There are several ways to extract funds from a business; salary, dividend, bonus or a shareholder loan. When a shareholder withdraws corporate funds by way of a shareholder loan, it will be recorded in the business financial statements and comes with tax implications to the shareholder.  This is because, a shareholder loan that is outstanding for more than one (1) tax year from the end of the tax year in which it was received, will be considered a taxable benefit and will be included in the shareholder’s income (and taxed accordingly).

In the context of estate administration, an executor should review the corporation’s financial statements early in the administration process and pay close attention if there is a “shareholder loan” entry.  If so, the executor should be reminded of CRA’s interpretation[1] that if the shareholder loan is not repaid within one (1) year following the taxation year-end of the corporation in which the taxpayer died, the loan amount will be included in the deceased’s income for tax purposes. Depending on the amount of the loan, this could result in a significant tax liability to the estate.

On the other hand, if the estate repays the shareholder loan, it can claim a deduction in the year the repayment is made to the extent that the deceased had included the loan amount as income in a previous taxation year. The CRA did note that the deduction is not available if the shareholder loan is repaid by a beneficiary of the estate. In other words, the deduction is only available to the estate on its repayment of the loan.

A dilemma for the executor is whether the shareholder loan should be repaid or simply included as income with the estate paying the resulting tax.  Reducing the taxes on death may be preferable but what if repaying the loan favours one beneficiary over the others?  How is an executor to deal with the shareholder loan in such a situation?

The entrepreneur may have also considered the shareholder loan as part of the estate plan and have specific repayment terms in case of death or have taken insurance and named the corporation as the beneficiary with the purpose of repaying the loan.  Estate planners can raise these planning options early.

Interest benefit

Another consideration for the executor is whether there could also be an interest benefit associated with the shareholder loan. Indeed, the tax rule is that unless interest equal to the prescribed interest rate is paid on the loan, another taxable benefit will be imputed to the shareholder.  The payment of interest must be made within 30 days from the corporation’s year end.  If interest was paid but at a lesser rate than the prescribed rate, the interest taxable benefit is reduced by the actual interest paid.

Therefore, if the executor notes a “shareholder loan” entry in the financial statements, he or she must also enquire with the tax advisor whether any interest was paid on the loan. If no interest were charged, the executor might also declare an interest benefit.

Conclusion

Entrepreneurs and tax advisors are well aware of the shareholder benefit rule and often have the loan repaid within the appropriate timeframe. However, this may not be the case on the death of a shareholder and therefore, the executor must seek guidance from tax advisors. There may also be instances where the executor may need to seek legal guidance as to whether the loan should be repaid – especially if it benefits a beneficiary to the detriment of other beneficiaries.

[1] technical interpretation 2012-0442911C6 (June 2012)