A Second Opinion Catches a Gap Before a North Bay Buyout Closes

The situation

The file landed on our desk with a closing date already fixed and three weeks left to get there. The accountant handling the transaction had asked the previous lawyer, who was winding down his practice, to confirm that the safe income sitting behind Shira's corporation had been correctly split between two classes of shares before a partial buyout closed. That lawyer had started the analysis, made some notes, and then stopped answering calls. What we inherited was a half-finished spreadsheet, a stack of old financial statements, and a closing date that was not going to move.

Shira had incorporated her anesthesiology consulting practice more than a decade earlier through a professional corporation. Not long after, on the advice of an earlier accountant, the corporation issued a second class of shares to a family holding company, giving her spouse Stavros, a commercial landlord with his own property holdings, and their adult daughter Anastasia an indirect stake in the growth of the practice corporation. Shira kept her original common shares. The arrangement had sat quietly for years, generating retained earnings that nobody had closely tracked against which class of shares those earnings actually belonged to.

Anastasia, now in her late twenties, wanted to leave the family structure to start her own business and asked to be bought out of a portion of her interest in the holding company. The plan, as the previous lawyer and the accountant had sketched it, was for the practice corporation to pay a dividend up to the holding company, which would then fund a partial redemption of Anastasia's shares. On paper it looked routine. The question that had stalled the previous file was whether the dividend, when it moved between the two corporations, would be treated as a tax-free flow of already-taxed corporate income, or whether some of it would instead be recharacterized as a capital gain because it exceeded the income properly attributable to the shares being redeemed.

That distinction turns on a concept called safe income: the portion of a corporation's retained earnings that has already been taxed and can reasonably be said to contribute to the value of a particular class of shares. Dividends paid out of genuine safe income generally move between related corporations without further tax. Dividends that outrun the safe income attributable to the shares involved can be treated differently, with consequences that fall on the shareholders receiving them. Nobody, including the accountant, could say with confidence how much of the corporation's accumulated earnings belonged to Anastasia's class of shares specifically, as opposed to Shira's.

What the documents showed

We started by pulling every set of financial statements the corporation had filed since incorporation, along with the share issuance resolutions, the shareholder register, and whatever notes the previous lawyer had left. The picture that emerged was messier than the accountant had assumed. The second class of shares had not been issued for a fixed subscription price reflecting the corporation's value at the time; instead, the resolution used a formula tied to future earnings that nobody had ever updated. That meant the growth in value attributed to Anastasia's class of shares over the years did not track a clean, calculable share of the corporation's income the way everyone had been assuming when they built the buyout plan.

Digging further, we found that a significant portion of the corporation's retained earnings had actually accumulated before the second class of shares was ever issued. Income earned before a class of shares exists cannot fairly be treated as safe income attributable to that class, because the shares were not outstanding when the corporation earned it. That earlier income belonged, for safe income purposes, to the shares that existed at the time — Shira's original common shares — not to the class Anastasia held through the holding company.

We also reviewed the corporation's intervening dividend history and found two prior dividends, paid several years apart, that had been allocated evenly across both classes without any analysis of which class's safe income actually supported them. Those earlier dividends had gone unchallenged, most likely because they were modest enough not to attract attention. The proposed buyout dividend was not modest: in the range of $400,000 to $900,000 depending on the final valuation, a figure large enough that an incorrect allocation carried real exposure if it were ever reviewed.

Put together, the documents showed a structure that had drifted from the assumption everyone was relying on. The safe income actually attributable to Anastasia's shares was materially lower than the amount the proposed dividend and redemption assumed, largely because so much of the corporation's early growth predated her class of shares altogether. Proceeding on the original plan risked having part of the dividend recharacterized, with tax consequences landing on the holding company and, indirectly, on Anastasia and Stavros as its shareholders.

What we did

1. Reconstructed a full safe income calculation by share class and by year. We built a year-by-year schedule of the corporation's after-tax retained earnings, matched against the dates each class of shares was outstanding, so we could say with confidence how much safe income genuinely supported each class rather than relying on the rough even split the earlier plan assumed. Building the schedule from the original statements, rather than the previous lawyer's half-finished spreadsheet, meant every figure could be traced to a source document if anyone ever needed to check it.
2. Confirmed the effect of the two prior undocumented dividends. Because those earlier payments had already drawn down some of the corporation's accumulated safe income, we adjusted the current available balance downward to reflect what had actually been paid out, rather than treating the full historical retained earnings figure as still available. Missing this step would have meant the new dividend was calculated against a balance that no longer existed, exactly the kind of oversight that turns a properly planned transaction into an overreach the CRA can challenge later.
3. Recalculated the maximum dividend that could safely move to the holding company. Using the corrected figures, we set a revised ceiling on how much could be paid up to the holding company as a genuine safe income dividend before any excess risked being treated as something other than tax-paid corporate income moving between related companies. This ceiling became the single number the accountant and the family could build the transaction around with confidence, instead of guessing at a figure that might not hold up.
4. Restructured the buyout to fit inside that ceiling. Rather than redeeming the full portion of Anastasia's shares the original plan contemplated, we worked with the accountant to phase the buyout, redeeming a smaller tranche now, funded entirely within the confirmed safe income figure, with a second tranche planned for a later year once further earnings accumulated and were properly tracked.
5. Corrected the shareholder register and share terms going forward. We amended the corporation's records to clearly document which earnings related to which class from that point forward, closing the gap that had let the original ambiguity develop in the first place and giving the next advisor a clean record to work from. This was as much about the second tranche as the first: without a corrected register now, the same confusion over which earnings belonged to which class would simply resurface when the remaining shares are eventually redeemed.
6. Briefed Shira, Stavros and Anastasia together on the revised plan. Because the phased approach changed the amount and timing of the cash Anastasia would receive, we walked all three shareholders through the reasoning before closing, so the family understood why the buyout looked different from what the previous lawyer had originally described to them. Anastasia in particular needed to hear the reasoning directly, since the reduced first payment affected the timeline for her own new business, and a plain explanation went further than a revised number on a page.
7. Closed the first tranche on the revised terms. With the corrected safe income figures documented and agreed, the reduced first-tranche redemption closed on schedule, with the corporate resolutions and dividend documentation matching the actual, defensible safe income position rather than the earlier estimate. Closing on the fixed date mattered to Anastasia, who still needed the funds to move ahead with her own business, so the correction had to happen within the three-week window rather than delaying the transaction further.

The outcome

The buyout closed on time, but for a smaller amount than originally planned: roughly $310,000 in the first tranche rather than the full amount the earlier draft contemplated, with the remainder deferred to a second phase once additional safe income had accumulated and could be properly documented. Because the dividend paid to the holding company stayed within the corrected safe income figure, it moved between the two corporations as intended, without triggering the recharacterization risk that the original, unexamined structure had been carrying.

Nothing went wrong here in the sense of an audit, a reassessment, or a dispute with the tax authorities — and that was the point. The problem was caught in the documents before it reached a return or a notice of assessment. Anastasia received less cash up front than the family had originally discussed, which was a genuine trade-off, but the alternative was a dividend that risked being partly taxed as a capital gain in the hands of the holding company's shareholders, a result nobody wanted and one that would have been far more expensive to unwind after the fact.

The corrected shareholder records and the documented year-by-year safe income schedule now give the family, and whichever advisor handles the second tranche, a clear basis for the next redemption when it comes due. Shira's practice corporation continues to operate as before; the only lasting change is that its share structure now has the paper trail it should have had from the beginning.

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