INDEX for My Notes on CCPCs
If your company is a Canadian Controlled Private Corporation (CCPC) and has loans to shareholders, be aware of the very specific rules that apply when a corporation loans money to its shareholders who own more than 10% of the shares and their family members.
If you have a negative shareholder loan balance (it is in a debit balance), these rules now apply to you.
You may also want to make sure you meet CRA criteria BEFORE you take any management fees or bonuses ... to ensure there are no negative tax consequences.
Unlike a sole proprietor, an owner / manager does NOT have free access to the company's funds and/or assets. Why? The corporation has its own legal identity that is separate from the owner / manager's identity.
What does this mean to YOU? All titles to assets MUST be held in the corporation's name, not the owner / manager's name. If an asset is registered in the owner's name, it is a personal asset regardless if the funds to purchase were removed from the corporation.
STOP ... before you write yourself that cheque or take that cash ...
There are very specific rules when a corporation loans money to its shareholders who own more than 10% of the shares and their family members. YOU need to be careful that money you remove from the company is not at risk to be taxable.
If you and other family members own less than 10% of the corporation, your transactions are treated the same as if you were an employee.
The Tax Guy from the Canadian Tax Resource website explains loans to shareholder in his August 29, 2008 blog. (This article is no longer available on his blog. It seems to have been replaced with a similar blog dated February 12, 2011 titled "How Shareholder Loans Affect Your Income Tax". The article titled "Shareholder Loans and Your Private Corporation" has now been republished on The Tax Guy's new website -Dean Paley.) I've recapped the original 2008 article here.
Generally, when a loan is made by the corporation to a shareholder, a taxable benefit arises for the shareholder. The amount received must be included in the recipient's income in the year the money was received. When the loan is repaid, it can be deducted from income in the year of payment.
However, there are exceptions to this rule.
If the loan is repaid within the year following the corporation's year end, then the loan does not have to be included in income. The loan cannot be a series of small borrowings and repayments for this rule to apply. The Tax Guy refers to this as the one year rule.
For example, let's say your corporation has a December 31 year-end, and you as a shareholder borrowed $15,000 in 2016 from the corporation. No taxable benefit will occur if you repay the loan by December 31, 2017.
If the loan was related to normal business activity, it is not considered a shareholder loan provided there is in place actual repayment terms where interest is charged at standard rates. The terms must be met and maintained. The Tax Guy refers to this as the lenders rule.
There must be a written agreement between the shareholder and the corporation. The agreement should state the amount of the loan and the time frame the shareholder will repay the loan. The shareholder should try to make actual payments with regards the loan and not journal entries. This makes it clear there was a financial obligation and it was being met.
If the shareholder is also an employee (as most small business owners are), a loan can be advanced due to employment and it will not be considered income (it is tax free). It could be to purchase a principal residence, a vehicle to be used for business purposes or new shares in the corporation. As with the lenders rule, payments must be in place for repayment and maintained. The Tax Guy refers to this as the principle residence rule.
Do not confuse these loans to shareholder with shareholder loans where you made to the corporation as an investment in the business. These rules only apply when the corporation lends the shareholder/employee money.
As these are very specific rules with regards the loan transactions, you should contact a tax professional for advice specific to your situation. You may also want to read CRA's bulletins IT-421R2 and IT-119R4.
The first bulletin discusses section 80.4(2) Benefits Arising by Virtue of Shareholdings. The second bulletin discusses subsection 15(2) Shareholder Debt and Certain Persons Connected With Shareholders (also discusses 15(1)).
The Tax Guy also posted a great article on November 30, 2010 called Employer Loans to Employees. He discusses the employee benefit, as well as home purchase loans, home relocation loans, investment loans and loans to buy a vehicle. You can find it at blog.taxresource.ca> Archive (found in very smmaaallll print at the top right hand corner of the web page)> November 2010> Employer Loans to Employees .
Spousal loans are a form of loans to shareholder. I create an account called Related Party Loans and track the transactions separately.
On September 25, 2009, The Vancouver Sun had a great article written by Jamie Golombek on how to income split by lending money to your spouse at the prescribed interest rate of 1%. This is where you can take advantage of an exception to the attribution rules.
By loaning money to your spouse at the prescribed interest rate, with interest paid back annually by January 30 of the following year, any resulting gains or income will be taxed in the lower income spouse's hands and not attributed back to the higher income spouse.
It is important to note that the interest income on the loan will be taxable on the higher income spouse's tax return while the lower income spouse may receive a tax deduction.
Mr. Golombek points out that although prescribed interest rates are set quarterly, the rate in effect at the time the loan was extended remains in place for the duration of the loan.
It is good practice to ensure you have a written loan agreement or promissory note stating the terms including amount, interest rate, term of the loan and repayment arrangements.
The Ernst & Young annual Managing Your Personal Taxes guide recommends that you have a separate bank account from your spouse to preserve the source of the investments and resulting gains / income.
The Knowledge Bureau September 29, 2010 newsletter explains you need to be aware that a formal spousal loan agreement with no interest charged does NOT meet the attribution rules criteria. If 0% interest is charged, then attribution rules will apply.
Attribution rules are very specific with respect to spousal loans ... interest must be charged at a rate at least equal to a minimum rate of an available commercial interest rate or the CRA prescribed interest rates ... AND the interest must actually be paid on time.
Owner Managers have other options besides loans to shareholders when they want to remove money and/or assets from the company. Let's discuss a few ... starting with management fees.
As a small owner managed corporation, before you book your management fees or bonuses this year end, check to make sure the circumstances meet CRA criteria.
In August 2009, Andrews & Company Chartered Accountants posted on their website (www.andrews.ca) an excellent tax tip on management fees and salaries. I summarize the article here ... but tax rules and therefore strategies are always changing so what was effective in 2009 may not be the best strategy for owner manager remuneration in 2011. To make my point ...
I found a BDO article from February 2011 titled Owner Manager Remuneration Strategies Integration Revisited.
The article explains how "the corporate tax system was substantially changed in 2006 with the introduction of the eligible dividend rules as an initial step to counter the stampede of corporate conversions to income trusts. At the same time, the federal government and some provincial governments started a gradual process of lowering general corporate tax rates." It discusses the advantage if the income remains and is taxed in the CCPC.
The BDO article pertaining to CCPCs is somewhat technical but worth reading. I'm not a tax expert by any stretch of the imagination. I didn't understand all the nuances but got the gist of what was being said. As I've noted before, use the article for talking points with your accountant.
BDO also released an article titled Owner-Manager Considerations on October 15, 2011 that is worth reading; as is Deloitte's January 2011Privately Speaking - Tax Insights article by senior tax manager Robert Leombruno titled Managing Your Management Fees.
BDO's article points out that "a complicating factor to this analysis (salary / dividend mix) is the fact that the personal tax rate on dividends will increase between 2011 and 2012, and then is projected to remain at the 2012 rate." It discusses the drawbacks of dividend income and advantages of having a portion of your income taken in salary.
Okay now that I've addressed the time sensitivities of various tax strategies, here are effective owner manager remuneration strategies that are not utilized as much since the 2006 changes mentioned above.
Before reducing the corporation's tax burden by bringing this year's profits down to the $500,000 small business deduction limit through the use of management bonuses and fees, be aware that CRA can challenge the amounts if they are not reasonable as discussed in Deloitte's article mentioned above.
The Corporate Minute Book
It is important that details be documented. There should be a written contract and the decision to pay the fees / bonuses recorded in the corporate minute book.
The fees should be for active participation in and services provided to the corporation and in line with the effort it took to earn the fees. You must have the skills related to what you are being paid for and they should be in line with other similar companies.
CRA also looks at whether the profits being distributed in this manner are a regular corporate policy.
Other Owner Manager Remuneration Options
Speak with an accounting professional before doing anything to avoid negative tax consequences. Your accountant will
Here are some points to consider:
I found an excellent CGA three part series of articles on owner/manager remuneration through google. Although the series is not dated, it is an older series as CRA is referred to as CCRA. This means it was written sometime between December 1999 and January 2004. So keeping in mind the 2006 changes mentioned earlier in this chat ... although the principles will still be valid, some of the information may not be current. Check with your own accountant before doing anything. Here are the links:
See CRA's publication Technical News No. 22 for their position on CCPC shareholder / manager remuneration.
As you can see, there are a number of ways to remove money from your company; loans to shareholder is just one of them.
Recommended Reading - Deloitte's recommends the fourth edition of Taxation of Private Corporations and Their Shareholders available through the Canadian Tax Foundation. From their newsletter:
"The book is a valuable resource for entrepreneurs, owners and those who advise them. It provides an analysis of incorporation, capitalization, compensation, the acquisition and disposition of assets, the drafting of shareholder agreements, the purchase and sale of a business, and the structuring of a business in the most tax-effective manner."
If you are driving the company car, don't forget to calculate a standby charge benefit and operating expense benefit ... and report it on a T4 or T4A depending on your circumstances.
What this means is you need to be aware of CRA's rules about shareholder benefits that arise due to personal use of the company vehicle.
Most owner-managers are employees of the corporation as well as shareholders. Use of the company vehicle is a taxable benefit and reported on a T4 slip.
However, when the shareholder is not an employee and has use of the company vehicle, then a shareholder benefit is conferred. This benefit is taxable and reported on a T4A slip.
You may also want to take some time to read CRA's publication IT-432R2 Benefits Conferred on Shareholders to make yourself familiar with what other benefits are taxable.
Subsection 15(1) discusses "the amount or value of a benefit conferred on a shareholder by a corporation in a taxation year is included in the shareholder’s income for the year, except to the extent that the benefit is deemed by section 84 to be a dividend."
A conferred benefit includes:
"(a) a payment by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction;
(b) an appropriation of a corporation’s funds or other property in any manner whatever to, or for the benefit of, a shareholder; or
(c) any other benefit or advantage conferred on a shareholder by a corporation.
If the person on whom the benefit has been conferred is both a shareholder and an employee of the corporation, a determination will have to be made, taking into consideration all the relevant facts and circumstances of the particular case, as to whether the benefit was conferred by the corporation on the person as a shareholder or as an employee. In the latter case, paragraph 6(1)(a) of the Act applies, rather than subsection 15(1)."
A more "user friendly" explanation of shareholder benefits can be found in a 2006 CGA Magazine article by David Nolke titled Shareholder Benefits: Beware the perils of a subsection popular with auditors. The article gives very practical examples of how this part of the tax act is applied. You'll find the article at www.cga-canada.org.