Planning for the Creeping Tax Liability in your Corporation

In January, I wrote a post titled RRSPs and Corporations – Your Silent Creeping Tax Liability. The blog noted that whether you are currently working, near retirement or in retirement, you and/or your corporation have silent creeping tax liabilities accumulating in your Registered Retirement Savings Plan ("RRSP") and/or corporation.

I followed up in April, with a post on some potential planning to address the creeping RRSP liability. Today, I discuss some planning and considerations to reduce the creeping corporate tax liability you may be accruing.

Corporate Tax Attributes

Many corporations have built up corporate tax attributes that can be accessed prior to retirement or in retirement that can reduce the tax liability related to you and/or your corporation. I discuss these below.

Shareholder Loans

Repayment of shareholder loans owing to you and other shareholders is the most tax efficient way to remove funds from your corporation on a tax-free basis.

Capital Dividend Account

If your corporation has a capital dividend account ("CDA") balance, paying out capital dividends is a great way to remove funds on a tax-free basis and reduce your ultimate corporate tax liability (Non-resident shareholders are subject to withholding tax on capital dividends). See this blog post I wrote for all the details of a capital dividend account. 

For some unknown reason, many corporations do not pay out tax-free capital dividends from their CDA on timely basis. Since this account is a "moment in time" account, this can prove very costly if you incur capital losses. For example, if your corporation had previous capital gains and the CDA balance is say $100,000 today, but the corporation incurs capital losses of say $60,000 tomorrow, the CDA account will be reduced by $30,000 to $70,000. Thus, your corporation will have forgone $30,000 in tax-free dividends if the capital dividend had been paid before the capital losses were incurred. 

Due to the poor stock markets this year, you may be triggering capital losses as part of the corporation's investment and/or tax planning. Discuss paying out a capital dividend with your investment advisor and accountant before triggering any capital losses this year. 

Refundable Dividend Taxes On Hand

Your corporation may have balances in the following two notional accounts: Eligible Refundable Dividend Tax on Hand (ERDTOH) and Non-Eligible Refundable Dividend Tax on Hand (NERDTOH). These accounts are the successor accounts of what was formerly known as Refundable Dividend Tax On Hand (RDTOH). These accounts are essentially prior years corporate taxes paid that are refundable when the corporations pays dividends to the shareholders. The accounts act as a mechanism to ensure that you and your corporation are not double taxed. 

While your corporation needs to pay a taxable dividend to trigger refunds from these accounts (the rules are confusing, speak to your accountant), the government essentially pays your corporation a refund somewhat equivalent to the personal tax you owe on the dividend, so you net out much better than if you paid a taxable dividend with no refundable tax.

Return of Capital

If your corporation has “hard” paid-up-capital (“PUC”) for money you previously paid to purchase corporate shares from treasury, you should be able to return most of the PUC tax-free.

Income Splitting

Payment of Wages

If you have family members who work in the business and are not paid a salary or are paid a very low salary, consider paying them a “reasonable salary”. I say reasonable, as the CRA requires a salary to family members to be reasonable to be deductible.

Tax on Split Income Rules

The Tax on Split Income Rules (“TOSI”) rules are very complicated and far beyond today’s brief discussion. However, in general, TOSI will not apply on amounts paid to a business owner’s spouse or common-law partner, who are inactive in the business, so long as the business owner has reached age 65 during the year. This will be the case where the amount would have been excluded from TOSI had it been received by the business owner directly, by virtue of the fact that they would have otherwise met another exclusion. So, an inactive spouse whose shares were subject to TOSI before the business owner turned 65, will in most cases, now be able to receive dividends on their shares without the TOSI rules applying. It may also be possible to reorganize the company when the business owner turns 65 to provide shares to the inactive spouse.

Tax Reorganizations/Tax Planning

If you have a successful corporation (especially an active corporation), your accountant or tax lawyer may have one or two reorganization/tax plan ideas to consider that could possibly lower your creeping tax liability. The Federal budget in April this year contains proposals to limit a couple of these planning ideas, so you should speak to your accountant to review whether there are any planning opportunities still available that may work for you and your corporation(s).

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

The Best of The Blunt Bean Counter - What Small Business Owners Need to Know - The Debits and Credits of Shareholder Loans

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a March, 2017 blog on what you as a small business owner need to know and understand about the debits and credits of your shareholder loan balance.

________

As an owner-manager, you can withdraw funds from your corporation as a salary and/or a dividend or as a shareholder loan. The Canada Revenue Agency (CRA) has incorporated strict guidelines into the Income Tax Act (Act) when shareholder loans have to be repaid and the tax consequences therein. These rules are often misunderstood by shareholders and can result in adverse income tax consequences where care is not taken.

The following discussion relates to situations where you have taken more shareholder loans than you have contributed to your corporation. This is often known as a shareholder “debit” as opposed to a shareholder “credit." A shareholder credits results when your corporation owes you money, since you have advanced funds or loaned back salary or dividends in a prior year on which you were personally taxed.

The Rules

Section 15(2) of the Act outlines these rules which also encompass loans to a person or partnership who does not deal at arm’s length (i.e., family members) with the shareholder.

The basic rule for shareholder loans is that they must be repaid within one year after the end of the corporation’s taxation year in which the loan was made. For example, if you borrow money from your corporation in 2016 and the corporation's fiscal year end is December 31, 2016, the loan must be repaid by December 31, 2017. If the amount is not repaid within the time frame above, it will be added to the income of the shareholder in the year the loan was received (i.e., 2016 in this example). Therefore, a T1 adjustment may be necessary for the shareholder to correctly include the loan in income in that particular year (2016) plus accompanying interest. If anyone related to the shareholder receives the loan the amount will be included in his/her income and not the shareholder.

The Exceptions

There are some exceptions to the 15(2) shareholder loan rules which would allow the loan amount not to be included in an individual’s income. If any of the criteria below are met than 15(2) does NOT apply:

i) If the loan was repaid within one taxation year;

ii) If the loan was made in the course of a money lending business i.e. bank, and bona fide terms of repayment are made.

Employees/Shareholders Exceptions

Absent of the criteria above, certain types of loans may still be exempt from 15(2) as described below for shareholders who are also employees of their business.

If the loan is to a specified employee (person who owns directly or together with related persons more than 10% of the shares of the business) the loan must be made for one of the following purposes:

1) Purchase a home (includes a house, condo, cottage);

2) Purchase a vehicle used for employment purposes; or

3) Purchase newly issued shares of the business.

Each of these loans must have bona fide arrangements for repayment within a reasonable time period and the loan must be provided as a result of the individual’s employment rather than shareholdings. This has generally been interpreted to mean that loans must be available to other employees who are not shareholders or related to shareholders, which could be difficult to prove if the owner is the sole employee of the business and preclude the loan where you have employees (unless you provide such loans to all other employees, which is very unlikely).

Where loans are made for a home purchase, the CRA often audits the loan and it can be problematic if not impossible to prove such a loan would have been made to other employees if there actually were such. As result of this burden of proof, where housing loans were once routinely recommended by accountants, they are now typically selectively recommended.

If the loan is to an employee-shareholder who deals at arm’s length with the corporation and together with related persons own less than 10% of the shares then the loan can be made for any purpose. This provides an exception for many employees who are minority shareholders. However, similar to specified employees above, the loan must have bona fide arrangements for repayment within a reasonable time period and the loan must be provided as a result of the individual’s employment rather than shareholdings.

Interest Benefits

Section 80.4(2) of the ITA provides for an imputed interest benefit if 15(2) does not apply. Meaning if the shareholder loan does not have to be included in income, a deemed interest benefit will still need to be reported by the individual. This interest benefit arises when the interest rate charged (if any) on the shareholder loan is less than the CRA prescribed rates per quarter - currently at 1%. The amount of the interest benefit is reduced by any interest actually paid on the loan no later than 30 days after the end of the calendar year.

If the loan is included in income by virtue of 15(2) than no imputed interest benefit would be reported.

Questions to Ask

Some of the key questions to ask when an individual shareholder or connected person (e.g. daughter) receives a loan:

1) Is it reasonable to assume the loan was received by virtue of employment?

2) Is the individual receiving the loan a specified employee (i.e., owns more than 10% of any class of shares of the corporation)? If so, was the loan made to acquire a dwelling, vehicle or shares are described above?

3) Are there bona fide terms of repayment?

If the answer is NO to any of the questions above, 15(2) applies to include the loan in income, unless the entire loan is repaid within one taxation year. Repayment of all or part of the loan that has been included in income will be eligible for a deduction by the individual on his/her personal tax return in the year of repayment.

It is very important that the loan(s) not be considered to be a series of loans and repayments or else CRA could deny the deduction upon repayment. E.g. repaying an amount at the end of 2016 only to borrow again in 2017. One of the more common ways to reduce or eliminate a shareholder loan is to convert it into a salary, bonus or dividend. Since this gives rise to taxable income, it is generally not considered to be a series of loans and repayments.

See Archived IT119R4 for more details and exceptions regarding shareholder loans.

Section 15(2) is one of the most commonly applied and misunderstood sections of the Act. You should always consult your accountant or tax specialist when dealing and planning with your shareholder loans.

I would like to thank Lorenzo Bonanno, tax manager for BDO Canada LLP for his extensive assistance in writing this post. If you wish to engage Lorenzo for tax planning, he can be reached at lbonanno@bdo.ca

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

What Small Business Owners Need to Know - The Debits and Credits of Shareholder Loans

As an owner-manager, you can withdraw funds from your corporation as a salary and/or a dividend or as a shareholder loan. The Canada Revenue Agency (“CRA”) has incorporated strict guidelines into the Income Tax Act (”Act’) when shareholder loans have to be repaid and the tax consequences therein. These rules are often misunderstood by shareholders and can result in adverse income tax consequences where care is not taken.

The following discussion relates to situations where you have taken more shareholder loans than you have contributed to your corporation. This is often known as a shareholder “debit” as opposed to a shareholder “credit”. A shareholder credits results when your corporation owes you money, since you have advanced funds or loaned back salary or dividends in a prior year on which you were personally taxed.

The Rules

Section 15(2) of the Act outlines these rules which also encompass loans to a person or partnership who does not deal at arm’s length (i.e. family members) with the shareholder.

The basic rule for shareholder loans is that they must be repaid within one year after the end of the corporation’s taxation year in which the loan was made. For example, if you borrow money from your corporation in 2016 and the corporation's fiscal year end is December 31, 2016, the loan must be repaid by December 31, 2017. If the amount is not repaid within the time frame above, it will be added to the income of the shareholder in the year the loan was received (i.e. 2016 in this example). Therefore, a T1 adjustment may be necessary for the shareholder to correctly include the loan in income in that particular year (2016) plus accompanying interest. If anyone related to the shareholder receives the loan the amount will be included in his/her income and not the shareholder.

The Exceptions

There are some exceptions to the 15(2) shareholder loan rules which would allow the loan amount not to be included in an individual’s income. If any of the criteria below are met than 15(2) does NOT apply:

i) If the loan was repaid within one taxation year;

ii) If the loan was made in the course of a money lending business i.e. bank, and bona fide terms of repayment are made.

Employees/Shareholders Exceptions

Absent of the criteria above, certain types of loans may still be exempt from 15(2) as described below for shareholders who are also employees of their business.

If the loan is to a specified employee (person who owns directly or together with related persons more than 10% of the shares of the business) the loan must be made for one of the following purposes:

1) Purchase a home (includes a house, condo, cottage);

2) Purchase a vehicle used for employment purposes; or,

3) Purchase newly issued shares of the business.

Each of these loans must have bona fide arrangements for repayment within a reasonable time period and the loan must be provided as a result of the individual’s employment rather than shareholdings. This has generally been interpreted to mean that loans must be available to other employees who are not shareholders or related to shareholders, which could be difficult to prove if the owner is the sole employee of the business and preclude the loan where you have employees (unless you provide such loans to all other employees, which is very unlikely).

Where loans are made for a home purchase, the CRA often audits the loan and it can be problematic if not impossible to prove such a loan would have been made to other employees if there actually were such. As result of this burden of proof, where housing loans were once routinely recommended by accountants, they are now typically selectively recommended.

If the loan is to an employee-shareholder who deals at arm’s length with the corporation and together with related persons own less than 10% of the shares then the loan can be made for any purpose. This provides an exception for many employees who are minority shareholders. However, similar to specified employees above, the loan must have bona fide arrangements for repayment within a reasonable time period and the loan must be provided as a result of the individual’s employment rather than shareholdings.

Interest Benefits

Section 80.4(2) of the ITA provides for an imputed interest benefit if 15(2) does not apply. Meaning if the shareholder loan does not have to be included in income, a deemed interest benefit will still need to be reported by the individual. This interest benefit arises when the interest rate charged (if any) on the shareholder loan is less than the CRA prescribed rates per quarter - currently at 1%. The amount of the interest benefit is reduced by any interest actually paid on the loan no later than 30 days after the end of the calendar year.

If the loan is included in income by virtue of 15(2) than no imputed interest benefit would be reported.

Questions to Ask

Some of the key questions to ask when an individual shareholder or connected person (e.g. daughter) receives a loan:

1) Is it reasonable to assume the loan was received by virtue of employment?

2) Is the individual receiving the loan a specified employee? (I.e. owns more than 10% of any class of shares of the corporation). If so, was the loan made to acquire a dwelling, vehicle or shares are described above?

3) Are there bona fide terms of repayment?

If the answer is NO to any of the questions above, 15(2) applies to include the loan in income, unless the entire loan is repaid within one taxation year. Repayment of all or part of the loan that has been included in income will be eligible for a deduction by the individual on his/her personal tax return in the year of repayment.

It is very important that the loan(s) not be considered to be a series of loans and repayments or else CRA could deny the deduction upon repayment. E.g. repaying an amount at the end of 2016 only to borrow again in 2017. One of the more common ways to reduce or eliminate a shareholder loan is to convert it into a salary, bonus or dividend. Since this gives rise to taxable income, it is generally not considered to be a series of loans and repayments.

See Archived IT119R4 for more details and exceptions regarding shareholder loans.

Section 15(2) is one of the most commonly applied and misunderstood sections of the Act. You should always consult your accountant or tax specialist when dealing and planning with your shareholder loans.

I would like to thank Lorenzo Bonanno, tax manager for BDO Canada LLP for his extensive assistance in writing this post. If you wish to engage Lorenzo for tax planning, he can be reached at lbonanno@bdo.ca

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Year-end Tax Tip Tweets - For the Week Ending November 15th

My Twitter year-end tax tips for this week are listed below. I really like this week's tips as many are not the standard tips you read, if I do say so myself. You can also see them as they come out daily on Twitter each morning and afternoon. My twitter name is @bluntbeancountr. I hope there will be one or two tips that are beneficial.

Tips for Week of November 11 - November 15, 2013

If you make installments, review your income tax situation to see if the Dec 15th tax installment is necessary #yearendtips

If you plan to withdraw $ from your #TFSA, do it before Dec 31 so the withdrawal will be + back to your limit on Jan 1/14 #yearendtips

If you own a corporation, review your shareholder loan account to determine what you may need to dividend in 2013 #yearendtips

If you cashed in a #RRSP in 2013, the tax is often under withheld. Prepare a draft return to see if you have a tax liability #yearendtips

If you have not made a #RESP contribution in 2013, consider making one before Dec 31st#yearendtips

Don’t wait until February 28th to contribute to your RRSP. Contribute now if you have the money #yearendtips

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.