Gestion Sersec Inc. And Lise Gosselin Huot v. Minister of National Revenue, [1993] 1 CTC 2229, 93 DTC 497

Tremblay, T.C.C.J.:—These appeals were heard on common evidence on April 28, 1992 at Québec City, Quebec.

1. Point at issue

The issue is the determination of the fair market value of a real estate complex situated on Lavigueur, Sainte-Claire and Saint-Réal Streets in Québec City on December 31, 1985. This was the date when the appellant company, Gestion Sersec Inc., transferred it to the appellant Lise Gosselin Huot for the priceof $325,000. Ms. Gosselin Huot is the owner of one hundred per cent of the voting shares.

The respondent contended that the fair market value on the date of the sale was $500,000. According to the respondent, the appellant company had a taxable capital gain of $85,000 and the appellant Lise Gosselin Huot received a benefit of $175,000 which must be included in her income.

2. Burden of proof

2.01 The appellants have the burden of establishing that the respondent's assessment is incorrect. This burden of proof results from several judicial decisions, including the judgment of the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486, [1984] C.T.C. 195, 3 D.T.C. 1182.

2.02 Also in that judgment, the Court held that the facts assumed by the respondent concerning Gestion Sersec Inc. in support of the assessments or reassessments are also deemed to be correct until proved otherwise. In the present case, the facts assumed by the respondent are described in subparagraphs (a) to (f) of paragraph 5 of the respondent's reply to the notice of appeal. Paragraph 5 reads as follows:

5. In assessing the appellant for its fiscal year ending on December 31, 1985, the respondent relied on the following facts, inter alia:

(a) "Gestion Sersec Inc.” is a private Canadian-controlled company; [admitted]

(b) Lise Gosselin-Huot owns 100% of the voting shares; [admitted]

(c) On December 31, 1985, "Gestion Sersec Inc.” sold to Lise Gosselin-Huot a real estate complex identified as [Translation] “buildings on Lavigueur, Ste- Claire and St-Réal Streets, Québec City”, for the price of $325,000; [admitted]

(d) the properties referred to in the preceding subparagraph had been purchased on October 16, 1981 at a cost of $225,000 and improvements at a cost of $50,910 were capitalized, so that the total cost of the properties on December 31, 1985 was $275,910, for a total capital gain on this transaction of $49,090; [admitted]

(e) the transaction was analyzed and the fair market value of the property transferred by the shareholders was revised to $500,000, according to the respondent's appraisers, so that the capital gain on disposition of the property was increased by $175,000, of which an amount of $87,500 was taxable; [denied]

(f) the appellant's appraisers disputed the fair market value of the property, which they estimated at $325,000, as set out in their appraisal report. [admitted]

[Translation]

The facts assumed with respect to Lise Gosselin Huot are of the same nature, except that the sale was assumed to have resulted in a benefit of $175,000 for Ms. Gosselin Huot ($500,000—$325 ,000).

3. Facts

3.01 The appellants’ appraisal report (Exhibit A-1), like the respondent's appraisal report (Exhibit 1-7), shows that the appraisers used the cost, income and parity approaches. The conclusions on each side are as follows:

3.02 The appellants produced the appraisal report signed by Léonard Fitzgerald, accredited appraiser, and by Patrice Dumas, real estate investment analyst, as Exhibit A-1. The respondent produced the appraisal report prepared by Gaston Laberge as Exhibit 1-7.

3.03 The replacement cost approach applied by both appraisers gives the following comparative result:

3.04 The appraisers' figures using the parity approach, that is, the approach in which recent sales of similar properties are examined, are as follows:

3.04.1 Parity: appellants' appraisal

The appellants’ appraiser first did an analysis using the gross income multiplier (G.I.M.), relying on two of the five comparables he had selected:

The Court was unable to determine the origin of the figure $101,275.

3.04.2 Still using the parity approach, the appellants’ appraiser did a second analysis by apartment price calculated for the five comparables: sale price divided by number of apartments, subject to adjustments for time, apparent age, upkeep, interest rate at the time of sale and type of apartment. Here again, the representativeness index and parity index were applied, to arrive at an average price per apartment of $9,504. By multiplying this figure by the thirty-four apartments in the subject property, the appraiser arrived at a price of $323,000 for the subject property. The parity conclusion is therefore as follows (A-1, page 27):

3.04.3 The rebuttal evidence showed, on the other hand, that comparable No. 1 was sold by a financial institution and comparable No. 2 had a tenant which was a pharmacy.

The appellant's analyst admitted on cross-examination that he had not consulted the contracts at the registry office but had relied on data banks which he could access by electronic means in his office. These data are compiled by a company [sic] to which the office has access. He also had to admit that he was not aware that one of his primary comparables had been sold by a financial institution under a mortgage repossession. The reason he did not check at the registry office was that he had no budget for that purpose.

Finally, on cross-examination, the analyst candidly admitted that if he had prepared an appraisal for submission to the bank, it would not have been the same.

3.04.4 Parity: respondent's appraisal

The respondent's appraiser also selected five comparables. Comparable No. 1 on March 1, 1983, the price of which was $205,000, was the same as the appellants” appraiser's comparable No. 1. However, the sale price according to the latter appraiser was $215,000.

The respondent's second comparable was property No. 1, of March 1983, resold on April 1, 1986 for $235,000. The respondent's comparables No. 4 and No. 5 are the same property, but No. 4 was the sale on December 27, 1985 for $155,000 and No. 5 was on September 18, 1986 for $200,000.

3.04.5 Using the data for each comparable, the respondent's appraiser arrived at the following conclusions, according to the following indications, based on the median:

(a) indication according to the price per apt.

14,286 x 34 apartments	$485 ,000
(b) indication according to the price per room
3,809 x 120 rooms	$457 ,000
(c) indication according to the price per sq. ft. of
building including land 22.05 X 19,174	$422,800
(d) indication according to G.I.M. 119,796 X 4.30	$515,100

3.04.6 According to the respondent's appraiser, the most representative units of comparison are the price per room, which takes into account the size of the apartments ($457,000) and the G.I.M., which takes into account potential income ($515,000). He therefore concluded that the value indicated by the parity method was $486,000 ($457,000 + $515,000).

2

3.05 Income approach

3.05.1 Based on the evidence adduced, the main point in issue, according to the calculation of value using the income approach was the vacancy rate and bad debts for the subject property, which were 15.8 per cent of gross income according to the appellants and six per cent according to the respondent. Maintenance and repair expenses, which were $17,000 according to the appellants and $11,261 according to the respondent, was the second point in issue.

3.05.2 The average figure of 15.8 per cent of gross income for vacancies and bad debts for the 34 apartments was calculated by the appellants based on 98 unrented or unpaid apartment-months in 1985 and 31 apartment-months in 1984 (Exhibit A-2). This is derived from the monthly compilations for the two years in respect of rents collected, uncollected, vacant, tenants moving rapidly, evictions, bad debts. The 15.8 per cent rate, applied to gross income of $120,279, gives a result of $19,004.

The respondent's appraiser argued that the vacancy rate published by the Canada Mortgage and Housing Corporation (C.M.H.C.) in October 1985 for Québec City was six per cent of gross income. That is the reason why he choosed [sic] that rate in his appraisal. When this is applied to gross income of $119,796, the result is $7,188. There was no discussion of the difference between the two gross incomes ($120,279 and $119,796).

3.05.3 Moreover, the appellants stated that maintenance expenses were $12,650 in 1982, $15,861 in 1983, $16,759 in 1984 and $19,071 in 1985 (Exhibit A-2). These expenses were taken from the financial statements filed with the income tax returns and admitted by the respondent in the income calculation.

The appellants' appraisal report (Exhibit A-1, page 31) indicates maintenance expenses in the amount of $17,000 for 1985. According to the analyst, this figure, which is, moreover, confirmed by the actual figures set out above, is also consistent with the figure of $500 per year for apartments built more than 30 years ago, using a weighted average established by statistics. The real estate complex in issue was built more than 35 years ago.

The respondent's appraiser allowed $11,261 for maintenance and repair expenses. According to him, this figure amounts to ten per cent of the actual gross income of $112,608 which he calculated as follows for 1985.

3.06 Apart from debits relating to vacancies and bad debts in the calculation of gross income, on the one hand, and maintenance expenses in the calculation of net income, on the other hand, the other expenses (municipal taxes, insurance, electricity, heating, and so on) presented by the two appraisers were not substantially different. The respondent's report (Exhibit 1-7, page 67) shows the application of the income approach, as follows:

Application of the income approach

[Translation; Emphasis added.]

3.07 As well, by applying an overall capitalization rate of 0.113 to this $55,750 net income, the respondent's appraiser arrived at the market value of $493,363, rounded to $493,000. On the other hand, starting with the net income of $38,720, the appellants applied a capitalization rate of .1198667 and arrived at a market value of $323,000.

3.08 In the analysis of the correlation of values (Exhibit A-1, page 37, and Exhibit I-7, pages 88 et seq.), both appraisers were of the opinion that less emphasis must be given here to the cost approach because of the age of the building: this approach is largely based on estimating depreciation (actual average age). More emphasis must be placed here on the parity and income approaches.

The appellants’ appraiser therefore set aside the figure of $353,000 (cost approach, 3.03) and took the figures of $330,000 (parity approach) and $323,000 (income approach), and averaged them, arriving at $325,000 (Exhibit A-1, page 37).

The respondent's appraiser explained his own final estimate of value as follows:

Taking into account the quality, quantity and relevance of the data in each of the two approaches used, based on parity and income, we are of the opinion that the most probable market value of the subject property is estimated at $490,000 on January 3, 1986.

land	$ 43,000
building	433,000
chattels	14,000
	$490,000
	[Translation]

4. Analysis

4.01 The Court notes once again the degree to which the science of valuation is not a precise science, and the degree to which appraisers may use approaches which cause the conclusions to vary.

4.02 Setting aside the cost approach, because it seems less representative (3.08), I shall deal only with the other two approaches.

4.02.1 With respect to the parity approach, the respondent rightly criticized the appellants for using comparable No. 1, because it cannot be seen as representative in terms of price: the vendor was a financial institution which apparently had acquired the property under a mortgage repossession. It is well known that in such cases the financial institution is not necessarily seeking the fair market value for the sale price, but rather simply to recover the debt secured by mortgage. However, the respondent also used the same comparable, also No. 1.

Moreover, it is hard to see the appellants comparable No. 2 as a good comparable since it has income from a business. In addition, in his appraisal using the parity approach, the appellants” appraiser did not take into account the value of the land, which he in fact set at $76,000 (Exhibit A-1, page 14).

Must this amount be added to the $330,000? That would appear appropriate to me, and would produce a result of $406,000.

4.02.2 The income approach seems to me to be the most realistic even though it is indirect: it provides a better indication of the considerations in the minds of investors who are often content with little return on their investment in order to accumulate equity eventually.

I do not share the opinion of the respondent's appraiser with respect to applying the six per cent vacancy and bad debt rates to the subject property. The appraiser relied on Canada Mortgage and Housing Corporation data for all of Québec City. Why use statistics established on the basis of an entire region when the subject property has its own figures, which were furthermore not contradicted by the evidence: 15.8 per cent (3.05.1 and 3.05.2). If we apply this rate to the respondent's figure for gross income, $119,796, we arrive at $18,927 instead of the $7,188 calculated by the respondent (3.06).

The same reasoning should be applied so that we ignore the ten per cent of gross income applied to maintenance and repairs, and rather use the figure for actual expenses: $17,000 (3.05.3).

Referring to the respondent's calculation in Exhibit 1-7, pp. 67-68 (3.06), changing the $7,188 for vacancies and bad debts to $18,927 and the $11,261 for maintenance and repairs to $17,000, we reach the following result: $17,478, that is, $35,927 ($17,000 + $18,927) less $18,449 ($7,188 + $11,261) = $17,478.

This figure results in a corresponding decrease in net income before depreciation, to $38,272, that is, $55,750 — $17,478.

Applying the overall capitalization rate of 0.113 to $55,570, the respondent arrived at a value of $493,000 (3.06).

Applying the same overall capitalization rate of 0.113 to $38,272, we arrive at a value of $338,690 as the value of the building. To this amount I would add the value of the land, calculated by the respondent as being $43,000. The appellants' appraiser's figure of $76,000 was not explained, except that this was his conclusion. The $43,000 figure was taken by the respondent's appraiser from the analysis of eight comparables. Moreover, the value of $14,000 for chattels also seems to me to be reasonable. (Land $43,000, building $338,690, chattels $14,000, which I round off to $395,000).

5. Conclusion

The appeal is allowed, without costs, the value of the building in question is set at $395,000 and the matter is sent back to the respondent for adjustment of the tax consequences according to this decision as they pertain to each appellant.

Appeal allowed.