Godcharles – Quebec Court of Appeal applies s. 68 to reallocate between a retirement home’s business operations sold by one vendor and the home sold by the other vendors
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 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.
What mattered instead was 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, as “its precise conditions are met” in this situation.
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.