What is a price adjustment clause in a section 85 rollover?

Under subsection 85(1) of the Income Tax Act, a taxpayer who transfers eligible property to a taxable Canadian corporation for consideration that includes shares can jointly elect with the corporation on the CRA’s form T2057, and the amount they agree on in the election is generally deemed to be the proceeds and the corporation’s cost. Because that transfer depends on a value, the parties may want protection if the CRA sees the value differently. The CRA’s Income Tax Folio S4-F3-C1 describes the tool for that: a price adjustment clause. The folio says it is typically used in agreements between persons who do not deal at arm’s length.

What the clause actually says

The folio describes the clause as an agreement that if the CRA or a court determines the fair market value of the transferred property to be greater or less than the price otherwise set, the price will be adjusted for the excess or the shortfall. It may sit in the covering agreement or in the terms of the shares issued as payment. The CRA says it is neither an arbitrator nor a valuator for the parties.

When the CRA recognizes one

The folio says the CRA will recognize a clause in computing the income of all parties only if every listed condition is met. As worded in the folio, the conditions include these:

• The agreement reflects a bona fide intention of the parties to transfer the property at fair market value.
• The value used for the clause is determined by a fair and reasonable method.
• The parties agree that, if the CRA or a court finds a different value, they will use that value.
• The excess or shortfall is actually refunded or paid, or a legal liability for it is adjusted.

The folio adds that relying on a different valuation method than the CRA’s, or a good-faith value that proves somewhat inaccurate, does not by itself defeat the clause. Whether the method was fair and reasonable is decided on all the facts.

What a recognized clause can do

Where the conditions are met, the folio treats the property as transferred for consideration equal to its fair market value. It says an effective clause may prevent adverse consequences under several provisions, including paragraph 85(1)(e.2), the benefit rule explained on our page on the section 85 benefit rule. The folio also says related adjustments may be needed in the parties’ income, including in later years.

How the adjustment is carried out

For a transfer paid in shares, the folio says the adjustment can be made by changing the shares’ redemption value, issuing a note, or changing a note’s principal amount. It can also be made by issuing more shares or cancelling shares without payment, but the folio warns this carries legal and technical difficulties best avoided. Ask your lawyer and accountant how the clause should be written for your shares.