwells in it i.e. rental properties are not eligible nor is the portion of a duplex which is not inhabited by the shareholder. Repairs and improvements to an existing dwelling do not qualify for the exception. However it is important to note that this exception only applies if the same terms are available to all employees of a corporation i.e. all employees may borrow funds from the business corporation to purchase a home. If you are the only shareholder of a corporation, it might be difficult to demonstrate that the same terms apply to all employees and it might be disallowed.
  

Keep in mind that, with respect to loans made to shareholders for the above purposes, a taxable benefit may arise for the shareholder if market rates of interest are not charged on the loans or one of the conditions is not met.

Do You Require a Written Agreement for the Loans?

While a written agreement is the preferable means of establishing that a loan exists, a written agreement is not necessary; however, in its absence there must be convincing evidence that a loan exists. Such evidence could include a corporate resolution setting out the loan, the terms of its repayment and such a corporate resolution should be reflected in the financial statements of the corporation.

Source

In other words, while a written loan agreement isn’t essential, there must be some other evidence showing that the shareholder loan exists. An example of this evidence could be a corporate resolution.

How Do you Account For Shareholder Loans

A shareholder loan account should be created as a current liability on the balance sheet. All withdrawals that are personal in nature should be allocated to this account including cash withdrawals and purchases of a personal nature made through the corporation.

For example: the portion of airline tickets that may have been purchased for a spouse accompanying you on a business trip or the personal portion of telephone expenses would be reflected in this account. This can be offset (reduced) by repayments by the shareholder in cash, or expenses paid personally by the shareholder that relate to the business including gas, repairs, business portion of dues and subscriptions, travel expenses, home office expenses etc.

The total in the shareholder loan account at the year end previous to the current year end, once all transactions have been entered and adjustments reflected, should then be cleared out by declaration of a dividend or by payment of a bonus or a salary. Note that the net amount of the bonus or salary should be sufficient to cover the shareholder loan balance.

What is The journal entry for a shareholder loan receivable (Due From Shareholder)

The journal entry for funds that are taken out of the corporation by the shareholder is as follows:

Debit: Shareholder loan receivable or payable

(it is best to have one shareholder loan account which is either a receivable depending on whether it is more often an asset or a liability)

Credit: Cash/Bank

See my video tutorial above on the various transactions that affect shareholder loans and how to account for them.

It is important for small business owners to understand that, although they may borrow funds from the corporation, they must repay these amounts  by the end of the following fiscal year either via a direct repayment or via salaries or dividends.  If not, the amount of the loan will be included in your income for the year in which the loan was taken, which can result in significant taxes payable as well as interest and penalties.

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