The Canadian tax reach

Some time back, I posted about the extent to which the US tax authorities can tax the income of foreign corporations. There are similar considerations at hand for when foreign corporations operate in Canada, albeit on different principles. The most important questions are:

• Is a corporation resident in Canada?
• Is it carrying on business in Canada?

These must be read together with the basic requirements of s.2 of the Income Tax Act, where liability to tax arises where:

• a person is resident in Canada, or otherwise
• a person is employed in Canada, carries on a business in Canada, or disposes of a taxable Canadian property.

This is reinforced by the requirement in s. 150(1)(a) to file the appropriate returns, which also covers other circumstances where tax is payable, or the income is exempt is exempt as provided under the provisions of an applicable tax treaty. In the latter case, a return must be filed together with the specified declaration claiming treaty protection.

Who is a Canadian resident?

We must first deal with where persons are deemed to have such status or not:

• s. 250(4) deems any corporation incorporated in Canada after 26 April 1965 to be a Canadian resident, as well as any similar corporation formed before 27 April 1965 that was a Canadian resident or carried on business in Canada.
• if an applicable tax treaty so provides, s. 250(5) will deem a corporation to be resident in the other country and not resident in Canada.

Otherwise, common law principles govern whether a corporation is resident in a jurisdiction or note. This is said to be "where the central management and control resides." This is said to be the place where the board of directors holds its meetings, but that cannot be said to automatically apply. A recent case in the High Court of Australia held several foreign corporations to be resident there, as the meetings of the board acted only as a rubber stamp to actions undertaken by a principal in Sydney. This was held to be distinct from a previous case where the board did not blindly accept the actions of others, as it actively discussed whether such moves would indeed be appropriate to accept. Tax treaties with the UK and Switzerland did not act to shield the taxpayers in the recent case, as the act of incorporating within those jurisdictions was insufficient to override where the actual management and control were taking place. The impact of this decision could be huge, and it will be interesting to see if the CRA picks up on it.

Who carries on business in Canada?

Common law principles govern whether business is carried on, and s. 253 deems certain activities undertaken by a non-resident as constituting such activity. Applicable tax treaties will usually specify that income earned by a non-resident is taxable only where it can be attributable to a permanent establishment.

The most important factor in determining where a business is being carried on is the place where the contract is made. Other factors such as the place of delivery and the place of payment (among others) may also play a role, but the analysis can be quite complicated.

The definition of a permanent establishment is generally left up to the tax treaties, but the following situations can arise:

• a fixed place of business will constitute a PE
• an agent authorized to conclude contracts on behalf of the foreign corporation can also be said to be a fixed place
• in some circumstances, office space made available by a subsidiary to a parents' employees can be a fixed place
• executives who can act on behalf of both a parent and subsidiary are problematic, as their presence in the other country's office can also constitute a PE
• similarly, it can be argued that a foreign corporation that is constantly seeking guidance from a manager in a Canadian parent can be said to possess a Canadian PE
• certain tax treaties (such as the one with the US) can specify that, where services are being provided, days spent in the other country will trigger a PE when the total passes a specified threshold
• there can be other complications, such as in the manner that e-commerce platforms are structured

This is not an exhaustive list, and discussions are taking place at the international level as to whether such scope should be widened. That is an area that should be watched closely.

Summary

This is a very short article on a very complex topic, and I have known of many companies that did not get this right. Foreign corporations must consider the various issues carefully before proceeding to enter the Canadian market. Similar issues also arise in assessing whether foreign entities are subject to GST/HST, but the rules are slightly different and must be assessed separately.

Domicile: it still matters

Depending upon the nature of the critical event, and where it took place, the question will arise as to whether you should take into account a person's:

• residence;
• citizenship; or
• domicile.

The last factor will strike some as rather surprising, but it can have surprising results. I will discuss this first, and address the others in separate entries.

Why domicile matters

The general rule

A person can only have one domicile at any given time, which signifies where his permanent home will be for the foreseeable future.  The domicile of origin is acquired at birth. That continues until the age of majority is reached, at which time he (or she) can adopt a domicile of choice. That arises from permanently moving to a new place, and being legally able to do so. Therefore, you cannot permanently move to a new country if you only have a temporary visa to go there, or if you are only attending a post-secondary institution. Neither the intent nor the ability are there. The domicile of choice can revert back to the domicile of origin when you permanently move away from the latter without yet establishing a new permanent home. This can get ugly, especially when more than two jurisdictions come into play, as seen in an Alberta case in 2011.

There is also a domicile of dependency, is conferred on legally dependent persons by operation of law. It will be that of the person on whom the person is dependent, and will change when that latter person's domicile changes. This currently extends only to people who are mentally incapable.

Domicile is normally that of the nation, but it is normally that of the Province or State in ones that are organized in a federal structure. In the United Kingdom, domicile exists in England and Wales, Scotland, or Northern Ireland, and the Isle of Man and the Channel Islands of Jersey and Guernsey (all being Crown dependencies) have separate domiciles as well

The historical rule

Historically, at birth, a child acquired the domicile of its father where the father was still alive at the time of birth. Otherwise, it will acquire the mother's domicile if the father is no longer alive, or if it is born out of wedlock. Where there were no known parents, as in the case of a foundling, the domicile will be that in which the child was found.

The doctrine of dependency extended to married women, who acquired the husband's domicile upon marriage, and to minors (then called infants) who took on the relevant parent's subsequent domicile of choice.

Perverse effects of the rule

Here is a relatively simple application of the rules. A person is born in Ontario, whose father was then working in Canada on a temporary work visa. The father then decides to become a landed immigrant, and settles in Ontario permanently. Upon attaining the age of majority, the child then decides to leave Ontario, but dies before being able to establish a permanent home elsewhere. In which jurisdiction should the child's will be probated?

It would be England. The child's domicile of origin is England, because his father was not able to establish an Ontario domicile by the time of the birth. The child would then acquire a domicile of dependency at the time the father became a landed immigrant. However, when the child leaves to seek his fortune elsewhere, his domicile will revert to his domicile of origin, and will remain that way until a new domicile of choice has been established. And that can happen even if the child has never set foot in England!

There is another example I can across which is even more over the top but still accurate. A goes from England (in which he is domiciled) to India, intending to return to England when he reaches 60 after having made his fortune. He marries in India and has child B there, who grows up with similar intentions. A dies in India. B marries in India as well and has child C there, who grows up with similar intentions as well. B dies in India.

C's domicile is in England. This is because domicile arises from permanent intentions, as well as permanent presence in a particular place. Because A always intended to return to England, India never became a domicile of choice. B's domicile of origin therefore was England and, because he always intended to go to England to retire, India never became a domicile of choice either, and therefore C's domicile of origin is England as well. This could extend indefinitely, as long as each generation desires to eventually move to England eventually, and thus decides not to make India the domicile of choice once the age of majority is reached.

Effect on marriage and death

A valid marriage depends on two components: It has to be valid under the law where the ceremony is performed, and it has to be valid under the law of the parties’ ante-nuptial domicile. If crossing borders may be involved, it is still a good idea to double-check the rules of each jurisdiction before you go ahead.

Under current law, a Canadian divorce is effective if one of the parties has been resident in a province for at least one year. From 1968 to 1986, there had been an additional requirement that the petitioner had to have been domiciled in Canada. Prior to 1968, the requirement was for domicile in a province where divorce was available (which ruled out proceedings in Quebec and Newfoundland).

If annulment is sought, the grounds become murkier. Generally speaking, a wife can gain a domicile of choice and then petition to annual a void marriage (on grounds of consanguinity, being underage, or bigamy). However, she can only petition in a court in her husband's domicile where the marriage is voidable (because of lack of valid consent or the marriage not being consummated).

The other area where domicile is important in Canada is when a person dies, and his estate is governed by the law governing his domicile at that time in all respects other than for real (or immoveable) property situated beyond its borders.

Reform of the law in Ontario

Ontario has simplified the law of domicile in several stages. In 1958, the adoption laws were changed to effectively provide that an adoptee's domicile of origin would become that of his adoptive parents as if born in wedlock, and that came into force on 1 January 1959.

The age of majority was reduced from 21 to 18 effective 1 September 1971. This was followed by the abolition of illegitimacy effective 31 March 1978. On the same date, s. 68 of the Family Law Reform Act, 1978 granted separate legal personality for married women, and simplified the law of domicile as it applied to minors:

68. Subject to subsection 2, a child who is a minor, 

(a) takes the domicile of his or her parents, where both parents have a common domicile; 
(b) takes the domicile of the parent with whom the child habitually resides, where the child resides with one parent only; 
(c) takes the domicile of the father, where the domicile of the child cannot be determined under clause a or b; or 
(d) takes the domicile of the mother, where the domicile of the child cannot be determined under clause c . 

(2) The domicile of a minor who is or has been a spouse shall be determined as if the minor were of full age.

The latest rule is found at s. 67 of the Family Law Act, effective 1 March 1986:

67. The domicile of a person who is a minor is, 

(a) if the minor habitually resides with both parents and the parents have a common domicile, that domicile; 
(b) if the minor habitually resides with one parent only, that parent’s domicile; 
(c) if the minor resides with another person who has lawful custody of him or her, that person’s domicile; or 
(d) if the minor’s domicile cannot be determined under clause (a), (b) or (c), the jurisdiction with which the minor has the closest connection.

 

Legal impact

You can see that most of the reforms have been to domicile by dependency. Domicile of origin, together with the doctrine of reversion, has remained essentially intact.

The 1978 reform relating to illegitimacy appears to have been retrospective. The following key dates appear to be prospective only:

• 1 January 1959: replacement of domicile of origin upon adoption.
• 1 September 1971: ability of those between 18 and 21 to acquire a domicile of choice.
• 31 March 1978: the ability of married women to acquire a separate domicile of choice.

The effect of the reforms relating to the domicile of minors appears to merely displace the effects of the existing common law rules on domicile of dependency.

Does it matter anywhere else?

Are there other instances where domicile may become a concern? The answer is yes, and more than you might realize:

• Many US states use domicile to determine liability for their income taxes, including New York and California, and residency is used as a position to sweep in other potential taxpayers within its scope.
• The US has a federal estate tax in which US domicile attracts liability on the value of the worldwide estate, while non-residents face liability only on the value of property located within the US. Most States have similar provisions.
• The UK uses domicile to determine liability for its inheritance tax. In fact, its scope only excludes those estates where domicile is outside the UK, and there are no UK assets in it. Domicile has historically been the basis for its income tax, but the UK has significantly expanded its statutory residence tests to widen the scope for collection, and those taxpayers who are UK-resident but not so domiciled must pay a significant levy to protect their previous status.
• Australia gives priority to domicile in its income tax system.

Those are the most relevant cases for Canadians to think about, but other nations have their own unique rules which may catch people unawares. For instance, I do not know anything about how China (as in the PRC) would affect Chinese-Canadians, so experts in that field would need to be consulted if circumstances warrant.

Takeover

I've been digging into some personal history lately, after having heard that several people I knew back in the early 1980s have recently passed away. I worked with them in a company that had a wonderful work ethic and environment, that also made a lot of money. It no longer exists, because of events that overtook it then, but the perpetrators themselves are no more.

I have written about Canadian Glass Industries Limited before, on another blog. However, how it collapsed would provide a great case study. I will just give a broad outline of it here.

Canadian Glass was previously known as Glaverbel Industries Inc, and it was taken over by Pilkington Glass Industries Limited (then a subsidiary of Pilkington plc) in 1976. As a condition of its acquisition, Pilks was required to keep Canadian Glass at arm's length to determine its own strategy and direction. The head office was moved to Toronto in 1979, and it occupied premises separate from Pilks, although only several blocks apart. The acquisition did reveal several surprises, such as the fact that CGIL could borrow money at prime, but PGIL had to pay prime plus 1! That was the first of several embarrassments, including the equally unavoidable fact that CGIL was a much more profitable operation. PGIL's Contract Division was its only operation elsewhere in the group that even came close to matching those results.

I joined Canadian Glass as its Corporate Controller in September 1980, and enjoyed it immensely. The job had broad scope, I had full responsibility for issuing consolidate financial results and preparing and filing all corporate and capital tax returns, and I was required to travel to all divisions across Canada to check on how things were happening out in the field. I got along well with everyone there, and the feeling was mutual, as my boss soon advised me.

In December 1980, Ford Motor Company reached an agreement with Pilks plc to acquire its Canadian operations. As part of its negotiations with Ottawa, Ford got the conditions relating to the 1979 Glaverbel acquisition cancelled. Ford's takeover occurred in the spring of 1981. That resulted in a particular witches' brew of corporate cultures coming into play:

• Ford had (and still has) a particularly forceful brand of management, where specific targets are set and pressure is brought throughout the organization to ensure such targets are achieved. In the early 1980s, the focus was on reducing headcount throughout all activities within an organization. I really do mean all activities, and not just through voluntary measures such as incentives for early retirement (which tends towards somewhat patchy results). I should also mention that Ford had a fairly unified management structure, where top managers crossed over quite often between management and finance functions and back again. I was familiar with this, having grown up listening to my father's stories about how this had been applied at Ford's Oakville operations.
• Pilkington had a decentralized country-by-country management structure, and the Canadian operation was fairly regimented in its approach. The finance side was quite humourless, and initiative was not expected but obedience was. There was a fair bit of bureaucracy there, which tended to slow things down. On the other hand, they always felt they were superior to CGIL, contrary to the evidence at hand.
• Canadian Glass was quite relaxed in comparison, and collaboration was encouraged at all levels. At each division, the General Manager and Controller had equal authority and responsibility, and I was expected to deal with all of them. Response to any concerns was quite quick in both directions, and no issues were allowed to fester. Again, financial results were quite good throughout all divisions.

Note the priority of the cultures involved. Looking back now, it was quite predictable who was bound to lose when headcount reductions were forced through. The Pilks crowd were essentially looking for job security. As one of the first steps, the CGIL head office was closed in April 1982, and all of us moved across to the Ford Glass offices. And then the reductions started, albeit discreetly at first.

I sawit then occurring in a rather blatant manner in 1983, when I was given a survey form to identify what proportion of my time was spent on various activities. I noted that no-one else was being given such forms, and it didn't take a rocket scientist to figure out what was going to happen. I just gave some (*ahem*) wild guesses, and it was shortly after that I was told that my position was now redundant. Several weeks after that, I heard through the grapevine that those managers were shocked to discover that I was doing the workload of six of their people combined , and they really had to scramble to try and figure out how to divide up what had to be done!

I went ahead and got my RIA the following year, which was transformed into the CMA designation in July 1985. There have been interesting moments since that time, but none were ever as exciting or as enjoyable.

Aftermath

And what happened to that operation since? It has essentially gone the way of all flesh:

• In 1988, Ford sold its entire glass operation to Asahi Flat Glass (owned by Mitsubishi), which is now known as AGC.
• Their float glass manufacturing plant in Scarborough,originally established in 1967, was shut down around 1999. Another float plant had been established at St-August-de-Demaures in Quebec in 1992, but that one shut down in 2008 because of manufacturing overcapacity in the North American market.
• All of the fabrication, contracting and retail centres in Canada have now been sold off or closed. There is only one automotive glass facility here now, as shown on AGC's map.

On a broader scale, I believe I got off a lot better than many others then. Many accountants came face to face with job losses for the first time in their lives. At Coopers + Lybrand, now part of PwC, the practice for articling students had been to allow them three chances to write the UFE (the CA final exam) before they would be told to leave if they still could not pass. Around that time, that was cut back to allow them only one kick at the can, as most UFE graduates decided to stay on at the firm instead of having a large proportion decamping to positions in private enterprise. From that point on, the senses of job security and loyalty were permanently shaken, and they have never really settled back down since. These days, it can be said that many actually suffered from a type of post-traumatic stress disorder from these events, although it was never described as such, and that had wide-ranging effects over the following decades that have never been discussed.

The desire for headcount reductions continues unchecked everywhere, and almost every acquisition seems to result in another head office being hollowed out as a result. I've heard it said that the fat has now been trimmed off everywhere, and now we're cutting into the bone!

I see the potential for several case studies and/or theses in several academic fields. I wonder who would be interested in following up on this?

"Going concern" v "insolvency": there is a difference

There are still too many among directors and senior management that believe an auditor's assessment of  a company as a going concern is the same as as a directors' assessment of its potential for insolvency. That is not a correct view, because the two concepts can diverge either way:

• an entity may still be capable of paying its debts as and when they fall due, but at the same time not be a going concern because the directors intend to liquidate or significantly curtail its operations within the relevant reporting period; and
• a company may still meet the criteria of being a going concern because of its intention and capacity to maintain the scale of its operations, while still facing significant uncertainty in being able to pay longer-term debts as and when they fall due.

An entity's status as a going concern arises from IAS 1, which is its current foundation  in Canadian GAAP. Securities laws require it to be addressed in an annual report's Management Discussion and Analysis, although the Ontario Securities Commission has noted major deficiencies in that regard.

The directors' assessment for the potential of insolvency is preemptive in nature, and arises from both statutory and contractual duties. CPA Canada has noted that there is a crucial need to ensure an early determination, in order to employ available  options and avert potential default on a timely basis.

Even if there are no immediate concerns, auditors must still address whether any material uncertainties may exist that need to be noted in a company's financial statements, and be prepared to issue an adverse opinion if such uncertainties are not addressed therein.

This is further evidence of the current requirement of directors and management to be proactive in addressing their duties, as being reactive will, in almost all cases, will be too late.

In performing their duties, directors must act reasonably.  It has been held that reasonable grounds do not include "unquenchable optimism," and the following list indicates factors that suggest where an unreasonable action has occurred in assessing insolvency:

1. Where, although the officer has never adverted to it, there is at the objective level no reasonable or probable ground of expectation  to the relevant effect;
2. Where the officer himself has a subjective expectation of the relevant kind, that there is no objective ground for the expectation;
3. Where, as a matter of subjective judgment, the officer lacks the expectation yet, unknown to him, there is, on an objective appraisal, a reasonable or probable ground of expectation; and
4. Where the officer does not care whether the postulated event of payment will occur, and it appears that objectively there was no ground of expectation.

On the other hand, directors cannot give a qualified opinion as to material uncertainties, either through an expression of hope or envisaging unlikely scenarios, and the use of boilerplate statements in either the MD&A or the notes to financial statements is viewed as being very unhelpful. For example, if a qualified opinion is being considered as to the availability of financing from a financial institution or shareholder to ensure continuing as a going concern, genuine negotiations with a reasonable likelihood of success should be shown to be underway at the date of the statement.

The future of HR for employers

Last month's ruling by the Supreme Court of Canada in Wilson v Atomic Energy of Canada Ltd—even though it is ostensibly restricted in scope to federally regulated employers—should give pause to all organizations in the management of their workforces. Taken together with other recent SCC judgments, we can see that the HR landscape is becoming quite different in many respects from what many of us have been used to over these past few decades.

This most recent decision has several notable aspects that have far-reaching consequences: Much comment has been made about the inability of federally regulated employers to terminate non-managerial employees without just cause (provided that they have worked for more than twelve months). It was noted that the federal scheme displaced the common law with a scheme requiring reasons to be given for dismissal, and that the payment of a generous package cannot avoid a determination under the Canada Labour Code on whether the dismissal is unjust. I can see this having an impact in dealing with complaints on human rights issues, such as under Ontario's Human Rights Code, where settlements can be reached only after a complaint has been filed. This scheme appears to qualify as another instance where the common law has been displaced in favour of a statutory right.

One commentator has suggested that perhaps, in the federal sphere, probation periods can be extended to twelve months in order to be able to quickly dismiss employees before the Code's protections kick in. I can see several practical reasons why this would not be so easy from the employer's point of view:

• such periods only exist when specified in an employment agreement, and its consequences must be explicitly laid out therein;
• they cannot be unreasonable in length (which will depend on the nature of the position and the qualifications of the incumbent), but can be extended when the agreement explicitly provides for such an option;
• there can be liability for negligent misrepresentation, where the parties are each under a duty to exercise reasonable care to ensure that any representations they make are correct, which can impact on the intent being expressed for the use of probation;
• if the specified period is greater than three months, the agreement must comply with the minimum notice provisions in the Employment Standards Act, 2000;
• liability for wrongful dismissal will still occur if termination occurs before a probation period even begins, as noted in a recent BC case;
• termination within the period does not mean that notice (or pay in lieu thereof) can be avoided, as the common law still requires adequate notice to be given even when statutory notice is not required; 
• keep in mind that employers in Québec are required to act in good faith during all stages of the employment relationship, while the common law provinces have such a duty only during the relationship and its termination.
• termination can only be done in good faith, and that concept should be reinforced by stating within the agreement the purpose for which the probation period is required, for which adequate documentation should be kept to support the employer's assessment of the employee's performance;
• however, there have been cases where a court has held that termination can occur without notice and without reasons when not done in bad faith.

The above list is not exhaustive, but it applies to provincially regulated employers as well, and other concerns may easily arise. These are interesting times indeed!

Paid vs unpaid labour: key distinctions

There have been many assertions I have heard over the years in the private sector as to what rules apply where a worker is being hired, raising distinctions between permanent and casual labour, employment vs independent contractors, and when unpaid work is allowed. Many of those assertions - including ones made by fellow professional accountants - have turned out to be wrong. Here is an outline of what the true situation is for employers, at least as far as Ontario is concerned.

Where unpaid labour is allowed

I can only find the following circumstances where payment would not be allowed:

1. Where the work was undertaken as a volunteer, with no reasonable expectation of being paid (such circumstances would be rare in the private sector, but would more likely be able to occur in the public and non-profit sector);
2. For activity undertaken in the role of a director of a charity (but the Charities Accounting Act does allow for work by a director outside that role to be compensated upon the approval of a prescribed order); and
3. Training given by an employer, in restricted circumstances as specified in the Employment Standards Act, 2000.

There is no statutory definition of a volunteer under Ontario law,but a regulation under the Occupational Health and Safety Act does state that a "volunteer worker" is:

"a worker who performs work or supplies a service but who receives no monetary compensation for doing so other than an allowance for expenses or an honorarium." 

That is not a comprehensive definition in the matter, as it only aids in determining which workers are not counted for assessing whether a joint health and safety committee must be appointed for a workplace. There are few court cases that discuss the unique nature of a volunteer, but more recent ones stress that an organization's vicarious liability does extend to those persons' activities.

Training given by an employer can be unpaid only where it is:

• similar to that which is given in a vocational school,
• for the benefit of the individual, and
• the person providing the training derives little, if any, benefit from the activity of the individual while he or she is being trained,

 and the individual:

• does not displace employees of the person providing the training.
• is not accorded a right to become an employee of the person providing the training.
• is advised that he or she will receive no remuneration for the time that he or she spends in training.

All six of these criteria must be fulfilled, which effectively kills off most such schemes that had been in effect over the course of the last couple of decades. The Ministry of Labour is conducting blitzes of specific industries, such as with magazine publishing in 2014. As well, some managers have asserted that it was OK to give such participants an honorarium at the end of their work term, as the CRA only requires a T4 to be issued where a payment is greater than 500 dollars within a year, but the last criterion above effectively bars that from taking place.

Other statutes to watch out for include:

• the Workplace Safety and Insurance Act, 1997, which extends WSIB coverage to volunteer firefighters, ambulance workers and police auxiliary members;
• the Human Rights Code does apply to volunteer employment;
• OHSA's definition of "worker" includes those receiving no monetary compensation as a result of participating in a secondary school work experience, a program approved by a post-secondary institution, or in a training scheme as prescribed under the ESA, which effectively means that an employer has a statutory duty to provide them a safe workplace together with appropriate training.

"Casual labour" is still labour

Many managers have also asserted that "casual labour" does not have to be passed through payroll, but they conveniently forget the CRA notice outlined above. As long as it constitutes employment, a T4 must be issued. However, the University of Waterloo does have a nice little classification for the types of appointments that are available within its organization, which would be good for others to adopt as well (with necessary modifications). In it, they define "casual earnings staff" as those "employed for less than three months or on intermittent bases or who do not have regularly scheduled hours of work, or who are employed under an arrangement where they may elect to work or not when requested to do so." Note that a one-time engagement would qualify under this definition, and I doubt whether such work would be performed for 500 dollars or less. This definition is in contrast to those given for indefinite or definite-term appointments or for collective bargaining arrangements, but payments for all persons must be processed through payroll.

Employee or independent contractor?

Whether an engagement constitutes employment or a contract for services is highly fact-dependent, and has nothing to do with what an agreement might state. The relationship will depend upon certain factors as determined over the years through the courts, which include:

• control over how, what, where and when work will be done;
• who furnishes the tools and equipment required to perform the work;
• whether a person can subcontract the work or hire assistants to help out
• who bears the financial risk for performing the job;
• who is responsible for making the necessary capital investment and business decisions that can affect the profit or loss on the contract; and
• the opportunity to control proceeds and/or expenses in order to maximize profit.

Again, the University of Waterloo has an excellent matrix covering the various possibilities. It is noteworthy that certain payments will require the issuing of a T4A at year-end, while others need only be accounted for in the contractor's Statement of Business/Professional Income required to be filed with their annual income tax return.

Some companies have attempted to do an end run around by this by claiming that an arrangement is with a separate corporation, as opposed to being with the individual concerned. This can work, but it also problematical, and it raises concerns of liability as well as whether the arrangement is legitimate and not a "sham" transaction. UW's policy is a good framework to help assess whether your arrangements in that regard might hold up.

What can be a "sham" transaction? I've heard of several instances where this was ostensibly in effect, but the principals never bothered to even set up a bank account in the corporation's name to receive the payments, preferring to deposit the cheques into their own personal account. One person even requested that the cheques be made out into his own name! Now that was obvious!

The Web is peering further into the past

It's interesting what you stumble across these days when you're searching on the Internet. I've known for years that the fact I lived in Acton means that all my family history as reported in The Acton Free Press in those years is now completely online. That is embarrassing enough, but I have discovered that another year in my life later on is available for viewing as well.


I've never hidden the fact that I attended Carleton University for a year after graduating from Acton High, but have never bothered to mention it on my résumé. After all, you only mention the places you graduate from! I have essentially treated it as my "gap year" before going to Sheridan and later heading into the business world.

However, I was a reporter with The Charlatan while I was living on campus, and all the work I did is available for the world to see. All you have to do is click on the link at the bottom left corner of the above image, type "Ellerby" in the search box, hit "Go" and see what pops up.

The first few issues see my name misspelt as "Ron Ellery" in the masthead, but then I started getting bylines and conducted some interesting interviews, including one with the eventual winning candidate for the presidency of the Carleton University Students' Association. Towards the end of that year, I was even editing the events section and working on layout at the printers. And now it can be verified by the entire world!

Since then, I have always had a great appreciation for the work of the media, especially for those in print. Perhaps that could have been a better calling? Who knows? I chose to pursue accounting as I thought it represented a similar quest for the truth, but, sadly, I have tended to be in the minority as far as that group has been concerned. Perhaps I was ahead of my time, as there appears to be greater emphasis these days on encouraging professional skepticism, as well as levying real penalties on those who cross the line. However, there has always been an undercurrent of power relationships and backroom politics in the profession that will still take a major effort to overcome. Those stories, however, are for another day.

For now, though, take a look back at what a bunch of intrepid reporters for a minor student newspaper were up to in 1972-1973.

NB: A version of this article appeared in my personal blog on Wordpress. However, the ability to embed the webpage above was lacking, so I have posted it here as well. Besides, Blogger is aimed at a somewhat different audience that might find it interesting.

How is your exposure with your bank?

We all know that the Canadian banks have always had a conservative approach towards minimizing their exposure when it comes to extending secured credit to businesses. The factors that such businesses must take into account have multiplied in recent years, but the banks have never been very explicit in their documentation as to why such factors are critical. Here is an attempt to classify them, based on past experience and current awareness.

For simplicity, we will assume only one line of credit secured by a charge against all company assets, with regular reporting of credit exposure to the bank in order to determine availability for drawing down upon the line. The basic formula for determining maximum availability of funds is:

$ (R*a + I) - (D+L) $

where R is eligible receivables (usually after deducting amounts over a certain age and amounts due from the Crown), a is the availability percentage specified in the credit agreement, I is eligible inventory (more often than not just a flat amount),  D is the sum of all statutory deemed trusts, and L is the sum of any liens against the business.

Each of these factors deserves separate discussion.

Receivables

How much you can get will depend on the creditworthiness of your customers, as well as the risk exposure of the sector you are in. These will influence the aging cutoff for determining the eligible amount, together with the overall percentage applied, against which the bank will extend funds.

Exclusion of debts due from the Crown is based on s. 67 of the Financial Administration Act, which states that, in general, "(a) a Crown debt is not assignable; and (b) no transaction purporting to be an assignment of a Crown debt is effective so as to confer on any person any rights or remedies in respect of that debt." Ontario does not have such a provision, but some other jurisdictions do. Further and more detailed discussion on this can be found here.

Inventory

Amounts allowed under this are quite variable, and it all has to do with the risk exposure involved. I was involved in an asset-based financing arrangement several years back, and the amount granted was quite minimal as the assumption was that, if the bank had to call their security, any goods would be disposed at a distressed value. In addition, suppliers have a super-priority right to claim back goods that had been shipped within thirty days prior to a bankruptcy, if a demand is filed with the bankruptcy trustee within the first ten days of such bankruptcy.

Statutory deemed trusts

Federal and provincial statutes have been providing an expanding list of what amounts can fall within this category, but they fall within one of two categories: those which can survive bankruptcy, and those might not.

In the first group (more fully discussed here):

• Payroll source deductions for tax/CPP/EI
• Municipal taxes
• Requirements to Pay issued under the Income Tax Act or the Excise Tax Act
• Remediation orders issued by the Crown to recover environmental remediation claims
• Current employer and employee contributions to pension plans

In the second group:

• GST/HST and other sales taxes due
• other payroll taxes accrued
• other pension plan liabilities
• liability for vacation pay
• liability to carriers for freight charges incurred shipping to consignees

 

Considerations

It is prudent to have your payroll service provider charge and remit your payroll source deductions every pay period, in order to minimize your ongoing exposure to this critical item.

Accounting systems allow for grouping of vendors, which will help to identify vendors that would be identified within any of the above items.

Vacation pay liability is a sleeper issue that deserves more attention than it gets. Most payroll systems track the accrual for hourly employees, but the liability with respect to salaried employees has historically been treated as a "pay as you go" arrangement. This is not quite right these days, as IAS 19 requires accrual for any liability. That could cause problems if many salaried employees have been discouraged from taking their vacation time, as has occurred too frequently in recent years. While ASPE does not explicitly call for such comprehensive treatment, it may only be a matter of time before materiality considerations call for similar treatment.

Liens

The bank will need to know about all that exist, but you will need to know what their nature is:

• Possessory liens will trump a secured creditor's right in the same item, up to the amount required to satisfy the lien in full.
• A non-possessory lien right also trumps a secured creditor's interest but only if the non-possessory lien is registered prior to the secured creditor's interest.

They can be in the form of:

• tax liens
• construction liens (including any holdbacks)
• repair and storage liens
• maritime liens
• equitable liens

Needless to say, you should work to ensure that such amounts, in general, never arise to begin with. That is more a question of financial management as opposed to accounting, but holdbacks can be separately identified in most accounting systems.

Honesty with your lender

I have heard of other companies where the exposure reporting has been somewhat less than truthful, in order to squeeze out as much funding as possible. This is never ethical, and can attract significant liability when things go wrong. Several years ago, the Ontario Court of Appeal held that a CFO was personally liable to a lender for misrepresentations he had made about the financial viability of a subsidiary that was subsequently sent into CCAA proceedings. In its ruling, the Court quoted from prior jurisprudence:

"The consistent line of authority in Canada holds simply that, in all events, officers, directors and employees of corporations are responsible for their tortious conduct even though that conduct was directed in a bona fide manner to the best interests of the company, always subject to the Said v. Butt exception."

The exception mentioned concerned inducing a breach of contract. In any case, this emphasizes the duty that we have to ensure that we are dealing with lenders in good faith.

How effective are your agreements?

In all of the management positions I have held, there was responsibility for examining and reviewing a fair bit of corporate documentation either for research or for assessment as to how it would impact decisions to be taken. In addition to documents prepared in Ontario and notarial acts « en minute » from Quebec!, there have been many documents prepared in the USA, the UK France and Belgium! That's given me an interest in keeping up to date with what's going on in the area of commercial law.

I've been gathering a bit of a "cheat sheet" as to what to keep in mind for B2B (business to business) contracts. First of all, we need to remind ourselves as to what a contract is, and Halsbury's Laws of England gives a basic definition, much of which is still applicable in Ontario. Here's the 1909 edition, at paragraph 740:




In brief:

• a contract may be made either verbally or in writing;
• if it is in writing, either under hand only or under seal; but
• certain contracts must be in writing, and of these some must be in the form of a deed (ie, under seal).

The area is horrendously complex, so let's focus on those that need to be in writing between corporations. However, there are certain other statutes that will come up.

The contract is formed when:

• an offer is made by one person to another, and it is accepted by the person to whom it is made;
• there has been valid consent by both parties, without duress, undue influence or fraud; 
• both parties have the capacity to enter into the contract;
• it is either sealed, or valuable consideration is given by the promisee to the promiser.

The rules governing the use of seals are fairly rigid. The one that can really trip up users is the "sealed contract rule", which states that when it is executed under seal, an undisclosed principal can neither sue nor be sued upon the contract. That's because only the named parties acquire rights and obligations under it. In a simple contract (ie, one with valuable consideration) an undisclosed principal is able to sue and be sued under contracts entered into by his agent. The Supreme Court of Canada confirmed this in Friedmann Equity Developments Inc v Final Note Ltd in 2000.

What, then, constitutes a deed? It is a written instrument that must be sealed and delivered. Signing and witnessing are not strictly required, but are encouraged for purposes of proof.




At common law it is necessary for:

• the conveyance between living persons of incorporeal hereditaments (eg, rents or rights of way);
• any power of attorney which authorizes the attorney to execute a deed;
• gifts or gratuitous assignments of tangible goods (where not accompanied by delivery of possession); and
• rendering enforceable any gratuitous promise.

In equity, a deed must be employed "whenever any claim is made in a court of equitable jurisdiction of any assurance or alleged assurance made gratuitously of any legal estate, interest or right." This applies with respect to any real or personal property, or any other right.




There are three statutes in Ontario that have modified the application of deeds. The first is the Conveyancing and Law of Property Act, which provided for the following:

• effectively requiring a deed to be used for any transfer of rights in land; and
• an execution of a power of appointment by deed must be witnessed by two or more witnesses.

In addition, there is the Statute of Frauds, which reinforces the CLPA's deed requirements, as well as stating that most leases must be under deed as well.




Finally, we have the Land Registration Reform Act, which notably provides that "a transfer or other document transferring an interest in land, a charge or discharge need not be executed under seal by any person, and such a document that is not executed under seal has the same effect for all purposes as if executed under seal."




Now that is quite a broad change, but it does not completely displace the requirements for deeds.They are still useful where it is necessary to declare that the parties are conclusively bound by its terms (subject to the discussion in Friedmann above), or where there are questions of the adequacy of any consideration. Guarantees and indemnities come to mind, as well as conferring rights upon third parties, and deeds conferring a power of appointment by a corporation for executing a deed has certainly not disappeared. Seals may still be necessary on occasion, unless Ontario finally decides to follow the UK's Law of Property (Miscellaneous Provisions) Act 1989. I'm not holding my breath.

Quebec is quite different. Their Civil Code only recognizes contracts, and consideration is not a requirement for validity. Instead, their definition is quite succinct:

1385. A contract is formed by the sole exchange of consents between persons having capacity to contract, unless, in addition, the law requires a particular form to be respected as a necessary condition of its formation, or unless the parties subject the formation of the contract to a solemn form.

It is also of the essence of a contract that it have a cause and an object. 

They can be expressed as authentic acts (the solemn form, in article 2813 et seq.) or private writings (most contracts, in article 2826 et seq.), for purposes of proof. The rules are quite straightforward, and we can learn a lot from their approach. That's a discussion for another day, though.

How does all of this impact the internal administration of a corporation? I haven't even discussed tax consequences, and they do exist in multiple circumstances. The question of intercompany agreements for the handling of goods, services and cost-sharing is another sprawling area as well. However, it is necessary to understand how agreements are formed and become valid, before we can worry about the other myriad details that arise!

The distinction between innovation and growth

I've been on this topic before, but an op-ed piece in The Globe and Mail today makes the case quite clearly:

"In the 21st century, prosperity comes from ideas commercialization throughout the private sector – high tech to low tech, agriculture to services. Countries that innovate prosper; countries that do not decline. We know that without public intervention to create an ecosystem enabling our innovators to make money here, we will have less innovation than we need for prosperity. By confusing general growth policies with strategic innovation policy, Canada risks falling further behind globally.

"The aim of growth policies is to entice people or companies pursuing specific, well-developed activities to move or create businesses in your jurisdiction. By handing out public money, a government can entice foreign companies to open new campuses and create jobs in "innovation industries." Singapore and Ireland achieved rapid economic development this way, and Canadian governments have tried to. Yet this approach does not help foster domestic innovation.

"The aim of innovation policy is to foster the development of industries, products and services that do not yet exist and whose business models and markets have yet to be created. Organizations and individuals capable of inventing these technologies must be attracted or developed, and the results of their labours must be channelled into economic growth.

"That means we cannot use a process of long-term planning. Instead, we need continuous experimentation. Policy makers must rapidly come up with new initiatives, kill those that don’t work, scale up those that do and then keep changing incentives to keep pace with growing, dynamic industries."

There's nothing here that states anything more than plain common sense. However, too many policy makers tend to conflate these two aims into something that is less than clear, and too many Canadian enterprises confuse innovation and growth with surfing on the next wave that is coming through, as opposed to really determining what will beneficially work for them. That probably also explains why our rate of capital investment is so laughably low.

Let's see if this never-ending debate will finally come to a real conclusion...

The CBSA wins again: the trouble with cost-sharing arrangements

When related companies reimburse one another for goods or services rendered, it's always important to have written agreements in place to justify the amounts being paid. While it's generally viewed as being important in terms of allocating profits for corporate tax purposes on a fair basis, you must not forget that there are consequences in other areas, such as customs duties.

That's right: duty is chargeable on more than the invoice price of goods. One corporate group found out the hard way, and they struck out in the Federal Court of Appeal last year. This is what happened:

• The US parent sold goods to its Canadian subsidiary at a price that equalled its landed cost into the US from China, plus markups for US warehousing and an arm's-length profit on the sale.
• There was also a cost-sharing agreement ("CSA") between the two parties that allocated costs relating to the costs of research, development, design, advertising and marketing activities.
• A Management Services Agreement covered charges for information technology support, accounting, finance and purchasing support, that the US parent undertook on behalf of the subsidiary.
• There was also a Canadian Intellectual Property and Proprietary Information Licence Agreement that conferred the right to exploit all intellectual property rights in the brand in Canada, in exchange for a lump-sum payment.

The Canada Border Services Agency assessed further duty on the imported shoes, based on the proportion of the cost-sharing agreement charges that related to research, development and design ("RDD"). The US parent appealed the assessment to the Canadian International Trade Tribunal, and lost.

In the end, the reasons for why the assessment was good were quite simple:

• The transfer price of the goods did not reflect the RDD that had been incurred to help create it, as the cost was being billed directly to Canada rather than through China.
• Reimbursement for that activity was effected through the CSA, which made it an adjustment to the purchase price, and the dutiable value must include its full amount.
• The design portion of the RDD could not be considered as a duty-free "assist", as it was not being furnished free of charge.

There is nothing new about the principles involved here, but it's still a useful reminder of what needs to be kept in mind when establishing a group's structure.

The employment minefield after hiring

The workplace certainly operates in a more complex fashion, compared to what many experienced in these past few decades. Certainly many stupid employers and employees have contributed to this, according to many cases that have been reported in the media, and there's a lot of dust that has yet to settle. However, some observations can be made.

There are several principles that have been enunciated by the courts, some of which may overlap:

• The employment contract is now considered to have an implied term that the employer must treat its employees with "decency, civility, respect, and dignity." All employees have a duty of good faith and fidelity towards their employer while working, and key or senior employees will also have a fiduciary duty which may continue after they leave.
• There is now an overarching principle in place that holds that both parties to a contract have a duty of honest performance.
• In the formation of a contract, both parties can be held to account for any negligent misrepresentations they may have made during its negotiation.
• In providing references for an employee, employers have a duty of care to ensure that they are accurate and fair, and failure to do so can constitute negligence.

 To be sure, this is just a thumbnail sketch. However, it is easy to see that this is an area where all decisions must be well and thoroughly thought out.

That's not all. There is also employer liability for acts during the working relationship. The list is complex, as noted by one of the larger Canadian law firms:

1. An employer is ALWAYS DIRECTLY LIABLE for its own negligence in hiring, training, or supervising employees.
2. An employer is ALWAYS VICARIOUSLY LIABLE for the wrongful acts of an employee within the scope of his or her employment.
3. An employer MAY BE VICARIOUSLY LIABLE for the wrongful acts of an employee outside the scope of his or her employment.
4. A party hiring an independent contractor is generally NOT VICARIOUSLY LIABLE for the wrongful acts of the independent contractor.
5. An employer is ALWAYS VICARIOUSLY LIABLE for wrongs committed by an agent in the scope of the agent’s actual, apparent, or usual authority.
6. An employer MAY BE VICARIOUSLY LIABLE for an employee’s breach of fiduciary duty owed to a previous employer, even if the new employer was unaware of the breach.
7. The most effective way for employers to limit unnecessary liability is to take PROACTIVE PREVENTATIVE MEASURES. 

All of this arises just from the common law, and there are many statutory obligations that we have not yet touched upon! You'll definitely have questions about many aspects of how this may affect you. It will always be good to have a great lawyer on your side.

The hiring minefield these days

I've addressed this issue several times before, but the topic just seems to be covering a wider area over time. Here are some current notes:

• Do your application and interview processes comply with current human rights laws? It may sound surprising to hear that, but there are still some employers out there that just don't get it.
• If you use agencies to assist you in the selection process, do they actually check out beforehand the candidates they send out to you? Many do not, hoping that the "halo effect" gained during the interview process will cause employers to not insist on finishing off the process, but they have been successfully sued in the courts for failing to do so.
• Regardless of that, are you conducting reference checks for positions that would involve contact with the public? One company that ran a tavern failed to do that in hiring some bouncers. A customer who was then viciously attacked by them in the tavern's parking lot successfully sued the employer for failure to properly check out the bouncers' background beforehand (which would have immediately raised some red flags). That principle was subsequently upheld in another case at the Supreme Court of Canada.
• Are you being straightforward in describing the position and its prospects to the candidate, and does he reciprocate in describing his capabilities and achievements, as well as assuring that he would not be in breach of his employment contract with his current employer? Failure to do so may constitute negligent misrepresentation, as noted by the SCC in Queen v Cognos, or potential exposure to suits from the former employer for poaching in breach of contract or fiduciary duty.
• Given the emergence of the common law in the area of privacy rights, as well as statutory requirements for several provinces and at the federal level, are you getting prior written consent for contacting referees, and are you explaining beforehand the exact purpose for checking such references?
• Does the employment agreement meet, at minimum, the requirements of employment standards legislation in your jurisdiction, as well as plainly explaining the terms that exceed such requirements? Among areas that many employers take for granted are the entitlement to, and calculation of, vacation pay and overtime.
• Are you making sure that the employment agreement presented to the candidate has been reviewed by your lawyers, that there are no terms outside the agreement that have not been properly documented, that the candidate has had the opportunity to get independent legal advice, and that it is fully signed off before he/she begins work? All  steps are extremely important in order to ensure the validity of what was intended.

This is an extremely complex area, and you really need to get good advice from a great employment lawyer on this. I wish you all the best of luck.

A social look at the Canadian profession

It's been interesting to see the heavy promotion CPA Canada has been giving lately for its brand, and fascinating to note that they are promoting a single image of what that is supposed to represent to employers. However, the legacies of the predecessor designations will last for a very long time.

It appears that very little work has been undertaken to examine the effects they have left on the profession. There was one very bad joke going around a while back to explain the differences:

"CGAs do good books. CMAs explain what they mean. CAs bend them to fit GAAP."

But it's not that simple. The former professional bodies were created to serve different needs that arose as time went by:

• The Chartered Accountants (CAs) were the first to be formed, initially in Montreal (the Association of Accountants of Montreal), and then in Toronto (the Institute of Chartered Accountants of Ontario). The Toronto group appeared to be  more aggressive in extending membership to people of various qualifications, and there was a breakaway movement that formed the Dominion Association of Chartered Accountants in order to raise standards and confer a uniform national designation. That caused a rift that only healed in 1910, with the ICAO being triumphant and the CA designation being conferred province by province. DACA would become the Canadian Institute of Chartered Accountants in the 1950s, and the qualification and reporting standards gradually became more uniform nationally with university degrees required before entry into their programme only in the 1960s.
• The Certified General Accountants (CGAs) began as a group to provide accounting training for employees of the Canadian Pacific Railway, and it branched out from there. There was a running battle going on for decades between them and the CAs as to the right to audit financial statements, and this was fought out both in the legislatures and the courts. Their final inclusion in CPA Canada is rightfully seen as a miracle of negotiation.
• The Certified Management Accountants were initially created by the CAs as a subgroup of their members to cover the growing field of cost accounting before the CGAs had a chance to get into it. It then started holding its own examinations to confer "certificates of efficiency" to newcomers, and then created the separate Registered Industrial and Cost Accountant (RIA) designation in the early 1940s. The RIAs became the CMAs in the mid-1980s, and that time they started to required the possession of a university degree before entry into their course of study.
• The Certified Public Accountants (the original CPAs) came about in the mid-1920s to professionalize the accountants and auditors that worked for the taxation authorities in Ottawa and Queen's Park. The designation originated as LA (Licentiate in Accountancy) during 1926-1931, changing to IPA (Incorporated Public Accountant) during 1931-1936, before becoming the CPA. They merged with the CAs in the early 1960s.
• There were also the Accredited Public Accountants (APAs) out West, which existed from 1950 to sometime in the 1970s before merging with the CGAs. I have no information as to the reason for their formation in the first place, but it does explain somewhat why the CGA membership tended to be more heavily weighted to the Western provinces.

It's been interesting to see how they all intermixed (or not) over the years. Some companies preferred to hire one group over the other, others were indifferent as long as the candidate did the job, and still others streamed them to fit various pigeonholes (eg, CAs for external financial reporting and tax returns, CMAs for management reporting, and CGAs for monthly reporting and reconciliation). The corporate attitude tended to dictate how they all related to each other.

The different modes of training also have had their effect: the "bullpens" the CA candidates were in while they got ready for the UFE created alumni networks that have helped them out greatly over the years, even if many of them adopted the white-shirt and navy-suit stereotype along the way. On the other hand,  the CMAs and CGAs had to study on their own (sometimes even by correspondence), and have tended to treat the organizations they work for as being the focal point of their social interaction. The latter probably explains why many of them have tended to be introverted in broader settings.

The CMAs also had an influx of membership back in the 1970s and 1980s from the transfer over of British graduates of ICMA (the Institute of Cost and Management Accountants, now the Chartered Institute of Management Accountants), and their superiority complex tended to muddy things up for a while for the homegrown RIAs. However, that is a story that has never been properly explored. Thankfully, the ICMA influx has long since retired.

I generally found the RIAs to be the most sociable of the bunch (conflict of interest disclosure: I'm one of them myself), and more likely to want to go out and relax together over a drink after work. You really learned a lot listening to those fellows in such a setting, and that type of camaraderie has been lacking for a long time among the more recent graduates. Of course, it cost a lot more for the newer CMA grads for funding their tuition compared to what we faced, and the Board Report stage did force some social interaction to take place in order to achieve a goal, so it may not have been that bad. However, I have heard instances of many employers not reimbursing all of the costs involved, or of setting up tracks to assure the progression of such candidates to more deserving positions, as opposed to the CATO system the CAs had.

What will the new CPA graduates face, and what will be the consequences for those that have come before? Those questions are very much open, and it would be interesting to see if someone (most likely an academic) will step up and investigate this.

What is a workforce worth?

When attempting to allocate fair values to assets upon acquisition of an enterprise, there is always a challenge when dealing with residual amounts to intangible assets, especially in distinguishing between those with finite lives as opposed to infinite ones. One argument I have encountered in several circumstances is how much of a valuation one can attach to an enterprise's workforce in contributing to enterprise value. Most of those instances have tended to be based on false assumptions, as a workforce can fundamentally change after a takeover, whether through turnover, planned reductions by the acquirer, or just overly optimistic estimations of the workforce's capabilities.

As far as financial reporting is concerned, IFRS has mostly ruled out such allocations to intangible assets of finite lives. IFRS 3 explicitly states that it is not an identifiable asset (at par. B37). In addition, IAS 38 points out that there is insufficient control over the economic benefits that may result from the assembled workforce (at par. 15). However, there are several identifiable assets that can arise in that area, such as non-competition agreements or employment contracts that are determined to be below-market from the employer's perspective. These, and especially the latter, would be quite sensitive information, in which the detail would be best kept locked away in the acquirer's files!

A valuation may still be relevant in determining allocations to intangible assets that are allowed to be recognized, such as a relationship with a key customer. In such an instance, it is seen as a contributory asset, a relevant part of which is there to sustain the relationship. The best method for determining its value is seen to be that of "reproduction cost" (as opposed to "replacement cost"), which would include the cost of recruiting, training and allowing for attaining maximum effectiveness after going through the appropriate learning curves. This is a component of what is known as the "multi-period excess earnings method," which is a fallback calculation when a more direct estimation of economic benefits is not possible. This is quite an arcane area which has still not been fully discussed in the professional literature, and I have never seen it being properly calculated in practice by others.

That is a summary explanation of the quantitative considerations involved in this matter. There is also the qualitative side, which is often given short shrift in M&A discussions. However, many acquisitions have failed spectacularly, because the acquirer failed to take note of what was happening under the surface at its target.

The corporate cultures of both parties, and potential clashes, is a particularly well-known area for potential downfalls. A target's corporate history, however, may be of more relevant interest. For example, the skills needed to handle startups are not necessary appropriate when the enterprise becomes more mature, and an owner-entrepreneur's behaviour is quite different from that of a professional manager. As well, personal relationships—on many levels, both inside and outside the enterprise—may influence future outcomes, both before and after an acquisition takes place, and those tend to be insufficiently documented. It may well be in an acquirer's best interest to buy some drinks at the bar for some of the key parties (not necessarily at the top levels) or third parties and have a wide-ranging chat with them, before any approaches are being considered. That would be money well spent, before intentions are actually expressed, non-disclosure agreements are signed, and people start feeling committed toward achieving an outcome that would not eventually be beneficial to the acquirer. Of course, there are some crucial legal aspects that are also involved in this entire process, so it might be a good idea to discuss your proposed tactics with a lawyer with great M&A experience before going ahead.