CRA faces difficulties in triggering price adjustment clauses for transactions in statute-barred years

Suppose that the redemption amount of preferred shares issued in Year 1 is subject to a price adjustment clause, and in auditing Year 16, when the taxpayer was deemed to dispose of those shares for their fair market value (e.g., under s. 70(5)), CRA concludes that the redemption amount was set too low.  The Rulings Directorate has stated that if the price adjustment clause complied with IT-169, it will treat the redemption value of the shares as having been increased to fair market value, thereby increasing the gain in Year 16.  On the other hand, if the clause did not so comply, the Directorate rather lamely states that "it could be argued" that the misvaluation in Year 1 constituted a misrepresentation that opened it up to reassessment (in this particular example, under s. 86(2)).

This situation illustrates a CRA dilemma.  One of the requirements in IT-169 is that the valuation method used in Year 1 was "fair and reasonable."   Accordingly, a CRA argument that the misvaluation of the shares was material may effectively be an argument that the fair market value of the shares disposed of in Year 16 cannot be increased - and CRA likely would find it difficult to discharge its onus (see D'Andrea, Cameron and Jencik) to establish that a valuation error made in Year 1 amounted to misrepresentation "attributable to neglect [or] carelessness."

Neal Armstrong.  Summary of 4 May 2012 T.I. 2011-0429991E5 under General Concepts - Effective Date.