Grimes v R: How Should Family-Controlled Private Shares Be Valued?


Authors: Alain Gaucher, Q.C., and Ravtej Grewal

In the recent decision of Grimes v R, 2016 TCC 280, the Court considered a myriad of differing valuations for shares held by a trust, in the context of the 21-year disposition rule applicable to trusts.

The 21-year deemed disposition triggers the realization of embedded capital gains and losses on the capital property held by a trust. The fact that the trust was subject to the application of the 21-year deemed disposition rule was not an issue in this appeal. Rather, the Tax Court of Canada considered the application of a minority discount and a marketability/liquidity discount on the valuation of shares of a holding company (“Holdco”) held by a trust in which one of the trustees was also its controlling shareholder and director.

A marketability discount is applied when there is a “lack of marketability” for the share – in other words, the share is relatively illiquid due to current market conditions, thus making it harder to sell at a higher price.

A liquidity discount is quite similar, as it relates to the relative ease of converting non-cash assets into cash. As seen in many cases, including this one, the marketability and liquidity discounts are usually combined into one when considering the types of assets held by the corporation.

Lastly, a minority discount is applied to make an adjustment or discount for lack of control associated with minority shareholdings.

In this particular case, the Ozerdinc Family Trust No. 2 (the “Trust”) had shares in Holdco, while the trustee, Ms. Kathleen Grimes, was the controlling shareholder. Ms. Grimes was also Holdco’s sole director and officer.

There were three differing expert opinions as to whether any of the discounts mentioned above should apply to the Trust’s shares in Holdco and the rates at which these shares ought to be discounted.

Mr. Gerald S. Blackman from MNP LLP gave the taxpayer’s expert opinion. His report included a minority discount of 12.5% and a marketability discount of 30% on the shares of Holdco. Mr. Blackman defined a minority discount and marketability discount as two distinct concepts. To determine the marketability discount, he considered the lack of control, the limited market for the share, various empirical studies and studies of the price relationship between private share transactions and subsequent public offerings.

Mr. Neil de Gray from Campbell Valuation Partners Limited (CVPL) gave the second expert opinion, for the Canada Revenue Agency (CRA). Mr. de Gray was hired specifically to critique the MNP report created by Mr. Blackman. Unlike Mr. Blackman, Mr. de Gray felt that the application of a minority or marketability discount to common shares in situations of familial control was highly unusual. Therefore, he concluded that there was no basis for a minority discount. Also, Mr. de Gray was of the view that, generally, minority and marketability discounts should be considered together.

The third expert opinion was a report provided by Mr. Timothy Spencer, a chartered business valuator for the CRA. Mr. Spencer agreed that no minority discount should be applied, based on several factors centring on the spousal and familial control of the Trust and Holdco. Mr. Spencer also combined both a marketability and liquidity discount, based on the corporate structure and corporate assets held, but concluded that neither applied, given the liquidity of Holdco’s assets and marketable securities.

The Court rejected Mr. Spencer’s report as resting on improper assumptions and flawed analysis regarding the inapplicability of these discounts.

First, with respect to the minority discount, Mr. Spencer assumed that Holdco would be sold as a whole and that the purchaser would acquire all the issued and outstanding shares, including the ones held by Ms. Grimes herself in addition to those held by the Trust. Thus, anyone acquiring shares would acquire control of Holdco in its entirety on the notional purchase. This assumption was based on the belief that Ms. Grimes had a fiduciary obligation to sell her personal controlling shares in order to obtain the highest price for a common share.

The Court disagreed on this basis, as Ms. Grimes had no fiduciary or legal obligations to sell her controlling shares. Rather, the determination should be based on the hypothetical that only the Trust would dispose of its shares, and not that all of the shareholders of Holdco would dispose of their shares.

Second, with respect to the marketability discount, the Court found that while Mr. Spencer considered the assets held by Holdco, he failed to consider the actual particulars of the share itself when determining the appropriateness and quantum of the marketability discount. As Mr. Blackman’s report accurately identified, the absence of a put arrangement, absence of a redemption policy, absence of distributions prior to the valuation date, and limited market for the share were all relevant factors in determining whether a marketability discount should be applied.

The Court agreed with Mr. Blackman’s reasoning for applying a marketability discount and a minority discount, while also considering case law that supported minority discounts in family-controlled corporations.

However, when considering the quantum of the discount the Court found that the lack of control was double counted as there was already a control premium placed on Ms. Grimes’s controlling shares. To remedy this, the Court halved the marketability discount applied by Mr. Blackman to 15% while keeping 12.5% as the appropriate value for the minority discount on the shares of Holdco.

This case is of interest when considering how family-controlled private shares should be valued for the purpose of other provisions of the Income Tax Act, as well as for the 21-year rule. It will be of interest to follow CRA’s response to this case moving forward.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.