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Director A buys out Director B

*Technical Question

Working on a Corporate income tax return & trying to figure out one transaction.

  • Two friends started a corporation - later realized the difference of business vision
  • Both are directors in articles (currently being amended). No other legal documents were created (e.g. certificate and consent to act as an officer, consent to act as a director, issuance of shares, subscription, etc.)
  • Director B decided he wanted to leave and asked for compensation
  • $8,000 paid to director B via corporate funds & director B signed:
    Two legal documents were produced and signed by Director B and a witness:

1. RELEASE
To: The Corp - Releasee
From: Director B Releasor

2. RECEIPT
To: The corp
RE: Amount payable to Director B

Generally, when a director / shareholder withdraws money from a corporation the entry is straight forward:

DT Shareholder Loan / Due from Director $8,000
CT Cash $8,000

(funds director A took out & used to pay director B off)

However, legal documents are between director B and the corporation - not - director A & director B

Can it be said that the transaction is between Director A and Director B because Director A is now the sole director?

Has any dealt with something similar or have any input?

Thanks kindly

@NiceGuy

Interesting situation. Need more information.

DIRECTORS FEES as personal income.
I am confused about how this would relate the roles as directors. Why would a director need compensation or buy out. This seems to hinge on who are the parties of this agreement and what is the nature of that agreement. However, if it is simply a directions fee then this could be either a regular director’s fee as a T4, a special payment in a T4A, or Other Income to that director.

Was this some type of finders fee or consultation fee for some asset acquisition, business opportunity proposal, or business structuring prior to the incorporation for which the directorship would have acted as compensation for that advice?

INDIVIDUAL INCOME OR OTHER PRIVATE CORPORATION INCOME
Was this an interest in the business due to an undocumented sharing of advice or other services during the initial setup. In that case this could be personal other income, subcontract income, or private corporate income if that director had a separate private corporation, or some other fees based income type.

COMMISSION OR OTHER INCOME
Did the corporation secure something such a right, interest, or sale agreement or representation agreement in which this individual participated and for which they want compensation.

SHAREHOLDERS OR SHARE BUY BACKS
Normally that happens in their roles as shareholders or investors with loans in kind (through change of use) or in cash. Even though share certificates seem not have been issued, if there were any business income then shares need to have been issued to carry on active income in the province of place of supply. Then this could be considered to be some type of buy back of shares such as a redemption or purchase.

https://lso.ca/lawyers/practice-supports-and-resources/practice-area/business-law/how-to-structure-the-share-provisions-of-a-corpora

As directors that would be directors fees payable as payroll.

As shareholders that could be proceeds of distribution of selling shares, or a number of other share transaction types.

etc

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I think you need to wait to see what the amended articles will contain. I assume A & B are both shareholders and not just directors. A re-purchase of B’s shares by the company could be a combination of a dividend and repayment of a shareholder loan (if there is one).

It could also be treated as A purchasing B’s shares and using the company funds to finance it, however, A would either have to pay tax on the funds at some point or make his/her shareholder loan balance a credit balance in some fashion (contribute funds or declare a dividend/wage to clear it up).

Normally those issues are settled on before the money changes hands since someone will likely have to pay tax on the funds.

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Unless this corporation was registered by a Lawyer who created a complete package with the Corporate Record Books and with all the required and recommended tabs, the chance of the client knowing that they need to obtain amended articles is slim to none. Buy sell and shareholder buyout agreements are the very very rare exception for the micro corporation.

You might recommend that the client obtain amended articles. You might research where to send them, at what level, and at what cost. You should also have an idea about why they should obtain this. To minimize tax risk and provide clarity to the corporation and individuals in question, etc.

Expect a push back on costs.

It is very common in Alberta and in Saskatchewan for someone to go to the Registry Office and buy the corporate certificate from an AB License and Registry Office. Those are the very same offices that sell Drivers Licenses, Vehicle Registration and License Plates, etc. Only the very best of these registry offices have stepped up to even begin to address classes of shares etc with a Level 2 Registrar. Almost never does the main holder of the books and records have a Binder to hold the contents of the Corporate Record Books. You lucky to find a crumpled or coffee stained copies of the Corporate Certificate and the Articles of Incorporation. Gone are the days of the heavy deep red and gold trimmed record books with the round heavy seal embosser (Mom was a tax accountant and many of my university friends went to Osgoode Hall Law School. So my first corp came with all the embossed trimmings). Also rare are the plastic flat corporate record book with the compact seal and tiny brass plate on the spine. You are totally lucky to get the Certificate of Incorporation and the Articles of Incorporation at registration. No Shareholders or Directors tabs. No share register. Etc. No annual minutes or resolutions. Eyes glaze over when you ask for a complete and update Corporate Record Book. Often I have to do a historical search from the date of incorporation to current for all changes and listed directors and shareholders.

In my experience, it is the very rare individual who hires a lawyer to customize the Articles, Classes of Shares, and adds buyout agreements, etc.

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@dominique_dabolczi, I was not suggesting that they amend the articles. The original poster mentioned that the articles are in the process of being amended so I suggested that he wait to see what those amendments may contain as it could affect his advice to the client and the tax/legal consequences of what the corporation and the directors/shareholders have already done.

In my experience, regardless of the size of a corporation, I always recommend buyouts be put in writing. What the client chooses to do is up to them but I document that I have advised them to have an agreement drawn up.

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Agreed. Always recommended.

I missed the fact that the articles were in the process of being amended. Serves me right for trying to respond when I am wanting to do a face splat from exhaustion.

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I feel your pain, @dominique.dabolczi. On a side note, I was in your city, Calgary, on the weekend to watch the Calgary Roughnecks play Buffalo Bandits. Nice city, but too bad it rained so I couldn’t do much sightseeing.

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Its tough to say anything with certainty. Initial read it looked like the corp was buying back the shares as in a redemption but their would need documentation to support such a transaction.

If the two signed the document you would need to try to figure out whether they were acting personally or a director of the corp. If it was a director they should have in the document which they did not.

The money could be redemption of shares, retiring allowance or Director A buying shares personally. Each possibility would be handled dramatically different. Of course to confuse things a bit more it could be a combination of the type of transaction.

You need to ask what was the intent? Does Director B still have shares or were they purchased? If not then who owns the Shares - Director A or did the Corp reduce the number outstanding.

Sounds like “good luck” is the best recommendation. They need to talk about the intent and then documentation must be done to support their intent.

Garth

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@dominique_dabolczi
To add:

  • Date of Incorporation Jan 2018
  • Director B wanted out Dec 2018
  • Director B wanted compensation because of his shares (not sure if shares were even issued to him) and design. According to Director A nothing but Articles of Incorporation was produced and more recently the signed release and receipt as mentioned above (both signed by director B and a witness).

@kevin

Yes, my first thought was the treatment of the transaction is director A withdrawing funds (dt to the sh loan account which will have to be cleared via contributing funds or declare a dividend).

@garth

Will look into this - Director B says he has shares in an email sent to Director A saying that is what he wants to be compensated for, however, Director A has mentioned other than the preparation of the Articles of Incorporation no other legal documents were produced.

@garth

Both the release and the receipt were signed by Director B and a witness - not by Director A.
I will inquire on the intent.

@NiceGuy
How can a corporation exist without shareholders? It would have to be a non-profit organization or something. Directors of a corporation are “chosen” or “appointed” by the shareholders - if there were never any shareholders, there could not be any directors.

I think, more likely, the two “directors” are de facto shareholders. They should have purchased shares with their own cash - this is something CRA or the tax court would look at. If one purchased shares, and the other did not, then the “non-shareholder” may not be entitled to anything other than payment for services. However, if they are both shareholders, then I would ditto what @kevin and @garth said.

Hope that helps!

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@Nezzer - thank you kindly for this response! Very informative - any other thoughts, as well?

@Nezzer @niceguys

In Alberta when you first register your corporation, the incorporation package does not include a registration of listed shareholders by class and type of share. Sometimes there are draft shareholder lists which are pending approval.

The annual corporate renewal fee in Alberta is called the ANNUAL RETURN. The name and form varies by Province. This Annual Return holds the shareholder names and % ownership. If these are not filed with the relevant Provincial Authority, then there is no formal registration of the shareholders.

Shelf or inactive corporations many not have issued shares in their first year of operation. A declaration must be made at the time or the filing of the Annual Return or equivalent.

Active corporations have shareholders even if only De Facto but not declared, documented, or registered with the Provincial authority.

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I agree with you, @dominique_dabolczi. Same in SK. But, just because it isn’t on record with the (provincial or federal) corporate registry, doesn’t mean the shareholders don’t exist.

If I was you @NiceGuy, I would encourage your client(s) to update their corporate registry information, as it is the first place that CRA/tax court/accountants/lawyers/etc look for that information. If your client(s) have to prove their ownership/entitlement by another method, it may be more difficult/costly/etc.

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@Nezzer
@NiceGuy

Agreed. I had shortened a much more detailed outline of shareholders and deleted that portion in error.

If there is a Provincial Corporate Registry then there is at least one deemed shareholder.

Shareholders are required to exist to file the T2, Schedule 50.

Shareholder list, classes of shares, treasury, share certificate list, share valuation, issues of shares, and changes to shares should be part of the Corporate Records and housed in the paper or virtual Corporate Record Book.

This information must match the Provincial Annual Return in % ownership.

For that reason it is best to have shareholder agreements, classes of shares, and share buybacks etc to be defined up front.

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@Nezzer
@dominique.dabolczi
Very good follow up points! Thanks for your input!

Taxpayers should have the following:

  • Resolutions which say how many shares issued & will have share certificate
  • Shares issued to a person/entity for them to be a shareholder
  • A legal document saying the corp issued the shares
  • A document that says the legal stated capital of those shares

I do understand in Ontario (can’t speak for other provinces I don’t reside in) that many think they can just incorporate and do little to nothing beyond that point as it pertains to legal documents.

Honestly, I am about to tell the taxpayer to go to their lawyer and have your corporate minute book updated and inform me of how the transaction actually took place. I want to present it in a way that helps them understand that although it is costly for legal services it is very important.

Further points:
Date of Incorp: Jan 2018
Date second friend says he wants out and wants to be compensated: Dec 2018
Province: Ontario
Year 1 profit: around $3k

Thank you all for your input!