How Is a Business Valued for Sale in Ontario? CRA Fair Market Value Methods

Setting a price for a business is part negotiation and part evidence. If the price is ever questioned for tax purposes, you will want to show how you got there, and the CRA has published its own approach to business equity valuations.

This article explains that approach in plain words: what fair market value means, the two main valuation methods, the factors the CRA looks at, and why the numbers matter once a deal closes. It is general information for Ontario owners and buyers, not a valuation.

What fair market value means to the CRA

For tax purposes, the CRA defines fair market value as the highest price obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length, with neither party under compulsion to transact.

In plain terms, it is not a bargain price, a rushed price or a price between family members that reflects something other than value. It is what well-informed strangers would agree on if neither had to deal.

The CRA sets this out in Information Circular IC89-3, a policy statement on business equity valuations.

The two main valuation methods

The CRA treats the earnings method and the asset value method as the two most generally accepted bases of valuation.

Which method fits depends on how the business actually makes money. A valuator will often look at more than one method and compare the results.

Liquidation value and going concern value

The fair market value of a business is generally the greater of its liquidation value and its going concern value.

• Liquidation value is used where the business is not viable as an ongoing operation.
• Going concern value is used where the business can earn a reasonable return on investment.

So a business that earns a good return is usually valued as a running operation, while one that cannot is valued on what its assets would bring if wound up.

Factors the CRA weighs, and what is not set by law

To justify a price, the CRA lists a range of factors:

• the nature and history of the business and the industry outlook
• the balance sheet, earnings record and earning power
• dividend capacity, goodwill and other intangibles
• prior share sales and the size of the block being sold
• comparable public company prices and underlying asset value
• control versus minority interests, and buy-sell agreements

Capitalization (multiple) rates reflect risks such as management depth, competition and ease of entry into the market. A business that depends on one key person, or that faces many competitors, is generally seen as riskier.

No official source sets industry multiples. Rules of thumb you hear in practice vary by industry and should be treated as starting points, not answers.

Why the number matters after closing

Where an amount can reasonably be regarded as partly paid for different property, services or a restrictive covenant, each part is treated separately. The part attributable to a property is that property's proceeds for the seller and its cost for the buyer.

If the agreement sets reasonable prices for individual assets, the CRA uses them. If not, the price goes to each asset at fair market value, then to inventory, and the remaining balance to goodwill.

This affects tax on both sides. For the seller, more price on depreciable equipment can create recaptured depreciation, which is included in income in full. Only one-half of a capital gain is taxable. For the buyer, the allocation changes future deductions, since goodwill goes into Class 14.1 and fixed assets go into their own classes.

What to do next

• Gather several years of financial statements, a current balance sheet and a list of major assets.
• Note any buy-sell agreement, prior share sales and who holds control.
• Ask a qualified business valuator to explain which method they used and why.
• Have a lawyer or accountant review how the price will be allocated before you sign.
• Keep your valuation work, since you may need to support the price later.

Valuation depends heavily on the facts of each business, so professional advice is worth getting before you set or accept a price.

Frequently asked questions