Arthur Donald Lauder v. Minister of National Revenue, [1979] CTC 2911, 79 DTC 764

Delmer E Taylor:—This is an appeal heard in the City of Vancouver, British Columbia on June 28,1979, against an income tax reassessment for the year 1974 in which the Minister of National Revenue disallowed an amount of $148,313 claimed by the appellant as a capital loss on the sale of company shares of stock, and further the Minister added to the appellant’s declared income an amount of $183,003.62 as a capital gain on the disposal of the same company shares. The appellant’s taxable income was thereby increased by $165,658.31 ($148,313.00 + $183,003.62 -:— 50%). In reassess ing the appellant, the respondent relied, inter alia, upon sections 3, 38 and 40 of the Income Tax Act, SC 1970-71-72, c 63 as amended.

The sole issue is the valuation of the shares on V-Day and the evidence adduced in this appeal, on consent of both parties, was considered common to the following other appeals and decisions will be rendered separately in those cases:

Marion D Lauder—Taxation Years 1974 & 1975

Manasu Holdings Ltd—Taxation Year 1974

Donald A Newson—Taxation Year 1974

Background

The appellant held 50,001 shares of the capital stock of Hayes Trucks Ltd (hereinafter referred to as “Hayes”) which were disposed of at a price of $7.04 per share (totalling $352,007) in the 1974 taxation year. In preparing his income tax return for that year, he valued these shares as at V-Day at $500,320, or approximately $10.06 per share. The value ascribed to these shares for V-Day purposes by the Minister was $3.75 per share. Hayes was a manufacturer of large specialized “off road” vehicles used in the logging industry.

Evidence

Testimony regarding Hayes and the taxpayer’s valuation was provided by the appellant, and by Mr Robert Edward Granger, Regional Director of the Investment Dealers Association. The evidence for the Minister was provided by Mr Robert Clark Smith, Business Equity Value Group Head with Revenue Canada.

Mr Lauder’s involvement with the company dated back to at least 1951, and he acquired control of Hayes in 1966 owning approximately 90% of the issued capital stock. The 10% balance of the capital stock was held by friends, relatives or business associates. Mr Lauder operated the company virtually as a sole proprietorship until 1969, at which time he sold 66 /3% of Hayes to Mack Trucks Ltd (hereinafter referred to as “Mack”) for $8.67 per share, leaving him with about 24%, with the balance of about 10% still in other hands closely associated with him. His daily operating functions in the Hayes plant continued virtually unchanged, until 1974 when that company was soldtoa third party. This 1974 sale included the 66%% of the stock owned by Mack, and the 24% owned by Lauder—it was a condition of the purchaser that Lauder also sell. The price received was $7.04 per share. Documents introduced through this witness included financial statements for the years 1970, 1971, 1972 and 1973, together with certain schedules of information related to calculation of share values of the company at various times. The fundamental point made by the witness was that he was not merely a minority shareholder at V-Day, but the individual responsible for the operation of Hayes, and knowing its value and potential, including undervalued inventory and real estate, anticipated contracts, etc, he would not have sold his stock at that date for $3.75 but would have demanded at least $10 per share for it. The business “downturn”, resulting in his shares going from his estimated value of more than $10 in 1971 to a sale price of $7.04 in 1974, came as a result of two factors—the general economic conditions, and the fact that a senior manager (Mr Cursio, I believe) left Hayes and was never replaced by Mack.

Mr Granger described the operations of the “bid and ask” stock market quotations, and it was his evidence that in this case only Mr Lauder would have been a reliable source to determine the real value of the stock at any time.

Mr Smith provided a valuation report prepared according to standard procedures—stock market, “bid and ask” quotations, capitalized earnings, liquidation or break-up value, and value as an investment. In addition, Mr Smith introduced copies of certain “insider trading” reports which showed several sales of small amounts of Hayes stock during a period generally relevant to these proceedings. One particular sale for 325 shares was shown as at December 31, 1971, for $3.50 per share. His conclusion was that $3.75 per share was a realistic value to attribute to the holdings of Mr Lauder at V-Day.

Argument

The essence of the appellant’s position Was summed up by counsel as follows:

Now, what is our case? Our case, I think, is very simple. If we do what one says you should do in valuation and do not look at hindsight, then we say, let’s assume that the world stopped on November 30,1971, and ask ourselves one question: is it feasible in anybody’s mind that Don Lauder would have sold his shares for $3,75 on that day? I suggest it’s beyond the pale that he would have so done. If we stop the clock on that date and look back, what do we know? We know there was a sale in 1966 for $5.67. We know there was a sale in 1969 at $8.67. We know that the last six months of 1971 have been the best that the company has ever had, and then the clock stops.

Now, I suggest that if you stop the clock there and say what are your shares worth, Mr Lauder was not unreasonable at all in saying you have got a gradual rise in price, we are having the best year we can possibly have, $10,00. I guess after hearing what I heard today, I probably would have said try twelve. It seems to me that the trend was there, everything was there to indicate that the shares had increased in value at that date.

I think you also have to look at the fact that Mr Lauder was in, I think, a rather unique situation with respect to these shares. I think the assumption of a minority shareholder’s position is that the majority can freeze them out, the majority need never pay dividends, the majority need never let them participate in decisions. Mr Lauder had already quadrupled his money in Hayes Trucks. He was still sitting with a 24% interest, he was in no hurry. I think things were very fine. I do not think the same tests that are applied to a minority should have been applied to Mr Lauder at that time.

I suspect, Mr Chairman, that the Crown has a difficulty and I have the same difficulty. I think that the Crown has the difficulty of saying why did the shares go from $8.67 in 1969 down to $3.75 in 1971 and back up to $7.04 in 1974. On the converse side of that, I have the same difficulty in saying why did the shares start at $8.67, rise to $10.00 and then drop to $7.04. I believe, Mr Chairman, I have discharged the onus. We have shown that in 1971 and the first half of 1972 the company had reached its peak. Indeed, if you took these thirteen months spanning that period, the company had earnings of eighty-eight cents. Truck sales were fantastic. We then know the evidence is that in the fall of ’72 and all of ’73, the lumber industry in this province fell out of bed. The company had strikes, its President quit. For the first time in its history, it lost money. For the first time in its history, book value, instead of increasing annually, dropped. I think that discharges the onus I have on me of saying why did the shares go up and down. I suspect that the Crown’s discharge of the onus is, why did they go down and then up?

I suggest to you, Mr Chairman, on the basis of the Friedman case that Mr Smith’s value is somewhat suspect. He has, if you will, an axe to grind. He is with the Department of National Revenue.

In the Friedman case having to deal with the validity or otherwise of an expert witness, the Friedman case is D & H Friedman v MNR, [1978] CTC 2809; 78 DTC 1599, and I will quote from p 1601:

The other point raised was whether an employee of the Department of National Revenue, which is a party to an appeal, can be accepted as an expert witness in the capacity of an appraiser or evaluator?

On the following page, it goes on to say in the second column:

Notwithstanding the witness’s knowledge in the field of evaluation, I believe that Mr Lussier (of the Department), though undoubtedly acting in good faith, has disqualified himself as an expert witness by admitting to having attempted to negotiate a fair market value of the subject property with the appellants, an activity which, in my opinion, is not consistent with my concept of the role of an expert evaluator or an expert witness.

The man you heard as the expert was the supervisor of the man who attempted to negotiate the shares with the appellant.

For the respondent, the matter was summarized as follows:

I find that I must open my submission by saying to you, much of what has been said today is true. Mr Lauder made the money. Mr Lauder had the experience, he knew Hayes Trucks, but very little of what has been said today, in our submission, is relevant or has any basis in law. And of the things that have been said today, that may be true about the value of the inventory or the value of the underlying assets in general, the land, Exhibit 1 was a photograph, but we don’t really know what that was worth, there has been no appraisal, no expert evidence on the value of those assets. Of what has been said, that may be true and I don’t know if it is or not. That has not been substantiated and not surprisingly, I come to the conclusion that I differ with my friend on fact that his submission is that he has discharged his onus. It’s our submission, Mr Chairman, that he has not.

The onus is on the taxpayer to substantiate the value that they have reported of the shares at V Day, the value reported was $10.00. There is no evidence before this Board, Mr Chairman, in my submission, that shows that those shares were worth $10.00 at V Day. What there has been is an attempt to cast some doubt on the method used by the Department to arrive at valuation.

Another thing, Mr Chairman, which we submit, and which is substantiated by all of the accepted methods of valuation is that there is a difference in value to the owner. Mr Lauder, granted he didn’t want to sell at December 31st, ’71, in his position on that day, he had dealt with Mack Trucks, they had come to a business agreement, he had had his history with the company, he was in touch with what was going on, he was on the Board of Directors, all of that is true. To him those shares attached to him in his position had a value to him as an owner of those shares. But a purchaser with those shares would not have the advantages that Mr Lauder has. What is being looked at to determine fair market value is not Mr Lauder’s shares, granted that all of the knowledge and ability of Mr Lauder is going to remain attached to those shares once those shares would become the property of a anew purchaser and that’s the value, a new purchaser is buying the shares, a new purchaser doesn’t get with the shares what Mr Lauder had with the shares. He had a combination of his experience, his history with the company, his ability, his position on the Board of Directors, he had all of those things. That is not what a purchaser is buying. A purchaser is only buying the shares. There is a difference.

Counsel noted in support of the assessment the case of Her Majesty the Queen v The National System of Baking of Alberta Limited, [1978] CTC 30; 78 DTC 6018.

Findings

Before commencing to examine the matter, the Board wishes to comment on the reference made by counsel for the appellant to the Friedman case (supra). While there is no doubt that in that decision the roles of “negotiator” and “expert witness” came in for some close scrutiny when they became intertwined, I fail to find therein the support suggested by counsel that the valuation report itself should be discarded. In that matter, there are two clear statements by Mr Lucien Cardin, Chairman of this Board, which must be kept in mind—both from p 1602:

Although such negotiations do not detract from Mr Lussier’s qualification as an evaluator and do not necessarily destroy all the contents and the conclusion of his report, they do force the Board to look more closely at how Mr Lussier, in his calculation, arrived at his conclusion.

The Board will, nevertheless, consider the evaluation report, but with more reservations than it otherwise would.

I subscribe to this perspective regarding evaluations, and it will be maintained in determining the present case.

It would appear to me that a major point in this matter is whether or not Mr Lauder has demonstrated that due to his role in Hayes, he was in any better position than a minority shareholder (about 24%) in any other company, when complete control (some 66%%) rested with another party. I am prepared to agree that he had substantial unique experience and background in the industry up to 1967, but it is not evident to me that he continued to occupy the same critical management role through 1971 and in later years, after the control position of Mack was established. For example, Mr Cursio was not replaced, even though it was apparently obvious to Mr Lauder that such a senior manager was necessary immediately. It would appear to me that the value of Mr Lauder’s holdings would be dependent almost exclusively upon the management and control of the majority shareholder—Mack, and that he himself could have only limited influence thereon.

Counsel for the appellant made a major point of noting that in 1967 (the date of the sale of 66%% to Mack) the remaining shares held by Lauder must be regarded as having had a value of $8.67 each. I find no ready support for such a proposition—and indeed it could be argued with some validity that the shares were worth considerably less, depending upon the direction in which Mack decided to take the company at any one point in time. It is difficult to conceive of any purchaser, with the possible exception of Mack itself, who would attribute to this minority shareholding a calculation greater than the per share break-up value of the company, according to its net disposable assets. There is no evidence that this was $8.67 per share in 1967 after the sale to Mack, and the testimony of Mr Smith is that even by 1971 this net break-up value was at most $4.91 per share.

In essence the position of the appellant comes down to the fact that he would not have sold his shares on V-Day for $3.75 per share and would have demanded at least $10. / can believe that statement, but that does not alter the problem before the Board—it merely establishes that there was not a willing seller at $3.75 but there would have been at $10. The line of reasoning put forward on behalf of this appellant is that under the circumstances, he and he alone was the best judge of the value of the shareholdings and any theoretical report prepared by a professional evaluator would serve no purpose.

The Board is not called upon to decide if, in fact, the valuation of $3.75 per share calculated by the Minister is correct, or if some amount between $3.75 and $10 is correct, but only to decide if the valuation of $10 has been substantiated by the appellant. Not only has the appellant failed to do this, but he has failed to seriously damage the basis upon which the Minister has made his own calculation. The Board recognizes the anomaly which apparently exists in looking at the $8.67 per share amount in 1967 (as a result of a sale), the $3.75 amount (calculated by the Minister) for 1971, and the $7.04 amount (the result of a sale) in 1974. But that anomaly is not resolved merely by reversing the curve (using $10 instead of $3.75), as suggested by the appellant, without the benefit of an independent qualified appraisal report substantiating the $10 amount. The general information related to the financial statements, provided by counsel, and the views of Mr Lauder, based on his experience and knowledge, do not fulfill this requirement. In my opinion, whether prepared for the appellant or for the respondent, any realistic evaluation report giving the opinion of a competent, experienced and independent person, would have been based upon the same general

criteria used by Mr Smith, and would have reached conclusions similar to those reached by Mr Smith. For that reason the evaluation report prepared by the respondent cannot be disregarded even recognizing Mr Smith’s involvement in the matter.

Conclusion

In this matter, the appellant ascribed the $10 valuation to the shares, maintained that position throughout, and, in my view, has failed to substantiate that valuation.

Decision

The appeal is dismissed.

Appeal dismissed.