An incorporated IT contractor operates through a separate legal entity. The corporation’s money is not the contractor’s money. Value that moves from the corporation to the shareholder outside of salary and dividends needs to be properly characterized, or CRA will characterize it for you, usually in a way that is more expensive.
Corporate leakage refers to value leaving the corporation in unplanned or undocumented ways: personal expenses run through the corporate account, draws without corresponding compensation treatment, and mixed-use items claimed fully as business expenses. The problem is not always obvious in the books. The entries may look clean. The issue is what they represent.
Personal expenses through the corporation
Under section 15(1) of the Income Tax Act, a benefit conferred on a shareholder by a corporation in their capacity as shareholder is generally included in the shareholder’s personal income. This applies whether or not the benefit was intentional.
Common examples in IT contractor files:
A personal vehicle expense claimed in full without a logbook. The logbook is required to establish the business-use percentage. Without it, the business-use percentage may be challenged, and unsupported personal-use amounts may be denied or treated as a shareholder benefit.
Personal equipment purchased through the corporation and used primarily for personal purposes. The fact that it was invoiced to the corporation does not make it a corporate expense. If the primary use is personal, the value is a benefit to the shareholder.
Meals, travel, or entertainment expenses with no business purpose documented. CRA expects a record of who was present, the business purpose, and the connection to the corporation’s income-earning activities. A credit card statement alone is not sufficient support.
Personal subscriptions, insurance, or services billed through the corporate account. These require either a documented business purpose or treatment as compensation.
A shareholder benefit is generally included in the shareholder’s personal income. Where the expense is personal or conferred in the shareholder’s capacity as shareholder, the corporation generally should not deduct it as a business expense. The result is worse than if the contractor had simply paid the personal expense from personal funds and received additional compensation through the corporation instead.
The shareholder loan account
Money that flows from the corporation to the shareholder outside of salary and dividends is commonly recorded through the shareholder loan account. This includes direct cash transfers, personal expenses paid by the corporation, and any other draw that is not declared as compensation.
Under section 15(2) of the Income Tax Act, shareholder loans may be excluded from income if repaid within one year after the end of the corporation’s taxation year in which the loan was made, provided the repayment is not part of a series of loans and repayments.
The shareholder loan account is covered in detail in the T2 and T1 filing guide. The relevant point here is that undocumented personal expenses accumulate in that account invisibly if the books are not reviewed with this in mind. A year-end balance that looks like a short-term loan may represent months of uncategorized personal spending.
Why leakage is more expensive than planned compensation
The tax cost of leakage is higher than the tax cost of equivalent planned compensation for two reasons.
First, shareholder benefits are generally not deductible to the corporation when the expense is personal in nature. Salary paid to the contractor reduces the corporation’s taxable income. A benefit under section 15(1) does not. The corporation may pay corporate tax on the income that funded the benefit, while the shareholder is also taxed personally on the benefit amount. In practice, this often produces a worse overall tax result than planned compensation.
Second, planned compensation can be structured. The decision between salary and dividends, the timing of bonuses, and the use of RRSP room are all planning decisions that affect the total tax cost across both the corporate and personal returns. Leakage does not allow for this. It produces personal income at whatever rate applies to the shareholder in the year it is assessed, with no opportunity to adjust.
The comparison is not between leakage and paying tax. It is between leakage, which produces a poor tax outcome with compliance risk, and planned compensation, which produces a better tax outcome within the same legal structure.
What CRA looks for
Shareholder benefit assessments typically arise from three sources: a GST/HST audit that identifies personal expenses in the corporate books, a T2 review that flags expense ratios inconsistent with the business type, and a T1 audit that does not match the lifestyle implied by the reported income.
Specific items that attract scrutiny in IT contractor files:
Vehicle expenses without a logbook, or a logbook that does not show the odometer readings, dates, destinations, and business purpose required by CRA.
Home office expenses claimed at a percentage that is inconsistent with the workspace used, or where the workspace is not clearly connected to the corporation’s income-earning activities.
Entertainment and meal expenses that are large relative to the reported client base, or that include amounts for family members without a business purpose.
Capital cost allowance claims on equipment that was purchased close to year-end and may not have been available for use in the business during the fiscal year.
None of these trigger automatic reassessment. They are the areas where CRA asks questions, and where the documentation either supports the claim or it does not.
What is within the contractor’s control
Keeping a separate corporate bank account and credit card, and using them only for business expenses, reduces the risk of personal expenses entering the corporate books in the first place. Mixed-use items require documentation at the time of the expense, not reconstructed later.
A pre-year-end review is best because it allows compensation decisions to be made before the year closes. A second review before the T2 is filed can identify remaining balances, but options may be more limited after year-end.
The documentation requirements are not separate from the bookkeeping. They are part of it. A vehicle logbook, a business-purpose note on entertainment receipts, and a workspace percentage calculation supported by floor measurements are standard requirements that apply to every fiscal year, not just years under review.
For incorporated IT contractors, the questions that come up in CRA reviews are largely predictable. The answers depend on whether the documentation exists. Working with a CPA who reviews the shareholder loan account and expense claims before year-end closes reduces the exposure before it becomes a reassessment.
Corporate funds are not tax-free cash
A common misconception among new incorporated contractors is that running a personal expense through the corporation makes it deductible. The reasoning is intuitive but incorrect: the corporation paid it, therefore it is a business expense.
The corporation is a separate legal entity. Its funds belong to the corporation, not the shareholder. When the corporation pays a personal expense, value has moved from the corporation to the shareholder. The tax system treats that movement as income to the shareholder, regardless of how the transaction is recorded in the books.
Canadian tax policy applies an integration principle: salary and dividends are structured so that income earned through a corporation and distributed to a shareholder results in a similar overall tax burden as the same income earned directly. Integration only works when compensation is properly characterized. Personal expenses run through the corporation sit outside that framework entirely. They are neither salary nor dividends. They are benefits, and they are taxed accordingly.
There is no mechanism in the Income Tax Act that makes personal consumption tax-free because it was paid by a corporation. The corporation’s taxable income and the shareholder’s personal income are connected by the compensation decisions made each year. Running personal expenses through the corporate account does not alter that connection. It adds a shareholder benefit on top of it.
Quebec perspective
For incorporated IT contractors with a Quebec establishment, shareholder benefit and leakage issues involve two agencies, not one. Revenu Québec administers its own audit and compliance programs under Quebec’s Taxation Act, which contains provisions broadly parallel to sections 15(1) and 15(2) of the federal Income Tax Act. A file that satisfies CRA does not automatically satisfy Revenu Québec, and the two agencies may review the same file independently.
The practical consequence is that a shareholder benefit identified by one agency may trigger a separate review by the other. Revenu Québec has its own reassessment process and timelines, and a federal resolution does not bind the provincial outcome.
There is also a QST dimension. If personal expenses were run through the corporate account and Input Tax Refunds were claimed on those expenses, Revenu Québec can assess the ITRs as improperly claimed on non-business inputs. This compounds the shareholder benefit exposure with a consumption tax adjustment on the same transactions.
The documentation requirements under both regimes are substantially the same: business purpose, allocation methodology, and records that support the characterization of each expense. A file that is well-documented for federal purposes is generally well-positioned for a Revenu Québec review as well. The risk is highest when documentation is weak, because both agencies can assess the same gap from their respective positions.