The first rule of business is to keep your personal and business finance separate. You can withdraw money from the business as salary, dividend, or bonus. You can also withdraw cash through dividends and bonuses to family members who are shareholders in the company. But if you use the company’s funds for personal reasons or use your funds to pay for business expenses, they are recorded under shareholder loan.
Shareholder loans might look attractive initially as it is your company’s money, but they could add to your income tax liability. Hence, small business owners need to understand how shareholder loan works.
How Shareholder Loan Works?
When a small business owner withdraws money from the business, that amount becomes a part of their income and is taxed as per their income slab. What about shareholder loans?
Your accountant may use the shareholder loan account to report the use of corporate funds for personal expenses throughout the year as ‘due from shareholders. In addition, the accountant may adjust any business payments you made from your personal account as ‘due to the shareholder.’ The balance left in the account is adjusted from the salary or dividend.
This method is not tax efficient because you must repay the loan before the company’s financial year ends. In addition, this loan cannot be a series of loans and repayments, which means you cannot repay the 2019 loan on December 31, 2020, only to borrow again in 2021. Therefore, it may trigger a tax implication. Let’s understand how.
How Shareholder Loan Can Impact Entrepreneur’s Tax Liability
The tax rates are different for individuals and corporates. Corporate tax is way lower than personal income tax. Hence, it is tax-efficient to keep the funds in the company and withdraw only the amount you need.
You add that amount to your taxable income when you withdraw money as a small business owner through salary and dividends. But when you withdraw corporate funds for personal use or swipe the business credit card to purchase for yourself, it adds to the shareholder loan account in the current liabilities of the balance sheet. If you do not repay this loan within a year from the end of the corporation’s fiscal year, you will have to add that amount to their income.
Remember, you have to pay interest on the loan as per the applicable market rate. Non-payment of interest is considered a taxable benefit, and you must add the interest amount to your income.
For instance, Joe is flying to the United Kingdom for a business trip. He purchased an airline ticket for his wife for $3,000 from the business credit card and paid $100 for business meals from his pocket. His flight ticket is a business expense, but his spouse’s ticket is a personal expense. Before the end of the financial year, he has to repay $2,900 + interest to the company or add that amount to his income tax. Joe can use his salary or dividends to clear the shareholder loan balance.
But this type of shareholder loan could have repercussions if the company wrongly reports a business expense as a personal expense. In the above example, if the corporation categorizes Joe’s airline tickets as personal expenses, the company would miss deducting $3,000 under business expenses. Joe will have to pay personal income tax on that $3,000.
How Small Business Owners Can Take Out Shareholder Loan For a Longer Duration
Just as you take a loan from a financial institution, you can take a shareholder loan from your company with a formal agreement, loan repayment schedule and interest rate in line with the market rate. Instead of paying interest to a bank, you can pay interest to your company. You can avail shareholder loan for the following reasons:
- Purchase shares in the corporation
- Buy a motor vehicle for company use
- Trade debts
- Buy a principal residence like a house, condo, cottage, or mobile home.
Loans for rental properties, repair and improvement of existing property or buying a property which shareholders won’t occupy do not qualify under shareholder loan.
Taking a shareholder loan needs proper paperwork and proper tracking of transactions to avoid troubles with the Canada Revenue Agency (CRA). A professional accountant and tax consultant can help you use shareholder loan tax efficiently and avoid costly accounting mistakes.
Contact McCay Duff LLP in Ottawa to Help You With Shareholder Loans
A skilled accountant can help you record your business and personal transactions accurately. At McCay Duff LLP, our accounting experts can provide accounting and tax planning services and provide you with recommendations on efficiently withdrawing money from the business. To learn more about how McCay Duff LLP can provide you with tax planning expertise, contact us online or by telephone at 613-236-2367.