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May 25, 2020

Should You Do A Business Valuation for Tax Purposes?

Business owners are often recommended to have a tax plan done in order to maximize value in their corporate assets and minimize the amount of taxes they would have to pay. In connection with this recommendation, the business owners, alongside their accountants and lawyers, need to decide whether a formal business valuation for tax purposes should be prepared.

CRA & Tax Implications

Canada Revenue Agency (“CRA”) does not explicitly state that a formal business valuation for tax purposes needs to be prepared by a chartered business valuator (“CBV”). However, under CRA’s information circular 89-3, CRA does repeatedly state that the valuation prepared for tax purposes needs to have “reasonable judgment and objectivity in the selection and analysis of the relevant facts.”

In my personal experience, in order to help their clients save on the costs involved in having a formal business valuation done, I have often heard of practitioners relying on a “quick and dirty” valuation prepared by either themselves or by the client. While a benefit to the client in the short-term, this strategy may backfire in the long-term if the value conclusion is challenged by the CRA.

This issue may be further exacerbated upon consideration of tax implications relating to shares redeemed based on the original business valuation prepared by the practitioner and/or the client, CRA penalties, and interest.

Price Adjustment Clause

Practitioners and their business clients could fall back on the price adjustment clause if their value conclusions are ever challenged by the CRA. It should be noted, however, that the CRA can set aside this price adjustment clause if they find that there wasn’t a “bona fide” attempt at determining the fair market value of the company or the company’s shares in question, as prescribed under CRA’s Income Tax Folio S4-F3-C1.

CRA further notes that it is “not sufficient to rely upon a generally accepted valuation method” but “also necessary that the valuation method be properly applied having regard to all the circumstances.”

Lewin Estate v. The Queen, 2019 TCC 21

To bring this notion into context, a 2019 court case Lewin Estate v. The Queen, 2019 TCC 21, resulted in an increase of taxes payable from $292,243.55 to $570,401.40 in addition to legal fees, both on the taxpayer’s end as well as on CRA’s end. The practitioner who provided the original business valuation was a chartered accountant at a national accounting firm and also acted as one of the executors of the estate. 

CRA determined that in the valuation of the company shares, “the error made…constitutes a misrepresentation of the actual fair market value of the shares” and the “misrepresentation is attributable to…neglect, carelessness or wilful default when filing the appellant’s terminal return.”

In the Court’s Reasons for Judgment, the Honourable Justice Réal Favreau concluded that the practitioner “made obvious errors in calculating the fair market value of the shares” and “in jurisprudence…an error made when filing a tax return whether made in good faith, by inadvertence or by a simple calculation error is considered to be a misrepresentation.”

In the assessment of whether the practitioner was negligent, the Reasons for Judgment noted “the evidence supports the conclusion that there was neglect…in the performance of his duties” and “the calculation of the fair market value…has not been carried with due care by an in-depth analysis of the supporting material.”

As the above case indicates, a misrepresentation on fair market value can be costly to the client. In addition, the practitioner(s) may risk exposing themselves to a lawsuit and substantial professional liability, both in monetary terms and in terms of their professional reputation.

Because of this, it is usually in the practitioner’s and the client’s best interests to engage a CBV to conduct a formal business valuation for tax purposes and assist in the tax engagement so that the resulting valuation conclusion can withstand scrutiny from the CRA. 

We Are Here to Help

If you have any questions on how to value your business at this time, please contact William Tam, CPA, CA, CBV directly.

Stay tuned for information on an upcoming webcast on tax planning and valuations. To be notified of this webcast, please subscribe to our mailing list here.

This content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent change. Professional advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.