Unless you're an accountant, tax specialist or a business valuator, you should probably stop reading now ;)
The Income Tax Act of Canada requires value to be determined for many different reasons. The most common reason that value needs to be determined for income tax reasons is for a corporate reorganization (more on that later).
First, below is a laundry list of most instances when the Income Tax Act would require value to be determined. Some are well known, others less so:
Section 7 - Employee stock options
Section 15 - Debts of shareholders and certain persons connected with shareholders
Sections 38 to 55 - Capital gains & losses
Section 68 - Purchase price allocation
Section 69 - Non-arm’s length transactions
Section 70 - Deemed disposition at death
Section 80 - Forgiveness of debt
Section 85 - Rollovers
Section 86 - Reorganizations, share exchanges (estate freeze)
Section 88 - Winding up – 88(1)(d) “bump”
Section 116 - Clearance requests
Section 212.1 - Non-arm's length sale of shares by non-residents
Some thoughts on corporate reorganizations and price adjustment clauses:
- A price adjustment clause is typically used when there is a corporate reorganization. Essentially, the parties agree that if CRA or a court of law determines that the fair market value of the transferred property is greater or less than the price otherwise determined in the agreement, that price will be adjusted to take into account the excess or the shortfall. It is something of a 'safety net'.
- Problems arise, however, when the price adjustment clause is found to be invalid.
- As per CRA’s Folio S4-F3-C1 Price Adjustment Clauses, a price adjustment clause will be recognized by the CRA when the agreement between the parties reflects a bona fide intention of the parties to transfer the property at fair market value.
- Fair market value must be determined using a “fair and reasonable method”
- The valuators at CRA follow the practice standards as set out by the Canadian Institute of Chartered Business Valuators (refer to Information Circular 01-1)
- If CRA challenges and it is found that the value amount was not determined using a "fair and reasonable method", this may invalidate the price adjustment clause and may lead to significant costs, disputes and even professional liability.
- For corporate reorganizations, an independent business valuation prepared by a Chartered Business Valuator is the prudent course of action.
Please contact us if you require an independent, professional business valuation.
Steve Skrlac, MBA, CFA, CBV
Keystone Business Valuations