Why do I Need a Valuation? Corporate Reorganization

(Originally Posted November 13, 2017)

So you’ve contacted your tax advisor looking for some tax planning advice. Perhaps you want to find a more tax effective way to run your business. Or maybe you’re planning for the future, trying to determine a tax effective way to sell your business or transfer it into the next generation in the family. Often, it will be recommended that your business be reorganized.

Here are some common reorganization methods:

• Transferring an unincorporated business (i.e. a sole proprietorship or a partnership) into a corporation;
• Amalgamating multiple businesses into one corporation;
• Reorganizing an existing corporate structure; or
• Winding-up an existing corporation.

Depending on the specific reorganization situation, your tax advisor may request that you obtain a business valuation. Why would you need a business valuation prepared when this seems like a purely tax-related matter?

Although it may seem purely tax-related, whenever a business is reorganized for tax purposes, any transferring of assets must be completed at fair market value to avoid adverse tax consequences. According to the Canada Revenue Agency (Information Circular IC89-3), you must make a “reasonable attempt” at determining fair market value when you undertake a business reorganization. Instead of using cost amounts (which are easy to determine and are often reported directly on the financial statements), the fair market value of individual assets or businesses as a whole must be determined.

This is where a Chartered Business Valuator enters the picture, to help determine the fair market value. Through the valuation process, a valuator can help determine the fair market value of an individual asset or group of assets, a business line or an entire business.

What is the consequence of not obtaining a business valuation for your corporate reorganization?

When you complete a business reorganization and the Canada Revenue Agency disagrees with the values you’ve chosen, there can be adverse tax consequences (such as unwanted income inclusions, penalties and interest). A price adjustment clause (right to change the transaction price) can act as an “insurance policy” against these adverse tax consequences by allowing you to revise the determined value if the Canada Revenue Agency disagrees with your original fair market value calculation.

However, one of the required conditions for gaining access to the price adjustment clause is that you have made a “reasonable attempt” to determine the fair market value of the assets of the business. If the Canada Revenue Agency 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’s considered best practice to obtain a valuation.

If you’re considering a reorganizing of your business or require a valuation, the team at Davis Martindale would love to work with you.