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Rising Valuations Demand Vigilance


​​​​​Savvy business and property owners understand that everything’s for sale — at the right price. That’s why valuations are such a powerful catalyst for action in Canada’s real estate and construction sector. An attractive offer can spark a flurry of activity, as companies rush to evaluate the offer and decide whether a sale makes financial or strategic sense. Understanding the tax implications of a potential sale can make all the difference between a great deal and one that just doesn’t deliver.

High Valuations Shouldn’t Guarantee a Sale

It’s easy for property owners and decision makers to become entranced by a shiny new valuation for one of their assets, especially if it’s one they acquired years ago for comparatively little. With current valuations often many multiples higher than the original purchase cost of these older assets, selling is the obvious decision — right?

Not so fast. To determine whether selling an asset is the right decision to make, companies need to be crystal-clear about what the net proceeds of the deal are likely to be. And that requires companies to have a solid understanding of the tax implications of the sale and what those mean to the business moving forward.

​This article is part of a series on key tax issues facing Canada’s real estate and construction companies.

​ ​ Read other articles in the series.​ ​​

Valuations and Tax Are Closely Linked

Any potential transaction has to take into account the tax implications of the deal, and reflect the impact of taxes on both the asset and the businesses involved. Real estate is a particularly long-lived asset; after years or even decades, companies find themselves paying tax on both the accreted value of the asset and simple price inflation. Addressing the inherent tax liability associated with a given asset is vital, and in many cases, it means that companies neither pay nor receive the actual fair market value for that asset. Negotiating the many ways in which valuations and tax intersect can be enormously complex, as the parties involved need to agree not only on the tax to be paid, but who pays it and how.

Beware Tax-Related Risks

It’s equally important that decision makers understand not only the potential tax implications of a deal, but the potential tax-related risks as well. Misconceptions around tax matters can quickly take the shine off a dazzling valuation and throw a company’s business plans and finances into disarray.

One of the more common assumptions many companies make is that the proceeds of a deal will be treated as a capital gain, and thus taxed at a lower rate. But in today’s business climate, where increasingly aggressive tax authorities worldwide work to maximize tax revenue and prevent tax leakage, there is a real risk that the Canada Revenue Agency (CRA) could take a very different view of the transaction. The CRA could even demand a deal receive a very different tax treatment from the one that led to the decision to sell.

Should that happen, the impact to a company can be huge. For example, a company might choose to sell based on their assumption that tax treatment “A” will apply and they’ll receive $950,000 in net proceeds. But on review, the CRA decides that the deal requires tax treatment “B,” a change that would reduce the net proceeds from the deal to $450,000. It’s a significant difference that could easily shift a company’s risk profile or leave a big gap in its balance sheet. Had decision makers known, they might have demanded a better price, or even declined the sale.

Making the effort to developing a full understanding of the implications and risks of a potential deal can help companies avoid such tax-related surprises. Yet it also helps companies ensure they’re able to fund the expected tax liability from the sale — and determine whether the net proceeds from the deal will have a positive impact on the business.

Avoid Surprises With Proper Planning

A promising valuation may be enough to set the wheels in motion for a potential sale in Canada’s real estate and construction sector, but it’s just the inciting action of a lengthy process. Decision makers need to ensure they devote time and effort to understanding the deal from every angle, especially tax. Proper planning and preparation can help you manage risks, avoid surprises and minimize the tax cost to your company. Here are some tips:

  • Start early. Companies can often minimize their tax burden or fund future tax obligations through the use of proper tax structures. It can take years to properly design and implement those structures, however. For optimum results, companies should start now.
  • Plan with the sale in mind. When it comes to asset acquisitions and sales, “plan for the exit”: when purchasing a property, ensure you and your advisors put the right tax structure in place to minimize the tax bill when it’s time to sell.
  • Have reasonable expectations. Paying zero tax on an asset sale is wishful thinking; paying the minimum tax, on the other hand, is an achievable goal. Having reasonable expectations will keep you and your advisors focused on feasible, well-founded solutions.
  • Capitalize on external advisors’ expertise. In today’s world of aggressive tax authorities, tackling complex tax issues on your own is a risky move. Specialized external advisors can provide the experience and expertise your company needs to implement forward-thinking tax planning that stands up to scrutiny.

Valuations Matter. Net Results Matter More.

It’s easy to be tempted by a great valuation, but net proceeds need to drive any decision to sell. Understanding the tax implications — and tax risks — of any potential sale is essential to determining whether the deal makes strategic and financial sense for your business. Proper tax planning and experienced tax advisors can help you avoid surprises and keep your business moving forward.

For more information, contact:

Eddy Burrello, CPA, CA
T: 647.943.4081
E: [email protected]

Glenn Willis, CPA, CA, CPA, CMA
T: 416.515.3850
E: [email protected]

This is the fifth in a series of MNP perspectives on key tax issues facing Canada’s real estate and construction companies. Other pieces have explored important tax considerations at play in business succession planning, tax cost minimization and doing business across borders. Click here to read the last article in the series.

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