This article was written by Chris Riccio, CPA and EEE at DMCL Chartered Professional Accountants, in the Quarterly Overview of Canadian News, a newsletter published by
Canadian members
of
Moore North America
. This article on business valuation experts is part of our mission to become your partner in success by keeping you informed.
If you’re a business owner, you’re probably no stranger to tax-planning strategies that aim to exploit incentives while minimizing your tax burden.
Since many of these strategies require you to determine the fair market value (FMV) of your business, one of the most frequently asked questions to EEEs (business valuation experts) is: ” Is it really necessary to have an official appraisal of the value of my business? “However, the answer to this question is more nuanced than at first glance, as it involves complex tax laws and practical business considerations. Read on to find out more about the benefits and implications of a formal business valuation, so you can decide whether it’s right for you.
Valuation considerations for tax planning
Although the Canada Revenue Agency (CRA) does not explicitly state that a formal business valuation prepared by a business valuation expert (BVA) is required for tax purposes, it is generally recommended that business owners hire an expert to avoid any potential penalties and interest down the road. In Information Circular 89-3, the CRA specifies that a tax assessor must “use common sense, discernment and objectivity in selecting and analyzing the relevant facts “.
Even if you think you can meet these criteria, the CRA assumes that an appraisal prepared by the owner or his or her financial advisors is necessarily biased. It will therefore view with increasing skepticism any assessment that has not been drawn up by an independent EEE.
Price adjustment clause
Many professionals and business owners believe they are protected by the price adjustment clause in the event of a CRA challenge to their valuation. However, as the CRA points out in the income tax folio S4-F3-C1the price adjustment clause will only apply if there was a “bona fide intention” to determine the FMV and the FMV was established”. on a fair and reasonable basis “. The CRA also points out that ” it is not sufficient to choose a generally accepted valuation method “. The method must also be ” applied appropriately, taking into account all the circumstances “.
Consequently, if the CRA finds that a general approach has been adopted without considering all the relevant facts and circumstances, it may consider the attempt to determine FMV to be unfair and unreasonable. This can result in substantial interest and penalty charges, as well as additional taxes.
Succession planning
Bill C-208
Succession planning has been a hot topic for many years, especially since the introduction of Bill C-208 by the CRA in 2021. Prior to Bill C-208, when a business was sold or transferred to a family member, section 84.1 of the Income Tax Act treated the transfer as a dividend and did not allow for the realization of capital gains or the claiming of the lifetime capital gains exemption (LCGE).
Bill C-208 has radically changed the way these transactions are handled. Now, if an individual transfers his or her shares in a qualified small business to a corporation controlled by one or more of his or her children or grandchildren, the transfer is taxed in the same way as an arm’s-length sale. This means that the ECGC can be used to reduce the tax paid on potential capital gains on transfer. However, the CRA explicitly states that :
” The individual transferring these shares must provide the CRA with a valuation report that constitutes an independent appraisal of the fair market value of the shares transferred.
In addition,
“In order for the CRA to accept an appraisal as an independent appraisal of fair market value, the appraisal must be performed by a person who meets the following requirements:
- It has no connection with the company or the seller and has no financial interest in the transactions; and
- It has sufficient knowledge and experience in the field of valuation and in the sector of activity concerned”.
EEE – The obvious choice
CRA goes further, stating that ” A report that meets the standards of the Institute of Chartered Business Val uators will meet CRA’s expectations “. So, although it’s not an explicit requirement, it’s a good idea to entrust the preparation of a report in line with standards of practice to the expertise of an EEE.
Using a business valuation expert, or BVA, as part of your tax planning may seem like an unnecessary effort, but don’t underestimate the long-term value that a professional, independent valuation can bring. Just as any investment involves spending money to make (more) money, a business valuation is often worth its weight in gold because it will save you money in the long run.
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