Sénécal v. MNR, 93 DTC 1155, [1993] 2 CTC 2218 (TCC)

Rip, T.C.C.J.:—Jean-Guy Sénécal ("the appellant”) instituted the appeal from the income tax assessment made by the Minister of National Revenue ("the Minister") for the 1979 taxation year. The point at issue was whether the appellant received a capital gain when he disposed of a piece of land in that year. The appellant claimed that, in 1979, the proceeds of disposition of a vacant land located on Boulevard d'Anjou in the City of Châteauguay were $90,000, that that amount corresponded to the adjusted cost base of the land and, therefore, that the appellant did not receive a capital gain upon disposition of the land. In assessing the appellant, the Minister computed the capital gain on the basis that the proceeds of disposition of the land were $105,000. [1]

Mr. Raymond Dulude ("Mr. Dulude") was the only witness at the hearing. He is a chartered accountant and one of the three directors of Restocal Inc. (” Restocal"). The other directors of Restocal are the appellant and his brother, Pierre Sénécal. Pierre Sénécal owns 70 per cent of the shares in Restocal; the appellant and Mr. Dulude own 15 per cent of the shares. The latter are brothers-in-law.

Prior to 1979, the appellant negotiated with Rôtisseries St-Hubert Ltée ("St- Hubert") to obtain a restaurant franchise in Châteauguay. He subsequently obtained two other franchises. He also discussed with St-Hubert the possibility of acquiring a master franchise. St-Hubert offered him a master franchise of five or six restaurants in the Ottawa area. Mr. Dulude explained that the appellant did not have the financial resources to finance the undertaking. [2] Mr. Dulude was the accountant of Pierre Sénécal, who, according to Mr. Dulude, did have the necessary financial resources. Mr. Dulude suggested to the appellant that the latter's brother and Mr. Dulude join with him in order to operate the St-Hubert franchises, and the appellant accepted the offer. The three men incorporated Restocal on April 26, 1979 in order to operate the franchises, and the appellant assigned his St-Hubert franchise rights and the land he had purchased in Châteauguay to Restocal.

At the start of the negotiations with St-Hubert concerning the acquisition of a master franchise, the appellant did not own the land in Châteauguay. He purchased the land in question in 1978 for $47,000; he also incurred expenses of $43,000 related to the land. This latter amount was advanced to the appellant by Pierre Sénécal. Mr. Dulude explained that the appellant, Pierre Sénécal and he had agreed that the land in question would be assigned to Restocal by the appellant for $90,000. In April 1979, the appellant stated that he wanted to increase the selling price of $105,000. His brother did not consent. In order to reconcile the brothers, the witness suggested that Restocal pay the sum of $90,000 and a promissory note of $15,000. The note would bear no interest and would, without restriction, be payable only upon payment of all Restocal's long-term debts. Both Sénécals agreed to the suggestion.

At a meeting held on April 26, 1979, Restocal's directors unanimously resolved:

THAT the Corporation purchase from Jean-Guy Sénécal the vacant land . . . as the whole currently stands for the price of ONE HUNDRED AND FIVE THOUSAND DOLLARS ($105,000) payable in cash. . . .

[Translation.]

At the same meeting, it was also unanimously resolved:

THAT a note in the amount of fifteen thousand dollars ($15,000) bearing no interest be and is issued to the order of Jean-Guy Sénécal in consideration of the land that he sold to the corporation; that bill being payable by the corporation only after all other long-term debt amounts have been fully paid by the corporation.

[Translation.]

The deed of sale between the appellant and Restocal for the land in Châteauguay was signed on April 30,1979 and provides that:

This sale is further transacted for the price of ONE HUNDRED AND FIVE THOUSAND DOLLARS ($105,000), which the vendor acknowledges he has received from the purchaser, to whom he gives full and final discharge.

[Translation.]

Mr. Dulude explained that Restocal had agreed to build five or six restaurants. Restocal was to finance construction by incurring a long-term debt. The appellant did not expect to receive the amount of the promissory note for 15 to 20 years. Consequently, as a chartered accountant, Mr. Dulude was of the view that the note had no value in 1979. [3] During his testimony, Mr. Dulude examined the 1979 interest rates published in the Bank of Canada Review. Counsel for the Minister was unable to cross-examine Mr. Dulude, and he acknowledged that the promissory note had no value in 1979.

Restocal posted the cost of the land in Châteauguay in its book of account by recording the sums of $47,000, $43,000 and $15,000, that is to say $105,000.

Section 54(h)(i) of the Canadian Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act") provides:

54. In this subdivision,

(h)"proceeds of disposition” of property includes,

(i) the sale price of property that has been sold. . . .

The appellant submitted that the “sale price” of the land in Châteauguay was the total of $90,000 and the monetary value of the promissory note. The respondent was of the view that the “sale price" was the sum of $105,000 appearing on the deed of sale of April 30, 1979.

Appellant’s argument

The issue before me is whether the term "sale price" in paragraph 54(h)(i) of the Act is affected by the consideration paid to satisfy the sale price of the property disposed of, that is, whether the face value or the market value of a promissory note given in consideration for the property determines the sale price thereof and, consequently, the proceeds of disposition to the vendor. The appellant is ultimately asking the Court to adjust the sale price and, consequently, the proceeds of disposition by deducting the real value of the non-monetary consideration, that is the promissory note. His counsel asked me to look at the matter" realistically” [translation], as did Walsh, J. in Fradet v. The Queen, [1983] C.T.C. 424, 83 D.T.C. 5445 (F.C.T.D.).

In that case, Messrs. Fradet and Demers had sold their shares in a corporation for $7,800,000, the reported sale price. According to the contract of sale, however, upon closing of the sale, the vendors paid the corporation $1,402,225 in return for the transfer to them of a $1,402,225 claim which the corporation had on another company called Samoco. The market value of that claim was only $600,000 at that time. The vendors reported capital gains computed on the basis of proceeds of disposition of the shares of $7,000,000. [4] The Minister computed the capital gain on the basis of proceeds of disposition of $7,800,000.

Walsh, J. found that the purchase of the claim at an inflated price was one of the conditions of sale of the shares. If the matter were looked at realistically, the sum of $800,000, representing the difference between the face value and the market value of the claim, had to be deducted from the proceeds of disposition for the purpose of computing the capital gain. In his reasons, Walsh, J. cited Aberdeen Construction Group Ltd. v. C.I.R., 52 T.C. 281, in which Lord Wilberforce stated, at page 429 (5448):

The capital gains tax is of comparatively recent origin. The legislation imposing it, mainly the Finance Act, 1965, is necessarily complicated, and the detailed provisions, as they affect this or any other case, must of course be looked at with care. But a guiding principle must underlie any interpretation of the Act, namely, that its purpose is to tax capital gains and to make allowance for capital losses, each of which ought to be arrived at upon normal business principles. No doubt anomalies may occur, but in straightforward situations, such as this, the courts should hesitate before accepting results which are paradoxical and contrary to business sense. To paraphrase a famous cliche, the capital gains tax is a tax upon gains: it is not a tax upon arithmetical differences.

The learned judge concluded, at pages 431-32 (D.T.C. 5451):

. . . I believe that equity as well as a liberal interpretation of the provisions of the Income Tax Act requires that the purchase of the claim at an inflated value was part and parcel of the transaction for the sale of their shares and if looked at realistically the sum of $800,000 representing the excess price, over the value of the claim which was admitted to be the case in 1976, should be deducted from the proceeds of disposition in their proportionate shares of same for purposes of capital gains tax calculation, and that the Minister should be directed to re-assess Messrs. Fradet and Demers accordingly for each of their 1976, 1977 and 1978 taxation years.

The Federal Court of Appeal confirmed the judgment delivered by the Trial Division in a decision cited as The Queen v. Demers, [1986] 2 C.T.C. 321, 86 D.T.C. 6411. Pratte, J.A. (to whose reasons McGuigan, J.A. subscribed) analyzed the facts as follows (pages 323-24 (D.T.C. 6412-13)):

There can be no question that if one looks only at the clause in the deed of sale setting the selling price of the shares and at the wording of clause 3(t), under which the sellers guaranteed that before the closing date they would have paid the debts owed to Chibougamau Lumber Ltée by its subsidiaries, it appears that the respondents by that deed of sale agreed to sell the shares of a company after receiving payment of the amounts referred to in clause 3(t). It could then be said that the sum of $7,800,000 represents the true price of the shares sold by the respondents.

However, a different conclusion is reached if one also looks at the clause in the deed of sale which indicates the way in which the price was to be paid. That clause makes it clear, in my opinion, that the parties agreed that the sellers would use part of the selling price they received from the buyer to pay off their obligations under clause 3(t). This being the case, it logically follows that the sum of $7,800,000 represents not only the price of the shares but also of the undertaking by the sellers to pay the amounts referred to in clause 3(t). In determining the selling price of the shares, which under subparagraph 54(h)(i) constitutes the proceeds of their disposition, therefore, one must deduct from the agreed price of $7,800,000 the sum of $802,225 which the respondents allegedly received in consideration of their undertaking to pay the debt of $1,402,225 owed by Samoco to Chibougamau Lumber Ltée.

The trial judge made no error in deciding as he did.

Like Walsh, J., Pratte, J.A. looked at the determination of the proceeds of disposition realistically. The purchase of the claim on Samoco was a condition of sale of the shares which Messrs. Fradet and Demers were required to meet. Consequently, while the vendors were to receive $7,800,000, they were also obliged to pay out $1,402,225 for an asset worth $600,000 on the date on which the sale closed. After all, the transactions had taken place on the date on which the sale closed, the vendors received net proceeds of $7,000,000, that is to say $7,800,000 less $802,225, the difference between the face value and the market value of the claim. The Federal Court of Appeal allowed the proceeds of disposition to be reduced since the sale price had been inflated because a component other than the consideration of the value of the shares had been included.

Counsel for the appellant also referred to the Exchequer Court judgment in Belle-Isle v. M.N.R., [1964] C.T.C. 40, 64 D.T.C. 5041 (aff'd [1966] S.C.R. 354, [1966] C.T.C. 85, 66 D.T.C. 5100), in support of the argument that the true value of property should be included in the proceeds of its disposition. In that case, the taxpayer had purportedly sold his hotel business in 1958 at a reported price of $118,280 to a company which he had formed. He had initially purchased the hotel for $175,000 in 1951. In consideration, the company assumed an $81,800 mortgage and issued 5,896 common shares to the taxpayer at the reported price of $29,480. In a separate contract signed on the same day as the sale of the hotel business, the taxpayer sold those shares for $121,700. The Minister had assessed the taxpayer so as to include in his income the recapture of the capital cost allowance on the sale of the hotel. Dumoulin, J. found that the proceeds of disposition of the hotel had to be increased to reflect the real value of the consideration received : the reported selling price of the shares did not represent their real value.

Reasoning by analogy, the appellant also cited Revenue Canada's Interpretation Bulletin IT-170R, dated August 25, 1980:

. . . it is the Department's view that the sale price of any property sold is brought into account for income tax purposes when the vendor has an absolute but not necessarily immediate right to be paid. As long as a “condition precedent" remains unsatisfied, a vendor does not have an absolute right to be paid. . . .

The appellant appeared to state that he did not have an absolute right to be paid under the terms of the promissory note because there was a "condition precedent”, that is that all Restocal’s long-term debts had to be satisfied before he could demand payment of the note.

Paragraph 6 of the same Interpretation Bulletin provides the following definition of a "condition precedent":

A "condition precedent" is an event (beyond the direct control of the vendor) that suspends completion of the contract until the condition is met or waived and that could cancel the contract "ab initio” if it is not met or waived. Two examples of conditions precedent are

(a) a condition in a contract for the sale of a hotel business that provides that the transfer of ownership is not to take place until the purchaser obtains a liquor licence, and

(b) a condition in a contract for the sale of land that suspends completion until

the purchaser's solicitor has approved the vendor's title to the property.

In the instant case, there was no "condition precedent" which would invalidate the sale of the Châteauguay land ab initio. The condition on payment of the note does not change the fact that the land was sold and that the appellant was entitled to the price in money, which Restocal was required to pay for the land. The fact that it might be necessary to wait many years for the note to be paid is immaterial.

Minister's argument

Counsel for the Minister relied on Avril Holdings Ltd. v. M.N.R., [1969] C. T.C. 397, 69 D.T.C. 5263 (Ex. Ct.), aff'd [1971] S.C.R. 601, [1970] C.T.C. 572, 70 D. T.C. 6367; Staffordshire House Ltd. v. M.N.R., [1967] Tax A.B.C. 532, 67 D.T.C. 379 (T.A.B.) and Attis v. M.N.R., [1984] C.T.C. 3013, 85 D.T.C. 37 (T.C.C.).

In Avril Holdings Ltd., supra, the taxpayer company had sold a land which was held to be depreciable property. The sale price of the land was approximately $762,000. The taxpayer had received debentures in an amount equal to the sale price which were to be paid off in instalments starting six years later. The taxpayer claimed that the proceeds of disposition should not be the sale rice, but rather the market value of the debentures, since the sale price of the land was payable in that form. The appellant had filed evidence tending to show that the debentures had no value. The value of debentures received in exchange for the land was held not to be valueless. Pigeon, J., writing the Court's reasons for judgment, stated at page 607 (C.T.C. 575-76, D.T.C. 6369):

Such value was not established although an attempt was made to prove by witnesses that they were worthless. In my view, Kerr J. was quite correct in disregarding that evidence. It is clear that although the debentures in question were not readily marketable, they were of substantial value, and it was not shown that their value to the appellant was less than the capital cost of the property sold. Furthermore, by virtue of paragraph 20(5)(c) of the Income Tax Act "proceeds of disposition" of property include

(i) the sale price of property that has been sold. . . .

In his final comment, Pigeon, J. deduced convincingly that, when the proceeds of disposition are determined, the fact that a non-monetary consideration is not marketable should not change its value for the taxpayer.

In Staffordshire House Ltd. v. M.N.R., supra, the Tax Appeal Board ("Board") considered the proper way to compute the proceeds of disposition in order to determine recapture of capital cost allowance. The taxpayer's company had sold property for $170,000. The sale agreement set out a number of conditions, one of which was that the vendor had to accept, at their face value, as part of the sale price, bonds with a face value of $50,000, even though their market value was only $45,765. The Board found that the sale price could not be reduced by the difference between the face value and the market value of the bonds since the agreement had clearly provided that the vendor had to accept the bonds at their face value. Mr. Roland St-Onge (as he then was) stated, at page 536 (D.T.C. 381):

. . . there is no doubt that, according to the evidence adduced and documents filed, the appellant accepted $50,000 in bonds at face value as part of the sale price. This is clearly stated in the relevant documents. Furthermore, the bonds given as collateral still belong to the appellant and will be worth $50,000 at maturity.

In a word, Mr. St-Onge found that, when a vendor accepts a non-monetary consideration at face value as part of the sale price, the sale price constitutes the proceeds of disposition.

Kempo, T.C.C.J. relied on both Avril Holdings Ltd. and Staffordshire House Ltd. in the reasons for judgment which she gave in Attis v. M.N.R., supra. That case concerned a non-arm's length transaction in which the taxpayer, in order to freeze his estate, had transferred to his children certain rental properties in consideration of a promissory note of a face value of $435,000. The note was to be paid without interest in five annual instalments. The taxpayer claimed that the real value of the properties thus transferred was approximately $350,000. He argued that the excess constituted a premium and that the proceeds of disposition had to reflect the real market value of the properties sold. Kempo, T.C.C.J. stated, at page 3015 (D.T.C. 38):

What is clear is that a sale price had been agreed upon in order to implement the sale transaction and that the appellant is seeking to convince the Court that in these close family circumstances their intent as to the consideration not exceeding fair market value should establish, and thereby govern, the calculation of the real gain to be taxed rather than that of $435,000 as evidenced by the promissory note.

The Minister had said he was of the view that the sale price constituted the proceeds of disposition and that the fair market value of the properties was immaterial. Kempo, T.C.C.J. ruled as follows, at pages 3015 (D.T.C. 38-39):

It is regrettable that the evidence on behalf of the appellant was as scanty as it was and notably in respect of the failure to produce the sale agreement itself. Additionally there is nothing in the evidence to diminish or rebut the strong inference that Schedule 2 of the appellant’s 1977 return had in fact been prepared on the basis that the appellant had employed the sum of $435,000 as proceeds of disposition of the properties as was argued by counsel for the respondent.

Accordingly the evidence has not convinced me that the price of the sale was other than that shown on the promissory note, that the value of same to the appellant was other than its face value or that its value was less than the capital cost of the property sold (vide, Avril Holdings Ltd. v. M.N.R., [1971] S.C.R. 601, [1970] C.T.C. 572, 70 D.T.C. 6366 at pages 575-76 (C.T.C.; D.T.C. 6368-69)). It is equally obvious that the appellant had accepted the $435,000 promissory note at face value (vide, Staffordshire House Ltd. v. M.N.R., [1967] Tax A.B.C. 532, 67 D.T.C. 379 at page 536 (D.T.C. 381)) in full satisfaction of the purchase price.

While there is authority in support of the appellant's plea that the determination of the real proceeds of disposition (that is, the gain) should be looked at realistically (vide, Fradet and Demers v. The Queen, [1983] C.T.C. 424, 83 D.T.C. 5445 at page 428 (D.T.C. 5448) the evidence submitted in support thereof falls short of permitting any relief from the respondent's assumptions on reassessment.

The evidence adduced by the taxpayer did not support his position that the value of the properties transferred to his children was less than stated in the promissory note. If there had been sufficient evidence to this effect, Demers might have applied. The determination of the proceeds of disposition must be looked at realistically if something suggests that the sale price included a component other than the consideration for the property itself. In Demers, that something was the obligation to purchase a debt at its face value, which inflated the sale price of the shares. In Attis, that something was the possible existence of a premium in excess of the consideration for the properties.

Analysis

The fair market value of a non-monetary consideration need not be cast into doubt unless one party alleges that the purported sale price includes a component other than the value of the property being sold. In Demers, for example, the fair market value of the shares was taken into consideration because the reported sale price consisted not only of the market value of the shares themselves, but also of the obligation to purchase a debt at its face value. Likewise, in Attis, the fair market value of the properties sold was taken into consideration because, according to the taxpayer, the sale price included a premium above the market value of the properties. In the instant case, however, the facts do not suggest that the promissory note was received in respect of a component other than the sale price of the Châteauguay land. Furthermore, there was no evidence that the Châteauguay land was not worth $105,000.

I agree with counsel for the appellant that the matter must be looked at realistically. In some situations, the real proceeds of disposition cannot be determined merely by computing arithmetical differences. Demers cannot be considered, however, as confirming in any general way that the fair market value of the non-monetary consideration must be determined in order to determine the proceeds of a disposition appropriately. In the instant case, the contract provided — and this was its true nature — that a land was sold for $105,000; part of the consideration in satisfaction of the sale price was that the appellant accepted a promissory note, regardless of the fact that it had no market value. Restocal expected that it would some day have to pay the note; it entered the property in its books at a cost of $105,000. Having entered into such an agreement, the appellant cannot ask the Court to examine the fair market value: see Staffordshire House Ltd., supra.

The fact that the promissory note was non-marketable did not strip it of all its value for the purpose of determining the proceeds of disposition: see Avril Holdings Ltd., supra. It is clear from the facts that the promissory note constituted an important consideration in the closing of the sale of the land to Restocal.

The sale price of property that has been sold is expressly stated in the definition of the expression" proceeds of disposition” in subparagraph 54(h)(i). No mention is made therein of the consideration paid to satisfy the sale price. Where the latter is not paid immediately, the Act permits the vendor to claim a deduction of a reasonable amount as a reserve in his income tax return (clause 40(1)(a)(iii)(B)) or, if he is unable to collect the face value of the note, to claim deduction of a capital loss after he has disposed of the property (paragraph 39(1) (b)).

Belle-Isle, supra, does not support the appellant's claim that a promissory note that might have no value should not be included in the proceeds of disposition. Of course, the sale price was adjusted in that case to yield the true value of the consideration received for the purposes of computing the recapture of the capital cost allowance. The Exchequer Court adopted no general principle making it possible to deduct from the sale price of a land the market value of a promissory note given in consideration thereof. If any lesson is to be drawn from Belle-Isle, it is that parties in a non-arm’s-length transaction must determine the sale price — and, consequently, the proceeds of disposition — on the basis of the real value of the asset being disposed of. Subparagraph 54(h)(i) is clear: the sale price constitutes the proceeds of disposition. It is not usually necessary to determine the value of a non-monetary consideration in order to determine the proceeds of a disposition. There are exceptions, however, and, in certain instances, the fair market value of the consideration must be taken into account in order to determine the actual proceeds of a disposition. The circumstances in the instant case, however, do not require me to examine anything but the reported sale price. The proceeds of disposition were $105,000. That was the amount which Restocal agreed to pay for the property and to which the appellant agreed: see articles 1472 and 1532 of the Civil Code. There was no evidence that the $15,000 promissory note represented anything but part of the consideration in respect of the $105,000 sale price.

The appeal is dismissed.

Appeal dismissed.