Business owners: Did you review the "buy-sell" clause in your Shareholders Agreement?

It is wise for corporations and their shareholders to consider amending their shareholders' agreements periodically, as they can become out-dated over time. In particular, the structure of the buy-sell component of shareholders' agreements evolves regularly as a result of new tax legislation and interpretations of the law by the Canada Revenue Agency (CRA). This is particularly evident in connection with spousal rollovers after death. Under normal circumstances, when a spouse dies, all property of the deceased can pass to the surviving spouse as a tax-free rollover as long as the property vests in the spouse (i.e. unconditional ownership). The CRA now takes the position that a mandatory buy-sell of the shares of a company from a deceased's estate negates the ability to use the spousal rollover rules. The mandatory buy out, in the CRA's view, prevents the shares from vesting. There is thus no spousal rollover and the full capital gain will have to be reported on the deceased's final return. This result poses no problem if the shares are eligible for the capital gains exemption and the deceased had enough capital gains exemption to eliminate the gain. However, if these factors are not present, the lack of a spousal rollover eliminates the ability of the surviving spouse to use his or her capital gains exemption on a sale. To alleviate this problem, modern shareholders' agreements include what are commonly referred to as put/call provisions. Such provisions give the deceased's estate the right to require the shares to be purchased from the estate, and give the surviving shareholders the right to purchase the shares from the estate. Both parties have the option to buy and sell, but neither is obligated to do so. Buy-sell provisions should also provide enough flexibility to allow either for the company to purchase the shares from the estate, resulting in a deemed dividend, or to have the surviving shareholder(s) purchase the shares directly from the estate, resulting in a capital gain. Shareholders should inquire of their advisors regarding the tax consequences that result from these options. When structuring agreements, it is important to predetermine the buy/sell prices on an ongoing basis rather than using pre-determined valuation formulas, which can often be misleading and not representative of fair market value. Ideally, predetermined prices should be updated annually. Where shareholders are related (non-arm's length), a valuation may be required to support the value, though the CRA might question and challenge a valuation in these circumstances. Although the CRA can challenge an agreement to value between two unrelated shareholders, it is less likely to do so. In any event, no valuations are required until a shareholder dies. It is thus prudent to have a mechanism in place to determine fair market value, ideally by an independent business valuator. Notwithstanding any of the above strategies, care should be taken in implementing any changes to shareholders' agreements. Some older agreements have been maintained in their original form specifically to preserve certain tax advantages that might remain valid even though more current tax laws have changed. For any questions regarding the above and/or if you wish to discuss your situation, please do not hesitate to contact me.