Showing posts with label buy-sell agreement. Show all posts
Showing posts with label buy-sell agreement. Show all posts

Tuesday 10 November 2009

A buy-sell agreement prepares for a possible change in a business’ ownership.

By Brenda McEachern

VALUING YOUR BUSINESS

When a business principal dies or becomes disabled, what are some options for the business? A buy-sell agreement is a plan that provides for an orderly change of ownership under certain circumstances. It’s designed to establish a value for the business and sets out the terms under which the interest of the disabled or deceased shareholder will be sold to the remaining shareholders.

If properly funded, the shareholder’s family will receive fair market value (FMV) for the shares, providing them with capital to help maintain their standard of living. Also, the remaining business owners are protected from the unwelcome intrusion of the deceased’s family into their business as shareholders.

The most cost-effective method to fund a buy-sell agreement, in the case of the death of a shareholder, is through life insurance. This approach helps to ensure that the required amount of capital will be available.

Assuming the use of life insurance, how much to put in place must also be examined, with reference to the particular business situation. For example, an arm’s-length arrangement would demand that the full FMV of the shares be covered. With a family business, however, there is flexibility to insure the tax bill, 100% of FMV or a lesser percentage.

There are three common priorities for businesses:

1. Maximizing the Benefit of the Capital Dividend Account (CDA)
Private corporations are entitled to maintain a notional tax account, called the capital dividend account (CDA), which keeps track of various tax-free surpluses accumulated by the corporation.
These surpluses may be distributed as capital dividends free of tax to the corporation’s Canadian
resident shareholders.

2. Maximizing the Capital Gains Exemption

Shareholders of farms or active businesses may qualify for a lifetime $500,000 capital gains deduction. This exemption benefits both the deceased and the surviving shareholders by reducing taxes to the estate and reducing the capital gains tax to surviving shareholders when they
ultimately sell the business.

3. Minimizing Tax

If tax minimization is a priority it is necessary to identify for whom—the deceased, the estate or the survivor. Even if the shareholders do have insurance funding in place, the tax implications vary drastically for these stakeholders, depending how the insurance proceeds are distributed.

Brenda McEachern is an estate and trust lawyer with Canada Life.

http://www.advisor.ca/images/other/ae/ae_0204b_valuingbusiness.pdf