Date: 19980720
Docket: 96-1172-IT-G
BETWEEN:
LES IMMEUBLES CHAL INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
P. R. DUSSAULT, J.T.C.C.
[1] The appellant is challenging an assessment for its
taxation year ending February 28, 1993. By that assessment
the Minister of National Revenue ("the Minister") added
the sum of $110,250 to the appellant's income as an
additional capital gain resulting from the sale of a commercial
property located at 1250 Boulevard Laflèche in
Baie-Comeau, Quebec, on July 7, 1992.
[2] The appellant sold the property to
Claude Lévesque, the son of its sole shareholder
Gilles Lévesque, for the sum of $325,000: $65,000 for
the land and $260,000 for the building.
[3]Following an audit the Minister concluded that the selling
price was below the fair market value of the property, which he
set at $472,000: $84,000 for the land and $388,000 for the
building, hence the addition of $110,250 as an additional taxable
capital gain.
[4] Only the value set by the Minister in making the
assessment was in dispute, the appellant contending that the fair
market value of the property at the time of the sale did not
exceed $360,000.
[5] It should be noted at the outset that in his report the
respondent's expert witness Gaston Laberge used imperial
measure while the appellant's expert witness
Marcel Furlong mostly used metric measure, and sometimes
imperial measure, which does not help at all to simplify the task
of determining the validity of the various assumptions or
comparisons presented. As an aid to comprehension, all the
information I consider to be relevant and worth mentioning has
been converted into metric measure if it was not already in
metric.
[6] In his appraisal report the respondent's expert
witness Mr. Laberge, preferring the income approach, set the
fair market value of the property at July 7, 1992 at
$467,000.
[7] The appellant's expert witness Mr. Furlong,
relying mainly on the income approach but also using the direct
comparison approach, arrived at a value at the same date of
$360,000.
[8]Messrs. Laberge and Furlong set the fair market value of
the land by itself at $84,000 and $82,000 respectively. It is a
rectangular lot of 2,860.9 square metres (36.81 m x
77.72 m), the axis of which is perpendicular to
Boulevard Laflèche. It is located in a commercial
zone.
[9] The building, a particularly detailed description of which
is provided in Mr. Furlong's report,[1] is also rectangular in shape and
on the same axis in relation to Boulevard Laflèche.
It has an area of 726.52 square metres (14.02 m x
51.82 m). The framework of the building is of steel. The
foundation and the floor are of concrete. The exterior is
finished with brick and enamelled sheeting. The interior is
divided into three areas used as a salesroom, workshops or
warehouses. Among other things, the building has, on one side,
five garage doors measuring 4.27 metres by 4.27 metres,
made of steel. The front and rear areas of the building are
arranged in a similar way, with double glass entry doors, display
windows on each side of the door and side windows. However, it is
clear that the building was constructed primarily for use as a
garage. The building also has three mezzanines differing from
each other as to their dimensions and layout, with a total rental
area of 727.78 square metres, that is, 282.05 square
metres for the premises in front, 188.03 square metres for
those located in the middle and 257.71 square metres for
those located at the back of the building.
[10] In fact, the building was put up in two separate stages.
The front part, representing about 65 percent of the
building's total area (14.02 m x 33.53 m), was
built in 1985. The back part, representing about 35 percent
of the total area (14.02 m x 18.29 m), was built in
1989.
[11] In 1985, Fortin & Lévesque Inc. ("Fortin
& Lévesque"), of which
Gilles Lévesque was one of the shareholders, built
the first part of the building on a lot purchased from the Town
of Baie-Comeau. Much of the materials, including the
structural steel, was used and came from a dismantled garage in
Forestville. Fortin & Lévesque was paid for the
demolition work and obtained the materials for nothing. In
February 1986 the building, constructed according to the
specifications of Léonard and Laurent Charron,
shareholders of the appellant, was sold to the appellant for
$163,500, $3,500 of which was paid in cash. The balance was
financed by a loan secured by a mortgage given by Fortin &
Lévesque. Les Ateliers Laurent Charron Enr.
("Ateliers Charron"), which operated a business selling
snowmobiles, Sea-Doos and boats, moved into the front premises.
The other premises were leased to Technique Auto Enr.
("Technique Auto"), a car and truck repair
business.
[12] In May 1988 the appellant had been in default on its
payments for several months and Fortin & Lévesque
served a 60-day notice on it pursuant to a giving in payment
clause. Gilles Lévesque then bought back the shares
in the appellant's capital stock owned by Léonard and
Laurent Charron and thus became the appellant's sole
shareholder. In 1989 he obtained financing of $200,000 from the
bank for the appellant and repaid Fortin &
Lévesque.
[13] In 1989, at the request of a customer, Pare-Brise
Côte Nord,[2]
Gilles Lévesque, now the appellant's sole
shareholder, agreed to add the third premises at the back since
he felt at the time that the building was not profitable. Much
used material was also used in building this addition in the
back, including the structural steel. This back portion was built
like the front portion, with glass doors, display windows and
side windows, apparently in anticipation of the opening of a
street parallel to Boulevard Laflèche at the back of
the lot, which in fact never came about. The conversion of part
of the premises to offices was apparently done by the tenant.
According to Gilles Lévesque, whose testimony was
confirmed by that of his son Claude, the back portion was never
profitable. It was described as being unappealing to a merchant
and was only sporadically rented, often for short periods, after
the first tenant left the premises in September 1991.[3] The building of
the back portion turned out to be a mistake for Gilles and
Claude Lévesque and Laurent Charron..
[14] In 1992 Gilles Lévesque, feeling he was
getting old, tried, he said, to sell the property. In the spring
he met with Laurent Charron, the tenant of the front
premises, to propose that he buy the property. However, while
Mr. Lévesque wanted to sell for $350,000, and
certainly not less than $300,000, Mr. Charron, who was
otherwise interested, was apparently only prepared to pay
$250,000 to $275,000, in view of the price initially paid for the
property in 1986. Mr. Lévesque admitted that he had
not taken any further action since he said there was no demand.
He said he knew the market as Fortin & Lévesque had
built half the commercial buildings in Baie-Comeau.
[15] For the period from March 1991 to February 1992
the rent paid by Ateliers Charron for the front premises was
$1,452 a month. In the spring of 1992 the lease had expired but
the tenant continued paying the same rent.
Gilles Lévesque stated that he did not want to sign a
new lease before selling. In fact it was his son Claude, who
purchased the property in July 1992, who negotiated a
five-year lease with the tenant at a monthly rental of $2,100
beginning in July 1992.
[16]From June 1992, and for the last year of the lease,
the rental paid by Technique Auto for the second premises
was $1,460 a month.
[17] The third premises, vacant since October 1991, were
apparently leased only in February 1992 for $300, and in May
and June 1992 for $700 a month, making a total of $1,700 for
the first six months of 1992. They apparently then remained
unoccupied until October 1992. They were then leased at
$1,300 a month from November 1992 to January 1993 and
at $1,500 a month from February to April 1993. No other
rental was collected in 1993.[4]
[18]Gilles Lévesque stated that ultimately it was
his son Claude, who owned the adjoining property, who in the
spring of 1992 indicated he was interested in purchasing the
appellant's property. In view of the fact that the back
premises had been vacant for several months and that the lease
for the front premises had not yet been signed,
Claude Lévesque considered that it would not pay him
to purchase the property for $350,000. As mentioned above, the
sale was concluded on July 7, 1992 for $325,000.
[19] In his testimony Mr. Laberge admitted that use of
the comparable sales approach to arrive at the fair market value
of the property sold to Claude Lévesque by the
appellant was probably not the most suitable method in the
circumstances, in view of the very significant adjustments which
had to be made in some cases to sales which were nonetheless said
to be comparable.
[20] As to the cost approach, although it is referred to in
his report and he testified regarding it, Mr. Laberge also
discounted it in his report as less valid than the income
approach for arriving at fair market value, since the property in
question was in fact a rental property. The appellant's
expert witness, Mr. Furlong, also mainly used the income
approach, but supported his conclusion by using the comparable
sales approach, a point I will deal with briefly before
discussing the analyses of the two expert witnesses with respect
to the income approach.
[21]Mr. Furlong's analysis, based on the direct
comparison approach, refers only to a single transaction,
considered by him to be the only comparable one, concluded on
November 15, 1991 and involving a property located at
1850 Boulevard Laflèche, in a different area but
regarded as equivalent to that in which the appellant's
property was located. The comparable property, the structure of
which appears at first sight to be similar to that of the
appellant's building, but which did not have the appearance
of a garage, housed a grocery store and another small business.
It was sold for $385,000. After a net negative adjustment of
$25,600, Mr. Furlong arrived at a value of $359,400 for the
appellant's property. Mr. Furlong first made a positive
adjustment of $10,400 as the area of the appellant's lot was
slightly larger (2,860.9 square metres) than that of the
comparable property (2,505.5 square metres). He then made a
negative adjustment of $11,000 as the floor area of the
appellant's building was less than that of the other
building: 726.52 square metres as opposed to 760 square
metres. Finally, Mr. Furlong made a negative adjustment of
$25,000 with respect to functionality because of the difference
in alignment in relation to Boulevard Laflèche. The
axis of the appellant's property was perpendicular to
Boulevard Laflèche while the comparable property had
a larger frontage on the boulevard, which, according to
Mr. Furlong, would have allowed it to subdivide the building
into several small premises that would be more attractive than
the premises in the appellant's building, especially those
located at the back, the foreseeable rental loss on which he
estimated would be about 30 percent, requiring an adjustment
representing some 10 percent of the selling price of the
building alone.[5]
[22] For the moment, I will simply say that I am far from
being persuaded that the choice of this allegedly comparable
transaction is significant. In my opinion, the very different
arrangement of the premises is clearly not likely to attract the
same type of business unless extensive changes are made to one or
the other of the buildings, assuming that such changes are
possible. A garage is certainly not a grocery store. In any case,
if there is one point on which I agree with the two expert
witnesses, it is that in the circumstances the income approach is
the most suitable and most valid one for determining the value of
the appellant's building.[6]
[23] I thus come to the valuation of the appellant's
building by use of the income approach. It is important to note
from the outset that the respondent's expert witness,
Mr. Laberge, did his analysis exclusively in terms of the
appellant's potential income based on leases regarded as
comparable in buildings located in the same area. In his report
the appellant's expert witness, Mr. Furlong, went
through the same exercise although he used different assumptions.
In addition, he attempted to arrive at the value of the property
based on the allegedly [TRANSLATION] "real" income
received by the appellant.[7]
[24]According to Mr. Laberge's report the rental
income reported by the appellant was $50,695, $53,223 and $46,859
for 1990, 1991 and 1992 respectively. Passing over these figures,
as well as the rentals in effect at the time of the sale for the
two premises rented at that time, and without providing any
explanation whatever, though in both cases the tenants were
dealing with the appellant at arm's length, the
respondent's expert witness then proceeded to determine the
value of the property using as a basis an effective potential net
income of $59,386 a year and an overall discount rate of
0.127200, thereby arriving at a value for the property of
$466,871, rounded off to $467,000.
[25] For the purposes of his calculations Mr. Laberge
first set the potential gross income at $67,216 a year, using the
median rental in five leases of commercial premises located on
Boulevard Laflèche out of 17 noted in the same area.
The leases used were net net net leases, that is, leases under
which all costs were the responsibility of the tenants.[8] Mr. Laberge
therefore did not make any adjustments to those leases in
determining the median rental. I would simply note that this is
not necessarily a positive factor inasmuch as the appellant's
premises were not leased on this basis. Moreover - and I will
return to this point a bit further on -, it is hard to see the
relevance of selecting only such leases when the leased premises
and their use are not necessarily comparable. One really wonders
what was being compared.
[26] The median rental for the five leases used by
Mr. Laberge was $92.36 a square metre ($8.58 a square foot).
Applied to the total rental area of 727.78 square metres
(7,834 square feet), this figure gives a potential gross
rental of $67,216 which, reduced by 7 percent, or $4,705,
for losses resulting from vacancies and bad debts, gives an
effective net income of $62,511. To arrive at a rental on a net
net net basis Mr. Laberge then proceeded to deduct only one
expense: administrative fees of 5 percent or $3,125. The
annual net income was thus estimated at $59,386. Applying an
overall discount rate of 0.127200 to this income,
Mr. Laberge thus obtained a value of $466,871 for the
property.
[27] In July 1992, at the time of the sale of the
appellant's property to Claude Lévesque,
Claude Lévesque had just renegotiated the lease with
Ateliers Charron at a rental of $2,100 a month for a term of five
years. The previous lease signed in 1989 provided for rental of
$1,452 a month until February 1992. As mentioned above, the
tenant continued to pay the same rental until the new lease was
signed, under which the rental was increased by nearly
45 percent for a total of $25,200 annually, a figure which
bears no relation to the $15,840 indicated in the comparative
table of Mr. Laberge's report under the heading
[TRANSLATION] "annual rental".[9] The latter amount also does not
correspond to the rental of $1,452 a month paid in the year
preceding the sale.
[28] The rental for the second premises, leased to Technique
Auto, was $1,460 a month at the time of the sale, which
corresponds to an annual rental of $17,520. The amount of $14,400
indicated in the comparative table of Mr. Laberge's
report[10] does
not correspond to the rental of $1,393.77 a month paid from
June 1991 to May 1992 and to the rental of $1,460.33
paid in June 1992, for a total of $16,791.80 in the
12 months preceding the month of the sale. It should be
noted that the rental increase on June 1, 1992 was nearly
5 percent.
[29] In July 1992 the third premises were not rented. As
mentioned earlier, between January and June 1992 they were
rented in February for $300 and in May and June for $700 a month.
They remained vacant until November 1992, when they were
rented to Ferblanterie Perron for three months at $1,300 per
month. For February to April 1993 the rental increased to
$1,500 a month. The premises were thereafter vacant, at least
until December 1993. In the same comparative table of his
report Mr. Laberge indicated "Ferblantier Perron et
Frère" as the tenant, "1990" as the rental
period and the sum of "$22,192" as the annual rental.
As can be seen, it is difficult to make any sense of this.
[30] It is impossible for the Court to check the
characteristics of the other leases used by Mr. Laberge in
his analysis, but the figures shown regarding the annual rental
for the three premises in the appellant's building raise
serious doubts as to the accuracy of the figures as a whole. This
might lead the Court to the conclusion that the exercise in
general probably did not have the validity claimed for it with
respect to the determination of the net potential income that
could be produced by the appellant's property based on a
median rental. But that is not all.
[31] The five leases used by Mr. Laberge are all in
buildings which have only a single tenant and which front onto
Boulevard Laflèche. Of these, three are leases in
which the rental is among the highest of the 17 leases noted.
Lease No. 5 is for a property located at
1290 Boulevard Laflèche owned by
Claude Lévesque and developed as air-conditioned
offices leased to the Ministère de l’Énergie
et des Ressources (Department of Energy and Resources) under a
five-year lease. Lease No. 6 is for a property located at
1300 Boulevard Laflèche owned by
Ginette Lévesque, built and developed in part as
offices and in part as a warehouse according to the
specifications of the Société immobilière du
Québec, which signed a five-year lease. Lease No. 11
is for a building built expressly for the Labatt brewery, fitted
up entirely according to the requirements of the tenant, in part
as a warehouse and in part as offices and a reception area. The
lease is for 10 years.
[32] To begin with, I would say that I have some difficulty
understanding how a five-year lease on adjoining property or a
10-year lease with the Labatt brewery is more relevant in
determining the value of the appellant's property than the
leases concluded by the appellant with third parties with which
it was dealing at arm's length. Unless it can be shown that
there was something unusual about the leases in effect at the
time of the sale, there is no justification for ignoring them
completely as Mr. Laberge did. This applies to the five-year
lease concluded with Ateliers Charron beginning on July 1,
1992 and to the lease in effect until May 1993 with
Technique Auto.
[33]There was no lease in effect on the third premises at the
time of the sale. In such a case it is proper to determine the
potential rental on the basis of comparable leases. However, it
is important in such a case that the comparison be with something
comparable. As these premises located at the back of the
appellant's building were fitted up in much the same way as
those at the front giving onto Boulevard Laflèche it
seems to me to be more relevant to use as a basis for comparison
the five-year lease that had just been concluded with Ateliers
Charron for those premises, rather than allegedly comparable
leases for premises fitted up differently and put in large part
to different use. The functional aspect related to location was
completely ignored by Mr. Laberge, although until then the
appellant had encountered difficulty renting which had occasioned
considerable losses. Nevertheless, it cannot be assumed that the
rental for a well-positioned building, built according to
the requirements of a single tenant, would be the same as that
for premises giving onto a back yard and located in a building
with several tenants. The inconvenience is no doubt not absolute,
far from it: but it is there all the same.
[34] In short, the exercise of establishing the potential
income from these third premises located at the back of the
appellant's building on the basis of the median rental of the
five leases selected is in my opinion of little evidentiary
value.
[35] The appellant's expert witness, Mr. Furlong,
also undertook to establish the fair market value of the property
from an estimate of income based on a comparison of eight leases
selected with respect to a period of 10 years on buildings
located on Boulevard Laflèche.[11] With adjustments varying from
29 percent to 40 percent (except in one case, where the
adjustment was 14 percent) to take into account operating
expenses and convert all the figures to a net net net basis, he
was able to establish an average adjusted rental of $74.56 a
square metre and a median adjusted rental of $73.18 a square
metre, despite the fact that the "real" rentals of
$89.31, $93.18 and $69.83 a square metre for the three premises
were respectively adjusted to $67.07, $70.94 and $47.59 a square
metre also to take operating expenses into account.
[36]From these figures he arrived at a potential gross rental
of $74.00 a square metre for the first two premises
(282.05 square metres and 188.03 square metres), that
is, an annual rental of $34,785 (470.08 m2 x
$74.00). He assigned a rental of $53.90 a square metre to the
third premises, that is, $13,820 on an annual basis
(256.40 m2 x $53.90)[12]. According to these calculations
the total potential gross income would be $48,605 ($34,785 and
$13,820). This amount was reduced by $3,402 (7 percent) as a
reserve for loss of rental and for vacancies, and by an
additional amount of $1,000 as a reserve for major repairs. The
so-called "net net" income obtained was $44,203.
By applying a capitalization rate of 0.1237, Mr. Furlong
arrived at a value of $357,340 for the property, rounded off to
$357,300.
[37]Mr. Furlong used a value of $53.90 a square metre for
the third premises, that is, a value 27 percent less than
the $74.00 assigned to the first two premises, as in his opinion
the third premises would not be leased for more than the least
expensive premises in the comparables used. Additionally, the
value of $74.00 a square metre used for the first two premises is
less than 10 percent greater than the real adjusted rental
for those two premises ($67.07 and $70.94 a square metre).
[38]Here again an attempt was made to determine the fair
market value of the appellant's property on the basis of
allegedly comparable leases, some of which were also used by
Mr. Laberge. However, Mr. Furlong made significant
adjustments to take account of operating expenses and convert the
rentals to a net net net basis. Those adjustments might seem high
at first sight and cannot in fact be verified in any way given
the evidence submitted. If, unlike Mr. Laberge,
Mr. Furlong took into consideration the continuing rental
problems affecting the third premises, he could have explained
more clearly his conclusion regarding the potential rental that
could be obtained from those premises. However, in view of the
approach I intend to take, it is not necessary to analyse any
further the comparable leases used.
[39]Mr. Furlong's report also contained figures on
the rentals as adjusted to take into account operating expenses
for the three premises located in the appellant's building.
Using the adjusted rental for these three premises according to
Mr. Furlong's calculations, namely $67.07, $70.94 and
$47.59 a square metre, rather than the $74.00 a square metre
arrived at in his report for the first two premises and the
$53.90 a square metre arrived at for the third premises, we get a
potential net income of $44,519. This income, reduced by a
reserve of 7 percent for loss of rental and vacancies[13] - that is,
$3,116 -, translates, if we ignore the reserve of $1,000 for
major repairs which does not seem justified for the purposes of
these calculations, into a net income of $41,403, an amount
almost equivalent to that of $41,456 appearing in another
document prepared by Mr. Furlong[14] and based on the so-called
"real" income less operating expenses.
[40] In that document Mr. Furlong set the appellant's
potential gross income at $60,723 and his actual income at
$57,623, after deducting from the potential gross income an
amount equal to 5 percent, namely $3,100, for vacancies and
bad debts. He next deducted expenses of $16,166.78
(26.6 percent of potential gross income), including $10,800
for municipal and school taxes, and arrived at a net income of
$41,456.22. Using a 0.128 capitalization rate, he obtained a
value of $323,876 for the property.
[41] The foregoing calculations give potential gross income of
$60,723 based on the real rental of $25,200 a year ($2,100 a
month) for the first premises, leased by Ateliers Charron, on the
amount of $17,520 a year ($1,460 a month) paid as rental for the
second premises, leased by Technique Auto, and finally, on a
suggested rental of $18,003 a year ($1,500 a month)[15] for the third
premises, located at the back of the building.
[42]There is no ambiguity as to the actual rental negotiated
and paid for the first two premises. Since this was rental agreed
upon between parties dealing with each other at arm's length,
and in the absence of evidence that there was anything artificial
or unusual about the leases concluded, in my opinion this rental
should be the basis for an appraisal using the capitalized income
approach.[16] In
the circumstances, it seems clear to me that actual income is a
better yardstick for determining the value of the appellant's
property than a theoretical potential income based on
approximations derived from an average or median income, using
allegedly comparable data which often prove however to be
questionable, as is the case here.
[43] The evidence concerning the third premises did not show
that the indicated rental of $18,003 a year, or $1,500 a month,
represented actual rental collected by the appellant which could
be treated as such in the calculations. However, all the figures
submitted by the appellant and its expert witness take this
amount into account. If we assume for the moment that this is a
maximum potential rental for the third premises located at the
back of the building, we find that at $69.85 a square metre
($6.49 a square foot) this rental is 78.18 percent of the
actual rental of $89.34 a square metre ($8.30 a square foot) for
the premises located at the front of the building and occupied by
Ateliers Charron. The difference of 22 percent to take into
account the poor location of the third premises might appear too
high to some.
[44]However, assuming that the potential rental of the back
premises was only 5 percent less than that of the front
premises, we would get a rental of $84.87 a square metre, that
is, an annual rental of $21,871 and not $18,003. This difference
of 5 percent between the potential rental that could be
obtained for the back premises and the rental actually agreed
upon under a five-year lease for the front premises seems minimal
and, in the circumstances, more than reasonable. On this basis
the total gross income would rise to $64,591 from $60,723. With a
reserve of only 5 percent and not 7 percent, that is,
$3,230, for vacancies and bad debts, actual gross income would
amount to $61,361. After deducting operating expenses of
$16,166.78, net income would be $45,194. Applying to that income
the overall discount rate of 0.127200, namely that used by the
respondent's expert witness, we get a value of $355,300 for
the appellant's property. In arriving at this conclusion I am
aware that in using an overall discount rate of 0.127200 any
error of $1,000 in income or expenditures is likely to produce a
distortion of over $7,860 in the estimated value of the
property.
[45]Clearly, I am not an appraisal expert. However, I have
carefully reviewed the reports of the two expert witnesses and
the evidence as a whole. It would be euphemistic to say that I am
not completely satisfied with the analyses submitted.
Nonetheless, having considered all the evidence before the Court,
I feel that Mr. Furlong's conclusions are closer to
what I believe to be the reality of the situation than those of
Mr. Laberge. The analysis using actual data relating to the
property in question rather than so-called comparable data
with respect to the first two premises, and the additional
assumption which I have just made regarding the maximum potential
rental which could be obtained by the appellant for the premises
at the back of the building, have satisfied me on a balance of
probabilities that the value of the property did not exceed
$360,000 on July 7, 1992. I will not dwell any further or go
into greater detail on the criticisms I have already expressed
since, by virtue of the relief sought in its appeal, the
appellant, although the sale of the property to
Claude Lévesque was for $325,000, is only disputing
the value set by the Minister of National Revenue in excess of
$360,000.
[46] In accordance with the foregoing, therefore, the appeal
is allowed and the assessment referred back to the Minister of
National Revenue for reconsideration and reassessment on that
basis.
[47] The whole with costs to the appellant.
Signed at Ottawa, Canada, on this 20th day of July 1998.
"P. R. Dussault"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 30th day of December
1998.
Erich Klein, Revisor
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