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Divorce is difficult. Apart from parental concerns if the ex-spouses have children, the most contentious issues tend to revolve around valuing and dividing property.

This is challenging enough when it’s about bricks and mortar, but it’s especially problematic when the nature of the property is unclear.

For example, say the ex-spouses are advisors who own a book of business. Is the book considered property that’s subject to matrimonial division? If so, what value should be placed on it?

These were the key questions raised in LMJ v. RGJ (2015 SKQB 136), a recent case from the Saskatchewan Queen’s Bench Family Law Division. LMJ and RGJ were married in 1984, and separated in April 2011 after 29 years of cohabitation. RGJ had worked at RBC DS since 1991. The couple agreed LMJ would remain at home and care for their four children, home and yard, and assist with RBC events.

While the questions of property division are not entirely novel, what caught my attention was the role that tax played—or arguably did not play—in the valuation.

Nature of the business

The definition of family property in the Saskatchewan Family Property Act is broad. And, the judge in LMJ v. RGJ did not have to look back more than a handful of years to find a number of cases in other provinces dealing with valuation of an advisor’s book of business. Consistently, there was goodwill associated with client contact, knowledge of investment objectives and familiarity with historic investments.

RGJ’s incentive would have been to minimize the value of his book, while LMJ’s incentive would have been to maximize it to receive a larger equalization payment. As to whether an advisor may not have the contractual right to take the clients from his dealer, such a limitation may reduce the book’s value, but does not detract from the fact that goodwill is a marketable asset. As a 2008 Supreme Court of Canada decision on property division put it, the “cultural reality” of the investment industry is that advisors “frequently change employers.”

RGJ stated that he had no financial ownership in the book of business: he did not own the list of clients and could not sell it. Though the judge acknowledged the dealer’s regulations, RGJ could not produce a written contract that explicitly prevented RGJ from taking the clients.

It was also noted that RGJ’s will refers to the “proceeds raised from the sale of my client accounts” being held for the benefit of his children, and that the dealer’s business succession plan (to which he was not yet subscribed) paid compensation based on a retiring advisor’s three most recent years of commissions. So, for estate planning purposes, there was a clear basis for there being a value for the book.

The judge ruled the book of business was subject to matrimonial division.

Gross valuation

RGJ’s position was that there should be no value attributed to the book of business.

By contrast, LMJ had an expert determine the value of the book. The expert’s report considered the most recent three years of RGJ’s gross commissions, recommending a valuation from $1.8 million to $2.1 million.

The judge accepted the three-year approach of the expert, but began one year earlier than suggested, arriving at a value of $1.6 million. This contributed $800,000 toward the ultimate equalization payment of $641,775 that RGJ owed LMJ.

And taxes?

RGJ’s counsel argued the valuations in the LMJ expert report should be discounted for taxes (and other inconsistencies). Unfortunately for RGJ, there was no evidence for the court to consider making such a ruling.

The judge referred to a case from the Saskatchewan Court of Appeal stating that it is not sufficient to merely raise the issue of potential tax liability. Evidence is required to support a tax discount; in the context of determining capital gains, that would at least require adjusted cost base (ACB) and marginal tax rates. In fact, the court suggests that this evidence, combined with the proposed calculation, may be sufficient, and not require an expert to be brought forward.

Assuming a nominal ACB on the $1.6-million valuation on RGJ’s book, the tax discount could have been close to $400,000. Alternatively, depending on the nature of the dealer’s business succession program, it’s possible that those future payments could be treated as regular income. This means close to half could be lost to taxes. However, the court did not account for this in the valuation.

Finally, the fact that the book is not currently being sold presents a further challenge for RGJ to find the liquidity to fund the equalization payment.

Doug Carroll, JD, LLM (Tax), CFP, TEP, is vice president, Tax and Estate Planning, Invesco Canada

Originally published in Advisor's Edge Report

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