Deconinck v. The Queen, 88 DTC 6410, [1988] 2 CTC 213 (FCTD)

Cullen, J.:—This is an appeal heard in the City of Saint John, New Brunswick against an income tax assessment for the year 1975 in which the Minister of National Revenue (MNR) assessed the taxpayer a capital gain on the sale of real property. The plaintiff and the purchaser filed an election pursuant to paragraph 85(1)(a) of the Income Tax Act (the Act) for an agreed figure of $668,700 which represents land at $301,700 and buildings at $367,000. The plaintiff concedes that his election at $668,700 is fixed. As counsel states,

He [the taxpayer] chose that figure . . . he and the company chose that figure and they filed a joint election and it's $668,700 ... the proceeds of the disposal. But the purpose of section 85 of the Act is to permit a tax free rollover from an individual to his corporation. And to do it successfully, the taxpayer and the company must simply choose to elect as the proceeds of disposition the taxpayer's actual cost of acquisition. And if they do that the rollover works, and the company acquires it at the cost of the taxpayer's acquisition.

The first issue to be determined is whether the election under section 85 of the Act relates only to property acquired on June 18,1971 from Fairlanes Ltd., or whether it also includes four parcels acquired by the plaintiff after 1971.

The evidence of the plaintiff is quite clear, namely, the conveyance in 1975 to Eastern Industries Limited was intended to convey all ten properties, shown numbered 1 to 10 on Exhibit 3, page 3, and Exhibit 3, page 1.

Page 33, Transcript: The plaintiff is being examined by his counsel:

Q. . . . How does it happen that you chose that figure as being the — the agreed price for the — for the disposition?

A. It was an error. I — I was a very busy person around — at that time and I — the lawyers that I used in that transaction was the lawyer that acquired all the properties. Mr. Anderson. He was also a secretary of Eastern Industries. The chartered accounting firm, Peat Marwick, that I used were my accountants back to 1970-71; they — they'd filed all my tax returns and they knew of the ownership of the property and I was only given direction to obtain the valuation — the — the V-Day property. I assumed that they used the right figures. I signed my return like at the last minute, likely, on April 29th and then I assumed that they had included all the right figures. They were professionals; they — they prepared the return. I didn't prepare my return. I never prepared my tax returns.

In my view, the plaintiff was the victim of errors made by accountants, lawyers and himself which, unfortunately for him, is not an accepted basis providing relief for a taxpayer. He must accept the ultimate responsibility for forms filed with the MNR on his behalf.

Counsel for the defendant made the point:

How can Revenue Canada possibly determine the question and apply provision 85(1)(c) if the taxpayer has never identified which properties are rollover. Okay?

Now that’s not the situation here. The taxpayer has on two occasions according to Exhibits 4 and 5 written some six years apart from Peat, Marwick — the taxpayer's designated accounting representatives — they have identified to Revenue Canada what was in the rollover, and they claimed that it was the building that had an historical cost of $136,000 the land which had an historical cost of $40,000.

These two properties are plainly — and they're identified as such by the plaintiff in the admissions which have been made or provided as Exhibit 16 — as the Fairlanes property acquired in June 1971 for $176,000.

Exhibit 4, the letter from Peat Marwick on December 3, 1976, encloses a schedule detailing "the original cost, valuation day value and estimated fair market value of the properties disposed of by Mr. Deconinck to Eastern Industries Ltd. on December 15, 1975 pursuant to the provisions of subsection 85(1) of the Income Tax Act. . .

Also enclosed was a report from Eastern Appraisals Ltd. (Mr. R.E. Poirier, A.A.C.I.) which inter alia has a survey of the property he appraised. It does not include the property acquired after June 1971. The plaintiff received a copy of that letter and apparently made no move to contact Poirier or Peat Marwick to state the property in the survey was not complete or incorrect. Revenue Canada would naturally accept the survey as correct.

Section 85 of the Act provides a significant advantage to a taxpayer, but to take advantage of the provisions such as a taxpayer rollover, the information provided must be correct. Here, clearly the taxpayer and/or his agents may have intended the election to apply to all the properties but that was not done and certainly it is not for Revenue Canada to speculate upon what the taxpayer meant the election to include. Intention of the taxpayer is not sufficient, it must have been done that way.

Given the fact that section 85 of the Act provides this most significant benefit to the taxpayer, accuracy of the information provided is paramount. If correct information is not provided, then the taxpayer must accept the consequences. At no time did the taxpayer ever identify to the MNR what he intended as the disposition of capital property.

One For Three Limited v. M.N.R., [1980] C.T.C. 2293 at 2295; 80 D.T.C. 1244 at 1246:

An election under section 85 is not tentative, it is final was it concerns the rights of primary parties — the taxpayer and the corporation.

Counsel for the defendant makes the point very well in argument:

Now the Court of Appeal has on a couple of occasions in tab 3 and tab 4 — the cases of Perrault [Perrault v. The Queen, 78 D.T.C. 6273 p. 6395] and Atinco [Paper Products v. The Queen, 78 D.T.C. 6387 p. 6395] — in an other-than-section-85 election context talked about the importance of arranging your affairs not only cosmetically correct but substantially correct, i.e., correct in every way in order to take advantage of provisions such as the tax-free rollover option under the Act.

In Perrault I refer to the passage underlined in green, under tab 3, My Lord, at page 6278.

The incidence of taxation depends on the manner in which a taxpayer arranges his affairs.

Just as he may arrange them to attract as little taxation as possible, so he may unfortunately arrange them in such a manner as to attract more than is necessary.

And under tab 4 which is the decision of Mr. Justice Urie of the Court of appeal at page 6395 there is a passage underlined in green and I won't read it, My Lord, but the essence of it is the same. The court has said that it must apply the law to the facts and the way the transaction was organized, and it’s not enough to say that it was the intention of a taxpayer to do it some way, it must have been done that way.

The underlined section reads:

It is trite law to say that every taxpayer is entitled to so arrange his affairs as to minimize his tax liability. No one has ever suggested that this is contrary to public policy. It is equally true that this Court is not the watch-dog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is correct in form, but, in fact, are in all respects legally correct, real transactions. If this Court, or any other Court, were to fail to carry out its elementary duty to examine with care all aspects of the transactions in issue, it would not only be derelict in carrying out its judicial duties, but in its duty to the public at large. It is for this reason that I cannot accede to the suggestion, sometimes expressed, that there can be a strict or liberal view taken of a transaction, or series of transactions which it is hoped by the taxpayer will result in a minimization of tax. The only course for the Court to take is to apply the law as the Court sees it to the facts as found in the particular transaction. If the transaction can withstand that scrutiny, then it will, of course, be supported. If it cannot, it will fall. That is what happened here.

The information that the taxpayer alleges he intended to be conveyed was at all times within the sole knowledge of the taxpayer, his lawyer and his accountant. The information actually conveyed is not in accordance with the taxpayer's alleged intention, and therefore the taxpayer must accept the consequence of the error. For the purposes of determining the adjusted cost base (ACB), reference can only be had to the properties acquired in June 1971.

Adjusted Cost Base

Plaintiff's Position:

According to the plaintiff, the ACB of the six properties owned on December 31, 1971 was $668,700 and this sum was determined in accordance with the Income Tax Application Rules (ITAR 26(3)). Moreover, the cost base was determined by appraisal and the properties were treated as one block. The ACB of the four properties acquired by the plaintiff after 1971 was $90,703.96. This figure was determined by adding the cost of acquiring each of the properties. In calculating the ACB in respect of the gain the ACB of the six parcels of land was added to the actual cost of the four parcels of land acquired after 1971. This amount exceeded the sum of $668,700.

The plaintiff contends that he and the purchaser made the election in the prescribed form T-2057 and in a timely manner, pursuant to subsection 85(1) of the Act in respect of all the property. The plaintiff also maintains that the ACB of all the property was not less than $668,700, the amount agreed upon by the plaintiff and the purchaser under subsection 85(1) of the Act.

Defendant's Position:

In assessing the plaintiff in respect of the disposition of the property the MNR assumed that: 1) the property disposed of in 1975 for a proceeds of disposition of $668,700 (land — $301,700 and buildings — $367,000) and reported on election form T-2057 related only to property acquired by the plaintiff on June 18, 1971 from Fairlanes Ltd; (and I have so decided.)

Therefore the plaintiff's capital gain in respect of the disposition was $462,000 based on the following calculation:

The Experts’ Evidence: Valuation

R.E. Poirier:

His estimate was not what he terms “a full narrative appraisal report" but rather “a letter of evaluation”. Later, as a result of work done by Poirier in the area, his evidence was that the letter of evaluation was eventually supported by work he did in 1980, and he refers only to three sales.

To be fair to all of the experts, it should be noted that New Brunswick does not require an affidavit indicating the selling price of real estate, so that information is not available to the taxpayer or his appraisal expert. Poirier had used prices for three sales he had been involved with as a real estate agent. Poirier’s evidence did not stand up very well to cross-examination, and in my view the sales certainly were at best suspect as comparable sales, and would not support the onus placed on the plaintiff to show the assessed value of $206,500 was too low.

C.P. Darby and G.K. Hayward:

The plaintiff called Mr. C.P. Darby (Darby) as a further expert witness and the defendant called Mr. G.K. Hayward (Hayward). Darby's evidence was that the open market value of the land and buildings as at December 31, 1971 was $645,000. Hayward, on the other hand, determined that as a result of his investigation and analysis, the leased free interest had an indicated value of $190,000.

Counsel for the plaintiff taxpayer has two significant hurdles to overcome, namely:

(1) property and a business purchased in June 1971 — in an arm's-length transaction for $176,000 and six months later could be worth approximately three times that amount;

(2) can the plaintiff meet the onus which is upon it for demonstrating that the fair market value is greater than the amount assessed by Revenue Canada of $206,500 at Valuation Day?

For reasons stated earlier I do not propose to comment further on the evidence of Poirier.

First I do not feel bound by the actual purchase price paid for the property in June 1971 because other factors must be considered. However, as stated by my colleague, Martin, J. in Doral Holdings Limited v. The Queen, [1987] 1 C.T.C. 398 at 405; 87 D.T.C. 5258 at 5264:

What I find most disturbing in Edwardh's appraisal is his failure to deal with the purchase price of the plaintiff's property. I agree that the purchase price of a piece of property is not conclusive of its market value but when, in 1987, one seeks to place a value on a property as of December 31, 1971, and that property was purchased in the open market in December of 1971, I am drawn to the conclusion that the purchase price paid at that time should at least be a factor in arriving at a market value.

[Emphasis added.]

Valuation

The valuation proposed here is a clear indication that appraising is indeed more an art than a science. As counsel for the plaintiff declared, ‘And so that it tends to be subjective in terms of assumptions and opinions and judgment calls that a person is going to make. And that two appraisers, appraising the same property can fairly and legitimately come to different opinions as to value." From time to time experts are so capable, knowledgeable and convincing that the Court has little difficulty in accepting that evidence. In this case the experts were convincing, obviously competent when presenting their evidence-in-chief, but each expert was severely challenged by excellent cross-examination, and each appraisal done was suspect at the end of the day.

Darby's appraisal seemed most comprehensive but he had been unable to examine the property in 1971 or see Moncton at that time because he was still living outside Canada.

Hayward was most familiar with the property, having worked in the provincial assessment branch and in the Moncton area. However, Darby's assumption about potential struck me as more credible. Darby saw the area of Fairlanes Bowling Centre in 1971 as having a bright and increasingly valuable future, whereas Hayward was of the view that the area was stagnant. Given the sales taking place, the large number of properties being developed or capable of development, the location of Mountain Road, franchises opening, a credit union expanding, and yes, the bowling business was now showing a profit and two competitors ceased business — it is evident that expansion rather than stagnation was taking place.

Second, I found it difficult to understand how Hayward would use the lease (Exhibit 1, Tab 1) as an open market or arm's length transaction. This was for all intents and purposes a lease between a husband and wife, with the husband as landlord setting a low figure as rent, thereby benefitting his wife with a small expense and enabling himself to write off losses against profits.

Transcript, page 23: direct examination by plaintiff's counsel:

Q. On what did you base that rental contained in the lease, Mr. Deconinck?

A. On what did I base it? It was — / had a free hand with the negotiations. I — l . . . Even though the company was owned by my wife, she depended on me and would

— in — do whatever I suggested or if I wanted to dispose of the property, that was my business, so I suggest —. I did a lease that was favourable to her to continue the bowling because she only would be probably showing more profits and the lease, the way it was structured gave me a loss on the rental of the property. It was structured that way because at — in 1971 you could offset losses on rental property against other income and it was structured to maximize my cash flow and to allow me to service the debt. . . My debt service on the property was significantly more than — than the income. It — it wasn't a very good deal as far as the landlord/ tenant on the surface.

[Emphasis added.]

Counsel for the defendant, in cross-examination, made the point that Revenue Canada has no indication that the rents charged were less than market value. However, it seems to me that Hayward, in doing his appraisal to establish value, should have seen the rents were indeed lower than fair market value.

Darby, in my view, was correct in assuming that the existing lease (Exhibit 1, Tab 5) might not be an open market lease and was not prepared to assume that the lease provided a reasonable indication of what the per-square-foot values of land in Moncton were.

Further weakening both appraisals was the fact that neither was able to find an identical property. This is not a criticism but the fact as they found it.

Hayward's statement that nothing in the Moncton area indicated to him that rents would increase, in my view, weakened support for his overall appraisal. Counsel for the plaintiff put it more strongly,

I submit to the Court that in 1971, or in 1951, or in 1981, that is a patently unreasonable statement to make at any time. Everybody, including everyone in this room, knows and has known since they were 10 years old that basically everything has been increasing steadily. The cost of everything.

We also know that in Moncton at that time land values were increasing steadily. And we also know that the lease that he chose as his indicator of the fair market value of land showed regular and fairly large increases over the first term.

In fact, an increase in rent between the first and last months of the term of over 87%. It was 85.5 assuming that the first month's rent was $800.00. In fact, it was worth a little less than that.

You can’t have it both ways. Either the rent that you use as your indicator of true economic value is the fair market value and does reflect the market, or it doesn't.

It's difficult to conceive of how anyone under those circumstances at a time of rising interest rates and rising land values, and in view of the fact that the lease was escalating in . . . rent, how one could assume that there would be absolutely no increase in rent four years hence and for a period of . . . of five years after that. Common sense tells you, I submit, that that is an unreasonable assumption.

Considerable detailed evidence was given by each appraiser which left both open to searching cross-examination. Counsel for the plaintiff alleges of Hayward,

. . . if in his calculation of the economic interest or value or the income approach he had simply stuck to what he knew in 1971, and used the indicators that he had then instead of ignoring them, his income approach calculation would have amounted to $336,367 and would no way have supported this $190,000 which he makes later in his report because we noted at page 46 of his report that in the cost approach he came up with $267,000 which he ultimately discarded. On the direct sales comparison approach he came up with $190,000 and he said $190,000 for that and the income approach was also $190,000 which supported it, so that's . . . that's my value.

And finally, I had some difficulty with an assumption by Hayward that a businessman would expect to get his value of his investment out of the building in 30 years, and so the economic life would be 30 years. Counsel for the plaintiff indicated how Darby stated the building was well built, and could last longer than 65 years. This was not contradicted by Hayward. Both experts agreed that the functional and locational obsolescence were not relevant factors in their consideration of their respective appraisals.

Again, counsel for the plaintiff:

But what Mr. Hayward said was, "Forget about how long physically it’s going to last. Forget about how long functionally it can last.

Forget about how long locationally it can last. As far as I'm concerned a businessman would expect to get his value of his investment out of the building in thirty years. Therefore, as far as I'm concerned the economic life is only thirty years.

But what he didn't say was if it takes thirty years to get the value of your investment out, aren't you going to want the next thirty to get your profit out?

In other words, the thirty years is an artificial figure which has nothing to do with the real life of the building, either functionally, locationally, or physically.

On land evaluation, it was quite clear that there were no properties that could be described as appropriate comparables but both experts did what they could with what they had. Constant questioning by counsel for the plaintiff culminated in Mr. Hayward conceding that of his six chosen comparables, two were not really comparables at all, and that land 200 feet back from Mountain Road is only worth ten cents a square foot compared to frontage figures from comparables of $2.25, $2.15, $.89, and $1.12 per square foot.

Counsel for the plaintiff:

If you're not within 200 feet of Mountain Road he concluded, and let's think about how reasonable this is, that land was selling or would sell for $.03 to $.10 a square foot.

But if we look at Exhibit 13, which is his report, and you look at the plot plan which is Exhibit C or appendix C to his report, we see that if that were true, the very land upon which the Fairlanes Bowling Alley was sitting, where the whole value of the lot was — the very building — was only worth according to Mr. Hayward between $.03 and $.10 a square foot? Because that building is . . . starts about 300 feet back from Mountain Road at its closest point to Mountain Road. And I submit to the court that anyone who suggested that the land on which that building sat was worth $.03 to $.10 a square foot was being patently unreasonable.

and finally,

So I submit that while there is no magic in Mr. Darby’s report there is also no magic in Mr. Hayward's report, and it falls to the reason we're here today is because we now have to ask this court to apply its knowledge, reason and common sense, to determine what the real value of the land was in 1971.

I have dealt to this point with the Hayward appraisal because it is after all the basis for defendant's proposition that the ACB of the property was $206,500. Had it stood up solidly against the conclusions in the Darby report and the searching cross-examination, the plaintiff's case would fail. Certainly, the appraisal has many weaknesses as has been seen. What, if any, support does the Darby report give to the plaintiff’s case? Darby has acknowledged that he did not see the property in 1971. Also, he has been unable to convince the Court that the comparables used were really appropriate to the circumstances here. Again, effective cross-examination by counsel for the defendant has considerably weakened the weight that should be given to the Darby report.

There is nothing in his report indicating why, in his opinion, the property tripled in value over a six-month period, even if we allowed for an element of "distressed sale” in the first instance. Next, in my view, he was unable to establish any real basis for $3.25 a square foot as a rental rate. His use of a 2.5 per cent vacancy rate certainly affected his calculations but nowhere is there any indication of the source of that figure. Darby did not agree with the Peat Marwick letter that the figures represented to Revenue Canada were “fair market value for rental rates". Here I feel Darby was correct to ignore the lease and his explanation is credible. The final figure for cost of reproduction of $364,350 is suspect because the Court has no real understanding about how that figure was reached. And in the final analysis, he stated, "when you're only paid to provide an opinion to back up another opinion it’s not like it’s as big a deal as doing a full appraisal report where you get the proper amount of money to . . . do a full investigation”.

Conclusion

More as a result of excellent cross-examination than the plaintiff's experts' reports, I find the plaintiff has met the onus of establishing that the MNR's assessment was wrong. However, the plaintiff has been unable to present sufficiently satisfactory evidence to convince the Court that his evidence is more reliable and more satisfactory than the evidence produced by the defendant, as Teitelbaum, J. indicated was necessary in Société de Gestion Richelieu v. The Queen, [1986] 1 C.T.C. 342; 86 D.T.C. 6149.

Certainly, it would be easier were the Court in a position to accept the evidence of one expert over that of another but here both appraisals are seriously flawed for the reasons already given.

I am therefore guided by the comments of Walsh, J. in Bibby Estate v. The Queen, [1983] C.T.C. 121 at 131; 83 D.T.C. 5148 at 5151:

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.

and will decide a value based on the evidence.

Evidence:

I accept the evidence of the plaintiff that he met with the vendor and negotiated a sale price well below what the plaintiff felt it was worth but high enough to satisfy the vendor who wanted out. The vendor was a respected businessman but his business was in another area, it was not bowling and with a small profit showing on the bowling business books he could unload it and get his investment back. The plaintiff as purchaser realized the property was worth more to him because he was doing business in the area, knew the bowling business and was optimistic about location and the local economy. His accountants naturally used the lower figure when endeavouring to get the real estate assessment down.

Also, New Brunswick was assessing or endeavouring to assess at true market value. Their determination was that the property was worth more than claimed by the plaintiff.

I am satisfied that this location was excellent for business and in all probability the highest and best use was as a bowling alley. The building is of excellent construction, will easily last 65 years and has sufficient parking facilities and adequate access, with even more access opportunities possible. Values of $4 a square foot for rental did not stand up to scrutiny nor did the figures submitted by Hayward.

It seems that Hayward's figure of $267,000 based on a cost approach is more in keeping with the value of the building than the figures eventually submitted by Hayward and Darby. The land value, with no perfect comparables, lends itself to the approach adopted in part by Darby, i.e., a wider view of the whole area. This indicates considerable activity, albeit with different types of property but property sales nevertheless. Certainly premiums were paid by those already located in the Mountain Road area to enable them to expand, but it indicates a determination to stay, and an indication that this was a good area for small business. Thus a businessman seeing future potential would certainly be prepared to pay more than the plaintiff paid. An average square footage is really not much help here, even allowing for land at the rear being much less valuable than frontage land.

On balance, I have determined that the value of the land is $100,000, a value on the building of $250,000 for a total amount of $350,000 as the Valuation Day value. As the plaintiff has enjoyed a large measure of success costs are awarded to the plaintiff. This matter will be referred back to the MNR for reassessment on the basis that the ACB is $350,000.

Appeal allowed.