The following is my summary of a presentation on price adjustment clauses (PACs) given by Nicholas Correia, CRA, to the CICBV Annual Conference, June, 2017. My comments and questions are in brackets.
PACs are typically found where parties transact not at arm’s length. One example would be a transfer among family members where section 69 would otherwise apply. Per IT Folio S4-F3-C1, the CRA will respect an adjustment under a PAC if there was a bona fide intention to transfer the property at FMV, the FMV was determined by a “fair and reasonable method”, the parties agree with the CRA value and the “value gap” is adjusted.
A “significant” value gap might indicate that the taxpayer did not intend to transact at FMV. “Significant” is decided on a case-by-case basis. [Do statements of intention in a transfer agreement help?]
What is a “fair and reasonable method”? Using a method or coming up with a value that determined to be inaccurate will not compromise the PAC, if the valuation was performed in good faith. The valuation need not be done by a valuation expert. Ultimately, what is fair and reasonable is determined on a case-by-case.
In considering whether the valuation report itself was “fair and reasonable”, one should consider (among other things, of course) the quantum of the value gap, the knowledge [credentials?] of the person preparing the valuation, the complexity of the valuation (was the business large and with complex valuation issues such that it was unreasonable to use an inexperienced or unqualified valuator?) and the participation of the taxpayer in the valuation process (“If there is some indication that a professional valuator has taken direction from the taxpayer to arrive at a conclusion of value that is inconsistent with facts, PAC may not be accepted”).
The parties need to agree to use the CRA value. [Folio S4-F3-C1, at 1.5(c), actually reads as follows: “The parties agree that if the FMV of the transferred property determined by the CRA or a Court of law differs from their valuation, they will use the value determined by the CRA or the Court.”]
How must the parties adjust the value gap? If shares were issued, then the redemption amount of the shares should be adjusted, a note issued or a change made to the principal amount of an already-issued note. [It’s not clear whether this is in descending order of preference from the CRA standpoint. Note that issuing or canceling shares for no consideration as a method of making an adjustment is conspicuous by its absence.] If shares weren’t issued, then the parties should change the principal amount of a note, issue additional non-share consideration or cancel any note issued or return all or part of the non-share consideration.