In a ideal world, it would be great to keep "borrowing" the cash from your business without ever paying personal tax on it #iWish. However the CRA have rules/regulations to ensure this does not happen and they collect the personal tax element by having you declare it as a dividend, bonus or salary. With some planning, you can minimize the personal tax hit on this. Generally speaking you as the director/shareholder can borrow funds from your company and when you do not repay it back within one year, the CRA will assess the loan balance as "ordinary income" which is a similar tax rate as salary. Unlike salary, however you can not expense the shareholder loans leading to no real benefit being realized. Confused yet? Let's run through an example
For example, John borrows from the business ($50,000) throughout the year which was tracked by his accountant in an account called "Shareholder loan" at the end of the year the proceeds of the loan were not declared as a salary or dividend. The CRA can assess this to be income carrying with it a tax payment of $9,000 personal taxation and $7,500 in taxes to your Corporate tax, roughly $6,000 more than had you declared this income to be a dividend or salary.
To avoid the double taxation hit you have a few options. You can repay the total loan amount of $50,000 back to the corporation within the year and not trigger any taxes. Borrowing more money from the corporation to offset the original loan won't work the CRA are smarter than this and have rules placed for this too. The CRA will call this out to be a continuation of the original loan leading to a bigger tax problem. #TaxProblems
Let's assume that you declared this loan as a dividend. You can now write off the entire $50,000 against your corporation as a Dividend expense. You can additionally claim the small business deduction and pay 15.5% on the income that is left over in the corporation after paying the Dividend. The shareholder can effectively take the non-eligible dividend amount of $35,000 tax-free and then pay the taxes on the left over $15,000 which would roughly be $2000 taxes on this dividend.
Being able to draw funds from your company is a great benefit rather than taking a salary because your cash needs changes on a year to year basis. Paying tax on money that you do not need does not make sense. It's important to figure out what your total budget is and withdraw the funds required. Remember to declare your dividends before Feb of the next year if your year-end is Dec 31st.
Bookkeeping helps to keep track of this. Don't be caught in a homegrown tax problem. Let your Accountant handle it!
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- Written by: Jag Bath