Northern Peat Moss Co LTD v. Minister of National Revenue, [1982] CTC 2855, 82 DTC 1866

Guy Tremblay:—This case was heard on August 11, 12 and 13, 1982, at the City of Vancouver, British Columbia.

1. The Point at Issue

The point at issue is whether the appellant company is correct in contending that the V-Day value for the 420 shares of Bell Farms Ltd. was in the amount of $659,400 ($1,570 each). The respondent contends that the said V-Day value was in the amount of $476,700 ($1,135 each). The said shares were sold in 1977 for $659,400. The V-Day value is required for the computation of the capital gain.

2. The Burden of Proof

The burden of proof is on the appellant company who must show with preponderance of evidence that its thesis must be maintained.

3. The Facts

The main facts are not in dispute.

3.01 In June 1977, the appellant disposed of 420 common shares of Bell Farms Ltd in a non-arm’s-length transaction in favour of Mr Jack Bell and his three children.

3.02 In its 1977 income tax return, the appellant reported proceeds of disposition for $646,800 on the sale of the Bell Farms Ltd shares and an adjusted cost base (V-Day value) in the same amount, hence reporting a capital gain of “nil” on the disposition of the said shares.

3.03 The respondent reassessed the appellant on the basis that the proceeds of disposition were in the amount of $659,400 and the V-Day value in the amount of $476,700, giving a capital gain of $182,700 and a taxable capital gain of $91,350.

3.04 At the beginning of the trial, it was admitted by the appellant’s counsel that the proceeds of disposition were $659,400. However, he informed the Board that the evidence would give the same amount as V-Day value.

3.05 The counsel for the appellant also admitted the amount of $5,088 calculated by the respondent as recapture with respect to a sale of 80 acres of bog in 1977.

3.06 The point at issue is therefore limited to the V-Day value of the shares.

One can see that in the computation of the adjusted book value of the shares on December 31, 1977, the important item which differs between the parties is the farm itself. The appellant gives the value of $1,850,000 and the respondent, $1,230,000.

3.07 The appellant’s first witness, Mr Jack Bell, President of the appellant company and President of Bell Farms Ltd, testified that:

(a) Bell Farms was a cranberry farm of 206 acres.

(b) He has been in the business of growing cranberries commercially since 1946.

(c) It takes three to six years for cranberries to mature.

(d) Ocean Spray Cranberries Inc, a cooperative organization of cranberry growers, purchased over 90% of all the cranberries grown in BC. It purchased 100% of Bell Farms’ production.

(e) In 1968 it was decided by the BC Marketing Board that the cranberry market would be restricted. Quotas would be fixed on the two best years of the period 1968 to 1973 (Exhibit A-1).

(f) The two best years of Bell Farms were 1971 (27,346 barrels) and 1973 (24,581 barrels) (Exhibit A-2 and A-3). The quota for Bell Farms was 25,964 barrels. A barrel is 100 pounds of cranberries.

(g) For a year’s production, the growers received an account during the fall of the said year and the balance during the spring of the following year. For the years 1964 to 1970, Bell Farms received an average of $6 per barrel in the fall.

(h) In the fall of 1971, the growers received only $4 per barrel. However, in April 1971, Big Red Cranberry informed Ocean Spray Cranberries Inc, by letter, that it provided a return of $16 per barrel. The witness said that in June 1971, they thought that they would receive $15.50 per barrel.

3.08 The appellant’s appraiser, Mr Anderson, computed the V-Day value by the income approach. He said that there was no direct sales comparison approach possible. Indeed, there were no cranberry farms sold for a period of 10 years.

3.09 Bell Farms Ltd was an operating cranberry farm of 206.6 acres, 172 acres of which were cultivated (155 acres were fully-cultivated and 17 acres were half-cultivated). One fully-cultivated acre produces an average of 150 barrels per year.

Mr Anderson, based on the sales of the five former years (1966 to 1970), took the average revenue of $14.23 per barrel. In fact, he took $14 per barrel to compute the gross income:

153 acres x 150 barrels x $14.

17 acres x 70 barrels x $14.

Gross Income:	$342,047
Less expenses:	$120,289
Net income:	$221,758
(Exhibit A-6)

He applied a rate of return of 12% (multiplier ration of 8.33) which gives $1,850,000 of value.

3.10 In computing the expenses, however, he did not include some of the expenses which he considered as I quote: .. not directly attributable to the real estate operation of the subject.” (Exhibit A-6, page 13).

The net income, before tax, was used in the application of the rate of return.

3.11 The respondent’s appraiser, Mr Koivane Yuh, computed the value of the farm on the basis of seven sales, not of cranberry lands, but on blueberry lands, shallow peat lands, and bared lands acquired in 1971 and 1972. The size of the lands varied from 92 acres to 42 acres. The prices paid were between $2,750 and $6,000 per acre. Mr Yuh took $4,000 per acre, subtracted $500 for the value of blueberries and added $2,470 for “field improvements and shrubs for cranberry”, which totalled $5,970, multiplied by 206 acres, which gives a total of $1,230,000. According to Mr Yuh, he considered the real estate portion of the farm, not the business portion. It was his mandate — the business portion being calculated by another appraiser.

3.12 Another appraisal report (Exhibit A-7) was made by Mr E W Palmer of Bell-Irving Realty Limited in February 1969. He arrived at a fair market value of $1,660,000, which gives an overall rate of $8,052 per acre.

3.13 Another of the respondent’s witnesses, Mr Turnbull, was not accepted as an expert. He testified as an employee of the respondent. He also used the income approach. He took the income of $10 per barrel. He used $10 per barrel because, in the notes to financial statement of Bell Farms Ltd for the year 1971, the accountant wrote that the estimated selling price was $10 per barrel. Taking the sales of 25,500 barrels, he arrived at gross sales of $225,000. He deducted $150,000 of expenses, therefore including those refused by Mr Anderson. He also took into account $40,000 of tax computed under the 1972 Income Tax Act, SC 1970-71-72, c 63 as amended. The net income being $65,000, he applied the rate of return of 11%, giving a business value of $585,000 rounded to $600,000.

3.14 Mr Turnbull, in the computation of the adjusted book value, did not take into account this $600,000 but the figures of Mr Yuh ($1,230,000) on the basis that to fix the market value, the higher value prevails between the income approach value and the comparative approach value.

4. Analysis

4.01 The Board thinks that the activities of Bell Farms Ltd must be considered as a business. In fact and in law (Income Tax Act), agricultural activities are businesses. Therefore, the best way to establish the value of the farm is the income approach, unless it could be proved that the liquidation value or the real estate value were higher.

4.02 The points in dispute between the two appraisals made pursuant to the income approach method are first, the amount of $30,903 of expenses (interest and bank charges — $10,707; travel and entertainment — $2,274; depreciation expense — $17,922) which, according to Mr Anderson, are not directly attributable to the real estate operation of the subject, and secondly, the amount of $40,000 computed under the 1972 Income Tax Act.

4.03 The Board does not see why interest and bank charges would not be taken into account, even if it could be said that this expense is “not directly attributable to the real estate operation of the subject”, ie, of a cranberry farm. It is, however, a normal expense for any business in the computation of its income. The same is true for depreciation.

In giving criteria to establish the objective notion of reasonable expectation of profit, the Supreme Court of Canada in William Moldowan v MNR, [1977] CTC 310; 77 DTC 5213, refers “to the capability of the venture as capitalized to show a profit after charging capital cost allowance’’. Hence its Capital cost allowance must be considered normal expenses in the computation of the income of a business despite the fact that, according to the Income Tax Act, the taxpayer is not obliged to deduct the capital cost allowance, and also, despite the fact that when it is deducted, it is not out-of-pocket money. In the latter case, the out-of-pocket money shall result when a new asset is purchased. If no capital cost allowance is taken, then the terminal loss is applied. Therefore, in one way or another, this expense is taken into consideration in one year or in another. In computing the value of shares with the income approach, it must be taken into consideration.

The Board agrees that in the present case the travel and entertainment expenses can be ignored. Such expenses are ordinarily incurred to sell production. All of the production of Bell Farms Ltd, as well as 90% of the cranberry production in British Columbia, was sold to only one purchaser, Ocean Spray Cranberries Inc (see paragraph 3.07(d)).

4.04 Is it possible for a prudent purchaser of shares of a private company not to take into account the impact of the Income Tax Act? I say private company because, for a public company listed on a prescribed stock exchange, a purchaser only looks at the dividends, but in fact it is understood that taxes have been paid before, even if the purchaser does not think about this. A dividend is paid from an income on which taxes have been paid. More particularly, would it have been possible, in 1971, for a prudent purchaser of the shares of Bell Farms Ltd not to take into account the impact of the taxation and especially the impact of the new Income Tax Act, the application of which started on January 1st, 1972?

Let us only suppose for one moment that the profit of the corporation would be taxed at 100%. Who would be interested in incorporating a business or in purchasing the shares of a corporation? Nobody. The basic intent of an investor is to make money. Now, let us suppose that there were no tax at all on the income. It would be normal for a purchaser of shares to consider only the earning power of a company, ie, the net profit of the corporation. This is the only criterion that would tell him the amount of money he would receive from his investment. However, when the rate of taxation of the income is 50%, the Board thinks that the fiscal impact is great enough to oblige a prudent purchaser to take the fiscal impact into account in the computation of the price to pay for the shares. In practical terms, he must take into account the profit after payment of tax.

The Board has found some cases at law where taxation was not taken into account in the computation of the value of shares, but they were cases dated back to the beginning of the century when fiscal impact was not so important.

Ordinarily, in reading a case, it is not easy to see if the parties have taken taxes into consideration or not. However, it was obvious in a few cases (Gilles Trépanier v MNR, [1979] CTC 3164; 79 DTC 924; Estate of Harold J Bonthron v MNR, [1981] CTC 2391; 81 DTC 337). In fact, no case was found where the point at issue was the same as in the present case. The present doctrine of valuation considers the taxation of income in the computation of the value of the shares of a corporation or a business valuation In The Principles and Practice of Business Valuation, by Ian R Campbell, it is clearly stated, on page 46, that the capitalization rate (or multiplier) must apply only “after indicated earnings from operations after tax are determined . . Also, at page 146 under the heading “The Selection of Corporate Income Tax Rates”, the author clearly shows that taxation must be taken into account but with the appropriate rate (Federal Income Tax rate, the credit of 10%, the incentive Canadian controlled private corporation, the credit to reduce the corporation rate on manufacturing and processing profits).

4.05 From the gross income of $342,047 (see para 3.09), the Board, taking into consideration the expense of $120,282 plus interest and bank charges of $10,707, plus depreciation expense of $17,922, arrives at a net profit of $193,129. Taking into consideration the taxation pursuant to sections 123, 124 and 125 of the Act, the Board arrives at the value of approximately $630,000 for the farm. The Board must retain, as the respondent did, the comparative value approach of $1,230,000. Therefore, the Board must maintain the reassessment.

5. Conclusion

The appeal is dismissed in accordance with the above reasons for judgment.

Appeal dismissed.