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.
What is interesting about this account is that it represents “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.
Okay, so here are two VERY important facts:
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.
How does CRA View a “Debit” Balance?
A “debit” balance in a shareholder loan account creates a tax problem or issue for the shareholder and the company. If the amount is not repaid by the shareholder to the corporation by the end of the first taxation year following the taxation year in which the balance arises, the amount will be added to the shareholder’s income and not deductible to the corporation. This results in a “double-tax” since the amount must still be repaid and will require the shareholder to use tax-paid funds to do so, or to take additional income to offset the outstanding debit.
A good “rule-of-thumb” is to never file a corporate tax return with a debit balance in the shareholder loan account. A debit balance in the field is a “red flag” alerting CRA of a potential tax problem for the taxpayer.
How Can You Fix a “Debit” Balance?
A solution is for the corporation to declare and pay a dividend to the shareholder in order to clear the debit balance. The payment of a dividend does not require any tax withholdings, and the entire gross amount of the dividend can be credited to offset any debit balance in the shareholder account. 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.
Ultimately it is best to keep the shareholder balance in a credit position on the balance sheet. Funds can then be drawn on a tax paid basis by the shareholder, against this credit.
We do realize that this can be very difficult because of cash flow and needing to draw from corporate funds throughout the year – perhaps to acquire a personal asset. So, it will most likely be on the debit side. What we recommend is to keep it as low as possible if on the debit side.
One way to go about this is towards the end of every year to contribute funds back into the corporation if you have a little “nest egg” of funds saved up, so as to reduce the debit balance. Essentially, the corporation would declare and pay a year-end bonus (net of tax withholdings), and credit the shareholder loan account. By doing so the corporation will not need to declare/pay as big of a dividend to the shareholder – ultimately resulting in the shareholder paying less in taxes.
At Green Quarter Consulting - Accounting and Bookkeeping Services for White Rock, South Surrey, Langley and Surrey BC, we are here to help. We can assist with navigating through things like the Shareholder Loan Account.