When a marital relationship breaks down, spouses in Ontario have the right to share the value of property accumulated from the date of marriage to the date of separation (the same does not apply to common-law spouses, who do not have that right). This property division scheme is known as equalization, and it’s distinct from that of other jurisdictions, both within and outside Canada.
Subject to certain exceptions, equalization provisions of the Ontario Family Law Act say that, upon separation, the spouses must share the increase in their combined net worths from the date of marriage to the date of separation. Generally, both spouses may retain all property in their names, and remain liable for all debts in their names.
To figure out the increase in combined net worth, both spouses must complete sworn financial statements showing all their property and liabilities at both the date of marriage and the date of separation, which also become the “valuation dates.” (The date of separation is usually the date the spouses separate, even if they’re still living under the same roof, and have no reasonable prospect of resumed cohabitation. Generally, it is the date one party gives notice to the other that the marriage is over.)
Then, the spouse with the larger increase in net worth pays the other spouse 50% of the difference, so the increase in their respective net worths has been equalized.
The definition of “property” in the Family Law Act is broad. It includes any interest in items such as real estate, bank accounts, accounts receivable, and almost all types of deferred compensation, whether vested or not.
What this means for advisors
Of particular interest to married advisors is that a book of business is usually considered property. That means the value of a book of business must be determined and listed on the advisor’s financial statement as a date-of- separation (and, sometimes, date-of-marriage) asset, and the book’s value will have to be divided. This raises three issues.
1. Does the book of business have value?
The answer is usually yes, except in cases of smaller firms, where there is a history of senior advisors departing and not receiving compensation for their client lists. But in most large firms, including those run by major banking institutions, there is often an internal program to help retiring advisors transition their books to younger advisors. In such cases, the transfer value is usually calculated pursuant to a specified formula. As a result, arguments that the client list belongs to the institution, and is not property, generally fail.
2. If so, what is it?
The first step to determine value is to review the program of the specific financial institution where the advisor works. The formula in the program should provide a road map.
A calculation is usually then prepared as if the advisor were retiring at the date of separation. Most parties tend to agree on this number, as it’s strictly formula- based. If the formula includes unknown benchmarks (e.g., part of the payment is based on retention of clients, or performance of the book of business), these will have to be determined.
Once the number under the formula is calculated, real valuation issues tend to surface. The two biggest valuation issues are usually:
1. whether the value determined under the formula should be discounted to the advisor’s retirement (i.e., the likely date of receipt, also known as the deferred approach), or whether to determine the value as if the advisor had retired at the date of separation (the current approach); and
2. whether the taxes payable on the determined amount should also be present valued.
Those who favour the deferred approach take the position that the book of business payment is essentially a pension, and should be valued as though it will be received at the date of retirement. On the other hand, those who favour the current approach take the position that the value should be determined as of the date of separation, since it could be monetized under several scenarios other than retirement, such as an employment change.
The discount applied to a book of business value at separation for a 45-year-old advisor who expects to retire at age 65 can be significant. This discount is generally what differentiates the current and deferred approaches for family law purposes.
The next significant issue is the income tax deducted in arriving at the net value of the book. One school of thought says income tax should be applied consistently with the approach used to value the book. So, if the current approach is used, current taxes should be deducted. If the deferred approach is used, the taxes should be deferred and discounted as well.
The other thought process is that the income taxes should always be deferred (regardless of which approach is used), since this is how such contingent disposition costs are ordinarily calculated for family law purposes. Confusing? It should be. The variables mentioned can result in wide swings in the value of a book. So, the further an advisor is away from retirement on the date of separation, the wider the swing in values will be.
3. Does the advisor have to share the capital value of the book of business? Does she have to pay support from the income realized when money for the book is received?
When a book’s value for family law purposes is determined (whether by way of agreement, arbitration or trial), and the advisor receives money in return for her book, that income (or part of it) should be excluded when determining income for spousal support. Otherwise, the ex-spouses would be counting something as an asset for property equalization purposes, and counting it again as income when received.
Originally published in Advisor's Edge Report
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