Risk in borrowing money

The three main ways an owner-manager can get funds from their business are:

• Payment of wages/salary
• Dividends are paid and
• Repayment of any loans that were previously lent to the company.

Many owner-managers find that borrowing money from the company is a fourth option to borrow funds. This sounds great until your company is audited and you are faced with a substantial tax assessment.

The income tax rules usually allow an owner-manager to borrow money from their business.

• If the loan is not repaid within a specified time period, the amount borrowed will be included as income to the owner-manager for tax purposes.
• If the loan amount was included in the income of the owner-manager, the owner-manager may be eligible to deduct future repayments of the loan.
• The owner-manager might be required to include an interest advantage in relation to the loan in their income.

These rules are not too difficult to follow. Problems arise when the documentation and repayments are not sufficient.

CRA auditors inspect owner-managed companies first by looking at the bank accounts of shareholders and owner-managers. If the CRA finds that the owner-manager is drawing money from the company and there is not enough documentation to support the claims, the CRA will declare the draws shareholder appropriations.

Owner-managers must include shareholder appropriations in their income. There is no deduction if the amount taken is later repaid to them. The CRA will often assess a "gross negligence penalty" when assessing the owner-manager's income tax for a shareholder appropriation. The gross negligence penalty equals 50% of the additional income tax.

The CRA is inclined to consider owner-manager draws as shareholder appropriations rather than loans. Owner-managers should only accept money from the company in the form of dividends, salary/wages or wages. This is the most secure thing. It is crucial that an owner-manager borrows money from their company. This must be documented legally and properly.

It is important for owner-managers to properly document and legally document loans made to companies. They also need to ensure that company accounting records match the documentation. The CRA could treat repayments of loans that an owner-manager receives for their company as shareholder appropriations if they fail to do so.