Calculate contingent liabilities in case of divorceJean-Claude Desnoyers
In a divorce, the parties will have to prepare a balance sheet of their assets and debts at the date of marriage and date of separation. This assessment is usually done with a lawyer and aims to divide the property equitably upon divorce. Besides the list of assets and debts, this document presents an amount that must be estimated: contingent liabilities.
A contingent liability is a debt, usually tax, payable on the disposal of an asset. It is calculated to ensure that none of the former spouses is disadvantaged at the disposal of the asset.
Divorce is never fun and neither is the separation of the property. It is therefore important to be able to make the right calculations and get the right results.
The case of Sengmueller v. Sengmueller
As a Chartered Business Valuator, I refer to the Ontario case, Sengmueller vs. Sengmueller, when it comes to contingent liabilities calculations. This case sets out principles for contingent liabilities determination and deduction as a liability in the spouse’s balance sheet for family law purposes.
In the Financial Principles of Family Law, the following principles apply to contingent disposition costs:
- Notional costs of disposition are to be deducted as long as it is clear that these costs will be incurred;
- If the costs of disposition are so speculative that they can safely be ignored based on evidence presented, they should not be considered;
- Whether the costs are considered to be a component of the valuation of the asset or segregated as a liability existing at the valuation date is inconsequential, i.e., the impact on a spouse’s net assets is identical;
- The underlying circumstances of each case should dictate the basis for calculating notional income tax and disposition costs. Specifically, the determination of the deduction largely will depend on:
- The nature of the assets,
- The probable timing of the disposition of the assets;
- The probable tax and other costs of disposition that will be incurred on the disposition; and
- The perception of risk and how it is incorporated in establishing the correct discount rate to be used in establishing the present value, or discounted value, of the notional income tax and disposition costs.
How to calculate the contingent liabilities?
The above criteria have to be examined to determine whether a contingent liability should be determined for some assets.
Take the example of an RRSP worth $ 10,000 as of today. The client plans to withdraw this amount at retirement in 15 years. Income is generally lower at retirement than it is while working. Therefore, if the client withdraws his RRSP at divorce, he will probably pay more tax at the time than at retirement. We must calculate the tax payable on the RRSP’s withdrawal at retirement and determine the present value of the amount of tax payable. Then we can add this to the amount of liabilities on the client’s balance sheet. It’s the same for real estate held for rental or, shares held in a company. In each case, the value of the liabilities at the valuation date will not be the same as at the time of disposal. Therefore, it is necessary to perform the calculation.
The Chartered Business Valuator (CBV) and the calculation of contingent liabilities in a family law case
In some cases, lawyers entrust a mandate to a CBV for a more precise calculation of a contingent liability. Generally, family law lawyers proceed to the calculations themselves for an RRSP, for example. They usually ask the CBV for advice on more complex assets such as shares in a company, real estate properties, etc.
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