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PAGE 8 COMMENT July 12, 2010 • law Times expenditures. Th e timing of tax payments, however, is just as im- portant as the amount. Time has value in all property transactions. Th us, people should always take time value considerations into account in structuring payments as the government wrote the rules to penalize tardy taxpayers. Time has two dimensions: T future and present. Given a sum of money, we can determine its value at some future date if we know the interest rate at which we will invest the money. Con- versely, if we know that we are to receive a sum of money in the future, we can determine its val- ue today if we know the rate at which it is, or can be, invested. To determine the value of money, we need the relevant interest rate. We express the value of all assets, tangible and he fundamental purpose of tax law is to collect revenue for government Considering the time value of money Financial intangible, in terms of their future or present value if we can determine the rate at which the asset is invested or discounted. Th at usually in- volves the prevailing market- determined interest rate. In economic terms, inter- est is the rental cost of bor- rowing money. As with all rent- als, the cost of renting money may be fi xed in advance, de- terminable at a future time or variable according to specifi ed conditions. Th us, interest and time are inextricably related. In- terest is relevant if, and only if, it's specifi ed in relation to time. Litigation lawyers and judges account for time value in com- puting damages. For example, suppose that a plaintiff 's law- yer is off ered a choice between a cash settlement of $500,000 and six successive payments of $100,000 payable at the end of each year. Should the lawyer See you July 26 Law Times will not publish in print next week. We will return on July 26, 2010. Meanwhile, enjoy fresh content on our web site at: www.lawtimesnews.com Matters By Vern Krishna accept the lump-sum settlement or pursue the extended payment plan? Ignoring issues of risk and insolvency, the answer depends upon the prevailing interest rate and income tax considerations associated with the two alterna- tives. At an interest rate of 10 per cent, the six payments of $100,000 have a present value of only $435,300. Hence, the plaintiff would be better off with the lump-sum settlement. If the interest rate was four per cent, however, the six payments would have a net present value of $524,000. Similarly, the defendant in a lawsuit involving future lost profi ts of a business enterprise may ask the court to reduce the size of any lump-sum award to the plaintiff to take into ac- count the accelerated value of receiving the money today rather than over an extended period of time. For example, if one can es- tablish that the defendant's ac- tions will cause the plaintiff a loss of $100,000 in business profi ts annually for a period of fi ve years, should the defen- dant be required to pay the nominal amount of the dam- ages up front or some lesser, discounted amount? At an interest rate of 12 per cent, the annual loss of $100,000 spread over fi ve years is worth only $360,000 today if the payments are receivable at the end of each year. Th us, ignoring the time value of money would penalize the de- fendant and provide the plain- tiff with a windfall gain. Although most lawyers are familiar with the calculation of simple and compound inter- est, we are less intuitive about the concept of the discounted value of future sums of money. Th is is because we are taught to think of investing for the future but not of the present value of future sums. Yet math- ematically speaking, future val- ue and present value are mirror images of each other. Th e pri- mary purpose of determining future and present values is to measure money in comparable terms across time periods by translating future dollars into equivalent current dollars and vice versa. As one might expect, the Canada Revenue Agency lives by its own rules. It compounds interest on a daily basis on outstanding amounts of taxes payable. Th e interest isn't de- ductible for tax purposes. For example, if an individual owes $10,000 in taxes, daily com- pounding of the amount at an equivalent of eight per cent per year would increase the tax payable at the end of two years to $11,735. Hence, as the compounding rate is set at about three per cent above market rates, it's almost always better to pay a tax assessment and then challenge it at a later date. It's virtually impossible for a taxpayer to obtain an investment that will yield an equivalent amount of interest for the same risk. Since tax disputes can quite easily continue for eight to 10 years, daily compound inter- est has an enormous impact on the ultimate amount payable if the taxpayer ultimately loses the fi ght with the CRA. At six per cent, money doubles every 12 years. Th us, tardiness in paying taxes is another lucrative source of government revenues. Th at shouldn't be surprising. Th e gov- ernment writes the rules. LT Vern Krishna is tax counsel at Borden Ladner Gervais LLP and executive director of the CGA Tax Research Centre at the University of Ottawa. He can be reached at vkrishna@blgcanada. com. Untitled-9 1 www.lawtimesnews.com 7/5/10 3:45:11 PM