Shareholder Loans - Income Inclusion May Be Required

For many small business corporations the use of shareholder loan accounts is a way of life.  Some owners use the account as their own personal ATM machine by withdrawing money whenever the mood or need strikes.  However, this practice has tax consequences often requiring experienced tax advice, and advisors must let their clients know about the rules.

Using the shareholder loan account is an area that many accountants and bookkeepers have difficulty with fully understanding the rules of the accounts, and when the amounts have to be added to the income of the owner.

In general, S. 15(1) of the Income Tax Act requires that a shareholder include in income the principal amount of any loan received from a corporation. In the year the loan is made, the amount received is included as business income.

There are several exceptions to this requirement to include the loan as income, however:

• The loan is repaid by the shareholder within 1 year after the corporation's year-end in which the loan was made
• The loan is made as part of the ordinary course of business, for a lending business, and repayment terms are made at the time of the loan (e.g. shareholders of a bank),
• The loan is made between persons who are non-residents of Canada .

An imputed interest charge must also be added to taxable income, based on the prescribed rate in effect at the time the loaned amounts are outstanding. The imputed interest to be included in income is the excess of interest calculated at the prescribed rate (at the time the loan is granted) over the amount of interest paid by the shareholder.  The current prescribed rate on these types of loans is 1%.

Note that where the principal amount of a loan has been included in income, a taxpayer is permitted to deduct an amount under S. 20(1)(j) when the loan is repaid. The deduction is the portion of the amount previously included in income that is repaid in the taxation year.