Ending a Business Marriage: A Tax Perspective

Maybe your business has been struggling since the 2008-2009 financial crisis, or better yet, maybe the business has become more profitable every year since due to better management practices and branding.

Despite progress or track record, maybe your finding that the relationships between the two or more shareholders involved in your business are strained, and this could be for various reasons. For example, one shareholder may not be pulling their weight because of personal issues while another might be wanting to expand.  A strained relationship could be the result of health issues, a lack of motivation, a lack of trust, or just plain old classic burn out. Whether the reasons are good or bad, often shareholders of successful businesses need to change or terminate their existing business relationship(s).

There are number of ways to terminate a business relationship.

One simple method is to sell the entire business to a third party.

If this is the chosen scenario, the buyer can acquire the target business in three ways:

  • The buyer can personally buy all the existing issued shares of the target business from the current shareholders,
  • The buyer’s company can acquire all the assets of the target business; or
  • The buyer can use a combination of these two methods.

The tax consequences for each option are discussed in my previous blog post “Due Diligence When Buying a Business in Vancouver B.C.”.

Another common way to end what is effectively a “business marriage” is for the remaining shareholder to buy out the departing shareholder.

I will keep the discussion simple by assuming there are only two shareholders in the following scenario.

A business relationship ends when the departing shareholder no longer has any legal obligation or interest in the assets of the business, and this is achieved by making the departing party no longer a shareholder of the business. In essence, the remaining party has to become the sole shareholder of the company.

There are only two ways the remaining shareholder can become the sole shareholder. They can buy the other shareholder’s shares personally so that it is effectively a transaction between two persons. The other way is for the company to buy back (“redeem” is the tax term) the departing shareholder’s shares so that in the end, only one person is holding shares – the remaining shareholder.

The departing shareholder should be aware that the tax treatments for the two transactions are very different. For the departing shareholder, the first option is preferable. If the shares being transferred are Qualified Small Business Corporation Shares (“QSBCS”), the entire transaction is tax free to the departing shareholder (see “Capital Gains Deduction for Canadian Business Owners”).  Even if these shares are not QSBCS, gains on the sale of these shares would be considered capital gains and hence only fifty percent taxable. Under the second option, any amounts above the amount paid for these shares initially to the company by the departing party would be deemed a dividend and be taxed as a dividend.

In rare instances the departing shareholder is offered a departing bonus on his final pay cheque in exchange for his shares.

From a tax perspective, this is the least desirable option for the departing party and the best option for the remaining party. The entire amount is taxable to the recipient as salary and the entire amount is deductible by the remaining business as an expense.  What’s really happening in this scenario is likely the shares are being purchased or redeemed for a nominal amount and the salary is “bumped” to make the business deal happen.  Unfortunately, from a tax perspective, this is sometimes the only option that can be agreed upon.

Regardless, professional advice from a Vancouver Chartered Accountant is a good idea when facing business divorce. Mew & Company Chartered Accountants have expert advise when it comes to Vancouver businesses and business consulting.

If you have any questions or would like to know more about how we can help you, contact us.