The importance of a sound price adjustment clause
Particular attention should be paid to transactions between family members and those involving a company and its controlling shareholders since certain tax mechanisms could lead to negative consequences for these taxpayers.
Indeed, when individuals at arm's length within the meaning of applicable tax legislation enter into a transaction, they must transact at fair market value, which is determined through a reasonable method to evaluate the object of the transaction. Most often, parties call upon an appraiser.
When this is not the case and should an audit be conducted, tax authorities may modify the sale price based on the fair market value they determine?most often by adjusting the tax impacts for the seller upwards. The buyer will also be penalized, since the acquisition cost will not be adjusted accordingly.
To protect themselves against any unfortunate consequences, taxpayers may include a price adjustment clause in their agreements, stipulating that the sale price will be adjusted should tax authorities contest the fair market value. Four elements are required for authorities to accept a price adjustment clause:
1- The parties must have intended to transact at fair market value
2- The fair market value of the object of the transaction must have been determined according to a fair and reasonable evaluation method
3- The parties must agree to use the amount determined by tax authorities (if applicable)
4- Should the price be adjusted, the revised amount will be paid or reimbursed by the parties
The attorneys in PFD's business law group will draft a price adjustment clause that complies with all applicable fiscal legislation to minimize the tax risks of your transactions.