A K Velan v. Minister of National Revenue, [1972] CTC 2138, 72 DTC 1178

Roland St-Onge:—This appeal was heard on March 15 and 16, 1971, at Montreal, Province of Quebec, before the Tax Appeal Board as it was then constituted. The subject of the appeal is the valuation of 12,500 common shares, no par value, of Velan Engineering Ltd, given to the appellant’s son, Mr Peter Velan, and reported on a gift tax return for the taxation year 1967 at $2.80 per share. The Minister reassessed the appellant on the ground that the shares given on November 21, 1967 had a value of $5 each.

Since the incorporation of Velan Engineering Ltd the appellant has been the sole owner of its legal capital which was as follows:

(a) Common shares of $100 par value, authorized,

issued and fully paid	250 shares
(b) Preferred shares, 5% non-cumulative, par value of $100
— authorized	2,750 shares
— issued and paid	1,530 shares

On December 31, 1964, the appellant sold to Canadian Aviation Electronics Ltd (hereinafter referred to as “CAE”) 50% of all his shares, that is to say, 125 common shares and 765 preferred shares, for an amount of $750,000. In June 1968, the 250 common shares of Velan Engineering Ltd of $100 par value were converted, through the obtaining of supplementary letters patent, into 275,000 common shares without par value, and the 1,530 preferred shares at par value of $100 were repurchased from the appellant by the company at par value, that is to say, $100 per share. Consequently, the respondent contended that the price paid for a common share on December 31, 1964 was as follows:

In September 1965, for the sum of $770,400 the appellant bought back from CAE the interest in Velan Engineering Ltd which he had sold to that company on December 31, 1964. The respondent contended that the price paid per common share at the time of the repurchase was as follows:

In 1966 Velan Engineering Ltd, by issuing bonds, obtained $900,000 from a company by the name of RoyNat Ltd. On that occasion RoyNat Ltd also purchased 10,000 common shares without par value of Velan Engineering Ltd for a price of $50,000, that is to say, $5 per share, and also obtained an option to purchase an additional 20,000 common shares without par value of Velan Engineering Ltd for a price of $5 per share. In June 1966, Velan Engineering also issued $400,000 in bonds which were purchased by a company by the name of Unas Investments Ltd. The said bonds were convertible at any time before June 15, 1972 to common shares without par value of Velan Engineering Ltd on the basis of 20 shares for each $100 bond, that is to say, $5 per share.

In 1968 the appellant made another gift of common shares of Velan Engineering Ltd — this time to his three sons, Ivan, Peter and Thomas — and declared the value of these shares to be $5.90 each. According to an exhibit filed, this value corresponds to the share book value of Velan Engineering Ltd on May 31, 1968.

Despite all these transactions, the appellant claimed that the share value at the time he made the gift to his son Peter on November 21, 1967 was only $2.80 for the following reasons:

(1) On November 21, 1967 the shares were evaluated by two well- known firms of chartered accountants: Peat, Marwick, Mitchell & Co and Lonn, Stromberg & Co.

(2) The said firms based their appraisal on the last available audited financial statement, consolidated, of Velan Engineering Ltd and subsidiaries, the date of which was May 31, 1966.

(3) The said financial statement shows a shareholders’ equity of $2,502,826.

(4) The said firms appraised the value of the shares as follows:

Shareholders’ equity:

Consolidation Velan Engineering Ltd

and subsidiaries as at May 31, 1966	$2,502,826
less:
Excess of appraisal value of fixed
assets over depreciated cost	1,044,945
501,000 shares — no par value	$1,457,881
	$2.80 per share

The respondent argued: that using the financial statement of May 31, 1966, was not the best way to appraise the value of the shares because a year and a half had elapsed between that date and the date of the gift, and during that period the company had known a substantial expansion due to a change in its financial structure; that the appellant cannot use the figure of “501,000” as the number of common shares as at November 21, 1967, since between the two dates there were two issues of common shares from the company treasury: one of 216,000 purchased by the appellant for $603,000, that is to say, $2.80 per share, and another of 10,000 purchased by RoyNat Ltd at $50,000, that is to say, $5 per share; that even if the sum of $1,457,881 is taken as the shareholders’ equity as shown in the aforementioned calculation by the chartered accountants, the share value is still higher than $2.80 because the shares should be appraised as follows:

Mr Bernard Desroches, appraiser with the Department of National Revenue, was called on behalf of the respondent to give an explanation of the result of his appraisal which is set out hereunder:

BALANCE SHEET AS AT MAY 31, 1967 (and U.S. Subsidiary Companies)

501,000 common shares npv 678,000 Excess of appraised value of

fixed assets over depreciated cost 1,116,832 Gain on sale of patents to subsidiary 127,926 Contributed surplus capital assistance grant 183,080 Earned surplus 1,321,118

Plus surplus for 6 months

operation from May 31/67

to Nov 21/67 196,369 1,517,487

3,623,325 7.28

Book value less Excess of

appraised value of fixed

assets over depreciated Cost 1,116,832

2,506,493 5.00

EARNING VALUE

SALES PROFIT OVER PROV. REVISED MINORITY INCOME

			CCA	PROFIT	INTEREST	TAX
1967	8,844,099	443,422	152,117	595,539	—	244,260
1966	7,701,007	737,079	30,601	767,680	28,018	223,021
1967 Net Profit after Income Tax					351,279
1966 Net Profit after Income Tax ....................................					486,040
					837,319
Average (2 years)					418,659
Capitalized at 7 times					2,930,613
Per share (501,000)					5.83

This appraisal was prepared by using information and documents provided by the appellant. Mr Desroches stated that the profit re-adjustment concerning the earning value for the years 1966 and 1967 was made by the company by using the accelerated rate of depreciation with respect to certain assets such as machinery, equipment and buildings for federal income tax purposes only, but when the company. wanted to find out the real earning value it used the normal rate of depreciation based on the normal wear and tear of such assets. Consequently, by using both methods, Mr Desroches arrived at an earning value of not less than $5 per share. He also took into account the operating results for the years 1967 and 1968 since the transaction was effectuated on November 21, 1967 (six months after the end of the fiscal year) and arrived at an earning value of $5.83 per share. The operation of the enterprise during a period of five years (1964 to 1968 inclusive) was also utilized. In 1964 the sales were $4,900,000 and the net profit before income tax was $233,000. In 1968 the sales were $10,500,000 and the net profit before income tax was $830,000. As may be seen, the sales and the net profits had increased substantially, and this is a very important factor in appraising the value of the shares.

In his written submissions to the Board the appellant asked the respondent why, if the prospects of Velan Engineering Ltd were so brilliant, CAE had sold back the 50% interest within eight months’ time, merely recovering the interest of 6% on the $750,000 purchase price. He also stated, among other things, the following:

The appraised value of fixed assets has been disregarded for the following reasons:

(a) Velan Engineering Ltd exports 80% of their products, mainly to the USA.

(b) To remain competitive automation must be introduced in the plant and present equipment will become obsolete.

(c) Most of the equipment in Velan’s plant at the time was purchased second hand, mainly in England and the USA and the valuation of this equipment was exaggerated.

Subsequently all these predictions became a reality when new sophisticated equipment was purchased and automation introduced.

(4) At the time of the gift, the US Customs authorities made a multimillion dollar claim, as per exhibit presented to the Appeal Court at the time of hearing, which frankly dropped the value of the shares, in the opinion of the appellant-President, to zero.

It was decided, however, to comply with the book value valuation in order to maintain continuity unless the company would go public and the value of the shares would become a public and determinable figure.

(5) The fact that an option has been given to RoyNat Ltd, and Unas Investments Ltd, in 1966 for the purchase of a certain amount of shares at $5.00 does not change the actual value of the shares gifted to Peter Velan for these reasons:

(a) The option for Unas Investments Ltd was extended to 1972 and if the shares would have a value of $5.00 at this time, the actual value in 1967 (5 years earlier) would certainly be much lower.

(b) The fact that RoyNat actually purchased 10,000 shares at $5.00 each was more or less a gesture made by the President of RoyNat when the appellant pressed hard for cash and objected to the high interest rates at which RoyNat was only willing to enter into a lending agreement.

(c) At the time of writing, April 1971, neither RoyNat Ltd, nor Unas Investments Ltd, took up their option and did not purchase one single share for $5.00.

Counsel for the respondent stated that facts purporting to diminish the company assets or its earning value were mentioned for the first time in the appellant’s written submission and cannot be taken into consideration by the Board because they were not proven at the hearing. He said that it appears from the evidence that the appellant, after benefiting by the use of the accelerated rate of depreciation for income tax purposes, decided to get an evaluation of certain assets in order to show in his financial statement a more accurate and more representative real value of the said assets.

As to the allegation by the appellant that the claim from the United States Customs had reduced the value of the shares to nil, the respondent argued that this claim did not prevent the appellant from evaluating the company shares at $5.90 on May 31, 1968, as shown on the financial statement filed as Exhibit A-4. He added that Unas Investments Limited was interested in obtaining an option to purchase the shares of the company at $5, exercisable at ali times before 1972, because of its expectation that the said shares would have a value greater than $5 in 1972, and because it would realize a supplementary income in addition to the interest from the bonds.: Therefore, in 1967 the shares must have had a value equal to if not greater than $5 because Unas would not have accepted the said option at $5 if the shares of the company at that time had had a value of less than $5. He also stated that Unas Investments Ltd and RoyNat Ltd were not interested in taking up their options before the expiry date because in the meantime they could have the use of their money and then in 1972 pick up their options at the same price of $5 per share.

The appellant, who pleaded his own case, did his utmost to show that the shares given to his son Peter had a value of only $2.80 per share and even went so far as to introduce new evidence in his written argument — which procedure, of course, is not permissible because the new alleged facts have not been proven. Furthermore, as may be seen, the evidence proving that the share value was $5 is so substantial that a lesser amount could, in no way whatsoever, be regarded as being reasonable. The appellant did not succeed in discrediting the appraiser’s report, especially with respect to the question of using a rate of depreciation based on the normal wear and tear of the company’s assets when appraising the value of the shares.

There is no doubt that the appellant, who had the onus to prove that the Minister’s assessment was wrong in fact and in law, failed to do so, and for the above reasons the appeal is dismissed.

Appeal dismissed.