Breaking up a marriage or common-law relationship involves a lot of big decisions, and many of those decisions are about money. Matters become more complex if you or your spouse (partner) are a business owner. Agreeing on how to divide your shared assets can be a major source of worry, confusion and conflict. Personal finance can become intertwined with business operations, resulting in the family enjoying a lifestyle that does not fully reflect the income reported for personal tax purposes. To make the most informed decisions for your family’s future, you need to know where you stand now and what your options are.
Typically, the business (whether a sole proprietorship, a corporation, a joint venture or partnership) will need to be valued as part of matrimonial property division. As value is sensitive to time and the private corporation’s share prices are not listed (as opposed to company shares listed on the stock exchange), a specialized professional such as a Chartered Professional Accountant who is also a Chartered Business Valuator (CBV) should be retained to help determine the value of the shares and/or interest in a joint venture or partnership. Depending on the circumstances, the business may need to be valued at the date of marriage (if it already existed), at the date of separation, as well as the court date (or current date if some time has lapsed between separation and the date in which property is to be divided).
Business owners often not only own an equity interest in the business, they may lend money to their business. The value of the shareholder’s loan, or loan to the joint venture or partnership should be accounted for as matrimonial property. The valuation of such is less complex than the equity ownership, however, is sensitive to time. All transactions leading up to the valuation date should be accounted for and the a consistent valuation date should be applied to other matrimonial property such as the bank account.
The premise of value in divorce for business assets is fair market value. Depending on the type of business, the primary approach to valuing it will be different. A holding company that holds passive investments such as rental property or a portfolio of stocks and bonds would typically be valued based on the underlying value of those assets, accounting for potential tax liability as at the valuation date. A company that is a going concern, providing services and/or products would typically be valued based on the potential cash flow that it will generate in the future and present, as valued to the date of valuation.
Valuation is both a science and an art, requiring professional judgment and specialized training. A general accountant who prepares the year-end tax return may be familiar with the business owners and the operations of the business, but may or may not be trained to prepare a business valuation. Moreover, there may be a conflict of interest and lack of objectivity if the year-end accountant who has an existing relationship with the parties prepares a valuation and continues to provide tax advice to one spouse or both spouses during and/or after the divorce settlement.
Non-taxable benefits enjoyed
As previously mentioned, a business owner’s household may enjoy a lifestyle that is partially supplemented by non-taxable benefits. For example, these non-taxable benefits can be expenses paid by the company such as cellular phone or automobile fuel, insurance and repairs that would ordinarily be incurred by the child (spousal) support payor but because he is a business owner, paid by his business instead. These benefits are not reflected on the child (spousal) support payor’s personal income tax return as they are non-taxable.
While total income (on line 150) of the personal income tax return is the starting point to determine income for child support purposes, a business owner may have more potential adjustments as income can be imputed according to s. 19 of the Federal Child Support Guidelines (the Guidelines) than an employee. Some examples of where income can be set at a different level includes where a spouse is intentionally under-employed or unemployed and where the spouse confers a benefit from the business he owns that is not reported on his personal income tax return. Moreover, imputed amounts may be grossed up for income tax to reflect the benefit the payor spouse enjoyed by using pre-tax dollars to pay for expenses deemed to be of a personal nature. Pre-tax income from a corporation where the payor spouse is a shareholder, director or officer based on s. 18 of the Guidelines may also be attributed in the determination of guideline income.
The potential adjustments to the level of income can be complexed and material. Professional advice should be sought.
A spouse who is self-employed is required to provide financial statements of the spouse’s business (may it be a sole proprietorship, corporation or partnership) for the most recent three taxation years. Recent case law has increased the level of detail that is required for expense disclosures by business owners. While the Court has initiated a process to determine if restricting access to family law files is appropriate for Alberta, this will take time. Some business owners may choose the collaborative divorce process, where parties sign a participation agreement to not go to Court. This prevents confidential information about the business strategies and operations from being available for the public or even a competitor. For more information about the collaborative divorce process which involves lawyers representing each party in a facilitated negotiation visit the Collaborative Divorce Association Alberta website at www.collaborativepractice.ca. or read my article here.
Your financial expert can assist you and your legal counsel in identifying key documents that would be important for the business valuation and guideline income determination. This is best done as soon as separation has commenced as it takes time to gather documents and when exemptions are claimed. For example when the spouse owned the business prior to marriage and is claiming that the fair market value of the business at marriage as an exemption. The longer the period has lapsed the more difficult it will be to gather the documents.
For a printable pamphlet on this topic, click here.
Agnes has nearly twenty years’ of experience helping people resolve financial disputes by providing objective evidence in and out of court. She has been retained in different capacities: by plaintiff counsel, defence counsel, jointly retained or served as a financial neutral in collaborative divorce.