In this blog, I’m going to tackle a pretty tax-heavy topic: price adjustment clauses. You see these clauses in documents whenever a dentist is attempting to transfer property into a corporation in exchange for shares on a tax-deferred basis. This could happen, for example, when the dentist is trying to do an estate freeze or trying to rollover their personal dental practice assets to take back shares (in preparation for a sale, for example).
Now, you’ll often see so-called “price adjustment” clauses in the paperwork. These clauses basically say that, if for whatever reason the Canada Revenue Agency deems the value of the property transferred in and out of the corporation to be less than fair market value, the shareholder will have received a benefit equal to the difference between the fair market value of what they received and what they transferred into the corporation. If the Canada Revenue Agency determines that the value of the property transferred in (and therefore the value of the shares received by the shareholder in exchange for transferring in that property) should be less than what the agreements say, then the taxpayer is deemed to have acquired those shares at their fair market value. While the shareholder’s COST of the shares will be limited to the fair market value, the shareholder will be punished because they will be DEEMED to have sold the property for proceeds that remain UNCHANGED (i.e. higher than fair market value) and therefore may need to pay higher capital gains tax! Ouch! Punishment… Remember: this is the case when the shareholder is not dealing at arm’s length with their corporation, which is typically the case with an owner/operator dentist of a dentistry professional corporation.
So… in the transfer documents (i.e. the documents dealing with the transfer of property in exchange of shares, for example), the parties’ lawyer(s) will include a so-called “price adjustment clause”. This clause is designed to avoid any adverse tax consequences. It says that the parties intended the transfer to occur at the fair market value AND that if the CRA subsequently redetermined (or the parties redetermine by agreement) that the fair market value is different, THEN the revised fair market value is to be adopted for all purposes of the transaction nunc pro tunc.
Now, the CRA will generally accept a price adjustment clause if the following conditions are met:
- The agreement must reflect a bona fide intention of the parties to transfer the property at fair market value, which must have been reached by a fair and reasonable method. This is based on the Court case of Guilder News Co. (1963) Ltd. v. Minister of National Revenue, [1973] CTC 1, 73 DTC 5048 (Fed. CA).
- Each party notifies the CRA, by letter attached to its tax return for the year, that that party is prepared to have the price reviewed by CRA in accordance with the price adjustment clause, will take the necessary steps to settle any resulting excess or shortfall and will provide a copy of the agreement to the CRA on demand. Note: the CRA has relaxed this requirement in certain situations through filling out various forms.
- Any excess or shortfall in price is actually refunded or paid, or a legal liability, therefore, is adjusted. Note: the CRA has indicated that the price adjustment clause should adjust the VALUE of the property received, not the QUANTITY of the property transferred.
For more information about price adjustment clauses, speak with a dental accountant and a dental lawyer.
