Citation: 2009 TCC 641
Date: 20091229
Docket: 2006-2238(IT)G
BETWEEN:
167849 CANADA INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Jorré J.
[1]
The appellant did
business in the fast-food industry and, over the course of its 2001 taxation
year, it sold six franchised A&W restaurants for the amount of $675,000. There
was no agreement between the appellant and the purchaser as to the purchase
price allocation.
ISSUE
[2]
The only issue herein
is the purchase price allocation.
PARTIES' POSITION
[3]
Upon filing its income
tax return, the appellant allocated
the price of purchase using the amounts entered in the company's accounting documents
for tax purposes at the time of the sale. For example, if, for the installation, the
undepreciated capital cost was $100, the appellant attributed $100 to installation.
The amount exceeding the book value was attributed to the goodwill of the
business.
[4]
The appellant's
position at trial was that $114,775 were to be attributed to leasehold
improvements, $118,800 to installation, $0 to franchise fees and $441,425 to
the goodwill of the business.
[5]
The position of the Minister
of National Revenue (the Minister) at the time of reassessment was that $183,000 were
to be attributed to leasehold improvements, $420,000 to installation, $51,668 to
franchise fees and $20,332 to the goodwill of the business.
[6]
At trial, the position of
the Minister was that $270,000 were to be attributed to leasehold
improvements, $350,000 to installation, $55,000 to franchise fees and
$0 to leasehold improvements.
[7]
Neither the appellant
nor the respondent attributed any value to the stock.
FACTS
[8]
Jean-Pierre Cadorette, the
appellant's owner, testified, as did Richard Dumas, the owner of the company
that purchased the restaurants in question.
Testimony of Mr. Cadorette
[9]
The appellant purchased
five out of the six restaurants in question in 1989, namely:
a) Place Fleur de Lys no 1
— opened in 1987-1988,
b) Place Laurier — opened in 1983,
c) St-Joseph Street (mail
St-Roch) — opened in 1975,
d) Place Québec — opened in 1986,
e) Place Ste-Foy — opened in 1983.
In that same transaction in 1989, the appellant
purchased twelve other A&W restaurants, including that at Galeries de la
Capitale, sold during the 2000 taxation year (which is not in issue herein).
[10]
The sixth restaurant in
question, Fleur de Lys No. 2, did not exist in 1989 and was opened in 1991-1992.
[11]
At the time of the
purchase and until the sale in question, the appellant did not change the equipment
or the leasehold improvements of the restaurants at Place Fleur de Lys No. 1,
at Place Laurier or on St-Joseph
Street.
[12]
In 2000, the restaurant
at Place Ste-Foy was closed and reopened at the shopping centre; the restaurant
was rebuilt.
[13]
Mr. Cadorette
testified that in 1989 and 1990, his relationship with the franchisor, A & W,
were a little strained because he had to renovate and change the equipment
every seven or ten years at most, and that he broke that obligation.
[14]
The required renovations
could cost between $100 000 and $150,000 per restaurant.
[15]
He decided at the time that
he wanted to sell the six restaurants in question as well as the restaurant at
Galeries de la Capitale.
[16]
He finally sold the six
restaurants in question to Gestion Richard Dumas. This was done through two
sale contracts on December 13, 2000, namely, a contract for the restaurant at
Place Laurier and a second contract for the other five restaurants. The appellant had
already sold the restaurant at Galeries de la Capitale to Gestion Richard Dumas
during the 2000 taxation year.
[17]
The two contracts contain
the same description of businesses sold:
[Translation]
DESCRIPTION
A business known and operated as "A&W Restaurant"
situated:
. . .
The present sale includes the following:
1. acceptance by A&W to use the name;
2. all merchandise already inventoried between the parties
with which the purchaser is familiar, and declares that he is satisfied therewith;
3. all furniture, movables and equipment for
operating the business and already inventoried between the parties with which the purchaser is familiar, and declares that he is satisfied therewith;
5. vendor's rights associated with the business' identification,
including telephone numbers, posters, signs, advertisement, permits, the
"A&W" franchise;
6. vendor's rights in the lease of sites sold.
[18]
Mr. Cadorette testified
that he could not sell his franchise rights as, pursuant to his agreement with
A&W, he had to surrender them to A&W if he no longer operated the restaurants.
[19]
In the [Translation] "termination and
granting of concessions agreement" of November 15, 2000, between the appellant,
the purchaser of the restaurants in question and A&W, it is stipulated
that A&W accepted the termination of certain concession agreements
(franchises) by the appellant in consideration of some conditions, namely, (i)
a payment by the appellant, and (ii) the payment by the purchaser of the restaurants
of a sum of money for the granting of granting rights required by the purchaser.
[20]
Mr. Cadorette
testified that he paid $25,000 for each franchise right for a duration of
20 years, but that at the time he sold the restaurants, the price of one franchise
right had doubled to $50,000 for 20 years or $25,000 for
10 years.
[21]
He also testified as to
the negotiations. He explained that the negotiation of the total price was based
on the restaurants' profits. The total price of $1,125,000, including the price
of the restaurant at Galeries de la Capitale, was nearly 2.5 times the
profits, plus an amount of $125,000 that took into account costs for redoing
the restaurant at Place Ste-Foy.
Mr. Dumas
[22]
Mr. Dumas testified
with respect to the purchase of the restaurants.
EXPERTS
[23]
The appellant and the respondent
presented Guy Hardy and Yvon Ouellet as expert witnesses.
Objections to Mr. Ouellet's testimony
[24]
The appellant objected to
the Mr. Ouellet's testimony as an expert, not on grounds of qualifications,
but for the simple reason that is an official of the Canada Revenue Agency (the
CRA). I do not agree. The simple fact that he is CRA official does not in
itself suffice for Mr. Ouellet not to be qualified as an expert.
[25]
However, I note that
around 2001, Mr. Ouellet was consulted on this matter, probably by the
auditor. He received some bits of information and made up some numbers without making
an assessment. This was done while the CRA hoped to broker an agreement between
the appellant and the purchaser of the restaurants on the issue of allocation.
[26]
Then, Mr. Ouellet did
not work on the file prior to 2007, when he did the assessment that was
presented at trial.
[27]
The participation of Mr. Ouellet
in 2001, prior to the assessment of October 27, 2003, the assessment in issue, does
not in itself suffice to prevent him from being qualified as an expert. However,
I am of the view that this bears on the weight that should be accorded his evaluation.
[28]
It would have been
preferable that Mr. Ouellet not have any role prior to the assessment in
issue.
Method
[29]
As for the installation,
Mr. Hardy used a method that consists in finding out the sales price for installation
of the same type. Mr. Ouellet used a recognized method of installation
depreciation by using the data of Marshall & Swift.
[30]
In terms of principles,
both methods are reasonable.
[31]
However, in both
reports, there are certain shortcomings that should be taken into account.
[32]
Mr. Hardy's task was
limited to appraising
leasehold improvements
and installation.
Date of improvements and acquisition of installation
[33]
As for the restaurants
at Place Fleur de Lys No. 1, at Place Laurier, on St-Joseph Street and at
Place Québec, both reports indicate 1989 as the date of leasehold improvements, and the report of Mr. Ouellet
indicates 1989 as the date of the acquisition of the installation.
[34]
However, the
uncontested testimony of Mr. Cadorette was that he did not make any
improvements at the time of purchase of these four restaurants. Therefore, the
leasehold improvements and the purchase of the installation for these restaurants
took place prior to 1989. Given the dates on which the restaurants were opened
and the testimony of Mr. Cadorette as to the policy of A&W that it was
required to make renovations every seven to ten years of operations, I conclude
that at the time of the sale in 1989, the leasehold improvements and the installation
for the restaurants at Place Fleur de Lys No. 1, Place Laurier and Place
Québec stem from the days the restaurants were opened, that is to say, 1987-1988,
1983 and 1986, respectively.
[35]
The restaurant on St-Joseph Street has been in existence since 1975. However, despite
the fact that several of the restaurants operated by the appellant went well
over ten years without being renovated,
it is highly unlikely that the restaurant on St-Joseph Street was not renovated prior to 1989. If that restaurant was
not renovated prior to 1989, it means that A&W would not have allowed the restaurant
to be renovated during the 25 years from 1975 to 2000. That is not likely.
It would be reasonable to suppose that the restaurant on St-Joseph Street was renovated at least one year prior to the appellant
purchasing it.
[36]
It is therefore
important to take into account those dates for the leasehold improvements and installation
purchases in considering the appraisals.
The specific case of the restaurant at Place Ste-Foy
[37]
The restaurant at
Place Ste-Foy was completely renovated in 2000 and was brand new from A&W's
point of view at the time of the sale.
[38]
However, the two
appraisals do not take that fact into account with respect to the equipment.
[39]
In his report, Mr. Ouellet
assumes that the equipment is nine years old, despite the fact that it was
replaced in 2000.
[40]
Although Mr. Hardy's
report is not based on how old the equipment was, it is obvious that there is a
problem and that the appraisal of the restaurant at Place Ste‑Foy cannot
take into account the renewal of the installation in 2000. For example, Mr. Hardy
appraised the value of the installation of the restaurant at Place Fleur de Lys
No. 2 (approximately 400 square feet), between 1991 and 1992, at $23,800,
whereas he appraised that of the restaurant at Place Ste-Foy (300 square
feet), which was renovated in 2000, at $24 890; there is a mistake
somewhere, perhaps in the descriptions of the equipment provided to Mr. Hardy.
[41]
Given that A&W estimates
that the equipment costs between $125,000 and $155,000, the value of
the installation at Place Ste-Foy must be much higher.
Mr. Hardy's report
[42]
One factor that influences
the validity of Mr. Hardy's work is the reliability the of descriptions of
the equipment provided. In addition to the case of Place Ste-Foy, it should be
noted that the differences between the descriptions provided to Mr. Hardy are
sometimes very substantial. For example, the description pertaining to Galeries
de la Capitale includes 39 types of different items, whereas the description
for Place Fleur de Lys No. 2 has 71 types of different items, even
though the meal sales at the restaurant at Place Fleur de Lys No. 2 are
half the meal sales at the restaurant at Galeries de la Capitale.
[43]
Each item's value is
based on the price at which an identical or similar item was sold. Over the
years, Mr. Hardy developed a data base that lists the sales price of the
different items of equipment. His point of departure was this data base, but
when he no longer had data, he contacted people in the installation resale
industry or colleagues to obtain prices for the equipment at the time of the
appraisal. His report does not present the comparative data used and it is
therefore impossible to verify whether it is the same brand or model, or a
similar object but slightly different.
[44]
In his testimony, Mr. Hardy
said that the equipment lost more value the first year and that after a certain
time, its value no longer depreciated, unless it became obsolete.
[45]
As for the leasehold
improvements, Mr. Hardy depreciated over a period of ten years. He considered
that after 10 years, there is no residual value.
Mr. Ouellet's appraisal
[46]
In examining Mr. Ouellet's
report, it is important to take into account, from the outset, a problem with
the report. The report concludes that there is a total value of $726,850 for
the equipment, leasehold improvements and franchise rights sold during the
taxation year, even if the sales price is $675,000. This conclusion means that
there is a negative goodwill of $51,850, but there cannot be a negative
goodwill.
[47]
In his testimony, Mr. Ouellet
recognized the problem and, as a result, said that it was necessary to adjust
the values for the goodwill to be null. He explained this conclusion by the
fact that his report had been prepared to determine the total values of the six
restaurants sold in 2001 and of the restaurant at Galeries de la Capitale sold
in 2000.
[48]
It remains that the need
to make adjustments
raises serious issues as to Mr. Ouellet's approach.
[49]
This is particularly
true when considering that the restaurant at Place Laurier was sold separately
for $250,000. If we take the appraisals for the equipment, the leasehold
improvements and the franchise rights of the six restaurants and divide them up
between the restaurant at Place Laurier and the five other restaurants sold for
$425,000, we will see that the result is a negative goodwill of about $135,000 for
the restaurant at Place Laurier and a negative goodwill of approximately $185,000 for
the five other restaurants.
[50]
I also note certain
other errors on page 15 of the report.
The restaurants at Place Fleur de Lys No. 1 and on St-Joseph Street both have equipment that is eleven years old, but, in
one case, there is a depreciation of 76% and, in the other case, there is a
depreciation of 86%. On the same page, the number of years of existence used
for the restaurants at Place Québec and Place Laurier is nine, although nothing
in the report suggests that the equipment of those restaurants is any more new
than that at Place Fleur de Lys No. 1 or on St-Joseph Street. Also, it is important to take into account the real dates
of the installation's acquisition (see paragraphs 34 and 35 above).
ANALYSIS
[51]
Accordingly, I do not
accept either report as such. It is necessary to take the reports and to
consider the necessary changes.
[52]
The following factors should
be taken into account:
(a) The equipment and
leasehold improvements are dated as follows:
(i) Place Fleur de Lys
No. 1: 1987 and 1988,
(ii) Place Laurier: 1983,
(iii) Place Québec: 1986,
(iv) St-Joseph Street:
before 1989,
(v) Place Fleur de Lys No. 2:
1991 and 1992.
(b) Given that A&W provides
for a minimal cost of $125,000 for the equipment, even assuming a very high
depreciation the first year and a smaller cost, the equipment of the restaurant
at Place Ste-Foy has a minimal value of $105,000.
(c) It is not reasonable to
not attribute any value residual value to the equipment and to the leasehold
improvements. However, although the data of Marshall & Swift indicates
residual values of 14% for the restaurants, they also indicate that "if
the equipment is unmarketable, however, then the value could go to zero." Consequently, given
the equipment’s age (12, 13, 14 and 17 years in four of the restaurants),
it is reasonable to use a residual value of 10%. The leasehold improvements
have an even lower residual value, given the age and the fact that the restaurants
only have an interest insofar as someone continues to operate them without
renovating them. Seeing as the purchaser continued to operate the restaurants and
that a certain time had to pass before any renovations could be made, a
residual value of 4% is appropriate, except in the case of the restaurant on St‑Joseph Street, which was closed shortly after the sale. As for the restaurant
on St-Joseph Street, the residual value of the leasehold
improvements is zero.
(d) As for the amortization
period for leasehold improvements, Mr. Hardy used a period of ten years
and Mr. Ouellet used a period of fifteen years. Despite the testimony of Mr. Cadorette
according to which renovations had to be made within ten years at most, I note
that in fact none of the restaurants sold in 2001 were renovated after
ten years, except for that at Place Ste‑Foy, which was renovated
owing to the move imposed by the shopping centre. The restaurant at Place
Ste-Foy had not been renovated since its opening in 1983, seventeen years
before the renovation of 2000. Consequently, it is reasonable to use an amortization
period of fourteen years.
(e) As for the costs to be
used to calculate the depreciation, one must use either the real costs if they
are known or a reasonable estimate thereof. If an estimate is used, I believe
more weight should be given to the written documents obtained from A&W
(Exhibit A-6) or to the estimate (also from A&W) which begins on the second
page of the appendix in Mr. Hardy's report (Exhibit A-8) than to the information
obtained from a franchisor's representative and orally confirmed by Mr. Cadorette. Finally, on the
subject, since the report deals primarily with the leasehold improvements and installation
of a certain age and that Exhibit A-6 is from 2003, it is necessary
to use an estimate at the bottom of the scale indicated in Exhibit A-6.
[53]
In taking into account
all these factors insofar as they apply to the one or other appraisal report, we
notice that both appraisals tend toward a comparable order of
magnitude. I conclude that the
value of the leasehold improvements is $180,000 and that the value of the equipment
is $190,000. The effect of the resulting corrections and calculations is shown in
the appendix.
Franchise rights
[54]
The appellant did not
provide an appraisal of the franchise rights. The appellant's position is that
it could not sell its franchise rights and that, as a result, no value could be
attributed to the franchise rights.
[55]
Indeed, the appellant
had to relinquish its franchise rights; however, it is necessary to look at the
contracts between the appellant and the purchaser, and also between the appellant,
the purchaser and A&W, as a whole. In examining the contracts, it is obvious
that one of the elements essential to the sale of the restaurants was that
A&W accepted to give the purchaser franchise rights. The condition was that
the appellant had to give up its franchise rights so that A&W could grant
the purchaser new franchises. Also, the continuity of the franchises is
reflected in the fact that A&W slightly reduced the costs of the new franchises
by taking into account in part the amounts the appellant had paid for the
periods of franchise rights that have yet to reach their maturity date.
[56]
Consequently, the
purchaser paid the purchase price, among other things, so that the appellant could
give up its franchise rights.
[57]
Mr. Ouellet calculated
the value of what the appellant gave up as being the value of the franchise
fees the purchaser saves. That approach is entirely reasonable and the calculation
is consistent with the amounts the purchaser saved according to Mr. Cadorette's
testimony.
[58]
However, the appendix
of Exhibit A-4 shows the amounts the purchaser undertook to pay to A&W for
the franchise rights.
Those amounts cannot be reconciled with the testimony of Mr. Cadorette and
the calculation done by Mr. Ouellet.
[59]
In the appendix of
Exhibit A-5, we notice a calculation similar to that of Exhibit A‑4. We
notice that the amounts are slightly lower in the appendix of Exhibit A‑5
than in the appendix of Exhibit A‑4 because there was an extra year added
to the duration of the franchise rights at the time Exhibit A‑4 was prepared. In comparing Exhibits
A-4 and A-5, we notice that the purchaser chose franchise rights for a period
of 10 years. If we exclude the restaurants at Place Québec and on St-Joseph Street, we notice that the amount saved by the purchaser is
very different from that stated in the testimony of Mr. Cadorette or the calculation
of Mr. Ouellet.
[60]
In the appendix of Exhibit
A-4, we notice that for the restaurants in issue, with the exception of those
on St-Joseph Street and at Place Québec, the purchaser saved
about $30,000.
[61]
As for the restaurants on
St-Joseph Street and at Place Québec, the franchise fees
are zero. That cannot be explained by a credit to the purchaser for the
remaining period of the appellant's franchise rights, as at Place Québec the franchise
right reached its maturity date at the end of January 2001, and on St-Joseph Street, it expired in November 2003. There must be
other reasons that have not been adduced in evidence. As a result,
the fact that there are no franchise fees for the two restaurants cannot be
attributed to a credit for what the appellant already paid for.
[62]
In any case, the only
true savings for the purchaser consisted in the reduction of $30,000 in franchise
fees. The value to be attributed to the franchises is therefore $30,000.
[63]
Considering my findings
on the value of the leasehold improvements, installation and franchise rights, the
value of the goodwill must necessarily be $275,000.
CONCLUSION
[64]
The appeal is allowed
and the matter is referred back to the Minister of National Revenue for
reconsideration and redetermination on the basis that the sales price of $675,000 must
be allocated as follows:
(a) leasehold improvements:
$180,000,
(b) installation: $190,000,
(c) franchise rights: $30,000,
(d) goodwill: $275,000.
[65]
Prior to signing the judgment,
I would ask the parties to inform the Registry within 30 days from the date
of the Reasons if they wish to make any observations pertaining to the fees, either
in writing or by conference call. I will sign the judgment thereafter.
Signed at Ottawa, Canada, this 29th
day of December 2009.
"Gaston Jorré"
Translation certified true
on this 8th
day of June 2010.
François Brunet,
Revisor
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