Normand Blais, Denis Blais, Pierre-Paul Blais v. Minister of National Revenue, [1979] CTC 2944, 79 DTC 745

The Chairman [TRANSLATION]:—The appeals of Messrs Normand Blais, Denis Blais and Pierre-Paul Blais, from assessments dated October 8, 1975 for the 1971 taxation year, were heard at Montreal, Quebec on March 16, 1978. Each of the taxpayers served his notice of objection on November 3, 1975 and the Minister confirmed his assessments on April 29, 1976. On July 28, 1976 the said taxpayers filed notices of appeal in identical terms.

Given the identical nature of the appeals, the evidence was heard jointly and the Board’s decision will accordingly apply to the three appeals.

By agreement between the parties and with the Board’s consent, the pleadings were made in writing. The transcript of the hearing was received by the parties in question and by the Board on September 22,1978. The parties filed written pleadings on February 8, 1979 and May 8, 1979.

Facts

By notarial deed dated December 30, 1971, the appellant and his brothers Denis and Pierre-Paul accepted an offer by their father, Fernand Blais, to sell 165 common shares in Fernand Blais & Fils Ltee (hereinafter referred to as “the company”) for the sum of $300,000 payable in instalments at the rate of $15,000 a year.

Issue

The Board must determine whether, by this transaction, a benefit was conferred on the seller in the amount of $105,300 ($35,100 by each buyer), on December 30, 1971, which was taxable in the hands of the appellants.

The Appellants’ Submissions

In the written pleadings counsel for the appellants submitted the following points.

1. He pointed out that the notarial deed of December 30, 1971 contained an acceptance by the parties of a suspensory condition by which the said shares would not be transferred to the buyers before the payment of $200,000. Legal title to these shares remained with the seller until payment of the said $200,000, and counsel for the appellant wondered whether this was really a gift within the meaning of Art 777 of the Civil Code of Quebec.

Counsel noted that in 1971 and the subsequent years the appellants were only required to pay their father $15,000 a year, and that the transaction as not completely concluded in 1971.

He further submitted that although the transaction had conferred a gift as the respondent maintained, that gift could only cover a part of the annual payments of $15,000, and should be calculated as follows:

105,000

x 5,000

300,000

that is, $1,750 per year for each appellant. This amount is less than $2,000 and therefore should not be taxable under subsection 112(2) of the Income Tax Act, RSC 1952, c 148.

2. The appellants further argued that the respondent had incorrectly varied the legal basis of his assessment, by alleging in his amended reply to the notice of appeal that subsection 245(2) of the Income Tax Act, SC 1970-71-72, c 63, as amended (subsection 137(3) of the old Act) was also applicable. This statutory provision had not been alleged in the reply to the notice of appeal which the respondent had originally served and it was not contained in his notice of confirmation. Her Majesty the Queen v Edmund Littler Sr, [1978] CTC 235; 78 DTC 6179, (to which I shall return below), was cited in support of this submission.

3. Counsel for the appellants made four points in reply to the respondent with regard to the fair value of the shares which were the subject of negotiations between the appellant and his two brothers on the one hand, and their father on the other hand, which were concluded on December 30, 1971:

(a) he noted that the tax on gifts was originally an accessory to the Estate Tax Act, which was created to prevent a taxpayer from distributing his assets free of tax before his death, thereby evading payment of estate tax on his death. He pointed out that Fernand Blais, the seller, was at least middle-aged and that his sons were only beginning to earn their living, and it would have been illogical for the children to have acquired their father’s company at an inflated price in order to make a gift of it to him or confer a benefit on him;

(b) he expressed serious reservations as to the manner in which Mr Fortin, the respondent’s appraiser, proceeded regarding valuation of the company. Mr Fortin arrived at a value for the company of the appellants’ father, an insurance broker, by treating it as a source of income derived exclusively from commissions, and fixed its value in accordance with his insurance portfolio. Mr Fortin stated that this was in accordance with generally accepted principles for the valuation of insurance businesses. In the submission of counsel for the appellants, Mr Fortin therefore did not take into account in his valuation the goodwill generally associated with an ongoing commercial undertaking and ignored the historic cost of the company which, from the balance sheet, amounted to $30,000.

He contended that the respondent improperly ignored the business’ reputation, which had been built up over a number of years. He further noted that Mr Fortin had allowed only a reasonable value for the customer list, without allowing for the fact that after the sale of the shares the customers would continue to do business without interruption, with the same company and in the same establishment. Counsel emphasized the distinction which should be made between the facts of this appeal and a transaction in which an insurance agent transfers only his list of customers to another agent. He concluded that the goodwill associated with their father’s company should have been treated separately and added to the goodwill of the company as a whole, that is, a functioning company with its list of customers.

(c) He submitted that the sum of $12,500 should have been added to the value of the shares by Mr Fortin, since a condition of the contract of sale provided for an advantageous rental for the premises where the company had always operated and which were owned by the father.

(d) He noted that the terms of the contract of sale provided for final payment for the shares to be made in 1991, and the appellants maintained that it could reasonably be expected that a significant portion of the purchase price would be paid in dollars the value of which had been seriously eroded by inflation.

The appellants concluded that the price of $300,000 for the shares was, in the circumstances, realistic and reasonable, and entailed no gift or benefit.

The Respondent’s Submissions

The respondent, on the other hand, maintained generally that the fair value of the shares purchased by the appellants by notarial deed dated December 10, 1971 was in fact $194,700, and that the selling price of $300,000 included a gift of $105,300, or $35,100 for each of the appellants. In particular, the respondent submitted the following points:

1. With regard to the amended reply to the notice of appeal filed by the respondent, counsel for the respondent stated that the Tax Review Board possessed, and in the past had often exercised, a reasonable flexibility and latitude in its acceptance of the scope of the law and the facts to be considered in an appeal before it, when one or other of the parties made a motion to amend its pleading in order to make a fuller and more thorough presentation of its case. He explained that in his amended reply to the notice of appeal he cited subsection 245(2) of the Act to show more clearly the legal effect of the facts as contained in his reply, on which the respondent had relied in making his assessment. Counsel noted that by so amending his reply, the respondent did not contravene the sine qua non condition imposed by the Board, of not taking an opponent by surprise. He maintained that the appellants had had sufficient time to consider a reply to the respondent’s amendment. In commenting on Littler (supra), cited by the appellants, counsel for the respondent explained the distinction which he saw between the facts of Litt/er and those of the appeal now before the Board. In Littler, the respondent had omitted to cite subsection 173(2) of the Act as the legal basis for his assessment. It was not until the case was on appeal before the Federal Court Appeal Division that the respondent, for the first time, referred to subsection 137(2) of the Act, at a stage of our judicial procedure when no new fact can be alleged. Counsel for the respondent admitted that, in the circumstances of Littler (supra), it would have been grossly unfair to the appellant if the Minister had been allowed to refer to and rely on subsection 137(2) of the Act for the first time as the legal basis for his assessment. The respondent noted that the facts now before the Board are not comparable to those of Littler (supra), since all the relevant facts had been disclosed and the appellants had had the necessary time to consider and reply to the respondent’s amendment.

2. The respondent emphasized that the presentation of evidence determining the value of the shares of Fernand Blais & Fils Ltée clearly rested with the appellants, and it was for them to establish to the satisfaction of the Board by valid evidence that the valuation made by the respondent was erroneous.

The fair market value of the company used by the respondent in his assessment was $194,700, that is a little higher than the valuation made by Mr Fortin and based on a second valuation of the company.

The appellants called no expert witnesses to explain how the value of the company was estimated by them or to refute the valuation used by the respondent. In his testimony Mr Fernand Blais, father of the appellants and the seller of the shares, stated that his company had a very good reputation with Lloyds of London, which gave it an “additional value’’. However, no evidence was presented of this fact or of its actual value, and an increase of the value calculated by the respondent cannot be justified.

In cross-examination the respondent dealt with the allegations made by Mr Fernand Blais that a financial benefit had been conferred on the appellants by the terms of the contract of the sale, by which he leased them his building at a rate which was favourable to them. Here again, no valid evidence was presented and no specific calculation made to suggest a valuation of the benefit which was allegedly conferred on the appellants. In his written pleadings, the respondent stated that none of the witnesses was able to give an acceptable explanation as to exactly how the purchase price of the company was determined. Quoting at length from the transcript made at the hearing, he stated:

From reading these few passages, there is no doubt that the appellants did not use objective valuation criteria in arriving at the value of the shares on December 30, 1971. They did indeed agree amongst themselves on an amount, namely $300,000; but the respondent maintains that this price is not based on any recognized valuation criterion which could allow the Board to conclude that the price of $300,000 reflected the fair market value of the shares at December 30, 1971.

Counsel for the respondent further submitted that Mr Fortin had, in valuing the said shares, meticulously followed the methods generally accepted in valuing insurance businesses. In his testimony, Mr Fortin stated specifically that a duplication would have resulted if, as the appellants suggested, good will had been added to the market value of the business as calculated according to the valuation methods for this type of business.

3. The third point raised by the respondent is as to whether the benefit was conferred in 1971 or whether, as the appellants contended, it should be distributed equally over a period of years from 1971 to 1991; counsel for the respondent cited the decision of the Federal Court of Appeal in James F Kennedy v MNR, [1973] CTC 437; 73 DTC 5359, where the learned Chief Justice stated, at pp 440 and 5361 respectively:

. . . In my view, when a debt is created from a company to a shareholder for no consideration or inadequate consideration, a benefit is conferred.

This opinion is referred to again in a decision of the Federal Court, Trial Division, in Her Majesty the Queen v Frank Leslie, [1975] CTC 155; 75 DTC 5086, where the Court observed at pp 159 and 5089 respectively:

Generally speaking, when a legally enforceable obligation to pay has been entered into, in one taxation year, and this obligation creates a taxable benefit in the hands of the obligee or of the payee and the legal obligation is met and paid in a subsequent taxation year, it is when the legally enforceable benefit is created and not when the taxpayer actually receives payment that the amount should be taken into account.

Despite the appellants’ submissions that the obligation which they assumed by the notarial deed of sale was subject to a suspensory condition, and that nothing was in fact paid in 1971, counsel for the respondent maintained that by signing the deed of sale the buyers had undertaken a definite obligation and were legally required to pay the sum of $300,000 for property which was worth less than that, thereby conferring a benefit on the seller.

The respondent further argued that the conditions of the notarial deed, whether suspensory or resolutory, were included in the contract exclusively in favour of the seller, and the buyers cannot interpret them and use them in their own favour.

4. Counsel for the respondent finally noted that subsection 137(2) of the Act does not require a person to intend to confer a benefit for a gift to be in question. It suffices that a benefit was in fact conferred for there to be a gift. For tax purposes “the intent to make a gift’’ or its absence is not a valid criterion in determining the existence or otherwise of the gift.

This summarizes briefly the respective position taken by the parties in question and certain observation of the Board. In my view, the salient points which emerge are:

l. was the respondent’s amendment to his reply to the notice of appeal invalidated by citing subsection 137(2) of the old Act or subsection 245(2) of the present Act as the legal basis of the assessment when in fact he did not allege it in his original reply or his notice of confirmation?

II. if the introduction of subsection 137(2) of the old Act is accepted by the Board as the legal basis for his assessment, despite the fact that the respondent only cited it for the first time in his amended reply, is the real value of the benefit which the appellants conferred equal to the amount determined by the respondent in his assessment?

We shall consider first the question the validity of the respondent’s amended reply, which was raised first by the appellants. In support of their submission that the respondent’s amended reply was invalid, the appellants cited the observations of the learned Chief Justice of the Federal Court of Appeal in Littler (supra), where he stated, at pp 240 and 6182 respectively, the following:

In my view, when a cause of action is to be supported on the basis of a statutory provision, it is elementary that the facts necessary to make the provision applicable be pleaded (preferably with a direct reference to the provision) so that the opposing party may decide what position to take with regard thereto, have discovery with regard thereto and prepare for trial with regard thereto. In this case, the Minister’s decision on the objection referred to section 137 but, when complying with section 99 in the preparation of his defence in the Trial Division, the respondent not only did not refer to that section although he referred to others, he did not plead facts showing that “the result of one or more . . . transactions . . . is that a person confers a benefit . . Had that been pleaded, other facts might well have been the subject of evidence in addition to those that were brought out at trial. In my view, it is no mere “technicality”, but a matter of elementary justice to abstain, in the absence of very special circumstances, from drawing inferences from evidence adduced in respect of certain issues in order to make findings of fact that were not in issue during the course of the trial.

It would be difficult to deny the legal validity and logic of the observations of the learned Chief Justice of the Federal Court. It goes without saying that the rules of procedure required that the issue be limited to the points raised by the plaintiff, and a fortiori when the issue goes before the Court of Appeal, where the discussion must deal with very specific facts which are determined in advance.

It is perhaps worth noting here that the Board is not only a court of first instance, but a court which, according to the statute which created it and for practical reasons, enjoys a certain flexibility and informality which could not properly be exercised by the ordinary courts. The Board’s flexibility allows taxpayers, who in some cases have only a vague knowledge of the Act and the procedure to be followed in tax matters, to present their grievances nonetheless to an independant tribunal and to obtain, not another administrative opinion, but a purely judicial decision on the legal basis for their claims.

In order for the Board’s flexibility to be equitably exercised, it must be applied equally to both parties.

If we examine the notices of objection and the notices of appeal which the appellants filed in the case at bar, it becomes clear that the Board has to exercise its flexibility and informality by accepting as valid a document which is too vague for the issue to be fully joined. The Board had to await the hearing of the appeals in order to know exactly what points it would be called upon to decide.

In such circumstances, if the respondent wishes to make a clarification or a change to his pleading by amending his (otherwise valid) reply to the notice of appeal, the Board’s flexibility must in all fairness allow him to do so provided his opponent is not taken by surprise, and provided the procedure followed as a whole causes him no real detriment.

Contrary to what took place in Littler (supra), with regard to the rules of procedure of the Federal Court of Appeal, no rule of procedure followed before the Board was broken. The appellants had all the time required to prepare and present to the Board their reply to the respondent’s amendment, and their rights were in no way impaired by the Board’s decision to allow the amended reply. I think it is clear that the Board must adopt a reasonable procedure which allows either side to present all the relevant facts necessary for the legal determination of an issue resulting from application of the Income Tax Act.

I am of the opinion that the amendment to the respondent’s reply to the notice of appeal is valid, and it follows that subsection 137(2) of the Act applies to the facts of these appeals, and that Art 777 of the Civil Code had no application in determining whether a gift exists for tax purposes.

I therefore conclude that a benefit was transferred to the seller in the said transaction, and it is taxable under the provisions of section 111 of the old Act.

The second point to be decided is the amount of the benefit so transferred by the appellants. The appellants did not succeed in discharging the burden of proof which was upon them. They presented no calculations or valid evidence to establish the fair market value of the shares of December 30, 1971, which was fixed in the deed of sale by consent of the seller and buyers, who of course were not dealing at arm’s length, and they did not show in what way the respondent’s valuation was erroneous.

Further, Mr Fortin, the respondent’s appraiser, indicated to the Board that the method which he had used in his valuation was in accordance with that generally accepted by the association of appraisers in determining the value of an insurance business. He further explained that adding an additional amount to the value of the business for good will, as suggested by the appellants, would result in a duplication since the method used in arriving at the value of the company included, and already took into account in its calculation, the value of this same good will.

In the circumstances, I must consider the valuation made by the respondent as reasonable and acceptable, and conclude that he did not err in calculating the amount in dollars which is deemed to represent the benefit which was transferred on December 30, 1971.

However, the real benefit so transferred remains to be decided. May a tax fairly be imposed on the amount of the benefit transferred on December 30, 1971 without allowing for the fact that this benefit will take the form of monthly payments over a period of 20 years, and will not be completely transferred until 1991? Is it fair for the respondent to require payment in 1972 of taxes in 1972 dollars on benefits which will be paid over a twenty- year period in dollars which will probably be worth less? In the circumstances can the Board, or should it, close its eyes completely to the economic phenomenon of inflation? In deciding on the taxable value of the benefit, may the Board fairly ignore the fact that the respondent, by thus requiring taxes payable in 1972, is avoiding the effect of any future devaluation of the dollar, while the appellants are required to pay taxes at a 1972 value on the transfer of a benefit which will not be completely paid until twenty years hence, and the value of which will be effectively and appreciably reduced?

I do not in any way underestimate the difficulties raised by these questions. However, I do not think that they should be completely ignored by the respondent and by the Board. In order to fix the exact quantum of the tax which the appellants are required to pay in 1972, I think the first step is to establish the real value of the benefit transferred. To do this, in the circumstances of this appeal, allowance should be made for an inflation rate of at least 6% per annum until 1991. Furthermore, to make this adjustment, the discounted value of the purchase price receivable on December 30,1971 should also be calculated on the basis of annual interest of 8%. In my opinion these calculations, the rates of which appear to be reasonable and even conservative, are essential in determining the real value of the benefit transferred by the appellants in 1971 and subject to tax.

For these reasons, the appeals are allowed in part and the matter referred back to the respondent for re-examination and reassessment, taking into account the observations contained in these reasons for judgment. In all other respects the appeals are dismissed.

Appeals allowed in part.