Are loans taxable in Canada?

Understanding the tax implications of various transactions is crucial in the intricate world of personal finance. Many of your financial goals likely rely on financing from some credit account, such as a credit card, instalment loan, or mortgage.

Loans, a fundamental aspect of modern financial life for many Canadians, often raise tax questions. Whether you're an individual with personal loans or a business with business loans, there are some specific rules and considerations regarding the taxation of these credit accounts.

A thorough overview of what you can expect during tax season for you or your business can make your life easier and prevent you from getting into trouble with the Canada Revenue Agency (CRA). We dive into the taxation aspects of loans in Canada, covering their respective implications during tax season.

Canada's tax system

Before diving into the world of loans and taxes, let's first grasp how taxes work in Canada. There are different types of taxes in Canada: income tax, goods and services tax, corporate tax, property tax, and excise duties and customs duties. You must pay federal and provincial or territorial taxes to the taxing authorities.

The Canadian tax system requires individuals to pay income tax based on where their total income from employment, investments, and business activities falls into the tax brackets. Tax brackets are specific income ranges with their respective tax rates. As you earn more income, you move into a higher tax bracket and pay a higher percentage of your income in taxes.

Taxpayers are also eligible for various tax credits and deductions, which can reduce your overall taxable income and payable amount. There are refundable and non-refundable tax credits, like the Canada Employment Amount and the Disability Tax credit. Tax deductions are subtracted from gross income and lower your taxable income, including contributions to Registered Retirement Savings Plans (RRSPs) and charitable donations.

Type of loans or debt

There are many types of Canadian loans you can apply for to help finance various goals, like buying a house or funding your post-secondary education. From mortgages to personal loans, here are some common ones you can find at a bank, credit union, private lender, or other financial institution:

• home equity loans

• credit cards

• car loans

• student loans

• payday and cash advances

• buy now, pay later services

Loans have different components, like the principal amount, interest rate, credit limit, and additional fees. It's essential to understand the terms and conditions of your loan so you can manage debt repayments responsibly. Loans are a powerful financial tool to help you reach different milestones in life.

Understanding taxation on loans

Not all cash inflows are considered taxable income by the CRA. Typically, you aren't obligated to pay taxes on the money borrowed. Whether you take out a business or personal loan, you don't have to worry about setting aside money for taxes. However, there are some exceptions to this tax exemption where you may be subject to taxes and other penalties on the borrowed money.

Personal loans

Personal loans are typically not taxable in Canada. The money borrowed isn't income since you must repay it within the loan payment periods. You don't need to report the amounts borrowed or the interest payments on the loan process as taxable income on your tax return.

Business loans

Loans obtained for business purposes are an integral part of many Canadian companies. Interest payments on business loans are generally tax-deductible expenses for the business, reducing the taxable income amount. The CRA may ask for dispatch slips and other documentation to prove the loan is used for legitimate business purposes to qualify for tax deductions.

Mortgages

In Canada, you don't pay taxes on the principal amount of the mortgage loan because you must repay it. However, the interest paid on your mortgage may have tax implications depending on the purpose of the loan and the criteria set by the CRA.

The interest paid on a mortgage loan for your principal residence may be tax-deductible under certain conditions. For example, if the mortgage is used to finance an investment property, the interest paid is typically considered an expense related to earning rental income. Any interest paid is tax-deductible against the rental income received from the property.

Student loans

Student loans aren't taxable income, and students don't have to pay income tax on any loans or grants received to finance their education. The interest paid on student loans may be eligible for a non-refundable tax credit, providing some relief to borrowers. To qualify for the tax credit, the student must have received the loan under the Canada Student Loans Act, the Canada Student Financial Assistance Act, or similar provincial or territorial legislation.

Car loans

Car loans are not taxable, and the interest paid is typically not tax-deductible for personal use vehicles. You can't claim any interest payments incurred on your personal car loan as a tax deduction on your income tax return. However, if you have a vehicle used for business purposes, the interest payments may be tax-deductible as a business expense.

Credit cards

Credit card loans aren't taxable income because the borrowed money does not represent income earned. The money charged to your credit card represents debt owed to the credit card issuer. Credit card interest is considered a personal expense and is typically not eligible for tax deductions.

Borrowing from RRSP

Your Registered Retirement Savings Plan is a dedicated account to fund your retirement. You can make contributions, subject to the yearly limit, and invest the money into different financial instruments. RRSPs are a great tool to ensure you are financially set to maintain the same or a similar quality of life when you no longer have employment income.

Borrowing money from your RRSP is typically not allowed under Canadian tax rules. RRSPs are a retirement savings tool, and you can withdraw the funds without penalties once your plan reaches maturity when you turn 71.

Early withdrawal taxes on RRSPs

Withdrawing money early may result in an immediate RRSP tax penalty. You're subject to withholding tax, which means the financial institution holding your RRSP withholds a portion of the withdrawal amount and remits it directly to the CRA. The withholding tax rates depend on the amount withdrawn and represent a prepayment of the income tax you will owe.

In addition to the withholding tax, the amount withdrawn is considered taxable income in the year of withdrawal. The amount is added to your taxable for the year and is taxed at your marginal tax rate based on your total income. You may owe additional taxes beyond the withholding tax amount, depending on your total income and tax bracket.

If you make an early withdrawal and don't repay the amount according to the repayment schedule, you may be subject to overcontribution penalties. Overcontributions occur when you contribute more to your RRSP than the allowed yearly limits set by the CRA. They are subject to an RRSP tax penalty of 1% per amount on the excess amount until it's withdrawn or absorbed by the future contribution room.

RRSP tax penalty exceptions

There are specific exceptions to the tax penalties associated with early withdrawals from RRSPs. In Canada, you can borrow money from your RRSP through a program called the Home Buyers' Plan (HBP) or the Lifelong Learning Plan (LLP) under certain conditions. These programs let you take out money from your retirement savings account to fund purchasing a qualifying home or full-time training or education for yourself or a spouse or common-law partner.

Home Buyers' Plan

Under the HBP, you can withdraw up to $35,000 from your Registered Retirement Savings Plan to finance the purchase of a qualifying home as a first-time homebuyer. The withdrawals made under the Home Buyers' Plan aren't subject to income tax, provided you meet the eligibility criteria and repay the money borrowed to your RRSP over up to 15 years.

If you don't pay the full amount required on time, the outstanding balance will be included in your taxable income for the year of non-repayment. Any amount not repaid will be subject to income tax at your marginal tax rate. A higher taxable income results in more taxes paid.

Lifelong Learning Plan

You can borrow funds from your RRSP to finance full-time training or education for yourself or your spouse or common-law partner under the Lifelong Learning Plan. You can withdraw up to $10,000 yearly, up to a maximum of $20,000 over four years.

Withdrawals made under the LLP aren't subject to income tax, provided you repay the borrowed amount to your RRSP over ten years. The first repayment is due five years after the first withdrawal. The outstanding balance will be included in your taxable income over the year of non-repayment, resulting in additional taxes owed.

Tax deferral on RRSP loans

Money borrowed under the HBP or LLP provides a form of tax deferral rather than a tax exemption. Here's how tax deferral works on RRSP loans.

No immediate taxes

The borrowed money from your RRSP isn't subject to income tax at the time of withdrawal. It provides some financial flexibility without incurring immediate tax liabilities.

Repayment requirement

You must repay the amount borrowed over a specified period, typically 10 to 15 years, depending on the program. The repayment schedule starts after a grace period following the first withdrawal. It gives you time to manage your finances before making repayments.

Taxes upon non-repayment

If you fail to repay the borrowed amounts according to the predetermined repayment schedule, the outstanding balance becomes taxable income in the year non-repayment. For example, if you fail to repay your HBP for the year, the unpaid amount is added to your taxable income, and you have to pay taxes at a higher marginal tax rate.

Tax implications upon repayment

When you repay the borrowed money to your RRSP, the repayments don't have additional tax deductions or benefits. The repayments help restore your RRSP savings and the tax-deferred growth potential of your investments within the retirement savings plan.

Business loans and taxes

Business loans are versatile financial tools to support a business's growth, operations, and stability. They can cover startup costs for entrepreneurs, expansion and growth investments, day-to-day expenses, equipment purchases, real estate financing, debt financing, emergency expenses, inventory financing, and technology investments.

Are business loan payments tax-deductible?

Business loans aren't considered taxable income and payments on company loans aren't tax-deductible, so you don't pay taxes when the money is deposited into your company account. Here's how the tax implications work for business loan payments.

Principal repayments

Unlike interest payments, the principal portion of business loan repayments isn't tax-deductible. The principal amount represents the loan repayment of the borrowed money. The business loan isn't taxable income, and repayments don't impact the business's income taxes.

Interest expenses

Interest paid on business loans is typically considered a legitimate business expense. Regardless of what the loan is used for, business owners can claim it as tax-deductible from the business's taxable income.

If you're claiming a tax-deductible, it's essential to keep detailed record-keeping and documentation of the loan agreement, including repayment schedule, interest rate, and evidence of payments made. Proper documentation supports the deductibility of interest expenses and ensures you comply with CRA requirements in case of tax audits or inquiries.

Impact of small business loans on Canadian taxes

Small business loans can have various impacts on your company taxes, both in terms of deductions and potential tax consequences. These loans are structured so your loan payments are balanced between the principal and interest charged. While your principal repayments aren't tax-deductible, the interest paid is. It lowers your company's taxable income, which reduces the amount of money you pay in taxes.

Typical business expenses you can deduct from taxes

Businesses can deduct certain expenses from their taxable income to reduce the overall amount they pay. Here are some typical business expenses that are considered tax-deductible.

Operating expenses

• Rent or lease payments for office space, storefronts, warehouses, and equipment.

• Utilities, such as electricity, water, heating, and internet services.

• Office supplies, such as stationery, printer ink, paper, and pens.

• Telephone and communication expenses, including phone bills.

• Postage and shipping costs for mailing and shipping goods.

Employee compensation

• Salaries, wages, bonuses, commissions, and other forms of compensation paid to employees.

• Employer contributions to employee benefit plans, such as health insurance, retirement plans, and other employee benefits.

• Payroll taxes, such as Employment Insurance (EI) premiums and Canada Pension Plan (CPP) contributions.

Business travel and entertainment

• Travel expenses, including transportation, accommodations, meals, and incidental expenses incurred while travelling for business purposes.

• Entertainment expenses directly related to business activities, such as business meetings, networking events, or employee team-building activities.

Professional services

• Fees for accountants, lawyers, consultants, and other professional services that are business-related.

• Subcontractor payments for outsourced work, such as freelance services and subcontract labour.

Marketing and advertising

• Advertising expenses, such as print ads, online ads, commercials, and other promotional activities.

• Marketing expenses, such as website development, branding, social media marketing, and promotional materials.

Insurance premiums

• Premiums paid for business insurance coverage, such as property, liability, business interruption, and professional liability insurance.

Depreciation and amortization

• Depreciation for tangible assets, such as equipment, machinery, vehicles, and buildings used in the business.

• Amortization expense for intangible assets, such as patents, copyrights, trademarks, and goodwill.

Interest expenses

• Interest paid on business loans, lines of credit, and other forms of business financing, including mortgage interest for business properties.

• Interest on credit card balances and other forms of business credit used for business-related activities.

Education and training

• Costs associated with employee training, professional development, and educational materials directly related to the business.

Business expenses you can't deduct from taxes

While businesses can deduct several types of expenses from their taxable income, there are a few that are typically not deductible for tax purposes.

Personal expenses

• Expenses for meals, clothing, vacation, and other activities unrelated to the business.

Capital expenditures

• Costs of acquiring capital assets, such as land, buildings, machinery, and equipment in the year of purchase.

Dividends paid

• Dividends paid to shareholders aren't deductible as business expenses.

Penalties and fines

• Penalties and fines imposed by government agencies or regulatory bodies are typically not tax-deductible, such as for non-compliance or violations.

Personal interest on loans

• Interest paid on credit card balances, personal loans, and lines of credit isn't considered a business expense and is not eligible for a tax-deductible on the company taxes.

Shareholder loans

Shareholder loans involve transactions where a shareholder loans money to or borrows money from the corporation. These transactions have tax considerations for both the borrower and the lender. Here's what you need to know about shareholder loans in Canada.

As a corporation

If your business borrows money from a shareholder, the interest paid on the shareholder loan is typically deductible as a business expense. However, if the interest is excessive on the shareholder loan balance, the CRA may adjust the interest rate expense deduction or impute interest income to the shareholder.

Suppose the shareholder loan isn't repaid within one year of the end of the corporation's taxation year. In that case, the corporation may be subject to the rules under the Income Tax Act regarding taxable benefits. The loan could be included in the shareholder's income.

As a shareholder

If a shareholder borrows money from your corporation, the amount is typically not considered income for tax purposes for the borrower. However, if the shareholder loan is forgiven or discharged without repayment, the forgiven amount may be considered a taxable benefit to the shareholder and included in their income. Suppose the shareholder loan isn't repaid within one year after the end of the corporation's taxation year. In that case, the shareholder may be taxed on the outstanding loan balance, unless the loan is for specific purposes outlined in the Income Tax Act.

Converting a shareholder loan on employment income or dividends

Converting a shareholder loan into employment income or dividends involves changing the nature of the transaction. It involves complex tax considerations for the shareholder and the corporation. Employment income is subject to payroll deductions, including income tax, CPP contributions, and EI premiums. Dividends are typically subject to lower tax rates than employment income, as they are eligible for the dividend tax credit.

It's essential to consult a professional, like a tax advisory firm, to assess the implications and develop an appropriate strategy. Tax professionals can guide on structuring the transaction to optimize tax outcomes and ensure compliance with laws and regulations.

Salary paid to offset shareholder loan

When a corporation pays a salary to offset a shareholder loan, it involves compensating the shareholder for services rendered to the corporation. The salary can be considered as employment income or a loan repayment with specific tax considerations respectively.

Employment income

The salary is treated as employment income for tax purposes, subject to income tax, CPP contributions, and EI premiums. The corporation deducts the payroll taxes and remits to the CRA on behalf of the CRA and issues the shareholder a T4 slip to report the employment income on their tax return. The shareholder may benefit from receiving a taxable salary, as employment income is eligible for various tax deductions and credits.

Loan repayment

The shareholder can use the salary paid to repay the shareholder loan borrowed from the corporation. By repaying the loan, the shareholder reduces or eliminates the outstanding debt owed to the corporation. If the loan is forgiven or discharged without repayment, it may be considered a taxable benefit to the shareholder and included in their income.

The Income Tax Act

The Income Tax Act is a federal statute enacted by the Parliament of Canada, which governs the imposition of income taxes in Canada and forms the foundation of our income tax system. It outlines the rules and regulations regarding the assessment and collection of income tax on individuals, corporations, trusts, and other entities. Here are some key features and components of the Act.

Income taxation

The Income Tax Act defines various types of income, including employment income, business income, investment income, capital gains, and other income, such as retirement income, social benefits, and foreign income earned by Canadian residents. It refers to the amount of income subject to taxation after allowable deductions, credits, and exemptions. There are established rules for determining the taxable income and the applicable deductions and credits.

Tax rates and brackets

The tax rates and brackets outlined in the Income Tax Act determine the amount of income tax payable by individuals and corporations in Canada. Tax brackets are the ranges of taxable income to which specific tax rates apply, and the tax rates are applied to different income brackets to calculate the total income tax owed. Using a progressive tax system, the tax rates increase as taxable income rises.

In addition to federal income tax, individuals may also be subject to provincial or territorial income tax. Each province has its progressive tax rates and brackets, which may differ from the federal rates.

Canadian corporations are subject to federal tax at a flat rate. They may also be subject to provincial or territorial corporate income tax based on the rate in their jurisdiction. Small businesses may be eligible for a reduced federal tax rate on their first $500,000 active business income.

Deductibles and credits

Deductions and credits are provisions outlined in the Income Tax Act that taxpayers can use to reduce their overall taxable income and income tax owed. Deductions are expenses or amounts you can subtract from your total income and are applied before calculating taxes owed, reducing your taxable income dollar-for-dollar.

Common deductions for individuals and businesses include:

• Business expenses, including rent, utilities, salaries, and office supplies.

• Employment expenses, including vehicle expenses, professional duties, and home office expenses.

• Rental expenses, including mortgages, property taxes, repairs, and maintenance.

• Moving expenses, including storage, transportation, and temporary lodging costs.

• Capital cost allowance for depreciation of capital assets used in business operations, including equipment, machinery, and buildings.

Tax credits are the amounts subtracted from the taxes owed instead of taxable income. Credits are typically applied after calculating taxes owed and directly reduce the amount of tax payable. Common tax credits include:

• Basic personal amount: A non-refundable tax credit available to all Canadian taxpayers to offset taxes owed on basic living expenses.

• Child and family benefits: Refundable and non-refundable tax credits for families with children to help cover childcare expenses, education costs, and other child-related expenses.

• Tuition and education credits: Non-refundable tax credits for eligible tuition fees paid for post-secondary education and other eligible educational expenses.

• Medical expenses: A non-refundable tax credit for eligible medical expenses paid by individuals or families that exceed a certain threshold.

• Charitable donations: A non-refundable tax credit for donations made to registered charities and other qualified donees.

Tax treatment of entities

The Income Tax Act outlines the tax treatment of different types of entities, including individuals, corporations, partnerships, trusts, and estates. Each entity may have its own rules for determining taxable income, filing tax returns, and paying taxes.

Capital gains taxation

Capital gains taxation includes provisions governing the taxation of capital gains realized in the disposition of capital property, such as real estate, stocks, and other investments. They may be subject to preferential tax rates and qualify for exemptions or deferrals under certain circumstances.

Anti-avoidance provisions

The Act includes anti-avoidance rules to prevent tax evasion, aggressive tax planning, and abusive tax avoidance schemes. These provisions empower the CRA to challenge transactions or arrangements deemed abusive or artificial for tax purposes.

Tax administration

Tax administration establishes the procedures and mechanisms for the administration and enforcement of income tax laws in Canada. It has provisions related to filing tax returns, reporting income, making tax payments, and complying with tax obligations.

Getting a loan in Canada

Before getting a loan in Canada, there are several steps and requirements to consider. Most lenders require an application for a loan, such as a personal or business loan or a line of credit. Lenders assess your creditworthiness based on your financial history and credit score to determine your risk as a borrower.

Your credit score will likely come up often in the finance world. It's an important component of your financial identity and scores your overall financial health. Whether you're applying for a loan or need a comprehensive background check, your credit score will likely be assessed.

A higher credit score typically results in a bigger loan with better interest rates and terms, so it's essential to pay off loans to positively impact your credit. It's also a good idea to get a thorough understanding of the risks of personal loans for Canadians to manage debt responsibly.

Once you secure the loan, read the terms and conditions carefully to understand your repayment responsibilities. On-time payments not only save you money from interest charges but can also help you score additional financing in the future.

Build your credit and secure financing with KOHO

Building your credit and securing financing is simple with KOHO. We offer many tools and resources to help create a strong financial foundation and habits that reach your goals faster. With a secured or KOHO line of credit, you get revolving credit you can borrow from any time. We report the amount you set aside as an on-time credit payment each month, helping you build credit over time.

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We understand emergencies can happen during your daily life or when travelling abroad. With overdraft protection coverage, you pay as little as $2 a month and get a cash advance of up to $250 over time as long as you continue to make regular on-time repayments. No matter how much cash advance you use, you don't have to pay interest.

Your financial journey is a long road, and staying updated on your overall credit history helps keep you on the right track. Request a free credit score and get monthly updates on your activities. Your credit score report includes helpful tips, articles, and insights into why your score may have changed, so you can work on improving.

Looking for more than credit? KOHO also offers a high-interest savings account where you can earn interest and cash back. Pick a KOHO plan that works best for you and start earning right away in your account.

Learn more about how KOHO can help you every step of the way on your financial road to success.