J. Allen Carr v. Minister of National Revenue, [1993] 2 CTC 3018, 94 DTC 1067

Brulé, T.C.C.J.:—This appeal involves assessed tax and interest in the income of the appellant for the 1982, 1983, 1984 and 1985 taxation years. Three separate matters were under appeal:

1. the V-Day value of shares of Pine Pass Coal Company Ltd. ("Pine Pass");

2. the determination of whether or not the appellant had an allowable business investment loss on the disposition of his shareholder loan in Symposium Restaurant Ltd.; and

3. unreported revenue from the appellant's law practice in 1982 and 1984.

During the trial the appellant abandoned his appeal respecting items 2 and 3 above, leaving only the value of his shares in Pine Pass as at December 31, 1971 in issue.

Facts

The appellant is a lawyer in the City of Vancouver who at December 31, 1971 (V-Day) owned 300 shares in Pine Pass. In 1965 Pine Pass was incorporated and obtained licences permitting the exploration and development of a coal property in north-east British Columbia.

Pine Pass entered into an agreement with Brameda Resources Ltd. (Bra- meda) to explore and develop the area covered by the Pine Pass Licences. This was on June 6, 1969. A new agreement between the same parties was entered into on July 21, 1970. The most salient feature of this second agreement was that Pine Pass was to receive a royalty of 0.15¢ per ton on any coal produced by Brameda in the area covered by the licences.

The appellant elected to have the cost of his shares in Pine Pass to be the fair market value at V-Day. He sold 100 of his shares in 1977 for $750 per share. The sale was not reported by the appellant in his 1977 income tax return. In 1980 he engaged a Dr. Guthrie, a professional business valuator, to value the Pine Pass shares as of V-Day. Dr. Guthrie valued the shares at $1,800 per share. This meant that the appellant had suffered a loss on the sale at $750 per share.

In a letter dated December 29, 1980 the appellant's accountant requested a reassessment of his 1977 tax year in order to add in the losses. Revenue Canada reassessed for the year and sent out form T7W-C agreeing to the valuation set by Dr. Guthrie. Subsequently Revenue Canada claimed that the reassessment was made due to a clerical error.

In 1983 the appellant sold his remaining shares for $2,319.75 per share thus causing a capital gain over and above the $1,800 per share original figure. This sale was duly reported.

On April 26, 1986 the Minister advised the appellant that there would be an additional reassessment on the basis that his adjusted cost base should be $700 per share instead of $1,800. This meant that the sale of shares in 1977 would actually have resulted in a capital gain rather than a loss, and a larger gain derived from the 1983 sale.

Appellant's position

First of all counsel for the appellant felt that once Revenue Canada had agreed to the valuation of $1,800 per share they could not introduce another figure later. At the same time in support of Dr. Guthrie’s valuation, an expert report was submitted and evidence given by a Stephen W. Semeniuk C.F.A. who was qualified by the Court to give opinion evidence on the basis of being an expert in the coal mining field and the stock market as related to coal mining shares. Mr. Semeniuk reviewed the facts and concluded that, if anything, Dr. Guthrie’s value was low. The appellant, however, was prepared to rest his case on the $1,800 per share valuation.

Minister's position

Counsel for the Minister stressed that he was not bound by the assessments of previous years nor the value of the shares of Pine Pass contained therein. As a result a new reassessment with a new value was produced.

As to the value itself of the shares an expert valuator from Revenue Canada, Dennis Turnbull produced a report in which he concluded that the proper V-Day value of the shares should be $1,125 per share. Mr. Turnbull proceeded on the basis that the proper method for valuing the future revenue potential of the agreement was to determine the present value of the after-tax cash flow from the anticipated royalty payments. This, he said, could be calculated by estimating the future production of coal from the area and then calculating the resulting royalty stream based on the payment of 0.15¢ per ton. The key factors to be considered were the timing, the amount of coal production and an appropriate discount rate to be applied. The discount rate is determined by risk and the time value of money. The result, in his opinion, of applying these factors was a share value of $1,125.

Analysis

Before proceeding with the Court's decision as to the V-Day value of the Pine Pass shares let me dispose briefly of the Minister's right to reassess on a basis different from the original assessment. It is clear from the case of Sogemines Development Co. v. M.N.R., [1972] C.T.C. 284, 72 D.T.C. 6254 (F.C.T.D.); aff'd [1973] C.T.C. 383, 73 D.T.C. 5304 (F.C.A.) that the Minister can take one position in one year's assessment and then take another position in subsequent years. There is no res judicata applicable in such a case.

This point was reiterated in Cohen v. The Queen, [1978] C.T.C. 63, 78 D.T.C. 6099 (F.C.T.D.); aff'd [1980] C.T.C. 318, 80 D.T.C. 6250 (F.C.A.). This case dealt with a situation where the Minister had taken a contrary position in the past to the one that was adopted in the reassessment. The Minister is entitled to assess and reassess by statute, not by what has been agreed upon in the past.

The most important consideration in this appeal is the valuation of the shares. Different opinions were expressed in evidence and we find the following:

1. Dr. Guthrie's letter of opinion dated August 30, 1980, valuing the shares at $1,800;

2. an estimate by a Dr. Penman used by Revenue Canada as a basis for reassessment of $700 per share;

3. an evaluation by Mr. Turnbull expressing his opinion that the Dr. Penman value was to be preferred to that of Dr. Guthrie;

4, the Semeniuk valuation of July 5, 1993 which endorses Dr. Guthrie's basic conclusions, but suggests that the shares should be valued at $2,100 or more;

5. Mr. Turnbull’s conclusion that the shares are worth $1,125 each;

6. a figure of $1,366 per share which was indicated at trial was the basis of a settlement with another shareholder.

It is interesting to note that in the reply to the notice of appeal it was pleaded that a "clerical error" resulted in the 1977 return being reassessed as requested. No further evidence of this was given at the trial, only a mention by counsel. Such a statement, without some form of justification, cannot be accepted by the Court.

Valuing a royalty interest as of V-Day when no payment had yet taken place does not present an easy solution. Pronouncements to this end have been made before. One such case which bears repeating is found in Attridge v. Canada, [1991] 1 C.T.C. 247, 91 D.T.C. 5161 (F.C.T.D.) wherein Muldoon, J., at page 269 (D.T.C. 5178), adopted the words of Lambert, J.A., in Cyprus Anvil Mining Corp. v. Dickson (1986), 8 B.C.L.R. (2d) 145, 33 D.L.R. (4th) 641 (B.C.C.A.). There Mr. Justice Lambert, J.A., said at page 158 (D.L.R. 52) of the report:

It is not necessary for me to analyze those cases or to quote from them. [Jurisprudence written by Macfarlane, J. in which he considered certain U.S. cases.] The point that they emphasize is that the problem of finding fair value of stock is a special problem in every particular instance. It defies being reduced to a set of rules for selecting a method of valuation, or to a formula or equation which will produce an answer with the illusion of mathematical certainty. Each case must be examined on its own facts, and each presents its own difficulties. Factors which may be critically important in one case may be meaningless in another. Calculations which may be accurate guides for one stock may be entirely flawed when applied to another stock.

The one true rule is to consider all the evidence that might be helpful, and to consider the particular factors in the particular case, and to exercise the best judgment that can be brought to bear on all the evidence and all the factors. I emphasize; it is a question of judgment. No apology need be offered for that. Parliament has decreed that fair value be determined by the courts and not by a formula that can be stated in the legislation.

In a V-Day valuation case it is proper to consider events as they existed on December 31, 1971, and I have attempted to exclude any factors which the experts introduced after this date.

In National System of Baking of Alberta Ltd. v. The Queen, [1978] C.T.C. 30, 78 D.T.C. 6018 (F.C.T.D.); aff'd [1980] C.T.C. 237, 80 D.T.C. 6178 (F.C.A.), Mahoney J., in the trial division, said at page 38 (D.T.C. 6024):

I expressly rejected the validity of hindsight as probative of fair market value at a given date and took nothing that occurred after valuation day into account.

As a background to arriving at a fair valuation it is interesting to follow the assumptions made by Dr. Guthrie in his report. They helped in forming his opinion and are reproduced as follows:

(i) It is inappropriate to use retrospective evidence; we must put ourselves in the position of a prudent investor at the valuation-date.

(ii) The changing value of the dollar must be ignored for the purposes of this valuation.

(iii) The Company, at the valuation-date had no contingent liabilities, unusual contractual obligations, substantial commitments or litigation pending or threatened.

(iv) It had been established that ample coal reserves existed; to quote for example, from Brameda Resources Ltd.'s Annual Report 1970, "the results of this (exploration) work outlined approximately 80,000,000 long tons of excellent quality coking coal, with a geological projection exceeding 100,000,000 tons.”

(v) It seemed clear from various news releases that, by 1976, mining and shipping would reach two million tons per year. For example, the July 31, 1971 George Cross News Letter revealed that Brameda Resources Ltd. had already spent $1.6 million on exploration and had signed a letter of intent with Teck Corp. and Mikas Oil Co. (a wholly owned subsidiary of Brascan Ltd.) for continued development of the Sukunka coking coal project. These agreements were subsequently concluded, according to the August 25, 1971 issue of the Journal of Commerce.

(vi) The royalty agreement between the company and Brameda Resources Ltd. was sound and would be honored, based on the evidence that the initial $35,000 and $50,000 payments had been made on schedule.

(vii) The royalties would be received monthly, evenly throughout the year and corporate income taxes would be paid annually, six months after the company’s year-end. Any interest charged by Revenue Canada-Taxation would not be material.

(viii) The 18 coal licences held by the company are redundant to the royalty agreement and have a cash value of $2,500 each (which would be treated as a capital gain for tax purposes).

(ix) The royalty income would be treated for tax purposes as income other than from an active business and subject to a combined corporate rate of 51 per cent.

(x) The $100,000 would be received as per the agreement, at the start of major construction of the mine and would be treated, first, as a return on capital (up to the amount of the deferred exploration, development and administrative expenditure) and, second, as business income.

(xi) No sale of shares and no other valuation of the shares has been made, which would aid in establishing the December 31, 1971 shares value.

(xii) A prudent investor would perceive little risk in the receipt of future cash flows because the royalty agreement seemed sound (see (vi) above) and the market potential for western coal was well known (see, for example, The Bank of Nova Scotia, Monthly Review, November 1970).

(xiii) Production and shipment of two million tons per year by 1976 would have seemed to be a conservative estimate because exploration programs were well advanced (for example, the B.C. & Yukon Chamber of Mines report of January 31, 1971 indicated that ecological studies and water tests had already been conducted) and various news releases were indicating a much earlier date for contracted production (for example, Metal News, July 24, 1971, had reported plans for two million tons from "around 1973" and had outlined Japanese participation). In the Fall of 1971 there were many news items about Japanese negotiations on coal (see, for example, the September 1971 issues of The Japan Echo).

(xiv) It would have been logical to expect, in future, greater than two million tons per year would be shipped because the coal was available, world demand existed, coal ports invoke pressure for high tonnages, and knowledgeable people in the industry suggest that four million tons per year is a viable level of operation in an area like the Sukunka coal fields.

(xv) Transportation would not have seemed to be a serious constraint, because of British Columbia Premier W.A.C. Bennett's well publicized plans to utilize B.C. rail facilities, the existence of Neptune Terminals in North Vancouver, the possible Prince Rupert alternative, and the fact that up to 1-1/2 million tons could be hauled by truck.

(xvi) In addition to the above-described relative certainty of payback, a potential investor would be attracted by the possibility that total tonnages might be even greater than projected. This expectation would have been fostered by the Southeastern British Columbia coal experience and the typical mining situation where what is eventually proven up far exceeds the reserves announced in advance of development.

(xvii) The corporate form would remain unchanged over the life of the royalty payments. This assumption tends to dampen the value of the shares, because steps could be taken by the shareholders to lessen the incidence of corporate and personal taxation on the royalty income.

(xviii) The company would remain an inactive conduit for what is essentially an annuity of payments. In fact, the shareholders planned to use the proceeds to engage in active operations which would involve salaries, etc. and probably reduce the amounts of corporation tax payable. (The annuity assumption could be used to justify a discount rate of eight per cent, which would yield a value at December 31, 1971 in excess of $2 million).

Dr. Guthrie then went on to apply a discount rate from the information he obtained. Taking into consideration such items as bank and mortgage rates of return he selected a discount rate of ten per cent which resulted in his valuation.

The one vital criticism of this report would seem to be the estimate of the coal reserves obtained from Brameda's annual report in 1970. The figures as in

(iv) above are high in comparison to other reports and articles published before V-Day. A lower estimate would result in a lower value per share.

The other major report was that submitted by Mr. Turnbull. He used reserve coal figures lower than the estimates provided by Brameda. His calculations were based on certain reports which he adapted and arrived at reserves of some 45,000,000 tons of saleable coal on the property. This information coupled with the fact that no production had started by V-Day and also that the potential market for the coal was not the subject of any contract, yet from all reports Japan was prepared to buy the product.

As to a discount rate Mr. Turnbull believed such should be in the 12-15 per cent range with the conclusion, after working out the mathematics of the situation, give a value of $1,125 per share at V-Day.

The most difficult task is to calculate the discount rate to be applied against a cash flow level. Based on the projected annual level of production which the experts seemed to agree upon there was a determination made that the V-Day value of cash flows would be $5,103,287.

What then is a suitable discount rate? Such is not an easy task. As a starting point it is instructive to see what other investments were returning at the time. The bank rate in 1971 was 4.75 per cent, Canada Savings Bonds were at seven per cent, mortgages at 9-9.5 per cent and common shares from the period 1967 to 1971 returned 10.2 per cent.

The shares of Pine Pass should probably fall somewhere in the range of 10 to 13 per cent. Dr. Guthrie calculated the former, Mr. Turnbull was near the latter percentage. Both gentlemen gave excellent reasons but I am not unmindful of the caution expressed by Adrian Keane in his text The Modern Law of Evidence wherein at page 377 he quotes from Taylor, Treatise on the Law of Evidence, 12th ed. at page 59 as follows:

The danger is particularly acute in the case of opinions expressed by expert witnesses, of whom it has been said, not without some sarcasm," it is often quite surprising to see with what facility and to what extent, their views can be made to correspond with the wishes or the interests of the parties who call them”.

Thus we have a low value by the Minister’s expert and a higher one put forth by the appellant.

In situations such as this, it is comforting to follow the comments made by Mr. Justice Walsh, in Bibby v. The Queen, [1983] C.T.C. 121, 83 D.T.C. 5148 (F.C.T.D.) at page 131 (D.T.C. 5157):

While it has frequently been held that a Court should not, after considering all the expert and other evidence, merely adopt a figure somewhere between the figure sought by the contending parties, it has also been held that the Court may, when it does not find the evidence of any expert completely satisfying or conclusive, nor any comparable especially apt, form its own opinion of valuation, provided this is always based on the careful consideration of all the conflicting evidence. The figure so arrived at need not be that suggested by any expert or contended for by the parties.

Conclusion

With this in mind and based on all the factors presented, the Court has reached the conclusion that the appellant's estimate was too high and that the respondent's estimate was too low. The net result then is that the Court has utilized a discount rate of approximately 11 per cent which would give a value for each share held by the appellant as of V-Day of $1,500.

As to the matter of costs the appellant abandoned two lesser objections at trial but pursued the major one and was substantially successful in achieving a value closer to what he sought than the original figure of $700 put forth by the respondent. Taking all into consideration the Court awards the appellant 60 per cent of his costs.

An order will go forth granting these costs and placing the value of the shares of Pine Pass at V-Day at $1,500 each and dismissing the appellant's appeal respecting Symposium Restaurant Ltd. and unreported income by the appellant in 1982 and 1984. The matter is returned to the respondent for reconsideration and reassessment.

Appeal allowed.