Citation: 2011TCC22
Date: 20110113
Docket: 2005-1930(IT)G
BETWEEN:
LLOYD M. TEELUCKSINGH,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
C. Miller J.
Facts
[1]
The very term
"Arabian horses" takes me back to the early 1960s watching in awe as Lawrence gallantly galloped across the Arabian sands on a
sinewy strong stallion. The power, the grace, the beauty – it was
unforgettable. In the 1990s, Montebello Farms Inc. ("Montebello") was in the business of breeding these
magnificent creatures. It required funds to attain a level of herd that would
make such a venture viable. It devised a plan whereby it sought investors as
limited partners in partnerships which acquired the Straight Egyptian Arabian
horses and held them for a very brief period of time before transferring them
into a company that would issue preferred shares in return. The limited
partners, Mr. Teelucksingh being one of them, could then transfer such shares
into their RRSP, using available RRSP funds. Based on the cost of the horses
and prepaid expenses, the limited partners claimed restricted farm losses for
the very brief first fiscal period of the partnership, which losses were then carried
forward. The Respondent denied the losses on the basis that there was no
partnership as there was no business nor an intention to make a profit, or if
there was a partnership, on the basis that the expenses incurred to create the
loss were not reasonable, primarily due to the horses being overvalued. The Respondent
also has included in Mr. Teelucksingh’s income the amount he withdrew from his
RRSP on the basis that the preferred shares were not qualified investments for
RRSP purposes (a position withdrawn in argument) or that, in any event, they
had no value.
[2]
What is most
interesting about this case is that, while the Respondent argues there may have
been no partnership business as such, it is clear there was an underlying
Straight Egyptian Arabian horse business founded in the operations of Montebello. The question is whether Montebello has created a legitimate financing arrangement that shifts the
business into the many limited partnerships and companies, such businesses
incurring fair market value costs and reasonable expenses in a manner that
attracts the tax consequences sought by the Appellant. The Respondent suggests
this is a scheme by unscrupulous businessmen to take advantage of investors by
offering them tax benefits that do not properly flow from the arrangement.
Rulings
[3]
Before turning to the
facts, I wish to comment on some rulings I made during the trial and also on
the general course of the trial. There were objections to the introduction of a
number of documents on the basis that they could not be authenticated. Just by
way of example, the Crown sought to introduce a letter signed by a non-party, a
Mr. Little, addressed to another non-party, Mr. Schiebelhut. The Appellant
had already entered as an exhibit a contract that had Mr. Schiebelhut’s
signature on it. As this arose on the Friday, I asked the parties to provide
very brief written submissions on admissibility of documentary evidence on
Monday so I could make an appropriate ruling. The Appellant’s counsel did so:
the Crown counsel did not.
[4]
Relevance and
authenticity are two different matters; simply because one document may appear
to flow from another admissible document, and on its face appears relevant, it
does not follow that it is admissible. Had the witness been familiar with Mr.
Little’s signature, that may have been sufficient to authenticate the letter. I
do not suggest the Court must always resort to a handwriting expert: some
practical considerations must come into play. It is not enough, however, for a
witness to see a signature for the first time in Court and compare it to the
signature on the document to be introduced, offering the opinion that it looks
the same. That, I suggest, would fall short of authenticating a document.
[5]
I also ruled against
the Crown introducing what they claimed to be similar fact evidence in the
cross-examination of Mr. Smith, who was on the stand for four days. Mr. Smith
was an executive vice-president of Montebello, the
moving force in the horse business giving rise to the investments in issue
before me. The Crown intended to impeach his character by raising an Ontario
Securities Commission ruling in 2007 concerning a 2003 – 2004 hedge fund
investment in which Mr. Smith was involved. Mr. Smith has appealed that
ruling. I did not allow the Crown to question Mr. Smith on this as I concluded
the probative value did not outweigh the prejudicial effect. Indeed, I
concluded there was little probative value to an assertion that, because 10
years after the investments in issue before me, Mr. Smith was involved in
a totally different investment, which has run afoul of the Ontario Securities
Commission, that he must have been unscrupulous in his earlier dealings. The
facts were not similar enough, the timing was too distant and there could be
some prejudice against the Appellant that would arise completely outside his
control. On balance, I concluded this was not an appropriate line of
questioning.
[6]
The third ruling I wish
to mention is allowing the Respondent to put certain Montebello customs documents to their Canada Revenue Agency (CRA) witness, Mr.
Coehlo. The Respondent had presented these documents, prepared by Montebello
for the shipping of horses between Canada and the United States, to Mr. Smith on cross-examination. Mr. Smith
could not identify the documents so I marked them for identification, as
Respondent’s counsel indicated they understood the author of the documents,
another employee of Montebello, was going to be called by the Appellant.
After Mr. Smith’s testimony, and after the expert’s testimony, the Appellant’s
counsel advised that she had decided that it was no longer necessary to call
this other employee. The Respondent’s counsel indicated they would attempt to
get a hold of this potential witness and, if necessary, subpoena her. Before that
occurred, the Respondent put its CRA witness on the stand, who testified that
as Chief of Appeals in Kitchener, he had asked the appeal’s officer to obtain
customs documents, if any, showing the movement of Montebello horses between
the United States and Canada. It is those documents that were then presented to
him. The Appellant’s counsel objected on the basis of the relevance and that
such documents had not been provided prior to trial either on the Respondent’s
list of documents or through any undertakings. The Respondent’s counsel argued
he had hoped to impeach the credibility of the Appellant’s witness, as the
customs documents showed much lower values for Montebello horses going from Canada to the United
States and higher values on
return. One of the horses in the Montebello Egyptian Bloodstock Investments R
and Company, Limited Partnership was part of the list of horses in one of
the bundles of the custom documents.
[7]
I had heard enough
evidence to satisfy me that the Montebello Egyptian Bloodstock Investments R
and Company, Limited Partnership and Montebello Egyptian Bloodstock Investments
XIII Limited Partnership investments were similar to many other such
investments and that the shipment of horses between Canada and the United States was part of the modus operandi of Montebello. There could be any number of explanations why
Montebello might show a much higher value of the horses on the customs forms on
leaving the United States than was shown on entering the United States, but it struck me it was some evidence relevant to
value, though by no means determinative. In having found relevance, and given
the circumstances of how the documents came to Mr. Coehlo, and how the line up
of Appellant’s witnesses was shifting, I exercised my discretion to admit the
documents.
[8]
The fourth ruling I wish
to mention is in connection with a line of questioning Appellant’s counsel
wished to ask Mr. Coehlo. Mr. Coehlo was the supervisor of the appeals officer,
Mr. Kodrick. Mr. Kodrick was the appeals officer in the Kitchener office who testified in 2003 in the case of Balvinder
Khaira v. Her Majesty the Queen,
a case also involving a similar Cabreah Limited Partnership investment, though
not a Montebello one. Mr. Kodrick is no longer alive.
Appellant’s counsel wished to read to Mr. Coehlo answers given by Mr. Kodrick
at the 2003 trial as prior inconsistent statements to impeach Mr. Coehlo’s
credibility. Counsel wished to do so on the basis Mr. Coehlo was only appearing
before me to replace Mr. Kodrick who obviously could not appear. I agreed
that was one of the reasons for hearing from Mr. Coelho, but it did not
overcome the fact that the prior statement was not Mr. Coehlo’s statement – it
was another person’s in another action. I found it would be improper to impeach
Mr. Coehlo’s credibility on the back of someone else’s evidence given in a
different case. I did not allow this line of questioning.
[9]
Mr. Coehlo was not the
CRA officer who was examined for discovery in the case before me. That was Mr. Tangredi
from the Laval, Québec
taxation office. Appellant’s counsel also wished to impeach Mr. Coehlo’s
credibility by referring him to answers given by Mr. Tangredi on examination.
While I permitted such questions to be put to Mr. Coehlo, I found it was
not to impeach his credibility as such, but to simply demonstrate to the Court
there were inconsistent views coming from the CRA. This I found was acceptable,
as Mr. Tangredi’s evidence could be, and to some degree was, read in. If
Mr. Coehlo provides a different answer it is for me to determine wherein
lies the truth.
[10]
Finally, with respect
to the conduct of the trial generally, it was clear that counsel had a long and
combative history in this litigation. Unfortunately, this would occasionally
brew over into the courtroom. While the frustrations evident on both sides may
be understandable and attributable to nothing more than human nature, I
implored counsel to check such baggage at the door and conduct themselves as
officers of the Court. Once the trial had started, the complaints, accusations
and concerns that may have become the rule rather than the exception in the
litigation process leading to trial, will not be tolerated at trial. The trial
judge, and certainly this trial judge, is not interested in receiving a litany
of such complaints and is only interested in a fair hearing where both sides
can properly and effectively put their case before me so I hear all evidence
and argument necessary to make a reasoned decision. While positions or
objections can be made forcefully, they must at all times be presented courteously
and respectfully. Enough said.
Facts
[11]
Mr. Dale Smith, the
former executive vice-president of Montebello gave a lengthy and detailed
description of the business of Straight Egyptian Arabian horse farming and,
specifically, the operation of Montebello. Indeed, I even saw a brief video of Montebello’s farming operations and was able to visually
appreciate the splendour of the Straight Egyptian Arabian horse. I also saw
photographs of the process by which semen is collected and heard details of the
science of breeding certain bloodlines together. I could go on at some length
describing an industry in which the Straight Egyptian Arabian horse represents
just a small fraction of the general population of Arabian horses. I could
likewise go on in greater detail of what appeared to be a modern, extensive
horse operation carried on by Montebello in Québec and in Texas.
It was fascinating evidence and provided some insight and background that set
the stage to address the issues raised by the investing arrangement, but this
case is about the tax consequences of the investing arrangement more than about
the intricacies and complexities of the horse business. All to say, my
description of facts related to the horse farming business will be a
significantly abbreviated version of what I heard at trial. The emphasis will
be on the investments.
[12]
Montebello was in the Straight Egyptian Arabian horse
farm business from the late 1980’s to 1997. The moving force behind Montebello was Mr. Paul Walker. Montebello obtained the nucleus of its horse inventory in an
acquisition of a herd at auction from Stonebridge in October 1990. Mr. Walker
was also involved with Stonebridge. It went out of business so there were deals
to be had in buying their horse inventory. There was also a major acquisition
of horses by Montebello in 1993 from Troy Associates Inc. of
Luxemburg for $7,050,000. Interestingly, Mr. Walker also signed on behalf of
Troy Associates. Mr. Smith recalled very few details of this major transaction.
[13]
At its peak, Montebello had control of over 200 horses. It operated from a 350-
to 400-acre farm near Montebello, Québec and also a training facility in Texas, with an administrative office in Pointe-Claire,
Québec.
[14]
Montebello started a Canadian Breeders of Straight
Egyptian Arabian Horses Organization (CABREAH) with a view to further refine
and improve the quality and reputation of Canadian bred Straight Egyptian
Arabian horses. All mares bred by stallions owned by Montebello or any of the many other limited partnerships would be bred from
CABREAH members’ stallions. Other CABREAH members were Edwards Arabian Farms, Heritage
Arabian Farms, SEAH Farms and Shiloh Ranches.
[15]
Revenue is earned in this
business primarily in four ways:
a) The sale of horses from a
successful breeding program.
The sales of horses would be by private treaty (i.e.
private sales), through sales agents or, in certain circumstances, by auction.
b) Breeding services of a stallion.
It is important to note that, according to Mr. Smith,
only one of 15 or 20 colts may become a productive stallion. The breeding was
described as part art, part science. At Montebello, Mr. Walker and the breeding manager, Mr. Simon made the decisions to
mix appropriate bloodlines.
At Montebello all mares were inseminated artificially.
c) Providing the board and care of
horses.
d) Winning prizes from
competitions.
In this regard, it should be noted there was an annual
Egyptian competition put on by the Pyramid Society, as well as a CABREAH
incentive program, the CABREAH Breeders Challenge, only open to CABREAH horses.
[16]
Just to give an example
of the financial side of the Montebello business, Montebello’s 1995 financial
statements showed revenues from the sale of horses of approximately $16,000,000,
revenues from breeding of approximately $900,000, and from board and care of
approximately $1,873,000. As Mr. Smith pointed out, however, the revenue from
the sale of horses did not necessarily equate to profits, as the $16,000,000
sales resulted in a $500,000 loss, while the board and care revenue resulted in
approximately a $200,000 profit.
[17]
As early as 1989, Montebello started to offer limited partnership investments to
the public. According to Mr. Smith, it had insufficient capital for the large
pool of mares it felt it needed to produce exceptional horses. Its strategy was
to get investors, who wanted to be the industry, as limited partners, allowing Montebello to grow more rapidly. As he put it, this was to use
the leverage of others’ capital. The two limited partnership arrangements
before me are just two of many such investment arrangements put together by Montebello and other CABREAH members but are representative of
these many other CABREAH limited partnership investments.
[18]
I will refer to the
Montebello Egyptian Bloodstock Investments R and Company, Limited Partnership
as the "R Partnership" and Montebello Egyptian Bloodstocks
Investments R Inc. as the "R Corporation" and the Montebello Egyptian
Bloodstock Investments XIII Limited Partnership as the "XIII Partnership"
and the Montebello Egyptian Bloodstock Investment XIII Inc. as the "XIII
Corporation". Cumulatively, I will refer to the R Partnership and R Corporation
as the "R Investment" and the XIII Partnership and the XIII Corporation
as the "XIII Investment".
[19]
Mr. Teelucksingh
testified that he attended a presentation by a financial advisor on the Montebello horse farm operation and later received a copy of the
Offering Memorandum, which I will soon describe, from the financial advisor. He
confirmed that he decided to invest on the understanding that there would be
profits coming out of these investments but also on the understanding that he
would use money in his RRSP to make the investment. It was clear Mr.
Teelucksingh was not intimately familiar with all the many details of the
investment arrangement. He acknowledged signing all the documents necessary to
make these investments
[20]
It is useful to
reproduce portions of the Offering Memorandum of the R Investment as
Appendix A.
[21]
The R Investment, as
described in the Offering Memorandum of December 16, 1993 consisted of the
following. The investor would acquire one unit in the R Partnership for $18,000
and 18 common shares in R Corporation for $18 (these shares could be put in the
name of a co-investor, and in Mr. Teelucksingh’s case some common shares were
put in his wife’s name). The maximum offering was $450,000. It was fully
subscribed. The investor could borrow $18,000 from Montebello to make the investment. Mr. Teelucksingh did this. The loan had to be
repaid within a relatively short period of time. Mr. Teelucksingh did repay the
loan.
[22]
The Offering Memorandum
went on to describe that the $450,000 raised plus a loan of $120,000 from Montebello would be used to cover the following:
- the acquisition of
50% of a stallion, The Atticus and a colt, MB Sehnari for $400,000 from Montebello;
- working capital of
$105,000;
-
commission $45,000;
-
expenses of issue
$20,000.
[23]
The business of the R
Partnership and R Corporation was described in the Offering Memorandum as the
business of acquiring, raising, showing and exhibiting Straight Egyptian
Arabian stallions and selling their breeding services, all for the purpose of
earning farming revenue. Indeed, the R. Partnership entered an agreement with
Montebello, the Stallion Services Purchase Agreement, whereby Montebello agreed
to buy, over a five year period, 13 breedings per year at $6,000 per breed for The
Atticus and, starting in 1996, 11 breedings per year with MB Sehnari,
totalling $78,000 per year in 1994 and 1995 and $144,000 per year in 1996, 1997
and 1998, for a total of $558,000 to be earned over five years. If the breeding
was unsuccessful, Montebello would have to provide the services of a
different stallion.
[24]
Montebello also contracted to provide board and care
for the two horses at Montebello Farms at $1,000 per month for the first three
years and $1,250 per month for the following two years, payable in advance. Montebello further agreed, in a Horse Replacement Agreement, to
replace any horse in respect of which there is a loss incurred. This was an
additional cost to the R Investment of one percent of the agreed insured value.
The R Investment was also charged the insurance cost of 1.34% of agreed insured
value: such insurance was taken out by Montebello.
[25]
Montebello also provided consulting and management
expertise to the general partner, a wholly owned subsidiary of Montebello, for an annual fee of two percent of the
purchase price of the horses, to be payable annually in advance. The general
partner was to charge the R Investment this two percent fee. The Offering Memorandum
also provided for a final closing on December 31, 1993 and that on January 15,
1994, the R Partnership would transfer the assets into the R Corporation
for preferred shares. Within 45 days thereafter the partnership would be
dissolved, distributing the preferred shares to the limited partners. The Offering
Memorandum stated that the R Corporation would be dissolved on December 31,
1998. The Offering Memorandum went on to describe the conditions for the
preferred shares to be considered a qualified investment for RRSP purposes.
[26]
The Offering Memorandum
indicated that, during the brief life of the R Partnership, any net income
or loss would be determined in accordance with the cash method, anticipating
losses available to the limited partners in 1993.
[27]
I find the Offering Memorandum
reflected closely what in fact occurred in this wholly subscribed offering. All
the agreements were executed to put into place the investment just as set out
in the Offering Memorandum.
[28]
Mr. Smith outlined what
happened. Montebello did lend money to the investors, who used
it to buy the units and shares. Montebello did lend an additional $120,000 plus some additional
monies for GST purposes. The R Partnership did use the funds to buy the
two horses for $400,000 ($350,000 attributable to the half share in The Atticus
and $50,000 for MB Sehnari), prepay expenses of $107,000, pay commissions and
fees of the $45,000 and $20,000 respectively. This all took place immediately
upon closing in 1993 effectively creating a loss in the period ended December
31, 1993 of $9,520 per partner, restricted to $6,010 in 1993, with $3,410
available for carry forward. The losses arose from the prepaid amounts and the
treatment of the inventory cost of the horses, based on the $400,000 value
attributed to them. See Appendix B for this calculation.
[29]
Effective January 15,
1994, the partnership assets were rolled into the R Corporation (by virtue
of a Transfer Agreement signed at closing and a meeting in January attended
only by the general partner with proxies from investors): preferred shares were
ultimately issued to Mr. Teelucksingh and his wife. At this time, the
horses were valued by David Christie at $490,000. Mr. Teelucksingh
transferred the preferred shares into his RRSP, using the RRSP funds to pay
back the Montebello loan. The preferred shares were valued at
$18,236. (see Appendix B for this determination)
[30]
In May 1995, a $45,000
dividend was paid by the R Corporation to the preferred shareholders, which in
Mr. Teelucksingh’s case, went into his RRSP accounts. A second dividend of a
similar amount was paid in April 1996.
[31]
The R Investment was
referred to as a stallion deal, of which there were only a few. The vast
majority of these types of investments were mare deals. The XIII Investment,
which Mr. Teelucksingh also invested in, is an example of the mare deals. While
the overall structure is similar, the proposed revenue streams differ in that
revenue in the mare deals is generated from the sale of the mares’ foals,
rather than breeding fees. Mr. Smith provided a chart demonstrating projected
births and sales of the XIII Investment foals.
[32]
The XIII Investment was
for 25 combined interests of $20,000 for one limited partnership unit in the
XIII Partnership and $40 for 40 common shares in the XIII Corporation for a
maximum subscription of $501,000. The schedule of events listed in the Offering
Memorandum is informative:
Schedule of Events
Event Date
Initial closing................................................................................ July
21, 1995
Fiscal year end of Limited Partnership(1)...................................... December
31, 1995
Limited Partners’ meeting............................................................. January
12, 1996
Asset transfer from Limited Partnership to
Corporation (1)............ January 15, 1996
Dissolution of Limited Partnership................................................. February
15, 1996
Distribution of Preferred Shares.................................................... February
15, 1996
Commencement of cash distributions............................................ 1998
Final cash distribution................................................................... December
2001
Dissolution of Corporation............................................................ December
31, 2001
[33]
Again this was fully
subscribed. Mr. Teelucksingh went through the same routine by first borrowing
from Montebello for the initial subscription, repaying the
loan once the horses were flipped from the partnership into the corporation.
The partnership paid $600,000 for seven mares. With the subscription funds plus
a Montebello loan of $360,000 the XIII Partnership had,
after commissions and fees, $190,000 for working capital, from which the
partnership incurred prepaid expenses of $171,000, including board and care at
$525.00 per month for the mares
[34]
The XIII Partnership’s
T5013 Schedule 1 form for the period ended August 15, 1995 showed a
farming loss per unit of $15,000. The XIII Partnership’s T5013 Schedule 3 form
showed $5,640 farming income per unit for 1996. Mr. Teelucksingh sought to
deduct the maximum restricted farm loss of $8,750 in 1995 and carry forward the
$6,250 loss available to offset 1996 income similar to the R Partnership. The
losses were derived from the prepaid expenses and the amortization of the mares
based on the value of $600,000 attributed to them. See Appendix C for this
calculation.
[35]
Similar to the R
Partnership, the assets were transferred into the XIII Corporation. Mr.
Teelucksingh and his wife used RRSP funds for the preferred shares valued at
$20,001 (Mr. Teelucksingh received 9,001 preferred shares and Mrs. Teelucksingh
received 11,000 preferred shares). For the calculation of the value of the
preferred shares see Appendix C. Note the horses were valued at $695,000 for
purposes of determining share value.
[36]
Mr. Coehlo testified on
behalf of the CRA. He was the Chief of Appeals in the Kitchener office of the CRA during the period the horse tax shelter partnerships
were being reviewed by the CRA. The Kitchener office was
chosen to manage this project. This involved reviewing the audit files, seeking
further information and getting an independent appraiser, Ms. Henderson. Mr.
Coehlo concluded that the value of the horses was overstated by 83% to 90%. The
Kitchener office’s recommendation was to confirm the
assessments based on:
a) evidence on the audit file;
b) no additional representations;
c) Ms. Henderson’s
valuation and lack of confidence in Mr. Villasenor’s valuation, the valuation
put forward by Montebello;
d) the Khaira
case, a decision in an informal procedure case by Justice Mogan going
against the taxpayer in a similar horse limited partnership investment.
[37]
I turn now to the facts
surrounding the value of the horses. I will review the reports from each sides’
expert as well as outlining what I consider to be other relevant facts that
shed some light on value, such as insurance and the history of sales of certain
of the horses. I will then address briefly any evidence regarding the value of
board and care, which, as indicated, was prepaid.
[38]
At the outset, I should
say that I found both experts well qualified to opine on Straight Egyptian
Arabian horses generally; Mr. Villasenor from an American large breeder
perspective and Ms. Henderson from a Canadian small breeder perspective.
[39]
Mr. Villasenor showed a
good grasp of what Montebello was attempting to do in creating a nucleus
of Straight Egyptian Arabian horses through a closed breeding program leading
to a very special group of Arabian horses or even a signature horse. He
testified that Montebello showed a lot of horses with success. With
respect to the horses in issue before me, Mr. Villasenor saw all the horses at
the relevant times in 1994 and 1995. I found the following excerpts from his
report particularly helpful:
…
Based on my research and analysis, inspection of the specific
horses, knowledge of the Arabian horse industry, and understanding of the
Montebello/Cabreah breeding program and business plan, the estimated fair
market value of the horses owned by the XIII LP was $685,000 CD at the
valuation date (September 1, 1995), and the estimated fair market value of the
horses owned by the R LP was $500,000 CD at the valuation date (January 15,
1994).
…
There are at least two major factors that drive the price for
Straight Egyptian Arabian horses in the breeding context. The first is their
rarity. Straight Egyptians account for only 1% of all Arabian horses. They are
rare and therefore there is demand for them. The second is the purity of the
horse’s bloodline and the desirability of the particular bloodline for a
particular breeding operation.
…
What was unique to the Montebello/Cabreah breeding program was the
size and quality of its horse population. No independent breeder would have
been able to duplicate this breeding program. This program involved the world’s
largest selection of Straight Egyptian Arabian bloodlines, and a wide palette
of colours. Had the program operated for as long as it was planned, because of
the international demand for exceptional Straight Egyptian Arabians,
Montebello/Cabreah would readily have cornered the market for Straight Egyptian
Arabians and controlled the price for these horses in the international market.
…
Just as Straight Egyptian Arabian horses are rare, there is not a
large number of breeders of Straight Egyptian Arabian horses. Because this
strain of Arabian horse is so rare, it is normally difficult to assemble a
large herd of quality breeding stock. As with any other commodity, rareness and
exclusivity drive the price upward in the market place. As noted, this
challenge was overcome by the Montebello/Cabreah breeding program through its
business plan. Limited partnerships were formed to provide the capital that
allowed the assembly of an unparalleled collection of quality Straight Egyptian
breeding stock. There are many strains and origins of Arabian horses and many
breeding programs around the world. All Arabian horse breeding is not the same.
The skillful mating of high quality Straight Egyptian Arabian horses is an art
form. The Montebello/Cabreah farms had the facilities, the personnel and the
bloodstock necessary to care for, Straight Egyptian horses of excellent
quality, and to breed these horses to produce progeny of exceptional quality.
…
The estimates of value of the subject Straight Egyptian Arabian
horses assessed for this report have been determined based on identification
and qualitative assessment of their individual quality and pedigree analysis
which can indicate future breeding success or failure. Of course, my estimates
also had to consider proprietary programs such as the Cabreah Breeders
Challenge Program. This program was open to an owner who had acquired a
Straight Egyptian mare through the Montebello/Cabreah breeding program.
Significant cash prizes were available to winning horses in a number of
different competitions. The eligibility to compete in this program is a factor
in the valuation of the XIII LP mares. In addition, in assessing the male
horses acquired by the R LP, I took into account the existence of breeding
guarantees over a five-year period. This guaranteed income stream from these
horses has a direct impact on their value.
…
… In the case of the subject horses, clearly the intent of the
business plan was to hold these animals as a breeding herd for a period of 5 to
7 years, and NOT to resell them to the open market in the near term. Hence, a
significant factor in valuing the horses was their intended use, and the
economic potential of that use.
[40]
Mr. Villasenor also
commented on Ms. Henderson’s report, suggesting that reliance on prices
obtained at a particular auction, the Gleannloch auction, was not appropriate
as he believed the cream of the crop in the Gleannloch herd had already been
sold privately.
[41]
Turning now to Ms.
Henderson’s report, she acknowledged that she paid no attention to the impact
of the business arrangements in valuing the horses. Indeed, she expressed
suspicion of the guarantee of revenue provision as described in the Offering
Memorandum. She also did not take into account access to the Cabreah breeders
challenge. She referred to the future offspring of some of the horses, which
obviously would not have been known as at the date of valuation. Finally, she
believed public auctions were a dependable source of valuation information as
opposed to private sales, where the price is often not known and parties would
exaggerate what was paid. She described as "optimistic" prices for
mares of $95,000, fillies of $55,000 and colts of $10,000, being the standard
prices Mr. Smith testified were used in Cabreah transactions.
[42]
Some excerpts from her
report, I found of interest:
…
My opinion as to value was arrived at through examination and
research of pedigrees and the condition of the marketplace at the time in
question. I have seen all but three of the horses and have notations in this
regard. I have assumed the three mares I have not seen to be average to above
average in Arabian type and conformation.
…
In 1992, overall prices were buoyed by the Gleannloch Final Legacy
Sale where the average price was $19,267.00 USD. Im 1994, prices for Egyptian
Arabians averaged $6,191.00 USD. The First Annual Scottsdale Egyptian Sale
averaged $6,843.00 USD for the same time period. The highest selling horse at
this sale went for $19,000.00 USD. One mare and one stallion went for this
price, while the balance of the mares were sold for an average of $5,770.00
USD. This information was taken from the Arabian Horse Digest International.
[43]
Ms. Henderson’s report
was not nearly as extensive or detailed as Mr. Villasenor’s.
[44]
Each expert had
something to say about each of the horses, but rather than going through all
horses, I will simply compare their comments on two of the horses.
[45]
With respect to The
Atticus, after outlining the bloodline of the horse Ms. Henderson stated:
The Atticus was 3 years old at the time of valuation. There was one
mare in foal to him at the time of valuation (which resulted in a chestnut
filly). I viewed The Atticus in 1994 when he was shown at the Great Lakes
Arabian horse show. I found him to be striking in appearance, with smooth
body and good length of neck. He was a little long through the loin and the
structure of his limbs has some faults.
The "black" gene in Arabian horses is rare and is quite
appealing to many people. The dam of The Atticus was black. The value of his
pedigree plus the black gene would be considered worth pursuing as a young
stallion.
…
BASED ON MY RESEARCH AND THE ABOVE INFORMATION, I VALUE THE ATTICUS
AT $75,000.00USD.
[46]
Mr. Villasenor after
outlining the bloodline of The Atticus stated:
…
The Atticus would have to be considered one of the heirs apparent to
the breeding legacy of the Minstril. The Atticus has a tremendous sire line,
which would indicate a high level success as a breeding sire. Under the
stewardship of a qualified and ongoing Straight Egyptian breeding and marketing
program such as Cabreah, I believe he will be a top breeding stallion. …
… Given the value of the breeding revenues over the first five years
as well as the intrinsic value of The Atticus, under those circumstances, his
fair market value would be approximately $850,000, so that his 50% interest
would be a fair market value of approximately $425,000CD.
[47]
I note that Montebello acquired The Atticus in an arms length deal in 1992
for approximately $105,000 Cdn when The Atticus was only a year old.
[48]
With respect to the
mare, Ansata Zaahira, after identifying the progeny and bloodlines Ms.
Henderson stated:
…
Ansata Zaahira was 9 years old at the valuation date of January 16, 1996. She had
a proven record as a broodmare. I have not personally seen this mare, but I do
have a photograph of her 1996 filly, which gives me a good idea of the quality.
BASED ON MY RESEARCH AND THE ABOVE INFORMATION, I VALUE ANSATA
ZAQAHIRA AT $20,000.00USD.
[49]
Mr. Villasenor goes
into greater detail as to the bloodlines of Ansata Zaahira concluding:
…
… Mares of this breeding are highly sought by Straight Egyptian
breeders around the world. Many of this mare’s relatives have been exported to
the Middle East and are now owned by Kings and Princes.
Under the stewardship of a well-managed, high quality ongoing
Straight Egyptian breeding program and business plan like that of
Montebello/Cabreah, I believe she would have been a top producing breeding mare.
Under these circumstances, I estimate her fair market value as $110,000
CD.
[50]
Attached as Appendix D
is a comparative chart of the experts’ values.
[51]
Apart from the experts’
reports, the following evidence addressed the issue of value. First, though not
with respect to the horses at issue before me, I received copies of two bills
of sale, both in 1995. The first, dated July 17, 1995 was for the sale of nine
horses from Arabco North Inc. to Heritage Arabian Farms Ltd. (a Cabreah member)
for $63,000 US. Four days later on July 21, 1995 Heritage Arabian Farms sold
the nine horses to Montebello for $857,500 Cdn. Mr. Villasenor,
when asked about this discrepancy in price, had no answer.
[52]
Second, Mr. Smith
testified that there were general prices for horses sold to the limited
partners:
$95,000 for a mare;
$70,000 for a two-year old mare
$55,000 for a one-year old mare
$10,000 for a colt
$50,000 for a colt with breeding potential
[53]
Third, according to Mr.
Smith, Montebello would insure mares at $60,000 to $70,000
in the mid-1990’s, but also provided mare replacement guarantees to the partners.
In 1989, Lloyd’s Livestock policy was produced indicating amounts insured
ranging from $100,000 to $200,000 per horse. By 1992, Montebello was co-insuring their horses. A Montebello Equine Mortality Insurance
Claims Report showed insured values and claim payments for the period 1992 to
July 1997. Due to the co-insurance, all payments were 50% of the insured value
which ranged from $15,000 to $97,000, with an average of approximately $25,000
for fillys and $40,000 for mares. This is remarkably close to a price paid by
Montebello ($31,200 CD) for a bay mare, Bint Foula, in an acquisition from
Gleannloch Farms in 1992, which Montebello sold shortly thereafter to another
Cabreah member for $50,000 US. A year and half later, Montebello reacquired Bint Foula for $95,000.
[54]
Fourth, the Appellant
also produced letters of support dated July 1997 from Chapel Farms in Georgia and Misheks Arabian Farms in Minnesota, letters that had been reviewed and authenticated by Mr. Villasenor.
Chapel Farms indicated it routinely sold its fillys for $30,000 to $40,000 US
and mares for double that. They also bought a half-interest in a five-year old
breeding stallion for $200,000, paid $75,000 for a yearling filly and $150,000
for a seven-year old mare. Misheks indicated it would market its Arabians at
$30,000 to $75,000 for fillys and twice that for mares. The authors of these
letters did not testify, therefore, there was no opportunity to cross-examine
them.
[55]
Fifth, in 1991, Montebello was negotiating for the acquisition of 50% of the
breeding rights of the Stallion Simeon Shai for $600,000. There was no evidence
this deal was ever finalized.
[56]
Sixth, the Respondent
put into evidence a number of customs forms indicating horses travelling from
Canada to the US would be listed with a value of $10,000
per horse and on return from the US to Canada,
sometimes only a few weeks later, listed with a value of $95,000 per horse.
[57]
Finally, it should be
noted that in reviewing the Arabian Horse Association Registry, some of the
horses appear to be registered with another Cabreah member or with Troy
Associates Ltd. before moving on to Montebello and then to the limited
partners.
[58]
With respect to the
value of board and care, Montebello charged $525 per mare per month at the
relevant time and $1,000 to $1,250 per month for the board and care of The
Atticus and MB Sehnari. I find that the quality in board and care provided by Montebello was first rate.
[59]
Mr. Villasenor stated
in his expert report:
… I find this amount to be very reasonable given the caliber of the
Montebello/Cabreah Farm facilities, the knowledge and experience of their horse
care staff and fine condition of the many animals I observed at their farms on
many occasions. The amount of this fee is consistent with what was charged in
the industry.
[60]
With respect to the
board and care of the stallions, Mr. Villasenor opined:
…
… In my experience as both a manager of a breeding farm operation as
well as in speaking with a number of Arabian horse breeders, this monthly
charge would be at the low end for board and care management of a breeding
stallion.
…
[61]
Ms. Henderson indicated
that she believed $250 per month would be the going rate in the mid 1990’s
though in her opinion she stated:
…
… I currently charge $600.00 per month per horse for board and care,
plus HST. The reasonable range for the cost of board and care would be from
$450.00 to $800.00 per month in today’s market, depending on geographical
location. This amount could increase to $1,500.00 per month per horse with training
for showing included. I checked my figures with colleagues in the business
of professional horse care, and these figures can be considered fair.
It is common practice to charge on a "pay on the first of the
month" basis. I do not know of any facility that would expect board to be
prepaid for a period of two years.
[62]
In 1997, the business
of Montebello started to unravel for a couple reasons,
according to Mr. Smith. First, the World Arabian Horse Organization disputed
some of the bloodlines showing up in the American Registry. This made it
difficult to sell horses outside the United States. At the
same time, the CRA was questioning the investment arrangements and future
funding dried up. The limited partnerships were offered the opportunity to move
the horses to a different breeder or to sell them at a fireside auction, which
took place in October 1997.
[63]
In 2001, the Minister
of National Revenue (the "Minister") reassessed Mr. Teelucksingh
to deny the restricted farm losses claimed by him and to bring into his income
$27,237, being $18,236 for the R Corporation shares and $9,001 for the XIII
Corporation shares, as withdrawals from his RRSP.
Issues
a)
Is Mr. Teelucksingh
entitled to the restricted farm losses as claimed?
The answer to this depends on the answers
to the following questions.
i) were the R Partnership
and XIII Partnership legitimate partnerships?
ii) if so, were the prepaid
expenses and cost of inventory (horses) reasonable?
b)
Were the withdrawals
from Mr. Teelucksingh’s RRSP of $27,237 used to acquire qualifying shares
valued at $27,237?
Analysis
a) Restricted
farm losses
i)
were the R Partnership
and XIII Partnership legitimate partnerships?
[64]
The Respondent argues
that because the Offering Memorandums described preordained steps that, when
actuated, required the dissolution of the partnership prior to the possibility
of any profit, then the R Partnership and XIII Partnership do not come within either
the common law or Québec Civil Code definition of partnership. The Appellant
counters that the R Partnership and XIII Partnership meet the more stringent
common law definition of partnership, being a group of persons carrying on
business in common with a view to profit. The fact that the partnerships did
not make a profit is no bar to finding the legal existence of a partnership.
The Appellant asserts that the requirement for a view to profit is not to be
interpreted so restrictively to limit the partners’ view to only while the
business is in partnership form. If the partners’ view is one that looks down
the road to profits from the same business, albeit in a different form, a
corporate form, that is sufficient to meet the test for partnership. I agree
with the Appellant.
[65]
Before exploring this
in more depth, I raise a matter not mentioned by the Respondent but that has
troubled me. The Respondent simply suggests there is no partnership and
therefore no losses available to Mr. Teelucksingh. But the Respondent has not elaborated
that if there is no partnership, what exactly is Mr. Teeleucksingh’s
position? Is he a co-owner, a joint venturer, an adventurer in the nature of
trade? He clearly paid money and received, at the very least, an interest in a
horse. He transferred that to a company. If these transactions were not through
a partnership, but individually, would the transfers therefore be arms length
and not subject to fair market value rules? As indicated, this avenue was not
flushed out by the Respondent, and given my conclusion that the partnerships were
legitimate, I need not explore this further.
[66]
Before considering the
case precedents that define partnership, and how they might apply to the
circumstances before me, I wish to make an observation about the commercial
reality of choosing a form of business organization. As the Appellant’s counsel
accurately pointed out, it is common practice for businesses to commence life
as proprietorships or partnerships, so that losses can be taken personally, but
when a business becomes profitable it makes economic sense to switch the
business into corporate form. This is basic corporate commercial tax planning.
There is no lack of intention to earn a profit from the business, but there is
also an intention to shift losses and profits to optimize the tax advantages
legitimately available to taxpayers starting a business. Does an individual, or
a group of individuals, receiving advice from their professional advisers
(lawyers or accountants) that they should immediately incorporate a company,
once losses convert to profits, no longer have a view to profit because it is not
their intention to have profits arise from the business in the partnership or
proprietorship form, but only in the corporate form? This approach would be the
death knoll for many a partnership. When I put this to Mr. Leclaire, his
response was that the difference between receiving such advice and entering a
deal such as the R Investment or XIII Investment is that under the latter
it was preordained or guaranteed that only losses, and no profits, would arise
while the business was in partnership form, while simply receiving advice to
transfer the business into a company left open the possibility of profit in the
partnership. Yet it is still preordained because it is known, with some degree
of certainty, when income, and subsequently profits, are likely to flow. I see
no compelling difference between a common commercial practice and the
commercial arrangement established by the R Partnership and XIII Partnership
that would warrant finding the R Partnership and XIII Partnership are not
partnerships. I will now explore this in more detail.
[67]
The case of Continental
Bank Leasing Corp. v. Canada
succinctly sets out the three essential ingredients of a partnership: (i) a
business, (ii) carried on in common, (iii) with a view to profit. It is
interesting to note that the Supreme Court Canada’s observation that:
24 The Partnerships Act does not set
out the criteria for determining when a partnership exists. But since most of
the case law dealing with partnerships results from disputes where one of the
parties claims that a partnership does not exist, a number of criteria that
indicate the existence of a partnership have been judicially recognized. The
indicia of a partnership include the contribution by the parties of money,
property, effort, knowledge, skill or other assets to a common undertaking, a
joint property interest in the subject-matter of the adventure, the sharing of
profits and losses, a mutual right of control or management of the enterprise,
the filing of income tax returns as a partnership and joint bank accounts.
[68]
In the case before me,
it is the Government that does not recognize the partnership as such. Certainly,
the partners and the Partnership Agreement suggests a partnership exists. Also,
the indicia of partnership are apparent in both the R and XIII Partnerships:
contributions of money, a common undertaking, sharing of profits and losses,
joint bank account. Obviously, with respect to a limited partnership, the
question of control and management is somewhat different and it is only the
general partner who would exercise such control and management.
[69]
As the Supreme Court of
Canada went on to advise in the case of Backman v. The Queen,
courts must be pragmatic in their approach to the three essential ingredients.
The Respondent did not suggest there was no commonality, but simply there was
no business, and, if there was, it was not carried on with a view to profit.
[70]
Mr. Leclaire argued
that a lot of paper does not mean there is a business. With respect, surely it
depends on what the paper says. Legal rights, obligations and ownership are
impacted by paper. Frankly, I am not sure what the Crown is getting at – are
they suggesting that limited partners, who for the most part simply sign paper
and pay their money must somehow do something more to be carrying on business?
As former Chief Justice Bowman pointed out in Grant v. The Queen:
"the limited partners’ role is a passive one, but if the partnership
carries on a business so does the limited partner.". The papers for the R
Partnership and XIII Partnership were meticulously put in place, assets
were transferred, horses were acquired and were boarded, payments were made,
accounts were established…. This was not a fiction. This was not a passive
investment. Businesses were being carried on. It was abundantly clear the
Government did not like how the businesses were being carried on, but they are
barking up the wrong tree to suggest no business was being carried on. The
evidence supports a finding there was a business in each of the partnerships.
[71]
The Respondent goes on
to suggest that the third element is missing, in that there was no view to
profit from the business. The Respondent relies on a passage from Lindley
and Banks on Partnership,
adopted by the Supreme Court of Canada in Continental Bank Leasing Corp:
43 …
…if a partnership is formed with some
other predominant motive [other than the acquisition of profit], e.g., tax
avoidance, but there is also a real, albeit ancillary, profit element, it may
be permissible to infer that the business is being carried on "with a view
of profit." If, however, it could be shown that the sole reason for the
creation of a partnership was to give a particular partner the
"benefit" of, say, a tax loss, when there was no contemplation in the
parties’ minds that a profit…would be derived from carrying on the relevant
business, the partnership could not in any real sense be said to have been
formed "with a view of profit."
[72]
The Respondent points
to the preordained steps in the Offering Memorandums and concludes that, as the
assets of the business were to be transferred to the corporations prior to the
making of any profit, this proves there was no view to profit. I disagree with
the Respondent’s reasoning and logic and overly technical, rather than
pragmatic, approach to this third element. In reading the passage cited in a
practical, commercially sensible manner, the question to ask is not whether the
parties intended to profit from the business during the operation of the
business as a partnership, but rather whether the parties intended to profit
from that particular business. Mr. Teelucksingh’s evidence, supported by the
Offering Memorandums and the testimony of Mr. Smith was that this investment
was not solely, or even primarily, to obtain the loss, although that was certainly
a selling feature of the investment, but Mr. Teelucksingh anticipated a profit.
He was the only limited partner who gave evidence. He was direct, intelligent
and honest. He intended to make money. Why else would anyone take funds from
their RRSP? Granted, the funds did not come out of the RRSP until the business
was shifted into a corporate form, this factor still corroborates Mr.
Teelucksingh’s stated intention, which he held at the time he initially entered
the investment arrangement, to profit in the longer term, and to profit from
the horse breeding business which started in a partnership form. This pragmatic
approach to determining whether an individual has a view to profit accords with
the Supreme Court of Canada’s view expressed in the case of Spire Freezers
Ltd. v. Canada:
26 … However, the determination of the
existence of a view to profit is not a matter of strictly quantitative
analysis. The quantum of the initial loss compared to the anticipated profit
does not negate the holding of partnership in this case. The law of partnership
does not require a net gain over a determined period in order to establish that
an activity is with a view to profit. For example, a partnership may incur
initial losses during the start-up phase of its enterprise. That does not mean
[page 404] that the relationship is not one of partnership, so long as the
enterprise is carried on with a view to profit in the future. …
[73]
I note that the Supreme
Court of Canada in Spire Freezers specifically addresses a partnership
historically incurring losses in the start-up phase, though recognizing the
"enterprise" is carried on with a view to profit in the future. I am
satisfied Mr. Teelucksingh intended to profit from the "enterprise"
in the future.
[74]
In the case of Agnew
v. Canada,
Justice O’Connor, in a very similar investment, summarized the situation as
follows:
126 The investment changed in form from one of
initial limited partnerships where losses were incurred to the later structure
where corporations were formed and assets were transferred by the partnerships
to the corporations and shares in the corporations were issued to the former
partners and the limited partnership was dissolved shortly thereafter. I do not
believe that a change of structure that was contemplated in the initial OM is sufficient to destroy the initial
concept of a business source and a profit. Even though the operation is carried
out at different stages by different entities it is one continuous plan which
considering there was no personal element was a source of business. Moreover,
although no profits were contemplated immediately for the limited partners, it
was planned they were to receive dividends in due course on the corporate
shares they received in exchange for the partnerships’ assets.
This supports my view that a view to profit is a view
to profit from the business or enterprise, not strictly from the particular
form of legal entity.
[75]
In conclusion on the
first question, I find the R Partnership and the XIII Partnership were
properly constituted legitimate partnerships falling squarely within the
definition of partnership as persons carrying on a business in common with a
view to profit. The fact that no profit was made while in the partnership form
is not sufficient to deny this form of arrangement its legitimacy. This was a
cleverly crafted investment vehicle, premised on the existence of a real
business.
[76]
Before turning to the
second question as to the reasonableness of the costs incurred by the
partnerships, I wish to address two aspects of the Respondent’s argument that
pertain to both the question of the existence of a partnership and the
reasonableness of the costs.
[77]
The first matter is the
reliance by the Respondent on the findings of Justice Mogan in the Khaira
case. Justice Mogan was faced with a similar investment by Mr. Khaira in that
informal procedure case. Justice Mogan found that the Appellant was not
carrying on business in common with a view to profit. He also concluded that
the shares in the corporation to which the horses were transferred had no
value.
[78]
Informal procedure
cases have no precedential value. There is good reason for this: the taxpayer
is often unrepresented (Mr. Khaira was unrepresented), there is no discovery
process unearthing all relevant information to assist the parties and a judge determine
the truth, rarely are experts called (Mr. Khaira called no experts), and
argument can be a David and Goliath event. The time, effort and preparation
that has gone into Mr. Teelucksingh’s General Procedure case is simply on a
different planet than what I understand would have occurred in the Khaira
matter. I feel no compulsion whatsoever, notwithstanding my great respect for
Justice Mogan, to give his case any precedential consideration. Indeed, in
these circumstances, it would be contrary to the interests of justice to do so.
[79]
The second matter I
wish to address is the Respondent’s argument that I should draw a negative
inference from the non-appearance of Mr. Walker as a witness. The Respondent
referred me to the case of Huneault v. The Queen
in support of this proposition. In Huneault, Justice Lamarre of this
Court refers to Justice Sarchuk’s comments in Enns:
25 …
In The Law of Evidence in Civil Cases, by Sopinka and
Lederman, the authors comment on the effect of failure to call a witness and I
quote:
In Blatch v. Archer (1774), 1 Cowp. 63, at
p. 65, Lord Mansfield stated:
It is certainly a maxim that all evidence is to be weighed according
to the proof which it was in the power of one side to have produced, and in the
power of the other to have contradicted.
The application of this maxim has led to well-recognized rule that
the failure of a party or a witness to give evidence, which it was in the power
of the party or witness to give and by which the facts might have been
elucidated, justifies the court in drawing the inference that the evidence of
the party or witness would have been unfavourable to the party to whom the
failure was attributed.
In the case of a plaintiff who has the evidentiary burden of establishing
an issue, the effect of such an inference may be that the evidence led will be
insufficient to discharge the burden. (Lévesque
et al. v. Comeal et al., [1970] S.C.R. 1010, (1971), 16 D.L.R. (3d) 425)
(emphasis added)
[80]
I make two comments
regarding this submission. First, exactly what issue does the Respondent
believe Mr. Walker could have elucidated on which I must draw the negative
inference? There are basically two issues before me: (i) was there a
partnership, (ii) were costs reasonable? Does the Respondent believe
Mr. Walker would have given testimony denying the legitimacy of the
partnerships? Does the Respondent believe Mr. Walker would have given testimony
establishing the value of the horses at far less that Mr. Villasenor’s values?
I do not see it. Perhaps Mr. Walker could have enlightened the Court in more
detail on the role of Troy Investments, but I already know from the testimony
that I did hear, that some horses were transferred in and out of this Walker
related company.
[81]
Second, to draw a
negative inference, there must be a vacuum in the evidence. It was certainly
clear in Justice Mogan’s decision in Khaira that many questions were, to
his mind, left unanswered because there was no one from Shiloh Farms (the
counterpart of Montebello in that case) who gave evidence. Before me, I had Mr.
Smith from Montebello testify for three days, going over in
detail the operation of these investments. I see no need to draw any negative
inference from Mr. Walker not testifying.
ii) Were the prepaid expenses and
costs of inventory (horses) reasonable?
[82]
I believe this is the
crux of the issue in determining the correctness of the Minister’s assessment.
The tax treatment sought by Mr. Teelucksingh, which he was led to believe from
the promoters of the investment he would receive, depends very much on the
value of the prepaid expenses and the horses acquired by the partnership. Given
the non-arms length relationship between the partnerships and Montebello, it is for me to determine the true fair market value
of these expenses and horses at the relevant time.
Valuation – horses
[83]
I start the valuation
analysis by observing that, unlike sales of real property, where there is a
public record of accurate comparable sales figures, valuing horses has no such
readily available comparative data, and is not therefore as easily
ascertainable. I attribute a number of reasons to making the valuing of horses,
in this case, more art than science:
a)
most sales of Arabian
horses are private and prices are unknown;
b)
public auctions are not
the first choice of a market for the horses;
c)
income derived from
horses is a factor, though often speculative;
d)
like art, beauty of a
horse is in the eye of the beholder;
e)
knowing a great deal
about Arabian horses is not enough to establish value; there must be an
appreciation of the financial trappings surrounding the purchase and sale of a
horse;
f)
two extremely
knowledgeable horse experts have provided opinions reflecting a widely
divergent value: this has not been particularly helpful as they simply have set
the parameters. I conclude, particularly in connection with Ms. Henderson’s
report, which I shall discuss in more detail later, that the experts
present more as judges of horses’ qualities for the purposes of competition,
rather than valuators for the purpose of commercial investment.
[84]
My valuation of the
horses is further influenced by a number of factors, apart from the experts’
reports:
a)
insurance values in the
mid-1990’s which averaged significantly less than Mr. Villasenor’s values but
significantly more than Ms. Henderson’s;
b)
lack of third party
sales data from the Appellant;
c)
some history of
ownership of horses going through non-arms length hands before passing on to
the partnerships;
d)
customs forms showing
significant increases in amounts shown as value on the return of the horses
from the United States;
e)
the remarkable
uniformity of values, given experts’ testimony of the importance of specific
bloodlines on value;
f)
evasive answers of Mr.
Smith concerning the transaction in 1993 for $7,000,000. While I recognize he
ran the financial side of the business and was not the horse expert, I found it
surprising he had little memory of this transaction which must have involved
several dozen horses;
g)
lack of any hard
financial analysis as to how a realistic income stream from a property such as
a horse could justify value;
h)
the original third
party acquisition of The Atticus at $85,000, recognizing he was unproven at
this time;
i)
the letters from Chapel
Farms and Misheks Farms, though untested.
[85]
A number of these
factors suggest to me that the values attributed to the horses by Montebello,
and indeed charged to the partnerships, have been set more for Montebello’s own purposes than to truly reflect their fair
market value. It is important though to scrutinize the experts’ reports in
greater detail before attempting to reflect in real numbers the impact of all
of the above observations.
[86]
With respect to Mr.
Villasenor, it was my impression he understood completely what Montebello was attempting to do in developing Canadian breeders
of Arabian horses industry, and was supportive of that attempt. He testified
that, in reaching his valuation, he considered the commerciality of the program
reflected in the Offering Memorandums. It is easy to make such a statement, but
it is not so easy to quantify how this actually factored into value.
Mr. Villasenor did not provide any financial analysis that could be
tested. He certainly struck me as an advocate for the industry. His comments
that Straight Egyptian Arabian horses are rare, their bloodlines are important
and that the size of the Montebello operation was significant are all general
comments that would suggest someone might pay more for the horses than other
horses, but again nothing quantifiable that proves to me a more exact value.
For example, no comparison of price is achieved for one bloodline of horses
versus another. It is not enough for me to simply hear that the horse has good
bloodlines and is therefore worth $500,000. Ms. Henderson acknowledged there
were good bloodlines, yet came up with totally different values.
Generalizations are not as helpful as specifics would have been.
Mr. Villasenor did give some specific examples of private sale prices but
without a great deal of information. For example, he indicated an Ansata mare
(of which there were some in the XIII Partnership) sold to an Israeli breeder
for $175,000; no information as to when or to compare with the Ansata mares in
the XIII Partnership. Are all Ansata mares valued the same – unlikely.
[87]
Mr. Villasenor also
relied on the letters from Misheks and Chapel, both dated in 1997, and both
suggesting prices for mares starting at $60,000 (I presume U.S. dollars given
both farms are from the United
States).
[88]
Overall, Mr.
Villasenor’s report was detailed, and recognized the business program in play
and provided some independent farms’ corroboration. What it lacked was any
expansive third party private sale figures of proven comparable horses, or any
financial analysis of the quantifiable impact of the Montebello breeding program on the value of the horses.
[89]
Turning to Ms.
Henderson’s report, while I do not doubt her qualifications in judging a
horse’s strengths, I have some concerns with her approach to valuing the horses
for the following reasons:
a)
she based her values
primarily on information from auctions, which I have concluded are not the
optimal gauge, and even then she provided no hard data to test; indeed, she
acknowledged that if she were to sell a horse, she would not look first to an
auction;
b)
she took no account of
the projected income stream to flow from the breeding program; she simply
expressed suspicion without satisfying me of a thorough understanding of the
commercial arrangements;
c)
she comes from a small
breeder background; nothing on the scale of Montebello;
d)
she took account of events
after the valuation date (offspring for example) that would not have been known
at the time of valuation;
e)
when asked directly
about Mr. Villasenor’s values, she simply described them as optimistic;
f)
her experience was
limited vis-à-vis Straight Egyptian Arabian horses;
g)
she did not take into
account the impact of the Cabreah Breeders Challenge.
[90]
Overall, Ms.
Henderson’s report lacked the detail and level of inquiry or sophistication
that would lead me to accept it unequivocally. Frankly, with no disrespect to
the experts who were clearly knowledgeable about Arabian horses, I find I
am not confident in relying fully on either of them as providing truly
independent valuations.
[91]
I conclude that Ms. Henderson’s
generalizations that Mr. Villasenor’s values are optimistic is likely
accurate based on:
a)
Mr. Villasenor’s support
for the Cabreah program;
b)
Mr. Villasenor had no
explanation for increased values on the non‑arms length transfer of
horses;
c)
the horses were insured
for less than suggested values;
d)
while the commercial
arrangement should not be ignored, it must also be considered that Montebello effectively created its own market and it would be
unwise, indeed artificial, to look only at what other Cabreah partnerships
would pay.
[92]
Yet, I also conclude
that Ms. Henderson’s values are pessimistic, having relied on auction figures
and totally ignoring the commercial nature of the Cabreah program. So, the
values are somewhere between the two extremes offered by the two experts.
[93]
It would be a mug’s
game for me to even attempt to review the characteristics of each horse and
reach some conclusion on the value of each horse. No, I need to deal in
averages and I need to find some hard reliable numbers, untainted by advocates
on either side. Chapel and Misheks’ 1997 letters might have been more helpful
if subjected to scrutiny; perhaps the low end of their evaluations though is
closer to reality (that is approximately $80,000 Cdn for mares). Yet this does
not appear to correspond to insured values as set out in the Montebello Farms
Equine Mortality Insurance Claims Report, which indicated values of $40,000 per
mare. Those are certainly real numbers. While Mr. Smith testified mares were
insured for $60,000 to $70,000 in the mid-1990s, this does not seem to accord
with the claims history just indicated. He did testify though that the horses
were not insured for their full value as Montebello’s was absorbing some risk. I believe this information does narrow the
range presented by the experts, suggesting that Ms. Henderson’s average
for mares of approximately $15,230 is too low and Mr. Villasenor’s average
of $97,800 is too high. I conclude that a more realistic range is $40,000 to
$60,000 per mare and will therefore take the middle ground average, or $50,000
Cdn as reflecting a truer picture of the fair market value at the relevant
time. I recognize this is a somewhat general approach not distinguishing fillys
from yearlings and mares, but it does accurately convey my balancing of the
following factors:
-
the experts’ reports deficiencies;
-
insured values;
-
untested third party
letters;
-
lack of explanation for non-arms
length transfer of horses between Walker related entities.
[94]
The stallion, The Atticus,
and the colt, MB Sehnari, are somewhat more problematic as there is little
insurance or third party information to assist. The evidence suggests stallions
can indeed fetch a pretty price, but there is no extensive hard core data on
stallion sales that support a value for The Atticus of $850,000 versus
$101,250. Both experts describe the horse and its bloodlines favourably and
then Ms. Henderson simply concluded, "based on my research and the
information, I value at $75,000". Mr. Villasenor concluded "given the
value of the breeding revenues over the first five years as well as the
intrinsic value of The Atticus, under those circumstances, his fair market
value would be approximately $850,000". Mr. Villasenor did not
attempt to illustrate his determination of the value based on The Atticus
yielding an income stream of $78,000 a year for five years, but I do accept it
produces some inherent value in the asset, the horse, even taking into account
the prepaid expenses and possible lost opportunity cost in funding the
acquisition: a more detailed analysis would have been helpful. But then
Mr. Villasenor’s reference to
"intrinsic value" and Ms. Henderson’s reference to
"research" are frankly both sketchy, untestable best guesses. The
fact some stallions sell for big bucks is not determinative. What I do know is
that Montebello paid approximately $105,000 Cdn in 1992, before The
Atticus was proven. I also know that, pursuant to the commercial arrangement
outlined in the Offering Memorandum, it would yield income after expenses of roughly
$330,000 over five years. When I add these factors to the fact that at the
relevant time, The Atticus was no longer a colt but closer to meeting its
potential as a stallion, I am satisfied the value is well beyond what Ms.
Henderson opined. Also, I have Chapel Farms statement it paid $200,000 for a
half-interest in a five-year old breeding stallion, though again this may be
comparing Chevrolets to Cadillacs. Who knows? For similar reasons expressed in
grappling with the mare’s value, I am not prepared to accept
Mr. Villasenor’s optimistic value. I find a more realistic value to be
$500,000, taking into account the original costs, the maturity of The Atticus
since its acquisition and its scheduled income yield.
[95]
With respect to MB
Sehnari, I start with Mr. Smith’s evidence that there were certain general
prices for the horses established for sale to the partnerships, $10,000 for a
colt and $50,000 for a colt with breeding potential. Mr. Villasenor valued MB
Sehnari at $75,000 while Ms. Henderson valued it at $13,500. Ms. Henderson
did not take into account the breeding revenue to be generated by MB Sehnari as
forecast by the Offering Memorandum. Frankly, I was never clear on how one
distinguishes a one-year old colt with breeding potential versus one without.
My approach, therefore, is to consider Ms. Henderson’s value as a starting
point and factor in the three year potential revenue stream contemplated by the
Offering Memorandum of $60,000 per year for three years, less of course
applicable expenses (mainly prepaid). This would, I find, justify a value for
MB Sehnari in line with the $50,000 which the R Partnership in fact paid
for the horse.
[96]
In summary, on the
value of the horses, I conclude that the value of MB Sehnari and the
half-interest in The Atticus totals $300,000, both at the time of the transfer
to the R Partnership and at the time of the transfer out of the
R Partnership to the R Corporation. I see no reason why the value would
have changed over a few-week period. I conclude the value of the horses
transferred into the XIII Partnership and subsequently to the XIII Corporation
is $350,000: again, I find there is no change in value during the time of
the two transactions.
Valuation – prepaid expenses
[97]
The Respondent only
addressed the board and care elements of the prepaid expenses, relying on Ms.
Henderson’s report to argue that the amounts charged were not reasonable. In
her letter of September 29, 2010 Ms. Henderson stated:
I currently charge $600 per month, per horse for board and care plus
HST. The reasonable range for the cost of board and care would be from $450 to
$800 per month in today’s market, depending on geographical location. This
amount could increase to $1,500 per month, per horse, with training for showing
included. I checked my figures with colleagues in the business of
professional horse-care and these figures can be considered fair.
[98]
Mr. Villasenor stated:
BOARD AND CARE FEES
Because of my knowledge of the industry and relationship with a
number of significant Arabian horse breeding operations in the USA and other countries, I am able to opine
as to the reasonableness of the amounts charged by Montebello Farms Inc.
("Montebello Farms") for board and care of these horses. It is my
understanding that during the relevant period, being the mid-1990’s, Montebello
Farms charged each mare partnership $525 Canadian per month for board and care
per horse 6 months and older. I find this amount to be very reasonable given
the caliber of the Montebello/Cabreah Farm facilities, the knowledge and
experience of their horse care staff and the fine condition of the many animals
I observed at their farms on many occasions. The amount of this fee is
consistent with what was charged in the industry. I have attached at Schedule F
a copy of a contract that I was able to obtain from Arabians Ltd., the
largest farm breeding Egyptian Arabians in the United
States of America, and an excerpt from this
organization’s website. As for the male partnership R LP, I understand that the
board and care charge by Montebello Farms to R LP and its successor corporation
was $1,000 Canadian for the first 3 years of the business, and $1,250 per month
for the following two years. In my experience as both a manager of a breeding
farm operation as well as in speaking with a number of Arabian horse breeders,
this monthly charge would be at the low end for board and care management of a
breeding stallion.
[99]
I also had the benefit
of the evidence of Tara Fox, a former manager at Montebello, whose testimony was sincere and straightforward. It was clear she had
the highest regard for the quality of the care the horses received at Montebello. From her testimony, and that of Mr. Smith and Mr.
Villasenor, and with no dispute from Ms. Henderson, I was left with a clear
impression of an extremely well‑managed and well‑equipped large
breeding operation at Montebello Farms. Given Mr. Villasenor’s broader knowledge of the larger herd industry, and
having obtained some third party corroboration in making this report, I accept
his assessment that the costs charged were reasonable.
[100]
The only evidence I
heard regarding the reasonableness of the prepayment nature of the payments for
board and care was Ms. Henderson’s opinion that it is common practice to pay
monthly, and that she did not know of a facility that would expect to be
prepaid for a two-year period. The Appellant’s position was that the
reasonableness of the prepayment provision is not an issue, only the amount of
the charges. While I have some concern as to the commercial reasonableness of
such a prepayment provision, I have nothing concrete upon which to substitute
my judgment for the partnerships’ judgment. Ms. Henderson’s statement is not
sufficient to rule out the possibility of prepayments. Neither party gave any
in‑depth argument on this point. Having concluded the costs are
reasonable, I am not going to reduce the deductibility of the prepaid expenses
simply because they are prepaid.
[101]
In summary on the first
issue, I find the partnerships are legitimate partnerships and that Mr. Teelucksingh
is entitled to claim restricted farm losses based on the partnerships’ prepaid
expenses as filed and based on a fair market value of the horses being limited
to $350,000 for the XIII Partnership and $300,000 for the R Partnership at the
relevant times.
b) RRSPs
Were there withdrawals from
Mr. Teelucksingh’s RRSP of $27,237 used to acquire qualifying shares with a
value of $27,237?
[102]
The answer to this
simply flows from my conclusion above. With the decreased value of the horses,
the value of the preferred shares must correspondingly decrease. So, for
example the Net Assets of the XIII Partnership would be reduced effective
September 1, 1995 by $345,000 (reflecting the reduction from $695,000 to
$350,000) from $500,044 to $155,044, resulting in the preferred shares’ value
going from $20,001 to $6,201. The same calculation for the R Partnership leads
to a reduction in the value of the preferred shares from $18,236 to $10,636.
This would result in $7,600 being a taxable withdrawal in connection with the R
Corporation. With respect to the XIII Corporation where the value is reduced
from $20,001 to $6,201, the amount of $9,001 withdrawn by Mr. Teelucksingh
should be prorated (6,201 ÷ 20,001) resulting in $6,210 being a taxable
withdrawal from his RRSP.
[103]
I wish to be clear that
I specifically asked counsel for the Respondent if there was an issue as to
whether the preferred shares were qualifying shares for purposes of RRSP
investments: I was assured that was not an issue. The only issue was the value of
the preferred shares eligible for RRSP investment purposes.
[104]
I recognize that Mr.
Teelucksingh is only one investor of many hundreds assessed by the Respondent,
and that they await the outcome of this decision. Both parties expressed some
expectation that this decision would allow these investors and the Respondent
to reach a mutual accord, and save the time and expense of any further
litigation. I have tried to make clear that the only failing, if I can call it
that, in this well crafted plan to raise funds for Montebello and provide some advantages to investors, was the inflated value of
the horses. I hope that I have provided some guidelines on the issue of value
that can, with some mutual cooperation, lead to resolution of the
remaining investors’ assessments.
[105]
In summary, the appeals
from the reassessments made under the Income Tax Act for the 1993, 1994,
1995 and 1996 taxation years are allowed and referred back to the Minister for
reconsideration and reassessment on the following basis:
a)
the Appellant is
entitled to restricted farm losses based on (i) the fair market value of the
horses being $300,000 in the R Partnership and $350,000 in the XIII Partnership
and (ii) expenses, including prepaid expenses, as filed by the Appellant; and
b)
in computing the
Appellant’s income arising from withdrawals from his RRSP the amount to be
included in income shall be reduced from $27,237 to $13,810.
[106]
Mr. Leclaire asked that
I refrain from making a costs order until the parties have had an opportunity
to review these reasons. I ask that they provide written representations to me
on or before February 11, 2011.
Signed at Ottawa, Canada, this 13th day of January 2011.
"Campbell J. Miller"
Appendix A
Excerpts from R Investment Offering Memorandum
The 25 Combined Interests offered hereby consist of
limited partnership units (the "Units") of Montebello Egyptian
Bloodstock Investments R and Company, Limited Partnership (the "Limited
Partnership") and common shares (the "Common Shares") of
Montebello Egyptian Bloodstock Investments R Inc. (the
"Corporation"). The General Partner of the Limited Partnership is
Montebello Bloodstock Management Inc. (the "General Partner").
Accepted subscribers for Combined Interests will become limited partners (the
"Limited Partners") of the Limited Partnership and shareholders of
the Corporation. The Limited Partnership and the Corporation have been formed
to carry on the business of acquiring, raising, showing and exhibiting Straight
Egyptian Arabian stallions and selling their breeding services, all for the
purpose of earning farming revenue. The Limited Partnership anticipates that
there will be losses available for income tax purposes in 1993 for use by a
subscriber against non-farming sources of income. The Limited Partnership has
to date entered into agreements pursuant to which it will acquire: (i) a
50% undivided interest in a Straight Egyptian Arabian stallion; and (ii) a
Straight Egyptian Arabian colt with the proceeds of this offering and sell
their breeding services, on a non-exclusive basis, for a period of five years,
for gross revenues of $588,000. The Limited Partnership will also seek to enter
into additional agreements for the further sale of breeding services. It is
anticipated that subscribers for Combined Interests will receive cash
distributions in 1994 and subsequent years arising from the net cash flow
derived from the foregoing sale of breeding services. The Limited Partnership
has also entered into long-term agreements relating to the board and care of
its Straight Egyptian Arabian horses and the management of its operations,
thereby fixing it operating costs in advance.
It is proposed that the Limited Partnership will carry
on business until approximately January 15, 1994. Subject to approval by the Limited
Partners, the assets of the Limited Partnership will then be transferred to the
Corporation (the "Asset Transfer"). In consideration of the Asset
Transfer, the Corporation will assume all of the liabilities of, and will issue
preferred shares (the "Preferred Shares") to, the Limited
Partnership. Within 45 days of the Asset Transfer, the Limited Partnership will
be dissolved. Upon dissolution, the Limited Partners will receive all of the
Preferred Shares on a pro rata basis. The Corporation will continue
operations until December 31, 1998, at which time it will be dissolved. Prior
to dissolution, the Corporation’s assets will be liquidated in order to permit
a final cash distribution on or before the dissolution date. It is expected
that the Corporation’s assets will then consist of its interest in the two
Straight Egyptian Arabian horses to be acquired with the proceeds of this
offering. See "Schedule of Events".
…
Event Date
Final closing................................................................... December
31, 1993
Limited Partners’ meeting............................................... January
14, 1994
Asset transfer from Limited Partnership to Corporation... January
15, 1994
Dissolution of Limited Partnership.................................. February
28, 1994
Distribution of Preferred Shares...................................... February
28, 1994
Commencement of cash distributions.............................. 1994
Final cash distribution..................................................... December
1998
Dissolution of Corporation............................................. December
31, 1998
…
The Common Shares and the Preferred Shares will not be
qualified investments for deferred sharing plans. Subject to certain conditions
being met, however, if the business of the Limited Partnership is transferred
to the Corporation pursuant to the Assets Transfer Agreement, it is expected
that the Common Shares and the Preferred Shares will be qualified investments
for a registered retirement savings plan or a registered retirement income fund
of a shareholder who deals at arm’s length, for income tax purposes, with the
Corporation. See "Income Tax Considerations".
…
Investment..................................................................... $18,000
Loss Allocated to Limited Partner (1)..............................
9,520
Income Tax Deductions
- 100% of first $2,500.....................................................
2,500
- 50% of balance (up to $6,250)......................................
3,510
$
6,010
Total Income Tax Savings (2)......................................... $
3,146
Total Income Tax Savings as a % of Investment..............
17.5%
…
The Limited Partnership will acquire from Montebello
Farms: (i) a 50% undivided interest in the Straight Egyptian Arabian stallion;
and (ii) Straight Egyptian Arabian colt set out in Appendix "A", for
an aggregate purchase price of $400,000. The Limited Partnership has also
entered into the Stallion Service Purchase Agreement with Montebello Farms.
Under the Stallion Services Purchase Agreement, the Limited Partnership has
sold non-exclusive breeding rights to its Straight Egyptian Arabian stallion
and Straight Egyptian Arabian colt to Montebello Farms for a period of five
years, for the purpose of breeding to mares owned by Montebello Farms or under
its care. The agreement provides for Montebello Farms to purchase 13 breedings
per year with the Straight Egyptian Arabian stallion at a price of $6,000 per
breed and, commencing in 1996, 11 breedings per year with the Straight Egyptian
Arabian colt, also at a price of $6,000 per breed. Montebello Farms will thus
pay the Limited Partnership and, after the proposed Asset Transfer, the
Corporation, an aggregate amount of $588,000, consisting of $78,000 in each of
1994 and 1995, and $144,000 in each of 1996, 1997 and 1998.The additional
$66,000 to be paid by Montebello Farms commencing in 1996 represents the
breeding fee for the Straight Egyptian Arabian colt, which will reach breeding
age in that year.
…
The Limited Partnership will be dissolved on
the earliest of:
(a)
a date to be selected
by the General Partner, which shall be within 45 days of the completion of
the Asset Transfer, unless the Limited Partners fail to confirm the Asset
Transfer;
(b)
December 31, 2025; or
(c)
an earlier date, if
approved by Special Resolution with the concurrence of the General Partner.
Pursuant to the Asset Transfer Agreement, the General
Partner will transfer all of the Limited Partnership’s assets to the
Corporation, subject to the Corporation assuming all of the liabilities of the
Limited Partnership. As consideration for the Asset Transfer, the Corporation
will issue Preferred Shares to the Limited Partnership. The number of Preferred
Shares to be issued to the Limited Partnership shall be determined based on the
net asset value of the Limited Partnership at the date of the Asset Transfer.
See "Share capital" and "Preferred Shares" under the
section entitled "The Corporation". Upon the dissolution of the
Limited Partnership, the General Partner will distribute the Preferred Shares
to the Limited Partners in accordance with their respective Sharing Ratios.
…
Business of the Corporation
The business of the Corporation will be to acquire,
raise, show and exhibit Straight Egyptian Arabian stallions and to sell their
breeding services, all for the purpose of earning farming revenue. To enable it
to carry on its business, the Corporation has entered into the Asset Transfer
Agreement with the Limited Partnership to purchase the Limited Partnership’s
assets, subject to confirmation by the Limited Partners, and has agreed to
assume the obligations of the Board and Care Agreement, the Stallion Services
Purchase Agreement and the Loan Agreement.
…
The Business of the Limited Partnership
The Limited Partnership will acquire, breed, raise,
show, exhibit and sell Straight Egyptian Arabian stallions, and will sell their
breeding services. Under the Federal Act, farming is defined to include
"livestock raising". Accordingly, the Limited Partnership should be
considered to carry on farming operations for income tax purposes, provided the
stallions have a substantial resale value at the end of the Stallion Services
Purchase Agreement. Montebello Farms is of the view that the stallions should
have such a resale value. Provided that the farming operations of the Limited
Partnership are carried on with a reasonable expectation of profit, the Limited
Partnership should be considered to be carrying on a farming business for
income tax purposes. Losses shall only be deductible in the manner described
below if the Limited Partnership is considered to carry on this farming
business with a reasonable expectation of profit. Since the determination of
when a business is carried on with a reasonable expectation of profit is essentially
a question of fact, no assurance can be given in this regard.
APPENDIX B
APPENDIX C
BALANCE SHEET-ROLL DATE
APPENDIX D
HORSE DESCRIPTION VILLASENOR HENDERSON
The Atticus Stallion $850,000.00
at 50% $75,000.00 US $101,250.00
$425,000.00 at
50% $50,625.00
MB Sehnari Colt $75,000.00 $10,000.00
US $13,500.00
TOTAL $500,000.00 $64,125.00
Ansata Zaahira mare $110,000.00 $20,000.00 $27,000.00
Imperial
Mareesiy mare $110,000.00 $20,000.00 $27,000.00
Zandai Petra mare $110,000.00 $
5,000.00 $6,750.00
Zandai Tabitha mare $110,000.00 $
5,000.00 $6,750.00
Alliah mare $110,000.00 $
5,000.00 $6,750.00
EAI Alikadheena mare $
75,000.00 $20,000.00 $27,000.00
EAI Immareekha mare $
60,000.00 $ 4,000.00 $ 5,400.00
TOTAL $685,000.00 $106,650.00
Average $
97,800.00 $15,230.00
Email this Content