Don’t mix personal and business expenses

Owners work hard to build their businesses. So, what’s the harm in rewarding themselves once in a while with the hard-earned company funds?

Some owners use company money to complete renovations or finance large purchases, for instance.

And from a tax perspective, if their business is unincorporated, they can do this so long as they don’t have financing or any other obligations restricting the use of funds from their business account.

But, this “mingling” action becomes far more of an issue if your client’s business is incorporated, the benefits of which are great. Simply, a corporation is a great vehicle for shielding liability.

As a separate legal entity, however, any funds withdrawn from the corporation are subject to tax in the shareholder’s (or business owner’s) hands. Shareholders often get into trouble when they withdraw funds for personal use and then don’t pay tax on it—or don’t repay the principal to the company.

Read: Claim business expenses now

Taxable Benefit

Consider the case of Ryan Smith, who incorporated his company shortly after he invented and patented a unique building product. When he decided to renovate his home, rather than personally borrowing money from the bank at a higher rate, he withdrew money from his corporation’s bank account. The amount was reflected as a loan receivable on the balance sheet and was never repaid.

Smith now has a problem. The Income Tax Act considers amounts loaned to shareholders as income in the year of withdrawal; unless the money is repaid within a set timeframe. In Smith’s case, the Canada Revenue Agency (CRA) assesses him for unpaid taxes for the year he withdrew the money and he will have to pay interest and penalties. The CRA will also regard the value of the interest Smith didn’t pay as income and tax him on it.

Read: Home business balancing act

Smith can address this is by voluntarily disclosing his actions to the CRA, which can use its discretion to waive a portion of the interest and penalties, but not the taxes. And, if Smith repays the loan now, he can also qualify for a deduction from his current year taxable income, provided the repayment is not part of a series of loans and repayments.

Read: Preventing questionable expenses

Stella Gasparro is a tax partner at Meyers Norris Penny in Toronto.

This article was originally published on capitalmagazine.ca.