When you receive a loan, it is generally not taxable so it seems like a smart way to “work” the system.
The problem is, the government has seen the loophole and has set up systems to stop taxpayers from taking advantage of this situation. These rules also stop employees from gaining benefits through advances from the corporation.
Firstly, if you are a shareholder of a corporation and receive an advance or loan, the amount may be included in taxable income. The same applies if you are connected to a shareholder or are a member of a partnership or beneficiary of a trust that is a shareholder.
There are a few exceptions to this first rule.
If you include the loan amount in your income and then later repay the loan, you can deduct the amount of repayment from your income in the year the repayment is made. Again, if you repay a loan and then subsequently reloan the money, this deduction will not apply.
If you receive a loan and then any amount of it is forgiven, the forgiven amount will be included in income for tax purposes.
If the first rule does not apply, shareholders and employees who receive a loan or advance may be required to pay personal tax on a taxable benefit for interest on the loan.
This taxable benefit is calculated by applying a prescribed rate to the principal balance. The amount is then reduced by any interest payments or reimbursements made within 30 days after the year end.
The prescribed rate is adjusted quarterly based on the average rate of a 90 day treasury bill. In 2022, the prescribed rate increased from 1 to 3% making loans from a corporation more expensive.
If the proceeds of a loan are used for income-earning, then you may be eligible for a deduction to offset the taxable benefit.
Needless to say, these rules will reduce or eliminate any tax advantages sought by taking out a loan instead of receiving a salary or dividends.
To be sure you are properly managing corporate distribution of funds to shareholders and employees, as well as loans, please contact us today.