The item on your corporate balance sheet that you should be most concerned about is the “shareholder loan” account. This loan account tracks cash advances to the shareholder(s) during the year. At the end of the corporate fiscal year, your accountant reviews shareholder loan transactions, monies which were advanced to the shareholders and for which income tax has not been paid. If the shareholder does not repay the monies, the accountant then converts these advances to income, in the form of either a salary or a dividend.
Given the marginal tax rates, the bigger the shareholder’s draw, the larger the personal tax. In order to keep personal tax at a minimum, shareholders are well advised to only draw funds from the corporation necessary to finance personal and living expenses. Funds set aside for savings should be kept inside the corporation where they will not be taxed at high personal rates.
Shareholder advances left outstanding at the end of the corporate fiscal year must be repaid by the end of the next fiscal year-end. Those that aren’t, must be reported as personal income tax which is taxed at a rate much higher than the corporate rate. Advances made in 2019 by a corporation with a December 31 year-end, must be repaid prior to December 31, 2020 to avoid personal income inclusion.
This strategy must be used prudently. Playing the game of paying back the shareholder loan just prior to the year-end, and then taking it back out just after the year-end, in order to ‘permanently’ avoid paying taxes at the personal rate on these loans, will be considered by CRA a ‘series of payments and repayments.’ In other words, the transaction will be ignored, the unpaid shareholder loan will be included in personal income and the shareholder will not benefit from the strategy. However, when you repay the shareholder loan, on which you have paid personal tax, you can then deduct the loan repayment in the year you made it.
