Small and medium-sized corporations and their shareholder(s) will often use shareholder loans for two distinct purposes. First, shareholder(s) borrow cash from the corporation for personal expenditures. Second, the corporation borrows funds from shareholders for purposes such as increasing cash on hand, funding investments in capital assets, or paying forecasted expenses.
This ultimate guide to shareholder loans in Canada will walk you through its two types. Further, it highlights important things to consider when providing or receiving loans from a corporation’s shareholders.
Shareholder Loans: Corporate Asset and Shareholder Liability
The shareholder of a corporation may take funds from the company to pay for personal expenses or make a personal purchase. These cash withdrawals by shareholders are often unplanned. Therfore, the corporation’s bookkeeper will need to record the withdrawal accordingly. For example, let’s say a shareholder took $1,000 from the corporation’s bank account to pay their personal rent. The bookkeeper would record the following journal entry:
Journal entry: Shareholder Loan Receivable
Balance Sheet: Account Balances
In this example, the transaction would result in a Shareholder Loan asset account as the corporation expects this money to be reimbursed. To make it clear, the loan becomes a receivable and not payable, so we put Receivable in the title of the asset account.
When the shareholder reimburses the corporation for this amount, the journal entry and the resulting change in the Balance sheet will show the following:
Journal entry: Shareholder Reimburses Corporation
Balance Sheet: Account Balances
Personal Income Tax Consideration
When shareholders take cash out of the corporation, they may inadvertently create a personal income tax liability if they don’t repay the shareholder loan within one year. The reason for this is that Canada Revenue Agency (CRA) would consider the withdrawn amount, the loan, to be personal income.
Depending on what the personal average and marginal income tax rate is for the shareholder, the shareholder could create a risk. In short, they may inadvertently end up paying the highest level of income tax by withdrawing cash from the corporation in this manner.
Instead, the shareholder should take cash out of the corporation through a salary or by declaring and issuing dividends.
Alternative #1: Receiving Funds Through Dividends
Rather than taking money directly out of the company and generating a shareholder loan, a shareholder can receive the money as dividends. The cash dividends disbursed to the shareholder would have already been taxed at the corporate level. Moreover, they would also get taxed at a lower personal income tax rate than regular income.
Advantageously, dividends don’t attract employment taxes such as Employment Insurance (EI), Canada Pension Plan (CPP), or Workers’ Compensation (WCB).
Alternative #2: Receiving Funds Through Salary
Shareholders can also take corporate earnings or funds out of the corporation by receiving a salary. Via this approach, the shareholder can expect a certain amount to be paid to them at each pay period.
The benefit to the corporation is that it can expense the salary, which reduces the corporation’s taxable income. However, providing a salary to the shareholder attracts payroll taxes that both the corporation and the employee will need to pay. While the corporation can expense the payroll taxes, the employee cannot.
Other Shareholder Considerations
It isn’t uncommon for shareholders to take ad-hoc cash out of the corporation or to make personal purchases using the corporation’s cash or corporate credit card. While this does make it more difficult for the bookkeeper to keep track of the money coming in and out of the corporation, the shareholders can and often do this.
However, many private corporations will have more than one shareholder. So, having one shareholder withdraw cash from the business or pay for personal expenses can invite conflict between shareholders.
To keep things onside with the corporation, the CRA, and other shareholders, only withdraw cash from the company through dividends or salaries.
Shareholder Loans: Corporate Liability & Shareholder Asset
When shareholder(s) lend money to their corporations, it creates a liability on the corporation’s Balance Sheet. This Statement of Net Position will be noted as a Shareholder Loan.
Further, the loan will become Current Liabilities or Long-term Liabilities on the Balance Sheet. Its status will depend on when the corporation and shareholder agree to repayment of the Corporation’s loan by the shareholder.
If the corporation plans to pay back the loan within one year, it will appear under Current Liabilities on the Balance Sheet. If the term expends over a period greater than one year, it will show up under Long-term Liabilities on the Balance Sheet.
Why Do Shareholders Lend Money to Corporations?
There are a variety of reasons why shareholders would lend money to their corporations. This guide will walk you through the two most common reasons.
Cash for Operations
Obviously, a shareholder would lend money to their corporation if the corporation needs funds for operations. Commonly, new businesses fall short on cash when they first start operations. The business may have anticipated greater sales, fewer start-up costs, or when throughout the year, the demand for their products or services will decline.
While a lack of cash flow affects a new business, it is a major business consideration for businesses of any age or maturity. If a corporation can’t pay its bills with the cash the business generates, before long it could face insolvency and ultimately bankruptcy.
Cash for Capital Investments
Secondly, shareholders lend money to their corporations to help fund the purchase of capital assets. Investments in capital assets aim to generate a return and cash flow for the corporation over time and help the corporation build wealth. This value and wealth generation will lead to the main objective of any corporation, the maximization of shareholder wealth.
Example of a shareholder loan to the corporation
For example, a lawn care company decided to purchase a ride-on lawn mower for $6,000, expecting to generate incremental revenue of $2,000 per month between May and August of each year. The operator, the only shareholder, believes this investment will allow their company to mow one additional lawn each day. Over time, the additional revenue will pay for the initial investment and generate more wealth.
However, if the corporation has limited financial history, it may not qualify for a traditional loan or line of credit for the purchase. The owner could personally guarantee a loan from a bank or use their own funds to lend to the corporation.
Say they decide to use personal cash as a loan to a corporation to purchase the ride-on lawn mower on behalf of the corporation. The owner anticipates the corporation will repay the loan at the end of three years. Below are journal entries for this example.
Journal Entry #1: Loan to company
Journal Entry #2: Purchase of Equipment (Capital Asset)
Balance Sheet: Account Balances
With the two posted journal entries noted above, the balance sheet accounts would have the following debits and credit.
Journal Entry: Shareholder Loan Repayment
When the corporation pays back the shareholder in year 3 (assuming one lump sum), it will record the following journal entry.
Balance Sheet: Account Balances
With the repayment journal entry above posted, the balance sheet accounts would have the following debit and credits:
Shareholder Loan Interest
It may be tempting and reasonable to think the corporation should pay the shareholder interest for the loan; however, this can get complicated. While the corporation can reduce its income tax liability by expensing the interest paid to the shareholder, the shareholder would need to pay personal tax on the interest received. If the shareholder’s marginal income tax rate outpaces the tax savings the corporation received, it does not make financial sense.
To keep things onside with the Canada Revenue Agency (CRA), the corporation shouldn’t pay interest to the shareholder on the loan. However, to ensure your corporation makes the best financial decision and stays onside with the CRA, consult with a Chartered Professional Accountant (CPA).
Another Shareholder Loan Example
Of course, when a shareholder lends money to their corporation, they would record this in the corporation’s financial bookkeeping. However, shareholders commonly use their personal funds for corporate expenses unintentionally or intentionally.
When a corporation starts its operations, its owner/shareholder will use their personal funds for business purchases. The shareholder may await a corporate credit card or perhaps didn’t have one when purchasing business supplies.
For example, let’s say the lawn care corporation noted earlier needed to purchase gasoline. The owner drove the work truck to the gas station and filled their work truck and gas cans with gas. When they went to pay for their gas, they realized they didn’t bring their corporate credit card. Instead, they used their personal credit card to make the purchase. In this example, the bookkeeping journal entry would look like this.
Journal Entry: Gasoline Purchase
When the corporation reimbursed the shareholder for using their own funds for this purchase, they would record the following journal entry.
Journal entry: Reimburse Shareholder
Income Tax Considerations
Often, shareholders who loan corporation funds ask whether they will attract income tax when they pay themselves back and withdraw the loan amount. In short, no because the owners repay the money they lent to the corporation. Therefore, the shareholder had already paid tax on the money they loaned. However, if the shareholder decides the corporation will pay interest on the shareholder amount, the interest will attract personal income tax.
When Should a Shareholder Loan be Repaid?
Welcome to an important and complicated question to answer. Most shareholders and corporations may think that repaying the shareholder loan(s) as soon as possible makes the best choice. However, this may not be the case. In situations where the loan is provided unintentionally, like the example above, pay these off as the funds become available.
However, when the loan works as a longer-term loan, a few factors determine when the corporation should reimburse the shareholder.
Determining the optimal time the corporation pays back the loan will ultimately come down to the return the shareholder can expect within the corporation. As well, factor in their personal opportunity cost.
For example, if the shareholder can earn 10% with the money outside the corporation, this is their opportunity cost. For it to make financial sense to leave the money within the corporation for a duration greater than a year, the corporation needs to earn a return on that loan that is greater than 10%.
The shareholder should consult with an accountant to ensure they make the best financial decision for both their corporation and themselves.
Keep it Simple and Use Petty Cash
With this example, clearly inadvertently using personal funds for corporate purchases can create an administrative burden. The bookkeeper must make the journal entries in the books and will likely cut a cheque to reimburse the shareholder. In situations where the dollar amount remains immaterial, using Petty Cash will make it easier on the shareholder and the bookkeeper.
Bringing it all Together
Shareholders can withdraw cash from the corporation for personal use. In this case, the corporation would list the shareholder loan as a receivable under current or long-term assets. As long as the shareholder repays the loan within one year, they won’t attract income tax. However, if they don’t, they may attract income tax at a higher rate than if they took cash out through dividends or a salary.
On the flip side, shareholders can also provide much-needed cash to their corporations when they cannot get traditional financing. Depending on the shareholder’s cost of capital or opportunity cost, it can also make sense to keep their money within the corporation to earn a return. This would only work if the corporation could earn a higher return than the shareholder’s cost of capital or opportunity cost.
As a shareholder within your corporation, consult a CPA to ensure you pay the least amount of tax and remain onside with the CRA.
Frequently Asked Questions
A shareholder loan occurs when the corporation loans money to the shareholder or when the loans money to the corporation. When a corporation loans money to a shareholder, its bookkeeper will record this as a Shareholder Loan under Assets on the balance sheet. To clearly identify this as an asset and not a liability, it makes sense to add Receivable after Shareholder Loan. Whether this qualifies as a Current Asset or a Longterm Asset will depend on whether the loan will last one year or longer. If the Shareholder Loan Receivable becomes a long-term asset beyond one year, the shareholder will need to report this withdrawn amount as income on their personal income taxes.
When a shareholder loans money to the corporation, it shows up on the corporation’s balance sheet under Current Liabilities.
A loan from their shareholder will see the corporation note the shareholder loan on the liability side of its balance sheet as a Shareholder Loan. Whether it stands as a short-term or long-term liability will depend on whether the loan gets repaid within one year or not. If not, it would becomes considered a long-term liability similar to an outstanding long-term loan with a bank.
Yes, a corporation can lend money to a shareholder. The shareholder needs to pay the loan back within one year or they will attract personal income tax. Whenever a shareholder inadvertently uses corporate funds for personal uses, such as using a corporate credit card for personal expenses, this also becomes a shareholder loan.
Shareholder Loans do not equal dividends and attract a higher income tax rate than receiving cash through dividends. Shareholder loans can exist for up to one year otherwise the shareholder must report the loan as income on their personal income taxes. To keep things onside with the corporation, the CRA, and other shareholders, only withdraw cash from the company through dividends or through salaries.
When a shareholder loans money to the corporation, the corporation would show the shareholder loan on the liability side of the balance sheet. Whether the shareholder loan shows up under short-term liabilities or long-term liabilities will depend on whether the shareholder loan gets repaid within one year or not. If less than one year, it will appear under short-term liabilities. However, if it will get paid back after one year, it will become a long-term liability.
If the corporation loans money to the shareholder, it will get recorded as an asset on the corporation’s balance sheet. Whether the shareholder loan appears under current assets or long-term assets will depend on whether the shareholder loan gets repaid within one year or not. If less than one year, it will become a current asset. If repaid after one year, it will become a long-term liability.
Yes, as the shareholder of your corporation, you can borrow money from your company. You, the shareholder, need to pay the loan back within one year or you will attract personal income taxes. If you inadvertently use corporate funds for personal uses, such as using a corporate credit card for personal expenses, this also qualifies as a shareholder loan.
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