Ranjit Ahluwalia, Julian Fa. Adams and John David Elltoft v. Minister of National Revenue, [1987] 2 CTC 2300, [1987] DTC 592

Bonner, T.C.J.:— The appellants Ranjit Ahluwalia and Julian F.A. Adams appeal from assessment of income tax for the 1978 taxation year. The appellant John David Elltoft appeals from assessments of income tax for the 1978 to 1981 taxation years inclusive. In assessing tax for the 1978 taxation year of all three appellants the respondent included in the income of each appellant the sum of $8,963 as the total of the taxable capital gains realized in the year on the sale of shares of Niagara Medical Dental Office Services Limited (hereinafter "the company"). On February 1, 1978, a partnership composed of the three appellants sold one-third of the issued shares of the company to each of the appellants. Subsequently, on May 10, 1978, each appellant sold 25 per cent of his shares to a Dr. Murphy. The explanation which accompanied the notice of each of the assessments in issue indicated that the respondent had calculated taxable capital gains as follows:

Transfer from Partnership to Partners on February 1, 1978.

	Proceeds	Cost	Gain
3000 Preferred	$ 30,000	$ 30,000	$ Nil
3004 Common	240,337	218,975	21,362
	$270,337	$248,975	$21,362

Sale of Shares from Partners to Dr. Murphy on May 10, 1978.

	Proceeds	Cost	Gain
750 Preferred	$ 7,500	$ 7,500	$ Nil
751 Common	92,500	60,080	32,420
	$100,000	$ 67,580	$32,420
Total Capital Gain (21,362 plus 32,420)			$53,782
Taxable Capital Gain - 50%			$26,891
Partners '/3 Portion			$ 8,963
Reported Taxable Capital Gain			$ Nil

It was the position of the appellants that the adjusted cost base of the shares was the amount determined under paragraph 26(3)(c) of the Income Tax Application Rules, 1971, being a figure greater than actual cost and less than fair market value on December 31, 1971.

The shares were acquired in 1966 by the partnership from Jaroslaus Z. Czerevko. The partnership was formed to carry on the practice of medicine in premises owned by the company, the name of which then was Virgil Medical Centre Hospital Limited. It was common ground that the cost of the common shares to the partnership was $218,975. There was also 3,000 issued preferred shares which at all material times had a value of $10 each.

There was a great divergence between the parties with regard to the fair market value on December 31, 1971, of the common shares of the company. Both the respondent and the appellants approached the case on the basis that in determining the fair market value of the common shares on that day for purposes of the application of paragraph 26(3)(b) of the Income Tax Application Rules the single most important factor was the value of the real property owned by the company. On this point the parties were very far apart. It was the appellants' position that the value of the real property on V-Day was not less than $632,240 and that in consequence the total value of the common shares owned by the partnership on that day was not less than $581,935. The respondent's position, on the other hand, was that the value of the real property on V-Day was $203,000 and that in consequence the total value of the common shares owned by the partnership was $182,696.

The real estate in question was a parcel of land of irregular shape having an area of 3.08 acres and a frontage of 200 feet on Highway 55 between Virgil and Niagara-on-the-Lake. There stood on the property a one-storey building having an area of almost 8,000 square feet used for purposes of a private hospital and doctors' offices. The company, at all relevant times up to April 30, 1976, operated the hospital. To do so lawfully it required a licence under the provisions of The Private Hospitals Act, R.S.O. 1970, c. 361. On the date last-mentioned the licence was cancelled.

The loss of the licence was significant both to the company which operated the hospital using the real property which it owned and also to the members of the partnership. So far as the company was concerned the cancellation of the licence left it with a building which had been designed and constructed for use as a hospital and which could not readily be adapted for other use. The evidence revealed, however, that the loss of the licence was not a complete disaster for the company because the business brought to an end had not been profitable. The Ministry of Health of the Province had controlled the financial affairs of the hospital in such a way as to prevent the realization of profit. The doctors who were members of the partnership were more seriously affected by the loss of the licence. The medical clinic operated by the partnership had its offices within the hospital building. The hospital attracted patients to the clinic. The proximity of the hospital to the clinic enabled the doctors to carry on their practices more efficiently. No travel time was required for the purpose of visits to inpatients. The doctors could remain in close proximity to patients recovering from surgery and at the same time see other patients at their offices. After the licence was cancelled two of the partners left. The three who remained, the present appellants, continued to use offices in the former hospital building for purposes of the medical practice of the partnership. Some modifications were made to the building to convert parts of it with a view to rental for use as dental offices and as a pharmacy.

William Losier, an appraiser accredited by the Appraisal Institute of Canada, was called by the appellants to give evidence as to the value on V-Day of the real estate owned by the company. He expressed the opinion that the value on that day was $600,000. He arrived at that conclusion by a process which in my view was so illogical that the conclusion must be rejected. He applied a "modified income approach". Mr. Losier started with "overall earnings after costs", a figure which combined the earnings both of the clinic and of the hospital. He then subtracted an amount said to be the average salary of doctors for 1971 as published in Revenue Canada statistics which amount he multiplied by the number of doctors practising in the partnership during the year. He then applied a capitalization rate derived from his analysis of the 1966 sale by Dr. Czerevko to the partnership. Thus he arrived at an “indicated value for property and equipment in 1971". He then subtracted the book value of equipment and arrived at a figure which he described as "value of land and improvements", $671,420.50. I can find no logical connection between the value of land and building and a figure arrived at by reference to the earnings or revenues of the occupants of the building. Such a relationship might conceivably arise in some cases where tenants pay rents fixed as a percentage of sales, but that was not the case here. The method used appears to capitalize not the income from real property but, rather, a notional profit of an enterprise that did not exist, that is to say, a clinic staffed by doctors all of whom were employed at statistically average salaries. The result of this calculation bears no relationship to reality.

Evidence was given by J.W. Tannahill, an employee of the respondent. He was qualified to give opinion evidence on the value of real estate. He was a member of the Appraisal Institute of Canada. He expressed the opinion that the value on December 31, 1971, of the real property was $256,200. He arrived at this conclusion using the cost approach. He stated that he was unable to use the market approach in valuing the real estate because there was no market for private hospital properties. Further, he was unable to use the income approach because there was neither income generated by the hospital property nor information as to economic rents which might be generated by such property. Mr. Tannahill’s conclusion based on the cost approach is not markedly different from the result arrived at by Mr. Losier when he applied the same method.

It is, of course, clear that the method adopted by Mr. Tannahill did not reflect as an element of the value of the shares on December 31, 1971, the advantage conferred on doctors who held those shares in respect of access to the private hospital. The value of that advantage might have been substantial, but no evidence was adduced on this point. Courts can and do arrive at conclusions as to value despite the conflicting evidence of experts. It does not follow, however, that a court is justified in arriving at a figure that is nothing more than a simple guess. The appellants have therefore failed to discharge the onus of establishing on the balance of probabilities that the fair market value of the shares on December 31, 1971, was higher than the amount found by the respondent. There are no remaining issues in the appeals of Ranjit Ahluwalia and Julian F. A. Adams and they will therefore be dismissed.

There is one remaining issue which arises in the appeals of John David Elltoft. In assessing tax for the 1979, 1980 and 1981 taxation years the respondent disallowed the deduction of rental losses incurred with respect to a condominium unit at Sand Cay in Florida. He did so on the basis that the losses were personal or living expenses within the meaning of subsection 248(1) and paragraph 18(1)(h) of the Income Tax Act.

Dr. Elltoft purchased the condominium townhouse unit in June of 1979. He stated that he did so after looking at about 50 different apartments, condominiums and small hotels. He said that the property was the best run of all the holiday accommodations that he had seen. It had an onsite manager. The location, he said, was excellent being on the beach and next door to the Hilton Hotel. In his opinion it appeared to have very good potential for attracting short-term renters.

The appellant stated that he stayed in the property one night at the time that he acquired it and for a period of four days in October of 1986 when he visited the project with a view to looking into the purchase of a second unit nearby. The appellant's wife visited the unit twice, once for the purpose of replacing the furniture and the second time for purposes of arranging for replacement of draperies and redecoration. It is plain that the property was not purchased for use by the appellant and members of his family.

Rental operations were handled by the Condominium Owners Association under an agreement with the appellant. The property is advertised in Florida magazines, by brochures, by postcards and by a large roadside sign.

The appellant paid $95,000 (U.S.) for the unit. $66,000 was borrowed on the security of a first mortgage and $30,000 (Canadian) was borrowed from a credit union in Canada. The difference was paid from the appellant's resources. The appellant paid off the credit union loan and subsequently, in October of 1986, he retired the first mortgage using savings and proceeds from the sale of another property.

The rental revenues from the property have increased from $3,150 in 1979 to $20,400 in 1986. Property taxes, maintenance, insurance and similar operating costs have increased as shown on Exhibit A-15, but at a significantly lesser rate. The investigation made by the appellant prior to purchase as detailed in his evidence in my view justified his conclusion that the financial picture would turn around within a year or two. It is evident that were it not for certain repair costs which could not have been foreseen the losses in 1982 and 1983 would have been substantially smaller and 1984 and 1985 losses would not have occurred.

There can be no doubt on the evidence that the property was acquired and that the expenses of the rental operation were incurred for the purpose of gaining or producing income. The respondent's assumption that there was no reasonable expectation of profit was in my view unfounded. The words “reasonable expectation of profit" mean just what they say. What is required is a reasonable expectation and not a certainty. In Clare B. Baker v. M.N.R., [1987] 2 C.T.C. 2271, Couture, C.J.T.C. said:

. . . a reasonable expectation of profit exists where given all the facts pertinent to a venture it could, within a realistic time (the period will vary depending on the nature of the operation), yield a profit barring abnormal circumstances. In other words, is the venture as structured and normally operated capable of generating a profit?

Counsel for the respondent relied on the decision in Barry S. Arbus v. M.N.R., [1980] C.T.C. 2872; 80 D.T.C. 1744. That decision does not support the respondent's position in the present case. The evidence there suggested that the acquisition was neither expected nor intended to earn a profit. As previously set forth, the present case is entirely different. The appeals of Dr. Elltoft from assessments for the 1979, 1980 and 1981 taxation years will therefore be allowed and the assessments referred back to the respondent for reconsideration and reassessment on the basis that the appellant is entitled to deduct the rental losses in issue. The appeal for the 1978 taxation year will be dismissed for the reasons given earlier. Dr. Elltoft will be entitled to such of his costs as relate to the rental loss issue alone.

Appeals allowed in part.