How can insurance fund a buy-sell obligation?

A buy-sell agreement creates an obligation to pay for shares when an event occurs. Insurance can supply the money for some events. A policy on an owner’s life pays cash when that owner dies, and the agreement then directs the cash to the purchase. The policy covers only the events it names, so the policy and the agreement have to be written to match. The buy-sell clause answer explains the agreement side.

Who owns the policy

The owners can each hold a policy on the others, or the corporation can hold the policies. Ask your lawyer and accountant how each choice changes who receives the cash and which legal and tax rules apply. Name the beneficiary in the policy and the agreement, and state who pays premiums and what happens to a policy if an owner leaves.

Corporate limits if the company buys

If the corporation uses insurance proceeds to buy a deceased owner’s shares, CBCA s.34(2) still applies. The corporation shall not pay if there are reasonable grounds for believing it would be unable to pay its liabilities as they become due, or that the realizable value of its assets would after the payment fall below its liabilities and stated capital of all classes, subject to the exceptions in ss.35–36. Ask a lawyer whether the proceeds change that test in your case.

Tax points to ask about

The Income Tax Act’s definition of capital dividend account in s.89(1) adds proceeds of a life insurance policy received by a corporation in consequence of a person’s death, less the policy’s adjusted cost basis immediately before the death, subject to conditions. A share redemption is taxed under s.84(3) as a deemed dividend above paid-up capital, if any. Ask an accountant how those two rules interact on your structure.

The estate must be able to sell

The CRA says the legal representative administers the estate of a person who has died. The agreement should bind the estate to sell and give the representative a clear process to follow. Review the policy amount whenever the share value or the owners change.