The building was never part of the deal. The rent it paid the owner’s own holdco was still doing most of the work in the trailing multiple.
Short answer
Yes, for valuation purposes — trailing EBITDA calculated on a below-market related-party lease overstates the margin the business will actually earn once the space is rented at what an arm’s-length landlord would charge, so a buyer should rebuild the purchase price on fair market rent rather than the historical figure. It is not, on its own, a problem the Income Tax Act’s related-party rules fix: section 69(1) recasts non-arm’s-length ACQUISITIONS and DISPOSITIONS of property to fair market value, and on the plain words of the section an ongoing lease with no disposition of the property is not one.
Income Tax Act s.69(1)(a) provides: “where a taxpayer has acquired anything from a person with whom the taxpayer was not dealing at arm’s length at an amount in excess of the fair market value thereof at the time the taxpayer so acquired it, the taxpayer shall be deemed to have acquired it at that fair market value.” That reaches an acquisition of property, not a continuing tenancy paying below-market rent year after year with no property changing hands.
The one provision written for related-party rent is narrower still: s.69(1.2) engages only “Where...a taxpayer disposed of property for proceeds of disposition...equal to or greater than the fair market value at that time of the property, and...there existed at that time an agreement under which a person with whom the taxpayer was not dealing at arm’s length agreed to pay as rent...an amount less than the amount that would have been reasonable in the circumstances.” That is, it only fires when the underlying REAL ESTATE is later sold. If the property stays with the vendor’s holdco — the common outcome when real estate is deliberately excluded from an operating-business deal — s.69(1.2) never engages either, and the fix has to be a market lease signed before closing, not a tax filing.
See it decided in the related-party-rent case file, the owner-salary normalization file and the closing-statement accounting-policy file.
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