Anonymised, illustrative composite. A single-location manufacturer occupied a building owned by its founder's separate holding company. The lease had not been touched since incorporation. Fair market rent was not what the trailing EBITDA assumed.
At a glance
A buyer was acquiring the assets of a precision-parts manufacturer through a newly incorporated purchaser. The seller had built the business over eighteen years, and at some point along the way had moved the building itself into a separate holding company — standard creditor-proofing, and standard enough that nobody in the room treated it as a red flag on its own.
The purchase agreement was for the operating business only. The real estate was staying with the vendor's holdco, and the buyer's newco would need somewhere to keep operating from the day after closing.
The trailing twelve months' financial statements showed rent expense of $36,000 — $3,000 a month. An independent commercial broker, engaged during diligence to opine on the space (11,400 square feet, light industrial, decent access to the 400-series highways), came back at $14,000 a month for a comparable arm's-length lease. The gap was not a rounding difference. It was $132,000 a year, and it had been sitting inside the reported EBITDA the whole time.
The buyer's advisor made the obvious first move: cite s.69(1) and argue the historical numbers should be restated to what CRA would actually assess. That argument does not survive a close reading of the section.
Reported trailing EBITDA was $1,850,000, built on the $36,000 actual rent. Substitute the $168,000 market rent and normalized EBITDA falls to $1,718,000 — a $132,000 haircut. At the 4.5x multiple both sides had already agreed to in principle, that is $594,000 of purchase price sitting on rent that no unrelated landlord would ever have charged.
Income Tax Act s.69(1) is the general non-arm's-length pricing rule, and it is worth quoting exactly, because the buyer's first instinct read more into it than it says: “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” — and, on the disposition side, a person who disposes of property to a non-arm's-length person “for no proceeds or for proceeds less than the fair market value thereof” is deemed to have received proceeds equal to fair market value.
Read the unit. Both limbs turn on an acquisition or a disposition of property. A monthly rent cheque under a lease that continues month after month is neither. The holdco has not disposed of the building; it still owns it. It has simply collected less income than an arm's-length landlord would have. s.69(1), on its own wording, has nothing to attach to.
Parliament knew this gap existed, and closed a narrow piece of it — not the piece this file needed. s.69(1.2) applies where a taxpayer disposes of property for proceeds at or above fair market value, and there existed, at that time, a non-arm's-length agreement to pay rent for the property at less than a reasonable amount: in that case the proceeds of disposition are deemed to be the greater of the actual proceeds and the property's fair market value determined without reference to the low-rent agreement. It is an anti-avoidance rule aimed at one specific manoeuvre — depressing a building's appraised value with a captive below-market tenancy just before selling it — and it only switches on when the building itself is disposed of. The holdco was not selling the building. It was keeping it and continuing to collect $3,000 a month from whoever occupied it next.
So the honest answer is that no provision of the Income Tax Act forces two non-arm's-length Canadian-resident corporations to charge each other market rent under a continuing lease. That is not a loophole anyone engineered here — it is simply outside what s.69(1) and s.69(1.2) do. The correction had to come from the deal, not from the Act.
The buyer stopped arguing the tax point and made it a closing condition instead: the vendor's holdco would sign a new five-year lease directly with the buyer's newco, at $14,000 a month, backed by the same broker opinion, effective on closing. The purchase price was then rebuilt on the $1,718,000 normalized figure rather than the $1,850,000 reported number, cutting $594,000 from the letter-of-intent price.
The purchase agreement also picked up a representation that no lease with a related party had been amended, extended or renewed within the preceding twenty-four months other than on arm's-length terms — not because the Act required it, but because nothing else would have caught the next one.
Had the deal closed on the original $1,850,000 EBITDA figure with the old lease simply carried forward, the buyer would have owned a business paying below-market rent to a landlord it no longer controlled. The first time that lease came up for renewal — or the first time the vendor's holdco simply declined to renew on the old terms, which it would have been free to do — occupancy costs would have jumped $132,000 a year with no warning built into the model. At the same 4.5x multiple the buyer paid, that is a $594,000 hit to the value of what was bought, landing entirely after the seller had been paid in full.
The tell was the number itself. $3,000 a month had not moved in years — no escalation clause, no adjustment for property taxes, no relationship to anything a broker would show a stranger. A market lease tracks comparables and moves with the building's carrying costs. A number frozen since incorporation is not a rent; it is a placeholder that happened to keep working because nobody outside the family was ever going to dispute it.
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