My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with BDO. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, August 26, 2019

The Best of The Blunt Bean Counter - What Small Business Owners Need to Know - The Debits and Credits of Shareholder Loans

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a March, 2017 blog on what you as a small business owner need to know and understand about the debits and credits of your shareholder loan balance.

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As an owner-manager, you can withdraw funds from your corporation as a salary and/or a dividend or as a shareholder loan. The Canada Revenue Agency (CRA) has incorporated strict guidelines into the Income Tax Act (Act) when shareholder loans have to be repaid and the tax consequences therein. These rules are often misunderstood by shareholders and can result in adverse income tax consequences where care is not taken.

The following discussion relates to situations where you have taken more shareholder loans than you have contributed to your corporation. This is often known as a shareholder “debit” as opposed to a shareholder “credit." A shareholder credits results when your corporation owes you money, since you have advanced funds or loaned back salary or dividends in a prior year on which you were personally taxed.

The Rules


Section 15(2) of the Act outlines these rules which also encompass loans to a person or partnership who does not deal at arm’s length (i.e., family members) with the shareholder.

The basic rule for shareholder loans is that they must be repaid within one year after the end of the corporation’s taxation year in which the loan was made. For example, if you borrow money from your corporation in 2016 and the corporation's fiscal year end is December 31, 2016, the loan must be repaid by December 31, 2017. If the amount is not repaid within the time frame above, it will be added to the income of the shareholder in the year the loan was received (i.e., 2016 in this example). Therefore, a T1 adjustment may be necessary for the shareholder to correctly include the loan in income in that particular year (2016) plus accompanying interest. If anyone related to the shareholder receives the loan the amount will be included in his/her income and not the shareholder.

The Exceptions


There are some exceptions to the 15(2) shareholder loan rules which would allow the loan amount not to be included in an individual’s income. If any of the criteria below are met than 15(2) does NOT apply:

i) If the loan was repaid within one taxation year;

ii) If the loan was made in the course of a money lending business i.e. bank, and bona fide terms of repayment are made.

Employees/Shareholders Exceptions


Absent of the criteria above, certain types of loans may still be exempt from 15(2) as described below for shareholders who are also employees of their business.

If the loan is to a specified employee (person who owns directly or together with related persons more than 10% of the shares of the business) the loan must be made for one of the following purposes:

1) Purchase a home (includes a house, condo, cottage);

2) Purchase a vehicle used for employment purposes; or

3) Purchase newly issued shares of the business.

Each of these loans must have bona fide arrangements for repayment within a reasonable time period and the loan must be provided as a result of the individual’s employment rather than shareholdings. This has generally been interpreted to mean that loans must be available to other employees who are not shareholders or related to shareholders, which could be difficult to prove if the owner is the sole employee of the business and preclude the loan where you have employees (unless you provide such loans to all other employees, which is very unlikely).

Where loans are made for a home purchase, the CRA often audits the loan and it can be problematic if not impossible to prove such a loan would have been made to other employees if there actually were such. As result of this burden of proof, where housing loans were once routinely recommended by accountants, they are now typically selectively recommended.

If the loan is to an employee-shareholder who deals at arm’s length with the corporation and together with related persons own less than 10% of the shares then the loan can be made for any purpose. This provides an exception for many employees who are minority shareholders. However, similar to specified employees above, the loan must have bona fide arrangements for repayment within a reasonable time period and the loan must be provided as a result of the individual’s employment rather than shareholdings.

Interest Benefits


Section 80.4(2) of the ITA provides for an imputed interest benefit if 15(2) does not apply. Meaning if the shareholder loan does not have to be included in income, a deemed interest benefit will still need to be reported by the individual. This interest benefit arises when the interest rate charged (if any) on the shareholder loan is less than the CRA prescribed rates per quarter - currently at 1%. The amount of the interest benefit is reduced by any interest actually paid on the loan no later than 30 days after the end of the calendar year.

If the loan is included in income by virtue of 15(2) than no imputed interest benefit would be reported.

Questions to Ask


Some of the key questions to ask when an individual shareholder or connected person (e.g. daughter) receives a loan:

1) Is it reasonable to assume the loan was received by virtue of employment?

2) Is the individual receiving the loan a specified employee (i.e., owns more than 10% of any class of shares of the corporation)? If so, was the loan made to acquire a dwelling, vehicle or shares are described above?

3) Are there bona fide terms of repayment?

If the answer is NO to any of the questions above, 15(2) applies to include the loan in income, unless the entire loan is repaid within one taxation year. Repayment of all or part of the loan that has been included in income will be eligible for a deduction by the individual on his/her personal tax return in the year of repayment.

It is very important that the loan(s) not be considered to be a series of loans and repayments or else CRA could deny the deduction upon repayment. E.g. repaying an amount at the end of 2016 only to borrow again in 2017. One of the more common ways to reduce or eliminate a shareholder loan is to convert it into a salary, bonus or dividend. Since this gives rise to taxable income, it is generally not considered to be a series of loans and repayments.

See Archived IT119R4 for more details and exceptions regarding shareholder loans.

Section 15(2) is one of the most commonly applied and misunderstood sections of the Act. You should always consult your accountant or tax specialist when dealing and planning with your shareholder loans.

I would like to thank Lorenzo Bonanno, tax manager for BDO Canada LLP for his extensive assistance in writing this post. If you wish to engage Lorenzo for tax planning, he can be reached at lbonanno@bdo.ca

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, August 12, 2019

The Best of The Blunt Bean Counter - No Will? You're in Famous Company

This summer I am posting the best of The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a February, 2018 post on famous people who did not leave a will and in many cases, caused havoc for their loved ones and/or their estate? If you do not have a will or it is outdated, please get it drafted or updated.

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Readers of my blog are aware of my inclination to harp on the fact that you should have a will, and where you have a will in place, that it should be updated for significant life events. I also think it is important to have up-to-date powers of attorney for financial and personal care. But today, we are talking wills and the lack of such for some famous people and the lessons you may learn from their estate planning miscues.

In my blog post “Canadians Don’t Have the Will”, I highlighted a 2016 survey conducted by Legalwills.ca, that found 62% of Canadians do not have wills.

The 62% number is astronomical and in my not so humble opinion, just irresponsible. I thought of this survey, when I was recently told by a colleague that they were working on an estate where the first spouse passed away without a will, and then the surviving spouse died a couple years later without ever having a will drafted. I can maybe understand that some couples don’t have wills based on the premise “everything will just automatically flow to the surviving spouse”, although this thinking may be flawed depending upon your province of residence as noted in this link for the laws of Ontario when you die intestate (without a will). But for a surviving spouse to not have a will drafted is just beyond my comprehension.

Since the advice of accountants, lawyers, finance columnists and bloggers is obviously being ignored, I thought instead of lecturing that you should have a will, I would reflect on the folly of not having a will by looking at famous people who have died intestate and the messes they left behind.

Please note: I have no ability to confirm that these people did not have wills and I am relying on articles and other internet sources for this list, so I cannot guarantee its accuracy. Some of the stories in respect of these people’s deaths and estates are fascinating. You may wish to read in detail the links and source documents I provide below.

Famous People Who Supposedly Died Without a Will


The Musicians

There seems to be a correlation between being artistic and financially irresponsible as noted by the extremely famous musicians I note below. This does not surprise me, as I have suggested in prior posts on naming executors, that at the risk of generalizing you will want someone more anal than artistic to carry out this task.

Prince


In this article by People Magazine it was reported: “A Minnesota judge has made it official – despite Prince’s estate being worth an approximated $250 million, the singer did not have a will in place to declare the distribution of his assets. A hearing was held Wednesday morning, according to court documents obtained by PEOPLE, and the judge has approved Bremer Bank, the institution Prince trusted with his finances over the years, to move forward with handling his estate – both personal and financial business”.

Prince's former manager, Owen Husney, in this USA today article said “he was too smart to have overlooked something that crucial and he had teams of lawyers, business managers and accountants over the years who would have advised him it was crucial”. Assuming that no will ever surfaces, it is mind numbing that with so many advisors, Prince did not have a will in place and it could have fallen through the cracks (unless he just refused to have one drafted).

"It's astonishing, absolutely astonishing that he did not have a will," says Jerry Reisman, an estate lawyer on Long Island who's been following the case. He predicted trouble ahead. You're going to have 'siblings' coming out of the woodwork alleging they are siblings. Everyone is going to be fighting over this estate.”

Will Lesson #1: Run Out and Write Your Will 

Hendrix, Marley and a Cast of Thousands


In this LegalZoom,com article the writer notes that both Jimi Hendrix and Bob Marley died without wills and that their estates were subject to legal battles for years. Musicians such as Prince, Jimi Hendrix and Bob Marley have complicated estates due to the publishing rights they hold on their music, the typically massive demand for their music once they pass away and the value in unreleased material that is often released posthumously.

Other musicians that have purportedly died without wills include Kurt Cobain, Barry White, Tupac Shakur, James Brown, Sonny Bono and Amy Winehouse.

Athletes

Many athletes are known for blowing fortunes, but you would again think that their advisors would have ensured they had wills in place, but that apparently is not the case, or the athletes ignore their advice.

Steve McNair


Mr. McNair who played in Super Bowl XXXIV as the starting quarterback for the Tennessee Titans and was the NFL’s Co-MVP in 2003, did not have a will. He also had, in addition to his wife and children, a girlfriend - who murdered him in a murder-suicide. The sad details of this case can be read in this Probate Lawyer blog. 

If this story is not tragic enough, this Family Archival Solutions Inc. article discusses how McNair’s mother subsequently lost her home because Mr. McNair had not put his mother’s name on the house or made provision in a will for her to inherit the property as he had intended for her.

Will Lesson #2: Unintended Consequences Transpire when a Will is Not Drafted

Lamar Odom


This is a story about almost dying without a will. In 2015, former NBA star and ex-husband of Khloé Kardashian was hospitalized after being discovered unconscious at the Love Ranch, a brothel in Crystal, Nevada. Mr. Odom’s heart supposedly stopped several times and was touch and go to live. Luckily for him, he survived the ordeal.

As Mr. Odom supposedly did not have a will, it was reported that if he died, his estate would have all gone 1/3 to Khloé and 2/3 to his children. It is my understanding that Odom and Khloé had a good relationship despite their divorce and she was there at his side while he recovered and she did not want his money. So this is not a story about an ex-spouse trying to get something that was not hers, but clearly reflects that an ex-spouse may be entitled to your estate or part of it, if you are not careful.

Will Lesson #3: When You Do Not Have a Will, Your Ex-Spouse May Inherit Part of Your Estate

Other Famous People Who Died Without a Will (or Updating Their Will)


Martin Luther King


Mr. King who was assassinated on April 4, 1968 was one of the best known civil rights activists in the World. His “I Have A Dream” speech made in 1963 during the march on Washington is known as one of the finest speeches ever given. Unfortunately, when assassinated Mr. King was only 37 years old and did not have a will per this Forbes article.

This LA Times article discusses how the children are threatening his legacy as the estate battles on 47 years after his death in respect of his tomb, sermons and memorabilia.

Will Lesson #4: When You Die Intestate You Create Possible Conflict amongst Your Family

Pablo Picasso


As detailed in this 2016 article by Vanity Fair on the estate of Pablo Picasso,  Picasso did not have a will and left over “45,000 works, all complicated by countless authentications, rights and licencing deals”. The legal fees on this estate have were supposedly over $30 million.


Will Lesson #5: When You Die Intestate, Your Estate Can Be Withered Away in Legal Fees

Heath Ledger


As I noted in the introduction, I not only stress the importance of a will, but that it must be updated to reflect significant life events. Heath Ledger died of an accidental drug overdose in 2008 during the editing of the Dark Knight Batman movie in which he played the Joker and posthumously won the Academy Award for best supporting actor.

Mr. Ledger had a will drafted a few years earlier in which his parents and sisters were beneficiaries. He however, had neglected to update his will upon his marriage to actress Michelle Williams and on the birth of their daughter Matilda. However, unlike many messy and nasty estate fights highlighted in this blog post, Heath’s family as detailed in this People article altruistically handed over the entire estate to Matilda. It is nice to see some kindness amongst the greed and fighting of the other estates.

Will Lesson #6: Update Your Will for Life Events, or You May Negate the Benefits of Having a Will

Howard Hughes


As per Wikipedia, Howard Hughes “was an American business magnate, investor, record-setting pilot, film director, and philanthropist, known during his lifetime as one of the most financially successful individuals in the world. He first made a name for himself as a film producer, and then became an influential figure in the aviation industry. Later in life, he became known for his eccentric behavior and reclusive lifestyle—oddities that were caused in part by a worsening obsessive–compulsive disorder (OCD), chronic pain from several plane crashes, and increasing deafness”.

As discussed in this New York Times article it took over 20 years to sort out the estate of the reclusive Howard Hughes. Mr. Hughes did not leave a will and his estate was subject to various forgeries.

Will Lesson #7: If You Have Not Decided to Draft or Update Your Will After Reading These Stories, I Give Up!

While most of these famous people had substantial estates, the lesson is still the same for the average person. Have a will drafted (and powers of attorney) so that you ensure your estate goes to whom you wish and it is not frittered away on legal battles that not only cost significant sums, but destroy the lives and relationships of your loved ones.


The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.