Small and medium-sized corporations and their shareholder(s) will often use shareholder loans for two distinct purposes. The first purpose is for shareholder(s) to borrow cash from the corporation for personal expenditures. The second purpose is for the corporation to borrow 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 these two types of shareholder loans and important things to consider when providing or receiving loans from a corporation’s shareholders.
- Shareholder Loans: Corporate Asset and Shareholder Liability
- Personal Income Tax Consideration
- Other Shareholder Considerations
- Shareholder Loans: Corporate Liability & Shareholder Asset
- Why Do Shareholders Lend Money to Corporations?
- Shareholder Loan Interest
- Another Shareholder Loan Example
- Income Tax Considerations
- When Should a Shareholder Loan be Repaid?
- Keep it Simple and Use Petty Cash
- Bringing it all Together
- Frequently Asked Questions
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, and 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 Shareholder Loan is receivable and not payable, 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 with a shareholder loan, 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 The reason for this is that Canada Revenue Agency (CRA) would consider the withdrawn amount, the shareholder loan, to be personal income.
Depending on what the personal average and marginal income tax rate is for the shareholder, the shareholder may inadvertently end up paying the highest level of income tax by withdrawing cash from the corporation in this manner.
To avoid this issue, the shareholder should take cash out of the corporation either 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 that would be listed as an asset on the balance sheet, a shareholder can receive the money as dividends. The cash dividends disbursed to the shareholder would have already been taxed at the corporate level and are also taxed at a lower personal income tax rate than regular income.
Another advantage of dividends is that it doesn’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. The advantage of receiving a salary is that 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, and having one shareholder withdraw cash from the business or pay for personal expenses using corporate cash or credit, can invite conflict between shareholders.
To keep things onside with the corporation, the CRA, and other shareholders, cash should only be withdrawn from the company through dividends or salaries.
Shareholder Loans: Corporate Liability & Shareholder Asset
When shareholder(s) lend money to their corporations, it will create a liability on the corporation’s Balance Sheet, also known as the Statement of Net Position, and will be noted as a Shareholder Loan.
Whether the shareholder loan will be under Current Liabilities or Long-term Liabilities on the Balance Sheet will depend on when the corporation and shareholder agree the Corporation’s shareholder loan will be paid back to the shareholder.
If the corporation plans to pay back the shareholder loan within one year, it will be shown under Current Liabilities on the Balance Sheet. If the shareholder loan is planned to be paid back over a period greater than one year, it will be shown 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, and this guide will walk you through the two most common reasons.
Cash for Operations
The first and most obvious reason a shareholder would lend money to their corporation is if the corporation needs funds for operations. It’s common for new businesses to be 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 is very common for 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, it won’t be long before it is insolvent and ultimately bankrupt.
Cash for Capital Investments
The second reason shareholders lend money to their corporations is to help fund the purchase of capital assets. Investments in capital assets are intended 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 which is anticipated to generate incremental revenue of $2,000 per month between May and August of each year. The operator of the lawn care company, who is also the only shareholder, believes this investment will allow their company to mow one additional lawn each day and is an excellent investment. Over time, the additional revenue from this one additional lawn mowed each day will pay for the initial investment and will generate more wealth for the operator/shareholder.
However, if the corporation is relatively new with limited financial history, it may not be able to get a traditional loan or line of credit to purchase the capital asset, the ride-on lawn mower. The owner could personally guarantee a loan from a bank, or they can use their own funds to lend to the corporation.
The owner decides to use personal cash they have on hand to loan to their corporation, who will then use the funds to purchase the ride-on lawn mower on behalf of the corporation. The owner anticipates the corporation will be able to repay the shareholder 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 shareholder 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 is greater than the tax savings the corporation received, it does not make financial sense.
To keep things onside with the Canada Revenue Agency (CRA), and to keep things simple, the corporation shouldn’t pay interest to the shareholder on the shareholder loan. However, to ensure your corporation is making the best financial decision and to stay onside with the CRA, it’s important to consult with a Chartered Professional Accountant (CPA).
Another Shareholder Loan Example
It’s easy to understand why a shareholder would lend money to their corporation and how this would be recorded in the corporation’s financial bookkeeping. However, it’s also common for shareholders to use their personal funds for corporate expenses either unintentionally or intentionally.
When a corporation is relatively new and is only starting operations, there will be times when the owner, who is also the shareholder, uses their personal funds for business purchases. The shareholder may be waiting for a corporate credit card or perhaps didn’t have their corporate credit card on hand when purchasing business supplies and had to use their personal funds.
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 proceeded to fill 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 and needed to use 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
A common question shareholders have when lending their corporation funds is whether they will attract income tax when they pay themselves back and withdraw the loan amount. The answer is no because the owners are simply being repaid the money they lent to the corporation, and the shareholder had already paid tax on the money they lent to their corporation. 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?
This is an important and complicated question to answer. Most shareholders and corporations may think that repaying the shareholder loan(s) as soon as possible is the best choice, but this may not be the case. In situations where the shareholder loan is provided unintentionally, like the previous example above, it makes sense to pay these off as the funds become available.
However, when the shareholder loan is intended to be a longer-term loan, there are a few factors to determine when the corporation should reimburse the shareholder.
Determining the optimal time the corporation pays back the shareholder loan will ultimately come down to the return the shareholder can expect within the corporation, as well as what their personal opportunity cost is.
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 shareholder loan that is greater than 10%.
The shareholder should consult with an accountant to ensure they are making the best financial decision for both their corporation and themselves.
Keep it Simple and Use Petty Cash
With this example, it’s clear that 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 is not material, employing and 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, and 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 pay it back within one year, they may attract income tax at a rate that is much higher than if they took cash out of the corporation through dividends or a salary.
On the flip side, Shareholders can also provide much-needed cash to their corporations when they may not be able to get traditional financing. Depending on what the shareholder’s cost of capital or opportunity cost is, it can also make sense to keep their money within the corporation to earn a return. This would only make sense if the corporation could earn a higher return than the shareholder’s cost of capital or opportunity cost.
As a shareholder within your corporation, it’s important to consult a CPA to ensure you’re paying the least amount of tax and remain onside with the CRA.
Frequently Asked Questions
A shareholder loan is when the corporation loans money to the shareholder or when the shareholder 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 make it clear this is an asset and not a liability, it makes sense to add Receivable after Shareholder Loan – Shareholder Loan Receivable. Whether this is considered a Current Asset or a Longterm Asset will depend on whether the Shareholder loan is planned to be paid within one year or not. If the Shareholder Loan Receivable is considered a long-term asset and isn’t paid back to the corporation within one year of withdrawal, 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 will be shown on the corporation’s balance sheet as Shareholder Loan under Current Liabilities. Whether this is considered a current liability or a long-term liability will depend on whether the Shareholder Loan is planned to be paid back to the Shareholder within one year or not.
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 is considered a short-term or long-term liability will depend on whether the loan is anticipated to be paid within one year or not. If it isn’t, it would be 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 is also considered a shareholder loan.
Shareholder Loans are not considered dividends and attract a higher income tax rate than receiving cash through dividends. Shareholder loans can be outstanding for up to one year because the shareholder needs to report the loan as income on their personal income taxes.
To keep things onside with the corporation, the CRA, and other shareholders, cash should only be withdrawn 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 is shown under short-term liabilities or long-term liabilities will depend on whether the shareholder loan is anticipated to be paid within one year or not. If less than one year, it will be shown under short-term liabilities. If it will be paid back after one year, it will be shown as a long-term liability.
If the corporation loans money to the shareholder, it will be shown as an asset on the corporation’s balance sheet. Whether the shareholder loan is shown under current assets or long-term assets will depend on whether the shareholder loan is anticipated to be paid within one year or not. If less than one year, it will be shown under current assets. If it will be paid back after one year, it will be shown as 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 is also considered a shareholder loan.
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About The Author: Arthur Dubois
Passionate about personal finance and financial technology, Arthur Dubois is a writer and SEO specialist at Hardbacon. Since his arrival in Canada, he’s built his credit score from nothing.
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