Personal Tax -> Shareholder loans
Income Tax Act s. 15(1.2), s. 15(2), s. 80.4(2), s. 110(1)(j), Regulations s. 4301(a),(c)
A loan by a corporation to one of its shareholders, or to a person or partnership who does not deal at arm's length with the shareholder, may result in a deemed taxable benefit to the shareholder.
If a person or partnership is:
and because of that shareholding, the person or partnership received a loan or incurred a debt to:
then under s. 15(2), the loan amount will be included in the income of the person or partnership for the year in which the loan is made, except in certain circumstances. S. 15(2) does not apply if the entire loan is repaid within 1 year after the end of the taxation year of the lender, as long as the repayment was not a part of a series of loans or other transactions and repayments. See IT119R4 (Archived) for more exceptions, including some loans made for specific purposes. See Mazzaferro v. The Queen, 2019 TCC 147 regarding a loan to a person not dealing at arm's length with the shareholder. This is discussed in the September 2019 Life in the Tax Lane video.
Another benefit will be deemed to have been received by the shareholder under s. 80.4(2), unless interest has been paid on the loan in an amount greater than or equal to interest calculated at the prescribed rate. The payment of interest must be made no later than 30 days after the the end of the year. If the entire loan is repaid before the end of the year, any unpaid interest will still be a deemed benefit under s. 80.4(2) if it is not paid within 30 days after the end of the year.
There will be no taxable benefit related to the interest on any debt or loan on which it is reasonable to conclude that the rate of interest is the same as or greater than that which would have been agreed upon by parties dealing at arm's length, having regard to all the circumstances, including the terms and conditions of the debt.
The prescribed interest rates are set quarterly, and can be found on the Canada Revenue Agency (CRA) prescribed interest rates web page. The prescribed interest rate for shareholder loans was 1% from April 1, 2009 until March 31, 2018, except for October 1 to December 31, 2013, when it was 2%. It was again increased to 2% effective April 1, 2018. The prescribed rate was reduced effective July 1, 2020, to 1%.
Based on the average yields for 3-month treasury bills sold at auction in October 2020 (1/10th of 1%), the rate will remain at 1% for the 1st quarter of 2021 starting on January 1st. The rate can't go below 1% because it's rounded up to next higher whole percentage.
Shareholder Loan Example
Mr. X is a shareholder of Corporation Y, which uses the calendar year for its taxation year. On January 1, 2019, Mr. X is loaned $100,000 by the corporation. No principal repayments or interest payments are made on the loan in 2019.
If Mr. X repays the loan by the end of 2020, then the $100,000 will not be a deemed benefit (in 2019), as long as the repayment is not part of a series of loans or other transactions and repayments.
Depending on the interest rate paid by Mr. X compared with the prescribed interest rate for shareholder loans, there may be a taxable benefit under s. 80.4(2) of the Income Tax Act.
Using the prescribed interest rates, the loan interest from January 1 to December 31 2019 would be $1,000, calculated as:
$100,000 x 2% x 365/365 = $2,000
Assume Mr. X paid $1,000 of interest on the loan, on Jan 3, 2020 (within the year or 30 days thereafter):
$100,000 x 1% x 365/365 = $1,000
The result is a taxable benefit in 2019 to Mr. X of $1,000 ($2,000 less $1,000).
If Mr. X did not pay any interest within 30 days of the end of 2019, then the taxable benefit would be $2,000.
If the loan is not repaid in full by the end of 2020, then any unpaid portion will be included in Mr. X's income for 2019.
Change in relationship
A loan received by a shareholder can continue to result in a taxable benefit under s. 80.4(2), even if the recipient of the loan is no longer a shareholder.
Interest expense deduction re shareholder loans
If the proceeds of the shareholder loan were used to produce income from business or property, the amount of interest included as a taxable benefit can be included as part of an interest expense deduction.
Forgiven shareholder loans
If the loan or debt to a shareholder is forgiven, the forgiven amount will be included as income in the shareholder's hands in the year of forgiveness, as per s. 15(1.2) of the Income Tax Act.
Loans to shareholder-employees
When s. 80.4(1) applies regarding an employee loan, the benefit is always included in the taxable income of the employee, even if the actual recipient of the loan is a third party, such as the employee's spouse. This treatment can also apply to loans to a corporation carrying on a personal services business. The personal services business corporation will be considered an employee for purposes of s. 80.4(1).
When s. 80.4(2) applies regarding a shareholder loan, the benefit is always included in the taxable income of the actual recipient of the loan.
If the shareholder is also an employee, an examination of the facts would be required to determine if the debt was incurred by virtue of employment, or by virtue of shareholdings. For instance, if a corporation has other employees to whom it does not make loans, it would appear that the loan is a shareholder loan.
Tracking shareholder loans
When advances or loans are made to shareholders this should be recorded in a general ledger account set up for this purpose. If a loan is made for which the interest would be tax deductible for the shareholder, it is important to track this loan separately from other advances or loans.
Converting a shareholder loan to employment income or dividends
Sometimes funds are advanced to a shareholder/employee throughout the year, and at the end of the year salary or dividends are paid or recorded to clear the balance of the shareholder loan. A deemed benefit under s. 80.4(2) will still apply if insufficient interest is paid for the period during which the shareholder loan was outstanding.
Care must be taken in the timing of salary or dividend payments to clear shareholder loans.
If a corporation has a December 31st year end, then for the shareholder loan to be cleared by a payment of salary, the salary payment must be made, or recorded in the books of the corporation as having been paid, in December. Income taxes, and any applicable employment insurance or Canada Pension Plan contributions must be remitted based on the remittance due date of the employer, which will either be the 10th or the 15th of January for salaries paid or recorded from the 22nd to the 31st of December. A payment by cheque is not necessary, but only the net amount of the salary amount can be used to offset against the shareholder loan balance.
If a dividend payment is made to the shareholder in order to clear the shareholder loan, this payment must be made, or recorded in the books of the corporation as having been paid, in December in order to clear the shareholder loan balance for a December 31st year end. T5 information slips must be filed no later than the end of February. Dividends, of course, are not a deductible expense for the corporation.
If a bonus to the shareholder is accrued for year end, but the bonus is not paid or recorded as having been paid prior to the end of the taxation year, it will have no effect on the outstanding shareholder loan until it is actually paid. Any bonus accrued for year end must be paid within 180 days of the taxation year end. This can be done by recording a payment of the bonus by a debit to the "bonus payable" general ledger account and offsetting credit to the shareholder loan account, which would be reduced by any withholdings for income tax and CPP. These withholdings must be remitted to CRA. Otherwise the bonus will not be deductible in the year it was accrued. If it is paid after the 180 days, it will be deductible in the taxation year in which it is paid.
Keep in mind that a loan from the corporation to the shareholder is considered an asset of the corporation. If the amount of the loan is significant, it could put a small business in a position where it is not a qualified small business corporation, and thus not eligible for the $800,000+ lifetime capital gains exemption for the shareholder, on disposal of the shares.
Canada Revenue Agency (CRA) ResourcesIT119R4 (Archived) Debts of shareholders and certain persons connected with shareholders
IT421R2 (Archived) Benefits to individuals, corporations and shareholders from loans or debt
To keep things simple, make sure loans to shareholders are not outstanding past the year end of the lender corporation.
This can be complicated, and professional advice is recommended!
Revised: October 28, 2020
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