So you just incorporated your business? Congratulations!
As you might already know, there are a number of advantages to incorporating a business (and if you’d like to know more about those advantages, click this blog post for a brief explanation).
If, prior to incorporating, you were operating a proprietorship (just a fancy name for an unincorporated business) you might remember that any personal cash you withdrew (or advanced) to your business was treated as a draw or a contribution, and that those funds really had no impact on your bottom line.
With a proprietorship, your business income is effectively included on your personal tax return and, provided you’re paying tax on that income, CRA generally won’t kick up a fuss as to the amount you’re withdrawing from your business.
Knowing how a proprietorship works, the temptation, for many recently-incorporated business owners (let’s call them shareholders), is to continue to withdraw (or contribute funds) through their corporation’s bank account, to continue to ignore the actual balance of the draws and contributions, and to record every “in and out” in a Shareholder Loan account. In other words, shareholders will often lend money to their corporation—crediting that Shareholder Loan account—and when they themselves need cash, they’ll just “borrow” it from the corporation—this time debiting that Shareholder Loan account.
And that’s where things can get ugly.
Unbeknownst to most shareholders, unlike a proprietorship, CRA views an individual and a corporation as two distinct and separate taxpayers. And as such, CRA takes a very different, very narrow, perspective on what a shareholder can and cannot do via a Shareholder Loan account. Though CRA’s rules can be somewhat arcane, here are some important principles to keep in mind.
- While a shareholder can “borrow” money from their corporation, it’s crucial to know that CRA has specific rules that address not only time-limits, but also the allowable purpose of those shareholder loans. And there have been countless instances of shareholders, unaware of CRA’s regulations, finding themselves on the receiving end of very severe (and very expensive) penalties.
- Because CRA views a shareholder and a corporation as two distinct taxpayers, any amount a shareholder regularly receives from her corporation should usually, in one way or other, be treated as taxable income by the shareholder.
- The balance, not to mention the series of transactions that contribute to the balance, of the Shareholder Loan account cannot be left unattended and ignored.
- If a shareholder inadvertently expenses personal amounts in her corporation’s books and, if CRA—via an audit—discovers the error, CRA might, regardless of the Shareholder Loan balance, impose tax on both the shareholder and the corporation.
Though there are exceptions to the rules mentioned above, those exceptions, (like the rules themselves) are somewhat complicated. As such, whether you are now (or about to become) incorporated, we strongly recommend that you get in touch with us so that we can discuss CRA’s rules regarding Shareholder Loans.