When advances or loans are made to shareholders this should be recorded in a general ledger account set up for this purpose. If a loan is made for which the interest would be tax deductible for the shareholder, it is important to track this loan separately from other advances or loans.
The same is true for loans made to corporations by their shareholders. Recording all transactions correctly in the general ledger is of extreme importance. Any payments made to a shareholder must be properly classified, with detailed information retained about the payments. Court cases can be won or lost based on bookkeeping records.
Keeping accurate records of all corporate transactions is extremely important!
If you have no bookkeeping knowledge, consult with a bookkeeper or accountant when you start a business!
Converting a Shareholder Loan to Employment Income or Dividends
Sometimes funds are advanced to a shareholder/employee throughout the year, and at the end of the year salary or dividends are paid or recorded to clear the balance of the shareholder loan. A deemed benefit under s. 80.4(2) will still apply if insufficient interest is paid for the period during which the shareholder loan was outstanding.
Care must be taken in the timing of salary or dividend payments to clear shareholder loans.
Salary Paid to Offset Shareholder Loan
If a corporation has a December 31st year end, then for the shareholder loan to be cleared by a payment of salary, the salary payment must be made, or recorded in the books of the corporation as having been paid, in December. Income taxes, and any applicable employment insurance or Canada Pension Plan contributions must be remitted based on the remittance due date of the employer, which will either be the 10th or the 15th of January for salaries paid or recorded from the 22nd to the 31st of December. A payment by cheque is not necessary, but only the net amount of the salary amount can be used to offset against the shareholder loan balance.
Dividend Paid to Offset Shareholder Loan
If a dividend payment is made to the shareholder in order to clear the shareholder loan, this payment must be made, or recorded in the books of the corporation as having been paid, in December in order to clear the shareholder loan balance for a December 31st year end. T5 information slips must be filed no later than the end of February. Dividends, of course, are not a deductible expense for the corporation.
Bonus Paid to Offset Shareholder Loan
If a bonus to the shareholder is accrued for year end, but the bonus is not paid or recorded as having been paid prior to the end of the taxation year, it will have no effect on the outstanding shareholder loan until it is actually paid. Any bonus accrued for year end must be paid within 180 days of the taxation year end. This can be done by recording a payment of the bonus by a debit to the "bonus payable" general ledger account and offsetting credit to the shareholder loan account, which would be reduced by any withholdings for income tax and CPP. These withholdings must be remitted to CRA. Otherwise the bonus will not be deductible in the year it was accrued. If it is paid after the 180 days, it will be deductible in the taxation year in which it is paid.
Shareholder Loan Effect on Capital Gains Exemption
Keep in mind that a loan from the corporation to the shareholder is considered an asset of the corporation. If the amount of the loan is significant, it could put a small business in a position where it is not a qualified small business corporation, and thus not eligible for the $800,000+ lifetime capital gains exemption for the shareholder, on disposal of the shares.