Gilvesy Enterprises Inc. v. R., [1997] 1 CTC 2410, 97 DTC 811

Bowie J.T.C.C.: — Gilvesy Enterprises Inc. appeals from reassessments whereby the Minister of National Revenue (the Minister) reduced the amount of its claim for an allowable business investment loss (ABIL) in the 1987 taxation year, and included in its income certain amounts as deemed interest under subsection 17(1) of the Income Tax Act (the Act) for each of the 1987, 1988 and 1989 taxation years. The ABIL claim arises out of the purchase by the Appellant of 50 per cent of the issued shares of a corporation called T.P.S. Industries Inc. T.P.S. Industries Inc. is the result of the amalgamation on January 31, 1981 of three predecessor companies, Tillsonburg Pipe and Supply Limited, and its two wholly owned subsidiaries, The Oil Well Supply Company Limited and T.P.S. Industries Limited. For convenience I shall refer in these reasons to the three predecessor companies collectively, prior to the amalgamation, and T.P.S. Industries Inc., after the amalgamation, interchangeably as TPS.

I was advised by counsel at the opening of trial that the Crown no longer contests the appeal with respect to the deemed interest amounts, and that the only issue remaining to be dealt with is the appropriate value to be assigned to the shares of TPS which were purchased by the Appellant in March 1981 from M.I.T. Concrete Ltd. (MIT).

The Appellant paid $1,794,159.13 (hereafter sometimes referred to as the offered price) for all of the shares of TPS owned by MIT, being a 50 per cent interest, and it claims an ABIL on the basis that this amount is the value of its investment. It is common ground that the Appellant and MIT are deemed not to deal with each other at arm’s length, [1] and that the Appellant is deemed to have purchased the MIT shareholding for a consideration not greater than its fair market value. [2] Thé reassessment was based upon the Minister’s assumption that the fair market value of these shares at the time of the transaction was $662,000.00. At the trial the Respondent took the position that the actual fair market value of the shares at the relevant time was $1,100,000.00, an amount which is based upon the opinion of the business valuator who gave evidence on her behalf.

The Appellant’s position is that the best evidence of value is the actual transaction between the Appellant and MIT, which it says took place on a purely commercial basis. During the trial I asked counsel for the Respondent whether he took the position that I am precluded from accepting evidence as to the sale of shares by one brother to the other as tending to show market value, by reason of subsection 251(1) and (2) the Act. His answer was that he made no such submission, and I therefore approach the valuation of the shares upon the basis that I may examine the circumstances surrounding that transaction to determine whether they satisfy the requirements of the generally accepted definition of fair market value, and on that basis assess the probative value of the transaction.

John Gilvesy (John) and his brother George Gilvesy Jr. (George) are successful entrepreneurs, as was their father before them. They initially undertook their various enterprises as partners; each carried out his extensive business activity through his own corporate vehicle of which he owned 60 per cent, with his brother’s wife owning the remaining 40 per cent. The Appellant was John’s holding company; MIT was George’s. Their business interests were many and diverse. Initially John’s lay primarily in the area of construction and development, while George’s centred on aviation and ready-mix concrete. They both expanded into other fields as time went on. In 1979 they decided that each of them would go his own way in the business world in future, and to that end they re-organized most of their holdings, so that henceforth each brother fully owned his own holding company, with each of them, through those companies, continuing to own a one-third interest in TPS. The remaining one-third was owned by Andren Investments Limited (Andren), their brother Andrew’s holding company. Also in 1979, Andrew wished to dispose of his interest in TPS in order to concentrate on tobacco farming, and so the Appellant and MIT purchased all of Andren’s TPS shares, with the result that each of John and George, through their respective corporations, became the owner of 50 per cent of the issued share capital of TPS.

On November 15, 1979 John and George entered into a buy- sell agreement containing what is sometimes called a shotgun provision. By this agreement neither of them could sell his interest in TPS without the written consent of the other. The shotgun clause provided that either brother could make an offer to the other to purchase his 50 per cent shareholding in TPS at a price to be stated in the offer, whereupon the offeree was required by the agreement either to sell his interest to his brother at that price, or alternatively to purchase his brother’s interest at that same price. That clause was invoked by George in February 1981, when he offered to purchase his brother’s shareholding for $1,794,519.13. John decided to purchase rather than sell, and he thus became the sole owner of TPS in March 1981. TPS subsequently became insolvent, giving rise to the claim for an ABIL, the amount of which is the subject of the dispute in this appeal.

It is necessary to set out some of the history of TPS. It had its start in 1949 as a local firm in Tillsonburg, Ontario, supplying both the oil and gas exploration and the water well drilling industries with the various supplies and parts they required, including joint casing, threaded pipe and drive shoes. During the next two decades it opened a number of branch offices in southern and eastern Ontario, and one in Quebec. TPS was acquired by the Gilvesy family in 1971. Day-to-day management of the business, under the general direction of the new owners, remained with Mr. Bob Herron, who had joined the company soon after its inception. Routine decision making was done by Mr. Herron and his management team, who reported to the Gilvesy family at monthly meetings held for that purpose. Oil and gas exploration and the water well drilling industry both prospered throughout the sixties and seventies, and so did TPS. Its after-tax profit grew from $128,951 in 1971 to $543,906 in 1976. [3]

Beginning in 1977, however, the company encountered some difficulties. In that year it acquired the Southern Pump Division of Crane Canada. This proved to be a disastrous move, for a number of reasons. Southern Pump brought with it to TPS a unionized work force whose influence caused a bitter strike to take place in 1978 over the issue of union certification for the existing work force. Although the company ultimately “won” the strike, in that it ended without the certification of a bargaining agent, it lasted for nine months and resulted in the company recording its first loss year. Southern Pump also brought with it to TPS a large and slow-moving inventory of pump parts which had a significant negative effect on profitability, which was made more severe by the sharply rising interest rates of that time.

Another event affected the company’s fortunes in the late 1970s. Couplings, which are short pieces of seamless pipe which have been threaded at both ends, are used to join the sections of pipe which make up an oil or gas well. Several miles of pipe may hang from a coupling, and its failure may result in the loss of the well, so a reputation for quality is of paramount importance in the industry. Since 1974 TPS had been supplying couplings used in oil well drilling to Interprovincial Steel and Pipe Company (IPSCO), a major supplier of pipe to the drilling industry in western Canada. This was a rapidly expanding market in the latter half of the 1970s, and IPSCO was a ready purchaser for the entire production capacity of TPS. In 1978 a blow-out occurred in an oil well in western Canada, resulting in very serious losses. Rightly or wrongly, the blame for this was placed on TPS by IPSCO, which alleged that the blow-out was caused by the failure of a TPS coupling. IPSCO threatened litigation against TPS, and it cancelled all of its existing orders for TPS couplings. As a result, TPS was unable to compete in this segment of the industry until 1979, when it replaced its outdated coupling production equipment with new and improved computer numerically controlled (CNC) machines. For technical reasons which I need not detail, these machines were capable of producing a coupling of higher quality than the company’s competitors could, and at a very competitive cost. With the acquisition of these machines TPS succeeded in acquiring a reputation for the highest standard of quality, which it achieved both by gaining approval for its product from the American Petroleum Institute (API), and by becoming the only manufacturer of couplings to stamp a serial number on each unit it produced. In this way TPS gained access to the very lucrative and rapidly expanding United States market, which soon accounted for 85 per cent of its coupling sales. During the interim, however, it suffered serious losses as a result of the cancellation of the IPSCO contracts.

Throughout the years of their joint ownership of TPS, George Gilvesy became increasingly frustrated with his brother John’s approach to the affairs of the company. It was George’s view that TPS should have been much more profitable than it was throughout the 19703. He blamed this on Bob Herron, whom he viewed as, at the best, an inefficient manager. He also recognized the Southern Pump Division as being a substantial drain on the profitability of the company. His preferred solution was to fire Bob Herron, for whom he had no use, and to divest the company of its Southern Pump Division. He had long advocated such a course, and as time went on he became more and more convinced that this was the only way to restore the company to its former profitability, and beyond. John, however, viewed Herron as a long-time faithful employee to whom they, as owners, owed their continuing loyalty and support. The impasse between the brothers steadily increased up to the beginning of 1981, when George, convinced following the January meeting with Bob Herron and his management team that matters could not continue as they were, decided to exercise the “shotgun” clause in the buy-sell agreement.

Evidence was given at the trial by George Gilvesy, his son Bryan Gilvesy, and his accountant Ed Bahula as to the way in which the offered price was arrived at. John Gilvesy and his accountant Frank Welsh gave evidence as to how John arrived at his decision to buy, rather than sell, at that price. I admitted the evidence of the two accountants, over the objection of counsel for the Crown, not as evidence going directly to the question of the value of the shares, but as evidence of the process by which each of the parties to the transaction arrived at the decision that the shares were worth at least the offered price. Neither Mr. Welsh nor Mr. Bahula professes expertise as a business valuator. Indeed the evidence was that both of them would have preferred to see their clients obtain advice as to the value of the shares from a qualified business valuator, but neither was inclined to do so. I was left with the impression that perhaps the one thing that John Gilvesy and George Gilvesy would easily agree upon is that they each had more confidence in their own opinion as to the value of the business than they would have had in the opinion of a stranger, however well-qualified academically.

The Appellant’s contention is that the sale which actually took place is the best evidence of value, and so it is important to examine the decisionmaking process of each of the parties, to see whether the transaction meets the requirements of the generally accepted definition of fair market value.

George Gilvesy’s frustration with his brother’s refusal to take a more hard line approach to the management of TPS reached a head following their meeting with management in January 1981. He left that meeting resolved to make an offer to buy under the shotgun clause, and to do so as soon as he possibly could. He sought advice as to the value of the company from three sources. His elder son, George J. Gilvesy, was a graduate of the Honours Business Administration program at the University of Western Ontario, and had worked for TPS. His younger son, Bryan Gilvesy, was an HBA student in his final year. As part of his studies he had recently completed, with three other students, a case study of TPS in which they examined the company in depth in relation to the industries in which it competed, and made recommendations for its future course. Ed Bahula had been George’s accountant for a number of years, but his knowledge of the business of TPS was relatively limited. I derive from their evidence, and from that of George himself, that he did not simply accept their advice, or an amalgam of it, but that he took into account what they each had to say, and then applied his own business judgment, having regard to both his own knowledge of the company and its business, and the considerations which their advice brought to bear. George was certainly aware of the earnings history and potential of TPS, including its history of profit and loss throughout the 1970s. He was aware, too, of the reasons for the recent losses. He believed that the inefficient management of Bob Herron was costing the company one-half million dollars per year in lost profits. He also was familiar with the real estate holdings of the company, and knew that they had been appraised in 1979 at $2,188,000.00. Most importantly, perhaps, he and Bryan saw an enormous potential for short-run profits to be made in the U.S. market for couplings, and the prospect for expansion of that line of business into the Mexican and South American markets in the future. Orders for couplings on the books at that time totalled about ten million dollars, and would absorb the company’s entire production capacity for several months. It was his intention, after acquiring John’s shares, to replace the existing management with himself and his two sons, and to dispose of the Southern Pump Division. These moves, he believed, would immediately add one million dollars per year to the company’s profits. Based on the foregoing factors, George presented his offer to acquire John’s 50 per cent interest for a total of $1,794,159.13.

This offer was made without any previous discussion between the brothers as to George’s intention, and came as a complete surprise to John. His immediate reaction was to seek the advice of his accountant, Frank Welsh, as to the value of the business. Mr. Welsh, who has no expertise as a business valuator, suggested that John should consult an expert during the thirty days that he had to respond to the offer. John rejected this advice, principally because he had more faith in his own assessment of the value of the company than in that of a stranger, however expert. He knew the business and its profit history, he had the benefit of the appraisal of the land and buildings that had been made when the Andren shares were bought in 1979, and he was well aware of the orders that were on the books for API couplings, and that a new CNC machine which was on order would contribute substantially to profits. Both brothers were aware at this time that management had predicted a net profit of about $1,488,000.00 for the financial year ending January 31, 1982. They were also both aware that two years previously they had paid their brother Andrew $1,000,000.00 for his one-third interest in the company. John concluded from all the information at his disposal, and from his consultation with Frank Welsh, that most of the purchase price fixed by George’s offer could be recovered from the profits to be made in the ensuing year, and that a 50 per cent interest in the company was worth at least the offered price. He therefore responded to the offer by electing to buy rather than to sell.

The generally accepted definition of fair market value contemplates a notional transaction between informed and prudent parties who act at arm’s length from each other, and who are under no compulsion to transact. There is no room to doubt that both George and John were informed and prudent parties when they made their decisions leading to the sale of these shares. They had both been intimately involved in overseeing the management of the company for a decade. During that time they had reviewed the financial statements, and had met on a regular basis with the company’s management team. George had formulated his own plans to restore the company to profitability. They each had many years of experience in a wide range of business ventures, and they both had received input from trusted and knowledgeable advisors before making their decisions. It is significant, too, that upon being advised of his brother’s decision to purchase rather than sell, George immediately went to Waco, Texas, where he and his younger son Bryan established a business manufacturing API couplings. With the benefit of the technology that had been developed by TPS, and using the same type of machinery as TPS, bought with the purchase money paid by his brother for his TPS shares, he was able to enter the market in time to share in the short-run profitability of this industry. This indicates the confidence that George had in the future of the coupling business, which was to be the mainstay of TPS in the years to come. I am satisfied, too, from the evidence of both John Gilvesy and George Gilvesy that they were in fact dealing with each other in the way that they would have dealt with strangers. In this, their evidence is corroborated by that of the other witnesses who testified as to the circumstances surrounding the transaction. Although friendly in their personal lives, the brothers did each other no favours in their business dealings.

The market in which this sale took place was not, of course, open and unrestricted; nor was John free from compulsion. After receiving his brother’s offer he had only two courses open to him. He could buy or he could sell, but he must do one or the other, at the offered price. There was no room for negotiation because of the terms of the buy-sell agreement, and in particular its shotgun clause. I do not believe, however, that these restrictions diminish the probative value of the sale for the present purpose. That neither brother could sell his shares without the other’s consent, and that George’s offer forced John to buy or to sell at the offered price, would tend to limit the price at which the transaction took place. What I have to decide, however, is not whether George might have realized a higher price, but whether the price actually paid by John was in excess of the fair market value of the shares. [4] The restrictions on their freedom to transact could not artificially inflate the price.

The evidence of value for the Respondent consists of the opinion evidence of Christine Senyk, B.A. C.G.A. C.B.V., who is employed by Revenue Canada as a Senior Business Valuator. Ms. Senyk graduated from the University of Waterloo with a Bachelor of Arts degree in history, and then worked for four years with a large firm of accountants. In 1985 she joined Revenue Canada as a Business Auditor. In 1988 she received the designation Certified General Accountant, and the same year she was promoted to Senior Business Valuator. In 1994 she received the designation of Chartered Business Valuator. Since then she has been involved in a large number of business valuations for Revenue Canada, she has attended numerous continuing education programs dealing with the theory and practice of business valuation, and she has assisted in training new valuators. Her evidence did not reveal whether or not she had previously given opinion evidence, but it does not appear from her resumé that she has had any personal business experience as either entrepreneur or. investor, and she admitted on cross-examination that she has never advised a potential buyer of a business.

Counsel for the Appellant did not challenge Ms. Senyk’s qualification to give opinion evidence; he did, however, after a searching cross- examination, challenge the probative value of her opinion. One of his bases for doing so was that as an employee of Revenue Canada, Ms. Senyk brought to her task a bias in favour of her employer. Bias in favour of the party for whom the evidence is given, and who therefore pays the witness, is always a potential cause for concern in evaluating opinion evidence. In the absence of specific evidence going to the issue, there is no reason to believe that the potential for bias is any greater cause for concern in the case of evidence given by an employee of a litigating government or corporation than in the case of a self-employed consultant who bills by the hour or by the day. In either case it is the integrity, training, experience and judgment of the witness that will ultimately determine the value of the evidence, not the type of contractual relationship shared by the witness and the party for whom the evidence is led. I have no reason to doubt the integrity or the sincerity of Ms. Senyk in giving her evidence, and I reject the suggestion that bias, even at a subconscious level, is a factor that should diminish its probative value.

Ms. Senyk took the position that the earnings history of TPS in the late 1970s, when substantial losses were recorded, made it inappropriate to value the business on the basis of its projected future earnings potential. She considered TPS to have no history of maintainable excess earnings, and consequently her opinion was that the appropriate method of valuation was the Modified Tangible Asset Backing (or Liquidation Value) approach, as defined by Campbell [5] the following words:

An amount equal to the aggregate value of all tangible and identifiable intangible assets, where the latter have values that can be separately determined, and where the value of both tangible and identifiable intangible assets has been determined on the assumption of piecemeal sale on the valuation/acquisition date, minus all liabilities, including disposition, income tax, and other costs related to said piecemeal sale.

In effect, this approach to valuation assumes that a potential purchaser will be unwilling to assume the risk of purchasing the business for a price greater than the sum that could be realized upon an orderly liquidation and distribution of the assets. In support of this approach she stated that, in addition to its recent losses, the company was over-leveraged, and that it suffered from a working capital deficiency. Her valuation, by the Modified Tangible Asset Backing method, then became largely a mathematical exercise based upon asset values and the taxation consequences of the notional liquidation of the business.

Quite apart from her relative inexperience, a number of factors cause me to give little weight to Ms. Senyk’s opinion of value. Her investigation was, I think, too limited. She had available to her the case study prepared by Bryan Gilvesy and his colleagues in 1980 and 1981, as well as the financial statements of TPS for years prior to 1981. However, she did not interview either George or John Gilvesy, the parties to the 1981 transaction. She explained that John Gilvesy was in the hospital at the time she did her valuation; there was no explanation as to why George, who fixed the offered price, could not have been interviewed. Had she spoken to him she would have learned of the changes which he intended to make in the company as its sole owner. She would also have learned the reasons for the loss years in the late 1970s, and that neither the labour unrest nor the problems resulting from the alleged failed coupling were likely to recur. By 1981 TPS had established a good reputation in its market for product reliability, and, according to the evidence of George and Bryan Gilvesy, considerable goodwill.

In my opinion Ms. Senyk was too willing to overlook the profitability of the company in the early and mid 1970s, and to concentrate on the unprofitable years. George had a business plan in mind which he believed would overcome the causes of the recent losses, and also exploit untapped markets for couplings. Although she said in her evidence that she knew of and took into account the very substantial orders on the books of the company at the beginning of 1981, there is no reference to that in her written report. Nor is it apparent from her report that she took into account the fact that only this company had the special technology which permitted the manufacture of a coupling by threading both ends of it without removing it from the machine. This technology, and the machine which supported it, enabled TPS to achieve a very high level of productivity, while maintaining superior product quality and reliability.

Finally, Ms. Senyk was, I think, somewhat influenced, whether consciously or not, by hindsight. Her opinion is, in large part, based upon the assumption that the coupling business was very vulnerable to declining oil prices, that this was what ultimately led to its demise, and that this was foreseeable in March 1981. However, the only evidence of this foreseeability to which she could point was a wire service story in the Calgary Sun of March 18, 1981, which suggested that the OPEC countries were concerned about a developing glut on the international crude oil market. There is no sound basis in the evidence before me that suggests that either of the Gilvesy brothers would have had reason to believe on March 5, 1981, when their contract was entered into, that a collapse of the oil exploration industry was about to take place. It seems unlikely that George and Bryan Gilvesy would have made the substantial investment that they did in the Waco, Texas operation if they had reason to believe that.

I do not think that it would be appropriate for me in this case to reject both the transaction which actually took place and the opinion evidence of Ms. Senyk, and reach a different conclusion as to value, although that course is open to me. [6] The position taken by counsel for the Crown was not that there was collusion to inflate the price of these shares artificially, but that both brothers had genuinely overestimated the value of the company, perhaps for reasons involving sentiment. Faced with a choice between the highly theoretical opinion of Ms. Senyk, and the real transaction between these two very experienced business men, knowledgeable about the company and the industry, dealing in the real world with their own money, I have a strong preference for the latter as evidence of value. While the restricted market in which they operated may have caused George and John to reach a price less than would have been arrived at in an open and unrestricted market, I am quite satisfied that the fair market value of the 50 per cent shareholding in TPS at March 31, 1981 was not less than $1,794,159.13. Subsection 69(1) of the Act therefore does not apply to this transaction.

The appeal is allowed, with costs. The assessments are referred back to the Minister for reconsideration and reassessment in accordance with these reasons.

Appeal allowed.