Shareholder Loan: Uses and Pitfalls

The Meeting

I was meeting with a client Ken, who had been working with me for several years. While going over the Balance Sheet in his year-end Financial Statements package, he asked a question. "What is this account "Shareholder loan" and what does it mean?"

Like any professional or tradesperson who has been doing their job for years, we get stuck in our jargon and assume everyone understands what we are talking about. Suppose my mechanic tells me my "muffler bearings" need replacing. I politely nod, pretending to understand what he is talking about and ask how much it's going cost.

At Zenally, we try to avoid the "accountant talk." Some terms like Shareholder Loan have no substitutes, so I do my best to explain them.

If I, or one of my Partners or staff, are speaking, and you don't understand, please stop us. Make us explain it so that you understand. We both win when we are actually communicating and not just talking.

If one client needs an explanation, then I expect many of you do, so hopefully the following article clarifies everything about the "shareholder loan" account.

What is a Shareholder Loan?

The shareholder loan is an account in your bookkeeping system used to track the money you (the shareholder) have loaned to your company, less any money paid back or borrowed from the company over time.

You can think of the shareholder loan as a bank account with overdraft protection. As the shareholder of your company, you can deposit or lend money to your company. It's placed in your shareholder loan account. You can withdraw money from your shareholder loan account, just like a bank account. When you take too much out of your shareholder loan account, it goes into 'overdraft'. Now you owe your company money.

Transactions Affecting Your Shareholder Loan

Loan Money to Your Company

You give money to your company, and it's not to purchase shares. Now your company owes you that money. It is a loan from you, the shareholder, to the company, hence the term - Shareholder Loan.

Make a Cash Withdrawal

In a previous article, I discussed the shareholder taking out money for payment of wages or a dividend. A third option is the company could be repaying your shareholder loan account, repaying the money you previously lent the company.

You can take back the money lent to your company, by cash, cheque, or a transfer to your personal bank account. That means you withdrew an amount of money from your Shareholder Loan account. It's balance is reduced by that amount.

Pay for a Personal Purchase with Company Funds

Suppose you buy plane tickets for a personal vacation and use your business credit card. This is just like taking cash from your company. So, this too will be treated as a withdrawal from your Shareholder Loan account. The balance is reduced.

Pay for Business Purchase with Personal Funds

Suppose you pay for office supplies with your own cash or personal credit card. If the company doesn't directly reimburse you for the expense, then your company owes you the amount of money you paid on behalf of the company for office supplies. The Sharehold Loan balance is increased.

Submit Expense Statements

You might incur business expenses such as automobile mileage (see FAQ link). The costs are often claimed on an expense form. Instead of issuing a cheque each time, your bookkeeper might treat it as a loan from you to the company. This will increase the amount of your Shareholder Loan.

Where Is the Shareholder Loan on Your Financial Statements?

Your Shareholder Loan is reported on your balance sheet.

If your company owes you money, then it is a company liability (payable). You will find it in the Liabilities section, usually titled 'Due to Shareholder.'

If you owe your company money, then the loan is a company asset (receivable). You will find it in the Assets section, usually titled 'Due from Shareholder.'

Why You Need to Watch Your Loan Balance

Your Company Owes You Money

You can withdraw money from your company up to the Shareholder Loan balance amount, and you won't have to include it in your personal income when you file your taxes since the company is just paying back money it owes you.

If you look for financing, your bank will view the Shareholder Loan you have contributed to the company as additional equity you have left in the company. So far, so good.

You Owe Your Company Money

If you have an 'overdraft' in your Shareholder Loan, you took out more money from the company than you loaned the company. If this is the case and you pay your company back before year-end, you'll avoid tax on the overdraft. Since you borrowed from the company CRA (Canada Revenue Agency) expects you to pay interest on the overdraft at the prescribed rate.

If you don't pay that loan back within a year this can become very problematic.

Potential Tax Pitfalls

A fiscal year is the 12 months prior to and including the month of your company's year-end. So, if your company year-end is September 30, its fiscal year is from October 1 to September 30.

Suppose you withdraw $40,000 from your company in the current year (2022) and don't pay it back before the September year end date. Assuming you had no opening balance and no other transactions to your shareholder loan then the account would show a $40,000 debit (overdraft) balance as of your September 30, 2022, year-end. On the balance sheet, the $40,000 would show in the asset section as a receivable 'Due from shareholder.'

Now assume that a year goes by and there are no other transactions to the shareholder loan account. It still shows that you, the shareholder, owe the company $40,000.

The company is a legal entity separate from you and there are rules to prevent you from having a permanent loan that never gets taxed.

That is the issue. You can't take money out of your company without paying tax. You can take money out only by paying wages or dividends. Both will trigger tax on your personal income tax return.

If your 'loan' from the company is owing at year-end, then the CRA can assess you with a taxable benefit of $40,000 in the tax year when you made the withdrawal. They would also assess a taxable benefit equal to the interest benefit you should have paid.

So, you got $40,000. You are required to pay tax on $40,000 plus the unpaid interest.

Well, that's bad enough, but it gets worse.

Your company cannot claim the $40,000 as an expense, as it could have, if the $40,000 was declared as a salary or a wage.

That means you and your company both get to pay tax on the $40,000!

If you subsequently repay the loan, the CRA will allow a personal tax deduction in the year you repay it, but this might not be a tax-efficient outcome.

How To Avoid Shareholder Loan Tax Problems

Repay Your Shareholder Loan

Ideally, repay any amounts you took by the end of your fiscal year. Any amounts 'overdrawn' at one fiscal year-end must be repaid before the end of the following fiscal year-end. This will avoid the double tax problem.

You can repay the loan:

• from your personal funds or personal debt
• by declaring a bonus to yourself. (Extra wages or salary that you leave in the company since you already have the cash).
  Just remember there will be withholding taxes on a bonus, so be sure it's large enough so the amount net of tax can repay your loan and interest. Remember, you need to remit any payroll source deductions the following month.
• by declaring a dividend to the shareholder(s) and leaving the money in the company to replenish your shareholder loan account.
  If you have not dealt with it prior to the year end date then this will be your only option.

Don't Take A Series of Loans

Don't try to pay back a shareholder loan before year-end and take out another shortly afterward. This is called a series of loans and repayments. The CRA takes a dim view of this and will apply double taxation when they find it.

Summary

There is no issue with lending your company money and paying yourself back whenever the cash becomes available. However, if you pay yourself more than you have contributed to the company, then CRA has an issue with it and expects it to be repaid within one year. Want to discuss your situation? Give us a call.

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