Omer Lortie v. Minister of National Revenue, [1986] 2 CTC 2216

Tremblay, T.C.J. [Translation]:—This appeal was heard on October 18, 1985 at Montreal, Quebec.

1. Issue

According to the notice of appeal and the reply to it, the issue is to determine whether the appellant was correct, in calculating his income for the 1979 taxation year, to consider the December 31, 1971 fair market value of his motel located at St-Canut, Quebec to be $137,371. Following the sale of this motel for $153,000, he reported a capital gain of $15,629.

The respondent maintains that the capital gain realized by the appellant was $83,010.

2. Burden of Proof

2.01 The burden is on the appellant to show that the respondent's assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.

The facts presumed by the respondent are set out in subparagraphs (a) to (f) of paragraph 4 of the respondent's response to the notice of appeal. This paragraph reads as follows:

4. In assessing the appellant for his 1979 taxation year the respondent, the Minister of National Revenue, relied, inter alia, on the following facts:

(a) During the period in question the appellant owned the Motel du Lac, located at St-Canut, Quebec.

(b) During that period the appellant disposed of his motel.

(c) The proceeds of disposition amounted to $153,000.00.

(d) The adjusted cost base included the following amounts:

PROPERTY	ADJUSTED COST
	BASE
Land	$12,500.00
Building	52,500.00
Furnishings	1,813.00
Sign	177.00
TOTAL	$66,990.00

(e) The appellant realized a capital gain of $83,010 on the sale of this motel during the period in question. The taxable capital gain that should have been included in his income calculation for the 1979 taxation year was $41,505.00.

(f) For his 1979 taxation year the appellant reported a capital gain of $15,629.00 and a taxable capital gain of $7,814.50.

3. Facts

3.01 The Court wishes first to point out an error that was not detected during the evidence. If the capital gain of $83,010 calculated by the respondent is based on the difference between $153,000 and $66,900 (this is confirmed by the calculation on form T7W-C (Exhibit 1-1, p 14), there is a calculation error. The capital gain must be $86,010 rather than $83,010.

3.02 The appellant’s testimony established the following:

(a) he built the motel — the property in question — in 1966;

(b) there were no additions to the motel between 1967 and 1974; he built it mainly for the purpose of giving his wife something to do; he operated it from June 24 to September 1;

(c) the motel has no bar, dining room or dance hall; it consists solely of 11 sleeping units;

(d) in his view the construction of the motel increased the value of the 150 acres purchased in 1962; he saw that it was a good location; as well as the 11 motel units there was an office which was used for his own business affairs;

(e) the charge per night varied from $10 to $18; the occupancy rate was 50 per cent.

3.03 According to the appraisal report (Exhibit A-1) prepared for the appellant by Messrs J-G Paquette and J-L Bélanger of La Cie d’évaluation métropolitaine Ltée, the market value of the motel as at December 31, 1971 was $122,500.

The appraisers used three different appraisal methods to arrive at this conclusion:

(a) The market data approach. This was based on

Attaching weights to these three results by using what is called the correlation method, they obtained the following as an indication of the value:

3.04 According to the appraiser, Mr. Bélanger, the municipality of St-Canut, in which the property in question is located, was from 1971 to 1976 subject to the special airport Act related to the construction of Mirabel Airport. As a result, all construction during that period was "frozen".

The motel in question was sold for $153,000 in 1976 and was later resold for $225,000 in 1978.

3.05 The respondent's appraiser, Mr. Clément Brochu, discarded the income approach in his appraisal report (Exhibit 1-6). In his view there was insufficient basic information to capitalize the stabilized annual net income. He also discarded the cost approach. In his view the property in question is an income property and the cost approach does not take this into account. He used the market data approach and also applied the method known as the gross income multiplier (hereafter referred to as “GIM”).

3.06 Applying the market data approach to 14 comparable motels studied (with 10 to 44 units each), he decided to base the comparison on five of them (a total of 104 motel units). He thus arrived at a December 31,1971 fair market value of $64,290.

3.07 It has to be pointed out that the appraisers for the parties, in appraising the value on the basis of the market data approach, based their calculations on the value of the motel units. The evidence concerning the number of motel units in the property in question is disputed. The appellant and his appraisers maintain that there were 12 units. The respondent's appraiser says that there were certainly 10 units, perhaps 11, but not 12, since in that case it would be necessary to include as a motel unit the reception office, which was also used by the appellant as a business office.

The respondent's appraiser adopted a rate or cost of $6,429 per unit and multiplied this by ten to arrive at a total value of $64,290.

3.08 He then applied the GIM method. This method is described in paragraph 9.6 of Principes et concepts généraux en évaluation foncière, where it is defined as follows:

(Translation): There is a very close relationship between the income derived from rental of a building and its value. It is appropriate to use this relationship in the market data approach if one knows the income from the building and from comparable buildings and if it is possible to derive a multiplier from this data.

The gross income multiplier is quite simply an arithmetical relationship between the selling price of a building and its stabilized gross income, assuming a 100% occupancy rate.

For example, if the selling price of an income property is $52,500 and the gross income from it is $7,500, the income multiplier is 7, that is, $52,500 + $7,500. After calculating the GIM for the five comparable sales used in the appraisal calculation based on the market data approach (4.46, 5.12, 4.05, 3.69, 3.90), Mr. Brochu extracted the arithmetic mean 4.24 and the median 4.14, and considered the GIM of the sale that most closely resembled the sale of the hotel, 4.46. He used the arithmetic mean (4.24).

In addition, having found the GIM for five other similar motels comparable to the motel in question — though these were not used in the appraisal calculation based on the market data approach — Mr. Brochu calculated an arithmetic mean of 4.37. From his point of view, this confirmed that the arithmetic mean of 4.24, the GIM of the five motels originally selected, was correct.

Multiplying this GIM by the gross income, $18,000 (the average gross income from the property in question reported by the appellant in his income tax returns for the 1974 to 1978 years, adjusted in 1971), he arrived at a market value of $76,740, rounded to $76,750.

According to the appraiser Mr. Brochu, the property in question is an income property. “Its sole purpose is to produce income. The income reflects the overall condition of the buildings, the overall situation. The value resulting from this part of the comparison is, therefore, the most appropriate and the most reliable. [Translation]” (Exhibit 1-6, p 25.)

3.09 In order to establish a rate per night, Mr. Brochu filed as Exhibit 1-2 a statement showing the actual income from the appellant's motel for the years 1970 to 1974 (the actual income for 1971 was $12,708). Taking into account the 50 per cent vacancy rate (he established that if the occupancy rate had been 100 per cent the income would have been $25,416), and also the 365 days in the year and the 11 motel units, he arrived at a rate per night of $6.33. The rates per night for the other years were $5.57 in 1970, $6.31 in 1972, $8.01 in 1973 and $10.48 in 1974.

3.10 The respondent also filed as Exhibit 1-4 a financial statement headed: "Capitalization based on income and expense statements” [Translation] for the property in question. In this statement he used the non-stabilized net income for the years 1970 to 1973, $5,547 (1970), $6,132 (1971), $5,835 (1972), $6,060 (1973), and the capitalization rate 0.0908 — the rate used by the appellant's appraisers to determine the value by application of the income approach (para. 3.03(b)).

Mr. Brochu arrived at a value of $67,533 for the land in question on the basis of the 1971 data. On the basis of the data for other years the figures were $61,090 (1970), $64,262 (1972) and $66,740 (1973).

3.11 After the appellant sold the motel in question, he continued to occupy the office which he had been using for business purposes since 1972. He paid rent of $300 per month.

4. Analysis

4.01 In this appeal, as in many others of the same kind, the appraisers have submitted reports based on different methods.

Thus, the respondent's appraiser discarded the appraisals made by application of the income approach (based on the net income) and the cost approach. These approaches are, however, two of the three used by appellant's appraisers, who also considered them the most important in their application of the correlation method: income approach: 38.9 per cent, cost approach: 36.1 per cent (para. 3.03).

Furthermore, although Mr. Brochu discarded the income approach, he filed a statement showing the value of the property in question by capitalizing a non-stabilized 1971 net income of $6,132 (para. 3.10), which is, however, quite different from the stabilized net income of $14,104.50 used by the appellant (para. 3.03).

Furthermore, whereas the appellant’s appraiser assigned the market data approach a value of only 25 per cent when he applied the correlation method (para. 3.03), the respondent's appraiser made it his principal basis for applying the method known as the gross income multiplier (GIM). He arrived at a value of $76,750 (paras. 3.05 to 3.08).

4.02 During his argument counsel for the appellant referred to the gross income multiplier (GIM) method used by Mr. Brochu; he pointed out that under that method the gross income was stabilized "assuming a 100 per cent occupancy rate” (para. 3.08, end of quotation describing GIM). Then using Exhibits I-2 and I-4 and taking the 1971 effective gross income $12,708.44 reported in the income tax return, he multiplied by 2 (to adjust the occupancy rate to 100 per cent), which gave $25,416. He made an addition for the $300 monthly rent for the twelfth motel unit (the one used as an office), which resulted in a figure of $29,016 — $25,416 plus $3,600. Because of a calculation error, however, counsel arrived at a stabilized gross income of $28,716, which he multiplied by the GIM of 4.24 arrived at by Mr. Brochu (para. 3.08). He therefore calculated a market value of $121,755. The GIM of 4.24 multiplied by $29,016 would in fact give $122,967 as the fair market value as at December 31, 1971.

4.03 In the Court's view, the gross income multiplier method is the fairest in the circumstances, even though the main purpose of constructing the motel was not exclusively to produce income, but to increase the value of the land and provide the appellant’s wife with an occupation.

The Court believes, however, that the addition of $3,600, representing the rent paid in 1977, in order to determine the 1971 stabilized gross income, is not acceptable. The Court adopts the figure of $25,348 as the stabilized gross income and, multiplying it by the GIM of 4.24, arrives at a rounded fair market value of $108,000.

5. Conclusion

For these reasons, the appeal is allowed in part and the case is referred back to the respondent for reconsideration and reassessment.

Appeal allowed in part.