Why does a business valuation matter to your accountant or tax advisor?
When you are buying or selling a business, the purchaser wants to know if they paid a fair price and the seller wants to know that they received a good price. “Value” is the price in a perfect market. Price can be different from value. However, markets are rarely perfect and the price can be higher if there is a limit on supply or lower if there is an oversupply at the exact moment the transaction occurs.
The primary situation where valuation matters to your accountant or tax advisor is in corporate reorganizations or other tax transactions that change ownership.
A tax transaction is an event that can trigger tax. Common events include change of corporate ownership or other tax deferred reorganizations (see FAQ #46). A tax deferred reorganization is when a person reorganizes his corporate structure to get a better business or tax result, but to also manage tax costs when doing it. Examples include when an established business brings in new owners (especially family members) and wants to have zero tax cost on that transaction; or when a business spins out a business division to a new stand-alone corporation. When these transactions occur, Canada Revenue Agency (CRA) is watching and will want to collect tax on the transaction. The business owner does not want to pay tax in most circumstances because he did not receive any cash with which to pay those taxes. Fortunately there are sections of the income tax act, like Section 85 rollovers (see FAQ #52), that can be used to reduce the tax to zero or defer the tax until a real cash sale occurs.
A valuation on these events is relevant because CRA might not be collecting any tax today; however, there may be future or related party tax consequences. The valuation is used in internal calculations to ensure that no benefit has been passed between family members or related corporations and escaped taxation or to establish a cost base for future events. The value must be at fair market value (FMV) otherwise there are avoidance and penalty provisions that apply.
The valuation is providing an independent third party assessment that CRA are more likely to accept rather than a self assessment. This then provides a more concrete base for the FMV of the transaction and quantifies both the current and future tax cost. If a non-FMV is used in a transaction, CRA are more likely to challenge the transaction and if successful will not only assess tax but also penalties and interest.
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