In the spectrum of business valuations, traditional thought has held that valuations prepared for tax purposes are the lowest risk valuations. The tax practitioner need only ensure that the file is adequately ‘papered’ and that a price adjustment clause is included in the transfer agreement. However, in our practice we have seen an increasing number of disputes with CRA regarding the fair market value of a business subject to a tax re-organization.

According to IT-169, a price adjustment clause will only be recognized by the Canada Revenue Agency (the ‘CRA’) if there existed a bone fide intention to transfer property at fair market value and that the parties determined that value by a ‘fair and reasonable method’. While the rules surrounding the applicability of a price adjustment clause are not new, recent evidence suggests that the CRA’s view as to what constitutes ‘a fair and reasonable method’ may be changing.  The CRA has not defined what it means by ‘a fair and reasonable method’ however, according to the CRA’s internal Business Equity Valuations Operations Manual, issued in 2010, the CRA recommends that ‘CRA valuators do not prepare a Calculation Valuation Report’ and that a Comprehensive or Estimate Valuation report should be prepared. As the CRA’s own internal policy manual suggests that a Calculation Valuation Report is not sufficient for a reassessment, it is likely that the ‘back-of-the-napkin one-page’ valuation that has supported some tax re-organizations in the past would not be considered to be a fair and reasonable method by the CRA.

The CRA’s internal policy manual on business valuations includes a section on the application of Third-Party Civil Penalties to preparers for making false statements. According to the CRA’s manual, a special rule applies under subsection 163.2(10) of the ITA regarding ‘a statement made by a person who expresses an opinion on the value of a property’. Under this rule a stated value is deemed to be a false statement if the stated value is outside a certain range of values as determined by the CRA. The manual notes that the regulations prescribing percentages to define this range of values have not yet been issued, but that CRA valuators may be asked to consider the appropriateness of the application of a third-party civil penalty in cases of significant valuation differentials.

In order to avoid the time-consuming and costly process of a reassessment by the CRA, we recommend that all clients have a Calculation Valuation Report prepared to support any corporate re-organization, and that an Estimate or Comprehensive Valuation Report should be considered when the value of the property to be transferred is significant.