Mayson v. MNR, 85 DTC 341, [1985] 1 CTC 2395 (TCC)

Brule, TCJ:—

Issue

This is an appeal from notices of reassessment of the appellant’s 1973, 1974, 1975 and 1976 taxation years. At issue is the value of shares of a private company owned by him on December 31, 1971 and subsequently sold.

The appellant was the major shareholder of Grosser Automotive Supplies Ltd (the “Company”). In 1973 he sold five Class “B” shares of the Company to a long-time employee of the Company, and he was assessed a gain determined on the basis of a Valuation Day value of $1,500 per share, which by reassessment was reduced to a Valuation Day value of $1,092.50 per share.

In 1975 the appellant sold ten Class “A” shares of the Company, representing 50 per cent of the voting shares, and 80 Class “B” shares for an aggregate price of $200,000 to his spouse and sister-in-law. The respondent assessed tax on the basis of deemed proceeds of disposition equal to an alleged fair market value of $247,500 and employed a Valuation Day value of $1,282.50 per share for the Class “A” shares and $1,092.50 per share for the Class “B” shares.

The appellant contends that the assets, performance and prospects of the Company as at Valuation Day (December 31, 1971) warrant a value being placed on each Class “A” and Class “B” share of $1,789.

Facts

About 1961 the appellant joined his father-in-law’s Company Grosser Parts Ltd. In 1964 the appellant was asked to go to Calgary to take over the operation of Grosser Automotive Supplies Ltd which was owned equally by Mr Grosser and a Mr Hutchison.

In 1964 the appellant purchased from Mr Grosser his one-half interest in the company, which purchase was well documented in a formal agreement.

While the appellant became a 50 per cent owner of the Company it was always recognized that Mr Grosser, even though not a shareholder, controlled the destiny of the Company. The subject Company purchased the majority of its mer- chandise through Grosser Parts Ltd which had good product lines. Because of its large purchases Grosser Parts Ltd received large volume rebates at the end of each year and if Mr Grosser so chose he could pass some of these along to Grosser Automotive Supplies Ltd. This he chose to do and the result was that the subject Company could show a profit. It was recognized however, that the shareholders of Grosser Automotive Supplies Ltd were at the mercy of Grosser Parts Ltd because without the sharing of volume rebates and the availability of the good product lines the operation would not be viable.

In 1967 Hutchison sold some of his shares to the appellant and some to a Mr Smith. This latter party left the Company and resold his shares to Hutchison who had the right to acquire these under the agreement of 1967. Hutchison then sold these same reacquired shares to a Mr Corbett by agreement dated July 10, 1970. In 1973 the appellant sold five shares to a Mr Nelson, one of the Company’s salesmen. This also was covered by agreement.

In each case the sale price of the shares was contained in the appropriate agreement and the price was fixed by the company’s auditors who, with Mr Grosser’s concurrence, believed this should be based on a break-up value plus a goodwill factor.

In 1974 the appellant decided as a result of some disagreements with his father-in-law, Mr Grosser, that he wanted to leave and therefore had to sell his shares. This was accomplished to take effect as of December 31, 1974 with a value to be placed on the transaction when the year-end financial statements were prepared. This value was not decided upon until the matter was concluded by an agreement in July of 1975. The sale was one-half of his holding to his wife and one-half to his sister-in-law. These two in turn sold part of their holdings in the same year to a Mr Mittelstadt at the same price they paid to the appellant.

A table of the various transactions and the price per share paid which was entered as Exhibit A-l is as follows:

TRANSACTIONS IN SHARES OF GROSSER AUTOMOTIVE SUPPLIES LTD

Price

Per

Date	Shares	Seller	Buyer	Share
1. Jan 10, 1964	75	Grosser	V Mayson	$ 533.33
(later changed to 10 Class “A”
and 65 Class “B”)
2. Dec 29, 1967	45B	Hutchison	A Smith	$ 940.00
	20B	Hutchison	V Mayson	$ 940.00
3. July 9, 1970	45B	A Smith	Hutchison	$1,252.00
4. July 10, 1970	45B	Hutchison	Corbett	$1,252.00
5. Dec 14, 1973	5B	V Mayson	Nelson	$1,536.00
6. July 22, 1975	5A	V Mayson	J Mayson	$2,222.22
	40B
	SA	V Mayson	H Maimann	$2,222,22
	40B
Dec 10. 1975	10B	J Mayson	Mittelstadt	$2,222.22
(effective
July 22, 1975)
	10B	H Maimann	Mittelstadt	$2,222.22

Taxpayer’s Appraiser

The main witness for the appellant, qualified as an expert, was Mr Clarence Maimann, CA, who was the appellant’s brother-in-law. Mr Maimann had worked for Grosser Parts Ltd for a brief period and also with Revenue Canada. For some years he had been in private practice. During his career he has appeared as an expert witness but never in Court in a valuation matter, although on a number of occasions he carried out valuations for Revenue Canada, and in his practice.

As his wife was Mr Grosser’s daughter and a shareholder the witness was indirectly involved with the operation since 1948, and closely with the appellant. He did tax planning for the companies until 1975.

In 1975 the valuation of the Company shares for the purpose of the principal transaction was carried out by the Company’s auditors, Winspear Higgins Stevenson & Co.

As to the Valuation Day (December 31, 1971) value of the shares Mr Mai- mann adopted three approaches as follows:

1. Income Approach

The capitalization of future maintainable earnings results in a value per share of $1,788.83

A 10 per cent capitalization rate was chosen by Mr Maimann as appropriate to this particular business, resulting in a multiplier of 10.

10 X 26,832.50 = $268,325

Value per share $268,325 788.83

150

The witness stated that the 10 per cent capitalization rate is fair as Grosser Automotive Supplies Ltd is in a strong position in the automotive trade. It would take a person starting at this time approximately $650,000 to get underway. In addition affiliation with the Grosser enterprises ensures overriding bonus (volume rebates) and their profitability. Ninety-five out of 150 shares were held by the appellant in 1971.

2. Super Profits Approach (Excess Profits)

Excess profits (after

The witness indicated that the most appropriate method is that which accurately reflects the nature of the business, and that is the industry approach, being $1,856.10 per share. However, as the most equitable figure to use for tax purposes, the lowest of the three was chosen as the Valuation Day value, namely $1,788.83.

Under cross-examination the witness said that the industry approach was as fair as any. It involved the investment in the company plus a goodwill factor based on inventory. This system was devised by Mr Grosser as his rule of thumb but was not necessarily a good accounting approach. The super profits approach was calculated because of the consideration given to bonuses which were a result of the arbitrary volume rebates given to the company by Grosser Parts Ltd.

The income approach is a conventional method used in valuation. Here a weighted factor was used because it was suggested that as the business grows you get a better and more accurate result from using this weighted factor.

Mr Maimann explained to the Court that he assigned an equal value to the voting and non-voting shares because 50 per cent of the voting shares were closely held by the family or by Mr Hutchison in all the Grosser companies.

The shareholders tended to look at both classes of shares as a package and traded at the same values. The witness said that this situation often applies in private companies with any casting vote being covered by the by-laws. This was not so in the present Company. The appellant, however, always believed Mr Hutchison had the controlling vote.

In 1974 when the appellant left the Company it was agreed to fix a price after the year-end statements were prepared. This was not done by Mr Maimann, but by the Company’s auditors. They based their calculations on the price of the shares sold to Mr Nelson with certain adjustments. This was entered as exhibit A-2 and is as follows:

GROSSER AUTOMOTIVE SUPPLIES LTD

COMPUTATION OF VALUE OF SHARES

AS AT DECEMBER 31, 1974

Selling price of Nelson’s shares		$1,536
Net income after tax
1973	$ 36,000
1974 (adjusted)	88,000
	$124,000
Increase per share		826
		2,362
Dividends paid (including tax)
1973 $39,127/150	260
1974 39,127/150	260	520
		$1,842

This calculation would produce a result for the value of of the appellant’s shares of approximately $166,000 but he did in fact insist on a price of $200,000 for all 90 shares or a per share value of $2,222.22. Mr Maimann, while not making the calculation, did assist his brother-in-law in negotiating the price of $200,000 which was paid. This then is the valuation which the appellant feels is justified.

Minister’s Appraiser

Mr Joseph Gazzard, a Business Equity Valuator with Revenue Canada presented to the Court, as an expert witness, two valuations for the Company shares as follows:

the four years prior to V-Day resulted in stable profits, increasing slightly from $33,500 in 1968 to $35,500 in 1971. A single average capitalization of after tax earnings appeared to be appropriate; a weighted average could possibly be justified but would not result in a significantly different figure. This Company did not own its land and building so that tangible asset backing is weak. Dun & Bradstreet indicates that profits to tangible net worth for this industry for 1969 and 1971 averaged about 13.5%. Applying this to after tax profits of Grosser would result in a V-Day value of $187,192. I selected a value of $200,000 as a high value based on 7 and 8 multipliers.

	July 22, 1975
Year		Pre-tax Profit
December 31, 1975		$117,085
December 31, 1974		127,057
		$224,142
Average Profit		122,071
Tax @ 26%		31,738
	90,333	90,333
Capitalize	X 7	X 8
	$632,331	$722,664

The Cumulative Deduction Account at December 31, 1975 is $329,000.00. Although dividends issued in the past have been out of TPUS, it is reasonable to assume that once that has been used up, the company will issue taxable dividends and thereby reduce the Cumulative Deduction Account. However, it is unlikely that the dividends will keep the account under $500,000.00 indefinitely. Therefore a higher rate of tax will arise in future and accordingly reduce after tax profits.

All things being considered I would suggest that a fair and reasonable value at July 22, 1975 would be $525,000.00.

Per Share: $525,000.00	$3,500.00 for Class A
Less 15%	525.00
Say	$3,000.00 for Class B

Mr Gazzard’s report contained the following commentary in the July 22, 1975 valuation:

Value at this date was based on information available at December 31, 1974 and December 31, 1975. There is an element of hindsight here, but at the valuation date (7 months after the previous year end) a prospective purchaser would have a good idea of the results of the current year. The sales and profit of 1974 and 1975 greatly exceeded any prior years so it is justified to use these two years to determine the fair market value and maintainable earnings of the Company. The average after tax profit of these two years was $90,333. Dun & Bradstreet’s average profits to net worth for 1974 and 1975 was 12.6% which applied to $90,333 would result in a value of $716,928. Because of the lack of tangible asset backing and only two year’s average was used and considering a possible increase in the tax rate, and assuming that the small business deduction would probably be exceeded, I selected a value of $525,000 as being fair and equitable.

Analysis

There are two valuation dates of the shares of Grosser Automotive Supplies Ltd which must be considered, that at December 31, 1971 and at December 31, 1974. In the latter case the transfer was at July 22, 1975 but by agreement the price was to reflect the value as of the preceding year-end. In addition to these two values the Court must decide whether or not the respective values of “A” shares should differ from those of the “B” shares.

Dealing with this second problem first, I recognize that it is common for voting and non-voting shares to be valued differently. The appellant’s expert explained (supra), why he felt the shares were of equal value while the respondent’s expert did not place much emphasis on this but believed a slight discount was warranted.

Where each of two shareholders own 50 per cent they are in effect, both minorities and in their respective positions can do nothing, except in unison, to change the share structure of the company and thereby prejudice the non-voting shares, which in this case, apart from the voting privilege were in all other respects equal.

In the Estate of Peter Angus Fiddes v MNR, [1970] Tax ABC 156; 70 DTC 1117, the Court ruled that the voting shares had no right to interfere with the rights of the non-voting shares and as a consequence it was held that the two classes were of equal value.

Again in Minister of Finance of British Columbia v Mann Estate, [1974] CTC 222, the Supreme Court of Canada did not interfere with the Court of Appeal of British Columbia which ruled that the voting and non-voting shares were of equal value as the voting shares could not prejudice the non-voting shares. This is the same situation here in so far as Mayson is concerned and only with Hutchison could any change be effected in the non-voting shares. As the two held all the shares no third party would be prejudiced by any change. If, in fact, Hutchison had the final casting vote, as the appellant believed, he could not by statutory law use this to change the rights and privileges of the non-voting shares.

Ultimately the value of the non-voting shares with their rights, privileges, conditions and restrictions, considered in conjunction with relevant statutory and common law that might restrain changes being made by the voting shares in addition to the same rights, privileges, conditions and restrictions often provides an equal value to the two classes of shares. This I believe we have in the present case.

As to the value of the shares in 1971, one sale in 1973 took place and was assessed on a Valuation Day basis of $1,500 per share. By reassessment these class B shares were said by the Minister to be worth only $1,092.50 per share and this was changed slightly in the expert’s valuation to $1,150 per share. Of the three methods used by the appellant he contended that the value should be $1,788.83.

In Edna I Bibby, Executrix of the Estate of Edward R Bibby v The Queen, [1983] CTC 121; 83 DTC 5148, Mr Justice Walsh of the Federal Court said at 131 (DTC 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.

This is the position I take with respect to the 1971 value of the shares. I did not find either expert using the figures of a fifth year (1967) when such were available and included in exhibit R-1. In addition the expert for the respondent used a rounded tax figure of 24.25 per cent when the actual figures were available, and being lower would lead to an increase in profits and therefore an increase per share valuation. In his explanation (supra), this expert mentioned that the asset backing was weak, but in evidence it was disclosed that the land and buildings belonged to the appellant, thus suggesting that this was not an important factor in the possible reduction of a share valuation. While a Dun & Bradstreet report indicated that profits to tangible net worth for this industry for 1971 would be about 13.5 per cent I did not consider this to be of extreme importance because of the rebate system employed by the principal purchaser of supplies, that of Grosser Parts Ltd. I made my own calculations using the figures available for the five-year period (1967-1971) and the true figures of income tax paid. Applying these to the average profit and using an average of eight to ten times earnings I arrived at a calculation of $1,485 per share. Inasmuch as the appellant used a December 31, 1971 value of $1,500 for his reported sale to Nelson (see exhibit A-l supra), and was assessed on this basis, I accept the figure of $1,500 as the value of each share of both Class “A” and Class “B”, as of December 31, 1971.

On December 31, 1974 the appellant sold his shares to his wife and sister-in- law. By agreement the value was to be as of this date and calculated after the year-end statements were available as shown in exhibit A-2 (supra). A value of $1,842 per share was suggested by the auditors, but because the price realized by the appellant was $200,000 in total or $2,222.22 per share this is the price he maintained was correct.

The expert witness for the Minister placed a value of $3,500 per Class “A” shares and a lower value for a Class ‘‘B’’ share. Inasmuch as I have dealt with the non-difference between Class ‘‘A’’ and Class “B” shares I considered this figure of $3,500 per share. The most troubling aspect of this calculation is that the valuator admittedly used hindsight and took into consideration the Company’s profits for 1975. He argued that as of July 1975 when the sale actually took place one could fairly well determine the year’s profits. Even if this were a valid opinion it has no application in the present case. First of all, the evidence disclosed that the sale was to take place based on the December 31, 1974 year- end value when such was determined in 1975. At the end of 1974 the appellant left the company. Secondly the application of hindsight using only one past year (1974) and one future year (1975) is not acceptable.

Mr Justice Mahoney of the Federal Court in the case of The Queen v National System of Baking of Alberta Ltd, [1978] CTC 30; 78 DTC 6018, stated at 38 (DTC 6024):

I expressly rejected the validity of hindsight as probative of fair market value at a given date . . .

In an article entitled “The Valuation of Private Business and Professional Practice” by George Ovens, then chief valuator of the Estate Tax Division, Department of National Revenue, the following statement was made:

There is a tendency for some valuators to read into retrospective valuations much material which was not actually available at the required valuation date. If a retrospective valuation is required many court judgments have indicated that hindsight is to be excluded excepting where it applies to evidence in existence or which can be reasonably assumed to have been true as of the required valuation date.

This article is found in a brochure issued by The Canadian Institute of Chartered Accountants, in December 1959, and the excerpt therefrom was quoted with approval by R S W Fordham, QC then assistant chairman of the Tax Appeal Board in Estate of Doris Kathleen Chipman Taylor v MNR, [1967] Tax ABC 555; 67 DTC 405.

In the present case it can hardly be said that the success or failure of the Company could be determined for the year 1975 as of December 31, 1974, even though this may have been more predictable in July of 1975. On this basis I feel that the valuator was wrong in considering the 1975 financial statements to determine a share value as of December 31, 1974.

By applying the often employed principle of using the previous few years’ experience and making a calculation I arrived at a figure slightly higher than that proposed by the Company’s auditors for December 31, 1974. In evidence it was disclosed that Mr Maimann assisted his brother-in-law, the appellant, to obtain $200,000 for his 90 shares, even though it was not considered an arm’s- length transaction (one of the purchasers was Mr Maimann’s wife). This figure was more than Mr Grosser’s auditors had calculated which was approximately $166,000 and the amount which Mr Grosser originally believed should be the sale price. Inasmuch as the appellant was able to conclude the transaction at a higher figure, ie $200,000 for his 90 shares, I find that this is the amount to consider and that the price per share as of December 31, 1974 be fixed at $2,222.22.

Conclusion

The result therefore is that I conclude there is no difference in the value of the Class “A” and Class “B” shares, that the value of these shares as of December 31, 1971 was $1,500 each, and that the value of the shares as of December 31, 1974 was $2,222.22.

On this basis the appeal is allowed and the matter referred back to the Minister for reconsideration and reassessment. The appellant is allowed his costs on a party and party basis.

Appeal allowed.