Can I use business cash to pay for a partner buyout?

Whether business cash can fund a partner buyout depends on who is paying the departing partner. If the company buys the shares itself, corporate law sets a solvency test. If the remaining owner buys them personally, the company’s cash would have to reach that owner first, for example as a dividend or a loan. This answer covers corporations; a business run as a partnership is a separate question for its agreement and a lawyer. For the wider funding options, see financing a partner buyout.

When the company buys the shares itself

Under the Canada Business Corporations Act, a corporation may, subject to its articles, purchase shares it issued, but it must not pay if there are reasonable grounds for believing it is, or after the payment would be, unable to pay its liabilities as they become due, or that the realizable value of its assets would fall below its liabilities and stated capital. Sections 35 and 36 set different tests for some acquisitions, such as settling a debt or redeeming redeemable shares. Ontario’s Business Corporations Act sets the same two tests in section 30, with its own exceptions in sections 31 and 32. A company formed under another province’s statute should check that statute’s own provisions.

When the cash goes to the remaining owner

A dividend has its own solvency test, in section 42 of the federal Act and section 38 of Ontario’s. A benefit a corporation confers on a shareholder, or a loan it makes to one, can also be included in that shareholder’s income under sections 15(1) and 15(2) of the Income Tax Act, subject to the exceptions in those sections. The route chosen, and the paperwork behind it, therefore matters as much as the amount.

Tax on the departing partner’s side

When a corporation resident in Canada buys back its own shares, section 84(3) of the Income Tax Act, subject to its exceptions, deems it to have paid a dividend equal to the amount paid above the paid-up capital of those shares, and deems the holders of the bought shares to have received it. The departing partner’s tax result therefore depends on who buys the shares, which is a question for their accountant.

If the tests are ignored

Directors who vote for or consent to a resolution authorizing a share purchase or a dividend contrary to those sections are jointly and severally liable to restore to the corporation the amounts paid and not otherwise recovered by it, under section 118(2) of the federal Act and section 130(2) of Ontario’s, subject to the defences in those Acts. Where the directors are also the people negotiating the buyout, the solvency question is one to put to an accountant and a lawyer before any resolution is passed.