What are the tax consequences of buying out a business partner?

The federal Income Tax Act sets the tax rules for a partner buyout, and which section applies depends on whether the business is a partnership or a corporation and on who pays the departing partner. This page covers the federal rules only. It cannot tell you what a particular buyout will cost in tax, so ask an accountant to model your structure before you sign anything.

If the business is a partnership

Section 98(1) of the Income Tax Act applies where, but for that subsection, a partnership would be regarded as having ceased to exist. Under s.98(1)(a), until all the partnership property and any property substituted for it has been distributed to the persons entitled by law to receive it, the partnership is deemed not to have ceased to exist, and each person who was a partner is deemed not to have ceased to be a partner. If a buyout would end the partnership, ask your accountant how s.98 applies and which date counts for tax purposes.

If one partner carries on alone

Section 98(5) applies where a Canadian partnership has ceased to exist and, within 3 months after that time, one (and not more than one) of the former members carries on alone the business of the partnership and continues to use in it any former partnership property received as proceeds of disposition of that member’s partnership interest. Under s.98(5)(g), where all the other former members have disposed of their interests to that person, the person is deemed to have acquired partnership interests from them and not to have acquired any partnership property. CRA’s form T2060 is for former members of a Canadian partnership that has ceased to exist to elect jointly under s.98(3), and s.98(4) says s.98(3) does not apply where s.98(5) or s.85(3) applies.

If the business is a corporation

Section 84(3) applies where a corporation resident in Canada has redeemed, acquired or cancelled shares of its own capital stock (other than by a transaction described in s.84(2)). The corporation is deemed to have paid a dividend equal to the amount, if any, by which what it paid exceeds the paid-up capital of those shares, and each holder is deemed to receive a share of it. Section 84(8) sets an exception for certain shareholders of a public corporation, and s.84 contains further provisions, so confirm which apply. Because s.84(3) speaks of the corporation buying its own shares, ask early whether the company or the remaining owner personally will be the buyer.

Questions to settle before closing

• Is the business a partnership or a corporation, and does the agreement say who buys the departing interest?
• Will one remaining partner carry on alone, and when does the 3-month period in s.98(5) start?
• Who will file the elections, and by when?

For the sale mechanics rather than the tax, see how to buy out a business partner.