Carruthers v. The Queen, 82 DTC 6009, [1982] CTC 5 (FCTD)

Walsh, J:—This action was joined for hearing with that bearing No T-396- 80 Emma Carruthers v Her Majesty The Queen, the evidence in the two cases being identical so that the decision in one is applicable to both. They concern the valuation as at valuation day, December 31st, 1971, of shares of a private company Griffith Saddlery and Leather Limited owned by plaintiff and his wife who disposed of the shares consisting of 3,361 common shares each in their 1976 taxation year at a price of $47.29 per share being assessed for capital gains tax on the profits resulting from the said disposition. On November 1, 1967, they had each purchased 2,101 common shares at a price of $2.39 per share and then on January 21, 1971, they each exercised options to purchase 1,260 additional common shares from Ewart Griffith also at $2.39 per share pursuant to an option agreement entered into between them and the said Ewart Griffith on October 20, 1969.

This was the first of many agreements between the parties and George Griffith, a nephew of Ewart Griffith who had 560 common shares. Ewart Griffith had 6,722 common shares, the same number as owned jointly by John and Emma Carruthers but there were also 2,000 voting preferred shares held by Trayte Holdings Limited which was a personal holding company controlled by Ewart Griffith so that he had voting control. He and George Griffith who became a director in December 1970 formed two thirds of the Board of Directors, John Carruthers being the third director. George Griffith was not active in the company until 1972 however according to the evidence of Mr Carruthers and it was Carruthers who was principal operator of the business in his capacity as Vice-President and General Manager.

He had been working for the company since 1953. The company had been in business selling equipment for horses including some cattle and pet related products. The horse harness equipment was the most important part of its business resulting in 75% to 80% of its sales. In later years he developed a line of strap-on tire chains sold through Canadian Tire which accounted for perhaps 10% of the sales. The chains and some of the harness equipment were manufactured by the company but most of the products such as saddles, vitamins for horses and so forth were purchased from manufacturers for resale. In the late 1960’s rapid growth was experienced and a full time sales representative was engaged. By this time Mr Carruthers devoted his efforts mainly to administration and finance and dealing with the suppliers. Most of the policy decisions were made by him although there was consultation with Ewart Griffith. Early in 1969 additional land was acquired and a new building was constructed with occupancy commencing in the autumn of 1969, at a cost of $87,500 for the addition. Prior to that part of the operations were carried on in rented premises on the second floor of the old building. According to Mr Carruthers’ evidence Ewart Griffith had a heart attack in 1968 and was contemplating retirement and not working full time, although he is still alive. He would have been about 71 years of age in the autumn of 1969 while Mr Carruthers was in his mid-30’s at the time. Their relative contributions to the business and growth of same are indicated by the salaries drawn, Mr Carruthers’ salary having increased from $10,010 in 1968 to $19,137 in 1971, while Mr Griffith drew $5,000, $6,000 and $6,000 respectively in 1968, 1969 and 1970 and $10,371 in 1971, the odd figures resulting from bonuses. He also received annually a $1,200 dividend on the preferred shares owned by Trayte Holdings.

Mr Carruthers testified that he was satisfied with his relatively low salary as he was taking into account the equity interest in the company which he was building up. If he had been working merely as an employee he would have sought more. The shareholdings of himself and his wife following the exercise of the options in January 21st, 1971, represented a 48% equity interest in the common shares. Ewart Griffith had a similar percentage interest, with 4% represented by the common shares held by George Griffith which he had acquired from one Colin Morrison, an original shareholder.

What complicates the evaluation of the Carruthers’ shares as at valuation day is the extraordinary number of options and other agreements containing certain restrictions entered into between the various parties consisting of no less than 22 agreements in a five-year period between November 1, 1967 and December 27, 1972, some of which contain provisions which are difficult to interpret. They were apparently all drawn by counsel for Ewart Griffith and Mr Carruthers only took legal advice on one occasion in connection with the December 27, 1972 agreement and then only with respect to the legal provisions thereof, without seeking advice as to the effects on him and his wife of said agreement. The October 20, 1969 agreement had weakened his position from that in the original agreement of November 1, 1967. Fortunately not all of the agreements are pertinent to the decision of this matter. While the agreements must speak for themselves and the motives of the parties for entering into them is not a concern of the Court it may nevertheless be said, by way of explanation that the relationship between Mr Carruthers and Mr Ewart Griffith appeared to be deteriorating.

While they were not actually in serious conflict, the evidence leaves the impression that Mr Ewart Griffith, who was getting on in years, was becoming somewhat alarmed at the rapid expansion of the company’s business under Mr Carruthers, and at the relatively minor part he was now called upon to play in policy decisions although he had voting control and control of the Board of Directors. Mr Carruthers for his part did not wish to antagonize Mr Griffith unduly and enter into open conflict with him which might result in his being forced to leave the company’s employ, and he was content to bide his time in the expectation of eventually gaining full control of the company. For his part Mr Griffith although dissatisfied with the changes which were taking place in the operation of the company and being more concerned with protecting his estate than expanding the business, nevertheless recognized the importance of Mr Carruthers to the business and did not wish to dismiss him which would certainly have damaged the company’s business at the time and might perhaps have led to a lawsuit for unjusified dismissal, although there was no employment agreement. This appears from a letter prepared by Mr J F Robinson of Clarkson, Gordon and Company but signed by Mr Ewart Griffith dated September 10, 1975, to Mr R H Clayton, Director of Taxation at the District Taxation Office in Hamilton, and also ina memorandum dated June 23, 1975, prepared by Mr Clayton following an interview with Mr Robinson. While it is true that this is ex post facto and at a time when it was the valuation day value of Mr Griffith’s own shares which was in issue rather than those of Mr Carruthers, as a result of Mr Ewart Griffith having sold his shares to Mr George Griffith at $8.63 a share on December 27, 1972, there is little doubt that some of the same problems existed at valuation day as a result of the terms of the various agreements. It is also of some interest to note than in the memorandum of Mr Clayton dated June 23, 1975, he states “Mr Robinson was also told that the value we arrived at would also be applicable for the shares of Carruthers and George Griffith the nephew.” His valuation was for $11 per share. Subsequently when examined for discovery pursuant to order of Mr Justice Collier in these proceedings and the further order of Mr Justice Gibson to answer questions he testified that he did a valuation of the Carruthers’ shares by way of a review of the evaluation produced by Price Waterhouse, the Carruthers’ evaluators and he rejected the liquidation method of evaluating the shares which had a book value of $21.57 at valuation day. He also rejected the book value method of evaluation. While he estimated maintainable income averaged over a three-year period at $49,000 he did not use a capitalization of earnings basis for the evaluation. He arrived at a valuation of $13,82 per share “determined under the orderly liquidation of it and this is a value for the company and not necessarily for specific shareholdings of the company”. (Answer to Question 142 on Discovery).

Initially the Minister had given a valuation of $2.39 a share as at valuation day to the Carruthers’ shares, or at most a valuation of $7.45 a share which was reached by applying the terms of the agreement of October 20, 1969, by which the Carruthers gave an option to Mr Griffith to purchase the 4,202 common shares which they held at that date at a price of $2.39 a share plus 30% of the book value of the shares as at March 31, 1971, if the options were exercised before that date. The Tax Review Board judgment assigned a value of $7.45 a share and in the present proceedings there is no cross appeal by the Minister disputing this value which is the value for which the Minister contends in the present proceedings whereas plaintiff seeks a valuation as at valuation day of $44.70 a share. Defendant objected strongly therefore to the introduction of the valuation given by Mr Clayton of $11 a share which appears in the Requisition for Business Equity Evaluation or Real Estate Appraisal form signed by him on May 2, 1979. The purpose of the requisition is shown on the form as being a “narrative valuation requested by regional appeals to be independent of valuation prepared by Kitchener District Office to determine the fair market value on V-Day.” One hundred and eight hours of time was spent in connection with this valuation according to the form. The Minister contends that this is a privileged document and moreover that it contains an opinion which can only properly be introduced according to the rules for the introduction of evidence of expert witnesses and Mr Clayton, although undoubtedly qualified, was not called as such. However by order of Mr Justice Collier in the present proceedings dated November 3, 1980, Mr Clayton was designated as the witness of the defendant to be examined for discovery by the plaintiff, and by a further order of Mr Justice Gibson dated April 27, 1981, he was ordered to answer questions to which objection had been taken on discovery. Portions of the discovery were read into the record including the answers which he was forced to give to questions to which objection had previously been taken, resulting in the full disclosure of his method of evaluation, and the report was produced as an exhibit on discovery. The Minister objects strongly to the introduction by way of discovery through a witness forced on defendant by order of the court of evidence in the nature of opinion evidence which tends to disprove the contentions of defendant as to the valuation day value of the shares in question.

Reference was made by plaintiff to the case of Irish Shipping Limited v The Queen et al, [1974] 1 FC 445, in which Collier, J reviewed the jurispru- dence respecting the nomination by the court of a witness other than one suggested by the opposing party, as was done in the present case in connection with the nomination of Mr Clayton. In a recent and as yet unreported case of Stanley M Smith v Her Majesty The Queen, [1981] CTC 476; 81 DTC 5351. Associated Chief Justice Jerome referred to the judgment of Collier, J in the present case and to the Irish Shipping case in ordering the examination for discovery of a departmental officer of the Ministry of National Revenue who prepared and appraised the real estate in an expropriation case, which appraisal was a major factor in defendant’s position on valuation.

It would appear to be well settled therefore that a witness who, in the course of his duty, in connection with which he has considerable expertise in evaluation, prepares a report on valuation subsequently can be designated by the court as the witness to be examined for discovery and cannot avoid such examination or refuse to answer questions arising therefrom as being privileged in his report to his employer the Minister. Rule 465 (15) dealing with the examination for discovery requires the individual being questioned to answer any question as to any fact within the knowledge or means of knowledge of the party being examined for discovery that may prove or tend to prove or disprove or tend to disprove any unadmitted allegation of fact in any pleading filed by the party being examined for discovery or the examining party. I conclude therefore that it must be entered into evidence as a fact that he in 1979 appraised the value of the Carruthers’ shares at valuation day at $11 a share. I do not conclude however that the validity of the valuation is beyond dispute or binding on the Minister, but it is certainly evidence which must be taken into consideration in connection with the other expert evaluations both for the plaintiff and for the defendant in reaching a conclusion as to the proper value, and of course the methods adopted by Mr Clayton in arriving at his figure can be examined, as they were during his examination for discovery, in the same manner as the valuations of the expert witnesses were examined by a cross-examination of their evidence in open court.

It is now necessary to examine the various share option agreements which are significant in the present proceedings before going into the evidence of the expert witnesses and what weight they gave to these agreements in their conclusions as to valuation day value of the shares in question.

The first agreement between John Carruthers, Emma Carruthers, Ewart Griffith, one Ronald R Blake and Trayte Holdings Limited dated November 2, 1967 sets out that Ewart Griffith owns all 14,004 common shares of the company and agrees to sell them at $2.39 a share to the extent of 5,252 common shares to John Carruthers, 5.251 to Emma Carruthers and 3,501 shares to Blake. The shares were to be held in escrow and payment was to be made by five equal instalments over a five-year period commencing June 1, 1972 with interest. It was agreed that the 5,500 preferred shares owned by Trayte Holdings would be redeemed over a four-year period commencing June 2, 1973. If any default was made Trayte had an option to purchase all 14,004 common shares at $2.39 per share.

In the next agreement on October 20, 1969 Blake sold to C Morrison 560 common shares and his remaining 2,941 common shares to Ewart Griffith. John Carruthers agreed to sell Ewart Griffith 3,151 of the 5,252 common shares that he had a right to get under the 1967 agreement and Emma similarly sold to Ewart 3,150 of the 5,251 common shares which she was entitled to purchase. The shares so transferred by John and Emma Carruthers were the unpaid portion of the 1967 agreement as of that time. The 1967 agreement was cancelled and shares came out of escrow, but following this agreement John and Emma Carruthers each had 2,101 common shares, Morrison had 560 common shares and Ewart Griffith, 9,242 common shares.

On the same date, October 20, 1969 a number of other agreements were signed. Ewart Griffith granted John Carruthers and Emma Carruthers in separate agreements new options to purchase 1,260 of his common shares each, the option to be exercised by the f i rst of the dates of March 31, 1979, or on the 120th day following the death of Ewart, or on the date on which John Carruthers ceased to be employed by Griffith as the result of his death or discharge, with or without cause, or voluntary leaving. The options could only be exercised if John was an employee of the company at the date of exercise of the options and the preferred shares of Trayte Holdings were redeemed by the company. The option price was $2.39 a share and both John and Emma Carruthers had to exercise their options contemporaneously. On the same date John and Emma Carruthers by separate agreements granted Ewart an option to purchase their respective 2,101 common shares together with any additional shares subsequently acquired and paid for, with the exercise to be within 120 days following the date on which John ceased to be an employee as a result of discharge with or without cause of voluntary leaving, or his death or bankruptcy. The purchase price of this option was to escalate from $2.39 plus 10% of book value as at March 31, 1969, going up additional increments of said 10% of book value each year until March 31, 1978. While there was no restriction in the option agreements against John or Emma transferring their shares it was provided that no transfer could be entered in the books of the company unless the transferee had entered into an agreement with Ewart Griffith to be bound by the terms of these agreements.

Again on the same day Morrison granted to John Carruthers an irrevocable option to purchase all of his shares any time within 120 days following Ewart Griffith’s death or 120 days following March 31, 1979, if John Carruthers was still an employee. The price was to be the book value of the shares as at the 31st of March in the year preceding the exercise and was conditional upon John Carruthers remaining an employee and would be void if he died or was discharged with or without cause or voluntarily left. Furthermore if John Carruthers should exercise his option to purchase Morrison’s shares then Ewart could request John Carruthers to purchase Ewart’s shares at the same price. This agreement was binding on transferees of either Morrison or Ewart shares.

By an agreement on December 22, 1970, Morrison sold his 560 shares to George for $2 per share subject to the option in favour of John Carruthers. On January 21, 1971, John Carruthers and Ewart Griffith agreed that in the event that John exercised his option under the Morrison agreement and was therefore required by Ewart to purchase Ewart’s shares then John’s option to Ewart with respect to his shares was at an end. A similar agreement was made the same day with respect to Emma Carruthers’ shares.

On the same date, January 21, 1971 by separate agreements John Carruthers and Emma Carruthers exercised their option to each acquire 2,260 common shares from Ewart Griffith at $2.39 per share. The agreements stated that they were dealing at arm’s length and that the sale represents the market value. It provides for possible disputes arising in future with the Department of National Revenue and/or the Ontario Succession Duty Department (at that time there was both Ontario succession duty and Federal estate tax but no capital gains tax). The Carruthers agreed that in the event that gift tax, estate or succession duty with respect to the sale resulted from the price of $2.39 a share they would indemnify Ewart Griffith with respect to all such taxes up to an amount not exceeding $2,775 each. Similar agreements were made on the same date whereby Ewart Griffith agreed to indemnify John and Emma Carruthers against any such additional taxation arising from a determination of fair market value as being in excess of the purchase price set out in the 1969 agreement.

By agreement dated December 27, 1972 between Ewart Griffith, George Griffith, John and Emma Carruthers all previous agreements were cancelled excpet for those of January 21, 1971, between Ewart Griffith and John and Emma Carruthers as to possible tax indemnity.

On the same date further agreements were entered into between John and Emma Carruthers respectively and George Griffith setting out the fact that they each now owned 3,361 shares of the company of which 2,101 shares had been acquired by the October 20, 1969 agreement between Trayte Holdings, John and Emma Carruthers, Blake and Ewart Griffith, and the 1,260 shares each acquired by exercising the option to acquire them from Ewart by the January 21, 1971 agreement. These agreements provided that if Carruthers ceased to be employed by the company as a result of discharge with or without cause or voluntary leaving, George Griffith would purchase his shares at an established price based on the book value of same as determined by the company’s auditors at the end of the preceding fiscal year. It further provides that if Carruthers is discharged without cause and if George Griffith within one year thereafter sells the common shares or transfers his right to purchase them from Carruthers, for a consideration greater than the established price, then he will pay the excess to Carruthers. In the event that George Griffith should assign his interest in the agreement he will guarantee to John Carruthers the performance of the agreement by the assignee. The agreement for the first time restricts the free disposal by Carruthers of their shares otherwise than in accordance with the agreement.

Certainly the position of John and Emma Carruthers was weakened by the October 20, 1969 agreement from that which they had as a result of the November 1, 1967 agreement. Under the 1967 agreement they would between them have the right to acquire approximately 75% of the common shares and upon completion of the purchase and redemption of the Trayte Holdings’ common shares would have voting control of the company, whereas by virtue of the 1969 agreement they only had a 48% interest between them with Ewart Griffith having voting control as a result of his preferred shareholdings. John Carruthers had to remain an employee of the company to exercise his options, but Ewart Griffith could exercise a similar option by dismissing John Carruthers. It is true that for him to exercise his option it would cost him somewhat more, since in addition to the $2.39 per share he would have to pay a percentage of the book value commencing from 10% on March 31, 1969 up to 100% as of March 31, 1978. Any transfer to third parties would be subject to the terms of the agreement and in addition by the terms of the company’s charter the transfer would have to be approved by the Board of Directors, which would give Ewart Griffith an opportunity of blocking a transfer by John and Emma Carruthers if he did not approve of the transferee. As previously explained John Carruthers agreed to the change in 1969 cause and if George Griffith within one year thereafter sells the common shares or transfers his right to purchase them from Carruthers, for a consideration greater than the established price then he will pay the excess to Carruthers. In the event that George Griffith should assign his interest in the agreement he will guarantee to John Carruthers the performance of the agreement by the assignee. The agreement for the first time restricts the free disposal by Carruthers of their shares otherwise than in accordance with the agreement.

Certainly the position of John and Emma Carruthers was weakened by the October 20, 1969 agreement from that which they had as a result of the November 1, 1967 agreement. Under the 1967 agreement they would between them have the right to acquire approximately 75% of the common shares and upon completion of the purchase and redemption of the Trayte Holdings’ common shares would have voting control of the company, whereas by virtue of the 1969 agreement they only had a 48% interest between them with Ewart Griffith having voting control as a result of his preferred shareholdings. John Carruthers had to remain an employee of the company to exercise his options, but Ewart Griffith could exercise a similar option by dismissing John Carruthers. It is true that for him to exercise his option it would cost him somewhat more, since in addition to the $2.39 per share he would have to pay a percentage of the book value commencing from 10% on March 31, 1969 up to 100% as of March 31, 1978. Any transfer to third parties would be subject to the terms of the agreement and in ad- dtion by the terms of the company’s charter the transfer would have to be approved by the Board of Directors, which would give Ewart Griffith an opportunity of blocking a transfer by John and Emma Carruthers if he did not approve of the transferee. As previously explained John Carruthers agreed to the change in 1969 as he did not want to have a showdown with Ewart Griffith.

I turn now to the reports of the expert witnesses, Philip W Bowman of Price Waterhouse who made the evaluation on which plaintiff relies and Bradley Dalgleish of Thorne, Riddell on behalf of defendant. Both experts are well qualified and it is invidious to make comparison of experts’ reports and do weigh the validity of them on the basis of their qualifications, but rather a court must consider the approach taken by the experts and to weigh the value to be given to a report on the basis of its contents and the evidence of the experts when cross-examined thereon. It does however appear that Mr Dalgleish has had somewhat more experience in the field and on the whole I find his report to be more accurate and complete on several of the issues. Both reports agree substantially in a number of areas and in particular the results arrived at for the value of all the shares of the company at valuation day on a capitalized income approach before they make adjustments as a result of the minority shareholding and for restrictions on share transfers resulting from the various agreements. There are of course some differences in figures even on the capitalized income approach but this is not where the main difference occurs.

As the fiscal year of the company was changed in 1971 from March 31, 1971 to end on December 31,1971, it was necessary to add estimated earnings for a three-month period ending March 31,1971 to the actual figures for December 31,1971, so as to arrive at the estimated earnings fora a full year. Although sales for the nine-month period ending December 31,1971 were $712,920 as against only $135,000 for the three-month period ending March 31, 1971, which is evidently a slow period of the year for sales, Mr Bowman applied the same percentage for cost of sales in the three month period as figures for the actual cost of sales were not available. It is not necessary to go into the details of these figures which appear in Appendix B of this report. He arrives at net earnings after taxes and provision for dividends on the preferred shares of some $66,000 for the year, as against $54,696 for the year ending March 31,1971 and $39,593 for the year ending March 31, 1970. He capitalizes the figure of $66,000 by a ratio of 8 to 9 arriving at a value of $528,000 to $594,000 for the value based on capitalized earnings to which he adds $32,000 in each case as the present value of Small Business Tax benefit, arriving at a total valuation of $560,000 to $626,000. Adopting the value of between $560,000 and $626,000 works out to $40 to $44.70 per common share. Due to the fact that the interest of Mr and Mrs Carruthers is a minority interest his report then would allow a discount of 5% to 10%. A 5% discount would give a range of $38 to $42.47 a share while a 10% discount would result in a range of $36 to $40.23 a share. The agreements referred to were looked at and reference is made to an Income Tax Interpretation Bulletin IT-14 OR which, in dealing with valuations for estate tax purposes states that the fair market value must be determined without reference to the provisions of any agreement. I may say that, quite apart from the fact that it has been held that such bulletins are not binding on the Department or the Courts, I do not consider the two situations at all similar. By the mere fact of death a valution has to be made at that date and quite obviously the parties could not by private agreement made prior to death establish a value other than the fair market value which would be binding on the Minister and therefore the agreement would have no bearing on the valuation. In the present case the situation is quite different. While it could again be said that the parties could not by agreement establish a binding value different from the fair market value it certainly does not follow that an informed purchaser, made aware of the agreements, would not take into consideration their effect on what he is prepared to pay, which in itself is what establishes a fair market value, together with the willingness of the vendor to sell at the fair market value figure. The report goes on to say, however, that despite the conclusion to the effect that the value should be established without reference to the option agreements, nevertheless, as they may create some uncertainty in the minds of a potential purchaser a nominal discount of 5% to 10% would be allowed. This brings the final figure from a low of $32.40 based on 10% discounts for each of the minority interest and the option discount to a high of $40.35 based on two 5% discounts.

During the preparation of this report some consideration was given to a report prepared by Clarkson Gordon & Company on January 7, 1975, at the time they were evaluating the shares of Mr Ewart Griffith at valuation day as the result of his sale of them to George Griffith in late 1972. This report referred to the agreement by which Ewart Griffith could have bought from the Carruthers 6,772 at $2.39 a share plus 30% of the book value as at December 31st, 1971, and concluded that the fair market value as at December 31, 1971 was equal to the selling price of the shares in December 1972 or $8.63 a share. Mr Clayton who later prepared an evaluation of the subject shares for defendant, and whose examination on discovery has been referred to previously reports in a memorandum of an interview with Mr Robinson of Clarkson Gordon & Company a suggestion by Mr Robinson that he would be willing to recommend that between V-Day and the date of sale the shares might have increased in value by $4 so that the proceeds of sale should be adjusted upwards to $12.63, and concludes with the statement to which I have referred that the V-Day value arrived at would also be applicable to the shares of Carruthers and his nephew George Griffith. In a letter from Ewart Griffith to Mr Clayton of September 10, 1975, respecting the said value all Mr Griffith’s arguments are set out. He insists he was dealing at arm’s length with Mr George Griffith in fixing the price of $8.63 a share. It is interesting to note that this letter which was prepared for his signature by Clarkson Gordon & Company calculates the $8.63 figure on the basis of deducting from book value as at December 31, 1972 of $431.72 an estimated loss of 10% on the collection of accounts receivable and 50% on liquidation of inventory reducing the value to $225,037.72 and makes a further deduction of 15% for the cost of removing the surplus of the company, and finally, and what is of special interest, deducts 35% to reflect a minority interest arriving at the final valuation for all of the common shares of $120,820 or $8.63 a share.

I myself find it somewhat surprising that a minority interest, even a substantial minority interest of 48% in a tightly controlled company, on which dividends on the common shares were only paid in two years, the years ending March 1969 and 1970 in the amounts of $9,802.80 and $2,800.80 respectively and dividends of preferred shares were only paid irregularly, would only be subject to a small discount of 5% to 10% according to Mr Bowman’s evidence and of 10% according to Mr Dalgleish’s evidence which I will come to later. While it is true that the 35% mentioned in the letter prepared by Mr Robinson of Clarkson Gordon & Company for signature by Mr Griffith is an argumentative figure included in submissions designed to reduce the value of the common shares he sold to George Griffith to $8.63, and hence cannot be treated as an expert opinion, it may well be more realistic. The letter concludes with figures as to estimated fair market value based on net shareholders’ equity of $322,065 as of December 31, 1971 and $451,393 as of the date of the sale in 1972, and after making the deductions referred to above for loss on accounts receivable, loss on inventories and 15% for remaining surplus, but without any reference to a discount to reflect a minority interest arrives at a value for a common share of $9.45 as at December 31, 1971, and $13.87 as of the date of the sale in 1972.

It is of interest to note that the Price Waterhouse initial report of February 24, 1977 to Mr and Mrs Carruthers gives no conclusion as to per share value although it is supplemented by a memorandum four days later on February 28, 1977 which gives the figures I have previously referred to. It was not until November 3, 1981, however, that they apparently realized as a result of evidence disclosed at the hearing before the Tax Review Board that Mr Ewart Griffith had voting control as a result of the 2,000 preferred shares owned by Trayte Holdings Limited as at December 31, 1971, so that it was erroneous for them to have said as they did in the 1977 memorandum “that no shareholder directly controlled the company at December 31, 1971, and that no shareholder was in a position to elect a Board of Directors”. The information as to the preferred shares controlled by Mr Griffith was readily available at the time of the initial report. The report in the November 3, 1981 letter now admits that although Mr Carruthers owned 48% of the common shares his effective voting power was 42%, George Griffith having 3.5% and Ewart Griffith 54.5% of the votes. Having said this, and admitting that control of the company is an important factor in determining whether or not a discount is appropriate for a minority interest and the magnitude of such discount, they then refer to the factual situation that Mr Griffith would not wish to dismiss Mr Carruthers in order to acquire his shares, so while Mr Carruthers was in a minority position as to voting rights he had a dominant position in his ability to manage and direct the business and affairs of the company. The report therefore refuses to increase the minority discount from the 5% to 10% figure previously given.

Turning now to the expert report of Mr Bradley Dalgleish for the defendant, he also adopts a capitalized income approach. In estimating the income for the three months from March 31, 1971 so as to be able to add it to the income for the nine months ending December 31, 1971, when the fiscal year was changed so as to arrive at income for a full year, he adopted what I believe to be a more accurate approach. While he agrees that the percentage profit on sales of 32% for the nine months ended December 31, 1971 is accurate he examines the expenses for the nine months ending December 31, 1971 and conludes that they are primarily of a fixed nature so that it is appropriate to consider / of the expenses for this period as the best estimate of selling and administrative expenses for the three-month period in question. This is more accurate than estimating the selling and administra- tive expenses for the three-month period in question on the same percentage as the sales of $135,000 in the three months ending March 31, 1971, bear to sales of $712,920 in the nine months ending December 31, as most of these expenses would continue to run even during the three-month period when sales are slow. As a result his estimate of selling and administrative expenses for the three-month period amounts to $36,716 as against $20,925 in Mr Bowman’s report, so income before taxes for this three-month period is $6,601 which he rounds off to $7,000 instead of $22,275 making total estimated income before taxes for the year of $125,000 as against the other estimate of $140,042 and after taxes of $60,000 as against $66,000 as estimated in the Price Waterhouse report.

For the preceding year his figure is $53,000, and capitalizing these by a multiple in a range between 7.7 and 8.3 gives a capitalized value of $440,000 to $462,000, to which $35,000 is added as the present value of the small business tax deduction (the Price Waterhouse report added $32,000 which is very close) making the fair market value of the company $475,000 to $500,000, which indicates goodwill of $153,000 to $178,000 (as against $288,060 in the Price Waterhouse report). After deducting $20,000 for the value of the preferred shares at par from the en bloc value of $475,000 to $500,000 leaves a fair market vlaue of $455,000 to $480,000, for the common shares, or $32.49 to $34.28 per share, (as against the $40 to $44.70 per share of the Price Waterhouse report).

At this stage the reports of value given by the two experts, although somewhat different do not differ to a very substantial extent. I have explained however why I consider the figures in Mr Dalgleish’s report to be more accurate, largely due to a different method in treating estimated expenses for the three-month period ending March 31, 1971.

In selecting a somewhat lower multiple than the Price Waterhouse report for capitalizing income, Mr Dalgleish’s report concludes that a prudent investor’s expectations of return on equity capital invested in a business of this sort would be in the nature of 12% to 13% (multiple of 8.3% to 7.7%) since at the time conventional mortgages yielded 9.10% and long term corporate bonds 8.24%. The nature of the company’s assets and in particular the large investment in inventory led to a conclusion that the net proceeds which would be obtained on the liquidation of the company’s assets and liabilities would be much lower than the net book value and hence would not provide a great deal of downside protection for an investor in the event that the company should cease to be viable as a going concern. (Mr Bowman in his evidence had stated that he did not believe that there would be a substantial loss on an orderly liquidation of inventory). The Thorne Riddell report refers to positive factors such as the prominent position of the company in the equestrian equipment industry, being the largest supplier of such equipment in Canada, the absence of dependence upon key customers, the amicable relationship with its long term work force and the absence of dependence on key suppliers, and to negative factors such as the near term dependence on John Carruthers for management of the company, the high inventory level at valuation date as a result of bulk ordering in anticipation of expected delays in delivery with the result that, significant funds were tied up in such inventory, and the comparative ease of eventual entry into the market, little capital expense being required, the comparatively simple manufacturing process involved in the equipment which the company manufactured itself, and the fact that over 60% of the company’s business was in the wholesale distribution of imported products.

Actually there is little dispute between the experts about this and there is agreement that the substantial amount of goodwill shown by the company’s financial records is business goodwill rather than personal goodwill of Mr John Carruthers. While there is agreement that he was an excellent general manager and deserves the credit for the rapid expansion of the company’s profits in the years from 1968 to 1971 and thereafter, it cannot be said that the business could not have continued to operate without him, as in fact it has done since he left the company in 1975, selling his shares to George Griffith in 1976. Unfortunately George Griffith died in 1977 or 1978 but the business is still operating despite John Carruthers having set up a competing business and taking some of the former employees with him.

In establishing a 10% discount for a minority shareholding interest the Thorne Riddell report of Mr Dalgleish took into consideration the fact that as a result of the voting control ultimate decisions as to the company’s future direction would be based on control of Mr Ewart Griffith, that the right to transfer shares required the approval of the Board of Directors, that there were no shareholders’ agreements which provide for automatic sale in the event of death or retirement of a holder of 48% minority interest or any guarantee of an equal share of proceeds of the sale of the company to a third party, and that historically no regular dividends had been paid on the common shares.

The report then analyzed the various agreements and states “Carruthers appeared to have been put in a much worse position vis-a-vis the 1967 agreement witht he drafting of the 1969 agreement’’. The report also states

Referred to above and outlined in Exhibit A are certain transactions at prices which appear to be less than fair market value. Although these purchases and sales are between parties apparently dealing at arm’s length, we are of the view upon consideration of the circumstances surrounding these sales that the prices transacted at are not indicative of fair market value otherwise determined.

This refers to the sale on December 22, 1970, from Morrison to G M Griffith of 560 shares at $2 per share and the sale on January 21, 1971 from Ewart Griffith to the two Carruthers of a total of 2,520 shares at $2.39 per share pursuant to the 1969 option agreements. I agree with the conclusion that these sales do not represent a fair market value.

The report goes on to state

The restrictions and rights provided by the foregoing agreements suggested to us that the Carruthers shares would have been attractive as an investment only to an employee in Mr Carruthers’ position. That is, the terms of ownership attached to the Carruthers shares were designed to appeal only to a key employee as this block of shares was not intended to be attractive to an outside investor. In our view, an investor looking at this 48% interest in the Company would likely have sought to have all of the restrictive agreements rescinded prior to making the investment.

Here again I agree with this statement. After pointing out that the purchaser of the Carruthers’ shares on December 31, 1971, was greatly influenced by the provisions of the October 20, 1969 agreements which had put such a purchaser in a position whereby Ewart Griffith could acquire the shares immediately subsequent to that date unless the agreement was rescinded and would thereupon have to pay only $7.45 a share on the basis of the sum of $2.39 and 30% of the book value as at March 31, 1971, which was lower than the fair market value of the Carruthers’ shares if they were not governed by the agreements the report concluded that this represented the minimum fair market value at valuation day but went on to conclude that a prudent investor might be prepared to pay some amount in excess of this sum. Such prudent investor according to the opinion expressed in the report would consider the portion of his investment which would be at risk in the event of the exercise of the option held by Mr Ewart Griffith, the potential increase in the option price which went up annually by 10% of the book value until 100% of the book value was reached, the fair market value of the minority interest if there were no restriction by agreement which would establish a maximum of what a prudent purchaser would pay, and the likelihood of Ewart Griffith exercising the option which would terminate Mr Carruthers’ employment. The future of the investment was therefore in the control of another party or parties and the circumstances which prevailed at December 31, 1971, could be changed at any time. The report further estimates that as early as April 1, 1972, the formula price for acquisition by Mr. Ewart Griffith of the Carruthers’ shares would have gone up from $7.45 per share to $11.13 per share.

The report then goes into some issues which are clearly a matter of opinion, which is of course the right and purpose of an expert, and concludes that a prudent investor will be unwilling to risk losing in excess of 25% of his investment as a result of the exercise of an option by a third party. If such a purchaser were to pay the Carruthers $11.13 per share and during the period between January 1, 1972 and March 31, 1972 Mr Griffith exercised his option and took back the shares at $7.45 a share the purchaser would have lost 33% of his total investment. On the other hand the option price would most probably have increased from year to year over and above the figure of $11.13 as the book value of the shares continued to increase. The report then looks at a hypothetical purchase price of $10 per common share which, if the option to purchase at $7.45 were exercised would result in a loss of approximately 25%, which a prudent investor might be willing to risk. The report therefore concludes for a valuation between $7.45 and $10 a share. It is important to note that a purchaser buying John and Emma Carruthers’ shares would, even if John had also sold him the option agreement of October 20, 1969, for purchase of Morrison’s shares, later transferred to George Griffith on December 22, 1970, not be in a position to gain control of the company, since this option could only be exercised within 120 days following Ewart Griffith’s death or 120 days following March 31, 1979 and then only if John Carruthers was still an employee of the company. The Price Waterhouse memorandum of February 28, 1977, outlining their basis for evaluating the shares states at 4;

A deciding factor in the whole arrangement was Mr Carruthers’ employment by the company. As a Director of the company and as Vice-President and General Manager this employment was not seriously in question at December 31st, 1971.

While this statement on the face of it is not inaccurate, it is evident that Mr Carruthers’ principal interest in remaining in the employ of the company was to eventually gain control and if he sold his shares as at December 31, 1971, it would be because he had abandoned this intention and a purchaser could therefore not count on his remaining in the employ of the company. The validity of this conclusion, which would be reasonable to make as of December 31, 1971, can be verified by the fact that he did in fact leave the company in 1976 following the sale of his shares to George Griffith in 1975 and set himself up independently in a competing business.

In the case of Diligenti v RWMD Operations Kelowna Ltd et al, 4 BCLR 134, Fulton, J at 142 stated:

. . . As stated, both valuators made projections of earnings, and assumptions on which they based their choice of the price: earnings multiple, but their estimates as reflected in their respective reports differ widely. With this in mind I ruled that evidence of actual results subsequent to 30th June, 1976 was admissible, not to establish the value as of the beginning of July but to test the validity of the forecasts and assumptions of the experts where those differed, and thus to assist in determining whose forecasts were, and accordingly whose valuation as of 2nd July 1976 was, the more valid.

In expropriation cases sales subsequent to the date of expropriation, not too long thereafter, of comparable properties are admitted in evidence. There appears to be no reason why an assumption which could be made in 1971 that Mr Carruthers would not remain long in the employ of the company if he and his wife chose to dispose of their shares cannot find some support in the fact that this is what took place eventually. The price paid by George Griffith to the Carruthers for their shares is of course in no way relevant to the valuation as at December 31, 1971, for George Griffith was obtaining full control of the company and moreover during the intervening years between 1971 and 1975 the company continued to prosper and the shares increased in value.

I believe that the capitalized normal earnings approach adopted by both experts followed by adjustment for the minority holding and the negative effect of the various agreements is the correct approach rather than relying on the closest sales to valuation day being the sale of 560 shares on December 21, 1970 from Mr Morrison to Mr George Griffith for $2 a share which was in itself subject to an option agreement in favour of John Carruthers to 120 days following March 31, 1979, and the January 21, 1971 purchases at $2.39 a share by John and Emma Carruthers from Ewart Griffith. While the parties were dealing at arm’s length these sales were clearly not representative of the shares’ market value. With respect to the valuation of $7.45 a share which Defendant now concedes, this again was one established by one of the agreements based on the initial figure of $2.39 plus 30% of book value as established at the end of the proceeding fiscal year of the company being the price which Mr Ewart Griffith would have to pay to acquire the Carruthers’ shares at valuation day. I also consider this figure, which was accepted by the judgment of the Tax Review Board, to be somewhat below the market value. It would merely establish the lowest figure which a purchaser of the Carruthers’ shares would get back if Mr Ewart Griffith discharged John Carruthers, if he had not already voluntarily retired, and exercised his option for these shares, but it does not eliminate the possibility of a higher price being paid by a potential purchaser to the Carruthers based on the potential increase in value of the shares and the possibility that Ewart Griffith might not exercise his option. In fact even three months late at the end of March 1972 the option figure would have increased to $11.13. Although this actual figure would not be known to a prospective purchaser as at December 31, 1971, a close approximation could have been foreseen, as the company was continuing to prosper.

I believe that both experts are right in rejecting the valuation of the shares based on the winding up of the company. A purchaser of the minority interest held by the Carruthers would not be in a position to force the winding up of the company and it is highly improbable that Ewart Griffith would have wished to, even if John Carruthers did sell his shares and leave the business. It appears to me that a potential purchaser outside the group (and the potential purchaser should not be limited to those already associated with the company such as Ewart Griffith and George Griffith) would most probably be someone who wished to take an active part in the operation of the business himself, perhaps replacing John Carruthers, and would be unlikely to be buying in contemplation of the company being wound up with a view of realizing a profit on such winding up. As an investment the purchase would not be of much interest in view of the complications of eventually gaining control as the result of the various agreements, the possibility of a forced sale of the shares by action of Ewart Griffith, and the possible loss of the services of John Carruthers which would be detrimental to the continued progress of the company at least in the short term, in addition to which dividends had seldom been paid on the common shares.

Before stating my final conclusions as to value I should refer to some of the voluminous jurisprudence which was cited by both parties. With respect to the experts’ reports reference might be made to a decision of the Federal Court of Appeal in the case of Harold P Connor v The Queen, [1979] CTC 365; 79 DTC 5256, in which Urie, J referring to the fact that the trial judge was entitled to accept or reject in whole or in part any of the evidence adduced before him stated:

. . . In this case he accepted some of the evidence but he rejected in all cases the methods, at least in part, whereby the experts arrived at their valuations. He was entitled to do so and unless it can be said that thereafter he proceeded on a wrong principle or that he made a palpable error in reaching his own conclusions as to value, we ought not to interfere with his findings. We have not been persuaded by the arguments of counsel that he proceeded on a wrong principle or made any such error. Certainly he appears to have adopted parts of the methods used by the witnesses in making their calculations but in using only parts and not the whole of their respective methods we do not believe that he erred in law.

This is what I propose to do.

In contending that in establishing market value the terms of the agreements should not be considered plaintiff relies principally on an old Newfoundland case re Harvey, Assessor of Taxes v Walsh, [1950] 3 DLR 257. This dealt with evaluation of shares of a revenue producing company for succession duty purposes. The headnote reads:

. .. This valuation ought to be made on the basis of the past, present and estimated future prosperity of the Company in view of all relevant business factors. Such ultimate valuation would involve their income-producing value, their breakup value in the event of a distribution taking place, and their consequent market value as among those persons qualified for registration as members.

As I have already stated in dealing with the effect to be given to the Interpretation Bulletin of the defendant the situation for valuation of shares of an estate is entirely different and it may be quite proper to ignore agreements requiring the shares to be sold at a predetermined value for greater or less than their actual value at date of death, although this is a controversial matter, as other cases show. However the situation is entirely different when what we are determining is market value at a given date resulting from sale by a willing vendor to a willing and fully informed purchaser, and certainly the purchaser will study and take into account the effects of any such agreements on the shares in the event that he decides to purchase them and this will affect the market price.

The case of George Edwin Beament, et al v MNR, [1970] SCR 680; [1970] CTC 193; 70 DTC 6130, to which plaintiff referred is also not pertinent. At 687 [198, 6133] Chief Justice Cartwright stated:

Once it is established (and it has been conceded) that the contract binding the deceased and his executors to have the company wound up was valid, the real value of the shares cannot be more than the amount which their holder would receive in the winding-up. To suggest that they have in fact any other value would be altogether unrealistic.

The present case does not involve a winding-up.

Finally it is argued by plaintiff that the onus is on defendant to support the assessment and state the assumptions on which reliance is placed. In the present case there was no reassessment following the decision of the Tax Review Board and it was only in defence in the present proceedings that defendant now relies on the $7.45 valuation which was decided on by it. However paragraph 4 of the statement of defence outlines in full the assumptions on which reliance is placed, and paragraph 5 explains how the figure of $7.45 is arrived at. Plaintiff is fully familiar with all the contentions and with the evidence adduced and decision of the Tax Review Board. In the case of Hillsdale Shopping Centre Limited v MNR, [1981] CTC 322; 81 DTC 5261 at 328 [5266] Urie, J stated:

It was next said that the learned Trial Judge had erred in proceeding on the basis that the onus of disproving that the Minister’s assumption that some part of the proceeds of the expropriation were taxable, lay upon the taxpayer.

If a taxpayer, after considering a reassessment made by the Minister, the Minister’s reply to the taxpayer’s objections, and the Minister’s pleadings in the appeal, has not been made aware of the basis upon which he is sought to be taxed, the onus of proving the taxpayer’s liability in a proceeding similar to this one would lie upon the Minister. This defect may be due to a number of reasons such as a lack of clarity on the part of the Minister in expounding the alleged basis of the taxability which could include an attempt by the Minister to attach liability on one of two or more alternative bases thus failing to make clear to the taxpayer the assumption upon which he relies.

In all other cases the onus is on the taxpayer to disprove the Minister’s allegation of liability on the assumptions propounded.

See also the case of Johnston v MNR, [1948] CTC 195; 3 DTC 1182, in which Rand, J stated at 203 [1183]:

. . . It must of course, be assumed that the Crown, as is its duty, has fully disclosed to the taxpayer the precise findings of facts and rulings of law which have given rise to the controversy. But unless the Crown is to be placed in the position of a plaintiff or appellant, I cannot see how pleadings shift the burden from what it would be without them. Since the taxpayer in this case must establish something, it seems to me that that something is the existence of facts or law showing an error in relation to the taxation imposed on him.

Plaintiff's contention that in the present case no evidence was adduced to support defendant’s valuation of $7.45 is without merit, as this is one of the figures given by Mr Dalgleish in the report of Thorne Riddell, defendant’s expert witness.

After a careful review of all the evidence including the evidence of Mr Clayton on discovery and the exhibits filed during the course of his testimony I have reached the conclusion that the figure of $7.45 is somewhat too low, being a base figure which would result in a purchaser suffering no loss except to the extent that he paid more than this. The Thorne Riddell report suggested a maximum of $10 per share based on the view that an informed purchaser would be prepared to lose up to 25% of his investment but not more. The extent to which a purchaser looks at the risks on the downside in making an investment is of course a matter of speculation and subject to expert opinion. It is not entirely unreasonable to speculate that a potential purchaser would also have approached Ewart Griffith to see about buying his shares as there is nothing in the option agreement to prevent the sale to third parties, although the transfer has to be approved by the Board of Directors. Ewart Griffith sold his shares to George Griffith in December 1972, dealing at arm’s length for $8.63 a share and it is at least possible if not probable that he would have been happy to sell his shares in December 1971 to a potential purchaser at the same price if a purchaser wishing to acquire the Carruthers’ shares had approached him, and at the same time to cancel his option to acquire the Carruthers’ shares at a lower figure. In disputing the valuation day value of his shares with the Minister he relied on the figures provided by J Robinson of Clarkson Gordon and Company which give a value of $9.45 at valuation day and $13.87 at the date of his purchase from George Griffith. There is some question however as to whether the valuation of his shares at valuation day would be the same as the valuation of those of the Carruthers since they are subject to slightly different agreeements, and the purchaser of his shares together with his preferred shares could get voting control. Finally we have the valuation of Mr Clayton of $11 per share for the Carruthers’ shares introduced indirectly into evidence as a result of his examination for discovery but without his being cross-examined as an expert witness. While I do not consider that it is binding on defendant it does in my view represent a conservative and reasonable valuation, made by a person who was familiar with the figures submitted by Mr Robinson of Clarkson Gordon & Company and Mr Ewart Griffith in connection with the valuation of his shares, and with full knowledge of all the facts, including the attitude of Ewart Griffith to Mr Carruthers, the effect Mr Carruthers’ departure might have on the business, and other pertinent considerations. This figure is only slightly above the top figure of $10 suggested by defendant’s expert witness, Mr Dalgleish, and I conclude that an informed purchaser knowing that the downside risk would not go below $7.45 a share and taking into consideration the rapid expansion and increasing prosperity of the company and its future potential would be willing to pay not less than $11 a share which I find to be the market value as at valuation day of the shares of John and Emma Carruthers. Their tax assessments for their 1976 taxation year will therefore be referred back to the Minister for reassessment of the capital gains tax in accordance with this finding, with costs.