Evan Wesley George Bodrug v. Minister of National Revenue, [1979] CTC 2593, 79 DTC 551

M J Bonner:—The appellant has been assessed to tax on capital gains realized on the sale, in 1972 and 1973, of shares of Canadian Hidrogas Resources Ltd (hereinafter called “the company’’). The company was a public company, the shares of which were traded on the Calgary stock exchange.

Before 1972 the appellant owned a control block of shares of the company. After 1971, that is to say in each of the years 1972 and 1973, the appellant both purchased and sold shares in the open market. His objective in doing so was to increase the volume of trade in the stock and thus increase its marketability.

The respondent, in assessing tax, used as the adjusted cost base of the shares sold the Valuation Day value as prescribed in Schedule F to the Income Tax Regulations pursuant to section 24 of the Income Tax Application Rules, 1971. On that basis he determined that the appellant had not suffered any capital losses as reported in his returns, but rather had realized gains.

The appellant’s first contention was that the 1972 and 1973 transactions were not on capital account. His objective had been to buy when the market was weak and sell when the market was strong. The total number of shares purchased and sold was as follows:

The 1972 sales include a block of 50,000 shares sold by the appellant to a director of the company pursuant to an option agreement previously formed. There was no evidence that the appellant purchased and sold shares in the open market either before or after the two-year period. There was no evidence that the appellant engaged in purchases and sales of any other security. The tenor of the evidence was such as to lead me to infer that the business interests of the appellant were centred on the operation of the company. The appellant could not be regarded as carrying on the business of a trader in shares. There was no evidence indicating whether there was any prospect of receipt of dividends, although in light of the decision of the Supreme Court of Canada in Irrigation Industries Limited v MNR, [1962] CTC 215; 62 DTC 1131, that factor would not appear to have much weight. Thus, the appellant’s first contention rests exclusively on the acquisition of shares with the intention of resale at a profit. That contention cannot succeed. In Irrigation Industries Martland, J stated at pages 223, 1135:

The only test which was applied in the present case was whether the appellant entered into the transaction with the intention of disposing of the shares at a profit so soon as there was a reasonable opportunity of so doing. Is that a suffi- cent test for determining whether or not this transaction constitutes an adventure in the nature of trade? I do not think that, standing alone, it is sufficient.

The appellant argued that, factually, there were two groups of properties, namely (a) the “control group’’ owned by him before 1972 and, save for the 50,000 share block disposed of pursuant to the option, thereafter kept intact, and (b) the group of shares, varying in size from time to time, acquired and disposed of on the open market. He argued that the shares in the two groups were not identical properties for purposes of subsection 26(8) of the Income Tax Application Rules. The appellant’s evidence was that he intended to and in fact was compelled to retain the control group. The compulsion arose from the fact that part of the control group was held in escrow. The remainder were hypothecated by the appellant to persons who had loaned money to the company. I assume that the shares were hypothecated in support of a guaranty given by the appellant to the creditor.

It is difficult to conceive of two properties which might more aptly be described as identical than two shares of the same class of the issued capital of the company.* [1] As between the appellant and the company, each share, whenever acquired, vested in the appellant the same rights as any other.

Unfortunately, the terms of the hypothecation were not described in evidence. Generally speaking, I should think that the identity of shares as property would not be affected by the act of pledging a security for the performance of an obligation.

The escrow agreement was not described by Mr Bodrug in evidence, but the terms were set out in Exhibit A-9. It was entered into as a condition of approval of the issuance of treasury shares of the company to the appellant and others. It is not necessary to decide whether a restriction imposed by an escrow agreement on the right of a holder to sell his shares makes such shares property not identical to other shares held by the owner which he may freely sell. It is clear that on December 31, 1971, the appellant held 627,300 shares in the company, free of the terms of the escrow agreement. Paragraph 26(8)(e) of the Income Tax Application Rules applies to deem at least that the escrow free shares were disposed of by the appellant before the otherwise identical shares acquired by him after 1971.

The next question which arose was what was the fair market value on Valuation Day of the shares, a figure required for the purposes of subsection 26(3) of the Income Tax Application Rules. The respondent apparently proceeded on the basis that such value was then equal to or less than 72¢, the amount prescribed in Schedule F. The appellant contended that it was $1.40.

The appellant called Jack M Pearce and Robert G Kennedy, co-authors of a written report (Exhibit A-9), on the value on Valuation Day of the shares. Both witnesses had, by their company, Pearce, Kennedy & Associates Ltd, carried on the business of business valuators and brokers for a period of 14 months. Before that period commenced both had prior experience in business valuation as employees of the Department of National Revenue.

The company carried on the business of purchasing, storing, shipping and selling liquefied propane gas. In addition, the company held resource properties.

Mr Pearce was of the view that the prescribed or stock market Valuation Day value of the shares owned by Mr Bodrug did not properly reflect the premium attached to Mr Bodrug’s shares which formed a control block. He proceeded to value the propane division of the company by capitalizing amounts which he computed to be normalized earnings of the company. Mr Kennedy valued the resource properties of the company which Mr Pearce stated “are probably traded on an asset basis”. In other words, the resource properties of the company were treated as redundant assets. A summary of the results which they arrived at is as follows:

This value of $1.40 per share is certainly realistic in view of the fact that the stock market price had risen to $1.65 per share in June, 1972.

I digress to observe briefly that a valuation such as this should be based on facts known or predictable at the date as of which the valuation was made. I assume, however, that neither witness was influenced by the performance of the stock subsequent to Valuation Day.

The 1.35 million dollar value of the propane division of the company was an amount arrived at on the premise that “no allowance was made for income tax because’’:

. . . due to the Company’s involvement in oil and gas exploration no taxes would be payable for probably at least 10 years. Also, a potential purchaser would probably be in the same position.

Given the approach to valuation adopted by Messrs Pearce and Kennedy, which involved the valuation, on an earnings basis, of the propane division of the company as a separate entity and treatment of assets outside that division as redundant, it would seem illogical to ignore income tax. Mr Pearce admitted that in valuing on the basis of capitalized earnings the most significant figure is after-tax return on investment. I am not at all satisfied that Mr Pearce was in any way qualified to express, as he did, the opinion that a probable purchaser would hold resource and development properties, be in a “position where he does not pay income tax’’ and therefore be prepared to pay “more than a company that would have to pay the tax’’. The reasoning seems to involve a non sequitur. Nothing in the evidence suggested that any such pattern of conduct had ever been observed by Mr Pearce. In the absence of that premise Mr Pearce admitted that the value of the propane division would be approximately $1,000,000, using the multiplier he had chosen.

On re-examination Mr Pearce suggested that higher multipliers might be used if the propane division were being valued as a separate company. He referred to price earnings multiples paid for stock listed on the Toronto stock exchange for merchandising companies and companies trading in wholesale petroleum products. However, such multiples cannot, I think, be selected solely by reference to industry averages. The multiplier to be applied to indicated earnings when valuing a business on an earnings basis must be related to the risk, as seen on the valuation, that such earnings can be achieved or maintained by the company in question. In short, I have concluded that Mr Pearce’s estimate of the earnings value of the propane division of the company was $350,000 to high.

Mr Kennedy’s contribution to Exhibit A-9 was the valuation of the company’s resource properties. His work was based on estimates of reserves prepared in December of 1971 by a firm, Blain, Binnie, and Associates Engineering Ltd. He then applied to those reserves figures which he had seen used by analysts reviewing oil and gas shares of publicly traded companies. Of the $1,969,439 total estimated value of resource properties, $1,538,880 was his estimate of the value of the company’s coal property. The latter figure was derived in reliance on (a) tonnages of coal from the Blain, Binnie report, and (b) discussions between Mr Kennedy and the manager of the company, which I gather is related to another company which is an active producer of coal. That manager apparently told Mr Kennedy that the value of the coal property which was not in production could be anywhere from 5¢ to 10¢ per ton. It was decided, I assume by Mr Kennedy and the appellant, not to employ anyone more expert than Mr Kennedy to do an appraisal of the fair market value of the coal property. A figure of 2¢ per ton was arbitrarily selected. Some reliance was placed on a selling price of $20 per ton of coal, if produced. No figure was suggested as the cost of production of the coal from the resource actually owned by the company.

A portion of the Blain, Binnie report was attached to the Pearce, Kennedy report. Blain, Binnie apparently relied, for tonnage figures, exclusively on a report prepared by one M J Rickert dated May 10,1928, which indicated that the coal seams were continuous, near the surface and that open pit mining could be employed.

The company’s coal property apparently consisted of a lease of 1,280 acres. According to Mr Bodrug, the company, in early 1970, paid an initial price of $1 per acre per year for the coal lease. Mr Kennedy had no idea of the prices paid for coal leases in 1971 and he could therefore not say that the price paid in 1971 for such leases was any different. There is no basis on this evidence for concluding that the value of the lease exceeded its cost.

Mr Kennedy was asked whether he had ever participated in the valuation of a coal property for purposes of its sale. He responded only that he had, when an officer of the Department of National Revenue, reviewed valuations of coal properties held by a company. He did not try to ascertain whether, at the relevant time, there was a market for a property such as the block of coal lands held by the company. He did some research to determine whether any sales of blocks of this sort had taken place during the relevant period and he could find none.

It was not suggested that Mr Kennedy’s evidence was inadmissible because his chain of reasoning was based entirely on hearsay. It might arguably be regarded as admissible on the basis of the principle laid down in The City of Saint John v Irving Oil Company Limited, [1966] SCR 581. Mr Kennedy’s evidence was in part directed towards establishing the value of the coal property as an asset of a company, the value of the shares of which is in issue. I cannot conclude, however, that Mr Kennedy was, by experience, education or otherwise, qualified to express an opinion on the value of the coal property held by the appellant and, in the result, I must conclude that Mr Kennedy’s evidence should be given no weight. I cannot, therefore, find that the value of the coal property exceeded its cost to the company.

The appellant’s assertion that the shares were worth more than /72¢ each has not, on the evidence, been established. The appeal is therefore dismissed.

Appeal dismissed.