Selling or Transferring a Shareholder Loan With Your Shares

What is the shareholder loan balance I am owed, and what built it?

When you sell your shares, the corporation can repay what it owes you at closing, or you can assign that debt to the buyer for a price. Sale agreements usually state either route as a line separate from the share price. The balance is a debt your corporation owes you, and what built it decides the tax when you get it back. One ledger line, often called "due to shareholder," can hold five different things.

The case is not simple if the sale closes within weeks, the buyer has asked for the loan to be dealt with, the balance is large, or the credits have no resolution, payroll record or slip behind them.

A credit in the ledger does not show that a dividend was declared or payroll was run. Match each credit to a resolution, a payroll record or a slip. A credit with nothing behind it is the unclear part: the pay or dividend may never have been reported for the year it was credited. A sale puts the ledger in front of the buyer, and unreported years can bring late slips, tax, interest and penalties. If pay credited to the account should have had payroll deductions, the corporation owed them, and its directors at the time can be personally liable with it; no action against a director can start more than two years after the director last ceased to be a director (section 227.1). To report pay after the fact, see Paying yourself a salary after the fact; for dividends and the T5, see Declaring and paying a dividend.

Rebuild a balance that grew over many years, or was never reconciled, before you price it.

Gather before you agree to anything:

• The ledger from the first advance, with the bank statement behind each line. For money wired from abroad, the transfer record showing currency and date.
• Any signed loan agreement or note, the shareholders' agreement and any bank loan agreement that limits repaying owners.
• The draft share purchase agreement.
• The last two years of T2 returns and financial statements.
• The T4, T5 and T4A slips the corporation issued to you.
• The resolutions for each dividend or bonus.

Can I sell or transfer my shareholder loan to the buyer or another shareholder?

Usually. A debt is property its owner can generally assign, unless the loan terms or a shareholders' agreement limit transfer; the buyer, a new owner or an existing shareholder, then becomes the corporation's creditor in your place. The other route is for the corporation to repay you at closing.

Is it taxable when the corporation repays my shareholder loan?

Repayment of cash you lent is generally not taxable, because it returns your own money. The Income Tax Act treats the settlement of a debt as a disposition of it, and a gain arises only when the amount received is more than the debt cost you (section 248, "disposition"; paragraph 40(1)(a); section 54). Cash you lent cost you that cash, so a repayment of the same amount leaves no gain or loss. The CRA lists settling or cancelling a debt owed to you among the events that can produce a capital gain or loss (CRA T4037).

That holds for a loan made in Canadian dollars. A loan made in another currency is worked out in Canadian dollars at the rates on the advance and repayment dates, so an exchange gain or loss can arise (Income Tax Act, section 39). A debt you bought from another owner may have cost less than its face amount.

Three things inside the balance are taxed on their own terms:

• Interest you are owed is income.
• Pay or dividends credited but never reported are taxed as pay or dividends, not as a repayment.
• Money paid to you above the balance on the books is not a repayment. The CRA can treat the extra as a shareholder benefit, which is reported on a T4A and is not deductible to the corporation (CRA).

If you borrowed to lend this money, repaying it can change whether your own interest stays deductible; see Lending borrowed money to your corporation.

What if I sell the shareholder loan for less than its face amount?

A loss from selling or settling the debt below its face amount is not automatically deductible, and the corporation may face debt-forgiveness rules.

Your loss. Under the Income Tax Act, your loss on disposing of a debt is nil unless you acquired the debt for one of these reasons (subparagraph 40(2)(g)(ii)):

An advance that bears no interest is a common case where the income purpose is questioned, but charging no interest does not by itself deny the loss. The CRA says that when a shareholder lends to a corporation to give it capital, a clear connection will generally exist through the shareholder's potential to earn future dividends; the connection must not be too remote, so the facts decide (CRA Folio S4-F8-C1, paragraph 1.46). If the debt is owed by a Canadian-controlled private corporation that is a small business corporation, a capital loss on a sale to an arm's-length buyer may qualify as a business investment loss (paragraph 39(1)(c)); for this rule the small business corporation test also counts a corporation that was one at any time in the 12 months before the sale, so its history decides (section 248, "small business corporation"). A debt that has gone bad because the corporation cannot pay is handled by an election in your return, and the same income test applies. The election treats you as disposing of the debt for nil and reacquiring it at nil; if you still hold a significant interest in the corporation or do not deal with it at arm's length, that reacquired debt can be a parked obligation under the rule below, so have both sides checked before electing (section 50; CRA T4037).

The corporation's side. When a corporation settles a debt for less than its principal, the shortfall is a "forgiven amount." It reduces the corporation's losses and other tax balances, and part of any remainder is added to its income (section 80). This applies to a commercial debt obligation: a debt on which interest, actual or hypothetical, was or would have been deductible to the corporation. Charging interest does not settle that; what the corporation did with the money does.

Assigning the debt to the buyer is not itself a settlement. But the Act has a debt-parking rule. If a buyer who acquired the debt from an unrelated seller holds a significant interest in the corporation, or does not deal at arm's length with it, and the buyer's cost is below 80% of the debt's principal, the corporation is treated as having settled the debt for that cost (section 80.01). A significant interest means shares carrying 25% or more of the votes or of the fair market value of all issued shares, counting shares held by people the holder does not deal with at arm's length. Whether the rule applies depends on who the parties are and the order of the steps.

How is the price split between my shares and the loan, and does it matter for my gain?

It matters. Each part of the price is taxed on its own, and only the share part can use the lifetime capital gains exemption.

The split must be reasonable. When one amount pays for both a share and a debt, the Income Tax Act takes as proceeds for each the part that can reasonably be regarded as its price, whatever the contract says (section 68). If the buyer does not deal with you at arm's length, the Act deems your proceeds to be fair market value when the price is lower (paragraph 69(1)(b)). Related persons, such as a relative or a company you control, are deemed not to deal at arm's length (section 251). Whether the shares qualify for the exemption, and the tax on the shares, are covered in Selling your business.

What do I give the buyer to transfer the loan?

Give the buyer a signed written assignment, and make sure the corporation is told in writing.

In British Columbia, a signed absolute assignment of a debt, with express written notice to the debtor, passes the legal right to the debt from the date of the notice (Law and Equity Act, section 36). Alberta's rule is the same in substance (Judicature Act, section 20). Other provinces have their own statutes; have the assignment checked against yours. Read any written loan terms, any shareholders' agreement and any bank loan agreement for limits on transfer or repayment.

The assignment and the share purchase agreement are legal documents. The lawyer drafting the sale should carry these terms, and your tax adviser should check the price split before you sign.

The traps are an oral promise to "sort the loan out after closing," an assignment never put on paper, and a ledger that still shows you as the creditor.

What if the corporation cannot pay the loan at closing?

You can have the buyer put in new money that the corporation uses to repay you, assign the debt to the buyer for a price, or take a note from the corporation and be paid later. Put the choice in writing with the amount, the due date, whether interest runs, and what happens if a payment is missed. Other choices exist: leave the balance owing after closing, forgive it, or convert it into shares. Each has its own tax result for you and for the corporation, so the choice belongs in the draft agreement, not after closing.

Interest on a note is income to you when received or receivable (Income Tax Act, paragraph 12(1)(c)). If the note carries interest, an individual may also have to include interest accruing to each anniversary of the note before it is paid (subsection 12(4)); an interest-free note accrues none. A note leaves you a creditor of a corporation you no longer control. If it is never paid, the bad-debt rules above apply and the loss may be denied.

Does Quebec work differently for assigning a debt?

Yes. In Quebec a debt is assigned under the Civil Code of Québec, not the statutes above. A creditor may assign a claim to a third person (article 1637). The assignment can be set up against the debtor and third persons once the debtor acquiesces in it or receives a copy or extract of the act of assignment, or other evidence of it (article 1641) (Civil Code of Québec). Get the corporation's written acknowledgement at closing or deliver a copy to it, and keep proof.

The federal tax rules above apply to Quebec residents too. A Quebec resident also files a Quebec return, which this page does not cover.

What if the balance runs the other way and I owe the corporation?

A balance you owe the corporation is a different debt with its own tax rule, and selling your shares does not undo it. The Income Tax Act can include a loan owed to the corporation in your income for the year it arose (subsection 15(2)). A buyer may ask for it to be cleared at or before closing, and how you clear it can change the tax. See Shareholder loans for the rule, its exceptions and how to clear it.

Example

These examples are illustrative; all amounts are Canadian dollars.

Cash you lent, repaid at closing

An owner of an Ontario corporation has lent it C$150,000 in Canadian dollars over five years, with a bank deposit behind each advance. The buyer pays C$500,000 for the shares, and the corporation repays the owner C$150,000 at closing. The repayment returns the owner's own money and is not part of the share price. The gain is worked out on the C$500,000 paid for the shares.

The debt sold below face

An owner is owed C$80,000 on an account that bears no interest and assigns it to an unrelated buyer for C$50,000, in writing, with notice to the corporation. The C$30,000 shortfall is a loss only if the debt was acquired to earn income from a business or property. No interest does not by itself fail that test: an advance made to give the corporation capital can meet it through potential dividends, so why it was made decides. Separately, if the buyer takes a significant interest in the corporation, the C$50,000 price is under the 80% line in the debt-parking rule, which applies only to a debt on which interest would have been deductible.

A balance built mostly of credits

An owner's C$60,000 balance is mostly dividends declared and credited to the account but never reported on a T5, plus some pay with no payroll record. Those amounts may have been taxable in the years they were credited. A closing is when the gap surfaces: late slips, tax, interest and corrections to the corporation's filings may follow. The ledger history decides what the C$60,000 is made of.

Different for you?

• You are within weeks of a share sale and the buyer wants the loan dealt with, or the balance is large and its history unclear: what the balance is made of, how the price is split, whether it is repaid at closing and what each return reports are the points that depend on your facts and documents. See corporate tax help.
• You also need the tax on the share sale: see Selling your business. For a venture-backed company, see the lifetime capital gains exemption on a startup exit.
• A holding company holds your shares or lent the money, or the corporation sells its assets instead of shares: who is the creditor and who is taxed changes. See Selling your business and corporate tax help.
• You or the buyer live outside Canada, or you are moving around the sale: residency changes who is taxed and what is withheld. See Non-resident owners of a Canadian corporation.
• A co-owner is being bought out or redeemed: see Adding or removing an owner.
• You owe the corporation instead: see Shareholder loans.
• You are unsure which way the account should run or how to record it: see the shareholder loan account.
• The ledger is incomplete or the books are behind: the balance cannot be priced until the ledger is rebuilt. See Catching up on overdue books and bookkeeping help.
• The corporation missed returns while the balance grew: see Catching up on unfiled corporate returns.