A shareholder had a debit balance in the shareholder loan account at the year-end of 2020 (in 2019 the account was in a credit position).
I have warned the taxpayer that this balance must be paid back and if it is not by year-end 2021 it will become an income inclusion for 2021. Income Tax Act s.15(2).
However, I have read in the business corporation act when dividend not to be declared. s. 38 (3)
(3) The directors shall not declare and the corporation shall not pay a dividend if there are reasonable grounds for believing that,
(a) the corporation is or, after the payment, would be unable to pay its liabilities as they become due; or
(b) the realizable value of the corporation’s assets would thereby be less than the aggregate of,
(i) its liabilities, and
(ii) its stated capital of all classes. R.S.O. 1990, c. B.16, s. 38 (3).
To be clear the shareholder understands and will pay down the Shareholder debit balance, however, if there is a balance at year-end 2021 it needs to be cleared out and made an income inclusion.
My question is would s. 38 (3) interfere with this? This dividend is not a cash flow to the shareholder it is simply to clear out the Shareholder loan account of its debit balance.
You are quoting Ontario law, so I am guessing you are in Ontario. I don’t think we have the same law here in Saskatchewan (?), because it is common practice here to clear out a debit balance in the shareholder loan using a dividend. I have never seen CRA question this (it may happen, but I’m sure there are extenuating circumstances).
Generally, we remind the client to record it in the company minute book as of the earliest date in the fiscal year and within the current calendar year (to prevent a late filing penalty). The rationale for this is:
The client (shareholder) effectively intends to “take” dividends throughout the year - that is, they had already made the decision at the earliest date in the year.
Many clients are not sufficiently educated about keeping minutes, or holding shareholder meetings, so their lawyer keeps track of the required resolutions - recording them in the minute book long after the events have occurred. Recording the dividend declaration is thus no different.
Assuming a dividend was effectively declared at the start of the fiscal year, and was payable immediately, the actual payments could have been made throughout the year.
T5 slips/returns need to be filed after the end of the calendar year in which they are declared/paid, which is the part that we accountants usually help with.
Remember that the entry to clear out the shareholder loan is effectively 3 entries:
DR Dividends declared (equity account)
CR Dividends payable
DR Dividends payable
CR Cash (when dividend payments made)
DR Cash
CR Shareholder loan (shareholder deposits cash to repay shareholder loan)
Entry (singular) to clear the Shareholder debit balance via a Dividend is:
DR Dividends (an account in the Equity section of the Chart of Accounts)
CR Shareholder
Lawyer notified to do up a Resolution declaring the dividend with a payment date = to last day of the fiscal year
T5 done for the declaration year
Then in the next fiscal year the Dividend is cleared to Retained Earnings: