Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Determination of fair market value under s. 111(4)(c) of the Act.
Position: A direct valuation of corporation's capital properties should be obtained, as per recommendation of Business Equity Valuations (Technical Applications and Valuations Division).
Reasons: Methodology used by taxpayer may be deficient and could understate fair market value of assets at time of change of control.
XXXXXXXXXX 2003-005073
J. MacGillivray
December 19, 2003
Dear XXXXXXXXXX:
Re: Determination of Fair Market Value Under Paragraph 111(4)(c)
We are writing in response to your inquiry of November 26, 2003 regarding the application of paragraph 111(4)(c) of the Income Tax Act (Canada) (the "Act") to the following set of facts:
1. Aco, a corporation that is not a resident of Canada for the purposes of the Act has become insolvent.
2. Bco is a corporation that is a resident of Canada for the purposes of the Act and was a wholly-owned subsidiary of Aco prior to the transactions described below.
3. Bco holds 60% of the issued and outstanding shares of Cco ("Cco Shares"), another corporation that is a resident of Canada for the purposes of the Act. The balance of the issued and outstanding Cco Shares are held by Mr. A.
4. The liquidators of Aco sold the shares of Bco (the "Bco Shares") to Dco, a corporation controlled by Mr. A., for proceeds of disposition of $800,000. At the time of the sale, Bco had two assets, 60% of the issued and outstanding Cco Shares and a $300,000 debt owed to it by Cco (the "Cco Debt"). In addition, Bco owed Aco $2,999,900 (the "Bco Debt"). As part of the sale of the Bco Shares to Dco, Dco also purchased the Bco Debt for cash consideration of $200,000.
5. As a consequence of the acquisition of Bco Shares by Dco, there was a change of control of Cco. Cco holds various assets that are used in the conduct of its business activities, including non-depreciable and depreciable capital property, inventory and accounts receivable.
Cco has taken the position that the $800,000 purchase price for the Bco Shares should be allocated among Cco's various properties for the purposes of determining the fair market value of Cco's capital properties in connection with the application of s. 111(4)(c) of the Act. You agree that the $800,000 purchase price for the Bco shares should be allocated to Bco's assets in determining their fair market value, but you question whether that purchase price represents the aggregate fair market value of Cco's assets. Furthermore, you question whether the $800,000 purchase price for the Bco Shares is a suitable basis upon which to ascertain the fair market value of Cco's assets, given that the purchase price was agreed to in the context of a liquidation of Aco. In this regard, it is unclear whether the price agreed to by a liquidator would conform to the common formulation of the concept of "fair market value", being "an amount obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length, neither party being under any compulsion to act".
Typically, it is not the practise of the Income Tax Rulings Directorate to comment on the income tax consequences of completed transactions nor do we give our opinions on matters regarding the determination of fair market value. However, we have consulted with the Technical Applications and Valuations Division of the Canada Customs and Revenue Agency's Compliance Programs Branch, which deals with questions and issues surrounding the determination of fair market value, and are prepared to offer the following general comments that may be of assistance.
The term "fair market value" is not defined in the Act. In our view, the term "fair market value" means "the highest price, expressed in terms of money's worth, obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length, neither party under any compulsion to transact." Under s. 111(4)(c) of the Act, it is necessary to determine a fair market value for each non-depreciable capital property held by Cco at the time that is immediately before the change of control of Cco.
Assuming that Aco and Dco were dealing at arm's length, it is our view that the $800,000 purchase price for the Bco Shares may not necessarily reflect the fair market value of Cco's capital properties. In our view, the $800,000 purchase price for the Bco Shares was obtained in circumstances where Aco's liquidator may have been under some compulsion to transact, with the result that the price obtained for the Bco Shares could be less than their fair market value at the time of the sale. Secondly, Bco held only 60% of the Cco Shares at the time of the change of control, so the $800,000 purchase price would have to be grossed-up in any event to reflect the fair market value of 100% of the Cco Shares. We are unsure whether such a gross-up would be appropriate given that the 40% block of Cco Shares held by Mr. A might bear a minority discount (i.e., the 40% block may have a fair market value that is less than two-thirds of the fair market value of the 60% block of Cco Shares held by Bco, which allows Bco to control Cco) depending on the circumstances. In addition, the gross-up would not take into account the fair market value of Cco's assets that is reflected in the Cco Debt or any other debts of Cco.
Finally, we take issue with Cco's contention that its total value at the time of the change of control was no greater than $800,000. In this regard, one must take into account the fact that Dco purchased the Bco Debt for $200,000 in conjunction with the purchase of the Bco Shares. If Dco was willing to purchase the Bco Debt for $200,000, then it would appear that the underlying fair market value of Bco's assets (i.e., the Cco Debt and the Cco Shares) was at least $1,000,000. Accordingly, determining the fair market value of Cco's assets with reference to the value of $800,000 would likely be mistaken because it does not take into account that the fair market value of Cco's assets could be reflected in the fair market value of the Bco Debt, the Cco Debt and Cco's other liabilities.
Therefore, to determine the extent, if any, by which the adjusted cost base of Cco's capital properties must be adjusted in accordance with s. 111(4)(c) of the Act, we recommend that you obtain a direct valuation of Cco's assets as of the time of the change of control. The valuation should include appraisals of Cco's non-depreciable and depreciable capital property, inventory, as well as a determination of the fair market values of other assets and liabilities (including goodwill) of Cco at the time of the change of control. However, our recommendation should in no way be construed as an outright rejection of the valuation methodology used by Cco in all situations involving a change of control of a corporation. In some circumstances, the aggregate fair market value of a corporation's assets may very well be reflected in the price paid for the shares of the corporation or for the shares of the corporation's parent. In such circumstances, an allocation of the share price among the corporation's assets could be acceptable in determining whether any adjustments are required to the adjusted cost base of capital properties pursuant to s. 111(4)(c) of the Act.
We hope the foregoing comments are of assistance. Should you wish to discuss the matter further, please do not hesitate to contact Jackson MacGillivray at (613) 948-5274.
Yours truly,
Manager
Corporate Reorganizations Section I
for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
cc: Elizabeth A. Shultis
Business Equity Valuations
Technical Applications and Valuations Division
Compliance Programs Branch
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