The
Chairman:—This
is
the
appeal
of
Wallace
R
Brunelle
from
an
income
tax
assessment
in
respect
of
the
1973
taxation
year
which
was
heard
simultaneously
with
the
appeal
of
Peter
Brunelle
for
the
same
taxation
year.
Both
appeals
deal
with
the
evaluation
of
shares
in
a
private
company
on
Valuation
Day
(December
31,
1971)
which
were
sold
by
the
appellants
in
1973
at
the
rate
of
$1,000
per
share.
Assessment
By
notice
of
assessment
dated
January
23,
1976
the
respondent
established
the
value
of
the
said
shares
on
Valuation
Day
at
$250
per
share
and
adjusted
the
appellants’
capital
gains
for
the
1973
taxation
year
accordingly,
to
which
the
appellants
objected
and
filed
notices
of
appeal.
Summary
of
Facts
In
1966
the
appellants
had
sold
a
small
hardware
business.
At
that
time
a
Mr
Nyback
had
obtained
from
K
&
K
Manufacturing
Inc
a
patented
formula
of
specialized
milk-based
products
for
new-born
animals,
as
well
as
an
automatic
calf-feeding
machine.
Mr
Nyback,
who
owned
a
farm,
fed
his
own
animals
with
the
formula
and
sold
the
product
to
close
friends
and
neighbours.
In
1967
Canadian
Nurs-Ette
Distributors
Ltd
(hereinafter
referred
to
as
“Canadian
Nurs-Ette”)
was
incorporated
in
which
Wallace
Brunelle
and
Peter
Brunelle
owned
47
shares
and
Mr
Nyback
owned
48
shares,
5
shares
being
held
by
Mr
Allan
Cook,
counsel
for
the
company.
By
agreement
with
K
&
K
Manufacturing
Inc
dated
November
1967
(Exhibit
R-4),
Canadian
Nurs-Ette
obtained
a
franchise
and
were
given,
for
a
period
of
10
years,
the
exclusive
right
to
use
the
trade
name
“Nurs-Ette”
in
connection
with
the
sale
of
the
livestock
milk
product
and
the
automatic
calf-feeder
manufactured
by
K
&
K
Manufacturing
Inc.
Canadian
Nurs-Ette
began
very
modestly
working
out
of
the
large
barns
on
Mr
Nyback’s
farm
which
the
appellants
leased
from
Mr
and
Mrs
Nyback
(Exhibits
R-2
and
R-3).
In
1968
the
sales
of
Canadian
Nurs-Ette’s
products
were
handled
by
one
salesman
in
Alberta
but
this
sales
force
grew
to
several
salesmen
in
other
provinces
in
Canada
and
the
company
sales
reached
over
the
million
dollar
mark
in
1973
at
the
time
the
appellants
sold
their
shares.
Mr
Brunelle
testified
that
he
not
only
financed
Canadian
Nurs-Ette’s
operations
but
that
he
personally
worked
15
to
16
hours
a
day,
seven
days
a
week,
in
promoting
the
company’s
sales.
The
evidence
is
that
Mr
Brunelle’s
salary
and
that
of
Mr
Nyback
were
unusually
low
during
the
pertinent
period.
Although
it
was
not
produced
as
an
exhibit,
the
appellant
referred
to
a
minute
of
Canadian
Nurs-Ette
which
included
a
buy-sell
agreement
and
a
shot-gun
clause
by
which,
as
I
understand
it,
if
one
of
the
shareholders
in
the
subject
company
were
to
make
an
offer
to
buy
out
the
other
shareholder,
the
latter
could
make
a
counter-offer
which
had
to
be
accepted
by
the
first
shareholder.
Mr
Brunelle
made
an
offer
to
purchase
Mr
Nyback’s
shares
and
Mr
Nyback
and
Mr
Allan
Cook
made
a
counter-offer
and,
because
of
the
shot-gun
clause,
purchased
the
appellant’s
and
his
son’s
shares
at
$1,000
per
share
late
in
1973.
Mr
Brunelle
had
offered
to
buy
Mr
Nyback’s
shares
at
a
value
of
$1,000
per
share
even
though
his
accountants,
the
firm
of
Zazula
and
Koehli,
allegedly
had
estimated
the
value
of
the
shares
to
be
$2,600
per
share.
Mr
Brunelle’s
explanation
was
that
he
felt
that
$1,000
per
share
was
what
he
could
afford
to
pay
and
assumed
that
Mr
Nyback
could
not
raise
the
necessary
capital
to
make
a
counter-offer
of
$1,000
per
share
and
pay
off
as
well
a
bank
loan
of
an
additional
$80,000,
for
which
Mr
Brunelle
had
provided
collateral.
As
things
turned
out,
Mr
Nyback
and
Mr
Cook
with,
as
I
understand
it,
the
financial
help
of
K
&
K
Manufacturing
Inc,
raised
the
necessary
money
and
forced
Mr
Brunelle
to
sell
his
shares
at
$1,000
per
share.
Issue
It
is
important
to
note
that
the
issue
is
not
what
the
value
of
the
shares
was
at
the
date
of
sale.
Since
the
shares
were
held
prior
to
1972,
the
issue
to
be
determined
is
what
the
value
of
the
shares
was
on
December
31,
1971,
Valuation
Day.
Appellants’
Evaluation
of
Canadian
Nurs-Ette
Shares
as
of
December
31,
1971
Counsel
for
the
appellant
introduced
Mr
Robert
Kergan,
a
chartered
accountant
with
five
years’
practice
in
Calgary,
as
an
expert
witness
in
evaluation.
Mr
Kergan
holds
a
Bachelor
of
Commerce
degree,
a
Master’s
degree
in
business
administration
and
is
a
member
of
the
Institute
of
Chartered
Accountants
of
Alberta
and
Canada.
Mr
Kergan
prior
to
that
was
assistant
professor
at
the
University
of
Calgary
in
accounting,
economics,
finance,
general
business,
statistics
and
advanced
management
seminars.
Counsel
for
the
respondent
did
not
object
to
Mr
Kergan
being
accepted
as
an
expert
witness,
but
did
establish
in
cross-examination
that
Mr
Kergan
was
not
a
member
of
the
Canadian
Association
of
Business
Evaluators.
Mr
Kergan’s
evaluation
of
the
Canadian
Nurs-Ette
shares
as
at
December
31,
1971
was
between
$1,500
and
$1,800
per
share
based
on
the
company’s
financial
statements
from
1968
to
July
31,
1972
inclusive,
using
what
the
witness
described
as
normal
evaluation
techniques
(Exhibit
A-2).
The
approach
used
by
Mr
Kergan
in
evaluating
the
Canadian
Nurs-
Ette
shares
was
to
capitalize
earnings
on
a
converted
cash
value
basis.
The
company’s
fiscal
year
ends
July
31.
By
using
the
adjusted
income
statements
of
the
company
for
each
pertinent
year
a
cash
flow
figure
from
assets
was
arrived
at
which
was
capitalized
at
a
rate
of
16%
using
a
multiplier
of
6.234.
Having
deducted
liabilities
and
inventory
Mr
Kergan
arrived
at
a
value
of
$879
per
share
in
1968,
$826
per
share
in
1969,
$1,471
per
share
in
1970,
$596
per
share
in
1971
and
$1,787
per
share
in
1972,
making
an
average
value
per
share
of
$1,112
for
the
years
July
31,
1968
to
July
31,
1972.
The
value
average
for
the
company’s
fiscal
years
1970
to
1972
was
$1,629
per
share.
Although
an
interim
statement
dated
January
31,
1972
was
available
Mr
Kergan
considered
and
used
only
the
statement
for
the
full
1972
fiscal
year
as
being
a
more
accurate
reflection
of
the
company’s
operations.
Mr
Kergan
concludes
that
as
of
December
31,
1971
the
value
of
shares
was
between
$1,500
and
$1,800
per
share.
In
cross-examination
Mr
Kergan
admitted
that
in
dealing
with
the
Department
of
National
Revenue
prior
to
the
hearing
he
had
stated
that
the
shares
were
worth
up
to
$2,700.
He
explained
however
that
the
figures
of
$1,500
and
$1,800
presented
to
the
Board
were
conservative
figures,
but
that
if
one
were
to
look
at
the
potential
income
of
the
company
and
the
actual
growth
in
the
figures
for
the
years
1973,
1974
and
1975
the
value
of
the
shares
as
of
December
31,
1971
would
be
higher.
The
Respondent’s
Evaluation
Counsel
for
the
respondent
introduced
as
an
expert
witness
Mr
Dirk
Vanderkooi
who
has
been
employed
with
the
Department
of
National
Revenue
and
who
for
the
past
six
years
has
been
exclusively
employed
in
equity
evaluations.
Mr
Vanderkooi
obtained
his
RRA
designation
from
the
Society
of
Accountants
in
Ontario
in
1969.
In
1970
he
obtained
a
CGA
designation
and
in
1972
obtained
his
MCAVB
designation
from
the
Canadian
Association
of
Business
Evaluators.
In
1974
he
obtained
a
CAM
designation
from
the
Certified
Administrative
Management
Society.
Counsel
for
the
appellant
did
not
object
to
Mr
Vanderkooi
being
accepted
as
an
expert
witness.
Mr
Vanderkooi
examined
the
records
of
Canadian
Nurs-Ette
from
1969
through
to
the
fiscal
period
ended
July
31,
1971
in
order
to
determine
the
fair
market
value
of
the
company’s
shares
as
at
December
31,
1971.
The
evaluation
method
used
by
Mr
Vanderkooi
was
based
on
the
capitalization
of
the
net,
after-tax
earnings
of
the
company.
In
order
to
look
into
the
company’s
financial
stability
and
to
obtain
a
guide
for
the
future
operations
of
the
company,
Mr
Vanderkooi
analyzed
the
company’s
balance
sheets
for
the
fiscal
years
1968,
1969
and
1970,
ending
July
31,
1971
(Exhibit
R-5).
In
1968
the
company
had
a
working
capital
of
$29,072
and
its
sales
were
$200,000.
In
1969
the
working
capital
was
$14,487.
In
1970
the
working
capital
was
$5,212
and
in
1971
it
was
$6,367.
In
1971
the
inventory
turn-over
ratio
was
less
than
four
times
a
year
and
no
tangible
fixed
assets
were
recorded
in
the
books
of
the
company.
In
the
period
from
1968
to
1971
no
capital
was
injected
into
the
company
which
had
received
$100
for
100
shares
at
its
incorporation.
Over
the
same
period
the
retained
earnings
increased
marginally
from
$7,749
in
1968
to
$13,090
in
1971.
Based
on
an
examination
of
the
company
records
which
included
goodwill,
Mr
Vanderkooi
arrived
at
a
book
value
of
the
shares
from
a
low
of
$77.98
in
1969
to
a
high
of
$131.90
per
share
for
1971.
From
the
examination
of
the
company’s
records
for
the
past
four
years
Mr
Vanderkooi
stated
that
the
sales
figure
which
was
$200,000
in
1968
increased
to
$563,000
in
1970
and
dropped
back
to
$492,000
on
July
31,
1971.
A
further
decrease
in
sales
is
recorded
in
the
period
of
July
31,
1971
to
December
31,
1971
(Valuation
Day).
Mr
Brunelle
had
testified
that
in
the
pertinent
years
he
worked
between
15
to
16
hours
a
day,
seven
days
a
week.
Since
the
wages
paid
by
the
company,
which
were
$12,000
in
1968
to
a
high
of
$25,890
in
1970
with
a
decrease
to
$22,200
in
1971,
Mr
Vanderkooi
considered
that
the
wages
paid
were
very
low
particularly
if
we
take
into
account
that
the
five-figure
Salaries
were
attributable
to
two
individuals,
Mr
Brunelle
and
Mr
Nyback,
and
he
concluded
that
the
management
salaries
paid
by
the
company
were
uneconomical
and
artificially
inflated
the
company’s
income
and
profits.
In
its
books
the
company
had
established
a
figure
of
$11,111
for
goodwill
and
this
figure
was
included
in
the
capitalization
of
earnings
in
relation
to
the
value
of
shares.
Mr
Vanderkooi
considered
that
the
constant
goodwill
figure
of
$11,111
does
not
reflect
a
fair
market
value
for
goodwill
and
added
that
goodwill
which
is
reflected
in
greater
earnings
and
greater
profits
must
be
transferable
and
saleable.
Mr
Vanderkooi
considered
also
that
the
only
possible
goodwill
the
company
had
was
Mr
Brunelle’s
hard
work
and
driving
force,
which
was
not
of
a
commercial
nature
because
it
would
disappear
whenever
Mr
Brunelle
withdrew
from
the
company.
The
company
records
did
not
show
any
amount
paid
for
the
exclusive
right
to
use
the
trade
name
Nurs-Ette,
the
formulae
or
the
calf-feeding
machine
and
Mr
Vanderkooi
suggested
that
the
value
of
the
franchise
can
only
be
gauged
by
the
earnings
it
generates.
In
his
calculations
of
value
(Exhibit
R-6),
Mr
Vanderkooi
based
his
calculations
on
four
12-month
periods
ended
July
1,
1968,
1969,
1970
and
1971.
The
after-tax
profits
for
1968
were
$7,748;
for
1969
a
loss
of
$50
was
sustained;
in
1970
a
profit
of
$5,565
was
made;
and
in
1971
a
profit
of
$126
was
realized.
These
figures
were
weighted
on
a
straight
line
factor
basis
giving
the
greater
weight
of
4
for
1971,
the
last
year
under
review.
The
annual
estimated
profit
arrived
at
on
that
basis
was
$2,480.
Since
the
fair
market
value
for
shares
is
indicated
as
being
within
a
range,
Mr
Vanderkooi
used
a
multiplier
of
6
as
the
lower
end
of
the
range
and
7
as
the
higher
range
(a
return
on
capital
of
16
/3%
and
14.3%).
On
that
basis
the
values
of
the
shares
were
estimated
to
be
between
$150
to
$170.
When
the
figure
of
the
$50
loss
for
the
1969
year
was
omitted
from
the
calculations
the
estimated
value
of
the
shares
was
about
$250.
Mr
Vanderkooi
also
calculated
the
value
of
the
shares
using
a
multiplier
of
8
for
the
four
years
and
arrived
at
a
figure
of
roughly
$200
per
share.
Mr
Vanderkooi,
however,
stated
that
a
multiplier
of
6-7
was
more
realistic
than
any
higher
figure.
In
fact
Mr
Kergan
used
the
figure
of
6.234
as
multiplier
in
his
evaluation
of
the
shares.
Although
Mr
Vanderkooi
had
in
giving
evidence
referred
several
times
to
the
impropriety
of
using
hindsight
in
establishing
the
value
of
the
shares
on
Valuation
Day,
he
did
at
the
request
of
counsel
for
the
respondent
evaluate
the
shares
using
the
figures
for
the
company’s
fiscal
year
ending
July
31,
1972
and
arrived
at
a
figure
of
$1,100
to
$1,200
a
share
(Exhibit
R-7).
It
might
be
noted
that
although
there
was
an
interim
statement
dated
January
31,
1972
the
evaluator
for
the
appellant
as
well
as
the
evaluator
for
the
respondent
considered
that
the
interim
statement
was
not
reliable
and
no
use
was
apparently
made
of
it
in
calculating
the
valuation
of
the
shares
by
either
evaluator.
The
Board
therefore
has
to
decide
which
of
the
two
evaluations,
that
of
$250
per
share
used
by
the
respondent
in
assessing
the
appellant
or
the
figure
of
$1,600
estimated
by
the
appellant’s
evaluator,
to
be
the
value
of
the
shares
as
at
December
31,
1971.
Finding
of
Fact
It
appears
to
me
that
the
considerable
difference
in
the
result
of
the
respective
calculations
in
arriving
at
a
valuation
of
the
shares
stems
from
three
main
sources:
1.
The
appellant’s
evaluator
added
back
to
net
income
before
taxes,
management
salaries
which,
as
the
evidence
has
shown,
were
unusually
low
and
in
my
view
even
higher
managerial
salaries
would
always
be
a
necessary
expenditure
for
the
company.
Adding
these
expenses
to
income,
in
my
view,
is
a
distortion
of
the
company’s
earnings.
2.
Depreciation
was
also
added
to
income
by
the
appellant’s
evaluator.
Mr
Vanderkooi
seriously
questioned
whether
Mr
Kergan
in
fact
used
the
earnings
approach
to
valuation
and
suggested
that
Mr
Kergan’s
evaluation
was
based
on
cash
flow
in
which
case
other
items
in
the
balance
sheet
would
have
to
be
considered
such
as
the
tangible
assets,
history
of
dividends,
the
lease,
etc,
which
Mr
Kergan
failed
to
do.
3.
In
arriving
at
a
value
for
the
shares
as
of
December
31,
1971,
Mr
Kergan
included
in
his
calculations
the
company’s
figures
for
the
fiscal
year
ending
July
31,
1972.
In
evaluating
shares
at
a
specific
prior
time
there
can
be
no
doubt
that
it
is
a
proper
evaluation
procedure
to
consider
the
company’s
actual
earnings
for
the
past
three
to
five
years.
It
is
also
proper
to
project
future
earnings
of
the
company
on
the
basis
of
its
past
performance
and
that
is
done
as
accurately
as
possible
by
means
of
the
weighted
averages
and
the
use
of
a
realistic
multiplier.
However,
in
my
opinion,
which
is
supported
by
other
members
of
this
Board,
it
is
not
proper
in
evaluating
shares
as
of
a
prior
date
to
use
the
company’s
actual
record
of
surplus
or
extra
earnings
which
occurred
subsequent
to
Valuation
Day
and
which
were
not
known
or
expected
on
Valuation
Day.
In
my
view,
this
hindsight
evaluation,
whether
it
increases
or
decreases
the
value
of
the
shares,
cannot
and
does
not
establish
the
fair
market
value
of
the
shares
as
at
Valuation
Day
and
should
not
be
employed
in
an
evaluator’s
calculation.
In
my
opinion,
however,
although
it
may
be
a
very
strong
indication
of
value,
the
application
of
an
accepted
mathematical
evaluation
method
based
on
earnings
(or
on
another
basis)
alone
may
not
always
result
in
the
fair
market
value
of
the
shares
at
a
given
time.
If
hindsight
based
on
the
company’s
subsequent
earnings
is
an
unacceptable
consideration
in
evaluating
its
shares
as
at
December
31,
1971,
it
seems
to
me
that
foresight
or
expectancy
based
on
the
potential
of
the
company,
the
plans
of
the
company,
groundwork
for
increased
earnings
already
laid
down
but
not
reflected
in
the
company’s
books,
or
any
factors
which
existed
and
were
demonstrable
as
having
existed
on
Valuation
Day
and
which
could
affect
favourably
or
unfavourably
the
company’s
normal
projection
of
future
earnings
should,
in
my
opinion,
also
be
taken
into
account
in
arriving
at
a
fair
market
value
of
the
shares
at
that
date.
In
other
words,
I
do
not
believe
that
the
simple
application
of
a
mathematical
evaluation
formula
without
taking
into
account
pertinent
considerations
other
than
financial
statements
will
always
result
in
a
true
and
fair
market
value
of
the
shares.
It
is
clear,
of
course,
that
any
special
facts
which
could
alter
the
company’s
normal
earnings
projection
and
justify
a
possible
increase
or
decrease
in
the
mathematical
valuation
of
the
shares,
would
have
to
be
established
as
having
existed
on
Valuation
Day.
In
the
instant
appeals
we
are
dealing
with
the
evaluations
of
shares
of
a
non-public
corporation.
Mr
Brunelle
testified
that
the
company
in
1967
and
1968
started
with
nothing
but
a
franchise
for
the
exclusive
right
to
use
the
name
“Canadian
Nurs-Ette”,
the
right
to
sell
a
milk
substitute
formula
and
the
calf-feeding
machine
for
which
the
company
paid
$1
(Exhibit
R-4).
Only
two
individuals
were
active
in
the
company;
the
barn
of
one
of
the
shareholders
was
rented
by
the
company
on
July
2,
1969
for
a
period
of
8
years,
which
was
amended
to
15
years
in
June
1973
(Exhibits
R-2
and
R-3).
There
is
evidence
that
the
company’s
offices
were
constructed
on
or
about
the
leased
premises
as
I
understand
after
1971.
Mr
Brunelle
stated
that
notwithstanding
the
agreement
with
K
&
K
Manufacturers
Inc,
certain
components
used
in
the
formula
were
no
longer
supplied
to
Canadian
Nurs-Ette
and
there
appears
to
have
been
some
misunderstanding
between
K
&
K
Manufacturers
Inc
and
Canadian
Nurs-Ette
prior
to
1972.
The
financial
statements
of
1968,
1969,
1970
and
1971
would
indicate
some
financial
instability
in
the
company.
Mr
Brunelle
testified
that
between
1970
and
1972
companies
such
as
Labatt’s,
Maple
Leaf
Milling
and
the
Federated
Co-op
seemed
interested
in
the
operation
of
Canadian
Nurs-Ette
but
none
made
any
offer
to
purchase;
Mr
Brunelle
also
Stated
that
he
had
done
considerable
sales
promotion
for
the
company
in
several
other
provinces
in
Canada,
but
there
is
no
clear
evidence
as
to
when
that
promotion
was
done.
The
books
showed
sales
in
other
provinces
only
in
the
1973
fiscal
year.
The
fact
that
the
company
had
very
little
tangible
assets
prior
to
1972
and
that
the
whole
company’s
business
rested
exclusively
on
the
sale
of
one
product
and
one
machine
presented
a
very
real
company
risk.
All
these
factors,
in
my
view,
would
have
to
be
considered
by
a
prospective
buyer
over
and
above
any
mathematical
valuation
that
might
be
made
of
the
shares
based
on
the
past
earnings
of
the
company.
In
my
opinion
in
determining
a
fair
market
value
of
the
shares
the
Board
must
also
look
beyond
the
mathematical
evaluation
based
on
past
earnings
and
take
into
account
any
fact
or
circumstances
which
existed
on
the
day
of
evaluation
which
do
not
appear
in
the
company’s
books
but
which
could
affect
the
company’s
future
earnings.
On
the
basis
of
the
evidence
presented
to
the
Board
in
the
appeals
there
are
no
special
facts
or
circumstances
that
existed
on
December
31,
1971
which
might
permit
anyone
to
expect
or
to
foresee
at
that
time
any
marked
increase
in
the
company’s
earnings
in
subsequent
years.
Nor
has
the
appellant
succeeded
in
establishing
to
the
satisfaction
of
the
Board
that
the
value
of
the
Canadian
Nurs-Ette
shares
on
December
31,
1971
was
between
$1,500
and
$1,800.
Because
of
the
reasons
already
stated,
of
the
two
share
evaluation
calculations
presented
to
the
Board,
I
consider
the
evaluation
made
by
the
respondent’s
evaluator
to
be
the
more
complete
and
the
more
accurate.
There
being
no
other
pertinent
factor
to
be
considered
I
conclude
that
the
value
of
the
Canadian
Nurs-Ette
shares
at
$250
per
share,
calculated
on
the
basis
of
the
capitalization
of
the
company’s
normal
past
earnings
is
under
the
circumstances
of
these
appeals
a
proper
value
for
the
shares.
The
appeals
are
therefore
dismissed.
Appeals
dismissed.
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