Our high net worth Vancouver family lawyers routinely deal with family property and family company business valuations and how to take into account income tax consequences that are payable both on capital gains on assets owned by the company and on monies that may need to be withdrawn to pay compensation payment to the spouse who will not be retaining their interest in the company after marital breakdown.
In these situations the spouse seeking to be bought out of the company will most often argue that no speculative income tax distributed taxes should be deducted off of the valuation of the company’s last maximize the amount of money they receive as compensation for their share. Conversely, the party retaining the company will most often argue that because income taxes of between 32 and 43% could be payable on monies that at some point will be withdrawn from the company so they can be used for the personal benefit of the company owner a reduction for as close to this full amount of what is called “distributive taxes”.
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Cases involving the division of family companies and professional practices require a deft hand to prevent disaster that could make a viable company begin to tank because of inappropriate valuation and compensation techniques. Call us early on in the days of separation so we can help plan for a fair division of the assets and the taxes. Ask about our case where we obtained 75/25 reapportionment in favour of a husband of his industrial real estate development company.
The recent BC Supreme Court decision of L.F V B.F reviews all of these principles and in addition dealt with the issue of what the proper date to value a company asset is. The question often arises when there is a long time between the date of separation and the date of trial particularly where one party has continued to work hard to operate the company and the other party may no longer have been involved. On the other hand the non-company operating spouse may be performing very valuable services in terms of looking after children. The default rule is to normally value a family asset including a family company just like the family home at the date of trial not the date of separation.
We have condensed the excellent analysis of the learned trial judge into the key evaluation principles and case law for your review.
What is the proper valuation date?
[72] L.F. submits that the shares should be valued as of the date of trial. B.F. asserts that the appropriate date for valuation is the date of the triggering event, which in this case is May 14, 2009. His counsel pointed out that this date closely coincides with the date that L.F. ceased participating in the business. B.F. submits that since he was responsible for the operation, preservation, and continuation of the business after August 2009, fairness mandates that the valuation should be at the triggering date.
[73] The principles regarding valuation dates are conveniently summarized in N.M.M. v. N.S.M., 2004 BCSC 346 at para. 76. Generally, family assets are valued as of the date of trial. However, the court retains the discretion to fix another date if that is necessary in order to achieve fairness.
[74] In Berg v. Berg, 2012 BCCA 92, the Court of Appeal affirmed that the date of trial is the appropriate valuation date in cases where the court takes away the interest of one spouse in a family asset and orders the other spouse to pay compensation for it. In other words, the appropriate time for fixing a valuation date is when one spouse’s interest in a family asset is taken away and a compensation order is made.
Valuation of the Shares in the Company
[92] Mr. Ron Tidball, a qualified business valuator retained by B.F., testified at trial. His report dated March 26, 2011, sets out his opinion as to the fair market value of the issued and outstanding shares of the Company as of April 2009. B.F. relies on this report and Mr. Tidball’s viva voce evidence at trial regarding the 2010 valuation.
[96] According to Mr. Tidball, the proper approach to determining the fair market value of the issued and outstanding shares of the Company as of April 2009, was on a “going concern net asset” basis. In his opinion, it is unlikely that any purchaser would acquire the shares of the Company. Rather, any purchase would likely be on an asset basis with the proceeds of the sale payable to the Company. There would be no corporate income tax payable on the asset sale transaction…..
[97] In Mr. Tidball’s opinion, it is not appropriate to value the Company shares based on the capitalization of maintainable earnings or cash flow because the goodwill of the business, if any, is personal to B.F. and is therefore not commercially transferrable. …
[100] In summary, according to Mr. Tidball’s methodology, the valuation of shares in the Company before tax is $942,954 as of August 31, 2010. Based on this analysis, the value of L.F.’s 50% shareholdings is $471,477.
[101] According to Mr. Tidball, cash could be distributed from the Company by way of wages or dividends “at the discretion of the shareholders”. He opined that distributive personal income taxes of approximately 33% would arise on the removal of cash or assets from the Company by either of the shareholders. He also stated that the rate of personal distributive income taxes depends on the amount of other personal income tax payable by the recipient shareholder. In his April 19, 2011, report, Mr. Tidball stated as follows:
Assumptions regarding the timing and amount of the distributions and the other personal taxable income of the recipient shareholder are necessary to estimate the actual amount of distributive income taxes. Smaller annual distributions to a shareholder with no other taxable income would yield a significantly lower rate of distributive income taxes.
[102] The leading case on distributive taxes and valuation of assets is Halpin v. Halpin (1996), 27 B.C.L.R. (3d) 305 (C.A.). There is no absolute rule as to whether tax consequences should or should not be taken into account in the valuation of assets or in the determination of the appropriate compensation order: Oliver v. Oliver, 2011 BCSC 1126 at para. 52. In Halpin, Huddart J.A. cited with approval, at 323-324, the following statements by McKinlay J.A. in Sengmueller v. Sengmueller (1994), 17 O.R. (3d) 208 at 215 (C.A.):
If the evidence satisfies the trial judge, on a balance of probabilities, that the disposition of any item of family property will take place at a particular time in the future, then the tax consequences (and other properly proven costs of disposition) are not speculative, and should be allowed either as a reduction in value or as a deductible liability.
[103] It is critical to the analysis to appreciate that compensation does not necessarily equate to “fair market value”: Blackett at 105; and Weintz v. Weintz, 2012 BCSC 120 at para. 129. The assessment of appropriate compensation “is not an exact science and is not a matter of precise accounting”: N.M.M. at para. 93. The following observation of Huddart J.A. in Kowalewich v. Kowalewich (1998), 50 B.C.L.R. (3d) 12 at 16 (C.A.) is instructive:
… As Madam Justice Southin reminded us in Blackett, section 66 is not an expropriation provision. It is a mechanism to adjust matters between spouses who do not wish to continue in their joint ventures as joint owners.
[104] The authorities direct that the income tax consequences arising from the sale of an asset in order to realize the amount of compensation payable in respect of it are a relevant consideration and must be taken into account when determining the amount of the compensation order: Laxton at para. 52. On the other hand, the court should not take into account notional tax liability or speculative disposition costs in calculating an equalization payment where there is no evidence as to the likelihood or date of the other spouse incurring that loss: Dowling v. Dowling (1997), 43 B.C.L.R. (3d) 59 at 60-61 (C.A.); Rick v. Brandsema, 2009 SCC 10 at para. 55.
[107] B.F. testified, and I accept, that he intends to cause the Company and/or the New Company to sell some of its inventory in order to pay L.F. any compensation ordered by this Court. As Mr. Tidball indicated in his report, a sale of this nature would attract distributive personal income tax. In the circumstances, I conclude that the tax consequences of drawing the requisite funds out of the Company and/or the New Company are not entirely speculative and are a proper factor to take into account in determining the appropriate compensation order. There was no evidence or suggestion that B.F. intended to sell the business or otherwise liquidate its assets in the foreseeable future.
[108] B.F. did not provide any specific calculations with respect to the distributive income tax consequences of drawing the requisite funds from the Company. Recognizing that I do not have a precise calculation on this aspect of the case, it is appropriate, in my view, to discount the amount of the compensation payment by 30% to account for the distributive taxes and/or the cost of borrowing. This reduces the figure of $312,118 to $218,482. In determining a fair compensation payment I have also considered that B.F. will continue to generate income from the shares of the Company from which he will be obliged to pay support to L.F. The authorities caution “about not killing the goose who lays the golden eggs”: Hausmann v. Klukas, 2009 BCCA 32 at para. 32.
Cases involving the division of family companies and professional practices require a deft hand to prevent disaster that could make a viable company begin to tank because of inappropriate valuation and compensation techniques. Call us early on in the days of separation so we can help plan for a fair division of the assets and the taxes.
