Introduction

Three equal co-owners of a corporation — each holding one third — have built something valuable together. When one wants to exit, the remaining two face a question: do they buy out the departing shareholder, find a third-party buyer for the shares, or restructure the entire ownership? Each path has different tax and financial consequences.

Scenario: Vertex Engineering Corp Loses One of Its Three Founders

Vertex Engineering Corp is a structural engineering consultancy owned equally by three engineers — Adaeze, Stefan, and Lena. Each holds approximately 33.3% of the shares, with ACBs of approximately $15,000 each (low original cost). The corporation is valued at approximately $2.1 million. Lena, 52, wants to retire and exit.

Lena's shares are worth approximately $700,000. Her capital gain is approximately $685,000 (proceeds of $700,000 minus $15,000 ACB). If the shares qualify as QSBC shares, Lena can apply her LCGE — sheltering the entire $685,000 gain tax-free.

Option 1: Adaeze and Stefan Buy Lena's Shares Personally

Each of the two remaining shareholders pays $350,000 for half of Lena's shares. Their ACBs increase by $350,000 each. The corporation is unchanged — the same assets, the same operations, just two shareholders instead of three.

From Lena's perspective: capital gain of $685,000, potentially sheltered by LCGE. Clean, straightforward.

From Adaeze and Stefan's perspective: each needs $350,000 in personal funds to complete the purchase. If they do not have that liquidity personally, they must borrow or draw from the corporation to fund it — which creates its own tax consequences (salary or dividends to fund the personal purchase).

Option 2: The Corporation Redeems Lena's Shares

Rather than Adaeze and Stefan buying Lena's shares, the corporation itself redeems them — paying Lena $700,000 from corporate cash.

The tax treatment of a share redemption is different from a sale. A redemption proceeds are treated as a deemed dividend to the extent they exceed the PUC of the shares — not as a capital gain. For Lena, whose shares have a PUC of approximately $5,000 (one third of the original $15,000 total capital), the deemed dividend on redemption is approximately $695,000 — taxed at the non-eligible dividend rate (approximately 47.74% at the top Ontario marginal rate), not as a capital gain. The LCGE does not apply to deemed dividends.

This is a significantly worse outcome for Lena than a share sale — the redemption produces a taxable deemed dividend instead of a capital gain eligible for the LCGE.

The section 84.1 risk: Where a related party (Adaeze and Stefan) is involved and the corporation redeems the shares, the CRA's surplus stripping rules may apply if the structure is seen as an attempt to convert dividends into capital gains. The specific transactions need to be reviewed carefully.

Option 3: A Third-Party Buyer Acquires Lena's Shares

If Adaeze and Stefan do not want to buy Lena out personally and the corporation cannot redeem the shares efficiently, a third-party buyer for Lena's one-third interest is another option. The buyer receives Lena's shares and becomes a co-owner alongside the other two.

This may not be desirable for Adaeze and Stefan — they may not want an unknown third party as a co-owner. If the shareholders agreement contains a right of first refusal (ROFR), Adaeze and Stefan have the right to match any third-party offer before Lena can sell externally.

The Shareholders Agreement: Again, Central

The shareholders agreement should have specified the buyout mechanism for this exact scenario — a departing shareholder, a valuation methodology, a ROFR, and a funding mechanism. Without it, the three paths above require negotiation from scratch.

When to Speak With a CPA

Lena's exit requires tax advice from two directions: a CPA advising Lena on QSBC qualification, LCGE availability, and the optimal sale structure, and a CPA advising Adaeze and Stefan on the cost of the buyout and the corporation's post-exit position. These are not the same advice — they may be in conflict at certain points.

Rotaru CPA works with shareholders on both sides of private corporation exit transactions. Book a consultation to discuss a shareholder exit.