As a small business owner you are well aware that proper tax planning and corporate structuring are essential for increasing your wealth and protecting the assets you have built up over many years of hard work. After carefully planning your, financial, legal, and personal affairs and with so much at stake would you put your plans at risk by not taking the necessary steps to ensure success? Unlikely, but many do just that by not appropriately valuing their assets prior to implementing their plans. Cutting corners on your tax plan by not obtaining a valuation of your assets is like buying a new car and not topping up the engine oil. The plan may seem to work fine for a while but there is a significant risk that it may come to a rather abrupt and unpleasant end.
The term "fair market value" (FMV) is used well over 1,000 times in the Income Tax Act (the Act); a number which would indicate some importance. The Department of Finance has stated its interest in valuation because it is essential to the administration of the Act. FMV is defined by case law as:
"the highest price, expressed in terms of money or money's worth, obtainable in an open and unrestricted market, between knowledgeable, informed and prudent parties acting at arm's length, neither party being under any compulsion to transact."
Essentially the definition means that a transaction at FMV is representative of a transaction between unrelated parties. When two people who are not related and are working for their own interests enter into a transaction, that transaction is considered to be at fair market value. When transactions occur between persons who are related to each other, it becomes unclear as to whether the parties are working in their own self interest or if they are working in concert to achieve some other desired result. For example, parents may want to gift assets to their children. Except in specific circumstances, the Act requires gifts to be transferred at FMV or significant penalties and interest charges may result. Not having exposed the assets to a market place to see what price an unrelated party would pay, it is prudent to have the assets valued to reduce the risk of reassessment by the Canada Revenue Agency (CRA).
Many tax plans involve a number of related party share transactions that meet certain shareholder objectives but do not change the beneficial interest in the underlying property. For example, an owner/manager may want to "freeze" his/her interest in his/her business to ensure future growth accrues to other family members. The "freeze" transaction does not change the owner's beneficial interest in the underlying property on the date of the freeze but does direct future growth to other persons who will now own the common shares. Many of these transactions are considered "roll over" transactions in that they are elected or deemed to occur at the original cost of the asset and, therefore, no income tax is triggered at the transaction date.
So now you might ask: If there is no change in the beneficial interest in the underlying property and the transaction is going to be a tax-free rollover at cost, why do I need a valuation at all? The answer is that the Act requires these transactions to occur at FMV. Although, the transaction may be a tax-free rollover at your cost, the consideration you receive must equal the FMV of the assets you transfer. If this doesn't happen, then there is the risk that an unintended benefit will accrue to another person who is a party in the transaction. For example, let's say an owner freezes his value in a company with a tax-free rollover at $500,000 and allows his/her children to acquire ownership in the company at a nominal amount. If the CRA subsequently reassesses the value of the owners company at $1,000,000 then there is a $500,000 transfer of value to the children. Needless to say, this situation will give rise to some nasty tax consequences which may include double taxation of the $500,000 transferred value.
A tool that many professional advisors use to mitigate the risk of reassessment by the CRA is the purchase price adjustment clause (or PPA). A PPA is designed to adjust the value of a transaction should the CRA or other competent authority determine a different value. In the above situation it would allow the value of the transaction to be adjusted from $500,000 to $1,000,000 and side step any adverse tax consequences. The catch is that the CRA will only accept a PPA under certain conditions, one of which is "the parties.....arrive at the [FMV] for the purposes of the agreement by a fair and reasonable method."
In the case of Guilder News Co. (1963) Ltd. et al v. MNR, the taxpayers included purchase price adjustment clauses in their reorganization agreements to mitigate the risk of a valuation adjustment by the CRA (then Revenue Canada), the CRA reassessed the shareholders on the transactions on the basis that the FMV of the assets sold was greater than the price stipulated in the agreement. The shareholder was assessed a benefit for the excess FMV over the price stipulated in the agreement, an assessment which would have resulted in double taxation of the excess FMV. The CRA did not recognize the PPA because the parties had not reasonably, and in good faith, attempted to transact at FMV. The courts concluded that the PPA was a sham and that the shareholders never intended to transact at FMV and, therefore, the CRA was justified in not recognizing the PPA.
The shareholders in Guilder had made no reasonable attempt to determine the FMV of the shares transferred, but transacted using a price of convenience that met their reorganization objectives. Whether a valuation error is intentional or unintentional is irrelevant when you are audited by the CRA. Engaging a Chartered Business Valuator to provide an independent opinion of FMV establishes that the shareholders acted in good faith and arrived at FMV using a fair and reasonable method. An independent valuation protects the PPA clauses included in your tax planning, supports the tax plan you intended to implement and avoids the penalizing implications that may come with a reassessment of value. Supporting the values inherent in your tax planning transactions protects your assets and keeps the plan running smoothly even under the scrutiny of the CRA.
Dave Clarke is a Principal with Collins Barrow Ottawa LLP providing valuation expertise to clients of Collins Barrow affiliated offices and other professional firms. Dave can be contacted at dclarke@collinsbarrow.com or by phone at 613-768-7550.
Contenue associé
