Wednesday 29 June 2016

Divorce and the Division of Property - How to Equalize Assets

In Ontario, when a married couple divorces and assets need to be divided, there is generally an equalization payment that is made from a payor spouse to a payee spouse in order to equalize the increase in the spouses' net family property.

The increase in net family property is essentially the net property (assets less liabilities) each spouse owned at the date of separation, less the net property they owned at the date of marriage.

Example – if John and Mary each had $0 (or very close to $0) in property when they married and then at the date of separation John owned $1,500,000 in net property and Mary owned $500,000 in net property, then John would be required to make $500,000 equalization payment to Mary. After the $500,000 payment they would each have $1,000,000 in net property (equal).

It is important to note that if John owned a specific asset that Mary could not demand to be compensated with that asset on demand (example – if John owned an investment property in his name, Mary could not demand that John sign it over). What Mary would be entitled to receive is an equalization payment that equalizes the value of net family property as at the separation date.

Assuming there is no marriage contract (a.k.a the "prenup") in place that states otherwise, this equalization can be satisfied in a number of ways, if the spouses are willing to deal amicably, including:

This is the easiest way. It's simple and clean. John pays Mary $500,000 in cash and that settles it.

Transfer Real Estate.
This is a little trickier. If John had an income property appraised at $500,000 and wanted to transfer title to Mary then this is NOT the same as giving Mary $500,000 in cash. John may have bought the property years ago for a song at $100,000, so.... now there is capital gains tax and possibly tax on recapture that has not been realized yet, but would be realized when the property is sold by Mary. There is also a timing issue. For instance, Mary may theoretically choose to sell the property immediately and get an immediate tax bill, or she may decide to sell it one day in the future (so perhaps a discount to the looming tax bill is appropriate then?), or she may not sell it at all. A Chartered Business Valuator can help with the tax calculations and help Mary calculate the contingent taxes associated with the property.

Spousal Rollover of RRSPs
If John had $500,000 in RRSPs then he could elect to do a spousal rollover to Mary. However, this is NOT the same as Mary receiving $500,000 in cash. The RRSPs will be taxed once they are withdrawn by Mary. She needs to consult with a CBV who can help with the appropriate tax calculations and discounts related to the timing and possible discounting of the future tax liability.

The Determination of Net Family Property May Not be Clear Cut

Now... there are many, many issues that can come up with respect to the valuation of assets and the calculation of net family property, such as:
  •     what if John were a 40% owner of a successful privately held company? What would his shares be valued at? Would it be appropriate to apply a minority discount to his pro rata value of shares to reflect that as a minority shareholder he has less control than the controlling shareholder(s)?
  • What if John was an executive at a publicly traded company and had stock options?  What if they were not vested? What if they were vested?  What if they were not 'in the money' yet?  How would these be valued?
  • What if John had Share Appreciation Rights instead of stock options? How would these be valued?
  • What if John's company had a loan on it that Mary personally guaranteed - but she was not a shareholder? How should this be dealt with in the context of a net family property calculation?
  • What if John owned another operating company that had $200,000 in accrued non-capital losses ? How would this impact his net family property?
  • What if John's company had threatened litigation for $1 million from a past disgruntled customer who had slipped on some ice?  How could this impact his net family property value?
As you can see, there are a variety of complex issues that can arise that can be very costly if not handled correctly. A professional Chartered Business Valuator can help you navigate these complex matters.

Please contact us for business valuation and also for income determination for spousal & child support issues.

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