Godcharles v. Agence du revenu du Québec, 2021 QCCA 1843

A group of unrelated individuals were the co-owners of a seniors’ residence (“SR”), which was leased by them to the corporate operator of the residence (“9118”), whose shares they owned in the same proportions as the residence. In order to access the capital gains exemption on a sale of the residence business to an arm’s-length purchaser (“SECA”), all the individuals, other than the one with the largest (35%) interest (NG), sold their shares of the operator to a holding company (“9084”) for NG for a sale price stated to be the FMV of the shares (which was not specified in dollars). Two days later (on January 20, 2006), the residence and the operating business were sold by the individuals and 9118 to SECA for a purchase price that was not allocated between the residence sold by the individuals and the operating assets (essentially, the goodwill) sold by 9118. However, when the vendors filed their returns, they treated all of the asset appreciation that had occurred as relating to the goodwill sold by 9118. NG received supposed capital dividends out of the goodwill gain reported by 9118.

Morissette, JCA found no reversible error in the finding below that a substantial portion of the proceeds should be reallocated to the sale of the real estate (the residence) under TA s. 421(a) (equivalent to ITA s. 68(a)), with resulting recapture of depreciation and (non-exempted) capital gains to the individuals. Although there were two vendors (9118 selling the goodwill, and the co-owners selling the residence), s. 421(a) nonetheless could apply. Morissette, JCA stated (at para. 29, TaxInterpretations translation):

[I]ts precise conditions are met. At the conclusion of the January 20, 2006 sale, there was an amount ($11,550,000) received or receivable from a person (SECA). This amount can reasonably be considered to be part of the consideration for the disposition of property (the Building) of the taxpayers (the Appellants), and the remainder of this amount can reasonably be considered to be part of the consideration for the disposition of the property of 9118, namely the goodwill and other moveable property of the SR.

The Court of Quebec had accepted the valuation of the real property (which had reached full occupancy three years’ previously) by the ARQ valuator using the cost method (i.e., the costs of construction, plus a promoter’s notional profit of 5%, plus net GST/QST of 9.495%, minus depreciation of 4% and plus the land appreciation since purchase), with there being a consequential reduction in the residual amount to be allocated to the goodwill. There also was no reversible error here.

A group of unrelated individuals were the co-owners of a seniors’ residence, which was leased by them to the corporate operator of the residence (“9118”), whose shares they owned in the same proportions as the residence. In order to access the capital gains exemption on a sale of the residence business to an arm’s-length purchaser (“SECA”), all the individuals, other than the one with the largest (35%) interest (NG), sold their shares of the operator to a holding company of NG for a sale price stated to be the (unspecified) FMV of the shares. Two days later, the residence and the operating business were sold by the individuals and 9118 to SECA for a purchase price that was not allocated between the residence sold by the individuals and the operating assets (essentially, the goodwill) sold by 9118. However, when the vendors filed their returns, they treated all of the asset appreciation that had occurred as relating to the goodwill.

Morissette, JCA affirmed the finding below that the sale of the shares of 9118 by the other individuals to NG’s holding company (9084) was a transaction between persons not dealing with each other at arms’ length, given the dominant role of NG in establishing the terms of the transaction. However, he agreed with the taxpayers that this had no significance, given that TA s. 422(c)(i) (equivalent to ITA s. 69(1)(b)(i)) only addressed situations where shares or other property was sold at less, rather than more, than its FMV. He stated (at para. 25, TaxInterpretations translation), in also discussing TA s. 422(b) (equivalent to ITA s. 69(1)(a)):

[W]hile section 422(b) allows the value of the property to be revised as regards the purchaser of the property, it does not allow the sale price to be adjusted to the seller. The proceeds of sale to the seller will be the actual sale price, which is the amount in excess of the fair market value. This explains why a similar provision in federal legislation has been commented on as follows: such a provision "does not have the effect of deeming the consideration received by the seller to be equal to the fair market value of property sold in a transaction between related persons if this consideration is greater than the market value" [citing Colubriale at para. 28]. This is because, as a general rule, "the tax authorities have no interest in reducing the proceeds of disposition actually received by a seller, whereas the opposite is true with regard to the price paid by a buyer” [ibid.]

A group of unrelated individuals were the co-owners of a seniors’ residence (“SR”), which was leased by them to the corporate operator of the residence (“9118”), whose shares they owned in the same proportions as the residence. In order to access the capital gains exemption on a sale of the residence business to an arm’s-length purchaser (“SECA”), all the individuals, other than the one with the largest (35%) interest (NG), sold their shares of the operator to a holding company (“9084”) for NG for a sale price stated to be the FMV of the shares (which was not specified in dollars). Two days later (on January 20, 2006), the residence and the operating business were sold by the individuals and 9118 to SECA for a purchase price that was not allocated between the residence sold by the individuals and the operating assets (essentially, the goodwill) sold by 9118. However, when the vendors filed their returns, they treated all of the asset appreciation that had occurred as relating to the goodwill sold by 9118. NG received supposed capital dividends out of the goodwill gain reported by 9118.

Morissette, JCA affirmed the finding below that the sale of the shares of 9118 by the other individuals to NG’s holding company (9084) was a transaction between persons not dealing with each other at arms’ length, given the dominant role of NG in establishing the terms of the transaction. In this regard, he stated (at para. 18, TaxInterpretations translation):

The record shows that NG was the real instigator and driving force behind the SR project. He had designed the underlying legal structure with the advice of his own accountants. The co-owners and shareholders of 9118 were all long-time acquaintances of NG, including a former spouse, a "childhood friend of 40 years" or, in his words, "partners from almost the beginning of my involvement in the business in 1989". Moreover, although the other appellants were kept informed of NG's actions, he informed them of the transactions after they had been planned and decided by him. He alone conducted the negotiations with SECA (whose officers he knew well and with whom he had previously dealt) and he remained, on behalf of all the co- owners and shareholders of 9118, the principal contact for the respondent's auditors.

However, he agreed with the taxpayers that this had no significance, given that the Quebec equivalent of s. 69(1)(b) only addressed situations where shares or other property was sold at less, rather than more, than its FMV.

At the time of the sale of a seniors’ residence to an arm’s-length purchaser, a group of unrelated individuals were the co-owners of the real estate (the residence), which was leased by them to the corporate operator of the residence (“9118”), whose shares they owned in the same proportions as the residence.

The Court of Quebec had accepted the valuation of the real property (which had reached full occupancy three years’ previously) by the ARQ valuator using the cost method (i.e., the costs of construction, plus a promoter’s notional profit of 5%, plus net GST/QST of 9.495%, minus depreciation of 4% and plus the land appreciation since purchase) - so that $9.385 million of the $11.55 million purchase price waws allocated to the real property, with there being a consequential reduction in the residual amount allocated to the goodwill. In finding that there also was no reversible error here, and that it was reasonable to allocate a portion of the purchase price to the goodwill, Morissette, JCA stated (at para. 40):

The SR acquired by SECA offered … services … that … varied by unit and by resident choice. Of the 109 housing units, those of the "studio" type were not equipped with a full kitchen, and the rent paid by residents included room and board for three meals per day. Residents with kitchen facilities could still purchase monthly food packages from the SR, whose kitchens were operated by 9118 itself. The SR also provided other services to residents, such as 24-hour security, concierge, assistance, movies, housekeeping and nursing, as well as a contracted hair salon and bi-monthly visits by a physician.