Countless times over the years, I have been told by some accountants and lawyers that they don’t bother with formal valuations when undertaking transactions such as estate freezes or corporate re-organizations. They either rely on a quick and dirty back of the napkin value estimate they do themselves or ask the client to estimate the value. Then they roll the dice – filing the documents and counting on a price adjustment clause should the CRA challenge their value at a future date.
I’ve always had an issue with this practice and a recent court case should give anyone pause in doing the same, both from a client’s best interest and professional liability perspective.
In the case of Laurance Lewin and Her Majesty the Queen, this approach yielded $278,158 in additional taxes payable and substantial legal fees for the estate as the judge dismissed the appeal with costs; meaning the estate had to pay its own legal fees as well as the CRA’s legal defense fees. The case took 10 years to wind itself through the re-assessment process, five years in court and may have also yielded a liability suit against a national accounting firm.
For those who aren’t familiar with Laurance Lewin, or this case, Mr. Lewin was the co-founder of La Senza (the lingerie retailer) and a judge on the Dragon’s Den for a few seasons. When he died in 2008, his longtime accountant of 20 plus years and managing partner at a national accounting firm, filed the terminal tax return based on a quick one page valuation of the holding company that he had performed himself, not taking into account the fair market value of the investments (the operating companies) held by the holding company.
CRA determined that “that the appellant made a misrepresentation attributable to neglect, carelessness or willful default in filing his tax return” and that “there is a substantial difference between the fair market value of Laurence Lewin Holdings Inc., as described by the executor and accountant, and the actual fair market value as assessed by the CRA” five years after the tax return was filed.
At issue in this appeal is part of the estate’s defense, hinging on the fact that the normal reassessment period had expired and the CRA did not have a right to reassess the terminal tax return five years after the fact. However, the above determination of neglect, carelessness or willful default allowed the CRA to invoke Subsection 152(4) of the income tax act which“allows the Minister, in certain circumstances, to make reassessment after the expiration of the normal reassessment period”.
The Honourable Justice Real Favreau determined “that the evidence is clear that the accountant made obvious errors in calculating the fair market value of the shares of the Holding company by not taking into account the fair market value of the two subsidiaries” and that “the calculation of the fair market value of the shares of the Holding company had not been carried with due care by an in-depth analysis of the supporting material” and ultimately, the case was“…dismissed with costs”.
For the same reasons as described above, CRA can also set aside any “price adjustment clause” should they conclude that a “bona fide” attempt at determining the fair market value of shares has not been made.
Business valuations can be costly but when taken into context of the potential tax consequences, CRA penalties and interest, and most importantly, the professional liability you may be exposing yourself to; a proper business valuation quickly becomes a very inexpensive insurance policy. By aligning yourself with a business valuator who will carry out a proper in-depth analysis that will stand up to scrutiny, you will be better serving your client’s best interests, while ensuring you are not liable “for neglect, carelessness or willful default” that allows CRA to reassess the filling indefinitely.
Ernest Bednarz is with the Malahat Group who specialize in business valuations, commercial real estate appraisals and equipment appraisals under one roof, ensuring assignments are completed faster while being very competitive.