This article is taken from our quarterly overview of Canadian news, a newsletter published by the Canadian member firms of
Moore Stephens North America
. It is part of our mission to be the partner of choice for your success, by keeping you informed of the latest news and developments..
Valuation for income tax purposes. What is the Canada Revenue Agency’s (“CRA”) position on this issue?
Tax planning and corporate restructuring are now an integral part of the services offered by professional advisors to their clients. Determining fair market value (FMV) is a crucial planning step, as it is the first step in analyzing the tax implications of a transaction.
Due to the increased complexity of many tax plans, “cutting corners” by not obtaining the advice of an independent appraiser can have unfortunate consequences such as tax penalties or failure to achieve the desired after-tax results.
In practice, you can call on an expert in business valuation (“EEE”) to help you in the following situations:
freezing of assets when the FMV of several classes of shares may have to be established ;
- business reorganization when the assets and liabilities of a business are transferred from one entity to another ;
- death of a shareholder when the FMV of the assets is required to complete the last tax return;
- emigration, when in certain cases a taxpayer is deemed to dispose of his worldwide assets at their FMV ;
- justification of a previously declared FMV during a CRA audit.
So what is CRA’s position on valuation?
Information Circular 89-3 Statement of Principles on the Valuation of Personal Property (“IC 89-3”) sets out the general valuation principles and policies that the CRA considers when valuing the securities and intangibles of closely held corporations.
IC 89-3 does not expressly require the use of an EEE. However, the “home-made” approach is not recommended, since CI 89-3 requires :
- to use the JVM as the standard value;
- take into account all the relevant factors of the company being evaluated;
- justify the valuation method used;
- disclose the factors used to establish the valuation multiples used ;
- discernment and objectivity.
In addition to IC 89-3, Income Tax Folio S4-F3-C1 sets out the CRA’s policy on price adjustment clauses, which states that :
- FMV must be determined using a fair and reasonable method;
- the FMV does not necessarily have to be established by a valuation expert, but choosing a generally accepted valuation method is not enough;
- a complete examination of all relevant facts must be carried out, and the method must be applied appropriately.
Finally, the Income Tax Act imposes gross negligence penalties on third parties (preparers) who make or participate in misrepresentations or valuation omissions where the FMV declared and the FMV assigned by the CRA differ substantially. Depending on the circumstances, these penalties can be considerable.
In light of the above, good practice dictates that you use an EEE to establish the valuation, or at least to review the valuation made by a non-professional, in order to avoid any potential problems, such as the CRA questioning your FMV.
An EEE will ensure that generally accepted valuation methods are properly applied, and will use his or her experience and professional judgment, two essential qualities in any situation where doubt may be raised as to the value of a private company.
If in doubt, consult an EEE for advice.
With the participation of
Michael Frost
and
Andrew Dey
from
Mowbrey Gil
. This article was written as part of the Quarterly Canadian Snapshot, a newsletter published by the Canadian member firms of
Moore Stephens North America
.
