Citation: 2006TCC670
Date: 20061208
Docket: 2003-1778(GST)I
BETWEEN:
LIONS VILLAGE OF GREATER EDMONTON SOCIETY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1] Lions Villageof Greater Edmonton Society (LionsVillage) built and operated two senior housing complexes in Edmonton- the Castledowns complex and the Railtown complex. Upon receiving professional advice about the self-supply rules in section 191 of the Excise Tax Act (the Act), Lions Village retained two appraisers, had the properties appraised and, based on the appraised fair market value (FMV) of the properties, submitted the required tax pursuant to subsection 191(3) of the Act. The Minister of National Revenue (the Minister) reassessed, rejecting Lions Village's appraised values, basing the tax required pursuant to subsection 191(3) on the actual costs of the two complexes. The issue is what value should be attached to the two complexes for purposes of the tax exigible pursuant to subsection 191(3). I find that the Appellant has been unable to demolish the Minister's assumptions.
Facts
[2] The former treasurer of LionsVillage, Mr. B. Berlin, testified that the property in which the Castledowns complex was built was leased from the City of Edmontonon a 40-year lease, with two 10-year extensions. The City attached a caveat to the property reflecting the City's restrictive covenant, restricting the use of the property for purposes of "public non-profit rental housing", meaning "the provision of residential accommodation on a non-profit rental or lease basis for low and moderate income senior citizens or disabled persons".
[3] LionsVillage entered a joint venture agreement with Christenson Developments Ltd., which provided the development and construction, as well as certain financial guarantees. The Castledowns complex was substantially completed in March or April 2000 and fully occupied by late summer or early fall of the same year.
[4] The Railtown complex was also constructed in a joint venture with Christenson Developments Ltd., but unlike Castledowns, was built on land owned by LionsVillage. It was substantially completed in 2001.
[5] The deal between the residents of the complexes and LionsVillage was governed by a lease agreement and a loan agreement, collectively forming what is called a life-lease arrangement. The loan agreement provided that the resident was required to lend to Lions Village an amount on an interest free basis repayable on the earlier of:[1]
4.1 the termination of the Lenders Tenancy in respect to the Leased Premises for whatever reason;
4.2 the bankruptcy or receivership of the Borrower;
4.3 the sale or transfer of the Lands and Project by the Borrower;
4.4 the nonfulfillment of any of the conditions precedent in the Tenant's Offer to Lease the Leased Premises by the date stipulated in the Offer to Lease.
5. Notwithstanding the provisions of paragraph 4 above, it is understood and agreed that in the event that the Lender should die or be permanently hospitalized or otherwise unable to take possession of the Leased Premises, then the principal sum shall be repaid to the Lender within ninety (90) days from the date that an Occupancy Permit is issued from the City of Edmonton in respect of the Leased Premises.
[6] Mr. Berlin testified that the amount of the loan was determined according to the unit's proportionate share of the cost of building the project, referred to in schedules provided at trial as the unit value.[2] For Castledowns, the schedule indicated a total unit value of $8,297,206. For Railtown, the schedule indicated a total unit value of $5,192,871.
[7] I conclude from these figures that the actual cost of the projects was approximately $13,490,077.
[8] The lease agreement provided in part for the following:
(i) the term was for life, with earlier termination on notice by the resident;
(ii) the resident was obliged to pay a proportionate share of operating expenses; and
(iii) the resident was obliged to pay "rent" of an amount equal to the Lions Village's principal interest payments attributed to Lions Village's equity in the unit (the equity being the unit value less the amount actually loaned by the resident). So, if the resident loaned the full unit value to Lions Villagethere would be no "rent" due.
The effect of the loan agreement and lease agreement was that on death, or earlier termination, the loan would be repaid and LionsVillage could obtain a new tenant under the same arrangement.
[9] With respect to both Castledowns and Railtown, Mr. Berlinindicated that Lions Villagesought advice regarding the application of the Excise Tax Act. Lions Villagewas advised that subsection 191(3) required a determination of tax based on a self-supply at the FMV of the property. LionsVillage accordingly obtained appraisals from Wall and Associates when the complexes were substantially complete. Mr. G. Downey of Wall and Associates provided an appraisal of Castledowns, indicating a FMV as at March 6, 2000 of $4,100,000. Mr. J. Wall, of Wall and Associates, provided an appraisal of Railtown indicating a FMV of $5,166,000 as at April 1, 2001. Tax was then reported at 7% of 90% of $4,100,000 and 7% percent of $5,166,000.
[10] The Minister did not provide an appraisal report at trial. The Canada Revenue Agency (CRA) auditor, Mr. C. Antulov, testified that the Minister's assessment was determined with a view to recovering the input tax credits (ITCs) claimed by Christenson Developments Ltd. of $867,747. So, briefly, what the auditor did was extrapolate from the ITCs of $867,747 the actual costs of construction incurred by Christenson Developments Ltd. on the two projects of $13,264,146. This figure was then relied upon by the Minister to determine the tax exigible from Lions Villagepursuant to subsection 191(3), being the $867,747 the Respondent wished to recover. This is an approach akin to section 191.1, which was not raised in the appeal, presumably as no government funding was involved.
[11] It is not surprising to note that the $13,264,146 cost figure so determined is close to the $13,490,077 amount, taken from Lions Village's schedules of loans from the residents referred to earlier. This confirms Mr. Berlin's view that the loan from the residents was intended to cover the construction costs of the projects. The CRA auditor indicated he was not provided with sufficient information from Christenson Developments Ltd. to break down the costs between the two projects.
[12] LionsVillage introduced at trial the City of Edmonton's Annual Realty Assessment and Taxation Notice for 2002 for the Castledowns complex.[3] It indicated an assessment amount for that complex of $4,424,000. This assessment amount was introduced with the following statement on the City's Assessment Notice:
This is the assessed value as established by the City based on market conditions. This is the most probable value your property would realize if sold in the open market.
[13] The following are some highlights from Mr. Downey's appraisal of the Castledowns project at $4.1 million:
(i) This appraisal is being completed on the basis of the property being a rental project on leased land from the City of Edmonton and excluding the "home for life" concept and the related monetary investments by the tenants and the existing caveat registered on the Title regarding the use of this site.
(ii) This Appraisal has been completed on a hypothetical basis for the purposes of GST. The actual market value of this site considering the restrictions as set out on the Title, restricting the use to providing residential accommodation on a non-profit rental or lease basis, for low and moderate income senior citizens or disabled persons together with all ancillary sports, fitness, recreation and health services would be different and the user is cautioned not to use this report for other purposes.
(iii) Market value is defined as follows:
The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing title from seller to buyer under conditions whereby:
1. buyer and seller are typically motivated;
2. both parties are well informed or well advised; and acting in what they consider their best interest;
3. a reasonable time is allowed for exposure in the open market;
4. payment is made in terms of cash in Canadian dollars or in terms of financial arrangements comparable thereto; and
5. the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
(iv) Highest and Best Use
The principle of Highest and Best Use is fundamental to the concept of value in real estate. It may be defined as "that use which at the time of appraisal is most likely to produce the greatest net return over a given period of time". Net return may be monetary or sometimes takes the form of amenities. In establishing Highest and Best Use consideration must be given to the physical and functional characteristics, legal restrictions, and economic considerations relating to marketability and financial viability.
The Highest and Best Use for the subject property either vacant or as developed is for multiple family residential purposes.
(v) In valuing this property both the Income Approach and the Cost Approach will be used with the greatest reliance on the Income Approach as it is by this method used by most investors. The Sales Comparison Approach will not be used because there are insufficient sales of similar properties in the market place to provide an estimate of value by this method due to most apartment buildings being sold being in the 20 to 30 year old range. It has been considered uneconomical to construct new buildings for rental purposes, as the rents that can be achieved in the market place will not support the cost to construct.
(vi) The replacement costs of this building have been determined by the actual costs less an adjustment for certain marketing pertaining to the "home for life" concept and certain preliminary architectural fees that were paid but were not used in the development of this building as well as any costs attributable to the portion of the site for future development. The construction costs with the contractor being Christenson Developments Ltd. who are well known and experienced developers of this type of construction, were $5,196,139 plus soft costs totalling $780,038 for a total of $5,976,177.
(vii) Income Approach: Gross Income $702,107
Expenses:
|
Land Rent
|
$40,723
|
|
|
Property Taxes
|
77,760
|
|
|
Insurance
|
6,912
|
|
|
Common Utilities
|
36,288
|
|
|
Common Area Maintenance
|
12,096
|
|
|
Waste Removal
|
3,456
|
|
|
Administration & Office
|
9,504
|
|
|
Site Manager
|
17,280
|
|
|
Maintenance Reserve
|
37,152
|
|
|
Management (5.0% EGI)
|
35,105
|
|
|
|
|
|
Total
|
$276,276
|
|
Net Operating Income:
|
$425,831
|
|
Capitalized @ 10.5%
|
$4,055,533
|
|
|
|
|
Indicated Value by the Overall Capitalization Method (rounded)
|
|
|
|
FOUR MILLION FIFTY FIVE THOUSAND ($4,055,000) Dollars
|
Mr. Downey testified that he used a higher than average 9% capitalization rate to reflect the property was on leased land.
(viii) The estimated values are as follows:
· Cost Approach $5,975,000
· Income Approach $4,100,000
The Cost Approach exceeds market value due to the fact that this property was not constructed for normal market rental purposes as has been set out previously in this report. The Income Approach was arrived at by both the Overall Capitalization Method and the Mortgage Equity Analysis which provide an excellent indication of market value for the subject property.
[14] The following are highlights of Mr. Wall's appraisal on the Railtown project of $5,166,000.
(i) The appraisal is completed on the basis of the property being a rental project, excluding the "Home for Life" Life Lease Concept, and related monetary investments by the tenants.
(ii) Mr. Wall relied on a similar definition of market value as relied upon by Mr. Downey.
(iii) ".... it is my opinion the Highest and Best Use for the subject land is split into a site for the existing development on the most northerly 40,377 sq. ft., while the Highest and Best Use for the balance is its existing use as roadway to provide access to improvements to the south."
(iv) Both the Cost and Income Approaches will be utilized in valuing the subject property, with particular emphasis placed on the latter. A thorough investigation failed to locate a sufficient number of truly comparable multi-family rental complexes which have sold, and which could be utilized in valuing through Direct Comparison.
(v) Based on the replacement cost approach, Mr. Wall provided an appraised value of $6,820,000.
(vi) Based on a gross annual income of $720,528 and expenses of $232,830, and relying upon a capitalization rate of 8.5%, Mr. Wall came up with an appraised value of $5,740,000 (90% of which yields $5,166,000).
(vii) There is a substantial difference between the values indicated by the two Approaches (Income is approximately 84% of cost) dues to this type of property's (multi-family) inability to generate sufficient net annual income to satisfy the investment in land and improvements. It is my opinion an investor investing in this type of property would be concerned with income and returns, and give very little if any consideration to the cost to create. Therefore, the value indicated by the Income Approach will be relied upon to indicate the Market Value of the Subject Property.
[15] Mr. Wall testified that his instructions were to appraise on the basis of a rental property, but in his opinion the effect of considering the life-lease concept would be to reduce the value determined on a rental basis.
Issue
[16] The Respondent phrases the issue as: what was the fair market value of the complex? As will be clear from the following reasons, the issue might more properly be framed as follows: Has the Appellant demolished the Minister's assumption that actual cost represents FMV for the purposes of applying the self-supply rules in subsection 191(3) of the Excise Tax Act?
Analysis
[17] Subsection 191(3) of the Excise Tax Act reads as follows:
For the purposes of this Part, where
(a) the construction or substantial renovation of a multiple unit residential complex is substantially completed,
(b) the builder of the complex,
(i) gives, to a particular person who is not a purchaser under an agreement of purchase and sale of the complex, possession of any residential unit in the complex under a lease, licence or similar arrangement entered into for the purpose of the occupancy of the unit by an individual as a place of residence,
(i.1) gives possession of any residential unit in the complex to a particular person under an agreement for
(A) the supply by way of sale of the building or part thereof forming part of the complex, and
(B) the supply by way of lease of the land forming part of the complex or the supply of such a lease by way of assignment, or
(ii) where the builder is an individual, occupies any residential unit in the complex as a place of residence, and
(c) the builder, the particular person or an individual who is a tenant or licensee of the particular person is the first individual to occupy a residential unit in the complex as a place of residence after substantial completion of the construction or renovation,
the builder shall be deemed
(d) to have made and received, at the later of the time the construction or substantial renovation is substantially completed and the time possession of the unit is go given to the particular person or the unit is so occupied by the builder, a taxable supply by way of sale of the complex, and
(e) to have paid as a recipient and to have collected as a supplier, at the later of those times, tax in respect of the supply calculated on the fair market value of the complex at the later of those times.
[18] It is easy to understand the Respondent's position, as succinctly put by the CRA auditor: "we just wanted to recover the ITCs". The way to do that was to impose subsection 191(3) on the basis of the costs incurred. This may well be how CRA supposes the mechanism of GST legislation should operate on a well-oiled no-leakage basis, and the mechanics will so operate if actual costs are the best indicator of FMV; for it is FMV that triggers the tax pursuant to subsection 191(3). Certainly, LionsVillage knew their actual costs and indeed, the schedules provided by Lions Villagereflected the costs close to that relied upon by CRA. But are costs reflective of FMV?
[19] The frustration in grappling with FMV in a case such as this is the lack of market, and the lack of an appreciation of the bundle of rights constituting the complex, where the complex is subject to a life-lease arrangement. In other words, is the complex just the bricks and mortar, the value of which is to be determined on the highest and best use basis; or is the complex the bricks and mortar plus the rights and obligations pursuant to the loan, lease and in the case of Castledowns, the restricted covenant? What is being marketed as the complex?
[20] The CRA simply assessed on the basis of actual costs, assuming this was equivalent to FMV for purposes of subsection 191(3). The appraisals for LionsVillage were carried out on a rental basis, ignoring the very nature of the properties and consequently, relying on an income approach to valuation. I do not fault the appraisers, as those were their instructions. Neither party attempted, however, to determine the FMV based on the fact that this property was operated on a not-for-profit life lease arrangement. As Justice Pelletier indicated in Villa Beliveau Inc. v. Canada,[4] a similar case on the issueof the FMV of this type of arrangement:
The fact of ignoring the effect of the leases is not trivial ...
The appraiser's decision to appraise the complexes on the basis of the fee simple, as opposed to the leased fee, was not questioned in these proceedings and as a result, we are not called upon to decide whether it was justified. Consequently, I express no opinion on that question and leave it to be decided in a case where it is argued.
[21] In Villa Beliveau, the Federal Court of Appeal accepted the findings of the Tax Court of Canada that the Respondent's appraiser offered the most appropriate appraisal based on the cost approach, on the basis that the highest and best use was a construction of the complex as a life-lease complex. As is clear, I have reservations about the approaches taken by both sides in this matter. I shall explore the Appellant's appraisal first. Both Mr. Downey and Mr. Wall relied on the income approach. This is understandable given instructions from the client that the life lease be ignored. What is left is the bricks and mortar. The appraisers could then readily go through the standard steps for determining value based on income. I accept Mr. Wall's conclusion that $5,740,000 is the correct result for an income valuation of the complex, if it was used as a rental complex. Oddly, this is not the highest and best use he identified, as he identified the existing use as the highest and best use. I have to ask what help is a valuation based on a use which is not the highest and best use.
[22] Mr. Wall also relied on the cost approach, finding a value of $6,820,000. Again, I take no issue with this methodology in coming to that value, though note that he acknowledged he was aware of the actual costs but opted to rely on replacement costs following the Marshall Costing System.
[23] Mr. Downey's reliance on the income approach was more consistent in that he identified the highest and best use was for multiple-family residential purposes. This clearly ignores the reality that the property was restricted from being used for that purpose. There was no evidence that the complex could be sold on the basis that it could be converted to either condos or rental: the evidence was just the opposite. Again, I question the appropriateness of an income valuation for a property restricted from being used to generate income. It just is not a lot of help.
[24] With respect to Mr. Downey's cost approach to Castledowns, I have difficulty reconciling his replacement cost value of $5,976,177 with actual costs of approximately $8.2 million. There is some significant disconnect here.
[25] What about the Respondent's reliance on actual costs? The Respondent provided no appraisal report that actual costs are the most valid criteria for valuating a complex subject to the life lease concept. The Respondent's approach was simply to recover the ITCs: if it costs $13 million to build the complexes that is then the FMV for purposes of applying subsection 191(3). The Respondent then refers to the Villa Beliveau decision and argues that valuing complexes such as this based on costs is the correct and accepted approach.
[26] The cost approach reflects the cost of construction. If another not-for-profit entity wanted to build a complex to be structured on the life-lease concept, what would it cost to build? This seems sensible enough at first glance, but only if the complex was going to be sold as condos or rented as units. In those two situations, the owner is unencumbered by any obligation that might impact on the sale price or the rental income. So, the cost of construction reflects what a reasonable investor presumes can be recovered plus some additional amount, yielding a reasonable return. At least in that situation cost does bear some relation to value, as it is part of what the owner has put out and seeks to recover.
[27] In a life lease, what has the owner invested? The owner has borrowed from the tenants with no obligation to repay until in a position to borrow from someone else (the new tenant) an amount no less than the amount necessary to pay out the former tenant's loan. The cost to the owner in reality is minimal: there is little or no cost to recover. Another not-for-profit entity looking to build a similar complex is not, in the conventional sense, investing millions of dollars in construction. It is effectively serving only as a middleman. In these circumstances, how can cost of construction reflect the FMV that a motivated buyer would be prepared to pay LionsVillage for its interest in the complexes. All to say I have misgivings regarding the correctness of the actual cost approach.
[28] What appears to be missing from all these approaches is attention to what I thought was at the root of a property valuation: what would a motivated buyer pay to Lions Village to acquire the complexes, which come with the loans and leases as part of the packages? This is not an economics exercise, where one is afforded the luxury of considering methods on the basis of "everything else being equal". Everything is not equal. The complexes are not rental units. The complexes are not condos. They are neither fish nor fowl. Why have the appraisers not properly addressed this? Why, if the Government's goal is simply to recover ITCs in a not-for-profit situation, have the legislators not more extensively addressed this issue, beyond simply section 191.1?
[29] What can I conclude? First, with respect to Railtown, as the Respondent has acknowledged that $5,192,871 accurately reflects the cost of the complex, based on evidence tendered at trial, and as the appraiser for Lions Village has put forth a very similar value of $5,166,000, then notwithstanding, I have reservations about both approaches, I conclude that no adjustment is required to the Minister's assessment as it pertains to Railtown. I do recognize that the Minister did not break down the assessment between the two complexes.
[30] Second, with respect to Castledowns:
(i) the highest and best possible use cannot, as suggested by the Appellant's appraiser, be for rental units, as the complex is restricted from being used as such; therefore the income approach is not helpful.
(ii) the Appellant has provided a FMV of $5,975,000 using the cost approach, based on actual costs of the developer, Christenson Developments Ltd. Schedule R-1 lists unit value of Castledowns' unit as $8,297,206, which supposedly reflects the costs of construction. I am simply unable to reconcile Mr. Downey's appraisal based on actual costs of $5,975,000 and the Appellant's schedule suggesting actual costs were $8,297,206.
(iii) The City of Edmonton's assessment based on market conditions and reported to be the most probable value of Castledowns if sold on the open market is $4,424,000. There is no indication whatsoever on what basis the City presumed the complex could be sold.
[31] The Minister has implicitly assumed that the actual costs of Castledowns was the basis on which to determine value. The Appellant has not demolished that assumption because:
(a) its appraisal specifically ignored the impact of the life lease concept;
(b) the appraisal's income approach was inappropriate;
(c) the appraisal's cost approach was irreconcilable with actual costs; and
(d) the City assessment lacked any explanation or support.
Further, Mr. Wall's bald statement that the effect of the life-lease concept on value is to reduce the value determined on an income basis, is not sufficient to displace the Minister's assumption.
[32] While I might conjecture as to what would be a more realistic approach to the valuation of a life-lease complex, it would be inappropriate for me to do so without some evidence from either party on alternatives to the standard income or cost approach. I received no such representations. I share Justice Pelletier's frustration as expressed in Villa Beliveau. I suggest that the answer does not rest with the appraisal industry, but with Parliament. Parliament addressed this area by enacting section 191.1, but that section is limited in its application. If the Minister, as contended by the CRA auditor, assessed simply on the basis of recovering ITCs, then the Minister should consider having that position clarified legislatively, rather than having taxpayers struggle with establishing the FMV of a property that practically does not have a market.
[33] I fear costs may not represent FMV, so it is with some reservation that I dismiss the appeal. As I hope is clear, I do so on the basis that the Appellant has not met the burden of demolishing the Crown's assumptions, not on the basis that actual costs represent the correct approach to valuing life-lease complexes. I have not heard convincing argument on that score. The appeal is dismissed, but without costs. Given that LionsVillage took the necessary steps to obtain appraisals and submitted the tax based on those independent appraisals, and given that the Respondent did not provide evidence that costs truly reflect FMV, I am not prepared to award costs against Lions Village.
Signed at Ottawa, Canada, this 8th day of December 2006.
"Campbell J. Miller"
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