Common Law Spouses and Intestacy
Many common law spouses believe that because they have been living together, they are considered married in the eyes of the law and consequently, if one common law spouse dies intestate (without a Will), the surviving one common law spouse is entitled to receive part of or the entire Estate. This is not the case.
The Succession Law Reform Act (the “SLRA”) states that if one dies without a will, married spouses are entitled to a preferential share of the estate equal to $200,000 plus 1/2 of the balance to share with the deceased child or 1/3 of the balance to share with the deceased’s children.
However, common law relationships of heterosexual or same sex partners, lack the same recognition as married spouses under the SLRA leaving the surviving common law spouse with no statutory right to an inheritance from their spouse’s Estate.
That means if a common law spouse dies without a will, the surviving common law spouse has no entitlement to any part of the Estate.
For example consider Jack and Jill who have decided never to marry but have been living together for 15 years and have three children aged 12, 9 and 7. Unfortunately, Jack dies in a car accident leaving an estate valued at $300,000. Jack has no Will.
Because Jack and Jill were never married, Jill has no legal right to an inheritance or to property through an equalization payment and Jack’s estate will be divided equally among his three children where each would inherit $100,000 (held in trust until they have reached the age of majority).
As a common law spouse, Jill can only hope to succeed in an action where she would sue the Estate seeking support as a dependent.
The above example may seem unfair but the Supreme Court of Canada in Walsh v. Bona, held that such distinction does not offend the Canadian Charter of Rights and Freedoms because the differentiation was based on the individuals’ choice of whether or not to marry.
Common law spouses who want their spouse to have a right to an inheritance in their Estate must have a valid Will. If you or someone you know is in a common law relationship and does not have a Will, to avoid a situation such as this, it is time to consider getting one.
If you have questions regarding this issue or any other issue pertaining to Wills and Estates Planning, please contact:
Sébastien Desmarais
LL.B., LL.L., J.D.
Associate, Tierney Stauffer LLP
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
The Effects of Marriage, Separation and Divorce on your Will
We generally recommended that if you have a Will, you review it periodically to ensure that it remains relevant and continues to reflect your wishes. We also recommend that you consult with a lawyer if there has been a material change in circumstances since your will was executed. It is extremely important to follow this advice if you marry or if you separate or obtain a divorce from your spouse. These “material changes in circumstances” can have a significant impact on your Will and need to be reviewed with a lawyer.
If you Marry, Your Existing Will will be Revoked
Upon your marriage, any Will that was executed prior to your marriage is automatically revoked pursuant to the Succession Law Reform Act. There are 3 exceptions to this rule, the most important being if there is a declaration in the Will that it was made in contemplation of the marriage. If your will does not fit into any of the 3 exceptions, you will have to have a new Will executed after your marriage otherwise upon your death, you will be deemed to die intestate and your estate will be distributed in accordance with the intestacy provisions of the Succession Law Reform Act.
If you Separate, Your Existing Will will not be Affected
If you separate from your spouse, your Will will not be affected. It will remain valid and your estate will be distributed in accordance with its terms even if your former spouse is the beneficiary of your estate.
It is our experience that upon separation, most clients do not want to benefit their former spouse. As such, it is important for an individual who has separated to meet with his/her lawyer to review their will and determine if a new Will needs to be executed.
If you are Divorced, the Interpretation of Your Will will be Affected
If you obtain a divorce from your spouse, your Will remains valid, however, its interpretation will be affected by the terms of the Succession Law Reform Act.
Pursuant to the legislation, any gift to your former spouse or an appointment of your former spouse as executor or trustee will be revoked and your will shall be construed as if your former spouse had pre-deceased you.
As such, it is also important for an individual who has obtained a divorce to meet with his/her lawyer to review their Will and determine if a new will needs to be executed.
If you have any questions regarding any of these issues, we would invite you to contact us in order that we can set up a time to meet and discuss your questions.
David Sinclair
B.Com., B.A., LL.B.
Senior Associate, Tierney Stauffer LLP
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
Separation: Issues to Consider
Upon the breakdown of a marriage or a long-term relationship, there are a number of issues which normally need to be resolved depending upon the circumstances of the parties. These issues may include: the custody of children, child support, spousal support and the division of property.
The following is a summary of these very important issues and the factors that are often considered in resolving them.
Custody and the Residency of Children
One of the most important decisions that will need to be resolved on the breakdown of a marriage or relationship is who will have “custody” of the children.
The term “custody” refers to a parent’s right to make important decisions regarding a child’s care. A custodial parent is entitled to make decisions regarding a child’s education, health, religion and welfare.
Upon separation, one parent may be granted “sole custody” which means that that parent is entitled to make all of these important decisions alone. If one parent has sole custody, the other parent does not participate in these decisions but is still entitled to be informed of the decisions after they have been made and also receive information about other important issues in the child’s life. In other cases, the parents may be granted “joint custody” of the children. This means that the parents are joint decision makers and they must both agree before a major decision affecting the child is made. In order for joint custody to work, the parents must have an ability to effectively communicate with each other and they must have a common outlook towards parenting.
The residency of the children is an issue, which although technically separate from the issue of custody, is closely related to it. Upon the breakdown of a marriage or relationship, the parents may agree that the children will maintain their primary residence with one parent and the children will see the other parent according to a fixed access schedule. A typical access schedule normally involves the children seeing the other parent once during the week, every second weekend and during all major holidays.
In other families, the parents may agree that the children should not have a primary residence but rather the children should reside equally with both parents. This is referred to as “shared residency” or “shared custody.” Finally, the parents may also agree that one or more children should maintain their primary residence with one parent and one or more children should maintain their primary residence with the other parent. This is referred to as “split residency” or “split custody.”
The issues of custody and the residency of the children are always decided on the best interests of the children. In determining the “best interests of the children”, the following factors are considered: the love, affection, and emotional ties between the parent and the child, the views and preferences of the child, the length of time the child has lived in a stable home environment, any plans proposed for the upbringing of the child, the ability of each party to act as a parent, and the ability and willingness of each parent to provide the child with guidance and education, the necessaries of life and any special needs of the child.
Child Support
Both parents have a responsibility to financially support their children, regardless of the custody or access arrangement that is in place.
Generally, child support will be determined in accordance with the federal or provincial Child Support Guidelines. The guidelines provide a comprehensive but straight forward method of determining how much child support each parent will pay.
A child support order is usually comprised of two amounts: the “table” amount and a contribution towards a child’s “special and extraordinary” expenses.
The “table” amount represents a parent’s contribution to the day to day costs of raising a child, namely: shelter, clothing, food, basic extracurricular expenses, etc. Within the guidelines, there are different sections which detail how the table amount is to be calculated based upon the residency arrangements for the child(ren). Thus, if the children maintain their primary residence (defined as at least 60% of the time) with one parent, the table amount is calculated in a certain manner. If the children reside with both parents at least 40% of the time (referred to as “shared custody”), there is a different method of calculating child support. Finally, if there is more than one child, and at least one child maintains his or her primary residence with each parent, there is another method of calculating child support.
Regardless of which section of the guidelines will be used, the other variables which must be known prior to determining the table amount are: the number of children, the ages of the children and the incomes of both parties. Once these are known, the determination of the table amount is relatively straight forward.
Special and extraordinary expenses, as the term implies, are those expenses which fall outside the purview of a child’s daily needs. Examples of such expenses include: child care costs, medical and dental insurance premiums relating to the child, health related expenses such as orthodontic treatments or eyeglasses, the costs of post-secondary education, or expenses for extraordinary extracurricular activities.
A separate section of the guidelines details how each parent’s contribution towards these expenses will be determined. First, one must determine if the expense in question is both reasonable and necessary. If the answer to both of these questions is in the affirmative, then the parents will each contribute to the after-tax cost of the expense in proportion to each parent’s income. For example, if the after-tax cost of the expense is $1,000 and the mother earns $100,000 and the father earns $50,000, the mother will pay 67% of the expense and the father will pay 33%.
Spousal Support
Spousal support is designed to provide financial assistance from one spouse to the other upon the breakdown of a marriage or relationship. It is one of the most controversial areas of family law and one of the most difficult on which to advise.
There are three major issues that need to be resolved when spousal support is considered: entitlement, quantum and duration.
Entitlement involves, as the name implies, the determination of whether one spouse should receive support from the other. It is normally resolved after reviewing various factors including: the length of the marriage, the roles the parties assumed during the marriage, the financial circumstances of the parties at the breakdown of the marriage and the self-sufficiency of each party.
If there is an entitlement to spousal support, the next issues to be resolved are how much support should be paid and for how long. In determining these issues, the following factors will be relevant: the ages, health and incomes of the parties, the length of the marriage or relationship, the incomes of the parties, the needs of the recipient and the ability to pay of the payor, and, the future employment prospects for the parties.
To assist in the determination of the issues of quantum and duration, the federal government created the Spousal Support Advisory Guidelines (“SSAG”). These guidelines are advisory in nature, unlike the child support guidelines which are mandatory. The SSAGs use the incomes and ages of the parties, the length of the marriage whether child support is being paid to develop ranges of spousal support. The parties can then use the ranges generated as a means of resolving the issues of quantum and duration of spousal support.
Division of Property
The division of property will be directly affected by the nature of the relationship in question. Married spouses participate in a property division scheme which is detailed in Part I of the Family Law Act. It is referred to as the Equalization of Net Family Property. Unmarried spouses do not participate in this scheme. Property between unmarried spouses is generally divided according to ownership.
The Equalization of Net Family property scheme is premised on the fact that there is an equal contribution by both parties for the care of children, the management of the household and the financial provision for the family during a marriage. When a marriage ends, both parties should share equally in any assets and liabilities that were acquired or incurred over the course of the marriage.
The rules that need to be followed in complying with the scheme are complex and numerous exceptions and exemptions exist. The following is a very basic outline of the steps that need to be followed:
Step 1 – Each spouse determines his or her net worth on the date of separation. An individual’s net worth is determined by subtracting the value of all debts and liabilities one has from the value of all assets that one has. An adjustment may also have to be made to take into account whether a spouse has “excluded property” on the date of separation. Excluded property may include such things as: ifts or inheritances that were received during the marriage and which still exist on the date of separation, damages for personal injuries that were received during the marriage and which still exist on the date of separation, or life insurance proceeds that were received during the marriage and which still exist on the date of separation.
Step 2 – Each spouse determines his or her net worth on the date of marriage.
Step 3 – Each spouse determines his or her net family property. Net Family Property (“NFP”) can be defined as a spouse’s net worth on the date of separation (see step 1) less his or her net worth on the date of marriage (see step 2).
Step 4 – The parties compare their NFPs. If the two amounts are equal, nothing needs to be done. If one party has a higher NFP, the party with the higher NFP will pay the party with the lower NFP half of the difference between them to “equalize” their NFPs. This will result in each party receiving half of the assets and liabilities that were acquired over the course of the marriage.
Step 5 – Determine if the result in Step 4 needs to be adjusted to account for any unconscionable results. It should be noted that the result in Step 4 will generally stand and it is only in very rare circumstances that it will be adjusted by Step 5.
If one party owes the other an equalization payment, it is normally paid through a cash payment. However, the parties may agree that the payment is to be funded through the transfer of property, the assumption of debt or some other transaction.
Summary
This overview of the basic family law issues is a very brief summary. These issues are very complex and are often only resolved after a full analysis of numerous factors. As such, one should not rely upon the foregoing as being a definitive answer to your individual situation.
If you have questions about your separation or how a separation may affect you in the future, please contact one of our family law lawyers at (613) 728-8057. You can also contact Kerri Ross directly at (613) 288-3238 or by e-mail at kross@tslawyers.ca.
Kerri Ross,
B.Sc. (Hons.), LL.B.
Associate, Tierney Stauffer LLP
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
Estate Planning and Probate Tax
Probate is a legal process that confirms and validates the last Will and Testament of a deceased person.
There is no specific law in Ontario that requires the Will of a deceased person to be probated. As a general rule, the larger and more complex the assets held by the deceased, the more likely the probating of the Will shall be required. Probate tax is calculated at an approximate rate of $5.00 per thousand dollars for the first $50,000 in the Estate and $15.00 per thousand for every thousand dollars over and above $50,000 in the Estate.
Depending on how the assets of the Estate are held, probate tax can be reduced or even avoided altogether.
With the proper estate planning, a business owner can eliminate some of the probate fees that are triggered by his or her death and the ensuing transfer of property. One way to do this is through the use of “double Wills” where one Will deals with assets requiring probate (such as cash and real estate) and the other deals with assets that do not require probate such as shares of a corporation.
If ou have any questions concerning the termination of an employee or employment law in general, please do not hesitate to contact David Sinclair directly 613.288.3226 or by email at dsinclair@tslawyers.ca.
David Sinclair
B.Com., B.A., LL.B.
Associate, Tierney Stauffer LLP
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
Different Methods of Resolving Family Law Issues
After the breakdown of a serious relationship or marriage, the individuals involved will often have a number of difficult 
issues to resolve in order that they may each move on with their lives. Those issues may include: custody of children, child support, spousal support, property division and the disposition of the matrimonial home.
One of the first decisions that the parties will have to make is how are they going to resolve these issues. Although there are numerous ways of resolving any dispute, this article will examine 4 methods that are often used in a family law context:
- Negotiation
- Mediation
- Collaborative Family Law
- Litigation
Negotiation
Negotiation is probably the most common form of dispute resolution in family law. It normally involves each party retaining a lawyer who, acting on the client’s instructions, will negotiate a resolution of the issues on behalf of the party.
Depending upon the issues involved, it may be necessary for the lawyers and parties to meet at a “4-way meeting” to help resolve any outstanding matters. If a settlement is reached, it will be documented in a Separation Agreement which will be signed by both parties.
Mediation
Mediation is a method of dispute resolution in which the parties retain a third party (i.e. the “mediator”) to assist them in resolving the outstanding issues between them.
The mediator does not take sides nor does he/she resolve the issues for the parties. The parties negotiate the settlement themselves. The mediator’s role is simply to facilitate a discussion between the parties that will hopefully lead to a settlement. If a settlement is reached, the mediator will normally draft a Separation Agreement that details the settlement.
Collaborative Family Law
Collaborative family law is a process where the parties agree to resolve the outstanding issues between them in a cooperative rather than adversarial manner. The parties, with the assistance of specially trained family law lawyers, will identify each party’s interests and will then attempt to craft a resolution that will respect and meet those interests. The process is designed to minimize posturing and tactical maneuvering and to focus as much as possible on settlement. If a ettlement is reached, it will be documented in a Separation Agreement that will be signed by both parties
Litigation
Litigation is a process whereby the parties go to court and ask the court to decide the outstanding issues for them. The parties will often have to attend in court on a number of occasions before the matter is either settled or a trial is held. If a trial is held, the judge hearing the matter will impose a decision which is binding on the parties. Notwithstanding that the parties are in court, they may still agree on a settlement. In fact, over 95% of the cases that go to court will settle before a trial is held.
The choice of the method of dispute resolution will be a critical aspect of resolving any family law dispute. Clients will have to consider the nature and scope of the outstanding issues, the reasonableness of the opposing party, the level of cooperation and communication with the opposing party, finances and any history of domestic violence in deciding which method is appropriate for them. It is highly recommended that a full and frank discussion
If you have any questions concerning the termination of an employee or employment law in general, please do not hesitate to contact David Sinclair directly 613.288.3226 or by email at dsinclair@tslawyers.ca.
David Sinclair
B.Com., B.A., LL.B.
Associate, Tierney Stauffer LLP
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
Planning Your Business Succession
Every successful business owner will one day be faced with the dilemma of having to choose a successor. Letting go of the reins of his or her business that has been built through years of labor will not be easy and a smooth succession can only be achieved if the business owner is ready to sell or pass the reins to his or her heir(s).
There is no single boilerplate for a succession plan for all businesses as every business succession is unique. However, all successful successions have similarities and I will highlight some of those similarities in this article.
BEAT THE ODDS
The statistics on small business succession are discouraging as approximately 50% of small businesses that pass to the next generation of owners remain in business five years later. The statistics concerning family owned-business are less encouraging as only 30% will survive a next generation and probably only half of those will survive to the following generation.
Although the reasons why some business successions fail while others succeed are vast and open to interpretation, lack of preparation and poor communication are common traits in many failed plans.
SHAREHOLDER AGREEMENT
Most successful entrepreneurs and professionals will agree that a shareholder agreement is important as it establishes a solid business foundation for the shareholders. The shareholder agreement can also provide the initial steps for planning the business succession as it usually maps out the structural transitions of the business in situations such as the death or disability of an owner, a marriage breakdown of a shareholder or the outcome of a feud between co-owners. Essentially, the shareholder agreement is a negotiated document between the shareholders of the business defining the relationship of the shareholders and the future succession of the business.
A well-drafted shareholder agreement provides solutions to those unfortunate situations by inserting specific clauses that pre-determine the outcome. A shareholder agreement should include clauses such as:
- Disability – addressing how and when the shares of a co-owner who becomes permanently disabled can be bought out.
- Death – determining how to deal with the deceased owner’s shares.
- Retirement – determining the retirement income for the owners who cease to work actively in the business.
In our opinion, a shareholder agreement should always be part of the business succession discussion.
HAVE A PLAN
Business succession planning is a process that should be considered sooner rather than later. To achieve a smooth succession of the business it is best to develop a comprehensive plan that both achieves the retiring owner’s objectives and serves the successor’s needs.
In an ideal scenario, the business owner(s) and the “next generation” would meet with a group of professionals (accountant, lawyer and advisors) to discuss their individual goals and the various options to attain these specific goals. The design of the plan should be viewed with an open mind as compromises are inevitable and without the input of all the succession would be vulnerable.
The succession plan should address three main areas:
- The transfer of labour
- The transfer of management and decision-making (control)
- The transfer of ownership.
However, the main issue to address in any succession plan is: who is/are the successor(s) and how it will be accomplished. The answers to those questions will provide the basis for the structure of the business succession plan.
IMPLEMENTING THE PLAN
Establishing a succession plan is only the first step of the business succession; that plan must then be implemented. It is often at this stage that plans derail because of a lack of willpower on behalf of the parties or because the plans are put on the backburner.
Once a succession plan has been agreed upon, someone must take the leadership role and establish the timetable for the stages of the succession. The leader must make sure that all parties involved (owners, accountant, lawyer and advisor) are made aware of the deadlines and, more importantly, he or she must ensure those deadlines are met.
It is possible that the succession plan may change in light of unforeseeable events so the parties involved must remain flexible and open-minded. However, unless those unanticipated events jeopardize the entire succession plan (such as the death of the owner), the succession plan should only be postponed and not dismissed in its entirety.
TAX CONSEQUENCES
You must take into consideration tax consequences when implementing an estate and business succession plan.
If one voluntarily avoids preparing a business succession plan, at his or her death he or she will be deemed to have disposed of all his or her assets at fair market value potentially resulting in a significant tax debt payable by the estate and the business being left in complete disarray.
Deemed Disposition at Fair Market Value
One of the greatest concerns business owners face when planning for their estate and the business succession is how he or she can minimize the capital gains tax that will arise on the sale or other type of transfer of ownership.
As mentioned above, although avoiding the issue and letting his or her Will dictate the business succession is probably the worst choice one can make, unfortunately many owners prefer opting for this option in hopes of avoiding conflict because of the succession. If the business owner decides to leave their shares of their company to their children under their Will, they will be deemed to have disposed of these shares at fair market value triggering a capital gain which may potentially deplete the value of their Estate.
Capital Gains Exemption
Every individual resident in Canada is entitled to a lifetime capital gains exemption of up to $750,000 upon disposition of shares of a qualifying small business corporation. To qualify for the exemptions the following criteria have to be met:
- The shares must have been owned throughout the 24 month period preceding the date the shares were disposed of;
- At least 50% of the fair market value of the business’s assets must be used in the course of carrying on an active business in Canada;
- At the date the shares are disposed, approximately 90% of the fair market value of the business’s assets must be used in the course of carrying on an active business in Canada.
The capital gains exemption allows the business owner to contemplate several succession strategies such as an estate freeze
Estate Freeze
One strategy that is often mentioned is the estate freeze; a technique that limits the growth of your capital property and the resulting tax on death during your lifetime by transferring the future growth in the capital property to your heirs.
In order to protect their Estate by preventing its value to grow to a size that might incur considerable taxes and probate fees, the business owner will:
- exchange their common shares for preferred shares of equal value where the new preferred shares would not grow; and
- family members (wife, children and grandchildren) would be given common shares and all future growth would attach to those common shares.
An estate freeze allows for a tax deferral for a period commencing when the family members acquire the new preferred shares until the sale of those shares. The estate freeze allows the business owner to minimize the taxes arising at his death.
However, it is important to understand that an estate freeze involves major changes on the part of the business owner and the family. Several issues will also need to be addressed as a result of the freeze and we recommend that anyone who is contemplating an estate freeze consult their accountant and their lawyer in order to fully understand the implications of a freeze for the business and for the family members.
The estate freeze is the most common technique used when a business succession is contemplated but it is not the only technique. Depending on the situation, there are other techniques that are more complex and beyond the scope of this Newsletter. For more information, we recommend you consult your accountant and lawyer.
SUCCESSION OF THE FAMILY BUSINESS – A WEB OF COMPLEXITIES?
Succession of the family business is more delicate as it often involves the varying interests of the children and the parents’ concerns of being fair toward them; it is a balancing act between the realities of the business and the family.
First, one must ask whether there is a viable family successor(s). It is also important to identify the goals of that successor(s) and to develop the right succession plan in light of those goals.
Second, involving family members in the business at an early stage provides an opportunity for the next generation to familiarize themselves with the requirements of managing the business to be involved in the decision-making process. Family involvement should be a key component of the family business succession plan.
Third, it will be necessary for the family to address important and difficult issues such as management authority and family participation. The emergence of a strong corporate governance plan will only be possible if all related parties participate in the generation of the plan and all recognize their responsibility in this plan. The ultimate goal is to have the parent recognize will be in the need to pass the reins to the next generation and having confidence that business is in good hands and will continue to thrive in the future.
CONSULT WITH PROFESSIONALS
Business succession planning can strain the personal relationship of co-owners or your family members. However, maintaining the status quo and doing nothing is the worst option as it only postpones the issues and your legacy could be jeopardized.
Letting go is seldom easy but making well-informed decisions will make the transition less stressful and ensure your business transition results in a lasting and profitable gift. In contemplating retirement and handing the reins of your business to your successor(s), we recommend consulting with your accountant, lawyer, and any other professional advisor that may be necessary for your particular business, in order to be thoroughly advised.
REVIEW YOUR WILL
After all this planning, don’t forget to review your Will. At Tierney Stauffer LLP, we will gladly review your Will with you and discuss more advanced estate planning aimed at maximizing the value of your estate while minimizing the taxes and probate fees.
Planning the succession of your business is not easy so reduce the stress and complexities by seeking proper advice. Don’t forget that this is in your own best interests as well as the best interests of your loved ones.
If you have questions regarding this issue or any other issue pertaining to Wills and Estates Planning, please contact Sebastien Desmarais at (613) 288-3220 or sdesmarais@tslawyers.ca.
Sébastien Desmarais
LL.B., LL.L., J.D.
Associate, Tierney Stauffer LLP
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
Shareholders’ Agreement & Tax Implications: Are You Informed?
When two people decide to begin a business venture, the implementation of a shareholders’ agreement is a key to preventing unfortunate consequences at a later time. The primary purpose of a shareholders’ agreement is to define the relationship amongst the parties and should include the procedure and actions to be taken in the event the relationship
sours over time or in the event that the parties change due to disability or death. Ultimately, a shareholders’ agreement aims at establishing provisions for future key decisions to deal eff ectively with any possible event and circumstance
that may arise.
However, as each situation is unique and requires an agreement that meets the intention of the parties it is preferable to avoid a “boilerplate agreement”, which are oft en ill-suited to the specifics of the shareholders’ goals and may fail to result in the most tax efficient outcome.
The following sets out a few provisions that should always be carefully considered and fully understood.
Survivorship Arrangements
One of the primary functions of a shareholders’ agreement is to provide for a buy-sell arrangement upon the death of a shareholder. Provisions are made for how a deceased shareholder’s shares will be dealt with and how the obligations of the surviving shareholders will be funded. These provisions should be structured so as to provide the most tax efficient result for all parties involved.
Certainly, one of the most tax effective strategies to fund such a buy-sell arrangement is to purchase life insurance on the
lives of each shareholder and designate the corporation as the beneficiary. The life insurance proceeds are received on a taxfree basis by the corporation and will thereby increase the capital dividend account. Depending on the shareholders’ agreement, the corporation may then issue a tax-free capital dividend to the surviving shareholders in order for them to purchase the shares from the estate. Such a clause is best implemented when the deceased shareholder has not claimed his or her capital gain exemption prior to death.
If the deceased shareholder has already claimed his or her capital gain exemption, then it may be the shareholders’ agreement that the corporation will redeem the deceased shareholders’ shares. Again, the goal is to have the corporation receive the life insurance proceeds in order to increase the capital dividend account. The corporation would then repurchase the deceased’s shares by issuing a tax-free capital dividend to the estate.
All survivorship arrangements in a shareholders’ agreement have tax implications that must be considered. There is no “magical template” as all shareholders’ agreements should be tailored specifically to the shareholders’ goal and intentions.
Control and the Association Rules
Another provision that requires careful consideration in a shareholders’ agreement is the avoidance of the association rules. Where a shareholder, or a related group of shareholders, owns or controls more than 50% of the voting shares of a corporation, that shareholder or group will control the corporation. Consequently, any other corporation controlled by the controlling shareholder or group may be found to be associated with the first corporation.
If two or more corporations are found to be associated, it will trigger a number of income tax consequences including, inter alia, a requirement to share the small business deduction as well as other deductions in computing income. Sections 256 of the Income Tax Act defines the association rules and these rules should be fully understood by the drafter of the shareholder’s agreement as well as all parties involved in order to avoid regrettable tax consequences.
Other Provisions to Consider
Th ere are several other provisions commonly included in a shareholders’ agreement that, unless carefully considered, may have adverse income tax consequences. One example is where a shareholders’ agreement provides for a “call option” allowing the majority shareholder to require that a minority shareholder sell his or her shares at a fixed price or at a price determined by a formula which could potentially exceed the fair market value of the shares at the time the call option is exercised.
In that case, the shares held by the minority shareholder will be considered to be short term preferred shares from the moment of their issuance. Th is may result in the acquisition price being based on the fair market value of the shares at the time the agreement was entered into rather than at the time of acquisition.
Another example of a potential planning pitfall is in the drafting of provisions for arrangements to be made in the event a shareholder becomes disabled who can no longer return to full-time activity. Another buy-sell provision may be considered as it would avoid such a situation becoming a burden for the other shareholders who would otherwise have to provide continuing support for the disabled shareholder for a lengthy period of time.
How can one fund such a buy-sell arrangement? Although income replacement insurance may be an option, it is important to note that proceeds of income replacement insurance do not increase the capital dividend account of the corporation and, therefore, cannot be transferred to the shareholder on a tax-free basis. If the shareholders opt for a corporate repurchase of the shares, consideration should be given to reorganizing the share capital of the corporation allowing for the creation of frozen, redeemable preferred shares which can be redeemed or purchased over time; for the disabled shareholder this would only trigger a tax liability as the proceeds are received and it also completely avoids depletion of the reserves of the corporations.
Where a shareholder of a corporation is another corporation and the holding corporation is used to hold the shares of the operating corporation, the buy-sell arrangements may be amended to provide for the most tax efficient result possible. In such a case who shall hold the life insurance policy? Who shall pay the premiums? Can we avoid a shareholder benefit? Should be we consider use intercorporate tax-free dividends to repay the payment of premiums thus avoiding a shareholder benefit? These are all questions that should be answered prior to the drafting of the shareholders’ agreement.
Conclusion
Th e foregoing are just a few examples of issues that should be discussed prior to the drafting of the shareholders’ agreement.
As previously mentioned, using a “boilerplate agreement” may result in undesirable tax outcomes that could have been completely avoided had the drafter foreseen the potential pitfalls and fully understood the fiscal repercussions of the various provisions.
We always recommend shareholders implement a shareholders’ agreement at the commencement of business while all the parties are on good terms. We also recommend shareholders’ seek professional advice from the outset as any attempts to resolve issues “after the fact” may turn out to be catastrophic for the shareholders and for the business and the costs will most surely exceed the initial expense of a well draft ed shareholders’ agreement prepared by a fully informed professional advisor.
Sébastien Desmarais
LL.B., LL.L., J.D.
Associate, Tierney Stauffer LLP
This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.
