Tyoxide Canada Inc. v. The Queen, 93 DTC 1499, [1994] 1 CTC 2569 (TCC)

Garon, J.T.C.C.:—These are appeals from assessments for the appellant's 1985, 1986 and 1987 taxation years. By those assessments the Minister of National Revenue, in reliance on paragraph 12(1)(x) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), included in calculating the appellant's income the amounts of $100,766, $107,638 and $191,618 for 1985, 1986 and 1987 respectively. These amounts represent tax credits granted the appellant for scientific research and experimental development pursuant to the Quebec Taxation Act, R.S.Q. 1977, c. 1-3. Further, under those same assessments for the three taxation years in question, the amounts of $63,854, $107,638 and $191,618 were deducted from qualified expenditures for the purpose of calculating the investment tax credit, and this the Minister of National Revenue said was in accordance with subsections 127(9) and (11.1) of the Income Tax Act.

The facts are not in dispute. Only one witness was called for the appellant. This was Mr. Max Maurice, who has been the appellant’s treasurer since 1981. This witness explained that in the course of his duties he was responsible for preparing the appellant’s tax returns. He indicated that since the appellant began its activities in 1962, long before the credit in question was created by the Quebec National Assembly, it has had a specialized team doing work pertaining to scientific research and experimental development both in the field of pollution and in developing new products or processes. He said that the survival of the business depends on this, after indicating essentially that the appellant had not undertaken research and development as a result of tne Quebec legislation on the matter. A table showing the effect of certain deductions for the years in question on the amount of tax the appellant had to pay the Government of Quebec was filed. The information in this table, taken from the provincial tax returns, is set out below:

TIOXIDE CANADA INC.

INFORMATION BASED ON PROVINCIAL TAX RETURNS FOR 1985, 1986 AND 1987

	1985	1986	1987
CAPITAL COST ALLOWANCE	$ 1,467,536	$ 3,203,144	$ 5,336,402
TOTAL SALARIES	13,293,415	14,762,377	16,648,479
DEDUCTIBLE EXPENDITURES	$14,760,951	$17,965,521	$21,874,881
EFFECTIVE RATE	5.50%	5.77%	5.90%
TAX REDUCTION	$ 811,852	$ 1,036,611	$ 1,290,618
			[Translation.]

Mr. Maurice further indicated that since 1985 the appellant has benefited from a tax credit under Quebec legislation for the salaries which it pays in connection with scientific research and experimental development. In cross-examination, it was established that as the result of an administrative error the appellant included in its income for the 1987 taxation year the sum of $191,618, representing the Quebec tax credit for scientific research and experimental development, and thereby reduced the amount of the qualified expenditures in calculating the investment tax credit.

In making his assessments for the years in question the Minister of National Revenue relied on the following facts, stated in paragraph 4 of the reply to the notice of appeal. Paragraph 4 reads as follows:

4. In assessing the appellant as he did for the 1985, 1986 and 1987 taxation years, the Minister of National Revenue relied, inter alia, on the following facts:

(a) during the 1985, 1986 and 1987 taxation years the appellant carried on business as a manufacturer of titanium pigments;

(b) during those years the appellant’s financial and fiscal year ended on December 31;

(c) during the years at issue the appellant was a corporation other than a Canadian- controlled private corporation;

(d) during those years the appellant was engaged in certain research and development activities;

(e) in connection with these activities, the appellant obtained from the Government of Quebec a refundable tax credit on the salaries paid to employees involved in these activities;

(f) during each of the years in question the appellant made tax instalments for its

Quebec tax, which were calculated and paid after deducting of the tax credits;

(g) during these years the appellant received such a tax credit, totalling $100,766 in 1985, $107,638 in 1986 and $191,618 in 1987;

(h) the tax credits were incentive payments made to the appellant during the years in question for research and development activities;

(i) these tax credits must be deducted from qualified expenses in calculating the investment tax credit to which the appellant was entitled for each of the years in question, since these credits were government assistance received by the appellant in the form of tax deduction.

[Translation.]

Appellant's arguments

In accordance with the substance of what was stated in the notice of appeal, the appellant argued that the tax credits it received under the Quebec legislation could not be governmental assistance within the meaning of paragraphs 12(1 )(x) and 37(1 )(d), and of subsection 127(9) and paragraph (11.1)(c), "because those tax credits were not received from a government or other public authority” but rather were "granted by the Quebec Taxation Act’. Counsel for the appellant referred in this connection to the theory of the separation of the three powers, the executive, the legislative and the judicial powers.

In its notice of appeal in support of its proposition that the tax credits it received under the Quebec legislation are not a tax deduction granted by the Government of Quebec, the appellant made the following observations:

Moreover, when the Government of Quebec wishes to grant a tax deduction it does so under section 94 of the Act respecting the Ministère du Revenu du Québec (R.S.Q. 1977,

c. M-31), as it is authorized to do by section 94 of that Act. In the instant case the tax credit received by the appellant under the Quebec Taxation Act during these taxation years was granted by the National Assembly under the Quebec Taxation Act and not by the Government of Quebec or any other public authority.

[Translation.]

The appellant argued in particular that it did not receive any amount under the Quebec Taxation Act, and in particular under section 1029.7 of that Act. On the contrary, its counsel argued that under that section the appellant was deemed to have paid an amount to the Quebec Minister of Revenue. The appellant relied on my decision in Blais v. M.N.R., [1990] 2 C.T.C. 2005, 90 D.T.C. 1494.

The appellant further relied on Donaldson v. M.N.R., [1976] C.T.C. 2132, 76 D.T.C. 1107, arguing that paragraph 12(1)(x) of the (federal) Income Tax Act does not apply here because Parliament clearly said "received" and not "deemed to have received”. The appellant also relied on decisions of the Federal Court-Trial Division and Appeal Division in G.T.E. Sylvania Canada Ltd. v. The Queen, [1974] C.T.C. 408, 751, 74 D.T.C. 6315, 6673.

Respondent's arguments

The respondent advanced as a general proposition in paragraph 5 of the reply to the notice of appeal that ”. . . during the taxation years at issue the appellant received governmental assistance as an inducement payment in the form of a tax deduction totalling $100,766 in 1985, $107,638 in 1986 and $191,618 in 1987”.

Counsel for the respondent first noted that the provincial tax credit mentioned in section 1029.7 of the Quebec Taxation Act is to be found in the part of that Act dealing with "refundable tax credits". He pointed out that by section 1029.7 the legislature set up special payment procedures which affect the calculation of monthly instalments to be made by a taxpayer. Counsel for the respondent noted the rule stated by M. Pierre-André Côté in his text The Interpretation of Legislation in Canada, 2nd ed., at page 51, that "There is no doubt today that the title forms part of the statute, and may be used to construe it".

In support of the proposition that the amounts of tax credit in question were "received" by the appellant, the respondent relied especially on the Federal Court of Appeal judgment in The Queen v. British Columbia Forest Products Ltd., [1986] 1 C.T.C. 1, 85 D.T.C. 5577. Counsel for the respondent argued that it is clear that paragraph 12(1 )(x) covers the situation at issue in the instant case, in particular if we consider that the appellant would have been entitled to a refund of the amounts of these credits if otherwise it would not have been required to pay any amount of tax. He further indicated that it was obvious that there was no physical operation when one speaks of an amount received in the form of a tax deduction.

Analysis

I will first consider the question of whether the benefit obtained by the appellant resulting from the provincial tax credit is an inducement or assistance within the meaning of paragraph 12(1 )(x) of the Income Tax Act. That provision reads as follows:

12(1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(x) any amount (other than a prescribed amount) received by the taxpayer in the year, in the course of earning income from a business or property, from

(i) a person who pays the amount (in this paragraph referred to as “the payor") in the course of earning income from a business or property or in order to achieve a benefit or advantage for himself or for persons with whom he does not deal at arm's length, or

(ii) a government, municipality or other public authority where the amount can reasonably be considered to have been received

(iii) as an inducement, whether as a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of inducement, or

(iv) as a reimbursement, contribution, allowance or as assistance, whether as a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of assistance, in respect of the cost of property or in respect of an expense to the extent that the amount

(v) was not otherwise included in computing the taxpayer's income for the year or a preceding taxation year,

(vi) except as provided by subsection 127(11.1), does not reduce, for the purposes of this Act, the cost or capital cost of the property or the amount of the expense, as the case may be,

(vii) does not reduce, pursuant to subsection 13(7.4) or paragraph 53(2)(s), the cost or capital cost of the property, as the case may be, or

(viii) may not reasonably be considered to be a payment made in respect of the acquisition by the payor or the public authority of an interest in the taxpayer, his business or his property. [1]

The purpose of paragraph 12(1 )(x), which was added in 1986, is to require — subject to certain restrictions mentioned in the paragraph and certain exceptions covered by Part LXXIII of the Income Tax Regulations — the inclusion in a taxpayer's income from a business or property of inducement payments received in any form whatsoever and the value of certain benefits received in respect of the cost of a property or of an expense as a reimbursement, contribution or allowance or any form of assistance. Such payments or benefits may have been received from certain classes of persons or from a government, municipality or other public authority. The paragraph is designed to reverse a trend in the courts not to include certain types of payment in calculating a taxpayer's income on the ground that the amounts received were payments on capital account and also should not be taken into account in calculating the capital cost of property.

To accurately determine the nature of the tax credit at issue in the instant case, we should first look at the legislation which created it. I refer in this regard to section 1029.7 of the Quebec Taxation Act, which reads as follows:

1029.7 A taxpayer not mentioned in section 984 or 985, who carries on a business in Canada and undertakes or causes to be undertaken in Québec after May 10, 1983, scientific research within the meaning of the regulations made pursuant to section 222, is deemed to have paid to the Minister, for the taxation year during which the research was undertaken, as partial payment of his tax payable for that year pursuant to this Part, an amount equal to ten per cent of the wages he has paid during the year in respect of the research to his employees of an establishment situated in Québec and of the portion of the remuneration that he has paid during the year in respect of the research to a person who has undertaken all or part of the research, that may be attributed to the wages of the employees of an establishment of that person situated in Québec or would be if he had such employees.

Furthermore, for the purposes of computing the payments that a taxpayer is liable to make under section 1026 or 1027, the taxpayer is deemed to have paid to the Minister as partial payment of his tax payable pursuant to this Part, on the date on which each quarterly or monthly payment is required to be paid, the amount which would be determined under the first paragraph if it applied only to the period covered by the payment, and on the date the last payment is required to be paid, the balance of the amount determined under the said first paragraph.

For the purposes of this section, "wages" means the income computed pursuant to Chapters I and II of Title II of Book III of this Part.

(2) This section, where it refers to a payment that a taxpayer is liable to make, applies in respect of such a payment that must be made after November 15, 1983.

This section appears in Division Il headed "Credit for research and development" of Chapter III.! titled "Refundable tax credit" of the Quebec Taxation Act.

Essentially, section 1029.7 provides that a taxpayer covered by this provision who undertakes scientific research and experimental development in Quebec or causes it to be undertaken is deemed to have paid, to the extent indicated, to the Quebec Minister of Revenue as partial payment of his tax payable for that year an amount equal to ten per cent of the wages he has paid during the year in respect of the research.

In considering how paragraph 12(1 )(x) applies to the facts of the instant case the Court must examine whether all aspects of this provision are met here, especially having regard to the nature of the credit created by the provincial taxation statute.

The first question is whether the tax credit which the appellant benefited from in the years at issue pursuant to section 1029.7 is an "amount received" by the appellant in the year in the course of earning income from a business.

As I have already indicated, counsel for the appellant strenuously contended that the appellant had not received anything, but that under section 1029.7 the appellant is deemed to have paid a certain amount to the Quebec Minister of Revenue. This concept of a deemed payment is the opposite of an amount received. There is no doubt that strictly speaking the appellant has not received anything from the Quebec Government. The word "amount" is defined in subsection 248(1) of the Income Tax Act as meaning "money, rights or things expressed in terms of the amount of money or the value in terms of money of the right or thing”. It follows that for each of the years in question the appellant benefited from a tax credit, and thus from a right conferred on it by the aforementioned provincial legislation. As a consequence of this right, the appellant benefited from an "amount" within the meaning of subsection 248(1) of the Act, in view of the very broad meaning given to the word "amount" by subsection 248(1). If it can be said that the appellant benefited from an amount, it is also correct to say that the appellant "received" an amount in the years in question within the meaning of paragraph 12(1 )(x), since during those years it benefited from the provincial tax credit in question which, in concrete terms, resulted in a reduction in the amount of income tax it had to pay the Quebec Minister of Revenue. The appellant accordingly received a real monetary benefit during the years in question.

I therefore conclude that the first requirement set by the preamble to paragraph 12(1 )(x) — namely that an amount was received by the appellant in the course of earning income from a business — has been met in the instant case. It must now be determined whether the amount received is of the kind covered by subparagraphs 12(1 )(x)(iii) or 12(1 )(x)(iv). To assist in considering this point, it seems to me that it would be useful to reproduce only the parts of paragraph 12(1 )(x) which may be relevant to the instant case:

12(1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(x) any amount (other than a prescribed amount) received by the taxpayer in the year, in the course of earning income from a business or property, from

(ii) a government. . .

where the amount can reasonably be considered to have been received

(iii) as an inducement, whether as. . . deduction from tax . . .

(iv) as a . . . or as assistance, whether as a . . . deduction from tax, . . . in respect of the cost of property or in respect of an expense.

It was not suggested to me that other parts of this paragraph could support the position taken by either of the parties. If we look at the part of paragraph 12(1 )(x) reproduced above, we are forced to construe that part of the paragraph very broadly if it is to receive a certain application. I do not feel that physical receipt of an amount by a taxpayer can conceivably be required when the benefit received by the taxpayer is in the form of a tax deduction. A tax deduction is an arithmetical operation involving a reduction in the amount of tax that would otherwise be payable. This operation results from a numerical disposition. By that disposition the taxpayer concerned sees his tax liability, his tax indebtedness, reduced by that amount as if he had paid the tax authorities the amount corresponding to the amount of the tax deduction. From an economic standpoint the benefit resulting from his tax credit corresponds to a payment by the government of an amount equal to the amount of the credit. Seen in this way the wording of this part of paragraph 12(1 )(x), dealing with an amount received in the form of a tax deduction, seems easier to understand.

If, as counsel for the appellant argued, the word "received" in the preamble to paragraph 12(1 )(x) necessarily implies a physical operation, the part of the paragraph dealing with a benefit in the form of tax deduction would never apply. This interpretation cannot be accepted as it would be contrary to the manifest intention of Parliament, which in subparagraph 12(1 )(x)(iii) expressly considers a tax deduction as a possible form of inducement, and in subparagraph 12(1 )(x)(iv) as a form of assistance in respect of the cost of property or in respect of an expense.

This way of interpreting the scope of paragraph 12(1)(x)seems to me to be quite consistent with the construction accepted by the Federal Court of Appeal in B.C. Forest Products, supra. In that case the issue was the application of subsection 13(7.1) of the Income Tax Act. Because of similarities in the wording of subsection 13(7.1) considered in that case and of paragraph 12(1 )(x) which is at issue here, it seems appropriate to reproduce the text of subsection 13(7.1) which then applied:

13(7.1) For the purposes of this Act, where a taxpayer has received or is entitled to receive assistance from a government, municipality or other public authority in respect of, or for the acquisition of, depreciable property, whether as a grant, subsidy, forgivable loan, deduction from tax, investment allowance or as any other form of assistance other than

(a) an amount authorized to be paid under an Appropriation Act and on terms and conditions approved by the Treasury Board in respect of scientific research expenditures incurred for the purpose of advancing or sustaining the technological capability of Canadian manufacturing or other industry, or

(b) an amount deducted as an allowance under section 65, the capital cost of the property to the taxpayer shall be deemed to be the amount by which the aggregate of

(c) the capital cost thereof to the taxpayer, otherwise determined, and

(d) such part, if any of the assistance as has been repaid by the taxpayer pursuant to an obligation to repay all or any part of that assistance,

exceeds

(e) the amount of the assistance.

As can be seen, subsection 13(7.1) provides that in calculating the capital cost of depreciable property, account should be taken of the assistance a taxpayer "has received" or “is entitled to receive” from a government, municipality or public authority, since that assistance can take the form of a "deduction from tax". In the case at bar Parliament has by paragraph 12(1 )(x) required that a taxpayer should include in income the amount of an inducement payment or assistance from a government, which may take various forms, and in particular that of a "deduction from tax”.

The observations of Mahoney, J.A. of the Federal Court of Appeal, speaking for that Court, also apply to the interpretation of paragraph 12(1)(x). The following passage from the English version of the reasons for judgment given by Mahoney, J.A. reported at page 3 (D.T.C. 5578) is of special interest for the purposes of the case al Dar:

Parliament has expressly contemplated that a taxpayer may "receive" assistance from a government in the form of a “deduction from tax". Whatever violence that does to one's semantic scrupulosity, the Court is obliged to give effect to Parliament’s clear and unambiguous intention if it can sensibly do so. The concept may be thought awkward, but it is clearly expressed. In Parliament's prescription, one can "receive" assistance when one takes advantage of an opportunity afforded to deduct from tax an amount that one would otherwise be required to pay. In the circumstances, the respondent did "receive" assistance within the terms of subsection 13(7.1) when it elected to take the $179,807 deduction permitted it in respect of its 1975 income tax.

In a passage from the notice of appeal reproduced in the part of these reasons dealing with the appellant’s arguments, the latter referred to section 94 of the Act respecting the Minister of Revenue and argued that the rebate mentioned in that section could be a tax deduction. Counsel for the appellant discussed this point in his oral argument as well. Section 94 reads in part as follows:

The government, whenever it considers it in the public interest, and to save the public from serious inconvenience or individuals from hardship or injustice, may remit any duty payable to the Crown relating to any matter within the powers of the Legislature

If i have correctly understood the aforesaid passage from the notice of appeal and the observations of counsel for the appellant in his oral argument, the appellant misunderstands the nature of the concepts of a “rebate” of debt on the one hand and a "tax deduction” or "tax credit" on the other hand. A tax rebate in the context of section 94 above is essentially a voluntary waiver on the part of the government made gratuitously of the right to receive payment of its debt, while a tax deduction or tax credit is an operation involving the subtraction of an amount at the stage when the amount of tax payable by a taxpayer is determined, as compared with the two earlier stages of the process established by the Income Tax Act, namely calculating income and determining taxable income. The concept of a tax credit is explained by Professor Krishna [2] as follows: “a tax credit directly reduces the amount of tax payable without reducing income".

In arguing that paragraph 12(1)(x) required the inclusion of the amounts of tax credits ?’ranted to it under the aforementioned Quebec legislation for those years, when catenating the appellant’s income for the years at issue, counsel for the appellant relied mainly on subparagraph 12(1)(x)(iii). 1, for one, am of the opinion that subparagraph 12(1)(x)(iv) applies equally well to the benefit received by the appellant in the circumstances of the instant case.

On this first question, I conclude that the amounts representing tax credits — covered by the Quebec legislation — from which the appellant benefited during the years in question were properly included in calculating its income for those years under paragraph 12(1 )(x) of the Income Tax Act.

I must now consider the second question relating to the deduction of certain qualified expenditures when calculating the investment tax credit for the same three taxation years. It seems to have been admitted by counsel for the parties in the case at bar that the outcome of the appeals now before the Court on the first and second question should be the same, although these two questions are fundamentally different. However, the application of the concept of government assistance is common to both.

Subsection 127(5) creates an investment tax credit for certain property acquired or expenditures made. The calculation of this credit is defined in terms of several factors, including that of the “investment tax credit at the end of the year in respect of property acquired, or an expenditure made” at specified periods. The phrase “investment tax credit" used in subsection 127(5) is in turn defined in subsection 127(9). Paragraph (a) of subsection 127(9) — which contains part of this definition — in the version applicable to expenditures made after November 30, 1985 reads as follows:

“investment tax credit" of a taxpayer at the end of a taxation year means the amount, if any, by which the aggregate of

(a) the aggregate of all amounts each of which is the specified percentage of

(i) the capital cost to him of a qualified property, qualified transportation equipment, qualified construction equipment, approved project property or certified property acquired by him in the year,

(ii) a qualified expenditure made by him in the year, or

(iii) his qualified Canadian exploration expenditure for the year. . . . [3]

The expression “qualified expenditure” in paragraph (a) of the definition of “investment tax credit" is described, also in subsection 9, as follows:

“qualified expenditure" means an expenditure in respect of scientific research and experimental development made by a taxpayer after March 31, 1977 that qualifies as an expenditure described in paragraph 37(1)(a) or subparagraph 37(1)(b)(i), but does not include

(a) a prescribed expenditure, nor

(b) in the case of a taxpayer that is a corporation, an expenditure specified by the taxpayer for the purposes of clause 194(2)(a)(ii)(A). . . [4]

Finally, for the purposes of the question before the Court at this stage, reference must oe made to paragraph 127(11.1)(c), which reads as follows:

127(11.1) For the purposes of the definition “investment tax credit" in subsection (9),

(c) the amount of a qualified expenditure made by a taxpayer shall be deemed to be the amount of the qualified expenditure, determined without reference to subsections 13(7.1) and (7.4), less the amount of any government assistance, nongovernment assistance or contract payment in respect of the expenditure that, at the time of the filing of the return of income for the taxation year in which the expenditure was made, the taxpayer has received, is entitled to receive or can reasonably be expected to receive. . . .

The meaning of the phrase “government assistance” used in paragraph 127(11.1 )(c) is indicated in subsection 127(9). The wording which follows reproduces the version applicable after May 23, 1985:

127(9) In this section and section 127.1,

"government assistance” means assistance from a government, municipality or other public authority whether as a grant, subsidy, forgivable loan, deduction from tax, investment allowance or as any other form of assistance other than as a deduction under subsection (5) or (6); [5]

The latter definition expressly states that government assistance may include assistance from a government in the form of a "deduction from tax". We realize that this terminology resembles that discussed in considering the first question involving the application of paragraph 12(1 )(x). Subparagraph 12(1 )(x)(iv) deals in particular with an amount received "as assistance . . . as a . . . deduction from tax". It is clear that in calculating qualified expenditures to which the investment tax credit applies government assistance received by the taxpayer must be taken into account.

The preceding comments, showing that the tax deduction provided by the Quebec legislation for scientific research and experimental development must be regarded as assistance from the Government of Quebec, also apply in considering the second question. Those same comments support the conclusion that we must, in calculating the investment tax credit, deduct from qualified expenditures, the assistance provided by the Government of Quebec to the appellant in the form of a tax deduction in accordance with section 1029.7 of the Taxation Act.

It follows from the foregoing that the assessments of the Minister of National Revenue for the three years in issue were well founded.

The appeals from those assessments are dismissed with costs.

Appeals dismissed.

Majean Investments Company Limited v. Her Majesty The Queen

[Indexed as: Majean Investments Co. v. Canada]

Tax Court of Canada (Hamlyn, J.T.C.C.), October 4, 1993 (Court File No. 91-1844).

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

M and his wife were the sole shareholders of the appellant. At all material times, the appellant owned 50 per cent of the shares of M Ltd. and M personally owned the other 50 per cent. During its 1987 taxation year, the appellant sold its shares in M Ltd. to M's children for $175,000. By reassessment, the Minister calculated the appellant’s capital gains on the basis that the fair market value of the shares disposed of by the appellant was $425,000. M Ltd. was involved in the debt collection business and M was its operating and directing mind. M had put together a number of interrelated and connected companies whose purpose was to enhance the debt collection business of M Ltd. by achieving residential status in various foreign jurisdictions. At the hearing, M testified that the trade territories were restricted and protected in large measure by virtue of his own personal presence and the membership in trade associations. In particular in one association, ACBC, the bylaws provided that membership was non-transferable. However, M stated, the unwritten rule of ACBC was structured to protect families, and the transfers to family members of a particular member could take place without objection if the lobbying and politics of the proposed transfer were handled properly. Beyond that, the bylaw was strictly enforced to prevent transfers to third parties. The ACBC relationship was the source of over 30 per cent of M Ltd.'s business income. M further emphasized that the federal government collection business that came through this connection was periodically up for tender, and that business could easily be lost in the contract-tender process. All of M's evidence was presented to support the appellant’s position at the time of the sale that a third party arm's length purchaser would have no guarantee on transfer of the same business level, and to some degree certain business could not be transferred because of the bylaw prohibition. At the hearing, the appellant’s expert, P, who had been M Ltd.'s auditor for 40 years, testified that the value of all the shares of M Ltd. at the time of sale was $350,000 (i.e., $175,000 for 50 per cent of the shares) while the Minister's expert, R, testified that the correct fair market value was between $700,000 and $800,000.

HELD:

Although R's approach to valuation was technically proper and in accordance with the methods and techniques generally accepted in the profession, in arriving at an opinion on the value of the shares, he did not accumulate sufficient data or information relating specifically to this company (i.e., M Ltd.). R was also unwilling to recognize new variations, as presented, that would significantly affect his valuation. P, on the other hand, had been associated with M Ltd. for 40 years and, as such, had an intimate knowledge of the company and its operations and he expressed himself clearly, such that his evidence showed a dept of analysis, not only on facts but on experience that was founded in his many years of private chartered accountancy practice, including other business valuations and opinions tendered in other clients’ tax matters. In the result, P’s evidence was accepted and the appellant’s valuation of the shares was confirmed. Appeal allowed.

Edward Masters for the appellant.

Roger Leclaire and Anne Michaud for the respondent.

Cases referred to:

Ample Investments Ltd. v. M.N.R., [1990] 2 C.T.C. 2217, 90 D.T.C. 1748.

Hamlyn, J.T.C.C.:—This is in the matter of Majean Investment Co., appellant, and Her Majesty the Queen, respondent.

This is an appeal with respect to the appellant's income tax reassessment for the 1987 taxation year. The appellant is a body corporate carrying on business at 72 MacLaren Street in the City of Ottawa, Province of Ontario.

On or about January 2, 1987, the appellant sold its 50 per cent share of the ownership of M. McGrath Canada Ltd., hereinafter to be called McGrath Canada, for the sum of $175,000. In reassessing the appellant for the 1987 taxation year, the Minister of National Revenue included additional capital gains to the income of the appellant in the amount of $250,000, and disallowed a claimed deduction for small business in the amount of $20,917.

The appeal on the deduction for small business disallowance was abandoned at the outset of the trial.

Facts

Mr. Matthew J. McGrath and his wife, Mrs. Jean McGrath, were the sole shareholders of the appellant Majean Investment Co. At all material times the appellant owned 50 per cent of the shares in McGrath Canada, and Mr. Matthew McGrath personally owned the other 50 per cent of the shares in the company.

During the 1987 taxation year the appellant disposed of itsshares in McGrath Canada in a non-arm's length transaction for proceeds of disposition in the amount of $175,000.

The appellant’s shares in the company were acquired by Kevin McGrath and Mary Jean McGrath, the children of Mr. Matthew McGrath and Mrs. Jean McGrath.

Significant evidence from the testimony of Matthew McGrath

Mr. McGrath, the chief executive officer and chief operating officer and president of McGrath Canada, testified at length about his involvement with the appellant holding company and the related, interconnected and associated companies involved in the debt collection business of McGrath Canada. He also testified as to the events leading to the sale of McGrath Canada.

Clearly Mr. McGrath was the operating and directing mind behind McGrath Canada. The interrelated and connecting companies, many incorporated by Mr. McGrath, were there to serve McGrath Canada. Those companies, through membership in industry associations or affiliations with ex juris corporations, or incorporations, to achieve residential status, all served to enhance the debt collection business of McGrath Canada. In particular, one company McGrath Quebec Ltée was a corporation formed to achieve Quebec residency but in reality all the business was conducted at the headquarters in Ontario of McGrath Canada.

Through these associations, affiliations or residency acquisitions the client base was built. Behind the development of this base was the personality of Matt McGrath. These associations, membership affiliations, and corporations created a business network of cooperation and protected territories that allowed the business to significantly prosper. Profits from these other related and inter-connected corporations were channelled to McGrath Canada by way of management fees.

Mr. McGrath, in testimony, was direct and adamant in his view that the trade territories were restricted and protected in large measure by virtue of his own personal presence and the membership in the trade associations. In particular, one association, "A.C.B.C.", (Associated Credit Bureaus of Canada), the membership was, by bylaw, non-transferable. He, (Mr. McGrath), however stated the unwritten rule of A.C.B.C. was structured to protect families, and the transfers to family members of a particular member could take place without objection if the lobbying and politics of the proposed transfer was handled properly. Beyond that, the rule (the bylaw) was strictly enforced to third arm's length parties. This A.C.B.C. relationship was the source of over 30 per cent of the business income of McGrath Canada.

Mr. McGrath further emphasized that the federal government collection business that came through this connection was periodically up for tender, and that business could easily be lost in the contract-tender process.

All this evidence was presented to support the appellant’s position at the time of the sale that a third party arm's length purchaser would have no guarantee on transfer of the same business level, and to some degree certain business could not be transferred because of contractual (i.e., bylaw) prohibition.

Mr. McGrath also stated the purchase and sale was handled through a longstanding experienced company auditor, Mr. Parrot, who, after deliberation, arrived at the purchase price and then presented it to the parties for their consideration. He further stated it took some deliberation and the passage of time before the agreement was agreed to and finalized.

The agreement was an in-escrow agreement that gave the vendor (i.e., in reality, Mr. McGrath) considerable latitude over a long period of time to nullify the sale. Moreover, the shares were in the hands of the trustee and not directly in the hands of the purchaser.

The appellant's position from the pleadings

The appellant states that the valuation of the company at $175,000, shown in the appellant’s tax return, is the correct valuation. The appellant further states that the company does not own any fixed assets such as land and buildings. Therefore, it is submitted that the true market value of the company sold would oe very close to its book value.

The appellant further submits that the valuation of the company should be similar to those of major financial institutions. A comparison of the sale prices of common shares in three Canadian banks reveals that the median sale price of the shares was 102.28 of book value at an average of 6.13 times the weighted adjusted average of earnings. The appellant further concludes the value placed on the company by Revenue Canada would be 15.07 times earnings.

The respondent's position from the pleadings

At all material times the fair market value of the shares in the company disposed of by the appellant was $425,000. The adjusted cost base of the shares in the company disposed of by the appellant was $154,814. The appellant realized a capital gain in the amount $270,185.50 in disposing of its shares in the company.

Issue

The fundamental issue to be decided is: what was the fair market value of the shares in the company at the time of the disposition.

The appellant's expert opinion as to valuation.

The appellant’s expert submitted the starting point to determine fair market value is to establish the maintainable after-tax earnings of the company. Once the net after-tax earnings have been calculated for the five years preceding the sale, the average earnings and the weighted average earnings would be determined. The average or weighted averaged earnings would have to be adjusted to account for the potential loss of business following a sale resulting in maintainable earnings between $64,000 and $72,000 per annum.

He further stated that a prudent investor would expect a rate of return on the purchase of McGrath Canada sufficiently high to compensate for the risks involved in the investment. The starting point for determining a reasonable rate of return, the witness submitted, is to look at the rate of return available on similar investments. The 1988 financial reports for three major chartered banks (Royal Bank, Bank of Montreal and Scotiabank) show that their average share price is equal to 6.13 times the earnings. This translates into an average return on investment of 16.3 per cent.

As all of the income generated by M. McGrath Quebec Ltée is transferred to McGrath Canada, it is this witness's opinion that the book value of M. McGrath Quebec Ltée should not be added to the capitalization value of McGrath Canada to obtain a reasonable purchase price for the companies.

The book value of the company represents the underlying value of the assets of the company which are used to generate its income was also the position of this witness. The book value of McGrath Canada Ltd. and McGrath Quebec Ltd. he found to be $337,329. The witness concluded the valuation using the capitalization method where he utilized a capitalization rate of 20 per cent and considering the book value of the two companies combined, was the fair market value of M. McGrath Canada Ltd. was $360,000 as at January 2, 1987.

The expert opinion of the respondent was presented as follows: The opinion commenced with a definition of fair market value. Fair market value is defined as the highest price available in an open unrestricted market between informed and prudent parties acting at arm's length and under no compulsion to act, expressed in terms of money or money's worth.

The respondent's expert considered also the capitalization of earnings approach. Under this approach he adjusted the historical earnings to reflect the maintainable after-tax earnings of the business and established a capitalization rate to reflect the rate of return an investor would expect for an equity investment in McGrath Canada.

Maintainable earnings

He established the maintainable after-tax earnings were between $80,000 and $90,000 per annum. In terms of a capitalization rate, he stated: a prudent investor would expect a rate of return in the order of 12 per cent to 14 per cent for an equity investment in McGrath Canada.

The rate of return will depend on the degree of risk associated with the expected maintainable earnings of the business. In order to assess the degree of risk, the following factors must be considered: general economic and market conditions prevailing, industry and market comparisons, financial condition of the business under review, and the qualitative assessment of the operations of the business.

He summarized by finding the range of maintainable earnings at $80,000 to $90,000; and indicated to him, on analysis a fair market value of the company: between $752,937 and $729,127.

The witness also referred to a rule of thumb. A rule of thumb is a common criteria used within a specific industry which is applied to gauge an element of business value. He further went to state, there is a rule of thumb that stipulates an established collection agency with a reasonable rate of growth pattern should be worth between 70 and 100 per cent of its average annual gross commission revenue. Under this rule-of-thumb approach, he established the value of the company to be between $850,000 and $950,000.

Summary

He concluded that 10,000 common shares of M. McGrath Canada Ltd. as of January 2, 1987, would be between $700,000 to $800,000.

General comments on the opinion evidence

Specifically, most of the sub-issues, including a reasonable expected level of revenue, the economic forecasts, the appropriate discount rates and the market rate of managerial services, as well as the question of whether McGrath Quebec was in reality McGrath Canada, have been addressed in varying degrees by the respective valuations.

Generally, the application of technical approaches adopted by experts is useful and dependent upon factors and assumptions which are entirely a matter of judgment. The end result is merely an opinion, not a precise solution arrived at by precise methods using constant factors. The value of property on a certain date is inextricably bound to be valuator's prophecy of the future.

Accordingly, the more accurate of two expert opinions will be the one that attempts to reflect all factors that affect the value and the value is no less real at that time, if later the prophecy turns out to be false than when it comes true.

The expert for the respondent, Mr. Racicot, in calculating maintainable earnings, adjusted the cash flow to reflect general uncertainty. However, particular uncertainties known at the time of the valuation were not reflected in the forecast cash flow. There was a failure to consider the possible loss of income that could result from the loss of membership in “A.C.B.C.”, as well as the effect of the renewal of the federal government collection contract.

Mr. Racicot was also unaware of the precise duties of Mr. McGrath and Mrs. McGrath, and, therefore, selected an inappropriate economic salary.

Generally, Mr. Racicot the expert for the respondent, in his analysis lacked sufficient information or refused to apply new information relating to the specific aspects of this company to properly determine maintainable earnings. The discount rate used to capitalize maintainable earnings is a synthesis, of inter alia the inherent risk in maintaining the projected cash flow, prevailing economic factors, risk-free rates of return ana the security of investment.

Mr. Racicot did not adjust his valuation to reflect the risk, (that is the lack of security of the investment and the inability of the vendor to transfer all the business).

The expert for the appellant also based his value upon a capitalization approach. In arriving at a fair market value, he did not place a value in the acquisition of a controlling interest. McGrath Canada was for sale, and a controlling position in a privately held business accords certain rights and privileges to the owner in which there exists value. Among these are the ability to draw salary and receive emoluments in excess of what would usually be paid for management services rendered.

When selecting a discount rate to capitalize earnings, Mr. Parrot drew upon information which would not have been available to him as of the date of valuation, namely the 1987-88 bank statements from Royal Bank, Bank of Montreal and Scotia Bank, however, he did state his long-standing review of those statistics left him with the conclusion they were stable and reliable.

Finally, Mr. Parrot expressed the opinion that McGrath Canada was worth $350,000 upon which the sale price proceeded.

Subsequently, he was requested to prepare a report of the fair market value of McGrath Canada. I do not believe there was a conscious effort to make the figures correspond, but I must recognize that there may be some aspect of a self-fulfilling prophecy operating.

Mr. Parrot and Mr. Racicot were both credible witnesses. In the end, Mr. Racicot's approach to valuation was technically proper and in accordance with the methods and techniques generally accepted in the profession, however, arriving at an opinion on the value, he did not accumulate sufficient data or information relating specifically to this company. He was also unwilling to recognize new variations, as presented, that would significantly affect his valuation.

Mr. Parrot, on the other hand, has been associated with McGrath Canada for 40 years as their auditor and, as such, had an intimate knowledge of the company and its operations and he expressed himself clearly, such that his evidence showed a depth of analysis, not only on facts but on experience that was founded in his many years of private chartered accountancy practice, including other business valuations and opinions tendered in other clients’ tax matters.

As a result, the degree of reliance I place in the report of the expert for the respondent is minimal; fundamentals were there but the ability to accept and assimilate new information was absent.

Expert opinion evaluation

The business of evaluation is an art and not an exact science. Judge Brulé of this Court has stated in Ample Investments Ltd. v. M.N.R., [1990] 2 C.T.C. 2217, 90 D.T.C. 1748, at page 2220 (D.T.C. 1750):

In trying to account for the differences in valuations in addition to explanations given or omitted one must consider the source of the valuations.

In The Modern Law of Evidence by Adrian Keane, 1985 edition, he said of opinion evidence at page 337:

The danger is particularly acute in the case of opinions expressed by expert witnesses of whom it has been said, not without some sarcasm, “it is often quite surprising to see with what facility and to what extent, their views can be made to correspond with the wishes or the interests of the parties who call them".

Judge Brulé goes on to say that the Court process is not merely choosing one opinion over another wherein he states at page 2220 (D.T.C. 1750):

In situations such as this, it is comforting to follow the comments made by Mr. Justice Walsh, in Edna J. Bibby v. The Queen, [1983] C.T.C. 121, 83 D.T.C. 5148, at page 131 (D.T.C. 5157):

While it has frequently been held that a Court should not, after considering all the expert and other evidence, merely adopt a figure somewhere between the figure sought by the contending parties, it has also been held that the Court may, when it does not find the evidence of any expert completely satisfying or conclusive, nor any comparable especially apt, form its own opinion of valuation, provided this is always based on the careful consideration of all the conflicting evidence. The figure so arrived at need not be that suggested by any expert or contended for by the parties.

During the hearing of this appeal, I encouraged the parties to attempt to resolve the dispute by indicating litigation of this type is seldom an all-or-nothing proposition. However, now, after all the evidence is in, I do not find myself faced with this dilemma of finding a compromise.

The expert evidence, for the stated reasons, was somewhat weak on the respondent's side. On the other hand, the appellant's expert, albeit an in-house opinion, was sound and full of many years of business experience and particular knowledge of this business. I am, therefore, not left in the position of finding that both opinions, being so diverse from one another, or defective that both opinions are wrong.

I accept the opinion of Mr. Parrot, the appellant’s expert witness, as being closest to best assist the Court in its deliberation. This evidence indicates the value of all the shares at disposition was $360,000.

Conclusion

On balance, I conclude the valuation arrived at in the agreement of purchase and sale was reasonable.

Decision

The appeal is allowed, and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that $350,000 was the fair market value of all the shares of M. McGrath Canada Ltd. as of January 2, 1987.

Costs

The appellant being successful is entitled to its costs. In argument prior to this judgment I asked for submissions as to costs. For its part, the appellant expressed frustrations in attempting to bring the matter to Court, specifically the appellant experienced difficulty in the rigidity of the respondent's expert witness. The appellant asked for costs on a solicitor/client basis, with full remuneration for consultations between the counsel and the appellant's expert witness.

I cannot come to that conclusion. I do not accept that the frustrations expressed by the appellant's counsel although real are out of the ordinary in the varied course of normal litigation. Costs to the appellant are awarded on a party- and-party basis.

Thank you.

Appeal allowed.