Although loans between shareholders and their companies might be common, a recent Tax Court of Canada case shows that they can have hidden tax costs, Toronto tax litigator Adrienne Woodyard writes in Lawyers Weekly.
In Mast v. Canada, a taxpayer who was also the sole shareholder of a corporation decided to use company funds to build a home. The taxpayer signed an agreement with the company for a non-interest bearing loan of up to $1 million with flexible repayment terms.. He funded a portion of the construction from advances from the company, repaying a portion of the debt in yearly instalments.
Following an audit of the company, the Canada Revenue Agency (CRA) determined that the loan was made to the taxpayer in his capacity as a shareholder. The taxpayer, however, said he received the loan as a company employee. The Tax Court of Canada agreed with the CRA.
"The distinction was significant because the tax treatment of a no- or low-interest home loan is very different, depending on whether the debtor is an employee or a shareholder," writes Woodyard, a lawyer with Davis LLP.
For example, when the shareholder benefit rule applies, says Woodyard, the entire amount of the loan must be included in the shareholder's income.
"For taxpayers who wear two hats, therefore, the question of whether the loan was received as an employee or as a shareholder is key. The answer could mean the difference between receiving small annual tax bills for a deemed interest benefit and a one-time charge on the entire principal," she says.
This case, writes Woodyard, "should encourage small, closely-held corporations to revisit their loan arrangements and make sure that the terms of their agreements and their financial records will not leave them vulnerable on a tax audit."
Originally Published in The Lawyers Weekly
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