Unless you’re on regular payroll, whenever you take out money from your company, it’s as though the company has loaned you those funds until something is done with that balance – maybe a dividend is declared, a bonus paid or the full balance is repaid.
In an ideal situation, you could keep ‘borrowing money’ forever from your company and never pay any personal tax on the funds that you’ve ‘borrowed’. Unfortunately, the CRA has rules in place to make sure you do end up paying taxes on this benefit but, with some planning, you can minimize the taxes that you have to pay.
Income Tax Provision
Generally, when you borrow funds from your company and don’t repay it within one year, the CRA can assess the outstanding balance as ordinary income at an income tax rate similar to that of a salary. The implication is that your company isn’t allowed to claim this as an expense the way they would if it was a salary, meaning you’re effectively double taxed.
For example, if you borrow or withdraw $50,000 throughout the year, without declaring a salary or dividend, the CRA could effectively call this income meaning that you’ll pay about $9,000 in income taxes and your corporation will pay about $7,500 in taxes, roughly $6,000 more than if you declared dividend or were paid a salary.
To avoid double taxation, please review the two strategies below:
Repayment of Loan
The simplest solution to avoid being taxed on the loan is to repay it within one year. If you can repay the funds that you borrow from your company within a year of borrowing them, you won’t be taxed on the funds that you borrowed.
However, if you take out a new loan from your company to repay the original loan the CRA will see this as a continuation of the original loan.
In the example above, if you borrow $50,000 from your company and are able to repay the loan within one year from when the first instalment was borrowed, there’s no amount that needs to be included in your income and no tax to pay on the $50,000 that you borrowed.
This works really well if the funds are needed to cover short term personal cashflow needs, maybe you’ve bought a new house but your old one hasn’t closed yet and you’re stuck juggling two mortgages. You can borrow funds from your company to help you cover your short term cash flow needs until your old house sells.
Declaring a dividend
As an alternative to a salary, you may draw funds from your company to cover your day to day living expenses or to cover a major unexpected expense and have no expectation of being able to repay those funds.
If this is the case, you can declare a dividend for that amount and you’ll pay tax at the lower dividend tax rates. You’ll need to prepare some tax filings that are due at the end of February following the year that the dividend is declared and you’ll pay any personal tax on the dividend at the end of the following April.
Referring back to the above example – if you took $50,000 from your company throughout the year to pay your living expenses or a major one-time expense, you could declare a dividend to cover off that amount. Depending on your personal situation and other income, you’d pay about $3,000 of personal taxes on this dividend.
Being able to draw funds from your company as you need them is a great way to deal with short term cash flow needs. The flexibility of drawing funds as you need them is also a good alternative to the rigidity of being on a regular salary and be able to cover unexpected expenses. With proper planning, you easily minimize your personal taxes related to those drawings by repaying the loans when possible or declaring a dividend.
Small Business Accounting Blog 