Gee-Gee Investments Ltd. v. MNR, 94 DTC 1419, [1994] 1 CTC 2707 (TCC)

Christie, A.C.J.T.C.C.:—The year under appeal is 1987. There are two issues to be determined. First, the taxable capital gain realized by the appellant on the sale by it of 60 The Bridle Path, North York, Ontario ("the property”). Second, the liability of the appellant for failure to deduct or withhold from an alleged deemed dividend paid to Mr. Earl Glick, a non-resident shareholder of the appellant, and to remit 15 per cent thereof to the Receiver General.

Because of health reasons, particulars of which were given to the Court by the appellant’s counsel, Earl Glick did not appear at the trial.

A partial agreed statement of facts was filed with the Court at the commencement of the hearing. It consists of 16 paragraphs that read:

1. The appellant is a taxable Canadian corporation as defined in paragraph 89(1)(i) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

2. At all material times, Earl Glick was a shareholder of the appellant and a resident of the United States of America.

3. Earl Glick and his children controlled the appellant at all material times.

4. On October 1, 1985, the appellant entered into an agreement (the "option agreement") whereby Earl Glick acquired an option (the "option") to purchase real property known as 60 The Bridle Path, Toronto (the "property") from the appellant. The option agreement provided that the purchase price of the property was $1,550,000. The consideration paid to the appellant by Earl Glick for the option was $50,000. The option agreement provided that the said consideration in the sum of $50,000 was deemed a deposit and credited as part of the payment of the purchase price of the property, and that the balance of $1,500,000 was payable on completion of the purchase transaction. The expiry date of the option was September 30, 1986.

5. Pursuant to the option agreement, Earl Glick renewed the option (the "renewed option") on September 15, 1986. The renewed option provided that the purchase price of the property remained $1,550,000. The consideration paid by Earl Glick to the appellant for the renewed option was an additional $50,000, which payment was to be applied as a further deposit on account of the purchase price of the property. The expiry date of the renewed option was September 30, 1987.

6. Pursuant to the renewed option, Earl Glick purchased the property from the appellant on September 14, 1987 for $1,550,000. After giving the purchaser credit for the two $50,000 deposit payments, the balance paid on closing was the sum of $1,450,000.

7. In 1988, pursuant to subsection 49(4) of the Income Tax Act, the appellant filed amended returns for the 1985 and 1986 taxation years, excluding from its income for those years the proceeds payable for the granting of the option and for the granting of the renewed option.

8. In computing its income for the 1987 taxation year, the appellant included a taxable capital gain in the amount of $333,148 from the disposition of the property, calculated as follows:

Proceeds of disposition	$1,550,000
Adjusted cost base	583,362
	$966,638
Deduct Pre-1972 capital gain	300,343
Capital gain	$666,295
Taxable capital gain	$333,148

9. In a letter to the appellant dated October 25, 1989, the respondent stated that:

On September 14, 1987, the company sold this property to Mr. Earl Glick for an agreed amount of $1,550,000. This amount was based on an “option agreement" dated October 1, 1985. Mr. Earl Glick is a shareholder of the corporation and because of the interrelated shareholdings is considered not to deal with the corporation at arm's length. Therefore, the corporation is deemed to have received proceeds of disposition equal to fair market value at the time of sale.

In the said letter dated October 25, 1989, the respondent proposed to decrease the adjusted cost base of the property to $375,112. Accordingly, the respondent calculated the appellant’s taxable capital gain as follows:

Proceeds = Fair market value
September 14, 1987		$3,721,000
Less: ACB	V-day value	375,112
Revised capital gain—1987		$3,345,888
Less: capital gains previously reported		666,295
Additional capital gains		$2,679,593
50 per cent taxable		$1,339,796
10. In the letter dated October 25, 1989, the respondent also stated that:

The difference between the fair market value and actual proceeds received by the corporation is deemed to be a taxable benefit to Mr. Earl Glick in the amount of $2,171,000 ($3,721,000 — $1,550,000). We understand that Mr. Earl Glick is a nonresident. Therefore, the above benefit will be considered as a dividend, which will be subject to non-resident withholding tax.

11. By notice of assessment dated February 9, 1990, the respondent assessed the appellant with respect to its 1987 taxation year for non-resident tax of $325,650 and $83,357 in interest on such non-resident tax.

12. The appellant filed a notice of objection dated April 17, 1990 with respect to the February 9, 1990 assessment, wherein the appellant submitted that no taxable benefit was conferred on Earl Glick, or alternatively, if a benefit was conferred on Earl Glick, the amount of the benefit was less than the amount assessed by the respondent.

13. By notification of confirmation dated October 22, 1990, the respondent confirmed the February 9, 1990 assessment.

14. By notice of reassessment dated March 9, 1990, the respondent reassessed the appellant with respect to its 1987 taxation year by, inter alia, adding $1,339,796 to its Canadian Investment Income as an additional taxable capital gain on the sale of the property.

15. The appellant filed a notice of objection dated May 16, 1990 with respect to the March 9, 1990 reassessment, wherein the appellant submitted that it correctly computed its capital gain from the sale of the property or, alternatively, if an additional capital gain was realized by the appellant on the sale of the property, the amount of the additional taxable capital gain was less than the amount reassessed by the Minister.

16. By notification of confirmation dated October 22, 1990, the respondent confirmed the March 9, 1990 reassessment.

Rani Glick, Earl’s daughter, testified that the house at 60 The Bridle Path was constructed in the late 19205. It was occupied by the Glick family in the 19605. She described the home as a tudor house on 6.3 acres. At the time of occupation and in 1978 mostly cosmetic improvements were made to the home. An extensive renovation of the property followed. Most of this work was done in 1987. There was some preliminary work in 1986 and some finishing up in 1988. The cost, including landscaping was in the order of $2.4 million.

The witness understood that the $1,550,000 price for the property in the option agreement was arrived at by Earl Glick having reference to an appraisal report prepared for Revenue Canada in respect of the rental value of the property in 1977, 1978, 1979. The report set these values per annum net-net unfurnished at $48,464; $52,800; $60,000 respectively. The estimated value of the property as of January 1979 was $935,000. The report was prepared regarding an unrelated dispute between Earl Glick and Revenue Canada arising under the Income Tax Act. She said her father was interested in the value of real estate and would speak to neighbours and real estate agents about this. He added approximately 50 per cent to the $935,000 for the period 1979 to 1985 and a further ten per cent for the period 1985 to 1987.

It was established through Mr. lan Riehl, C.A. that the appellant acquired the house in 1963 for approximately $118,000. During the period relevant to this appeal there were 400 issued common shares of the appellant. One hundred of those shares were held by each of Earl Glick’s children. He held 2,000 class A preferred shares.

Mr. Phillip J. Ewing is the owner of the corporation that did the renovations to the residence at 60 The Bridle Path. At the invitation of Earl Glick he inspected the property in 1985. As will be seen shortly, his description of the home is in stark contrast to that of Revenue Canada’s real estate appraiser. According to Ewing the outside was in need of repair and maintenance. The windows were basically rotted. The stucco was cracked and broken. The roof leaked very badly. The plumbing was old, some of it was galvanized, some of it was lead. Neither the plumbing nor the electrical wiring was up to code. The heating and air conditioning was defective. There was a problem with dampness in the basement. The plaster was said to be: "What's known as dead plaster". The insulation was inadequate and old. The kitchen dated back to the 19605.

The evidence of primary probative value in this appeal is that of the experts called by the appellant and on behalf of the respondent. In very large measure the determination of this appeal flows from a consideration of that evidence.

Mr. Robert N. Height testified for the appellant and Mr. Flynn Beharry [1] testified for the respondent. Both are real estate appraisers and qualified as experts in that field.

Each witness gave his opinion about the market value [2] on two dates: October 1, 1985, which is the date of the option agreement between the appellant and Earl Glick; and September 14, 1987, which is the date on which Earl Glick acquired the property from the appellant. Height fixed market value on October 1, 1985 at $1,600,000 and on September 14, 1987 at $2,750,000. These amounts were arrived at without reference to the option agreement. Beharry fixed market value on October 1, 1985 at $2,311,000 and on September 14, 1987 at $3,663,000.

Before recounting the highlights of this evidence I shall decide whether the date October 1, 1985 is relevant to this appeal. The general rule is that under the Act capital gains only arise on the disposition of capital property. The word "disposition" is key. In Plant National Ltd. v. M.N.R., [1989] 2 C.T.C. 2145, 89 D.T.C. 401 (T.C.C.), Bonner, J.T.C.C., had paragraph 40(2)(e) of the Act under consideration. It relates to a corporation's capital loss "from the disposition of any property disposed of by it." He cited with approval Black's Law Dictionary. He said at page 2146 (D.T.C. 402):

The definition of the word "disposition" in Black’s Law Dictionary, fifth edition includes "the parting with, alienation of, or giving up property". In the same dictionary "dispose of" is defined in part as follows: "to alienate, relinquish, part with, or get rid of; to put out of the way; to finish with; to bargain away".

None of these things occurred under the option agreement. Indeed paragraph 5, which refers to the renewed option, reads:

5. It is understood and agreed between the parties hereto that this agreement constitutes an option only, and that until the same has been exercised by the giving of notice as provided for in paragraph 2 above, nothing herein contained shall obligate the optionee to exercise his said option. It is further agreed that upon the exercise of the option this agreement shall constitute a binding contract of purchase and sale.

Reference is also made to subsection 49(3) of the Act. It provides:

49 (3) Where an option to acquire property is exercised so that property is disposed of by a taxpayer (in this subsection referred to as the "vendor") or so that property is acquired by another taxpayer (in this subsection referred to as the "purchaser"), for the purpose of computing the income of each such taxpayer (other than a vendor who is an individual) the granting of the option and the exercise thereof shall be deemed not to be dispositions of property and there shall be included

(a) in computing the vendor's proceeds of disposition of the property, the consideration received by him for the option; and

(b) in computing the cost to the purchaser of the property, the adjusted cost base to him of the option.

The property was disposed of by the appellant when it was acquired by Earl Glick on September 14, 1987, pursuant to the exercise of his option.

Counsel for the respondent emphasized that Earl Glick and the appellant did not deal with each other at arm's length. This pertains to the relevance of fair market value at the time of disposition. She said and I agree: "Mr. Glick, a nonresident shareholder of the appellant, and his children controlled the appellant. Earl Glick and the appellant were related persons as defined by subsection 251 (2) of the Act, and were therefore deemed, by paragraph 251 (1 )(a) of the Act, to not deal with each other at arm's length". What is relevant for the purposes of this appeal in paragraph 69(1 )(b) of the Act provides that except as expressly otherwise provided in this Act, where a taxpayer has disposed of anything to a person with whom he was not dealing at arm's length for no proceeds or for proceeds less than the fair market value thereof at the time he so disposed of it, he shall be deemed to have received proceeds of disposition therefor equal to that fair market value.

There is no dispute between the parties about the V-Day value of the property. In reassessing, the Minister of National Revenue fixed this value at $375,112 and they agree with that amount.

What is relevant to this appeal is therefore the fair market value of the property on September 14, 1987. I shall now address that.

Height described The Bridle Path as a prestigious residential area in metropolitan Toronto. It is zoned for single family residential development. The relevant y-law calls for minimum standards of two acres and frontage of 200 feet.

The increase in the price of houses for metropolitan Toronto from 1985 to 1989 was the largest he had ever witnessed. After 1989 those prices fell dramatically. The lot at 60 The Bridle Path is, as already mentioned, 6.3 acres. The estimated gross floor area of the residence excluding basement level is in square feet: ground floor 2330; second floor 2740, third floor 744 for a total of 5,814. The basement includes a billiard and recreation room, sauna with shower and a two piece washroom. Finished basement (internal) was about 1,500 square feet. The witness's appraisal report states:

Outside there was a heated swimming pool at the rear of the dwelling, with an associated detached cabana/double garage and there is a tennis court to the southeast of the dwelling. Patios were alongside the rear of the house.

It should be noted that there is a crawl space under the living room, which is the southerly section, on the ground floor and there is an enclosed breezeway between the garage and the main dwelling. The basement, crawl space, breezeway, garages and cabana have not been included in the gross floor area.

The dimensions of the lot as set out in that report are: frontage (west boundary): 422'1 IV2"; south boundary: 962’; rear (east boundary) 578 2". No mention is made in this report of the north boundary, but this is given as 796'6" in Beharry's report.

In Height's opinion the highest and best use of the property as of September 14, 1987, was as a site that should be developed into two building lots after demolition of the existing improvements. What led the witness to this conclusion is set out on page 17 of his appraisal report:

Enquiries revealed that the dwelling was in poor condition and in need of immediate renovation as of October 1, 1985. The condition is assumed to have been the same as of September 14, 1987. As of this latter date, contractors were undertaking renovation work.

From the early 1970s to 1978, the house was neglected. Some members of the family lived in the house from 1978 to 1980, but no major changes were undertaken. In 1985, major works were required and it was recognized that the basic internal services, such as heating, plumbing and electrical were in need of replacement. The air conditioning system was “breaking down" and there were leakages in the foundation walls. It is understood that no formal structural survey, or engineering investigation was carried out prior to making a decision to renovate and upgrade the house at a cost estimated by a general contractor of about $700,000 (about $120/sf).

Reference is made to an extract from 1 he Toronto Real Estate Board—Schedule of Unit Costs”, which will be found in the addenda. As of January 1986, a short time after the initial appraisal date of October 1, '985, it will be noted that the indicated cost to build a luxury two storey home was about $60.00 per square foot.

It is considered that a hypothetical purchaser would have commissioned a full structural survey of the property, irrespective of whether it was his or her intent to upgrade the dwelling and this was not done by the property owner before having the work commenced. During the course of upgrading/renovating, a number of structural defects were detected. Enquiries with sales agents, who are active in the neighbourhood, advised that it is normal for thorough inspections to be made on behalf of purchasers. Ultimately it is understood that about $1,500,000 (about $327/sf) was spent on the dwelling.

Given the state of disrepair and the significant amount required to bring the dwelling up to the standard of the area and given the relatively small size of the dwelling, it is considered that a hypothetical purchaser, with no sentimental attachment to the property, would have preferred to demolish and rebuild to his or her own design.

It should be noted that the subject dwelling is relatively small and much older than other homes in the neighbourhood. Even after the renovation and upgrading, the subject dwelling was still basically a 65 year old home with a gross floor area of less than 6,000 square feet, whereas most new homes in the area are very much larger.

It would appear that physically the subject dwelling could be accommodated within the existing property on a site of about three acres and that a separate three acres lot could be severed inside the southerly part of the existing site. Because of the location of the existing dwelling “Top of the Bank”, there would be a loss of aesthetics and thus loss of value to both parts.

His oral evidence about highest and best use is to the same effect. He confirmed that the existing lot at 60 The Bridle Path would have, under his scheme, been split in two down the middle.

He employed the valuation method known as direct comparison approach and concluded that in 1985 if the property was divided into two lots of about three acres, then the market value, i.e., and value of each lot would be $800,000. He carried this figure forward to September 14, 1987, and added a 70 per cent increase in value with this result: $800,000 + $560,000 $1,360,000. This was rounded to $1,350,000. The market value of the two lots as of September 14, 1987, was therefore $2,700,000.

Height also did a calculation as of September 14, 1987, under which he treated the property as consisting of one lot of about three acres with the dwelling on it plus an adjoining three acre lot with no construction. His method and result IS:

He then split the difference between the land value estimate of $2,700,000 and the "severed components" value of $2,800,000 and adopted $2,750,000 as the market value of the property on September 14, 1987.

With reference to the 15 per cent adjustment for loss of aesthetics, the evidence is that the dividing line creating the two lots at 60 The Bridle Path could not simply be a line straight down the middle because of the existence of the dwelling house and other construction on the property. Of necessity the dividing line would have been irregular and this would affect both lots. In this respect Height's report under the heading "Potential Severance" said:

The zoning by-law would allow a maximum of two single family dwellings on the site. The number of lots is limited by the available frontage of 422 feet 11'/2 inches and the by-law requires a minimum of 200 feet per lot, thus the site provided the potential for two severed lots.

The subject has about half of its area below the top of the bank, thus buildable/ usable table land is about three acres. Thus if the site was severed into two lots each would have to allow for the "Top of the Bank” and each would have about 1.5 acres of buildable land.

The existing dwelling has been inspected on site and reference has been made to aerial photographs, as well as surveys. If the dwelling was to be retained and noting the layout of the site and the location of the "Top of the Bank”, it is considered that a lot could have been severed in the southerly part of the site. Any house that was to be built on this severed portion would have to be set to the side and rear of the existing dwelling, without infringing on the "Top of the Bank”, thus resulting in a lack of privacy and aesthetics, to the existing development (such as the tennis court would have to be removed). The existing residence is located in about the middle of the site and it is considered that it would be impossible to avoid a loss in value to the existing dwelling and outside improvements if another house was built on the existing site. It is also consideration that the severed lot could anticipate a loss in value because of having an irregular shape and allowing for the proximity of the existing dwelling.

The reference to the "Top of the Bank” is to a line running north and south at about the middle of the property which limits the building area to that area running from the front of the property (west side) to that line. This is said about "Top of the Bank” in the report:

The area between the "Top of the Bank” and the street frontage, is the location of the dwelling, the garage/cabana, swimming pool and tennis court. Reference is made to the "Topographical Plan”, which follows the “Site Plan". The paved semicircular drive has entrances at the north and south extremities of the frontage, onto The Bridle Path. The area in front of the dwelling comprises lawns, with mature trees and landscaped areas. It is understood that prior to the dates of valuation, the landscaping was of inferior quality.

The rear portion of the site, below the "Top of the Bank” is heavily treed and leads down to the Wilket Creek.

The above mentioned "Topographical Plan”, shows the Top of the Bank”, which provides the easterly limit, for development on the site and it will be seen that the land slopes down to the Wilket Creek. No soil analysis has been made in conjunction with this report, but it has been assumed that the site is similar to other lands in the area and suitable in drainage qualities and load bearing capabilities to support the existing improvements.

Beharry’s opinion about highest and best use is continued use of the property as a suburban residence. As will be seen, however, in arriving at market value he deals with the property as consisting of four acres with the dwelling on it plus an additional two acres as a vacant lot.

This witness had, in July 1981, inspected the property inside and out with the permission of Earl Glick and his wife. He stated that ne was denied access to it for the purpose of preparing an appraisal report for the appeal at hand, so the "appraisal is being done on the measurements and inspection I did in July 1981. One suffers a disadvantage when you're not allowed to”. In cross-examination the witness admitted, however, that he had not requested access to the property for the purpose of this appeal. He appears to have assumed, on the basis of other unrelated refusals, that permission would not be granted.

Reverting to the examination-in-chief he said records at North York City Hall showed the house at 60 The Bridle Path was constructed about 1938. The cabana was added in 1968. He also regarded The Bridle Path area as an exclusive single family neighbourhood. At the time of his 1981 inspection he found the house to be "impeccable". It was a "stately home". He found nothing to indicate that it was in a “derelict condition." He was asked this question by counsel for the respondent and he gave this reply:

Q. Did the property appear that it needed substantial renovations to you?

A. No, the washrooms were impeccable, the kitchen was impeccable, everything in the house was well set away. It had the gum trimming, the stained oak, the floors, as far as I can remember, were well maintained.

Beharry arrived at market value as of September 14, 1987, in this way. He assigned a value to the dwelling plus about four acres to which he added the value of a vacant lot of about two acres. He concluded the number of square feet in the dwelling to be 7,161, arrived at as follows: ground floor 2,981; second floor 2,752; third floor 831; total 6,564; add 2nd floor cabana 597; revised total area 7,161.

Using his comparable he arrives at a unit rate of $330 per square foot. This takes into account the four-acre lot. Thus 7,161 X $330 = $2,363,000. To this is added the two-acre lot valued at $1,300,000. In arriving at this amount he again resorts to his comparable. His total market value as of September 14, 1987, is $2,363,000 + $1,300,000 = $3,663,000.

There is a considerable difference of opinion between the experts on a number of points. On the basis of all of the evidence, I have reached these conclusions regarding them.

1. Beharry's highest and best use, being the continuation of present use with the possible severance and sale of a two-acre parcel, is preferable.

2. Height assigns 5,814 square feet to the dwelling. He excludes the cabana. Beharry’s number is 7,161 square feet. I accept this, but in doing so I exclude 597 square feet in respect of the cabana.

3. I would reduce Beharry's assigned value of $1,300,000 to the two-acre lot by 50 per cent.

The reason for this is that the configuration of the two-acre lot was not altogether desirable and in cross-examination it became apparent that serious difficulties might be encountered in attempting to market the two-acre lot because of zoning restrictions. The problem especially relates to the frontage of the two-acre lot. If this two acre lot proved to be unmarketable it would still enhance the value of the contiguous four acres, but its market value in that context would be far less than as a saleable lot. In the result my conclusion is that the market value of the property as of September 14, 1987, is:

The revised capital gain is $2,815,990 - ACB (V-day value) $375,112 = $2,440,878, of which 50 per cent or $1,220,439 is taxable.

With reference to the issue regarding the benefit alleged by the Minister of National Revenue to have been conferred on Earl Glick, it is clear from the partial agreed statement of facts that at all times relevant to this litigation he was a shareholder of the appellant and resident in the United States. In reassessing the appellant, the Minister assumed the fair market value of the property to be $3,721,000 as of September 14, 1987, and the benefit received by Earl Glick to be the difference between that amount and the $1,550,000 paid by him for it: $3,721,000 - $1,550,000 = $2,171,000. This amount is deemed by paragraph 214(3)(a) of the Act to have been paid to him as a dividend. The matter is succinctly put in paragraph 7 of the reply to the notice of appeal:

The appellant conferred a benefit on a non-resident shareholder, Earl Glick, by selling property to such shareholder for a consideration substantially below the fair market value on September 14, 1987. The amount or value of the benefit being the amount of $2,171,000.00, was properly assessed, pursuant to the provisions of subsections 15(1), 212(2), 215(1) and 215(6) and paragraph 214(3)(a) of the Act, in computing Earl Glick's income for the year 1987.

In reassessing on February 9, 1990, the Minister said: "You have failed to deduct and remit a tax of $325,650 on $2,171,000 paid or credited to Earl Glick, non-resident of Canada. Interest on the unpaid tax has been charged at the applicable prescribed rate.”

I am satisfied that Earl Glick received a benefit from the appellant on the acquisition of the property. Indeed little was said at the hearing challenging the fact of such a benefit. The real dispute was the amount, and that was directly related to the issue of the fair market value of the property. The amount of the benefit should be calculated on the basis of the fair market value of the property being $2,815,990 as of September 14, 1987. Interest is to be adjusted accordingly.

The appeal is allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis set out in these reasons.

Appeal allowed in part.