David Friedman and Hyman Friedman v. Minister of National Revenue, [1978] CTC 2809, [1978] DTC 1599

The Chairman:—The appeals of Mr David Friedman and Mr Hyman Friedman from income tax assessments in respect of the 1973 and 1974 taxation years were, by consent of the parties, heard on common evidence.

The Issue

The issue which arose in 1973 is the determination of the fair market value of a certain property as at December 31, 1971.

Summary of Facts

In 1952 David Friedman and his brother Hyman Friedman purchased a general store known as Ronald Caron Limited in which each appellant held a 50% interest. Mr David Friedman testified on behalf of both appellants.

In 1962 the appellants purchased a certain parcel of land on St Hubert Street in Montreal for $140,000 (Exhibit R-1) and built thereon a four-storey department store known as Plaza Mart, the fifth storey of which was an outdoor parking area. The building was completed in 1964 at a cost of $705,769.

The building owned by the appellants was then leased to Ronald Caron Limited, also owned by the appellants.

The evidence is that after the construction of a shopping centre in the area of the subject property the volume of business of Ronald Caron Limited diminished substantially and in 1971 the appellants sought to sell the property. Eventually it was listed for sale by a Mr Abe Weiser, a real estate broker dealing in large commercial properties, at a price of $1,600,000.

On October 22, 1971, a formal offer to purchase the building for $1,500,000 was received by the appellants through their agent, Mr Weiser. The offer to purchase contained, among others, the condition that the vendors, through Ronald Caron Limited, would lease the property for a period of twenty years. The lease was to be secured by the appellants by means of a second mortgage of $500,000, the balance of the sale price (Exhibit A-1).

Although the purchase price was considered adequate Mr David Friedman, who was sixty-four years old at the time, and his brother Hyman, who I understand was older, did not accept the condition by which the twenty-year lease would be personally secured. by the appellants. The purchaser, not being willing to purchase the property without the secured lease, the sale did not take place.

In September of 1973 the building was effectively sold to Otto Happel for a price of $1,430,000 (Exhibit R-5). The property was leased back by Ronald Caron Limited for a period of sixteen years at a rate of $150,000 a year for the first five years, $160,000 a year for the next five years, and $170,000 a year thereafter (Exhibit R-6).

In assessing the appellants the Minister estimated the fair market value of the subject property on valuation day at $850,000 and concluded that the appellants realized a capital gain of $580,000 on the disposition of the property, and that the taxable gains to be added to the appellants’ income is $145,000 for each of the appellants.

In support of what the respondent considered was the fair market value of the subject property as at December 31, 1971, counsel for the respondent introduced Mr Roger Lussier, a real estate evaluator for the Department of National Revenue, and asked that he be accepted by the Board as an expert witness.

In this respect two important procedural points were raised; one in respect of the status of evaluators who are employees of the Department of National Revenue and the second dealt with the proper procedure to be followed in presenting evaluation reports to the Board.

Dealing with the second point first, the introduction of the capital gains tax in 1972 has made the testimony of evaluators and evaluation reports frequent evidence before the Board in most appeals dealing with the fair market value of property as at valuation day.

The point raised was whether it is proper for a party to the appeal to have an evaluation report prepared by a competent appraiser with the intention of introducing it at the trial without giving the opposing party prior notice of that intention and without forwarding a copy of the report prior to the hearing, as was allegedly done in the instant appeals.

Unlike the Federal Court whose rules of practice set out a specific procedure to be followed for the presentation of evaluation reports before the trial, the Tax Review Board rules do not contain any procedure dealing with such reports. However, in my opinion it would be taking the adversary by surprise and would be contrary to the basic principles of proper procedure for a party to introduce, during the course of a hearing, a usually long and detailed evaluation report without giving the adversary sufficient time to study the report before the hearing.

Based on the principle and rule of natural justice of not taking the adversary by surprise, I am of the opinion that it would not only be a proper procedure, but a necessary one, to be followed for parties intending to present evaluation reports as evidence to give notice of and serve copies of the report on the adversary within a reasonable period of time before the date of trial. A reasonable period of time in my view would be fifteen days before the hearing.

In the instant appeals the hearing was adjourned for some three hours to permit the appellant to study the report which he had not previously seen. Although counsel for the appellants agreed to this suggestion, the above-described procedure would, in my opinion, have been more proper and more fair to the parties and should be followed in the future.

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 appraiser or evaluator? There can be no doubt that employees of the Department of National Revenue can and do have the training, the knowledge, the competence, the experience and the recognition of any one else in that profession. However, inherent in the point raised is the question as to whether such an employee should be precluded from being qualified as an expert witness because of his relationship with and his dependence on the respondent. In my opinion, if a competent employee of the Department. of National Revenue was to be precluded from being accepted as an expert witness because his role is to support the respondent’s assessment, it would be most difficult for the Board not to exclude as an expert witness an independent evaluator who has been hired to present the taxpayer’s case in the most favourable light.

The answer, it seems to me, is that an employee of the Department of National Revenue can in principle be accepted as an expert witness and the Board, as with any other expert witness, will decide what it considers to be the fair market value after studying the evaluation report (or reports) on its (or their) merits and after taking into consideration all other factors and circumstances that were brought into evidence. In the instant appeals I can accept Mr Lussier as a competent evaluator with the proper training and experience. However, the evidence is that Mr Lussier, unsuccessfully perhaps, negotiated with the appellants’ accountants to arrive at a fair market value of the property. At page 52 of the transcript we read:

M ROGER LUSSIER: J’ai eu une demande d’évaluation par le ministère par monsieur, je ne me souviens pas de son nom, de faire faire une evaluation dans les années ’75 fort probablement. Et puis on a fait l’évaluation de cette propriété-là et on est arrivé a une valeur spécifiquement la même chose à $860,000 qu’on a négociée avec les comptables de M Friedman.

Me MARIO F MENARD: Vous dites que vous avez négocié?

M ROGER LUSSIER: Oui.

Me MARIO F MENARD: Quel genre de négociations, vous êtes-vous entendus sur un montant?

M ROGER LUSSIER: Qui, on a réglé la question du terrain. Ils avaient accepté l’évaluation du terrain mais on ne s’est pas entendu sur la valeur totale.

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. Negotiations between the Department of National Revenue and the taxpayer in respect of his assessment prior to instituting the appeal procedure is not only a usual procedure, but a commendable one. However, I am not sure that those negotiations should be carried out by someone who is to be presented as an expert evaluator. Negotiations, to my knowledge, are not one of the several methods of establishing the fair market value of property recommended by any recognized institute of professional evaluators in Quebec or in Canada. In the circumstances, should Mr Lussier be accepted as an expert witness? In my opinion the very fact that he negotiated with the appellants’ accountants as to the value of the property sows in my mind a seed of doubt as to the objectivity and the expertise of the witness’s report and his conclusion which should be arrived at only on the basis of accepted evaluation methods. Notwithstanding the witness’s knowledge in the field of evaluation, I believe that Mr Lussier, 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 Board will, nevertheless, consider the evaluation report, but with more reservations than it otherwise would.

Counsel for the respondent is asking the Board to find that the fair market value "of the subject property on Valuation Day be $861,000, the conclusion reached by Mr Lussier as a result of his evaluation study.

Counsel for the appellants, on the other hand, is asking that the Board find that the offer to purchase the subject property at a price of $1,500,000, dated October 22, 1971, (Exhibit A-1) be considered as indicative of the fair market value of the property as at December 31, 1971.

“Fair market value’’ is defined in Mr Lussier’s evaluation report at page 2:

La juste valeur marchande peut être définie comme suite:

“Le prix le plus élevé estimé en termes monétaires, qu’une propriété rapportera, si elle est mise en vente sur le marché libre, par un propriétaire qui désire la vendre, en allouant une période de temps raisonnable pour trouver un acquéreur intéressé pourvu que ni l’un, ni l’autre ne soient l’objet de pressions indues qu’ils soient bien au fait des usages auxquels cette propriété est adaptée et pour lesquels, elle peut être utilisée et qu’ils soient pourvus d’un bon jugement”.

Translation:

The fair market value can be defined as follows:

“The highest estimated price in monetary terms which a property will attract if it is put up for sale in a free market by an owner who is desirous of selling it, allowing a reasonable period of time to find an interested buyer, providing that neither the vendor nor the purchaser be the object of undue pressures; that they are aware of the uses to which the property is adapted and for which it can be used; and that they possess good judgment’’.

The evidence is clear on the following points:

1. That the highest and best use of the property was the one to which it was being put and which was to continue.

2. The appellants were desirous of selling.

3. The property was listed for sale on a free market for $1,600,000.

4. The purchaser, who made an offer of $1,500,000 was evidently interested in purchasing the property.

5. The prospective vendor and prospective purchaser were at arm’s length.

6. There is no evidence of undue pressures on either party.

7. Both know the use to which the property was to be put.

8. Both the prospective vendor and the prospective purchaser had good judgment and indeed were very knowledgeable in real estate and in the economic climate at the time the offer was made.

9. The property was effectively sold in September of 1973 for $1,430,000 with conditions comparable to those included in the offer to purchase.

It seems to me that the offer to purchase of October, 1971, meets all the requirements of Mr Lussier’s definition of what the fair market value of the property was in December of 1971.

In his report, although Mr Lussier mentions the cost method of evaluating property in only general terms, he did not consider the fact that the land on which the subject property was built had cost $140,000 in 1962 (Exhibit R-1), and the uncontradicted evidence is that on completion the building cost $705,769 for a total cost of $845,769 in 1964. It is very difficult to conceive that the value of the property would be only $861,000 in 1971.

On page 37 of his report Mr Lussier states that “an informed purchaser will not pay more for a property than the cost necessary to replace it”. Since the offer to purchase the property in 1971 was made by an informed purchaser, it is logical to suppose that the prospective buyer considered that the replacement cost of the property was $1,500,000.

In cross-examination the witness stated that the cost of the property had no bearing on its fair market value. I can visualize that in some instances that might well be the case, but in this instance, particularly in the light of the offer to purchase, I am not convinced that the witness’s statement applies. The difficulty here as I see it is that Mr Lussier did not consider the offer to purchase of October 22, 1971, at all. Unless the said offer was proven to have been invalid or fraudulent, which was not done, I do not see how it can be ignored in arriving at a fair market value of the subject property.

The comparative sales section of the report includes several photographs of buildings which had been sold in the pertinent time period. However, the subject property was photographed and very little details concerning the building were included in the report. Mr Friedman testified that the property was a four-storey building with escalators such as exist in large department stores with a fifth storey serving as an outdoor parking area, and that the building was unique in that section of the city.

According to Mr Lussier there were no real comparable buildings in the area and those compared were three-storey buildings a quarter of a mile from the subject property. In the circumstances I am not satisfied that the list of comparable sales can be relied upon as being

a-realistic basis on which to determine the fair market value of the subject property.

In arriving at a fair market value of the subject property a great deal of reliance was placed on the comparative analysis of the rental income derived from other properties in the area. On the basis of leases listed at page 44 of Mr Lussier’s report, the rates of which ranged from $1.82 to $8.37 per square foot, Mr Lussier chose four leases whose rates varied from $2.03 to $2.61 per square foot, and concluded that a realistic rental rate for the subject property was $2 per square foot. Since Mr Lussier agreed that there were very few comparable buildings in the area and no comparative details were given as to what the subject property offered by way of interior amenities as opposed to the buildings to which it was compared, how can the Board decide that $2 per square foot is a realistic rental rate for the subject property?

Mr Lussier noted that prior to 1975 the rent paid by Ronald Caron Limited to the appellants, then owners of the building, was $96,250 in 1970, $84,000 in 1971 and $95,047 in 1972. However, the lease was not at arm’s length since the appellants, at that time, owned the building as well as Ronald Caron Limited and it is my understanding that non-arm’s length transactions make very poor criteria of the rental market as at December 31, 1971. Counsel for the respondent pointed out that after disposing of the property in 1973 the appellants did not in fact pay $150,000 per year for rent to the owners. However, how can that fact be related to, and establish, the rental market in the area in 1971 without using hindsight?

Whatever the fair market value of the subject property may have been I am not, on the basis of the evaluation report, convinced that the property was worth only $861,000 on valuation day.

The question that now arises is whether the offer to purchase dated October 22, 1971, can be a valid indication of the fair market value on December 31, 1971. In my opinion it can and does.

In support of his contention that the fair market value of the subject property was $1,500,000, stipulated in the offer to purchase dated October 22, 1971, counsel for the appellants cited, among others, the case of Crown Trust Company v Her Majesty the Queen, [1977] CTC 320; 77 DTC 5173. I do not find, as indeed did counsel for the respondent, that the facts of any of the cases cited were at all in focus with the facts in the present appeal. However, notwithstanding that the above-mentioned case dealt with “Allocation of purchase price between land and building”; that the sale had indeed taken place; and that no one had attempted to establish that the price paid did not represent the fair market value; Mr Justice Addy did say at pages 322 and 5174 respectively:

Since no one has attempted to establish that the purchase price of $1,317,000 paid on the 30th of December, 1969, as aforesaid, did not represent the fair market price at that time of both lands and buildings as a whole, and since the transaction was an arm’s length one, and both the vendor and the purchasers were obviously astute and well-informed parties and, finally, since the vendor was under no particular pressure to sell and the purchasers had no particular need for that specific property, I find no difficulty in coming to the conclusion that the price paid represented the actual or real value of both the lands and buildings.

In my opinion the basis of Mr Justice Addy’s decision and the conditions which he enumerates in the Crown Trust Company (supra) appeal have been met in the offer to purchase dated October 22, 1971. The fact that the offer was not accepted and that the sale did not go through does not, in my opinion, mean that it cannot represent the fair market value in December of 1971. Since the offer to purchase was not proven to be invalid or fraudulent; since the offer conforms to the general principles set out in Mr Justice Addy’s decision; and since it meets to the letter all the conditions set out in the definition of fair market value included in Mr Lussier’s evaluation report which does not in fact require that a sale be made to establish the fair market value of a property; I must conclude that the fair market value of the subject property on December 31, 1971, was $1,500,000 as set out in the offer to purchase dated October 22, 1971.

For these reasons the appeal is allowed and the matter referred back to the respondent for reassessment according to the above reasons for judgment.

Appeal allowed.