Lachance Kirouac v. The Queen, docket 96-1944-IT-G

Date: 19980617

Docket: 96-1944-IT-G

BETWEEN:

LISE LACHANCE KIROUAC,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

ARCHAMBAULT, J.T.C.C.

[1] On October 15, 1993 ("the relevant date") Lise Lachance Kirouac purchased from her husband Denis Kirouac for the sum of $1 all the shares ("the shares") held by the latter in Les Pétroles D. Kirouac Inc. ("PDK"). As at the time Mr. Kirouac owed the sum of $24,969.82 to the Minister of National Revenue ("the Minister"), the latter made an assessment pursuant to s. 160 of the Income Tax Act ("the Act"), and under that assessment Mrs. Kirouac was made liable for her husband's tax.

[2] The only question raised by this appeal is as to the value of the shares on the relevant date. The respondent's expert witness considered that the fair market value of the shares on that date was $190,000, while the witness for Mrs. Kirouac argued that it was nil since the value of the shares amounted to the negative sum of -$1,550.

Facts

[3] Before analysing the opinions of the appraisal experts it will be helpful to relate the circumstances surrounding the transfer of the shares by Mr. Kirouac to his wife. PDK was created pursuant to Part 1A of the Quebec Companies Act and its fiscal year ends on September 30. In 1993 it was operating a fuel oil home delivery business in the vicinity of Sherbrooke. In addition, it was involved in heating equipment and water heater sales and service. However, the maintenance and repair services were delegated to a subcontractor. PDK also offered its customers a protection plan for heating equipment and water heaters.

[4] In the early 1980s PDK operated as a retailer of fuel oil supplied by Gulf Canada Limited ("Gulf"). Gulf was PDK's sole source of supply. The supply contract was not entered in evidence but, according to Mr. Kirouac's recollection, Gulf set both the purchase and resale prices of Gulf products. PDK was responsible for delivery charges and the cost of bill collection. Under the contract PDK was to make a profit. However, as competition was very keen in the Sherbrooke area and prices were falling, Mr. Kirouac told Gulf PDK would have to be given additional discounts so it could compete with its competitors.

[5] In late December 1983 Gulf submitted a draft settlement ("the draft settlement") which would terminate the supply contract as of January 15, 1984. Gulf also offered to pay PDK the sum of $15,000 to avoid any future litigation regarding the contract. PDK accepted this settlement offer. Additionally, according to Mr. Kirouac, PDK took over Gulf's customers without providing any consideration. However, the draft settlement is silent on this point. The contract actually provided that Gulf undertook to continue supplying the necessary fuel oil to supply seven commercial or institutional customers and that Gulf waived its option to repurchase PDK's accounts receivable.

[6] Mr. Kirouac maintained that about 1,100 customers were being served at that time and about seven million litres of fuel oil were being delivered annually. The volume in litres continued to fall between 1983 and 1993. In 1993 PDK sold 1,903,000 litres of fuel oil. There was also a similar drop in its turnover, from $1,847,000 in 1984 to $627,000 in 1993. This decline in fuel oil deliveries was apparently due largely to the arrival of natural gas in the Sherbrooke area in 1983 and the introduction of a government dual energy program.

[7] PDK had only one truck to deliver fuel oil. Mr. and Mrs. Kirouac were employed full time throughout the year. The delivery truck driver was employed seasonally. Two Kirouac children were also hired to perform certain administrative duties in the summer. However, it was Mr. and Mrs. Kirouac who handled the primary administrative duties. Mr. Kirouac was responsible for the general management of the company: he handled not only purchases of fuel oil and other products from suppliers, but also the sale of heating equipment and water heaters. It was he who recorded the business's financial information on the computer: fuel oil sales, accounts payable and so on. Mrs. Kirouac was responsible for credit, monitoring and collection of bills and secretarial work in general. Mr. Bergeron, an employee not related to the Kirouac family, handled fuel oil sales. In its 1989 fiscal year PDK sustained an operating loss of $6,968, which apparently prompted it to let Mr. Bergeron go in June 1989. His salary was about $30,000 a year. Mr. and Mrs. Kirouac divided his duties between them. Mr. Kirouac took over delivery operations, including maintenance of the truck and monitoring of maintenance services provided to customers. Mrs. Kirouac added to her duties that of canvassing customers by telephone and checking on houses sold.

[8] Analysis of the financial statements prepared for the 1989 to 1996 fiscal years indicated the following information:

Year	Turnover	Gross profit	Profit (loss) before income tax and write-off	RNI (deficit)
1996 (nine months - ending June 27, 1996)	732,219	120,714	(8,281)	(2,547)
1995	721,015	180,858	21,080	9,212
1994	607,344	149,426	32,922	(1,640)[1]
1993	626,603	149,333	34,390	43,496
1992	678,279	172,617	58,688	31,483
1991	695,147	150,279	37,175	(2,206)
1990	721,808	105,164	1,753	(33,330)
1989	765,999	128,869	(6,968)	(34,750)

[9] Until April 1, 1989 PDK's credit line stood at $150,000. It was then reduced to $75,000. The National Bank of Canada also required Mrs. Kirouac to give it a mortgage as security for this credit line. The mortgage was on immovable property owned by her and used as the family residence.

[10] The financial statements for the fiscal year ending September 30, 1990 indicated that on that date there was an unpaid loan of $55,000. The loan was made to Mr. Kirouac for the purchase of a car in 1986 or 1987. The financial statements for the 1989 to 1996 fiscal years indicated the following information on money owed by directors and officers:

Year	Accounts receivable - directors and officers	Investments - automobile purchase
1989 1990 1991 1992 1993 1994 1995 1996	14,600 24,600 35,600 41,300 66,000 6,000 — —	55,000 55,000 55,000 40,000 — — — —

[11] The same financial statements show the following information regarding salaries and dividends paid by PDK. The information on salaries is contained in one of the following three items: labour, sales and administrative expenses.

Year	Labour	Sales	Administrative expenses	Salaries paid to family*	Dividends
1989 1990 1991 1992 1993 1994 1995 1996	53,868 53,976 20,694 20,554 20,077 19,531 18,925 25,318	N/A N/A N/A N/A N/A 3,275 32,366 9,764	62,068 43,823 71,182 67,650 67,956 66,276 62,719 52,913	N/A N/A 70,712 70,532 69,569 N/A N/A N/A	10,000 0 0 15,000 15,000 0 6,000 0
* according to T4 summaries at December 31 of each year.

[12] In 1983, in addition to several multinational oil companies offering fuel oil in the Sherbrooke area, there were a number of independent companies of which, in 1993, according to Mr. Kirouac, only PDK was left. A number of these independent distributors had gone bankrupt and at least one of the independents had been purchased by one of the multinationals.

[13] In 1993, among PDK's multinational competitors were Esso, Shell, Petro-Canada, Irving and Ultramar. Between 1983 and 1993 competition was fierce not only in fuel oil prices but also with regard to methods of payment: PDK's suppliers required it to pay within 15 days, while those same companies often gave their own customers 30 days to pay.

[14] According to the testimony of Mr. and Mrs. Kirouac, the latter was not satisfied with the management of PDK by Mr. Kirouac. He was very aggressive with customers, sales volume continued to fall and Mrs. Kirouac was concerned about the mortgage she had given the bank as security for PDK's credit line. She met with Patrick Cloutier of Raymond Chabot Martin Paré, who was PDK's accountant. Mr. Cloutier told her that the company was virtually bankrupt and its shares were worth no more than a dollar. Mr. Cloutier confirmed in his testimony that it was his opinion between 1989 and 1993 that Mr. Kirouac should sell his shares for $1 and the release of Mrs. Kirouac from her surety.

[15] In arriving at this value for the shares Mr. Cloutier assumed that the balance of PDK's advances to Mr. Kirouac ($66,000 in 1993) was not recoverable. The only assets Mr. Cloutier took into account were PDK's shares and a registered retirement savings plan ("RRSP") of about $100,000, property which, according to him, was not subject to attachment. He did however acknowledge that with his wife's consent Mr. Kirouac could have withdrawn money from the RRSP, but that there would have been a major problem with that: tax would then have had to be paid! Mr. Cloutier also admitted that he had not used any balance sheet drawn up by Mr. Kirouac. The fact he had known him for a long time was sufficient.

[16] Mr. Kirouac said that, in addition to his $66,000 debt to PDK, he owed money on his credit cards, that his credit line of $25,000 to $30,000 had been completely used up and that he owed taxes to the tax authorities. However, the evidence did not disclose that Mr. Kirouac had declared bankruptcy.

[17] On October 15, 1993 Mr. Kirouac sold all his shares to Mrs. Kirouac for the sum of $1. When cross-examined by counsel for the respondent, Mr. Kirouac was unable to confirm that he would have sold his shares to an outsider for that amount. He admitted that he had received offers to purchase his clientele in 1986. He rejected them since the price was ridiculously low: 2 ¢ to 2.5 ¢ a litre.

[18] After purchasing all her husband's shares Mrs. Kirouac took action to make PDK's operations profitable. In May 1994 she began looking for a new sales manager. She found one in August 1994 and hired him at an annual salary of about $30,000. This new manager was able to concentrate on establishing more personal contact with PDK's customers. According to Mrs. Kirouac, he was able to attract 364 new customers between August 1994 and June 1996. This was reflected in the sales figures. They increased from $607,344 in 1994 to $721,015 in 1995 and to $732,219 in the 1996 fiscal year ending June 27, 1996. Although this was a nine-month period, it must be borne in mind that the busiest season for fuel oil sales was over.

[19] Thirty-two months after purchasing her husband's shares for $1, namely on June 27, 1996, Mrs. Kirouac sold them to Ultramar for $401,719. Mrs. Kirouac estimated the volume of fuel oil sold by PDK to be 2,500,000 litres at the time of this sale.

[20] Mr. Desrosiers, of the firm Raymond Chabot Martin et Paré, filed an expert report establishing the fair market value of the shares at September 30, 1993. This date was used because it was the closest date to that of the financial statements. To arrive at the fair market value of the shares he used the technique of capitalizing net indicated earnings (or the yield method) and the adjusted shareholder's equity method.

[21] The fair market value of a given company according to the yield method is generally calculated in the following way:

Value of shares = (net indicated earnings x multiple) +

market value of redundant assets.

The following are the calculations Mr. Desrosiers made using this method:

	LOW $	HIGH $
Indicated earnings before other adjustments and income tax Other adjustments: Less: Salaries Plus: Bank charges adjustment (see Appendix — 4.1) Indicated earnings before income tax Less: Income tax at 18.59% First $200,000 37.74% Excess Net indicated earnings Multiple[2] Capitalized value of net indicated earnings Plus: Redundant assets (negative) - (Appendix 4.1)[3] Value of all shares issued and outstanding Rounded to:	34,300 (30,000) 2,850 7,150 (1,300) 5,850 X 3.75 21,900 (32,137) (10,237) (10,200)	41,900 (30,000) 2,850 14,750 (2,700) 12,050 X 3.25 39,200 (32,137) 7,063 7,100
Average:	(1,550)

[22] The adjusted shareholders' equity represents the fair market value of the assets of the business, minus total liabilities and making provision for a reserve for tax on appreciation. This value, according to Mr. Desrosiers, was negative, namely -$7,260.

[23] Benoît Renaud, an employee of the Minister, also testified as a business appraisal expert. In determining the fair market value of the shares Mr. Renaud used two approaches: the yield method and the empirical method. Using the first approach, he estimated the value at $200,000. The estimated value according to the empirical method was $190,000. This latter value was what he used as the fair market value at October 15, 1993. Let us look more closely at the approach taken by Mr. Renaud.

[24] According to the empirical method, the value of the tangible assets must be determined and the value of goodwill added thereto. Here the value of the goodwill was determined by assuming that it was between 5 ¢ and 7 ¢ per litre sold. In Mr. Renaud's experience, this method has frequently been used to ascertain the value of this type of business. Mr. Renaud added the following at p. 11 of his report:

[TRANSLATION]

We contacted three Sherbrooke heating oil suppliers (Sonic, Shell and Esso), and they confirmed that the selling price per litre of heating oil was 34.9 ¢ in 1992 and 1993. At that price level, discounts of up to 7 ¢ per litre for the best customers had to be deducted, and this enabled us to estimate the number of litres sold as being between 1.8 and 2.2 million. One thus arrives at a goodwill valued at between $112,000 and $125,000.

[25] This is how he calculated the value of the goodwill, at p. 49 of his report:

[TRANSLATION]

Empirical method:
1993 sales:		$626,603
Maximum price per litre: Average price per litre: Minimum price per litre:	$0.349 ________	$0.314 ________	$0.279
Estimated number of litres sold:	1,795,424	1,995,551	2,245,889
Goodwill per litre in our experience:	$0.070	$0.060	$0,050
Goodwill:	$ 125,680	$ 119,733	$ 112,294

[26] The value of the tangible assets was determined as follows:

[TRANSLATION]

Value of tangible assets:

Book value at September 30, 1993: $45,946

Plus

Appreciation on rolling stock net of tax shields

F.M.V. of rolling stock

(estimated) 40% of cost: $26,112

Net value: (7,969)

V = Appreciation of assets 18,143

T = Tax rate 18.59%

R = Capital cost allowance rate 30.00%

I = Capitalization rate 20.00%

Formula = (V x T x R/(I + R) x 1-I/2(1+I) (1,855) 16,288

(half-rate rule)

Appreciation of listed shares

after tax, as company has $44,000 in capital

losses to carry over

Fair market value according to financial statements 35,966

Cost: (28,594)

Gain on investments 7,372 7,372

Adjusted book value at September 30, 1993 $69,606

[27] The fair market value therefore amounted to $190,000, arrived at as follows:

[TRANSLATION]

Goodwill: $125,680 $119,733 $112,294

Tangible assets: 69,606 69,606 69,606

Fair market value of shares: $195,286 $189,339 $181,900

Selected value: $190,000

[28] Mr. Renaud arrived at similar results using the approach based on yield. In order to make this appraisal Mr. Renaud had to first make adjustments to the calculation of the net indicated earnings, in particular for the administrative salaries item. He realized that the administrative salaries were three times higher than direct compensation. He found from examining the reference work Robert Morris Associates Annual Statement Studies for 1993 that owners' salary percentage did not exceed 2.6 percent of sales. In the case of the Kirouac family that percentage was somewhat over 10 percent of sales. Mr. Renaud therefore reduced to $45,000 the owners' salaries, which had averaged approximately $70,000 for the three calendar years 1991 to 1993.

[29] Mr. Renaud also found that PDK held assets not required for operations, such as listed shares and loans receivable, including an advance to a director. The amount of bank debts for 1993 exceeded $57,000, while total redundant assets represented $114,829.

[30] Mr. Renaud concluded that PDK was borrowing to hold unnecessary assets and proceeded to appraise the business without taking debts into account. He therefore increased the company's income by adding interest paid and deducted the amount of the debts from the total value of the business, which was to give him an unleveraged share value.

[31] This is how he arrived at the value of the shares by the yield method. He began by determining net indicated earnings to be $58,000, as follows:

[TRANSLATION]

Appendix VI Determination of sustainable earnings
Before-tax earnings:	1993 $34,390	1992 $58,688	1991 $37,175
Plus: Depreciation of rolling stock: Short-term interest: Long-term interest: Directors' salaries:	3,360 6,078 393 67,956	4,320 4,834 1,936 67,550	6,707 7,962 4,277 71,182
Less: Depreciation of rolling stock: Dividend income: Administrative salaries:	(6,528) (60) (45,000)	(6,528) (60) (45,000)	(6,528) (60) (45,000)
	$60,589	$85,740	$75,715
Weighting:	3,00	2,00	1,00
Weighted before-tax adjusted earnings: Calculation of tax: On first 200,000 at rate of:	18.59%	$71,494 13,291
After-tax adjusted earnings:
		$58,203
	Rounded to:
		$58,000

[32] Mr. Renaud then determined the capitalization rate as follows:

[TRANSLATION]

APPENDIX VII

DETERMINATION OF CAPITALIZATION RATE

	HIGH	LOW
No-risk rate: (3-month treasury bills) Add: Premium for risk capital (according to Principles of Corporate Finance, chap. 7) Premium for special situations (internal and external factors)	4.08% 7.00% 13.00%	4.08% 7.00% 17.00%
Subtract: Inflation rate (projected) (overall price index) Growth rate (projected) (GDP index at constant prices) Capitalization rate without debt factor:	2.00% 2.00%	1.50% 1.50%
	20.08%	25.08%
Rounded to:	20.00%	25.00%

External and internal factors:

- Competition is very strong in this sector.

- Interest rates are low.

- The base price of the product has been the same for several years and costs are rising.

- Sales are falling even though the price of the product has been holding steady.

- The company is not affiliated with any major company and so must obtain its supplies at lowest possible cost.

- Operating costs are lower than those of large businesses because of reduced administration and staff.

High: Low:

So additional risk to be taken into account: 13.00% 17.00%

[33] It only remained for him to calculate the fair market value:

[TRANSLATION]

APPENDIX VIII

DETERMINATION OF FAIR MARKET VALUE

Sustainable after-tax earnings: $58,000

Capitalization rate: 20% 25%

Result: $290,000 $232,000

Less:

Bank overdraft (12,108) (12,108)

Bank loan (45,000) (45,000)

Fair market value of

100% of ordinary shares: $232,892 $174,892

Average: $203,892

Rounded to: $200,000

Analysis

[34] Essentially the only point raised by this appeal is as to the fair market value of the shares sold by Mr. Kirouac to his wife on October 15, 1993. In this case we have two appraisals reaching diametrically opposite conclusions. The taxpayer's expert witness arrived at a value of $1 while the Minister's expert set the value at $190,000. Nonetheless, both experts agreed on the definition of fair market value. Essentially it is the highest price estimated in terms of money which a willing seller can obtain for his property in an unrestricted market from a knowledgeable and willing buyer. (See Dominion Metal & Refining Works Ltd. v. The Queen, T-1981-83, at p. 9, 86 DTC 6311.)

[35] How do we explain the fact that two professionals can arrive at such different conclusions? It has to be recognized that appraisal is not a science, but an art. Although the two expert witnesses used in part the same approach to determine the fair market value of the shares, their application of that approach depended on how each of them saw the relevant facts and on their point of view with respect to the required adjustments. The evidentiary value of their opinions thus depends largely on the assumptions on which they relied in arriving at the value.

[36] Fortunately, in Marcus v. National Capital Commission, [1970] S.C.R. 39, the Supreme Court of Canada recognized that a court is not bound by the values determined by expert witnesses and may disregard certain factors which it considers unimportant and rely instead on others.

[37] From the outset the value estimated by PDK's expert witness seemed to me to be entirely unrealistic in view of the circumstances of this appeal. The method which he adopted, based on yield, led him to conclude that the shares had a negative value. In other words, a potential buyer would have to be paid to take the shares! A good way of determining whether the sum of $1 represents the fair market value of the shares is to ask whether the taxpayer would actually have sold the shares for that price! Here, Mr. Kirouac could not confirm that he would have sold his shares at that price.[4]

[38] Another indication that the shares were worth much more than $1 is the fact that they were sold 32 months later for $401,719. I would refer here to the rule stated by the Supreme Court of Canada in Roberts and Bagwell v. The Queen, [1957] S.C.R. 28, that it may be relevant to take sales subsequent to the date of the appraisal into account. This is what Nolan J. said at pp. 36 and 37:

In my view, evidence of a sale after the enactment can, in the absence of special circumstances, be relevant to the value prior to the enactment. The sale must be shown to be as free in all respects from extraneous factors such as prior sales and made within such time as the evidence shows prices not to have changed materially from those before the critical date. In other words, the mere circumstance of the sale being before or after a particular date cannot nullify the relevance of subsequent sales while the general market conditions have remained the same.

[39] In his argument counsel for PDK maintained that market conditions had changed considerably in 1996 as compared with those that existed in 1993. When I pointed out to him that there was no evidence of this, he argued that judicial notice could be taken of the fact that the economic situation had improved in 1996. In his submission, therefore, it would be dangerous to determine value on the basis of what was obtained for the shares on June 27, 1996. I am willing to admit that this viewpoint has some validity.

[40] However, I must point out that PDK's financial situation did not improve substantially during that period. Although there was an increase in turnover for the 1995 and 1996 fiscal periods, it should be noted that there was a reduction of profits of some 40 percent compared with net profits in 1993 and that in 1996 PDK sustained a loss of $8,281.

[41] Although it may be risky to determine the exact value of the shares in October 1993 based on the selling price in June 1996, the fact remains that this June 1996 price is an indication that the shares had some value. There would have to be very exceptional circumstances for one to conclude that the share value increased over 400,000 times in such a short period!

[42] Let us look at the appraisal submitted by Mr. Desrosiers, PDK's expert witness. It is important to set out the assumptions on which he based his report and to explain the scope of his mandate. On page 1 of his report Mr. Desrosiers noted that his client asked him to determine the fair market value of the shares [TRANSLATION] ". . . in a situation where an ordinary buyer might be willing to purchase the company's shares". He added: [TRANSLATION] ". . . our mandate was not to value the company's shares in a situation where a special purchaser might be interested in purchasing them". On page 17 of his report Mr. Desrosiers indicated that: [TRANSLATION] ". . . we did not attempt to quantify the premium a special purchaser would be willing to pay". This appraiser appears to have accepted rather readily his client's statement that he had not received offers from special purchasers in the years prior to the date of the appraisal.

[43] Yet it would seem to me that the most likely purchaser of the PDK shares in the circumstances would have been a special purchaser, that is, one who was already involved in fuel oil distribution and could pay a higher price than ordinary buyers because of economies of scale, as well as for reasons of synergy and because of the elimination of a competitor.

[44] There was in fact vigorous competition in fuel oil distribution in the Eastern Townships. Mr. Cloutier, PDK's accountant, confirmed that multinationals can eliminate competition by forcing independents out of business or by buying them up. However, he acknowledged that even if an independent distributor went bankrupt it was not certain that a given multinational would get its customers. He therefore admitted that it was in the interests of such a multinational to buy out an independent.

[45] If Mr. Desrosiers had attempted to ascertain whether special purchasers for the shares existed, I think he would have found some and that the result would have been to substantially increase the value of the shares. In my view, the fact that Mr. Desrosiers was instructed to determine the market value of the shares for an [TRANSLATION] "ordinary buyer", not a [TRANSLATION] "special purchaser", lessens the evidentiary value of his opinion.

[46] Further, I feel that in accepting the $66,000 advance shown in the financial statements to September 30, 1993 as a bad debt for PDK he was being accommodating. Mr. Desrosiers admitted that he did not try to obtain a balance sheet from Mr. Kirouac in order to be able to determine how reasonable it was to conclude that the $66,000 advance could not be recovered.

[47] He appears to have relied on his colleague Mr. Cloutier, in whose opinion this debt was not recoverable. According to Mr. Cloutier, Mr. Kirouac did not have sufficient resources to repay the advance. When it was pointed out to him that he held shares in PDK, Mr. Cloutier replied that Mr. Kirouac's shares were worthless. In his view, PDK was virtually bankrupt. I did not find this testimony by Mr. Cloutier persuasive. How can it be concluded that a company was virtually bankrupt when it paid members of the Kirouac family salaries of some $70,000 from 1991 to 1993 while generating profits for the 1990 to 1993 fiscal periods?[5]

[48] When Mr. Desrosiers testified I asked him to indicate what the fair market value of the shares would be if he altered his working hypothesis that the $66,000 advance was a bad debt. He produced calculations (Exhibit A-10) showing that the fair market value of the shares would then be $64,450. Although this value was arrived at on the basis of assumptions which seem to me to be unreasonable — and I will get back to this a bit further on —,Mr. Desrosiers came to a value almost equal to the amount of the $66,000 advance!

[49] I personally feel it is entirely unreasonable to determine the value of the shares on the assumption that Mr. Kirouac was not able to repay his $66,000 advance. To begin with, this advance still appeared on PDK's balance sheet at September 30, 1994. It was not until January 1995, after consulting with the accountant Mr. Cloutier, that PDK took the decision to write off this $66,000 advance.

[50] In my view, this write-off was an act of accommodation on Mr. Cloutier's part. If Mr. Cloutier was so determined to write off the advance, why did he not suggest that PDK declare a dividend of $43,496, since at September 30, 1993 it had undistributed earnings in that amount? PDK could at least have allocated such dividend to the payment of Mr. Kirouac's debt. The amount could also have been recovered from the salary owed to Mr. Kirouac.

[51] Even if one were to conclude (and I do not agree with this) that Mr. Kirouac was not able to repay his advance in the very short term, I do not think it was reasonable for the appraiser to conclude that writing off this asset was necessary for the purpose of valuing the shares. Indeed, the approach taken by this appraiser is based on faulty reasoning: the shares were only worth a dollar because the advance was a bad debt and the debt was bad in large part because the shares were only worth a dollar.

[52] It would seem more reasonable to assume that, as PDK's sole shareholder, Mr. Kirouac would someday be able to repay the advance. Valuing the shares on the basis that the debt could be recovered we arrive at a value of at least $64,450, using Mr. Desrosiers's assumptions. If Mr. Kirouac had sold his shares to a third party while he owed this amount to PDK, the third party would certainly have taken steps to ensure that the $66,000 was deducted from the amount payable to Mr. Kirouac for his shares. In my view, this approach gives much more accurate results.

[53] Although I think it would have been desirable that Mr. Desrosiers value the shares according to a scenario in which a special purchaser existed, the evidence does not provide sufficient information to explore that possibility. In any case, the crux of the matter is whether the shares were worth at least $24,970.82, which is the amount of Mr. Kirouac's tax debt. The yield method used by PDK's expert witness can be applied in valuing the shares for the purposes of this case as it gives us a value much higher than the amount at issue. Of course, some of Mr. Desrosiers's working assumptions must be changed to reflect more reasonable assumptions. Additionally, instead of considering two scenarios, one optimistic, namely that of the highest value, and the other pessimistic, namely that of the lowest value, and then averaging them, I prefer to use a single scenario based on assumptions which I regard as fair and reasonable.

[54] The first change I would make to Mr. Desrosiers's calculations concerns calculation of the net indicated earnings. Unlike Mr. Desrosiers, I do not think the administrative salaries should be increased by the sum of $30,000. To begin with, according to the Robert Morris Associates studies consulted by Mr. Nadeau, those salaries were much higher than is usual for businesses of PDK's size. Moreover, this business only had one delivery man. I find it surprising that three full-time managers would have been needed year-round to deal with a single delivery man employed only during the winter season.

[55] It should be noted that this is a family business which employed not only Mr. and Mrs. Kirouac but also their two children. It is not unusual to find that salaries paid by a family business to members of the family that owns it are not in line with those that would be paid to outsiders. A family business may also employ people who do not have the skills or qualifications necessary to do the work. Here, Mrs. Kirouac explained her taking over PDK by the fact that she found Mr. Kirouac's management to be inadequate. If Mrs. Kirouac was so dissatisfied, why did she continue to employ him? In fact she felt it necessary to hire a new sales manager as of August 1994.

[56] For the purposes of the appraisal it seems reasonable to think that a new purchaser might replace all the members of the Kirouac family with two people working full time. It would therefore not be necessary to add a new employee. It is even possible that Mr. Renaud was right to reduce the total administrative payroll by lowering it from $70,000 to $45,000. However, I am prepared to give the taxpayer the benefit of the doubt and to conclude that administrative salaries might amount to $70,000. Consequently, the amount of the total payroll should be neither increased nor decreased.

[57] I am prepared to adopt the average rate of return described by Mr. Desrosiers. However, the overall rate of return on no-risk investments which he used to calculate the rates of return must be changed. Mr. Desrosiers used a rate of 7.5 percent for long-term bond investments of 10 years or more, while Mr. Renaud used the 4.08 percent rate of return applicable to 40-day treasury bills. Mr. Renaud's approach seems more appropriate because, as he said, the 7 percent premium for risk capital — another factor entering into the calculation of the overall rate of return — takes into account a no-risk rate on short-term rather than long-term investments. This explanation by Mr. Renaud was not contradicted by Mr. Desrosiers. If the 7.5 percent rate of return on no-risk investments is replaced by the 4 percent rate used by Mr. Renaud (which I am rounding off), the two rates of return calculated by Mr. Desrosiers then become 23 percent and 27 percent, for an average rate of 25 percent. This rate of return corresponds to a multiple of 4, that is, the lowest multiple suggested by Mr. Renaud. This multiple is also lower than the median multiple of 4.125 between the lowest multiple, namely 3.25, suggested by Mr. Desrosiers, and the highest multiple, namely 5, suggested by Mr. Renaud.

[58] Making all these changes to the calculations done by Mr. Desrosiers in establishing the fair market value using the yield method, one obtains the following results:

Indicated earnings before adjustments $ 38,100

Plus: Financing costs $ 2,850

Indicated earnings before tax $ 40,950

Less: Income tax at 18.59%

on first $200,000 $ 7,613

Net indicated earnings $ 33,337

Multiple 4 x 33,337 $133,350

Plus: Redundant assets $ 33,863[6]

Value of all shares issued and outstanding $167,213

Rounded off $167,000

[59] To determine fair market value by the empirical method, Mr. Renaud added the value of the tangible assets and that of the goodwill. If I do this calculation in reverse, that is, if I deduct from the value of $167,000 the amount of the net tangible assets calculated by Mr. Renaud, namely $69,606, I get a value of $89,394 for the goodwill ($167,000 - $69,606). This value of the goodwill represents a value of 5 ¢ a litre ($89,394 ÷ 1,900,000 litres). It can be seen that this 5 ¢ value corresponds to the lowest value per litre used by Mr. Renaud in his appraisal report. This figure also seems to me to be entirely reasonable, since according to the information provided by Sonic, Shell and Esso, who were operating in the Sherbrooke area in 1992 and 1993, the amount of the discount given to the best customers could be as high as 7 ¢ a litre. This approach based on the empirical method thus confirms the plausibility of the value obtained by the yield method.

[60] For all these reasons, I conclude that the fair market value of the shares is $167,000. As the amount of tax for which Mrs. Kirouac is liable represents the difference between the fair market value of the shares she acquired from her husband less the amount paid, up to a total of $24,969.82, I conclude that the Minister's assessment is valid. Mrs. Kirouac's appeal is dismissed and costs are awarded to the respondent.

Signed at Ottawa, Canada, this 17th day of June 1998.

"Pierre Archambault"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]

Translation certified true on this 29th day of October 1998.

Erich Klein, Revisor

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