Lauria – Tax Court of Canada accepts that shares transferred 3 weeks prior to filing the IPO preliminary should be valued at a 40% “marketability” discount to the IPO value

On April 1, 2006, the taxpayers, who were executives of Gluskin Sheff+Associates Inc. (“GS+A”) (but with less clout than the founders), sold a portion of their shares to newly established family trusts at a price that was approximately 4.8% of that at which those shares were sold under an initial public offering that closed on May 26, 2006, following the filing of the preliminary prospectus on April 18, 2006. The pricing for the sale to the trusts applied a formula that had been used in agreements under which they (and other executives) had purchased their shares from the founders a few years previously, namely, 1.0 times the weighted average base management fee revenues of GS+A for the three preceding years. Such purchase agreements gave the right to the Board to require them at any time to sell their shares back to other executives at an amount determined under the same formula.

The taxpayers did not provide a valuation expert. Pizzitelli J accepted the opinion of the Crown’s expert, who estimated the maintainable earnings of GS+A (including performance fees) and capitalized those earnings to arrive at an en bloc enterprise value for GS+A (which, perhaps not coincidentally, largely coincided with the IPO valuation), and then applied a 40% “marketability” discount (to effectively the IPO price) to reflect “the risks that the IPO may not take place or the market for the shares does not materialize, or there would be a failure to agree on price, or the worsening of market conditions or a change of heart by the Founders.” Pizzitelli J considered this discount to be eminently fair to the taxpayers given his finding that, on the valuation date (April 1, 2006), the prospects for a successful IPO were high (and of the founders requiring the taxpayers to sell their shares back at the formula price, quite fanciful). Accordingly, the gains realized on the taxpayers’ sales to the trusts were substantially increased pursuant to s. 69(1)(b).

The taxpayers were reassessed well beyond the normal reassessment period. In finding that this was justified based on carelessness or neglect, Pizzitelli J stated:

[T]he Appellants did not seek an independent valuation and cannot be said to have thoughtfully, deliberately and carefully considered whether the proposed IPO would affect the share price. In fact, the Appellants just seemed to ignore it, when in my opinion, having regard to their skills in and knowledge of the securities industry from working as executives for a wealth management firm and the multiple other circumstances or red flags that went up … they were clearly aware of the impact of the IPO’s value on their holdings.

Neal Armstrong. Summaries of Lauria v. The Queen, 2021 TCC 66 under General Concepts – FMV – shares and s. 152(4)(a)(i).