BUY-SELL AGREEMENT INSURANCE

Buy-sell agreements provide for the transfer of the ownership of the business in different circumstances death, disability, retirement or disagreement.

To illustrate how the cross-purchase method of the buy/sell agreement works.
1. Y and Z are equal shareholders in a Canadian-controlled private corporation.
2. The adjusted cost base (ACB) of each shareholder’s shares is $1000.
3. The shares in corporation have a fair market value of $5000000.
4. A buy/sell agreement is in place between Y and Z which is fully funded by personally-owned insurance i.e. Y owns an insurance policy on the life of Z for $2500000 and Z owns an insurance policy on the life of Y for $2500000.

Upon the death of Y, Z is obligated, under the terms of the buy/sell agreement, to purchase the shares from the deceased’s estate, at the price agreed to in the buy/sell. Likewise, Y’s estate is so obligated to sell the deceased’s shares to Z.

Tax Consequences to the Deceased Shareholder
Upon his/her death, Y has a deemed disposition of shares in the corporation equal to the fair market value of $2500000. This deemed disposition will generate a capital gain of $2499000, equal to the FMV of the shares minus their adjusted cost base. One-half of this capital gain will be reported as income in Y’s final tax return.

Tax Consequences to the Surviving Shareholder
Z will purchase Y’s shares at the price agreed to in the buy/sell agreement ($2500000) from the insurance payout that Z receives tax-free. The ACB of the acquired shares is averaged with the ACB of Z’s original shares to determine the capital gain or loss realized when Z eventually sells his shares.
 
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