FAMILY

Business Valuation and the Family Law Act

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TAX OR NO TAX

Most people are familiar with the property concepts of the Family Law Act, 1986.  Simply put, the act requires a valuation of net family property and an equalization of that property between the parties.

In the majority of situations, family property involves a home, investments, R.R.S.P.’s and other assets, the values for which are readily determinable.  Family property, however, may also include a business or shares of privately held corporations, the valuation of which can be considerably more difficult.

There are two generally accepted approaches used for the valuation of privately held businesses:

1. Liquidation value

2. Going concern value

The valuation approach will dictate the specific techniques used (i.e. asset-based; earnings/cash flow-based) and the results can be quite diverse.  For Family Law purposes, the objective is to determine, in a notional market contest, the “value to the owner” for settlement purposes.  This most often results in a going concern approach which assumes that the business will operate for an indefinite future.

One frequently disputed issue in family law business valuations involves the effect of future tax costs on the value of the business.  Should these Notional Tax Costs of Disposition (NTCD) be deducted from the value of the business and, if so, to what extent?

Within the valuation community, there are three general theories:

1. 100% Allowance for NTCD, which assumes that all family property should contain full tax allowances.

2. No Allowance for NTCD, which assumes that a disposition of the assets is not likely to occur in the foreseeable future (Note:  this is not consistent with the “value to owner” concept)

3. Partial allowance for NTCD, which provides for a discounted value of future tax costs.

The first two theories, being completely opposite, will provide undue benefits to one party of the other.  The spouse who retains the taxable property (i.e. business, R.R.S.P.’s) will benefit from a valuation utilizing a 100% allowance for NTCD.  The spouse retaining the non-taxable property (i.e. matrimonial home, cash) will benefit from a valuation utilizing no allowance for NTCD.

The partial allowance theory evolved to lessen the skewed effects of these all or nothing methods.  Realistically, there will be a tax cost on the future disposition of taxable assets and their values should be adjusted accordingly.  Since the timing of the disposition is not determinable, it follows that this adjustment should be reduced using a set of reasonable assumptions and present value calculations.  The partial allowance theory allows for such an adjustment thereby achieving a measure of fairness and equity in the settlement process.

In Ontario, the NTCD can be deducted directly from the fair market value of the business assets(s) or disclosed separately as a liability on the individual’s net worth statement.  The latter method is preferred since it maintains the integrity of the business valuation while illustrating the estimated effects of future tax costs.

The final valuation placed on a business can be materially affected by a valuator's assumptions regarding the treatment of future tax costs.  Parties in family law proceedings and their advisors should be aware of the differing theories and the affect they have on their settlement position.

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