Technology Valuations and the Canada Revenue Agency

• Author: Dennis Turnbull
• Pages: 749-775

749

Chapter 27

Technology Valuations and the

Canada Revenue Agency

dennis turnbull

The Canada Revenue Agency’s (CRA or the Agency) Equity Valuations Sec-

tion is a service function which provides valuation opinions and advice to all

sections of the Agency. This includes reviewing and preparing valuations

from t he initial assessment level through appeals to expert testimony in

court. T he CR A currently has about f‌ifty valuators in eight regional off‌ice

teams. CRA valuators follow the same generally accepted valuation princi-

ples and practices as private sector valuators and their training includes the

full set of t he Canadian Institute of Char tered Business Valuators’ courses

and the Institute’s f‌inal qualifying examination.

The CRA valuation teams are responsible for the valuation of intangible

properties including businesses, corporate equity, government rights, and

intellectual properties including technology. Technology values reviewed by

the CRA have included such diverse assets as computer software, medical

patents and formulations, manufact uring processes, engineering patents

and designs, and commercial research and development.

The valuation of technology is a signif‌icant issue for the CRA. The

CRA generally becomes involved i n technology-based transactions when

the transactions are non-arm’s length, such as the offshore migration of

technology, or arm’s-length transact ions where the consideration is largely

non-cash or performance based. The software tax shelter partnerships were

a principal example of this second category. In these ty pes of transactions

there is usually a signi f‌icant ta x advantage to either maximizing or mini-

750 dennis turnbull

mizing value and, in the absence of a support ing qua lif‌ied valuation, t he

stated price may not be considered reasonable by the CRA .

The very rapid pace of technological development, along with the accom-

panying rapid obsolescence of existing technology, makes t he valuat ion of

intangible technological asset s highly spec ulative. This is particu larly true

in early development stages where there is great uncertainty about both the

functional viability and the economic potential of the asset. These valua-

tions can become highly subjective and values can f‌luctuate d rastically in

very short time frames. This was brought out by Mr. Justice Bow man of

the Tax Court of Canada in his comments on the value of the MarketVision

software in McCoy v. The Queen:1

Fair market va lue is in some measure a fu nction of perception at the t ime

whether we are talking about real estate in boom times in the late 1980s,

stocks in 1929 before t he crash or exotic tu lips during the pe riod of tulip-

mania in 17t h century Holland. In that percept ion irrationa l or overly opti-

mistic expec tations may play a part. A cold blooded analysis f‌ive years after

the event, and after the rosy predictions have proved to be wrong, may be

scientif‌ically defensible but it may not ref‌lect the true state of the market

at the time.2

A. VALUATION METHODOLOGY

CRA valuators approach t he valuation of tec hnology on the same basis as

outside valuators. Valuation principles and methods are standard regard-

less of the reasons behind the preparation of t he v aluation. General ly the

technology values we review are based on either cost or d iscounted cash

f‌low calculat ions. The Relief From Royalty method, essentially a variation

of the Discounted Cash Flow model, has sometimes been used in technol-

ogy valuations submitted to the CRA .

1) Cost Basis

Technology costs can be the actual costs, direct and indirect, to develop

technology to a specif‌ic stage, they can be the hypothetical replacement

costs to reproduce t he same technology, or they can be open market costs

of fu nctionally similar technology. Development costs are generally most

relevant at the early stages of technological research prior to reliable indi-

1 2003 DTC 660 (T.C.C.) [McKo y].

2 Ibid. at para. 57.