Fair Market Value (FMV) for Canadian Tax Purposes

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

The Canada Revenue Agency generally defines Fair Market Value (FMV) as "the highest price, expressed in dollars, that property would bring in an open and unrestricted market, between a willing buyer and a willing seller who are both knowledgeable, informed, and prudent, and who are acting independently of each other." This definition emphasizes a few important elements:

• Highest price: It's the maximum price an asset could fetch, not just any price.

• Open and unrestricted market: The valuation assumes a free market with competing buyers and sellers.

• Willing buyer and seller: Neither party is forced, induced, or reluctant to make the transaction.

• Knowledgeable, informed, and prudent: Both parties are aware of all relevant facts and are acting in their own best interest.

• Acting independently (arm's length): The buyer and seller are not related or connected in a way that might influence the price (e.g., family members, related corporations).

While the concept of Fair Market Value seems straightforward, its application in practice presents several key issues and challenges.

A. Subjectivity and Lack of a Precise Definition

• The Income Tax Act in Canada, while relying heavily on FMV, does not provide a precise, statutory definition. The working definition is derived from jurisprudence, which, while helpful, can still lead to ambiguity. This subjectivity makes it difficult to apply consistently, especially for unique or complex assets.

B. Difficulty in Valuing Certain Assets

• Determining FMV can be especially challenging for assets that don't have a readily accessible market or a large number of comparable sales. This includes:

  • Private Businesses and Shares: The value of a business can be highly subjective, depending on factors like its intellectual property, brand reputation, customer base, and future earning potential. Different valuation methods (e.g., income, market, or asset-based) can produce vastly different results, leading to disputes with the Canada Revenue Agency (CRA).

  • Intangible Assets: Valuing patents, trademarks, copyrights, and other intellectual property is inherently difficult as there may be no direct market comparables.

  • Unique Property: Valuing specialized real estate, art, or other one-of-a-kind items often requires a professional appraisal, and even then, the valuation can be contested.

C. Non-Arm's Length Transactions

• The CRA is particularly vigilant about transactions between "non-arm's length" parties, such as family members or related corporations. In these cases, the CRA will often scrutinize the transaction to ensure it was conducted at FMV. If the value is understated, the CRA may "re-deem" the proceeds of disposition to the actual FMV, which can result in significant tax consequences, including retroactive tax adjustments and penalties. This is especially relevant in situations like:

  • Gifting Property: When an individual gifts a property, it is considered a "deemed disposition" at FMV for tax purposes, and capital gains may apply.

  • Corporate Reorganizations: When a sole proprietorship or partnership transfers assets to a corporation, the transaction must be at FMV unless a specific tax election is made.

D. Economic Fluctuations and Market Conditions

• FMV is a snapshot in time. Its determination must be based on market conditions at the time of the transaction. This can be a significant issue during periods of high market volatility, either with excessive optimism (booms) or pessimism (busts). In such periods, it can be difficult to determine a "normal" market value. A legal precedent has shown that courts may consider market conditions in a "normal" market, but this is not always a given.

E. Lack of Documentation

• Even if a valuation is calculated correctly, a lack of proper documentation can be a major issue during a tax audit. The CRA may challenge a valuation if the taxpayer cannot provide a detailed and defensible report outlining the methods used, comparable market data, and the assumptions made. Failure to do so can be interpreted as a lack of due diligence, leading to increased scrutiny and potential penalties.

F. "Fair Value" vs. "Fair Market Value"

• In some legal contexts, particularly in shareholder disputes, there can be confusion between "fair value" and "fair market value." The two concepts are distinct:

  • Fair Market Value often includes a "minority discount," reflecting a shareholder's lack of control in the company.

  • Fair Value, on the other hand, is a broader, more equitable concept that does not typically include a minority discount and is used to ensure a fair price for an oppressed minority shareholder.

For knowledgeable and experienced tax law representation for transactional tax matters and tax planning, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

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