Canada: Price Adjustment Clauses In Contractual Agreements

This article highlights the importance of price adjustment clauses in contractual agreements from a tax perspective.

A price adjustment clause is often used in transactions if property is transferred between non-arm's length taxpayers and the intention of the parties is for the transaction to occur at fair market value (FMV). If the transaction is later determined by the Canada Revenue Agency (CRA) to be at something other than at FMV, disastrous tax consequences can result. For example, under the Income Tax Act (Canada), if a taxpayer acquires property from a non-arm's length person for an amount in excess of the property's FMV, then the taxpayer will be deemed to have acquired that property at FMV. This can be harmful since the taxpayer's adjusted cost base of the newly acquired property will only include the FMV amount and not the excess amount. A non-arm's length transaction under non-FMV circumstances may also derail certain rollover transactions.

Price adjustment clauses help to ensure that transactions between taxpayers occur at FMV, especially if shares form part of the consideration for the transfer of property. A price adjustment clause will generally state that if the CRA determines that the transfer did not occur at FMV, then the number of shares or the redemption price of each share that a transferor of property receives will be adjusted so that the transferor receives FMV consideration for their property. For example, if a taxpayer transfers land to a corporation in exchange for three preferred shares that are redeemable at $3 per share (the total value of the three shares being $9), but the CRA determines that the FMV of the land was $12, the price adjustment clause will retroactively adjust the redemption price of the shares to $4 per share to match the FMV of the land.

The CRA has stated that the following criteria must be satisfied for a price adjustment clause to exist:

  • the agreement reflects a bona fide intention of the parties to transfer the property at fair market value;
  • the fair market value for the purposes of the price adjustment clause must be determined by a fair and reasonable method;
  • the parties agree that if the fair market value of the transferred property determined by the CRA or a court differs from their valuation, they will use the value determined by the CRA or the court; and
  • the excess or shortfall in price is actually refunded or paid.1

In addition, to have a properly drafted price adjustment clause in place, parties should also document all data and assumptions used to arrive at its valuation of FMV.


[1] Canada Revenue Agency, Income Tax Folio S4-F3-C1,"Price Adjustment Clauses" (24 November 2015).

Norton Rose Fulbright Canada LLP

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