Erawan House Limited v. Minister of National Revenue, [1976] CTC 2060, 76 DTC 1049

The Assistant Chairman:—This is the appeal of Erawan House Limited from income tax assessments in respect of the 1970 and 1971 taxation years.

The issues in this appeal have to do with the allocations which the appellant made of the values of land and buildings included in the purchase price of two properties. The respondent considered the amounts allocated to be neither reasonable nor fair market values for the properties in question and reallocated the said values pursuant to paragraph 20(6)(g) of the Income Tax Act.

The appellant, engaged in a real estate investment and mortgage brokerage business, acquired a property at 951-971 Gladstone Avenue in Ottawa for a total purchase price of $395,000. In the Agreement of Purchase and Sale, in which the purchaser and vendor were dealing at arms length, it was stipulated that the value of the property be allocated as $35,000 for the land and $360,000 for the buildings (Exhibit A-3). The figure of $360,000 was added by the appellant to its Class 6 buildings for the purposes of capital cost allowance for the 1970 taxation year, such class being depreciated at the rate of 10 per cent.

The Minister, in his reassessment pursuant to paragraph 20(6)(g), holds that a reasonable allocation of the purchase price of the Gladstone Avenue property is $125,500 for the land and $269,500 for the buildings.

On April 1, 1971, the appellant acquired a property at 264-276 Elgin Street, Ottawa, for the sum of $400,000, which the purchaser and vendor, who were again dealing at arm’s length, stipulated in the Agreement of Purchase and Sale to represent $50,000 for the land and $350,000 for the building (Exhibit A-1). The amount of some $350,000 was added by the appellant to its Class 3 building assets for capital cost allowance purposes for the 1971 taxation year and was depreciated at a rate of 5 per cent.

The Minister in his reassessment considers that a reasonable allocation of the purchase price of the Elgin Street property is $152,000 for the land and $248,000 for the building.

Paragraph 11 of the Minister’s reply to the Notice of Appeal reads as follows:

The Minister submits that in accordance with the provisions of the Income Tax Act, he reasonably regarded the amounts of $269,500 in relation to the Gladstone property and $248,000 in relation to the Elgin property as reflecting a reasonable portion of the purchase price of the respective properties paid for depreciable property of the respective classes claimed and having a reasonable bearing on the fair market value of the respective buildings and property.

I am satisfied from the evidence that the acquisition of both properties by the appellant was the result of transactions at arm’s length in fact carried out in both instances through the agents for the contracting parties. In both transactions the appellant unquestionably had a declared interest in the proportion of the purchase price to be allocated to the buildings. I am also satisfied that there was hard bargaining between the agents of the purchaser and vendor in both transactions with regard to the total selling price of the properties. However, the evidence did not convince me that the specific allocation of values between the land and the buildings in the selling price of either property was seriously negotiated between the parties through their agents.

There is evidence that the total purchase price of $400,000 for the Elgin Street property was arrived at after hard bargaining but, notwithstanding innumerable questions on cross-examination in that respect, there is no evidence that the bargaining included any negotiations as to the allocation of specific values for either the land or the building. All that the evidence revealed was that such allocation varied with the various fluctuations of the total purchase price during the negotiations, but the ratio between land and building apparently remained the same.

The Gladstone Avenue property was owned by Ottawa Rodney In- vestments Limited and, from the evidence of Harold E Jodoin, CA, and from the balance sheets of the vendor as at May 31, 1968 and May 31, 1969 (Exhibits R-5 and R-6), no capital cost allowance was ever claimed on the property by Ottawa Rodney Investments Limited. Consequently, no recapture of capital cost allowance was sougnt by the Department of National Revenue as a result of the sale. In the sale of the Gladstone Avenue buildings to the appellant, therefore, the allocation of the selling price between land and buildings, though of importance to the purchaser, was of no interest to the vendor, and evidence was that the allocation of the purchase price between the land and the buildings was not negotiated by the vendor.

It therefore seems clear to me that, though there may have been hard bargaining for the total selling price of both properties, there is no evidence that similar bargaining for allocation of the value of the land and buildings in either of these transactions took place.

In the absence of any real interest or negotiation on the part of the vendors in the allocation of land and building values of the

properties being sold, the allocation in the respective contracts of $360,000 for the buildings on Gladstone Avenue and of $350,000 for the Elgin Street building appears from the evidence to have been a unilateral decision of the purchaser (the appellant in this appeal).

Notwithstanding the fact that the allocation of values for land and buildings is included in the terms of the sale contracts for both the Gladstone Avenue and the Elgin Street properties (Exhibits A-1 and A-3), the only question the Board must decide is whether the values so allocated for the buildings in each of the contracts, and on which the appellant based its capital cost allowance, are reasonable within the meaning and intent of paragraph 20(6)(g) of the Income Tax Act.

In the determination of the reasonableness of the allocated values of both the Elgin St and Gladstone Ave buildings, the Board is guided by evaluations of these properties made by professional appraisers or by persons knowledgeable in the real estate market in the area in which the buildings are located. However, I do not consider that such evaluations or the accepted methods and techniques employed in the evaluation of properties flow from an infallible and exact science which can determine the value of a building to the penny. In my view, the appraisal and property value reports are but one of the guides which can help the Board determine, not the exact value of the property, but whether the value allocated to a building as the amount on which capital cost allowance is based is reasonable and within the meaning of paragraph 20(6)(g) of the Act. I feel constrained to include these remarks in my reasons for judgment because of what I consider to have been at times unduly severe questioning, accompanied by some somewhat derogatory remarks during the course of the hearing, with regard to the relative value of the different techniques of evaluating property employed by different appraisers, some of the remarks having implied either incompetence or lack of pro- fssional integrity on the part of the different appraisers who evaluated the buildings with which we are concerned here.

In my view, unless incompetence or bad faith on the part of an appraiser is proven beyond a reasonable doubt, then the reports of each appraiser must be taken on their face value as having been conscientiously compiled, and any discrepancies in their evaluations must be considered as honest differences of opinion as to the value of the buildings. For many marketing reasons, honest differences of opinion can easily arise in the evaluation of properties. These differences of opinion are taken into account by the Board in deciding on the reasonableness of each evaluation.

Mr Allan G Martin, the executive administrator of the appellant company, testified that he would not, for business reasons, have purchased the Elgin Street property at the price stated in the contract if the allocation of $350,000 for the building had not been stipulated in the overall selling price. Although this may confirm the appellant’s interest in the allocated value of the building, it does not indicate a similar interest on the part of the vendor, and does not prove that such an allocation for the building was reasonable within the meaning of paragraph 20(6)(g).

Mr Weinstein, counsel for the respondent, when cross-examining Mr Martin, who has been dealing in properties in Ottawa since 1967, obtained from him a confirmation that land prices had in this time increased in the area. However, Mr Martin stated that the land on which the Elgin Street property was built was zoned C-1, and was subject to “a non-conforming use clause” which would now prevent the erection of a similar type of building. Therefore, in Mr Martin’s opinion, the allocation of the value between land and building that appears on the Elgin Street property contract is reasonable.

Mr Albert Richardson, a real estate broker who negotiated with the vendor, testified that there was bargaining on the total selling price, which ranged between $375,000 and $400,000, and although he had very little to say about any negotiations with regard to the allocation of values in the selling price, he felt that the allocation was reasonable.

Counsel for the appellant, in support of the reasonableness of the allocation of the purchase price of the Elgin Street property, produced an appraisal report (Exhibit A-2) made by Mr J Levinson, who has been active in real estate sales, appraisals and management since 1969.

In allocating the value of land and building on the Elgin Street property, the land residual technique was used because the land in question allegedly is an improved parcel of land that cannot, in the appraiser’s opinion, be evaluated by the comparative method.

The operating expenses of, and the income from, the building in 1971 were taken into consideration and analysed. The construction rates for the erection of a similar building were confirmed. A depreciation of 25% for obsolescence and physical deterioration was applied. The capitalization rate used was 7% and the remaining economic life of the building was considered to be 50 years or a return of capital at the rate of 2%.

Mr Levinson’s final estimate of the value of the building was $353,000 with a value of $51,000 for the land.

Counsel for the Minister, in support of the evaluation of the building which the respondent considers to be reasonable in the circumstances, produced a report of allocation for land and building drafted by Mr Orville J Lennon, a Senior Revenue Appraiser of the Department of National Revenue (Exhibit R-3).

In allocating the value for land on the Elgin Street property, Mr Lennon considered the highest and best use of the Elgin Street site, and employed the cost approach and the comparable sales method in evaluating the land.

The income approach, used by the assessor on the request of the appellant and concurred in by the respondent, was not considered by the Board.

In the cost approach, the appraiser, in attempting to estimate the current value of land, which in the pertinent area was practically all built up, produced a comparable land sales chart dating back principally to 1963 and 1964, at which time the price of land ranged between $5 and $17 a square foot. In 1971, however, 7,412 square feet of land sold at $21.59 a square foot. In evaluating the Elgin Street property, which had an area of 8,690 square feet, the appraiser, on an adjusted basis, estimated the value of the land at $152,000.

In his estimate of the reproduction cost of the building, and basing himself on the Stevens Valuation Quarterly, the appraiser arrived at a value of:

$100,528 for the stores area of the building

128,304 for the office area

27,120 for the basement

A total of $255,952 depreciated value for the building

Plus land $152,000

$407,952

On the selling price of $400,000, the appraiser allocated $152,000 for the land and $248,000 for the building.

Counsel for the respondent produced as Exhibit R-1 an indenture in respect of the sale in 1954 of the then vacant land at the site of the Elgin Street property with which we are here concerned, where the selling price to Glabar Realty Company Limited is stipulated as being $62,000.

The Gladstone Avenue property was appraised by Joseph Allan Kelly, an accredited member of the Appraisal Institute of Canada, who has been active in appraisals since 1946.

It is important to note that what is referred to as the Gladstone Avenue property is a parcel of land with a frontage of 316.5 feet on Gladstone Avenue North by a depth of 225.6 feet, containing an area of 62,601 square feet. This property is described as Lots 1, 2, 3 and 4 Loretta Avenue East, Lots 1, 2, 3 Champagne Avenue West and part of Black C, Plan 73 (Exhibit A-3).

On the second page of Mr Kelly’s appraisal (Exhibit A-4), the following is found:

DEFINITION OF THE APPRAISAL PROBLEM

The property described as Lots 1, 2, 3 and 4 Loretta Avenue east, Lots 1, 2 and 3 Champagne Avenue west and part of Block C Plan 73 containing a land area of approximately 62601 square feet was sold on December 31 st, 1969, for the sum of $395,000 and the vendor and purchaser agreed on the purchase price being allocated on the following basis: Land $35,000 — Improvements $360,000. This allocation of values is not acceptable to the Department of National Revenue and my assignment is to appraise the property effective December 31st, 1969, to estimate as accurately as possible the values to be allocated to the land and improvements.

In his appraisal, Mr Kelly, relying on the photographs of the property which are part of his report, and knowing the improvements on the land, considered that the income approach technique in estimating the value of the land was unnecessary because of the strong support for the land value estimates. In estimating the value of the land, Mr Kelly compared sales of land in the period between April 1969 and September 1972, and the price per square foot for land so compared ranged between 42 cents a square foot in 1969 and $1.50 a square foot in September 1972. On that basis, Mr Kelly estimated the value of the land of the Gladstone Avenue property at $62,000.

In support of its evaluation of the Gladstone Avenue property, the Department of National Revenue had an appraisal made by Ronald Dacey, also a member of the Appraisal Institute of Canada, who from 1966 to 1972 was Property Tax Assessor for the Municipality of Ottawa- Carleton (Exhibit R-4). Taking into account data on the neighbourhood and the site and the zoning of the area in which the property is located, the appraiser concluded that, within the zoning M2(1.0) of the site (which is for industrial and commercial purposes), one of the best and highest uses was made of the subject property.

Mr Dacey’s appraisal contained a study of land valuation based on sales of comparable property in the vicinity of the Gladstone Avenue property, the description of the buildings, the cost approach method, the income approach to value, and the market approach. From the report, it appears that the municipal assessment of the Gladstone Avenue property is $127,925. The land value comparison is based on 14 sales, the first eight of which date from 1966 to 1970 in which the selling price ranges from $1.50 to $2.79 per square foot for an average of some $2.40 per square foot. The last six comparable sales were made in 1969, and the prices ranged from $1.75 to $2.31 per square foot. From a study of the comparable sales, Mr Drury arrived at an estimated selling price of $2.30 per square foot. For the 62,625 square feet comprising the Gladstone Avenue property, the evaluated price for the land is $144,037. Using the cost approach to the five buildings on the property, and taking the depreciation factor on each of the buildings, the assessor arrived at a total depreciated value for the buildings of $251,800, whereby, with the cost of the land evaluated at $144,000, he arrived at a total value for the Gladstone Avenue property of $395,800, which, in round figures, he estimates at $396,000. Using the income approach, he arrived at a value of $252,377 for the biuldings, which, in round figures, he states to be $252,000, plus $144,000 for the land, which also gives a total value for the Gladstone property of $396,000.

Using the market approach, Mr Dacey arrived at an estimated market value of $395,000 for land and buildings. On the basis of the several accepted methods of evaluation of property, Mr Dacey concludes that the allocation of respective values of the land and buildings comprising the Gladstone Avenue property is $144,000 for the land and $251,000 for the buildings.

The allocation used by the Minister with regard to the Gladstone Avenue property is, as already noted, $125,000 for the land and $269,000 for the buildings.

The allocation in the sale contract of a value of $50,000 for the land on Elgin Street irrespective of any appraisal made on the property seems to be unreasonable when, in 1954, the land was sold for $62,000 and the evidence is that land values in that area have increased tremendously since that time. I am not satisfied, from the evidence, that any bargaining took place between the parties as to the allocation of values to land or buildings, though hard bargaining as to the overall selling price of the property was proved to my satisfaction. The onus of establishing that the Minister’s allocation of the purchase price between land and buildings is unreasonable rests on the appellant and, in my opinion, the appellant did not prove that. the Minister’s apportionment of the selling price between land and buildings was other than reasonable within the meaning of paragraph 20(6) (g) of the Income Tax Act.

Although the sale contract for the Gladstone Avenue property allocated $35,000 to land and $360,000 to the buildings, the appellant’s own assessor, Mr Kelly, evaluated the land at $62,600. In comparing Mr Kelly’s appraisal report of the property, which was based exclusively on the estimated value of comparable sales of land (some of which were located as far away from the Gladstone Avenue property as St Laurent Boulevard), to the rather complete and explicit appraisal made on behalf of the respondent by Mr Dacey, using most of the accepted appraisal methods and techniques available and arriving consistently at the approximate figures at which he finally evaluated the property, I find the appraisal produced on behalf of the respondent to be the more reasonable of the two.

And since the evidence established that no bargaining had taken place with regard to the respective allocations for land and buildings in the Gladstone Avenue property sale contract, I again feel that the appellant did not prove to the satisfaction of the Board that the Minister’s allocation of values for land and buildings on the Gladstone Avenue property was unreasonable.

For these reasons, I hold that the Minister’s allocation of values of land and buildings for each of the Elgin Street and Gladstone Avenue properties is reasonable within the meaning of paragraph 20(6)(g) and should not be changed.

The appeal is therefore dismissed.

Appeal dismissed.