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tax matters

A few years ago, Japanese toy maker Tomy Co. Ltd. built an exploding piggy bank. The idea was supposed to motivate kids to save more money. If the user failed to deposit cash in the piggy bank, it would shake and beep – on an hourly basis – and eventually "explode," scattering the contents all over the place. It was reusable after the "explosion," and no kids were hurt in the process – that I'm aware of.

Many business owners treat their corporations like a piggy bank, taking money from the corporation and, sometimes, making deposits to the corporation. There tend to be more withdrawals than deposits if the business is earning any reasonable amount of money. The problem? There are rules in our tax law that can cause big problems for owners who make more withdrawals than deposits – not unlike the exploding piggy bank. A recent court decision reminds us of these rules.

The case

The Tax Court of Canada (TCC) handed down its decision three weeks ago in the case of 468543 B.C. Ltd. v. The Queen. In this story, the owner of the company, Mr. S., and the corporation itself, were reassessed to include an amount in Mr. S's income for benefits he had received from the company. In addition, the corporation was reassessed and denied certain deductions, and both Mr. S and the corporation were assessed penalties for gross negligence.

In this case, the corporation made mortgage payments on Mr. S's personal residence, which is taxable as a shareholder benefit. As a result, the TCC ruled that the amounts paid on Mr. S's behalf should be added to his income. In addition, the evidence showed that a loan was made to Mr. S from the corporation. Since the loan was not repaid within a certain period of time, the amount of the loan became taxable to Mr. S. under our tax law – which is how the court ruled. It's no surprise that the TCC also held that the interest on the mortgage payments was not deductible to the corporation since the payments were not made for business reasons. The court also held that amounts reported as wage expenses to the corporation were not deductible because they were, in fact, dividend payments.

The law

If you're looking to get money from your corporation to use personally, or to have your company pay for certain costs which are personal in nature, it's important to understand what our tax law says about this. There's no shortage of cases like Mr. S's story.

First, Section 15 of our tax law says that any time a benefit is conferred on a shareholder by a corporation, the value of the benefit is taxable as income in the year it's received. This was the provision that applied to Mr. S when his company made his mortgage payments for him.

But what about loans to you from your corporation? That same section also deals with these loans. The law says that if you, or someone connected with you, borrows money from your corporation, the loan is taxable as income, unless certain conditions are met. If your company is in the business of lending money, then the loan may not be taxable to you – but this exception won't apply to many. You'll also avoid tax on a shareholder loan if you receive the loan in your capacity as an employee, not a shareholder (which can be difficult to prove), and you borrow the money for one or more of three purposes: To assist in purchasing a home for you to live in, to acquire shares from the treasury of the corporation, or to acquire a vehicle to be used by you in your employment with the company. In addition, it's important that there be bona fide terms for repayment of the loan within a reasonable time.

If you don't meet the exceptions I've mentioned, you'll have to make repayment within one year of your corporation's year-end to avoid facing tax on the loan amount. So, if your company's year-end is Dec. 31, and you borrow from your corporation in 2017, you'll have to repay that loan by the end of the following fiscal year of your company – that is, by Dec. 31, 2018, in my example.

I should mention that you could also face a taxable interest benefit for low- or no-interest loans from your company. The rules here have been simplified, so if you are borrowing from your corporation, speak to a tax pro about your situation.

Next time, I'll share some ideas for getting money out of your corporation in a tax-free, or low-tax manner.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices.

Rob Carrick goes over some ups and downs of investing in dividend stocks, bonds and GICs.

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