The Shareholder Loan and the Policy Loan

Two transactions in an incorporated owner's file carry similar names and share almost nothing else. One is a loan between an owner and the company that owner controls, recorded in an account the bookkeeper maintains. The other is an advance made by an insurer against the accumulated value of a life insurance contract. Owners confuse them constantly, and the accountants who clean up afterwards can tell you what the confusion costs.

This page sets the two side by side, attribute by attribute, and reaches no verdict. They are not substitutes for one another, and nothing here suggests that either should be preferred. The timing question on the corporate side belongs to a CPA holding the company's figures and its year end. The question about the advance belongs to your own contract and to your Financial Security Advisor, who can read the loan provisions with you.

What is a shareholder loan, actually?

A shareholder loan is money that has moved between an owner and the corporation, in either direction, recorded in a single account in the company's books. It is a running balance and not a product. Nobody applies for it, nobody underwrites it, and it usually comes into existence without anyone deciding that it should.

The account runs both ways. When the corporation pays a personal expense, or advances cash to the owner, the owner owes the company and the balance sits on the asset side of the statements. When the owner puts personal money into the business, covers a shortfall from a personal account, or leaves a declared amount undrawn, the company owes the owner and the balance sits on the liability side. Most owner-managed companies have carried both positions at different times, and almost none of them planned either one.

What makes the account matter is that the Income Tax Act treats the two directions very differently. Money owed by the company to its owner can generally be repaid without further tax, because it was taxed on the way in. Money owed by the owner to the company is the subject of a specific timing rule, and that rule is why this account draws attention from the Canada Revenue Agency at all. Your CPA maintains the account and is the person who can tell you which way it currently runs and by how much.

What is a policy loan, actually?

A policy loan is an advance the insurer makes to the owner of a life insurance contract, secured against the accumulated value inside that contract. The owner submits a written request, the insurer confirms the amount available, and the money is released. There is no credit assessment, and no third party can withdraw the provision.

The insurer advances its own funds and holds the contract's value as security. That value stays inside the contract and continues to be administered under the contract's terms, while a new obligation now exists between the owner and the insurer. Anyone who describes this as taking money out of a policy has described a different transaction, with a different tax treatment and a different effect on the contract. The full mechanics, including how much is available and how interest accrues, are set out in policy loans.

Two features carry most of the weight here. The first is that no lending decision is made: the contract obliges the insurer to advance against value that has accumulated, and the insurer is carrying out that obligation without forming any view about the borrower. The second is that the amount available is capped by the value that has actually accumulated, so the provision is small in the early years of a contract and grows slowly. Neither feature can be altered once the contract has been issued.

Who is on the other side of each one?

On a shareholder loan the counterparty is your own corporation, a separate legal person you happen to control. On a policy loan the counterparty is a life insurance company with no relationship to your business at all. One transaction stays entirely inside your own affairs; the other brings an outside institution into them.

A corporation is a separate legal person with its own taxation year, its own return, its own creditors and its own records. Every difficulty in this area begins with an owner who feels otherwise, moves money across that line when it is convenient, and discovers on an audit that the Act took the separation seriously even when the owner did not. The money that came out of the company in March was a transaction between two parties, and one of those parties keeps books that somebody else will eventually read.

The insurer is a counterparty in the ordinary sense: an institution that has signed a contract with you and can be held to it. It has no view about your business, no covenant over your receivables, and no right to reconsider the arrangement because your industry has had a difficult year. It also has no reason to be generous. The terms are the ones printed in the contract, and they were fixed at issue and cannot be renegotiated afterwards.

What does section 15(2) of the Income Tax Act require?

Section 15(2) of the Income Tax Act generally includes in a shareholder's income the amount of a loan the corporation made to that shareholder, in the year the loan was made. The provision is about timing, and its practical effect is that an owner who draws from the company and leaves the amount sitting there can be taxed on it.

Subsection 15(2.6) sets out the exception owners hear about most often. Where the loan is repaid within one year after the end of the taxation year of the lender in which it was made, and the repayment is not part of a series of loans or other transactions and repayments, subsection 15(2) does not apply to it. That is the outline, and the outline is all this page offers. The words about a series of loans and repayments carry real weight, and the Canada Revenue Agency has taken a published position on what they cover.

How those provisions apply to your account depends on facts this page cannot see: when the amount was advanced, what the corporation's taxation year end is, whether a pattern of drawing and repaying already exists, and whether the amount is properly characterised as a loan at all. Take the account to your CPA well before the year end and not after the return has been filed. This page does not give tax advice, and the practice does not give tax advice.

What is the deemed interest benefit on an amount left outstanding?

Where an amount is owed by a shareholder to the corporation and no interest, or too little interest, is actually paid, section 80.4(2) of the Income Tax Act deems a benefit to have been received and includes it in that shareholder's income. The benefit is computed using a prescribed rate that the Canada Revenue Agency publishes quarterly.

The deemed benefit can arise even where the income inclusion does not, which is the part owners find surprising. An amount repaid inside the window the Act allows may escape inclusion under section 15(2) and still produce a deemed interest benefit for the period it was outstanding. The two provisions answer two different questions. One asks whether the principal itself is income; the other asks what the use of the corporation's money was worth while the owner had it.

The Act also contemplates paying actual interest to the corporation, which can reduce or eliminate the deemed benefit, and there is a deadline attached to that payment which owners routinely miss. Its value in your own circumstances, the arithmetic behind it, and what the payment does to the corporation's own income are all questions for the accountant who prepares the return. No figures belong on a page that cannot see your year end.

What documentation does each one require?

A shareholder loan requires bookkeeping and, where the amount is significant, a written agreement stating amount, rate, repayment date and security. A policy loan requires a request on the insurer's own form, signed by the policy owner, with signing authority confirmed where a corporation owns the contract. One is evidence you create; the other is a form you complete.

Documentation on the corporate side is what turns an entry into a loan. An amount sitting in the account with no agreement, no stated terms and no repayment history invites the question whether it was ever a loan, and the other characterisations available to an auditor are considerably less pleasant. A directors' resolution, a promissory note and a repayment schedule cost very little to prepare, and they are worth having in the file long before anybody asks to see them.

Documentation on the insurer's side is thinner and still catches people out. Corporate ownership adds a signing-authority check, and a company that reorganised years ago and never told its insurer will discover the gap at the moment it wants money. An irrevocable beneficiary designation can require a consent. Confirm what your own insurer needs while nothing is urgent, because the first request is the one that surfaces every paperwork problem you did not know you had.

What interest does each carry, and who receives it?

A policy loan carries interest set by the contract and accruing to the insurer, on terms printed at issue and never negotiated. A shareholder loan may carry no stated interest at all, which is exactly what triggers the deemed benefit, and where interest is genuinely paid it goes to the corporation, which is a party you control.

Where the money ends up is the difference owners notice first. Interest on a policy loan leaves your household permanently, because it is paid to an insurance company and it is a real cost, whatever anyone tells you about value continuing to be credited inside the contract. Interest on a shareholder loan paid to your own corporation stays within your affairs, although it becomes income to the corporation and is taxed there, which is one more question for the CPA and one more reason to ask it early.

The rate mechanisms differ in kind as well. A contract states how its own rate is determined, whether fixed, tied to a published benchmark, or set by the insurer within stated limits, and that mechanism cannot be changed after issue. The rate on a shareholder loan is whatever the parties actually documented, measured for tax purposes against the prescribed rate. No figures appear on this page. Read your contract for the first and ask your accountant for the second.

What does each do to a balance sheet a lender or a buyer will read?

A shareholder loan appears on the corporation's balance sheet, as an asset where the owner owes the company and as a liability where the company owes the owner. A policy loan taken by a corporate owner appears as a liability, with the contract's value on the asset side. Both are visible to anyone conducting diligence.

A receivable from the shareholder is the entry that draws attention. A lender reading the statements sees an asset it could never collect and usually discounts it to nothing. A buyer sees money that left the business and will want it cleared before closing. A balance owed to the shareholder is generally more comfortable, although a lender may require it postponed to its own security, which turns money you assumed you could take back into money you cannot touch until the facility is repaid.

The insurance entry reads differently because there is an asset behind it. Where a corporation owns a contract, the value sits on the balance sheet and the advance against it appears beside it, so the net position is visible and explicable to anyone who asks. What surprises owners is how that value is presented and how a buyer's accountant will treat it, which depends on the accounting framework the company reports under. Ask your accountant how it will appear on the statements before it appears on them.

What happens on death with either one outstanding?

An outstanding policy loan is deducted from the death benefit, so the amount paid is reduced by the balance and by the interest accrued on it. An outstanding shareholder loan survives the death. It becomes an obligation of the estate where the owner owed the company, or a claim by the estate where the company owed the owner.

The estate consequence on the corporate side is the one families miss. An executor who inherits a shareholder receivable owes real money to a company now controlled by somebody else, at a moment when the family has no cash and no appetite for a negotiation about it. Where the balance runs the other way, the estate holds a claim against a business that may be unable to pay it without selling something the surviving owners wanted to keep.

The insurance consequence lands somewhere else and should never be minimised. The reduction in the capital paid to a beneficiary is real, it arrives at the worst possible moment, and it is the price of having used the value while living. Where a corporation owns the contract there is a further step, since the amount credited to the Capital Dividend Account is measured against the adjusted cost basis, and an outstanding advance changes what the corporation actually receives. That calculation belongs to the accountant.

What happens if the company is sold with either outstanding?

A shareholder loan is almost always cleared at closing, because no buyer takes on a receivable from the seller and no seller leaves money inside a company they no longer own. A policy loan follows the contract. If the corporation keeps the contract, the advance stays with it, and if the contract moves, the balance moves too.

Clearing a shareholder receivable at closing is where the cost becomes visible. Repaying it requires cash the owner may not have, and drawing a salary or declaring a dividend to raise that cash triggers personal tax in the year of the sale, which is the year the owner's income is already at its highest. Owners discover this in the second week of diligence, and the accountant who has been asking about the account for three years says nothing out loud.

The insurance side of a sale is settled long before closing. A corporately owned contract is an asset of the company, so a share sale carries it across to the buyer unless it is removed first, and removing it is a disposition with its own tax consequences. An outstanding advance complicates that removal, because the balance has to be settled or carried with the contract. Raise it with your accountant and your Financial Security Advisor at the point a sale becomes plausible, well before it becomes certain.

What is the mistake of using one to fix the other?

The specific error is taking a policy loan from a corporately owned contract to repay a shareholder loan before the deadline in the Act, and then treating the problem as solved. It has not been solved. One obligation has been replaced by another, on different terms, with a different counterparty and a different consequence on death.

Run the sequence out. A corporation takes an advance against a contract it owns; the money is corporate money, so it can be applied against a receivable from the shareholder. The shareholder's exposure under section 15(2) may well be addressed, which is the whole point of the exercise. What now exists is a corporate liability to an insurer, accruing interest to that insurer, reducing the capital the corporation will receive on the owner's death, and doing so permanently until it is repaid. The problem moved. It did not end.

The reverse error exists too, and it is quieter. An owner whose corporation has an advance outstanding may be tempted to clear it by moving personal money into the company through the shareholder loan account. That is a transaction between the owner and the corporation with its own characterisation and its own consequences, and it does not become invisible because the money went to an insurer. Every step of either sequence has to be priced by a CPA before any of it is executed.

A properly advised version of this sequence does exist, and it looks very little like the version described from a stage. It is documented in advance, priced against the corporation's actual tax position, checked against the shareholders agreement, and undertaken with the accountant in the room from the first conversation. What it never is, and never can be, is a way of making a statutory deadline disappear.

Who this suits, and who it does not

A shareholder loan suits nobody in particular, because it is a record of transactions that already happened and every incorporated owner has one. A policy loan suits an owner whose corporation already holds a contract with accumulated value, who wants access without an application, and who understands what the advance does to the capital paid on death.

Neither belongs to an owner who is looking for a way to avoid a conversation. The account with the corporation is a tax question with a statutory deadline attached to it, and the person who can answer it is a CPA holding the company's figures and its year end. The advance from an insurer is a contract question, and the person who can answer that one is your Financial Security Advisor working from the contract itself.

The advance does not suit a corporation that bought a contract in order to manufacture a source of borrowing, because a life insurance contract is an expensive way to arrange access to money and it is not an investment. It also does not suit an owner who has never read the loan provisions in the contract, including how the rate is set and what maximum the insurer applies. Read them while nothing is urgent.

The corporate framework this sits inside, including who should own a contract and why that ownership decision is made before an application is signed, is on the business owners page. The tax treatment of the account belongs to your accountant, the terms of the advance belong to your contract, and this page decides neither of them for you.