What is the Shareholder Loan Account?
Knowledge Bureau Faculty
New business owners often have difficulty managing their shareholder loan account, mistaking it for a tax free way to access funds. For these reasons, it’s a good idea to advisors to review what this account is and how it functions. Here’s a primer from Knowledge Bureau’s MFA™-Corporate Tax Services Specialist Program:
A shareholder loan account is the amount of money that a corporation owes to one or more shareholders. The balance will usually be a liability on the books and records of the corporation.
The shareholder loan account can arise in a number of ways; for instance:
- A shareholder may loan or advance money to the corporation, so that the corporation can undertake its business or acquire an asset.Sometimes a financial institution will be willing to lend funds directly to the owner/manager with appropriate security, and not to the corporation directly.The shareholder would then loan or advance these funds to the corporation, thereby creating a shareholder loan.
- A corporation might declare a dividend payable to the shareholder and credit the shareholder loan account.Funds can then be drawn on a tax paid basis by the shareholder, against this credit. Note that the dividend becomes taxable to the shareholder in the taxation year in which the dividend is credited to the shareholder loan account, regardless of whether it is actually paid out in cash.Constructive payment and receipt is considered to have occurred when an amount is credited to the shareholder loan account.
- A corporation might also declare and pay a year-end bonus (net of tax withholdings), and credit the shareholder loan account.
- A shareholder loan account might also represent “long term” equity within the corporation, if it is subrogated in favor of another creditor, such as the corporation’s financial institution or lender.Most lenders require a corporation to maintain a certain debt/equity ratio and where a shareholder loan credit balance is subrogated in favor of the lender, such amount will generally be included as “equity”, for purposes of calculating the debt/equity ratio, agreed upon for lending purposes.The subrogated amount cannot be repaid to the shareholder without the lender’s consent and therefore represents “equity” for financing purposes, while still maintaining the advantage of being “tax-paid” capital for a potential future repayment to the shareholder.
A debit balance in a shareholder loan account arises when amounts drawn out or paid to the shareholder exceed available amounts credited to the shareholder account. This can occur in a variety of ways; for instance:
- A shareholder draws cash from the corporation, but no amounts are treated as a salary or dividend.Consequently, the cash draw must be treated as a loan to the shareholder for accounting and tax purposes.This situation can arise because the shareholder incorrectly treats the corporation as though it was an unincorporated entity.Since there is a legal distinction between corporation and shareholder, cash draws must be accounted for as a “loan” to the shareholder.
- A shareholder makes an appropriation of an asset or uses corporate funds to acquire a personal asset.For instance, a shareholder might transfer ownership of a corporately owned vehicle to their own personal name, with the result that a “deemed sale” of the asset occurs.If no cash is involved in the transaction, the fair market value of the vehicle should be charged to the shareholder loan account.
Additional Educational Resources: Learn tax strategies for investors and owner-managers at the November 10, 2021 Virtual CE Summit.