Why do I Need a Valuation? Estate Planning

“In this world, nothing can be said to be certain except death and taxes”. This enduring phrase, written in a letter from Benjamin Franklin to Jean-Baptiste Leroy is arguably more relevant to our modern society than when it was first written in 1789 .

Unsurprisingly, a lot has changed in the past 230 years, including increasingly complicated legislation regarding estates, inheritance and taxation. The purpose of this blog is to shed some light on estate planning, and to provide business owners with an understanding of how they can best shelter their estate from unwanted taxes, interest and penalty inclusions.

The Canada Revenue Agency (“CRA”) imposes capital gains tax upon death. Section 70(5) of the Income Tax Act states that an individual is deemed to have immediately sold all capital assets at fair market value upon death. A well-planned estate, however, may provide a tax shelter for the business owner from these unwanted income inclusions. An estate freeze, incorporating the Lifetime Capital Gains Exemption, is one such strategy.

There are two main types of estate freezing strategies:

• Section 85 Rollover (aka Holding Company Freeze): A holding company is incorporated and the common shares are transferred to the holding company in exchange for debt or preference shares with an equivalent value.
• Section 86 Rollover (aka Internal Freeze): Principally the same as a section 85 rollover, but without a new holding company. The corporation undergoes a capital reorganization, and the existing shareholder exchanges their common shares for debt or preference shares with equivalent value.

Other parties (children or trusts) can then subscribe for new common shares, to which any future growth will accrue.

Setting the value of the company may be a critical component for an effective rollover. Getting an independent valuation from a Chartered Business Valuator (“CBV”) or other accounting professional is key to the success of the estate freeze because it may allow the shareholders to take advantage of a price adjustment clause, if the value is later scrutinized by the CRA.

A price adjustment clause can act as an “insurance policy” against adverse tax consequences by allowing you to revise the value if the CRA disagrees with your original fair market value calculation. One of the required conditions for gaining access to the price adjustment clause is that you have made a “fair and reasonable attempt” to determine the fair market value of the assets of the business.

It is worth noting that the CRA considers it insufficient to simply rely on generally accepted valuation methods. A valuation must be performed with a “complete examination of relevant facts”. If the CRA deems that you have not made a reasonable attempt, you do not gain access to the price adjustment clause. In order to avoid any potential adverse tax consequences, it may be considered best practice to obtain a formal valuation.

Value-Related Information for Estate Planning

CBV’s may provide business owners with additional value-related information to ensure their families are compensated fairly upon the business owner’s death. These may include:

• Establishing proper value for tax purposes;
• Helping set the price of the business when selling to a third party; and
• Assisting with the estate transfer voting shares to family members.

If you and your family are in a situation that requires consultation for estate planning, give the experts at Davis Martindale a call. We’d love to work with you.

Information Sources:

1-  Curiously enough, Benjamin Franklin was not the first to use the phrase “death and taxes”. According to literature scholars, the first written record of the phrase was by Christopher Bullock, an English actor, nearly 75 years earlier.