Citation: 2014 TCC 52
Date: 20140214
Docket: 2011-3600(GST)G
BETWEEN:
Beaudet Claude et Saucier
Alain,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Lamarre J.
[1]
The appellant is an undeclared
partnership made up of two partners, Claude Beaudet, chartered appraiser, and Alain
Saucier, actuary. This partnership operates a business that builds multiple unit
residential complexes for rental purposes. During the period from April 1,
2006, to June 30, 2009, it built four buildings, all located on one lot that it
had acquired in 2003, governed by a co-ownership agreement signed in 2008 and
having street addresses 6300, 6400, 6305 and 6405 Rue de l’Aster, Québec. This
project was known as "Les Jardins de l’Aster" and was built in four
phases, one building per year. Since these buildings were constructed by the
appellant, which became the owner in the course of its commercial activities
(namely renting apartment units), it is deemed to have paid as a recipient and
collected as a supplier the tax in respect of the supply of these buildings,
calculated on the fair market value (FMV) of each building on the day the work
was substantially completed or, if later, the day it gave possession of the
apartment building or an apartment in that building to a tenant This is a
self-assessment by the builder for the self-supply of a multiple unit residential
complex, pursuant to subsection 191(3) of the Excise Tax Act (ETA). This
statutory provision states the following:
191(3) Self-supply of
multiple unit residential complex — For the purposes of this Part, where
(a) the construction or
substantial renovation of a multiple unit residential complex is substantially
completed,
(b) the builder of the
complex
(i) gives, to a particular person who is not a purchaser under an
agreement of purchase and sale of the complex, possession or use of any
residential unit in the complex under a lease, licence or similar arrangement
entered into for the purpose of the occupancy of the unit by an individual as a
place of residence,
(i.1) gives possession
or use of any residential unit in the complex to a particular person under an
agreement for
(A) the supply by way of sale of the building or part thereof forming
part of the complex, and
(B) the supply by way of lease of the land forming part of the complex
or the supply of such a lease by way of assignment, or
(ii) where the builder is an individual, occupies any residential unit in
the complex as a place of residence, and
(c) the builder, the
particular person, or an individual who has entered into a lease, licence or
similar arrangement in respect of a residential unit in the complex with the
particular person, is the first individual to occupy a residential unit in the
complex as a place of residence after substantial completion of the construction
or renovation,
the builder shall be
deemed
(d) to have made and
received, at the later of the time the construction or substantial renovation
is substantially completed and the time possession or use of the unit is so
given to the particular person or the unit is so occupied by the builder, a
taxable supply by way of sale of the complex, and
(e) to have paid as a
recipient and to have collected as a supplier, at the later of those times, tax
in respect of the supply calculated on the fair market value of the complex at
the later of those times.
I Issue
[2]
The issue is the market
value of each of the buildings on the respective dates the first units were
occupied by the first tenants, namely:
6300 Rue de l’Aster June 1, 2006
6400 Rue de l’Aster June 1, 2007
6305 Rue de l’Aster June 1, 2008
6405 Rue de l’Aster June 1, 2009
(See expert
reports, Exhibit A-2, page 3, and Exhibit I-1, page 3.)
[3]
The appellant is of the
opinion that this market value, in a self-assessment context, corresponds to
the construction costs (Exhibit A-2, page 52).
[4]
The respondent, on the
other hand, favoured the value established using the comparison method
(comparable sales) and income method (value based on the income the building
can generate) (Exhibit I-1, page 69).
[5]
Thus the respective
values of the buildings as determined by each of the experts are as follows (Exhibit
A-2, page 53, and Exhibit I-1, page 71):
|
|
|
Value Determined
|
|
|
|
Appellant
|
Respondent
|
|
6300 de l’Aster
|
June 1, 2006
|
$4,450,000
|
$5,054,000
|
|
6400 de l’Aster
|
June 1, 2007
|
$4,550,000
|
$5,524,000
|
|
6305 de l’Aster
|
June 1, 2008
|
$4,900,000
|
$5,859,000
|
|
6405 de l’Aster
|
June 1, 2009
|
$5,150,000
|
$6,335,000
|
II Facts established by the evidence
[6]
The two partners call
themselves real estate investors. Since 1984, they have been purchasing land on
which they build apartment buildings for rental purposes. In 1989, they created
their company, Beaudet Saucier Inc., which acted as a building contractor. To
date, they have built 26 buildings with a total of 1,400 units. Since the goods
and services tax (GST) was introduced in 1991, they have always
"self-assessed" on the basis of construction costs. This was never
questioned by government authorities until July 2010, when the Agence du revenu du Québec (ARQ) adopted a different position for the period at
issue. According to the auditor, Alain Tremblay, the ARQ assessment service had
never conducted a specific assessment before. This was only done in 2010.
[7]
According to Mr. Beaudet,
who is a chartered appraiser, the value of the consideration for
self-assessment purposes is the amount an investor is ready to pay to acquire
the building for the purpose of carrying on a business renting the apartments
in that building. He considers that this value corresponds to the construction
costs. Included in the construction costs are the builder’s profit on labour
and the worksite mobilization costs (fixed costs such as trailers, temporary
electrical service, and equipment).
[8]
In his opinion, subsequent
financial success or failure is not an element to be considered. He explained
that, for the ARQ, the value for self-assessment purposes is the fair market
value of a building that is already in operation in a secondary market (with a
history of rental income and operating costs and with financing in place). Mr. Beaudet
is of the view that the building should rather be assessed in a primary market
(that is, on the basis of the cost of the building, which includes the price of
the land and the cost of construction, on day one). He submits that as long as there
is no history, future profitability cannot be accurately determined, and this
is why, in his view, the building cannot be assessed in a secondary market for
self-assessment purposes.
[9]
Mr. Beaudet further
explained that the appellant had thought it appropriate to make a downward
adjustment of the actual costs to take into account unusual problems related to
soil tests that had given unfavourable results with regard to bearing capacity,
which occasioned exceptional additional excavation costs and a greater use of
concrete and steel.
[10]
Similarly, there was an
unusual cost overrun because the first building had to be built over a
condensed period of five months following a default by the business that was to
have manufactured the buildings at the factory. There were also unexpected issues
with inadequate soundproofing between the rental units and with water leaking
through the roof. All this led to unexpected additional costs that, in his
opinion, should not be taken into consideration when establishing the value of
the buildings for self-assessment purposes. Mr. Beaudet also referred to the
fact that a certain percentage of the parking area could not be rented because
of its use for building maintenance purposes. Lastly, the swimming pool for the
four buildings was only built in 2008 and did not open until 2009.
III Expert
testimony
A. Testimony of the appellant’s expert
[11]
Jérôme Lampron, chartered
appraiser, testified as an independent expert for the appellant. He more or
less repeated Mr. Beaudet’s statements that, in a self-assessment context, the
appraisal should be based on a building that is still empty and not yet in
operation (which he, as did Mr. Beaudet, describes as the primary market, as
opposed to the secondary market, in which rental buildings are already on the
market). In this context, although he analyzed three appraisal methods, he selected
the cost method as the most appropriate.
(1) Cost method
[12]
Mr. Lampron explained
that the most reliable method for appraising a building that has just been
constructed and is not yet on the rental market is to establish its value using
construction costs. He determines cost using actual production costs, that is,
the cost of the land, the physical components of the building, labour and the
builder’s profit (which corresponds to the total amount the contractor charges
the appellant for delivering the building before the appellant begins operating
it).
[13]
He established these
costs using invoices, contracts and accounting records, which had been double-checked
in the preparation of his report. Moreover, he added to the construction costs the
cost of the project manager hired by the appellant to complete the building
finish because this cost had not initially been included in the builder’s
project cost.
[14]
The market value of the
land was determined using the actual cost (purchase price of $245,000, to which
were added the various costs incurred, after acquisition, for the development
of the site for the overall project: Exhibit A-2, pages 20-21) and verified by the
comparison method using transactions on vacant lots, and thus comparing the
unit rate per square foot. Since the four buildings were constructed in four
phases over four years on a single lot, with each building holding a share of
25% under a declaration of co-ownership, Mr. Lampron allocated 25% of the
determined cost of the land to each of the buildings. Mr. Lampron accordingly
calculated the actual cost of the land at $1,391,862, which he divided into
four for each phase, thus giving the land a value of $350,000 per building
(Exhibit A‑2, pages 21 to 24). He determined that this amounted to $5.26
per square foot, which accurately reflects the price per square foot of
comparable land, in his opinion. He also determined that the price per unit of $5,374
which he arrived at was in the range of the market rate per unit for a
comparable project (between $5,000 and $6,000 per unit) (Exhibit A-2, page 23).
[15]
With regard to the
buildings, as mentioned above, the expert used the actual costs incurred to
carry out the project because these were new buildings. Additionally, he concurs
with Mr. Beaudet with regard to the downward adjustment of these costs to
take into account extra construction costs that should not, in his opinion, be
included when establishing the market value of a building.
[16]
In that regard, he
noted labour costs that were abnormally high for the construction of the first
three buildings. He compared the number of hours per unit generally required in
the construction of a residential rental building (around 165 hours/unit) with
the hours compiled in this case (256 hours/unit for Phase I, 205 hours/unit for
Phase II and 218 hours/unit for Phase III). As Mr. Beaudet had explained, these
extra hours are attributable to the fact that, initially, the first building
was to have been factory-built but in the end had to be built by a contractor
in five months (therefore requiring additional labour). As for the next two
buildings, the additional cost is attributable to poor management by the
contractor in charge. For Phase IV, the developer changed the team of employees
on the worksite and construction was carried out in the standard number of
hours (Exhibit A-2, page 27).
[17]
The second downward adjustment
is for additional costs related to the bearing capacity of the ground. In
comparison with a similar construction project, but where there was adequate
bearing capacity, the expert considered that there were cost overruns due to a
greater use of concrete and steel and to additional costs for laying the foundations.
He deducted $102,000 for obsolescence (depreciation) from the construction cost
of each phase (Exhibit A-2, page 28).
[18]
The third adjustment is
for poor soundproofing between the apartment units and for water leaking from
the roof, to which Mr. Beaudet referred. He calculated an amount of $179,000
per building for functional obsolescence in relation to these problems.
[19]
The expert arrived at a
depreciated replacement cost, which he used to establish the final value of
each building (including the value of the land) according to the cost method,
and which he used for the purposes of the appeal before this court, namely the
amounts at paragraph 5 of my reasons (see Exhibit A-2, page 30).
(2) Comparison method
[20]
Mr. Lampron did not adopt
the comparison method because he could not find any comparable sales on the
primary market. He felt that taking sales from the secondary market involves
too many adjustments, making the result difficult to rely on. These adjustments
consist in subtracting from the value of the building on the secondary market
the developer’s profit (estimated at 5% of the cost of a project) as well as
the promotional costs related to launching the project (advertising, office
costs, wages and unit delivery costs, and usual rental losses an investor can
anticipate) (Exhibit A-2, pages 35 and 36).
(3) Income method
[21]
He did not adopt the
income method either because it consists in determining the value of a building
using the expected net income adjusted by the application of an overall
discount rate (ODR). This rate is established on the basis of comparable sales.
As with the comparison method, the expert did not find any comparable sales in the
primary market, but had to fall back on sales in the secondary market. The ODR
was therefore established on the basis of sales in the secondary market, which,
he repeated, is not adequate in a self-assessment context. He concluded that
this method was too indirect (transcript, Volume 1, page 134, Exhibit A-2, page
52). However, he went through the exercise of establishing the value using this
method nonetheless (Exhibit A-2, page 50). I will come back to his approach in
my analysis of the approach used by the respondent’s expert, and highlight the
differences.
B. Testimony of the respondent’s expert
[22]
Jacques Flynn, chartered
appraiser, was mandated by the ARQ in 2011 to appraise the four buildings in
question for self-assessment purposes. He conducted the appraisal using three
methods: the cost method, the comparison method and the income method. He stated
that he ultimately decided to use the results from the last two methods (Exhibit
I-1, page 69).
(1) Cost method
[23]
At the outset,
Mr. Flynn explained that cost overruns that occur for various reasons in
the construction of a building have an impact on the cost for the contractor,
but do not necessarily influence the value of the building for a potential
buyer (transcript, Volume 1, pages 165-167).
[24]
Moreover, he noted that
one must be careful to verify what the workers worked on before suggesting that
there was an additional labour cost per unit, as the appellant’s expert contended.
He argues that this additional labour cost could very well have been for the
construction of additional parking or the swimming pool or for laying sod on
the property. He also stated that even though it was built at the end of the
project, the swimming pool was part of the project’s overall promotional plan
and it had to be taken into consideration from the start in appraising Phase I
(transcript, Volume 1, pages 170-171).
[25]
Mr. Flynn first
did an analysis using the cost method (adopted by the appellant’s expert) to
establish the value of the land and the buildings for self-assessment purposes
on the various dates mentioned above.
[26]
With regard to the
land, he noted that the appellant paid $245,000 for it according to the contract
of sale signed August 19, 2003, following an offer to purchase made in 1992
(Exhibit I-2). He calculated that this represented $1.17 per square foot, which
was the value established in 1992.
[27]
For self-assessment
purposes, Mr. Flynn reappraised the land as at the specific dates noted
above, namely June 1, 2006, 2007, 2008 and 2009.
[28]
To do this, he analyzed
26 transactions made between 2003 and 2009 and involving vacant lots that were
used to build multiple unit residential complexes. The appellant’s expert had
analyzed 10 sales of similar lots. Mr. Flynn observed that the unit price
per square foot had gone up to $6.75 in 2007.
[29]
However, contrary to
Mr. Lampron (the appellant’s expert), Mr. Flynn preferred to conduct
a per-unit appraisal (based on the number of units planned in each project) rather
than a per-square foot appraisal. Mr. Lampron explained that he did not
use the per-unit value because the density (the number of units, which could be
different even for lots having the same area) was too variable. Mr. Flynn simply
ignored this factor, assuming that all the lots considered for appraisal
purposes were comparable and that the units built on these lots were the same
size (transcript, Volume 2, page 40).
[30]
Mr. Flynn therefore
established the value of the land according to a unit price varying from $6,500
to $8,000 from Phase I to Phase IV, for a total land value rising from $435,500
for Phase I to $512,000 for Phase IV (Exhibit I-1, pages 20 to 23).
[31]
To establish the value
of the buildings using the cost method, Mr. Flynn relied on the
unit-in-place method rather than actual costs as Mr. Lampron had done. The
method Mr. Flynn chose was to estimate the replacement cost of each unit, basing
his estimate on a catalogue of unit costs. Mr. Flynn chose the American
manual, Marshall & Swift, which provides estimated replacement costs
with conversion tables for each Canadian province. Mr. Lampron dismissed
this approach because the buildings had just been built on the appraisal date
and there was no need to turn to this alternative method. He explained that
such a manual was useful for estimating the replacement cost of old buildings,
but it was far from accurate. Mr. Flynn noted that, since he, unlike the
appellant and Mr. Lampron, did not have the actual costs, he resorted to
this manual. In cross-examination, it was demonstrated that the cost estimates
in this manual seem far from reflecting actual prices in the province of Quebec, which are apparently much lower than those shown in the manual.
[32]
Moreover, Mr. Flynn
applied a reduction for obsolescence of 5% of the replacement cost for Phase I,
2% for Phase II and 1% for Phase III to take into account the cost overruns
related to the soundproofing and roof issues. He also admitted in
cross-examination that he did not perform any soil analysis. He added that the
appellant was aware of the soil problem before construction began and should
have known that it would result in additional costs. In his opinion, this was not
an exceptional cost because the appellant, with full knowledge of the facts, decided
to go ahead with construction (transcript, Volume 2, pages 24-26).
[33]
He ultimately arrived
at a total valuation (including the land) under the cost method by using the unit-in-place
method (based on Marshall & Swift) (Exhibit I-1, page 32). I have reproduced
his valuations below, comparing them with those of the appellant’s expert (Exhibit
A-2, page 30):
|
|
Appellant
|
Respondent
|
|
6300 de l’Aster
|
$4,450,000
|
$5,125,657
|
|
6400 de l’Aster
|
$4,550,000
|
$5,469,903
|
|
6305 de l’Aster
|
$4,900,000
|
$5,987,045
|
|
6405 de l’Aster
|
$5,150,000
|
$5,947,701
|
[34]
Mr. Flynn also
verified the value of the buildings using the cost method the appellant’s
expert used (Exhibit I-1, page 34, and Exhibit A‑2, page 30). He arrived
at a higher valuation for the buildings than the appellant. In so doing, he
considered financing costs, promotional costs, and the delivery cost of the
units, as well as the salaries of the two partners, which, according to him,
were indirect costs that were incurred prior to the self-assessment date and
that may be included in the mandatary’s cost (transcript, Volume 1, pages 209 to
214). Mr. Lampron (the appellant’s expert) did not include these costs in
his calculation (Exhibit A-2, pages 25 and 30).
[35]
Lastly, Mr. Flynn applied
the cost comparison method to verify whether the estimated value using the Marshall
& Swift method was reasonable. He explained that, for the first year,
the value he arrived at for the building was around $47 per square foot whereas
the value determined by the appellant was $40 to $42 per square foot
(transcript, Volume 1, page 220). According to the market data he had
confidentially traced in other ARQ files (which were therefore not available to
the appellant), the indicators varied between $58 and $93 per square foot
(Exhibit I-1, page 35 and transcript, Volume 2, pages 77 to 82). He therefore
concluded that the value at which he arrived using the cost method is closer to
the price a buyer would have paid to a general contractor for the buildings in
question than is the price at which the appellant’s expert arrived, even though
he concedes that the market prices he used are not necessarily for identical
buildings (transcript, Volume 1, page 221).
(2) Comparison method
[36]
Mr. Flynn himself admitted
that this method is not appropriate in this case, but could be useful for
verifying the value obtained through the analysis done using the other two
methods. As this method consists in reviewing recent sales of similar – to the
extent possible – properties on the market, it provides an indicator of market
value.
[37]
Most of the comparables
used in this case were older buildings, without indoor parking, without an
elevator, and without a swimming pool. The indicator derived from these comparables
is therefore weak (transcript, Volume 2, page 106).
[38]
The values Mr. Flynn
arrives at using the comparison method (Exhibit I-1, page 57) show differences
of between approximately $100,000 and $300,000 as compared with the
results obtained using the cost method, which, he said, is not a significant disparity.
(3) Income method
[39]
According to the
experts, this method requires finding the price an investor would pay for a
building, considering the net income and expected rate of return on the capital
invested (Exhibit I-1, page 58, Exhibit A-2, page 41).
[40]
One must begin by
determining the potential gross income from the buildings. The two experts made
an estimation thereof based on the lists of pre-rentals provided by the
appellant. It corresponds to the projected income before delivery of the units
(Exhibit A-2, pages 41 and 44-47; Exhibit I-1, page 58). Mr. Flynn admitted
that he had slightly overestimated the parking income because he did not have
the exact data.
[41]
A reserve of around 3% for
vacancies and bad debts was then calculated by each expert.
[42]
Next, the effective
gross income (EGI) so established must be reduced by the annual operating costs
to establish the net income from the building. According to Mr. Flynn, certain
expenses, such as custodial services, maintenance, and repairs, must be
standardized using reliable standards (which can be obtained, for example, from
the Canada Mortgage and Housing Corporation (CMHC)).
[43]
Broadly speaking, it
can be seen that the appellant’s expert determined an expense amount
corresponding to 44% of effective gross income, compared to 37% for the
respondent’s expert (Exhibit A-2, page 45, and Exhibit I-1, page 66). Mr. Flynn
stated that, since he did not have the appellant’s income statements, he simply
took the 2009 expenses that he had and applied them to the previous years. He
stated that the actual expenses from 2009, which he had not standardized or
updated, are likely higher than they should for the previous years (transcript,
Volume 1, page 250). Moreover, Mr. Flynn explained that the appellant’s extra
expenses could be attributed to the "salary" item, which, in his
view, should not be taken into account for the purposes of this exercise
(transcript, Volume 1, pages 252 and 253). In his opinion, the fact that the partners
decided to manage their property themselves should not be reflected in the
value of the building. In his judgment, it would have cost the appellant less
to contract out the building management. That is why this item should be
standardized. The appellant’s expert, in taking into consideration salaries and
management, allocated 10% of the effective gross income to these expenses,
whereas Mr. Flynn standardized this item at 5% (transcript, Volume 1,
pages 256–259, Exhibit I-1, page 66, and Exhibit A-2, pages 44‑47).
[44]
In his report, the
appellant’s expert, Mr. Lampron, explained that this salary expense was
standardized [translation] "using
the difference between the assumed actual expenses for rental costs,
administrative support, advertising, management, etc., and the standard
management fees (4.5% of the EGI) generally assumed for a comparable
building". He added that [translation]
"this higher expense allows, in particular, the rental of units at higher
rates than in comparable buildings" (Exhibit A-2, page 42, Salaries). As for
the maintenance and repair expenses, which were greater than the amount used by
Mr. Flynn, Mr. Lampron explained that he used the actual costs
because the building under consideration offered many more services that the
other rental buildings in the area (Exhibit A-2, page 42, Maintenance and Repairs).
[45]
As for the ODR which is
applied to the net income from the building in order to capitalize its value, Mr. Flynn
used a slightly higher rate than Mr. Lampron, which had the effect of
reducing its value (transcript, Volume 1, page 249).
[46]
Lastly, the respondent’s
expert, Mr. Flynn, took into account a shortfall of $23,000 and $25,000
for the last two buildings only whereas the appellant’s expert took into account
lost rent varying between $131,500 and $137,000 per year (Exhibit I-1, page 66,
and Exhibit A-2, page 50). According to the indications Mr. Flynn obtained,
the buildings were almost fully rented on the date of the self-assessment. This
is why he did not take into account any shortfall for the first two buildings
and why he allowed only a small shortfall amount for the two others. In
cross-examination, on looking at the [translation]
"list of pre-rentals" in Appendix C of his report (Exhibit I-1), he admitted
that on June 1, 2006, there were 41 of 67 units that were not rented, 21 of 64
not rented on June 1, 2008, and 23 of 64 not rented on June 1, 2009. He stated
that this is why he took into account a shortfall for the last two phases
(transcript, Volume 2, pages 131 to 134).
[47]
Another significant
difference between his report and Mr. Lampron’s is that Mr. Flynn did
not deduct any amount for the developer’s profit. According to him, this profit
is earned when the building is full. The promotional work was thus, in his
opinion, practically completed at the time of the self-assessment and there is
no reason not to consider the developer’s profit.
[48]
Mr. Flynn believes
that the promotional costs (advertising, office costs, salaries and delivery
charges) deducted by the appellant should not be handled in this way (Exhibit A-2,
page 50). These expenses are already included in the price charged to tenants,
in accordance with the principle of anticipation (transcript, Volume 1, page 265).
That, according to him, is the main difference between Mr. Lampron’s
result and his own, that is, the treatment of the promotional expenses
(transcript, Volume 1, page 266).
[49]
As for the
soundproofing and roof expenses, he took them into account in the [translation] "building reserve"
item in the proportion of 2.5% (Exhibit I-1, page 66).
[50]
Mr. Flynn further stated
that he had never seen in the literature the distinction Mr. Lampron made
between the primary market and the secondary market (transcript, Volume 1, page
265). He mentions, however, at page 36 of his report (Exhibit I-1), with regard
to the comparison method, that [translation] "it
is rare for an appraiser to find significant sales of new buildings in the
primary market". In cross-examination, he also explained that one speaks
of a primary market where there is a sale between a builder and a buyer, and that
in such cases one seeks to determine the minimum price a contractor would be
willing to sell for (transcript, Volume 2, pages 75-76).
(4) Correlation
[51]
Mr. Flynn concluded
that all three methods gave practically the same indicator, within $100,000,
for the first three buildings. It was only for the fourth building that the appraisal
using the income method resulted in a considerable difference of $300,000 (more)
compared to the value established using the cost method (a difference of 5%).
The production cost did not really change, but the market shot up following the
drop in mortgage rates. He said he used the income method precisely in order to
quantify this difference, which represented the developer’s profit (transcript,
Volume 1, page 268, line 26, and Volume 2, pages 45 and 46). However, in his
report, he seems to come to a slightly different valuation for the first two
buildings and notes that he used the indications obtained using the comparison
method and the income method. The results he ultimately used (Exhibit I-1, page
69) are those found at paragraph 5 of my reasons.
[52]
Moreover, Mr. Flynn
filed in evidence an appraisal report prepared for the appellant’s financial
institution in July 2005 for financing purposes (Exhibit I-4). The market value
of the building (Phase I) at that time was assessed at $5,800,000 (Exhibit
I-4, page 3) and the appellant obtained a hypothec of $5,440,000 (Exhibit I-4, tab
2).
IV Analysis
[53]
The parties agree that
the sole issue is the fair market value of the four buildings on the dates used
for the self-assessment, namely June 1, 2006, 2007, 2008 and 2009.
[54]
The expression
"fair market value" is defined at subsection 123(1) of the ETA as follows:
DIVISION
I INTERPRETATION
123. (1) In section 121, this Part and
Schedules V to X,
“fair market value” of property or a
service supplied to a person means the fair market value of the property or
service without reference to any tax excluded by section 154 from the
consideration for the supply.
[55]
The two experts referred
to policy statement P-165R, "Fair Market Value for Purposes of Part IX of
the Excise Tax Act", published by the Canada Revenue Agency (CRA), in
which, under the heading "Fair Market Value", the Minister’s position
is described as follows: "Generally, the Department’s [Revenu Québec’s]
position is that fair market value represents the highest price, expressed in
terms of money or money’s worth, obtainable in an open and unrestricted market
between knowledgeable, informed and prudent parties acting at arm’s length,
neither party being under any compulsion to transact" (Exhibit A-2, page
5, Exhibit I-1, page 3).
[56]
The two experts
disagree about the appraisal method for estimating the fair market value in
this case. The appellant’s expert is of the opinion that the value, in a self‑assessment
context, corresponds to the value which would be established in a notional
contractual agreement with regard to a substantially completed building ready
to receive its first occupants. On the appraisal date defined in the ETA, the realization
of the project’s profitability remains an expectation. Mr. Lampron considers
that the fair market value in a self-assessment context corresponds to the
price of a property on the primary market, that is, its value established on the
basis of production costs, i.e. the cost of the land, the building components,
labour and the builder’s profit.
[57]
Mr. Lampron further
states that the developer’s profit should not be considered in the appraisal at
this stage because what is being appraised is the building (including the land)
as such, not the business carried on, namely a residential leasing business,
which is subject to secondary market forces (Exhibit A-2, pages 5-6).
[58]
As for the respondent’s
expert, he does not distinguish between the primary and secondary markets. He considers
it wrong to say that the cost of production with respect to a property is solely
the sum of the property’s physical components. In his view, the property to be
assessed is a building that has been sold and with which income is associated
by virtue of a lease. In his opinion, the leases are part of the sale of the
building and all the rental and management activities give added value to the whole
of the elements that make up the property (Exhibit I-1, page 70). He therefore
includes the developer’s profit in his appraisal.
[59]
Thus, as has been amply
explained, the appellant’s expert applied the cost method using the adjusted
actual costs. The respondent’s expert emphasized that the developer’s profit
must be determined using the comparison or the income method, and then added to
the value established by the cost method. He noted that, for the first three
buildings, he arrived at roughly the same result with each of the appraisal
methods. It was only for the fourth building that the value estimated on the
basis of income was higher, by around 5%, than the value estimated by cost, and
this is why he used the income method in the end.
A. Method used by the Court for
self-assessment purposes: cost method
[60]
In my opinion, since
the respondent’s expert integrated the developer’s profit into his estimated
value in any case, regardless of the method used, I believe that the cost
method can quite readily be used in this case and that what must now be decided
is which components are to be taken into account in using this method to arrive
at the value on which the self-assessment will be based. The cost method of appraisal
is moreover the one that has generally been used by this court for
self-assessment purposes (see Desjardins v. Canada, 2010 TCC 521, [2010]
T.C.J. No. 401 (QL), [2010] G.S.T.C. 179; 9103-9438 Québec Inc. v. Canada,
2004 TCC 466, [2004] T.C.J. No. 361 (QL), [2005] G.S.T.C. 95; Charleswood Legion
Non-Profit Housing Inc. v. Canada, [1998] T.C.J. No. 503 (QL), [1998]
G.S.T.C. 65). Moreover, this court may accept or reject, in whole or in part,
the opinions offered with regard to the valuation of property to be appraised,
and may itself estimate the value, taking into account the admissible evidence
available to it(Petro-Canada v. Canada, 2004 FCA 158, [2004] F.C.J. No. 734
(QL), 2004 CarswellNat 1163, paragraph 48).
[61]
The cost method
requires establishing the value of the land on the one hand and the buildings
on the other.
(1) Land
[62]
The appellant appraised
the land using the total cost of the development of the site for the four
phases. It arrived at a value of $1,391,862, for a unit price of $5.26 per
square foot, and a price of $5,374 per apartment.
[63]
This value was allocated
equally to each phase, thus giving the land a value of $350,000 per phase.
[64]
The respondent decided to
compare sales of vacant lots that were used for the construction of multiple unit
residential complexes of various sizes. She arrived at a total value of close
to $1.9 million, that is, a value between $6 and $7.40 per square foot, and a
price per unit varying between $6,500 and $8,000. The respondent’s expert
admitted he did not take density into consideration in his comparisons, and
that is an element that can cause significant variations in the price per unit
(the price per unit will undeniably vary according to the number of units built
on the same lot).
[65]
I agree with the appellant
that it is more accurate to compare on the basis of price per square foot.
[66]
On the other hand, I
agree with the respondent that the price the appellant paid does not quite
correspond to the actual value because it had negotiated the purchase price a
number of years earlier. I note, however, that the value assigned to the land
by the appraiser who was retained by the financial institution in relation to
the granting of a hypothecary loan in 2005 was $1,463,000, or $5.50 per square
foot (Exhibit I-4, page 3).
[67]
I would therefore assign
this same value of $1,463,000 to the land ($5.50 per square foot), and
distribute this value over four years as the appellant did. I therefore arrive
at a value for the land of $365,750 to be included in the cost of the property
for each of the phases.
(2) Appraisal of the
buildings
(a) Method used in the appraisal
by cost
[68]
For the buildings, the
first difference between the experts is the method used in the appraisal by cost.
In the appellant’s case, actual costs were used. In the respondent’s case, a method
was used whereby the estimation of costs was based on the Marshall &
Swift manual. I agree with the appellant that, since the buildings being
appraised were new at the appraisal date, it is not necessary to resort to a reference
manual that is used for older buildings. In addition, the appellant noted
significant differences between the estimated costs of certain building components
in the manual and the actual costs.
[69]
I will therefore adopt the
actual cost method. Each of the experts made adjustments to the actual costs (Exhibit
A-2, page 30, and Exhibit I-1, page 34), and I will now analyze these
adjustments. This court has accepted the principle that an appraisal by cost can
be reduced in cases where there are construction cost overruns, or particular
problems with regard to soil contamination, or errors in design or construction
(Desjardins, supra, paragraphs 33‑34; Charleswood Legion,
supra, paragraph 47).
(b) Appellant’s adjustments
(i) Labour
[70]
The first adjustment by
the appellant was for labour. No such adjustment was made by the respondent. In
his report, the respondent’s expert assumed that the buildings had been
constructed in factory-built sections (Exhibit I-1, page 12). He admitted in
court that he was not aware that the appellant had not been able to proceed in this
fashion and that it had had to turn to another contractor, resulting in the
first building having to be built on an expedited basis over five months. I
agree with the appellant that in this context the labour costs were higher than
expected and that this must be taken into consideration. With respect to the next
two phases, the appellant also made an adjustment based on hours worked in
excess of the industry standard. Here, I tend to agree with the respondent: the
evidence did not clearly establish the reasons put forward by the appellant.
The appellant’s expert did not really submit any evidence to support his assertion
that 165 is the standard number of hours per unit in the industry. Moreover,
the two partners have been involved in the construction of rental buildings for
a number of years and I doubt that they would not have maintained control over the
hours invoiced during Phases II and III, waiting until Phase IV to correct
the situation. Lastly, for appraisal purposes, it would be surprising if the
appellant had agreed to sell at a price lower than its actual cost, unless
there were particular circumstances as in the first phase.
[71]
I therefore accept the
adjustment for labour for the first phase only. The appellant took into consideration
a difference of 91 hours per unit at the contractor’s hourly rate of $50. The
expert calculated this difference on the basis of a standard number of 165 hours
per unit. As I am of the opinion that this figure was not proven, I would
instead consider a difference determined according to the average number of
hours of work in the other phases. A difference of 60 hours at $50 per hour for
Phase I, that is, an adjustment of $200,000 for 67 units, therefore appears
more appropriate to me.
(ii) Bearing capacity
[72]
The second adjustment
the appellant made was with regard to bearing capacity. In view of the geotechnical
study carried out two years after the purchase, which showed very poor soil
conditions, the appellant incurred additional costs for laying the foundations
and for unexpected oversizing (Exhibit A-2, page 28). In his report, the
respondent’s expert indicated that he did not take any soil analysis into account; he thus felt that the quality of the
soil and its compaction was adequate (Exhibit I-1, page 6). The respondent
therefore did not many any adjustments in this regard.
[73]
The appellant’s expert
compared the expenses in this case with those on a similar-sized project
carried out by the same developer in a zone with a better bearing capacity. I
agree that the adjustment proposed by the appellant should be made, namely a
deduction of $102,000 from the actual cost for each phase.
(iii) Functional obsolescence: roof
and soundproofing
[74]
The third adjustment
made by the appellant’s expert was to reduce the cost by an amount allowed for
functional obsolescence for the problems related to the roof and to soundproofing.
For the roof, Mr. Lampron used the actual cost of resolving the insulation
issue ($11,000 per building). For the soundproofing, the issues seem to have
been caused by the fact that the construction was carried out according to plans
drawn up for assembly in factory whereas assembly in fact took place at the actual
location of the building. Mr. Lampron therefore calculated the adjustment on
the basis of a contractor’s tender for the necessary corrective work ($168,000
per building) (Exhibit A-2, pages 29 and 30). The respondent’s expert, not having
the actual costs, chose to apply a combined reduction for obsolescence of 5%
for the first building ($243,000), 2% for the second building ($101,000), 1%
for the third building ($55,000) and nothing for the fourth building, stating
that the problems should have been resolved by the time Phase IV began (Exhibit
I-1, pages 30 and 32 to 34). Since Mr. Flynn admitted, by allowing for obsolescence,
that the problems related to the roof and soundproofing could affect the value
and since he did not have the exact amounts while Mr. Lampron based his
calculation on the actual figures, I will accept the reduction for functional
obsolescence calculated by the appellant for each building.
(c) Respondent’s adjustments
(i) Financing costs
[75]
The respondent added
financing costs of 1.5% of the total costs. The appellant did not include any
such costs, and provides no explanation for this. At pages 180 to 182 of the Traité
de l’évaluation foncière by Jean-Guy Desjardins, Éditions Wilson &
Lafleur, Montreal, 1992, which was referred to during the hearing and from
which an excerpt was filed in evidence as Exhibit I-3, it is stated that when
property is being appraised using the cost method, the costs are made up of
three elements: direct costs, indirect costs and the contractor’s profit. At
page 181, it is stated that the financing costs for the land purchase can
be taken into account in the indirect costs. In Évaluation immobilière, Principes,
concepts et pratiques by Dominique Achour, Éditions Agence d’Arc, Sillery,
1992 (excerpts filed as Exhibit A-3), at page 82, the interest charges on
construction financing are also included in indirect costs. A reading of the
contract for the purchase of the land (Exhibit I-2) shows no reference to any financing
for the purchase of the land, and no evidence was adduced in this regard. Nonetheless,
the appellant did secure a $5,440,000 loan in April 2006, which was related to
financing for the first building at issue (Exhibit I-4, tab 2). I
therefore agree with the respondent that financing costs should be added.
However, I would apply the rate of 1.5% to the total actual costs for the
buildings according to the appellant’s figures found in the appraisal of the
buildings by the cost method, in Exhibit A-2, page 30.
(ii) Promotional, advertising
and project management fees and contractor’s profit
[76]
Finally, the respondent
increased the cost of the buildings by an estimated amount of $30,000 per
building for promotion and advertising, as well as an amount corresponding to
5% of the total costs to take into account the project management fees normally
charged by the general contractor (in this case, the appellant, which for its
part did not calculate any amount for such fees). These additional costs are
part of the developer’s costs, which the appellant did not see fit to include in
the appraisal for self-assessment purposes.
[77]
At this point, the
respondent’s expert considers the cost method to be practically identical to
the income method. His opinion is that the value of the buildings, even using
the cost method, must take into consideration the rental income from each
building and that therefore the cost should be increased by the costs incurred
by the appellant as developer to make the project eventually viable. Thus, in
his opinion since the partners invested time in the project and incurred promotional
costs and costs for signing leases, these indirect costs are part of the cost
of the project on the date of the self-assessment. The appellant, however, contends
that in a primary market these costs should not be taken into consideration for
appraisal purposes as they are related rather to a business in operation. At
the time of the self-assessment, according to the appellant, the building was
still empty and no judgment can be made as to rental performance and the amount
of the resulting expenses for each building.
[78]
The respondent’s
expert, Mr. Flynn, noted in court that the two partners paid themselves
salaries of $100,000 in the first two years, but a minimal salary in the last
two years (transcript, Volume 1, pages 211-12). He himself standardized the
expense related to management, indicating management fees varying between $238,136
and $263,695 over the four years (Exhibit I-1, page 34).
[79]
In theTraité de l’évaluation
foncière by Jean-Guy Desjardins, cited above, the author seems to
distinguish between indirect costs and the contractor’s profit. In indirect
costs he includes, among other things, advertising costs and those related to
leasing and sales, as well as the contractor’s administration fees. These can
be expressed as a percentage of the direct costs. As for the contractor’s
profit, he stresses that it varies, depending on, among other things, economic
circumstances, and that it is essential that the appraiser first verify the
market conditions to be sure that such a contractor’s profit exists. On this
point, he refers in a footnote to the following from Real Estate Appraising
in Canada, The Appraisal Institute of Canada, 3rd Edition, 1987, pages 158 and
159:
35.
Real Estate appraisal in Canada, The Appraisal Institute of Canada, 3rd Edition, 1987, pages 158 and
159.
Entrepreneurial Profit
It is a common mistake
to assume that the cost approach sets the upper limit of value as based on the
principle of substitution, although sometimes true in the residential market,
the cost approach result is often far below the actual market value when
applied to other classes of property. This occurs when a sale is made of an
income property where the leasing of that property by the developer has created
an addition to so-called hard costs which cannot be found by summation of land
value and construction costs. Nonetheless, it is quite apparent from the price
paid by an informed purchaser that such a phenomenon is a function of the
market place. Under conditions of perfect competition, value cannot exceed the
cost of producing a product for long. Entrepreneurs would soon enter the market
and partake in the large profits produced. The principle of competition
dictates that such a flood would result in the lowering of prices. Real estate,
however, does not operate under ideal conditions and, hence, value may exceed
costs.
There are four primary
reasons why real estate fails to conform to perfect competition. First, some
sites are unique or limited in number either because of the physical qualities
of the area or because other sites cannot be made available. Second, zoning
laws may limit the areas of competing uses. Third, license laws, regulating
agencies or clauses in leases may prevent the establishment of competing units.
Fourth, the restrictions may temporarily prevent new competing construction.
Communities have, for example, declined to issue building permits for home or
apartment construction due to crowded schools.
Such barriers to free
competition require time and effort to overcome. The ability of a developer to
do so, coordinate a parcel of real estate and arrange a proper lease on it,
requires a payment which should be recognized as a cost. It is recognized in
the market place by purchasers and should logically be considered by appraisers
when applying the cost approach.
Over-compensating,
however, is not the solution. Care must be taken not to readily accept
entrepreneurial profit as inherent in most real property. It can be recognized
in cases where the cost approach results in a very low value indication when
compared to the results of other approaches. If there is evidence of a possible
entrepreneurial profit, it should be listed separately rather than being
apportioned between land and building values.
[80]
What I draw from this
is that in an ideal competitive market, the substitution test enables one to
verify that a rational user is not paying more for a building than the price that
user should pay for an identical and substitutable building (see also, Évaluation
immobilière, supra, by Dominique Achour, page 26). However, this ideal
competitive market may be affected for various reasons, such as the construction
of the building on a unique site or in an area with special zoning or that is regulated
by various restrictions limiting the construction of apartments in the area. In
that case, the market value could exceed the cost of construction. The appraiser
is nevertheless warned to be careful not to integrate the contractor’s profit
into the cost of the property as being inherent therein.
[81]
In my opinion, I was
not presented with evidence that the various above‑noted elements that
could mitigate the conditions of an ideal competitive market were present in
this case (there was no evidence of specific zoning regulations or of any
restrictions at all). On the contrary, it is the case, rather, that the
construction site turned out to be problematic following a soil study conducted
after the appellant purchased the land. Moreover, the respondent acknowledged
that it was only for the last phase, in 2009, that her expert established a significantly
higher value for the building by taking into account the contractor’s profit.
The expert explained that this was due to the drop in mortgage rates at that
time. In my opinion, this estimated profit should not be taken into
consideration here for self‑assessment purposes since, although the
fourth building was constructed in a year in which an increase in building
values was possible, this building was part of an overall plan developed at the
beginning of the construction of the first building in 2006. It was very
difficult at that time to predict the drop in mortgage rates in 2009. Additionally,
the evidence shows that 35% of the units still had not been rented at the time
the building was ready to be occupied in 2009.
[82]
I therefore conclude
that, since what is involved is the construction of an entire four-building
complex, the same appraisal method should be applied for each building on the
respective self-assessment dates. In the circumstances, I believe that the application
of the substitution test mentioned above and doing the appraisal by the cost
method without taking the developer’s profit into account are justified.
[83]
Since I understand from
the literature that indirect costs include promotional and advertising costs as
well as certain administrative costs, and that these costs appear to be
distinct from what is called the contractor’s profit, I would take into account
a certain amount for indirect costs for the purpose of determining the value of
the buildings. The evidence shows that the appellant paid around $170,000 for
advertising, as well as incurring salary and office expenses of approximately $120,000,
for each building (Exhibit A-2, page 50). The respondent added roughly $270,000
in total for such costs (including the developer’s profit) for the first two
buildings and $290,000 for the last two (Exhibit I-1, page 34). The respondent’s
expert acknowledged that the advertising costs actually incurred by the
appellant were too high to be used for the purposes of the appraisal (he
himself had allowed $30,000 per building) (transcript, Volume 1, page 269, Volume
2, page 72). In the end, I consider it fair to increase the total cost of the
buildings by $150,000 each to take into account the indirect costs.
V Conclusion
[84]
Taking the appellant’s
expert’s table in Exhibit A-2, page 30, and making the adjustments I have accepted
above (underlined in the table), the final value for each of the phases under
the cost method, which is the method I have adopted, is modified as follows:
Cost method – Final value determined by the Court
|
|
Phase I
|
Phase II
|
Phase III
|
Phase IV
|
|
Appraisal date
|
June 1, 2006
|
June 1, 2007
|
June 1, 2008
|
June 1, 2009
|
|
|
|
|
|
|
|
Actual cost of
buildings
|
$4,667,845
|
$4,603,522
|
$4,999,269
|
$5,066,709
|
|
Financing
costs (1.5%)
|
$70,017
|
$69,052
|
$74,989
|
$76,000
|
|
Total cost
|
$4,737,862
|
$4,672,574
|
$5,074,258
|
$5,142,709
|
|
Adjustment of
actual cost
|
|
|
|
|
|
Labour
|
($200,000)
|
$0
|
$0
|
$0
|
|
Bearing capacity
|
($102,000)
|
($102,000)
|
($102,000)
|
($102,000)
|
|
Advertising
and management fees
|
$150,000
|
$150,000
|
$150,000
|
$150,000
|
|
Adjusted actual
cost
|
$4,585,862
|
$4,720,574
|
$5,122,258
|
$5,190,709
|
|
Physical
deterioration
|
|
|
|
|
|
Curable
|
$0
|
$0
|
$0
|
$0
|
|
Incurable
|
$0
|
$0
|
$0
|
$0
|
|
Cost after physical
depreciation
|
$4,585,862
|
$4,720,574
|
$5,122,258
|
$5,190,709
|
|
Obsolescence
|
|
|
|
|
|
Functional
|
|
|
|
|
|
Roof
|
($11,000)
|
($11,000)
|
($11,000)
|
($11,000)
|
|
Soundproofing
|
($168,000)
|
($168,000)
|
($168,000)
|
($168,000)
|
|
Economic
|
$0
|
$0
|
$0
|
$0
|
|
Depreciated
replacement cost
|
$4,406,862
|
$4,541,574
|
$4,943,258
|
$5,011,709
|
|
Market
value of land
|
$365,750
|
$365,750
|
$365,750
|
$365,750
|
|
Final value
according to the Court
|
$4,772,612
|
$4,907,324
|
$5,309,008
|
$5,377,459
|
|
|
|
|
|
|
[85]
I note that the value
of the hypothecary loan the appellant obtained to finance the first building
was $5,440,000. However, this loan was guaranteed to the extent of $800,000 by another
building the appellant owned (Exhibit I-4, tab 2, page 3, article 5.2), which
reduces the value attributable to the first building to $4,640,000. Moreover,
the municipal assessment for the first building when the financing for it was
obtained was $4,616,455 (Exhibit I-4, tab 1, page 13). Lastly, the value of $5,800,000
determined by the financial institution’s appraiser in 2005 was based on the
assumption that the building was entirely factory-built, that there was no soil
contamination problem, that the level of soundproofing was satisfactory and that
all the leases were signed (Exhibit I-4, tab 1, pages 3, 4 and 16). The
evidence showed that such was not the case. In the circumstances, the final
value I have arrived at by reconciling the adjustments made by the two experts
seems reasonable to me.
VI Decision
[86]
The appeal is allowed and
the assessment is referred back to the Minister for reassessment on the basis
that the fair market value of each building for which the appellant was to make
a self-assessment for the purposes of subsection 191(3) of the ETA is as
follows:
6300 Rue de l’Aster June 1, 2006 $4,772,612
6400 Rue de l’Aster June 1, 2007 $4,907,324
6305 Rue de l’Aster June 1, 2008 $5,309,008
6405 Rue de l’Aster June 1, 2009 $5,377,459
[87]
The appellant is entitled
to its costs under Tariff B of the Tax Court of Canada Rules (General
Procedure) (Rules), as well as an amount of $300 per day for services
rendered by its expert witness in preparing his report and testifying before
the Court, pursuant to subsection 5(2) of Tariff A of the Rules.
Signed at Ottawa, Canada, this 14th day of February 2014.
"Lucie Lamarre"
Translation
certified true
on this 29th day
of July 2014.
Erich Klein, Revisor
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