Borrowing Money From Your Company Is Risky

An owner-manager has three options to draw funds from his company.

• Payment of wages/salary
• Dividends paid,
• Repayment of previous loans to the company.

Owner-managers often find that borrowing money from their company is an alternative to drawing funds from it. This may seem like a good idea until the Canada Revenue Agency ("CRA") audits the company and the owner-manager is faced with a significant tax assessment.

If an owner-manager borrows money for their company, the income taxes rules generally allow that:

• The amount borrowed will be added to the income of the owner-manager, tax purposes, unless the loan has been repaid within a specific time.
• The owner-manager might be entitled to a deduction for future repayments if the loan amount is included in his income.
• Owner-managers may have to include interest benefits in their income in order to cover the loan.

These rules by themselves don't seem too bad. Problems can arise when there is not enough legal documentation regarding the loan and the repayments.

CRA auditors will inspect the bank accounts and shareholder loan accounts of owner-managed businesses when they audit them. If they discover that the owner-manager has been taking money from the company without the necessary documentation, then the CRA may consider the draws to have been shareholder appropriations.

The owner-manager must include shareholder appropriations in his income. If the amount is repaid, there is no deduction. Often, the CRA will also assess a penalty for gross negligence if the owner-manager is assessed for additional income tax due to a shareholder appropriation. The gross negligence penalty is equal to 50% of any additional income tax.

The CRA tends to view owner-manager draw as shareholder appropriations, rather than loans. The best thing for an owner-manager is to not take money from the company as salary/wages, or dividends. Owner-managers who need to borrow money from the company must document it legally.

As such, it is crucial that owner-managers who loan money for their company legally document the loan as well as the repayment. It is also important that the accounting records of the company are consistent with this documentation. Failing to do this could lead to the CRA treating the repayments of the loan the owner-manager received from their company under shareholder appropriations.