Should below-market related-party rent be adjusted for in EBITDA?

When the owner’s holding company owns the premises and charges the operating business less than a stranger would, the profit on the books includes a benefit that may not continue. Treadstone Associates writes that trailing EBITDA calculated on a below-market related-party lease overstates the margin once the space is rented at what an arm’s-length landlord would charge. Whether and how to restate is a call for the buyer’s accountant.

Find the lease and the relationship

BDC says to review the leases and other building documents, and lists the impact of potential normalizations among the items to examine. Ask for the lease, any amendments and the rent history. Confirm who owns the premises, how they are related to the seller, whether the lease transfers or ends at closing, and whether the landlord will sign a new lease.

Do not count on the tax rules to fix it

Except as the Income Tax Act expressly provides otherwise, s.69(1) deems a taxpayer who acquires anything from a non-arm’s-length person for more than fair market value to have acquired it at that value, and deems proceeds of disposition at fair market value where something is disposed of to a non-arm’s-length person for less. Section 69(1.2) deals with below-market rent agreed by a non-arm’s-length person, but it works on the proceeds when the taxpayer disposes of the property. Neither provision sets the rent your business will pay; ask your accountant how they apply to your facts.

Settle the rent before closing

Treadstone Associates says that where the real estate stays with the vendor’s holding company, the fix is a market lease signed before closing. Treat that as something to negotiate, not a given. Ask what rent a comparable space would command, get support for it from a local professional, and have the lease terms, renewal rights and any rent review written into the deal. The EBITDA entry explains the measure.