If you are in business, you must have heard the term fair market value (FMV) several times in tax planning, estate planning, and asset buying/selling. FMV is administratively important in implementing several income tax rules related to businesses and individuals. 

For instance, you want to transfer your personal computer to business, transfer your property to your child, or sell your business to your employees. Such transactions may involve family, and you may not want to make a profit from the sale or transfer. However, the Canada Revenue Agency (CRA) has a process to treat transactions to fair market value for income tax purposes. A failure to do so could have significant tax consequences, while rule compliance could be rewarded with tax benefits. 

This article will decode the relevance of fair market value for tax purposes.

What Is Fair Market Value (FMV)? 

As per the legal definition, fair market value is “the highest price, expressed in terms of money or money’s worth, obtainable in an open and unrestricted market, between knowledgeable, informed and prudent parties acting at arm’s length, neither party being under any compulsion to transact.”

The FMV applies only to capital assets like land, vehicles, manufacturing equipment, and office furniture. Inventory, accounts receivable, and stationery are not capital assets and don’t need to undergo the FMV process. 

The FMV only applies when there is transfer of ownership. Even if you are a sole proprietor using your personal computer for business, you might want to consider transferring the ownership to your proprietor self. It might sound absurd, but it has a tax benefit. 

Benefit of Fair Market Value in Transfer of Assets to Sole Proprietors 

While sole proprietors file income tax returns like individuals, the CRA allows them to deduct business expenses and capital cost allowance (CCA) or input tax credit (ITC) on business assets from their taxable income. Only the income left for personal consumption is taxed. 

Suppose you are using your personal computer full-time for your business. You can claim CCA and ITC by showing the PC as a business asset in the balance sheet at fair market value. Even though there is no physical transfer of assets, you have to follow the FMV rule to transfer the ownership from you to a sole proprietorship. A PC is a depreciating asset. 

Suppose you purchased the PC for $1,500 three years back. The FMV of the PC is $800 today. You can add PC to your balance sheet at $800 and deduct CCA on this $800 from that year onwards. Suppose you paid 13% GST on your PC at the time of the purchase. You can claim 13% ITC on the FMV of $800, provided you are registered with GST. 

While no actual money will change hands, the transaction can help you reduce tax. There are several ways to determine the FMV of an asset. A skilled accountant can help you choose the FMV of your assets. 

Fair Market Value In Estate Planning 

While the FMV rule can bring tax benefits, it could impose tax penalties if violated. Suppose you are doing estate planning wherein you freeze your shares and allow your children to buy the shares and accrue future capital gains. Here again, the children have to buy the shares at FMV. If you enable them to buy shares at a nominal value lower than the FMV and the CRA later scrutinizes the transaction, you could face hefty tax consequences. 

Whenever you transfer the estate, it should be done at FMV, where your inheritor bears the capital gain tax. 

Calculating the Fair Market Value During Sale of Business

Like assets, when you sell your business, you must first value it at FMV. A professional business valuator can help you value your business. The buyer will add all the business assets to his balance sheet at the FMV. He/she can add any excess amount under goodwill and deduct future CCAs from FMV.

As a seller, you can claim the lifetime capital gain tax exemption (LCGE) if you qualify for the benefit. A professional tax consultant can help you execute the transaction in a way that qualifies for maximum tax benefits. 

Contact McCay Duff LLP in Ottawa to Help You with Tax Planning 

Talk to a professional tax consultant to help you execute the capital transactions for maximum tax benefits. At McCay Duff LLP, our accountants and tax experts can provide services such as asset valuation, recording of transactions, and claiming benefits. To learn more about how McCay Duff LLP can provide you with the best accounting and tax planning expertise, contact us online, or by telephone at 613-236-2367, or toll-free at 1-800-267-6551.