John a Carruthers v. Minister of National Revenue, [1979] CTC 3150, 79 DTC 906

Roland St-Onge:—The appeal of John A Carruthers came before me on September 13 and 14, 1979, at the City of London, Ontario. The issue is the valuation of some 6722 common shares held in Griffith Saddlery and Leather Limited and sold by the appellant in his 1976 taxation year.

The figures with respect to each position of the parties are well spelled out in the notice of appeal in subparagraphs 1(b), (c) and (d) and in the reply which read as follows:

1.(b) With respect to the disposition in 1976 of capital property (being shares of a non-public Ontario corporation) by the appellant the Minister of National Revenue for Taxation (“Minister”) in the 1976 assessment adjusted the taxable capital gain of the appellant on such disposition for 1976 upwards by $63,791.77.

(c) The upward adjustment referred to in the immediately preceding paragraph hereof was calculated as follows:

Gross proceeds of disposition	$158,950.00
Less Minister’s appraisal	8,032.79
Less outlays and expenses	1,791.68
Capital gain	$149,125.53
Taxable capital gain ( /2 of $149,125.53)	$ 74,562.76
Taxable capital gain reported	10,770.99
Adjustment	$ 63,791.77

(d) The appellant’s position as to the disposition of his capital property in 1976 and the amount of taxable capital gain is as follows:

Gross proceeds of disposition	$158,950.00
Less Valuation Day value of appellant’s
Capital property as per appellant’s appraisal	135,616.35
Gross gain	23,333.65
Less outlays and expenses	1,791.68
Capital gain (gross)	$ 21,541.97
Taxable capital gain (1/2 of $21,541.97)	$ 10,770.99

The respondent reassessed the appellant on a taxable capital gain of $74,562.76 on the following assumptions of facts:

2.(b) on Valuation Day, December 22, 1971, Griffith Saddlery and Leather Limited (“Griffith”), a private company manufacturing and distributing equestrian equipment, had 14,004 shares outstanding owned as follows:

The appellant	3,361
Emma Carruthers (wife of the appellant)	3,361
E T Griffith	6,722
G N Griffith (nephew of E T Griffith)	560
Total	14,004

(c) the Carruthers (the appellant and Emma Carruthers) and the Griffiths (Mr E T Griffith and Mr GN N Griffith) are not related persons;

(d) in accordance with an agreement dated November 1, 1967, the appellant and Mrs E Carruthers each purchased 2,101 common shares of Griffith for $5,021.39 ($2.39 per share);

(e) by virtue of an agreement dated October 20,1969 the appellant and Mrs Emma Carruthers were granted options to acquire 1,260 common shares each of Griffith from Mr ET T Griffith for $3,001.40 ($2,39 per share) and these options could be exercised at any time prior to the “Termination Date” which was defined in clause 1 of those agreements to mean the first of the following dates or events to occur:

(a) the thirty-first day of March, 1979;

(b) the 120th day next following the date of death of Griffith;

(c) the date on which the appellant ceased to be employed by the Company as a

result of his death, discharge with or without cause or voluntary leaving.

(f) on October 20, 1969, both the appellant and Mrs E Carruthers gave Mr E T Griffith an option over the 2,101 common shares that each held at that time in addition to all other common shares which each acquired thereafter by virtue of agreement of said date and under those agreements the said options could be exercised at any time within the 120 day period next following the earliest of the following dates to occur, namely:

(a) the date on which the appellant ceases to be employed by the Company as a

result of his discharge with or without cause or voluntary leaving; or

(b) the date of death of the appellant; or

(c) the date of any assignment in bankruptcy or receiving order against the said appellant.

and, the said options were to be exercised at a price of $2.39 per common share plus an amount equal to 30% of the book value of the common share as at March 31st, 1971 if the said option were exercised between April 1, 1971 and March 31, 1972; and, under each of those options it was provided that:

The provisions of this agreement shall be binding upon any transferee of any of the shares covered by this agreement and no transfers of such shares shall be made or recorded unless a transferee has entered into an agreement with Mr E T Griffith, his heirs, administrators and assigns to be bound by the provisions of this agreement.

(g) on December 22, 1970, Mr GN N Griffith bought 560 common shares from Mr Colin Morrison who was an original shareholder in Griffith, subject to Mr G N Griffith entering into an option agreement with respect to those 560 shares with the appellant and Mrs E Carruthers; further, Mr G N Griffith did enter into such an option agreement covering said 560 shares but that option could only be exercised at any time within either of the following periods:

(a) the 120 day period next following the date of the death of Mr E T Griffith, or

(b) the 120 day period ending the 31st day of March, 1979, but only if

(i) the appellant is an employee of the Company at the date such option is exercised, and

(ii) (irrelevant);

(h) on January 21, 1971, the appellant and Mrs E Carruthers exercised their options granted on October 20,1969 in respect of 2,520 common shares of Griffith held by Mr ET T Griffith and received those shares at $2.39 per share (a total amount of $3,011.40 each);

(i) on January 21, 1971, two further agreements were entered into between Mrs E Carruthers and the appellant with Mr E T Griffith which provided that the option granted by the Carruthers (the appellant and Mrs E Carruthers) to Mr E T Griffith on October 20, 1969 would be void if:

(a) the appellant exercised the option to purchase 560 common shares owned by Mr GN N Griffith as outlined in paragraph (g) above;

(b) the appellant purchased 6,722 common shares owned by Mr E T Griffith, if Mr E T Griffith’s heir so requested;

(j) on Valuation Day the appellant was a Director, Vice-President and General Manager of Griffith;

(k) on Valuation Day, the shareholders’ equity of Griffith was $322,065.73 of which $20,000 related to preferred equity;

(l) the fair market value of each share of Griffith held by the appellant at Valuation Day was $2.39.

At the hearing, counsel for the appellant filed two appraisal reports, one prepared by Mr P W Bowman of Price Waterhouse & Co and the other by Mr R Carlin, business evaluator with Revenue Canada.

In order to value the shares on V-Day, Mr Bowman used the price-earning ratios of eight to nine times the representative current earnings of $66,000, which would indicate a range of capitalized earnings of $528,000 to $594,000 but, after an adjustment for future tax benefits of $32,000, the total amount was a minimum of $560,000 to a maximum of $626,000, and the value of the shares was fixed in a range of $40 to $44.70 per share.

On the other hand, Mr Carlin utilized the comparable sales and valued the shares at $8,032.79 or $2.39 per share.

On November 1, 1967, the appellant purchased from Mr E T Griffith 4204 common shares for $5,021.39 or $2.39 per share and some 22 months later, on October 20,1969, ws granted an option by the said Mr Griffith to acquire 2520 shares for $6,022.80 (2,520 x $2.39 per share).

On the same day, October 7:0, 1969, the appellant gave an option to Mr Griffith over the 4202 common shares at a price of $2.39 per share plus an amount equal to 30% of the book value of the common shares as at March 31, 1972 if the options were exercised before that date.

On December 22, 1970, Mr G N Griffith bought 560 common shares from Mr Colin Morrison at $2.00 a share, subject to an option with the appellant.

On January 21,1971, the appellant exercised his option dated October 20, 1969 and acquired 2520 shares at $2.39 per share but on the same day, he agreed that the option he had granted to Mr E T Griffith to buy the appellant’s 4202 shares would be void if the latter exercised his option to purchase 560 shares owned by Mr GN N Griffith or if he purchased 6722 shares owned by Mr E T Griffith in the event that the latter’s heirs so requested.

At the hearing, the respondent’s appraiser, called as a witness by counsel for the appellant, explained that, in his opinion, the two most important sales to determine a value of $2.39 per share were as follows:

(1) the January 21, 1971 transaction between the appellant and Mr E T Griffith at $2.39 a share because the parties were dealing at arm’s length and had declared that this price was the fair market value;

(2) the December 21, 1970 transaction because Mr Morrison held a key block of 560 shares which were sold to Mr G N Griffith for $2 a share. However, this sale was subject to an option agreement by which Mr G N Griffith would be bound by the option agreement to purchase in favour of the appellant John A Carruthers and dated October 20, 1969.

Mr Carlin also testified that he did not take into consideration the December 1972 transaction by which Mr E T Griffith sold shares to Mr G N Griffith at $8.63 per share because it was hindsight information subsequent to V-Day and represented control of the company.

The witness did not consider the 1976 transaction by which the appellant sold his shares to Mr GN N Griffith for $47.29 each because the said transaction was too remote.

He also explained that, according to the option agreement dated October 20, 1969, the appellant John A Carruthers could not force Mr E T Griffith to purchase the shares but the latter could discharge Mr Carruthers without cause; that Messrs Morrison and Carruthers could not exercise their option on V-Day and obtain the book value of some $21 a share because Mr ET Griffith was still alive; that Mr E T Griffith could purchase the appellant’s shares at $7.45 but the appellant could not from Mr ET T Griffith, and that a third party would pay less than $7.45 for the appellant’s shares because of the risk involved, namely there was no return on the investment.

Mr Carlin disagreed with Mr Bowman’s report because the latter used the earning method to appraise a minority interest when he should have utilized the comparable sales method; he did not take into account the relationship between the shareholders who were in disagreement; he did not discount (to a fair degree) the minority shareholding nor did he take into consideration the fact that no one was in control of the company even if Mr E T Griffith had the de jure control with his 200 preferred voting shares.

Mr Carlin terminated his testimony by saying that only one option was exercisable on V-Day namely Mr E T Griffith could discharge the appellant without cause but the former was afraid of a lawsuit for wrongful dismissal.

Mr D Aldridge, Mr Carlin’s supervisor, also called as a witness by counsel for the appellant, testified and corroborated Mr Carlin’s report. In his opinion, the best indication to appraise the appellant’s shares were the two main transactions of

(1) December 22, 1970 and

(2) January 21, 1971.

He also explained that, according to the option agreements, if $2.39 a share was not the right amount for the appellant’s shares, $7.45 would be the top value; that on V-Day, Mr E T Griffith could acquire the appellant’s shares at $7.45; that on that date the appellant was not in a position to acquire the Griffith shares or control; that the book value of $21 a share on V-Day was irrelevant for appraising purposes because it was too close to the liquidation value and Mr E T Griffith was not in a position to liquidate his company.

Mr Aldridge was critical of the Price Waterhouse & Co’s report because the latter did not give adequate weight to the option agreements especially as in the case at bar of a private company; and also because it appraised the company instead of shares which were very restricted.

Referring to the definition of fair market value and more particularly to the words “unrestricted market”, he explained that the appellant was before a restricted market because the buyer of the appellant’s shares would have to replace Mr John A Carruthers as key man of the company.

Mr R Clayton, who was five years in the Hamilton office as appraiser, was also a witness for the appellant and testified that because the earning and the liquidation methods could not apply, he utilized the comparable sales to arrive at a price of $11 a share; that although Mr John A Carruthers was a minority shareholder, he was responsible for the earnings of the company and should obtain the full benefit of his efforts; that the earnings method could not be used because it gave a higher value than the liquidation method and was not the proper one to appraise a non-public company, especially when the marketability of the shares was so restricted; that the liquidation method could not be utilized because none of the shareholders had liquidation control; that he gave a higher value to the minority shares because Mr John A Carruthers was remunerated two ways: by a salary and an increase of his equity in the company.

He did not approve the Price Waterhouse & Co report because it was the evaluation of a company instead of minority shares; it would not give enough weight on the non-marketability of the minority shares; it should have given a discount of 50% instead of 5% to 10% for the minority interest in the company and tax consideration should not have been considered to arrive at a value.

He did increase the value of the minority shares from $7.45 to $11 because he tried to envisage a purchaser who would be ready to take a chance.

Counsel for the appellant claimed that the respondent’s experts in their appraisal of the shares made too numerous errors to really rely on them. First, Messrs Aldridge and Carlin wrongly placed a great reliance on the 1971 agreement because there was no price bargaining in 1971 but in 1969 only. Then, Mr Aldridge made a second error by claiming that the shares of the company could not be transferred without Mr Griffith’s consent when, in fact, they could, provided however that the transferee entered into an agreement to be bound by the shares held. Thirdly, Mr Carlin put a value of $2.39 a share, Mr Aldridge up to $7.45 a share, Mr Clayton $11 a share, Price Waterhouse $40 a share and there is another value of $21 a share.

Counsel for the appellant then argued his three major points:

(1) the company under the Company’s Act of Ontario (section 217) could have been wound up by Mr Carruthers upon application to the Courts because there was a breakdown in the relationship between the two minority sharesholders;

(2) the Board, for the purpose of determining fair market value on V-Day, should ignore the various agreements;

(3) if Mr Carruthers was able to discharge all the assumptions of facts made by the assessor, then the onus shifts to the respondent and if he does not meet the onus, the appeal should be allowed in full.

In arguing his three major points, he referred the Board, among other cases, to the following ones:

R W S Johnston v MNR, [1948] CTC 195; 48 DTC 1182;

MNR v Pillsbury Holdings Limited, [1964] CTC 294; 64 DTC 5184;

N C Brewster v The Queen, [1976] CTC 107; 76 DTC 6046;

D Tobias v The Queen, [1978] CTC 113; 78 DTC 6028.

On the other hand, counsel for the respondent stated that the valuation of $2.39 a share was correct and alternatively, the maximum value for the shares should be $7.45; that the respondent proved his point since all his witnesses were called by the appellant to establish different values and that no one from Price Waterhouse & Co was called to prove the appellant’s own appraisal report and that a valuation report has very little effect if the person who prepared it is not subject to cross-examination.

He then argued that both Mr Carlin and Mr Aldridge relied on the January 21, 1971 agreement because the parties were dealing at arm’s length and agreed that $2.39 was the fair market value of a share. The experts also relied on the sale by Mr Morrison to Mr GN N Griffith on December 22,1970, at $2.00 a share.

At to Mr Clayton, counsel for the respondent argued that although Mr Clayton said that the January 1971 sale was not an indication of fair market value at V-Day, he did not ignore the sales and said that they were representative of fair market value at an earlier date.

Counsel for the respondent also argued that the appraisor’s report on which the appellant relies does not even mention the sale of shares and, in his opinion, this is a critical deficiency; that although Mr Aldridge changed his mind and said that Mr Carruthers could transfer his shares freely, there was a Stipulation in the company’s charter to the effect that no shares shall be transferred without the consent of the majority of directors of the company expressed by the Resolution passed by the Board of Directors. Thus, there was no complete freedom. Furthermore, according to the October 20, 1969 agreement, where it lays out a formula price, it states that Mr Griffith could buy Mr Carruthers’ shares on the following conditions:

(1) Mr Carruthers can be discharged with or without cause;

(2) In the event of Mr Carruthers’ death;

(3) In the event of Mr Carruthers being petitioned into bankruptcy.

This means that a purchaser of Mr Carruthers’ shares at V-Day could purchase those shares subject to that restriction and it he pays $20 a share, Mr Griffith can discharge Mr Carruthers the following day and purchase those shares for $7.45 each, causing the third party a significant loss.

Then, referring to the jurisprudence, he agreed that the C/R v Ethel Maclean, Douglas Crossman et al, [1937] AC 26, and Attorney General v Jameson, [1905] 2 IR 218, decisions are solely based on the British Finance Act and he preferred to rely on the decison in George Edwin Beament v MNR, [1951] CTC 184; 51 DTC 489 and in The Estate of John Joseph West v Minister of Finance for the Province of British Columbia, [1976] CTC 313, because, in order to appraise the value of shares, we do have to look at the restrictions on the transfer of those shares.

He agreed that it is within the court’s discretion to determine whether a wind up should occur but the court can also say to a shareholder: “Sell your shares and get out of the company”.

Counsel for the respondent terminated his argument by saying that the bottom level at which the shares must be valued is not the book value, as contended by counsel for the appellant, but the liquidation value, not at a distress situation, but just the liquidation value at $9.82 a share. However, Price Waterhouse had not considered a liquidaiton value at all.

After a careful examination of the jurisprudence cited to me, the evidence adduced and the various options, the Board cannot consider the valuation of the shares under review by using the appraisal based on the earning ratio of the company because the Board is not called to appraise the company but the appellant’s minority shares held on V-Day. Furthermore, the appellant’s appraiser did not even testify to establish the veracity of his report.

Neither is the liquidation method the appropriate one because the possibility of liquidation was too remote due to the fact that both minority shareholders had no interest whatsoever in liquidating the company on or around V-Day.

To summarize the facts, on January 21, 1971, Mr Carruthers exercised his option and acquired 48% of the shares. It was stipulated that if John acquired the 560 shares from Mr G N Griffith or the other 6722 shares from Mr E T Griffith’s heirs, in other words, if he took control of the company, the option granted to Mr E T Griffith to buy 4202 shares or more from the appellant at $2.39 a share plus 30% of the book value as at March 31,1972, the 1969 option granted by Mr Carruthers to Mrs Griffith would be void. This could mean that Mr Carruthers himself considered his minority shares to be valued at $7.45 but if he were to acquire the control of the company, he would not be ready to pay the same price to Mr E T Griffith. It shows that the appellant himself made a distinction between the value of minority and majority shares.

However, it can also be said that the appellant had the power de facto since he was the director, vice-president and manager of the company, in other words, the key man whereas Mr Griffith had just the power de jure and was not the active force behind the company. In such a case, it can be considered that the appellant had more than a pure minority interest in the company and that the top value of $7.45 would be more appropriate than $2.39. Furthermore, Mr Aldridge, the respondent’s appraiser himself said that the appellant’s shares could have a top value of $7.45 and Mr Clayton, the other appraiser of the respondent put a value of $11 a share, consider- ing the possibility that the appellant could have found a purchaser who would have been ready to take his place as key man of the company. It Is difficult to conceive that the appellant could find such a purchaser close to V-Day and consequently this valuation should be put aside.

According to the evidence adduced, the Board believes that the best method in the circumstances would be the comparable sales and would accept the highest value of Mr Aldridge since the appellant had more than a pure minority interest in the company.

For these reasons, the appeal is allowed and the matter referred back to the respondent for reassessment so that the appellant’s 6722 shares on V-Day be evaluated at $7.45 instead of $2.39 a share.

Appeal allowed.