Many Canadians operate their business through a corporation. Even though the finances of small business corporations are directly linked to the finances of their owner-managers, it’s important to remember that corporate funds are not personal funds and should not be treated as such. Treating your corporation like a personal bank account can lead to adverse tax consequences. Under the Canadian Income Tax Act (the “Act”), shareholders who fail to keep the seperation between corporate and personal funds can be assessed as having received “shareholder benefits” and/or “shareholder loans”, both of which result in double-taxation. Taxpayers who face a CRA audit should be aware of the CRA’s collection powers and the CRA’s power to compel information. In many cases of shareholder expropriation from a corporation, the shareholder is assessed gross negligence penalties.
Subsection 15(1) of the Act provides that a shareholder benefit arises where a corporation confers a “benefit” on a shareholder, a contemplated shareholder or an individual who does not deal at arm’s length or is affiliated with a shareholder (e.g. spouses, children, parents), otherwise than by way of a dividend or other taxable payment. The CRA considers a “benefit” to include any payment, appropriation of property or advantage conferred on the shareholder by the corporation. Accordingly, where any corporate property is misappropriated by a shareholder, the value of that benefit is included in the income of the shareholder. Personal use of a corporately-owned car by a shareholder’s spouse, for example, can lead to an income inclusion equal to the fair market value of having the use of such a car. The application of subsection 15(1) is particularly punitive since it provides for an ordinary income inclusion at the shareholder level where there often is no deduction at the corporate level or accompanying tax credit. In effect, the ultimate distribution to the shareholder is subject to much more tax than otherwise would result from an ordinary dividend payment.
Subsection 15(2) of the Act provides that where a corporation makes a loan to a shareholder, a member of a partnership that is a shareholder or a person connected to a shareholder, the full amount of the loan is to be included in the shareholder’s income. The shareholder can only deduct this amount from his or her income in the taxation year in which the loan is repaid. There are various situations in which certain shareholder loans are not subject to the subsection 15(2) inclusion. The provision does not apply to loans made to shareholders who are Canadian-resident corporations, loans made within the ordinary course of a lending business, and certain loans to employees. One of the more notable exceptions applies to loans repaid within one year after the corporate lender’s year-end. For example, where a corporation with a July 31 year-end makes a loan to an individual shareholder in January of Year 1, the shareholder must repay the loan by July 31 of Year 2 in order to ensure that the loan is not subject subsection 15(2).
Subsection 15(1) and 15(2) are common tools used by CRA auditors. If you have been reassessed as having received a shareholder benefit or shareholder loan, please contact one of our tax lawyers for a consultation.