Family ties: The family shareholders’ agreement

June 23, 2020 | Raymond G. Adlington

Family (however you may personally define that term) is our common societal unit globally.  The family business has long been a fundamental cog of the Canadian economy. Investing in both the family and the family business by entering a shareholders’ agreement (and updating it as the family and business evolve) helps maintain family harmony and increases the chances of a successful transition of the business to the next generation. While unique, but surmountable, tax challenges apply to the family shareholders’ agreement and there are some tax opportunities to consider as well.

Family Business

Canadian family businesses are prolific, with each one uniquely individualistic. According to the research conducted by the Family Enterprise Xchange Foundation and the Conference Board of Canada, approximately 63% of all businesses in Canada were family-owned in 2017.  These businesses were responsible for about 49% of Canada’s annual private sector economic output and the employment of 6,900,000 Canadians in that year. This makes family-owned businesses a crucial contributor to the Canadian economy. Family-owned businesses dominate in key economic sectors of agriculture (80% of employment), transportation (85%), accommodation and food services (71%), and construction (68%).

The entrepreneurial family’s identity and psyche almost universally include the family business; after all, many of them include either the founders’ surname or a name of significance to the founder. Most frequently, a single familial generation founds a family business: an individual with an idea, a couple able to combine a personal and professional relationship, or siblings able to extend the bonds of a common upbringing into a fruitful business partnership.

Leadership within a family business might extend for 20 to 30 years, in contrast to the average leadership tenure in publicly-owned companies of less than six years. This extended tenure provides significant stability with a long-term focus, but comes with challenges. Studies show that 70% of family businesses leave the family before a transfer of ownership to the second generation. The emotional decision-making that arises from the unique interdependence between owner(s) and business makes adaptation to shifts in the business environment more challenging. Entrepreneurs must balance the dynamics of the business with the emotional nature of family relationships, particularly as the founders age and begin contemplating their children’s assumption of active roles in the family business. Relationship complexity also increases with kinship distance, as ownership dilutes generationally from one individual, to siblings, to cousins and beyond.

Family Shareholders’ Agreement

A family shareholders’ agreement maximizes the probability of maintaining both family harmony and prosperity through the triumphs and trials of running a business. The nature of the familial relationship often results in a ready consensus on terms, and thus a relatively inexpensive investment in the family and the business. Reaching an agreement early and revising it periodically as circumstances change minimizes family discord by guiding ownership, decision-making, conflict resolution, and importantly, the distribution of money within the family.

A unanimous shareholders’ agreement (USA) is a specific type of shareholders’ agreement recognized in most Canadian corporate legislation, with particular utility in the family context. The real benefit of a USA is that the corporate legislation deems a transferee of shares to be a party to the agreement. In the family context, this effectively means that by signing a USA, the founder (let’s call them Mom or Dad) can set the rules of their children’s ultimate engagement with the family business, whether they receive shares directly from their parent(s), from a discretionary family trust or an inheritance. To qualify as a USA, the shareholders’ agreement must restrict, wholly or partly, the directors’ powers to manage the corporation’s business and affairs. Directors and shareholders share power in a corporation: directors manage the corporation’s day-to-day business and affairs; shareholders elect directors and must approve certain fundamental decisions. There are two key ways to achieve USA status:

  1. Under most Canadian corporate legislation, a USA is a written agreement among all of the corporation’s shareholders that restricts, in whole or in part, the directors’ powers to manage the corporation’s business and affairs.
  2. A declaration by a person who beneficially owns all of the corporation’s issued shares that restricts, in whole or in part, the directors’ powers to manage the corporation’s business and affairs is also a USA, allowing the individual entrepreneur founder of a family business to personally implement a USA (presumably after an easy negotiation).

The restriction of the directors’ powers can be as minimal as requiring shareholder consent to dividends or the purchase of assets in excess of a specified amount, or as extensive as a complete shift of responsibility for the management to the shareholders. This comes with the caution that any shift in responsibility from directors to shareholders carries the attendant shift in personal liability for those decisions. A family considering a shareholder agreement can ask themselves these 20 preliminary questions to start to explore the terms to be included in the family shareholders’ agreement. Don’t be surprised when the answers to these questions lead to further questions to deepen that exploration.

  • Who serves as directors of the corporation (recognizing the personal liability exposure)?
  • How will the directors’ powers be limited?
  • What is the current leadership structure?
  • Which family members are now or likely to be actively involved in the business?
  • How is compensation set for family members employed in the business?
  • How are bonuses determined and disseminated?
  • What debt covenants or other contractual restrictions bind the business?
  • Are residual profits reinvested, used for other investments or declared as dividends?
  • How will retirement be financed?
  • What short- and long-term disability protection is available from the business?
  • What financial disclosure about the business do family members receive?
  • Are family members subject to restrictions, such as confidentiality or non-competition covenants?
  • Would the business survive if divided?
  • Can a family member pledge shares to secure a personal loan?
  • Can a family shareholder sell shares?
  • If yes, then to whom, at what price, and upon what payment terms?
  • Are there any events that would result in a mandatory share transfer within the family?
  • How is the business to be valued for the purposes of inter-familial transactions?
  • How is intergenerational capital gains tax minimized and financed?
  • How are disputes resolved at the business and family levels?

Tax Challenges

Authors of private corporation shareholder agreements among unrelated shareholders already deal with numerous tax issues in their drafting.  Unique – but surmountable – tax challenges apply to the family shareholders’ agreement that call for variation from the terms normally included in a shareholders’ agreement among unrelated shareholders.

The authors of the Income Tax Act[1] have waged a long battle against transactions within family units, creating dozens of rules that only apply to transactions between related parties. The magic phrase in tax law is “arm’s length” (the definition of which has nothing to do with the actual length of anyone’s arm). Parents and their children are not at arm’s length, but aunts and nephews are at arm’s length. The test can be complex to apply: Cinderella and her stepmother are not at arm’s length, but Cinderella and her stepsisters are; and what about Cinderella’s mice friends Suzy, Perla, Jaq and Gus? That depends on whether they’ve been cohabitating in a conjugal relationship for 12 months (or less if they have a child together).

To be effective, the family shareholders’ agreement terms must work with the Income Tax Act provisions respecting transactions between family members not at arm’s length. Dozens of rules may be found in the Income Tax Act to alter the tax result of a transaction between related parties that do not apply to transactions between unrelated parties. The most important of these is the fair market value requirement. A non-arm’s length buyer that overpays for shares is deemed to have only paid fair market value; the seller, however, must report their capital gain based on the actual sale price. This cost reduction to the buyer results in eventual double tax in the family to the extent of the difference between the actual selling price and the fair market value because the buyer must also pay tax on that difference when they dispose of the shares.

Similarly, a non-arm’s length seller that undercharges for shares is deemed to have actually received fair market value, and must pay capital gains tax based on the fair market value – an amount they didn’t actually receive. This, too, leads to eventual double tax because the buyer doesn’t receive a corresponding increase in their tax cost. The transfer of property for less than fair market value might also make the related buyer vicariously liable for any of the seller’s past tax liability.

Because of the frequency of transactions, the Canada Revenue Agency’s information circular on business equity valuations devotes an entire section to valuation in the context of family and group control.  Keeping these principles in mind is important when determining value for the purposes of transactions contemplated in the family shareholders’ agreement.

The leveraged buy out model most frequently employed in traditional shareholders’ agreements requires modification to fit the context of family shareholders’ agreements. Shareholders’ agreements between unrelated parties often contemplate holding company leveraged buy outs within the shareholder group. The plan allows the operating corporation to deduct the interest expense from operating profits and the corporation, rather than the individual shareholder, can repay the loan principal, avoiding tax on a dividend otherwise needed for the individual to repay the principal. The Income Tax Act transforms the proceeds received in a non-arm’s length leveraged buy out from a capital gain into a taxable dividend, robbing the seller of both the benefit of the lower effective capital gains tax rate (the tax rate for dividends exceeds the effective rate for capital gains in every Canadian province and territory by up to 20%) and the benefit of the lifetime capital gains exemption (in 2020, slightly over $880,000 or $1M for farming or fishing property).

One option to contemplate as part of the family shareholders’ agreement discussion is a division of the family business (and other assets that might be held through one or more family-controlled corporations) before an intergenerational transfer. If the divided business could survive then a division may allow siblings to maintain a positive relationship by not working together in a single business. Splitting up a corporation is relatively easy where a related group controls it; however, for this single purpose, siblings are deemed unrelated to each other. Therefore, carefully consider potential corporate divisions in the drafting of the family shareholders’ agreement and create a contractual environment where it may occur more readily should family harmony demand the division.

Key Tax Benefits

Parliament has made some concessions in its battle against transactions within family units, of which a carefully drafted family shareholders’ agreement can exploit.

Where shares of the family business would qualify for the capital gains exemption, and where the transaction is between parent and child, the selling family shareholder can spread the capital gain over the exemption amount across ten years instead of the normal five. Where shares are destined to be transferred from a parent to their inactive children, the family shareholders’ agreement can instead cause active children to buy out those shares followed by a gift of sale proceeds from the parent to the inactive child, reducing cash flow strain on the family business by facilitating a longer-horizon buy out.

Transactions between spouses or common-law partners are generally tax-deferred in nature, with the transferor deemed to sell, and the transferee deemed to have bought, at cost. Tax-deferred intergenerational transfers are available for family farm and fishing property, along with family farm or fishing corporations and partnerships. For family farm or fishing corporations (with the terms ‘farming’ and ‘fishing’ receiving liberal interpretations by the courts), structuring the family shareholders’ agreement to take advantage of this tax-deferred intergenerational transfer both reduces current life insurance needs and multiplies potential access to the lifetime capital gains exemption.

Including provision in the family shareholders’ agreement allowing a post-mortem transfer of shares to a surviving spouse or common-law partner before their purchase by other family members may multiply family access to the lifetime capital gains exemption.


The family shareholders’ agreement will be as unique as the family business and the family it is crafted to protect. The tax planning mechanics will be an important element to ensuring proper implementation of the family objectives. As a final note, professional fees incurred in the preparation of the family shareholders’ agreement may be a deductible expense.  A former Tax Court Chief Justice wrote in a 2006 decision:

I believe the costs incurred for the Shareholder Agreements were for the purpose of a bona fide business reorganization which facilitated effective management, good governance and protection … against any disruption due to the disability of key employee/shareholders. These expenses were an integral part of … business and were made for the purposes of gaining or producing income.

[1] R.S.C., 1985, c. 1 (5th Supp.)


This publication is provided as an information service and may include items reported from other sources. We do not warrant its accuracy. This information is not meant as legal opinion or advice.

Miller Thomson LLP uses your contact information to send you information electronically on legal topics, seminars, and firm events that may be of interest to you. If you have any questions about our information practices or obligations under Canada’s anti-spam laws, please contact us at

© Miller Thomson LLP. This publication may be reproduced and distributed in its entirety provided no alterations are made to the form or content. Any other form of reproduction or distribution requires the prior written consent of Miller Thomson LLP which may be requested by contacting