Transcript Buy/Sell Agreements - Insurance Concepts

The Buy Sell Agreement
For Private Corporations and Partnerships
Insurance Concepts
This presentation is for educational or informational purposes only.
It is not intended to provide anyone with legal, taxation, accounting or
other professional advice and no one should act upon the information
provided here without a thorough review of the specific facts with the
appropriate professional advisory team.
Corporate Buy Sell Arrangements
The death of a shareholder creates two significant problems for
those who are left behind.
1.
2.
The family is left without the support of their loved one
The remaining shareholders are left without the advice of one of
the team, plus they are now “in the business” with a new,
unknown, and possibly inexperienced shareholder.
The latter may not be a problem for large public companies, but it
is a major difficulty for smaller private companies that rely on the
stability and continuity in management.
Both these problems can be solved using an Insured Buy Sell
Arrangement, but the options have become more complex due to
changes in the Income Tax Act.
Normally, shares of an operating company (Opco) or a holding
company (Holdco), that are owned by a deceased shareholder,
can be purchased by the survivors or their holding companies
outright.
Or, alternatively, the operating company itself could purchase the
the shares for cancellation from the deceased shareholder or
their holding company.
To accomplish any type of Buy Sell Arrangement, the
shareholders should enter into a binding Buy Sell Agreement that
will trigger in the event of death, disability, retirement or even
bankruptcy of a shareholder.
This sort of agreement is universally recognized as a solution that
will provide for a smooth transfer of ownership, more confidence
for the employees and creditors and security for the heir of the
deceased shareholder.
Since the interests of the remaining shareholders will, in most
cases, differ from those of the heirs of the deceased, it is usually
best to arrange for a seamless transfer of ownership at a fair
market price to avoid confrontation and financial hardship.
The agreement provides for a mechanism to identify the buyers
and sellers and the conditions and price involved in the sale.
This is commonly solved by using a corporate owned life
insurance policy on the lives of the shareholders, as an ideal
vehicle for a buyout on death.
Taxes – consequences of
sale/redemption of shares
A shareholder is deemed to dispose of their capital property at death
for value equal to the fair market value immediately prior to death.
This can result in a capital gain unless the property is transferred to a
spouse or a testamentary spousal trust, in which case the tax is
deferred until the spouse disposes of it.
However, the ownership of the shares by the spouse is usually what
a Buy Sell Arrangement is designed to avoid.
Rollover provisions not useful…
For the rollover to work, the property must vest “indefeasibly” in the
spouse or spousal trust not later than 15 months after the death of
the taxpayer.
To vest indefeasibly, the spouse must obtain a right to absolute
ownership of that property in such a manner that such right cannot
be defeated by any future event, even though that person may not
be entitled to the immediate enjoyment of all the benefits arising
from that right.
This means that a Buy Sell arrangement which enforces the sale of
shares, will not permit a tax-free rollover to the surviving spouse of
the deceased shareholder.
Put Call Arrangements
One way to arrange for the rollover of the shares to the spouse is to
use a Put Call arrangement, where the sale is not mandatory if the
put and call are not exercised.
The estate could exercise a put (a desire to sell) and the survivors a
call ( a desire to buy) on the shares of the deceased. To make this
type of agreement most effective, the spouse should be a party in
the agreement and it should be made binding on the parties, that
any put or call will be binding.
In this way, the shares may vest indefeasibly in the spouse.
Arm’s Length and Non Arm’s Length
Occasionally, family members will agree that the shares in the
corporation will be sold to a family member on the death of the
parent, say, for less than the fair market value.
This, however is a dangerous tactic since the Income Tax Act (ITA)
views this type of tactic with disdain and will value the shares without
regard to the Buy Sell arrangement. This can have very negative
implications to both parties.
First, the heirs of the deceased have received less than the
value of the shares while being assessed tax on the full fair
market value. This may result in tax that eats up most of the
proceeds.
As well, the new shareholders have obtained shares at a lower
than fair market value, which means that they have not received
a full increase in the cost base of the shares acquired.
A subsequent sale, (or the death of a shareholder), will result in
higher tax than normal due to the low cost base of the shares,
causing double taxation.
How does Buy Sell work?
Objective
To allow the surviving shareholder(s) to run the company without
interference from, or concern for, other non active shareholders, plus to
free the heirs of the deceased shareholder from the worry that a
significant portion of their wealth is not under their control.
How can you fund the agreement?
There are at least five options to fund the agreement :
Pay Cash
Borrow
Use promissory note
Sell assets
Use life insurance
Cash Option…..
Would sufficient cash be available?
Earnings may already be depressed
Purchase price to be paid with after-tax dollars
Borrow……..

Lenders may be unwilling

No cash liquidity
- interest and principal payments strain cash flow

Loan repaid with after-tax dollars
Use promissory note……

Repayment of note strains cash liquidity

Note is repaid using after-tax dollars
Sell Assets……..

Reduces Company’s potential for earnings

Market Value of shares impacted negatively

Additional costs associated with selling assets:
- will there be transaction costs?
- will the value received be depressed?
- will taxes have to be paid on sale of assets?
Life Insurance……….
Clearly provides high benefit with a low annual cost
Immediate access to funds
Tax free death benefit
Requires premium payments
The Insurance Advantage…..
Other Solutions
Insurance Solution
You pay 100%
of funding cost
Insurance Cost
The premium is not the problem… it is the solution to the problem of funding.
The small premium outlay NOW ensures that the problems of the unfunded
agreement never arise.
Next Steps……..
Establish a value for your business.
Decide on the most appropriate structure for the purchase or
redemption of shares.
Arrange a buy-sell agreement.
Apply for the necessary insurance protection.
Types of Buy Sell Agreements
Criss Cross Buy Sell
Hybrid Buy Sell
Corporate Criss Cross Buy Sell
Corporate Share Redemption
The Buy Sell Agreement
Thank You
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