$44 for 44% of the shares: flawless fair market value, or a taxable gift?

Picture the scene. A business owner reorganizes their company. In the new structure, a family member — say their spouse — subscribes for 44% of the participating shares for the grand sum of $44. Forty-four dollars. For 44% of a company that may be worth several hundred thousand dollars.

At first glance, it smells like a suspicious bargain. And the Canada Revenue Agency's first question would be: is that really fair market value (FMV)?

The perfect-stranger test

Here's a simple way to find out. Put yourself in my shoes. I, Dany Turgeon, a complete stranger to your business, walk in and offer you $44 to take your spouse's exact place — the same 44% of participating shares, at the same price.

Would you accept?

If the answer is no, ask yourself the real question: why not? Is it because $44 just isn't "enough"? If so, take note: the CRA may think exactly the same thing. Selling a family member something you'd never sell a stranger at the same price is the very definition of a transfer below FMV — and an open door to a taxable benefit.

Why $44 can nonetheless be the right answer

And yet — in a properly executed reorganization, $44 for 44% of the new participating shares is perfectly defensible. Here's why.

In an estate freeze, the owner exchanges their common shares for preferred shares whose value is frozen at the company's current FMV. All the value accumulated to date is now "locked" into those preferred shares, which rank ahead of the rest.

The new common shares issued after the freeze therefore carry no entitlement to the current value — only to future growth. If the company were wound up the day after the freeze, those common shares would receive zero: the preferred shares take the entire value. Their fair market value, at that precise moment, is nominal.

This is where the perfect-stranger test turns in your favour: an arm's-length stranger would also pay only a nominal amount for shares worth nothing today that represent nothing but a bet on future growth. The nominal amount is the FMV. It isn't a gift — it's how a freeze is meant to work.

The line between "flawless" and "gift"

The difference between flawless FMV and a taxable gift therefore has nothing to do with the dollar figure. It comes down to the quality of the freeze. For $44 to hold up, you need in particular:

• properly designed preferred shares: redemption and retraction value equal to the full FMV, priority ranking, recognized attributes — so they genuinely capture all of the accumulated value;

• a defensible valuation of the company's FMV at the time of the freeze;

• a price adjustment clause: if the CRA later revalues the company upward, the redemption value of the preferred shares adjusts accordingly — and the common shares stay at a nominal value.

If the freeze is sloppy — preferred shares that don't capture the full value, no adjustment clause, a weak valuation — then the common shares retain real value. At that point the $44 truly becomes a gift, the benefit is taxable, and the perfect-stranger test no longer protects you: it condemns you.

The takeaway

A nominal price on growth shares is never "too low" in itself. It is exactly as solid as the structure behind it. That's precisely why a reorganization should never be improvised: the defensibility of the $44 lives in the details of the freeze, not in the number itself.

If you're guiding a client through a reorganization — or considering bringing a family member into your own structure — the right reflex isn't to set a price and hope. It's to make sure the freeze is designed so that the price itself is beyond dispute.

This article deals solely with fair market value. Bringing a spouse or other family member into a structure raises other distinct issues — notably the attribution rules and the tax on split income (TOSI) — which will be the subject of future articles.

The comments above are general in nature and do not constitute tax advice. Every situation is different. To confirm the treatment of a specific file, please feel free to contact me.