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
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.
 Canada Revenue Agency, Income Tax Folio
S4-F3-C1,"Price Adjustment Clauses" (24 November
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general guide to the subject matter. Specialist advice should be
sought about your specific circumstances.
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Under the Income Tax Act, the Employment Insurance Act, and the Excise Tax Act, a director of a corporation is jointly and severally liable for a corporation's failure to deduct and remit source deductions or GST.
Under the Income Tax Act, the Employment Insurance Act, the Canada Pension Plan Act and the Excise Tax Act, a director of a corporation is jointly and severally liable for a corporation's failure to deduct and remit source deductions.
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