Gestion Bertal Inc. v. Her Majesty the Queen, [1996] 3 CTC 2183, 96 DTC 1433

Archambault J.T.C.C.: — Gestion Bertal Inc. (Bertal) is contesting an income tax assessment by the Minister of National Revenue (Minister) for the 1988 taxation year whereby the Minister taxed a capital gain of $284,812.

According to Bertal, the Minister underestimated its adjusted cost base (ACB) by $171,900. This is the only point at issue.

Facts

Bertal owned real property purchased in July 1982 for a total amount of $165,000, which consisted of two properties situated at 95 and 135 St-Jean Street in Québec City. The properties were used by Manoir St-Jean- Baptiste Inc. (Manoir) in the operation of its housing business for elderly persons. Louise Bertrand owned all the shares of both companies during the 1988 fiscal year.

At the time they were purchased, the properties needed renovation because they had been damaged by fire. Furthermore, new buildings and walkways between the various buildings had to be erected in order to accommodate more tenants. A new dining room and a chapel were fitted up in 1983 and 1984. A new 19-bedroom building bearing address number 95A was also built in 1984 behind the property situated at 95 St-Jean Street in 1984. In 1985, a new walkway was built between 95 and 135 and 95 underwent transformations to convert those four units into seven bedrooms. It appears that most of the construction and renovation work was completed in early 1986.

During the renovation and construction period, Bertal’s shares were held as a guarantee by Guy Lapointe, a hardware store operator from St-Philémon, who acted as main contractor for the work and obtained the necessary financing, which moreover he had to guarantee in part in order to finance the purchase, construction and renovation of Bertal’s real property complex. The shares of that company were transferred to Ms. Bertrand on February 2, 1986.

The construction and renovation work was carried out in accordance with estimates which unfortunately did not prove accurate. Cost overruns were incurred requiring additional outlays by Bertal. On May 31, 1984, Ms. Bertrand had to agree to Bertal’s granting a $140,000 second mortgage to Mr. Lapointe on June 15, 1984, for materials that he had provided for construction and renovation work carried out prior to September 1, 1983. That mortgage was transferred to Philippe and André Aubin on June 25, 1985, and to Gilles Piché, in trust, on December 16, 1985. That mortgage seems not to have appeared in Bertal’s balance sheet until the 1986 fiscal year. That debt appears therein as an amount owed to “P. Aubin”, the balance of which was $135,937 as of January 31, 1986. It should be noted that the 1985 balance sheet contains an addition error. The total cost of all the capital assets described in a note to financial statements amounted to $849,038, but the figure that appeared in the balance sheet was $749,038. Like the addition of the unpaid balance of the $140,000 mortgage, this error was corrected only in the 1986 balance sheet.

The additions to the properties were $208,601 in 1985 and $44,647 in 1986. On June 14, 1984, the date of the $140,000 mortgage, Bertal refinanced previous loans which, according to Ms. Bertrand’s testimony, had been used to pay the acquisition cost of the properties and part of the construction and renovation costs of the real property complex. Bertal borrowed $750,000 from the Caisse de dépôt et placement du Québec, to which it granted a first mortgage. That amount correctly appears in the balance sheet for the 1985 fiscal year.

At the end of the previous fiscal year, that is, on January 31, 1984, Bertal’s long-term debt was $463,200. It therefore appears that that loan was used to finance the construction and renovation underway at Bertal’s real property complex. Ms. Bertrand stated that no part of those funds had been used in Manoir’s business and that she had seen [TRANSLATION] “not a cent” of that loan. It should be borne in mind that Bertal was under Mr. Lapointe’s control at that time.

According to an agreement entered into on February 13, 1985, with Mr. Lapointe, Ms. Bertrand also had to advance the sums necessary to pay some of Bertal’s debts. In particular, a sum of $30,000 had to be deposited with Mr. Boivin, Mr. Lapointe’s solicitor, to pay some of Bertal’s creditors and a sum of $20,000 to other creditors of Bertal in order to finish the work.

On March 14 and April 1, 1985, Ms. Bertrand paid $25,000 and $6,900 to Mr. Boivin in trust, in compliance with the agreement of February 13, 1985. Ms. Bertrand also had to release Mr. Lapointe from liability as guarantor toward CIBC and the St-Philémon caisse populaire. The sum of $21,446 was paid on January 15, 1986. Ms. Bertrand provided proof of payment of the sum of $31,900 in March and April 1985 and of the sum of $21,446 in January 1986. No proof was adduced in respect of the sum of $20,000. It is possible that that amount was paid at least in part by Bertal out of a new loan of $116,450 to which I shall return below.

Nothing in Bertal’s 1986 balance sheet indicates that Ms. Bertrand made an advance to that company. On April 9, 1985, Bertal borrowed an additional sum of $116,450 from the Caisse de dépôt et de placement du Québec in order to finance construction costs of $80,000 owed to Menuiserie Roy et Gagné Inc., additional construction costs of $28,600 for a walkway between the 95 and 135 St-Jean Street properties and the transformation of the 135 St-Jean Street property. This new loan was reflected in the 1986 balance sheet.

On July 15, 1987, Bertal and Manoir sold their properties and their business for $1,700,000, $1,325,000 of which was attributed by the Minister to the sale of Bertal’s real property and chattels. Bertal did not dispute this attribution.

The calculation of the capital gain, like the preparation of the balance sheets from 1984 to 1988, was done by an accountant who did not belong to any professional association of accountants and was retired from the Quebec Ministry of Revenue. In computing the ACB, the accountant not only used the aforementioned cost of the real property and chattels, that is, $964,635, but also added the cost of a $3,596 inventory, even though the inventory had never appeared on Bertal’s balance sheet, and the sum of $194,719 described as Ms. Bertrand’s total advances; those amounts did not appear either in Bertal’s balance sheets. No accounting evidence, voucher or cheque was filed at the hearing to support that amount of $194,719. The cheques that were filed jointly at the hearing may have represented advances; all the cheques concerned Manoir. The ACB computed by the accountant thus amounted to $1,162,940.

The Minister’s auditor stated that, in making his assessment, he had determined the ACB of the properties based on Bertal’s balance sheets. In the 1988 balance sheet, the total cost of the properties and chattels amounted to $964,635. When examining the file in which an objection had been filed, the Minister’s appeals officer gave Bertal the benefit of the doubt and allowed it an additional cost of $21,446 representing the amount paid by Ms. Bertrand in order to pay certain amounts owed to the St- Philmon caisse populaire and CIBC for costs relating to the construction and renovation of the real property complex, thus releasing Mr. Lapointe as guarantor. The ACB allowed by the Minister thus amounted to $986,081.

Analysis

Counsel for Bertal contended that the Minister should have added to the cost of the properties the amount of the $140,000 mortgage and the sum of $31,900 paid by Ms. Bertrand representing a total sum of $171,900. I am prepared to give Bertal the benefit of the doubt and agree that the amount of $31,900 represented an advance from Ms. Bertrand which was not recorded as an advance in Bertal’s balance sheet, that that amount related to Bertal’s renovation and construction costs and that it is likely that that amount was not added to the costs of the properties in that company’s balance sheet.

Ms. Bertrand seemed to me to be a highly credible person. The 1986 balance sheet does not show any advances from a director other than the $140,000 mortgage loan that appears in a note as an advance from a director. However, these financial statements are of poor quality and lack coherence. I need only mention the $100,000 error appearing in the 1985 balance sheet and the fact that the $140,000 loan was not reflected in the correct fiscal year.

With respect to the $140,000 loan, I do not understand how Ms. Bertrand could believe that that amount was not reflected in the cost of Bertal’s properties. Perhaps she was relying on the testimony of the accountant who stated that he had never seen the mortgage deed and that he had not taken it into account in preparing the financial statements. Although I believe that the accountant was in good faith at the hearing, I am nevertheless convinced that he was mistaken. The $140,000 mortgage debt appeared in the 1986 balance sheet and the name of P. Aubin is described therein as the creditor. Mr. Lapointe’s $140,000 claim was transferred to Philippe and Andr Aubin on June 25, 1985, and I have every reason to believe that it was the same claim as that described in the 1986 balance sheet.

Having concluded that the $140,000 claim was reflected in the balance sheet, I can only believe that the cost of the assets was increased by $140,000 so that the balance sheet balanced. It is true that the amount could have been used to finance operations. However, there is no evidence that the company carried on a business activity from 1985 to 1988. The 1984 balance sheet shows an operating loss of $10,666 for that fiscal year. For each of the following fiscal years, that balance sheet item. remained the same. There was no evidence that Manoir paid a rent to Bertal. The accountant even stated that, in economic terms, the two companies formed a single entity, even though there were legally two of them. One has the distinct impression that Bertal merely held the properties for Manoir’s operations and that that company was used more to enable Mr. Lapointe to have a certain control over the construction of the properties and to protect himself in the financing of the work, part of which had to be guaranteed by him.

For these reasons, Bertal’s appeal is allowed and the assessment for the 1988 taxation year is referred back to the Minister for reconsideration and reassessment on the basis that the ACB of the property and chattels sold during the 1988 fiscal year was $1,017,981. The whole without costs.

Appeal was dismissed with respect to $140,000, but was allowed with respect to $31,900.