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How to avoid a shareholder loan becoming a taxable benefit?

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To avoid a shareholder loan becoming a taxable benefit, follow these steps:

  • Ensure the Loan Terms are Commercially Reasonable: The loan should have terms similar to what you’d expect from an arm’s-length lender, including interest rates and repayment schedules.
  • Document the Loan Properly: Draft a formal loan agreement outlining the terms, including the interest rate, repayment schedule, and any other relevant conditions.
  • Charge Market Interest Rates: Ensure the interest rate on the loan is at least equal to the prescribed rate set by the Canada Revenue Agency (CRA) to avoid interest imputation issues. The loan must bear interest at a rate that is at least equal to the CRA’s prescribed interest rate at the time the loan is made. The prescribed rate is set by the CRA on a quarterly basis.
  • Repay the Loan According to Schedule: Make regular payments as per the loan agreement to show that the loan is being managed responsibly. Interest should be paid on the shareholder loan in accordance with the terms of the loan, as documented. This interest on the shareholder loan must be paid within 30 days after the end of the year. In the absence of this, the interest will be considered a ‘shareholder benefit’ and added to the shareholder’s income.
  • Avoid Forgiveness of the Loan: If you forgive the loan, it could be considered a taxable benefit. Any forgiveness should be documented carefully, and tax implications should be considered.
  • Report the Loan Appropriately: Ensure that the loan is reported correctly on the company’s financial statements and tax returns.

    • Additional Considerations:

  • Repayment Before Year-End: The simplest approach is to repay the loan before the end of the one-year term. If the funds are no longer available for repayment, consider alternative options.
  • Declare a Salary or Bonus: One option is to declare a salary or bonus to the individual equal to the outstanding loan amount. While the salary or bonus would be taxable to the individual, the corporation would receive a tax deduction for the amount. For the salary or bonus to be considered paid by year-end (for a corporation with a December 31 year-end), payroll source deductions must be remitted to the CRA by their due date.
  • Declare a Dividend: Alternatively, the corporation could declare a dividend to offset the outstanding loan. While the dividend is not a deductible expense for the corporation, the personal income tax rate on dividends is generally lower than the rate on a salary or bonus.

    • Posted on 15 September 2024