Business valuation for the purposes of division on net family property
Generally, divorcing spouses in Ontario would look to divide their increase in net family property as at the date of separation. The law that governs this in Ontario is the Family Law Act. If the spouses had entered into a valid marriage contract (commonly referred to as a “pre nup” agreement) then the marriage contract may possibly take precedence.
A (very) simple example --
Assume a husband and wife decide to separate. Let's assume that their only asset is a bank account and their only liability is a debt. For simplicity, let's pretend that they have no other assets or liabilities. As you can see in the chart below, the husband's net family property did not grow while the wife's net family property grew by $10,000.
In this simple example, the wife would need to pay an equalization payment of $5,000 to the husband in order to equalize the increase in net family property between the two of them.
The above example is, obviously, a simple one. They key is that the principle holds true if the division of assets is to include cash, RRSPs, real estate, GICs and business interests. Tax factors must also be considered. For instance, rolling over RRSPs to a spouse is not the same as giving them cash since there are future tax implications for the spouse that receives RRSPs that must be factored into the equalization. The timing of taxes must also be considered (if taxes accrue immediately or if they are expected to accrue many years down the road is important to know).
Other assets, such as the matrimonial home are also generally added into the equalization 'pot' regardless of who is on title. Other assets, such as those received from an inheritance, may be excluded from the equalization.
One of the most complicated interests to value is a privately-held business. A business is usually not simply worth the value of its tangible assets. There is also goodwill and other intangible assets that must be considered. Determining the value of a privately held business requires the use of a professional – a Chartered Business Valuator (CBV). Many times a business is the largest asset that must be equalized between divorcing spouses and it is not unusual for both sides to hire their own CBV.
An important point is that in the division of net family property, the net value is divided - not specific assets. For instance, if a spouse owned shares in a privately held business that was valued for $1 million then the other spouse would not necessarily be entitled to 50% of the shares. He or she would only be entitled to the increase in value, which may possibly be settled in cash (or other assets).
Income assessment for child support and/or spousal support
Divorcing couples must also contend with support payments. In Ontario, there are two types of support that can be paid: child support and spousal support. If a spouse is an employee at a company and receives income that is recorded on a T4 slip then the income assessment is relatively straightforward. However, if the spouse is self-employed or is a business owner then they may need an income assessment to determine their true income to be used for support purposes. An income assessment is also done by a Chartered Business Valuator. The statute that governs the determination of income for child support is the Federal Child Support Guidelines (FCSG). The advisory guidelines for spousal support are known as the Spousal Support Advisory Guidelines (SSAG).
Determination of income for support purposes is more difficult for business owners
If you are a business owner who owns a company then there are many different ways to reduce your reported income for income tax purposes. The FCSG considers this and has a set of rules to normalize your income for support. For instance, if you own a company you could theoretically income split with another person. You might also put personal expenses through your business and receive a tax write-off benefit from doing this. You might possibly under-report your revenue or divert income to another legal entity that is not acting at arms-length. You might also decide to hold off on declaring a dividend for tax or other reasons. Sometimes, a forensic accounting review of the business is required to find any unreported revenues and expenses
Once the normalizations to corporate income are completed, then a decision must be made as to the amount of corporate income that should (or could) be attributed to the spouse for support purposes. The FCSG states that some, none or all of the company income can be attributed to a paying spouse for their income for support purposes. If there is a valid reason that corporate corporate income should not be attributed to you, but should remain in the company, then a court may possibly consider this. For instance, if you owned a company that earned $500,000 in pre-tax profit, but the company had banking covenants in place or legitimate capital investment needs or needed money to fuel growth, then there may be a case for not attributing the full corporate income.
We often get asked by clients on what they can do to reduce professional fees. The biggest driver of fee overruns is typically a lack of proper information disclosure. To simplify the process, and to reduce fees, we encourage you to get your financial information in order and ensure that there are no bottlenecks in the process to get the Chartered Business Valuator the information they need. Be honest and complete in your information disclosure too. We tell all of our clients not to hide any information and to provide full and complete disclosure.
In summary, the key is that if you are a divorcing business owner then you may very likely require an independent business valuation from a CBV to value your company. You may also require a CBV to produce an income assessment report, to determine your income for child support and/or spousal support.
Please contact Steve Skrlac, B.A.(Econ), MBA, CFA, CBV for a professional valuation if you are in the divorce process.
Our office is in Burlington and we serve clients in Toronto (GTA), Oakville, Burlington and Hamilton.
Divorce and Separation - Ontario Ministry of the Attorney General
Divorce FAQs - Ontario Ministry of the Attorney General
Protect Your Business in a Divorce - Inc.com
Peel-Halton Collaborative - An alternative to the contentious divorce process
Tax treatment of support payments - Canada Revenue Agency
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Chartered Business Valuators serving the GTA including Toronto, Mississauga, Oakville, Burlington, Hamilton & southern Ontario.
Advice to Divorcing Business Owners
Going through a divorce is one of the toughest experiences that a person can go through. There are important decisions that must be made regarding living arrangements, custody and planning for the next chapter of your life.
There are also many important financial decisions that must be made. The two key financial considerations pertain to:
If you are a divorcing business owner, or are self-employed, the professional that you will need to assist you is a Chartered Business Valuator (CBV). A CBV is the professional that will complete an independent business valuation of your business interests and also prepare an independent income assessment report that will be used to determine your child support and spousal support obligations.