Godcharles v. Agence du revenu du Québec, 2020 QCCQ 2219, aff'd 2021 QCCA 1843

The taxpayers were a corporation (“9118”) and its eight individual shareholders who co-owned a fully-occupied retirement residence whose business was carried on by 9118. Two days before the sale referred to below, a corporation (“9084”) owned by one of the individuals (“Godcharles”) purchased the shares of the other shareholders of 9118. The retirement residence (treated as consisting most relevantly of the immovable and the goodwill) was sold to a limited partnership (“Anjou LP”) for a global purchase price of $11.55 million whose allocation was to be as subsequently determined (which occurred at the time of filing the returns, with the parties treating all of the appreciation in the sold assets as pertaining to the goodwill belonging to 9118 rather than to the immovable - which thus was lower than a valuation previously provided for financing purposes.) The partners of Anjou LP were not disclosed in the reasons for judgment, but presumably overlapped considerably with the taxpayers. There was a voluntary dissolution of 9118 before the hearing of this appeal.

The ARQ treated the proceeds for goodwill received by 9118 as being reduced to $2.1 million, and accordingly reassessed to (i) increase the taxable capital gains realized by all the taxpayers (i.e., from the disposition of the immovable), (ii) include recapture of income for 9118 and five of the individuals, (iii) reduce the capital gain from the eligible capital amount from the disposition of goodwill for 9118, and (iv) in the case of one of the individual co-owners who also was a shareholder of 9118 (“Godcharles”), treat a purported capital dividend received by him as a grossed-up taxable dividend.

In finding that the TA s. 422(c)(i) (equivalent to ITA s. 69(1)(b)(i)) could be applied to the sale of the immovable, Quenneville, J.C.Q stated (at paras. 88-91, TaxInterpretations translation):

It is reasonable to conclude that all of the plaintiffs had a common purpose and acted in concert. …

Splitting the ownership of the building and the ownership of 9118, which continued to operate the [residence], had only one goal, to minimize the taxes payable.

Also, how else to explain that they agreed to sell their shares in 9118 without knowing the price that would be paid to them?

The evidence shows that Mr. Godcharles was the sole director of all aspects of the transaction, from the purchase of the land in 2002 to the sale in 2006, with all the other plaintiffs seemingly absent from the entire negotiation.

Quenneville, J.C.Q largely confirmed the ARQ assessments respecting the allocation of the sale of a retirement home - by the individual owners of the home (which had reached full occupancy three years' previously) and the corporate operator (jointly owned by them until two days before the sale) of the home - as between the real estate and goodwill portions of those assets. In particular, she accepted the valuation of the immovable by the ARQ valuator using the cost method (i.e., the costs of construction, plus a promoter’s notional profit of 5%, plus net GST/QST of 9.495%, minus depreciation of 4% and plus the land appreciation since purchase), with there being a consequential reduction in the residual amount to be allocated to the goodwill.

A retirement home was co-owned by eight individuals and operated by a corporation of which they were the shareholders. The home and operating business were jointly sold for a global purchase price to a limited partnership whose owners apparently were for the most part those individuals, with the allocation of the purchase price not yet determined. This was done at the time of filing their tax returns: all of the appreciation in the sold assets over their costs was treated as being goodwill (sold by the operator) rather than appreciation in the immovable.

The sale clearly would have been a non-arm’s length transaction but for the fact that a corporation (“9084”) owned by one of the individuals (“Godcharles”) purchased all the shares of the operator from the other shareholders two days before the retirement home business sale. Without attaching any apparent significance to the purchaser being a limited partnership rather than a co-ownership, Quenneville, J.C.Q found that the sale transaction of the retirement home and the related goodwill was one between persons who were acting in concert (and, thus, not dealing at arm’s length), given inter alia that the sale of the others’ shares to 9118 was agreed to by them without knowing the price that would be paid and, more generally, that the evidence showed “that Mr. Godcharles was the sole director of all aspects of the transaction, from the purchase of the land in 2002 to the sale in 2006, with all the other plaintiffs seemingly absent from the entire negotiation.”

As this (partial) roadblock to the ARQ applying the Quebec equivalent of s. 69(1)(b) to the sale was removed, Quenneville, J.C.Q largely confirmed the ARQ assessments of the individuals for missing capital gains and recapture of depreciation in their returns (and Godcharles for receiving an ordinary dividend rather than a capital dividend from the operator).