February 15 2016
Your Shareholders' Agreement and the Impact of Taxation
For many, a shareholders’ agreement is a necessary evil that will only be useful in the unlikely event of a major disagreement between shareholders. As a consequence, not enough effort is put in drafting the agreement, and shareholders are often caught off guard when an event occurs involving this document.
One aspect often neglected when drafting a shareholders' agreement is tax legislation, even though it may have important economic consequences. Here are some of the tax issues to be considered when drafting a shareholders' agreement.
A shareholder’s death is definitely an event that can impact your company, in more ways than just taxation. Nonetheless, relief measures should be included in case of death in order to lower heirs’ and surviving shareholders’ tax burden. Essentially, two relief measures are available: either the deceased’s shares are bought by the corporation or they are purchased by the surviving shareholders. Different variations of these two measures can be included in the agreement according to the particularities of each case. Although a life insurance benefit can be used to buy back, tax-free, the deceased’s shares through the capital dividend account (CDA), it might be more advantageous if surviving shareholders took the CDA’s dividend and they themselves bought the shares. If the deceased had a spouse, maybe some shares should be rolled over to the spouse who can sell them to the surviving shareholders and benefit from the exemption on capital gain. A well-written agreement allows some flexibility in its application to achieve an optimal result.
Some rights granted in a shareholders’ agreement allow the association of companies to share the small business deduction (SBD). A shareholder who is granted the right to purchase shares from the treasury or from another shareholder is deemed to hold these shares even if he/she has not exercised his/her right. If this shareholder controls another company, the two companies will be associated and will have to share the $500,000 business limit to which the SBD applies. This same shareholding assumption can be applied to a corporation to make it lose its Canadian-controlled private corporation status, for example when a non-resident shareholder owns 49% of voting shares in a company, but the shareholders’ agreement grants him/her rights to gain control of the company.
Your agreement is gathering dust and you can’t quite remember what it stipulates? It may be time to update it!