Shareholder loans are a great little tool that the business has access to. The gist of it is that a shareholder of a company can borrow money from that company for pretty much anything they want. Every shareholder, technically, has the right to do so and the only thing Canada Revenue cares about is that the loan is documented with the minimal interest rate applied (1%) and that the loan is repaid within one year following the fiscal year end that the money was borrowed in.
The repayment plan
The borrowing term is referred to as the “one-year rule,” which in some cases is actually a two-year period; but this depends on when you take out the loan. For instance, if you take the loan out at the beginning of a fiscal year, your one year repayment period does not begin until the end of the fiscal year you took the loan out. Essentially, you have the whole year in which you received the loan, plus the following year – of course this is only if you take the loan at the beginning, or relatively early in a fiscal year.
Exceptions to Shareholder Loan
The one-year rule can be waived if you use the borrowed money to purchase your primary residence, or to purchase a vehicle for business use. In these cases, the repayment period is stretched to 25 years for the primary residence, and up to 5 years for a vehicle.
I can borrow money for anything?
Absolutely – but let’s not get carried away here. Shareholders typically borrow money for emergency situations, unforeseen expenses and even tuition for children, but that money has to be paid back to the company within (at the most) two years. With this in mind, you don’t want to take out some exorbitant loan that you can’t possibly hope to repay. Of course, a major caveat to this whole situation is that your loan request has to be approved by fellow shareholders, owners, partners, etc. If the reasoning behind the loan request isn’t legitimate, or practical, there is a better than good chance you won’t be allowed to borrow the money.
An extra benefit
During the ‘growth’ years of your business, you are likely to take a pittance for salary. This is a good time to borrow from the company without having to worry about the one year rule, because you simply declare the loan as income. At this point you’ll be in a lower tax bracket so it won’t cause you much harm. Eventually you will make a greater income, forcing you into a higher tax bracket, at which time you make the loan repayment and take the entire amount as a tax deduction for that year.
Shareholder loans are very beneficial, especially in a pinch. The low interest rate makes the loan far more manageable, and given that these loans aren’t typically massive in size (excepting of course home and auto purchases), paying them off in 24-48 months is very reasonable.
