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Employee/Shareholder Loans
Employees and owner/managers often receive loans from their employers or companies or otherwise become indebted to them. While most times these loans can be very beneficial, other times they may inadvertently trigger adverse income tax consequences. To avoid tax surprises for your 2004 filing, make sure your loan is properly structured.
Employee Loans If you receive a no-interest, low-interest or any other loan from the company that employs you, you are deemed to have received a taxable benefit for that year. The benefit is added to your taxable income based on the Canada Revenue Agency’s (CRA) prescribed interest for the period the loan was outstanding, less any interest paid by you before 30 days after the end of the year, i.e., by January 30th of the following year.
If the company provides a home purchase loan or a home relocation loan, the amount of the benefit is the lesser of the prescribed interest rate for the current period and the prescribed interest rate at the time the loan was made. In this case, the loan is considered a new loan after five years. In addition, the benefit on the first $25,000 of a home relocation loan is deductible in arriving at taxable income for up to five years if you moved at least 40 kilometres closer to your new work location and the loan was used to purchase a house.
Shareholder Loans If you are also a shareholder of the company, you must consider the tax implications of the shareholder loan rules in the Income Tax Act in addition to the taxable benefit for low-interest loans discussed above.
The purpose of the shareholder loan rules is to prevent shareholders from continuously advancing funds to themselves in the form of loans with no intention of repaying them. If these rules were not in place, the loans would, in effect, be tax-free and a means to eliminate the shareholder’s personal tax liability on salary or dividend payments.
Repayment of Shareholder Loans Like most owner/managers, you are likely aware that if your shareholder loan is repaid within one year from the end of the corporation’s taxation year in which it was made, it is not taxed in your hands.
However, did you know that it is also possible for a loan to be outstanding for longer than 12 months without its being included in income? For example, say your corporation has an August 31, 2004 year-end and it makes a loan to you as its major shareholder on September 14, 2004. In order for this amount not to be included in your taxable income, you must repay the loan by August 31, 2006. This provides a period of almost two years to repay the loan without adverse tax consequences.
If you do not repay the loan within this time period, it is included in your income as at the time the loan was made; however, you may reverse any interest benefit included in a previous year’s income. This reversal avoids a double tax situation where you would be taxed once for including the loan in income and again for the taxable benefit.
In addition, where the entire loan has been included in your income, you can receive a deduction for subsequent repayments. However, proceed with caution. The tax consequences could be significant if the CRA considers the loan and repayment to be a “series of loans and repayments”. Generally, if the shareholder only makes a temporary repayment of the loan and then borrows again shortly thereafter, the CRA will not allow the deduction.
Non-taxable Loans Traditionally, the rules have allowed corporations to loan money to individual shareholders in certain limited cases. Non-taxable loans include those made:
Each of these loans must have bona fide arrangements for the repayment of the loan within a reasonable time. With the exception of loans made in the ordinary course of business, the borrower must also be an employee of the corporation.
The shareholder loan rules do not apply to employee-shareholders who deal at arm’s length with the corporation and who, together with related persons, own less than 10% of the shares of any class of the corporation. This provides an exception for many employees who are minority shareholders.
Note, however, that for a loan to meet the above exceptions, it must be received by virtue of the individual’s employment and not because of the individual’s shareholdings. This has generally been interpreted to mean that similar loans must be available to other employees who are not shareholders or related to shareholders. To complicate matters more, it would appear that if the owner/manager is the sole employee of a company and wants the borrowings not to be taxable, he or she will have to prove that the loan is a loan which would otherwise be available to non-shareholder employees. This, of course, could be an onerous task.
Since most small companies do not loan funds to non-shareholder employees, this supports the CRA’s position that the owner/manager is likely receiving the loan as a shareholder, not as an employee. In this case, the shareholder would have to include the loan in income, unless it is repaid within one year from the end of the corporation’s year.
Minimize Your Tax Risk Be wary: the risk you take in receiving loans from the corporation could be very costly.
Before You Take that Loan Whether you are an employee, owner/manager or shareholder, discuss your plans with your chartered accountant before you take a loan from your employer or company. If the loan is not properly structured, the costs could be far more than you anticipated.
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