Date: 19990122
Docket: 96-506-IT-G
BETWEEN:
JEAN-YVES DESCORMIERS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on November 17 and 18, 1998, at Trois-Rivières, Quebec, and on November 30 at Québec, Quebec, by the Honourable Judge Alain Tardif
Reasons for judgment
Tardif, J.T.C.C.
[1] This is an appeal from an assessment based on subsections 152(8) and 251(1) and section 160 of the version of the Income Tax Act (“the Act”), R.S.C. 1985, c. 1 (5th Supp.), that applies to this case.
[2] The issue is whether or not the appellant and Jacques Lafond were dealing with each other at arm’s length when an immovable property was sold on May 27, 1993. If they were not, the Court will have to determine what the fair market value of the property was at that time.
[3] Although no admissions were made in respect of the facts set out in the Reply to the Notice of Appeal, I consider it helpful to reproduce those facts.
[TRANSLATION]
4. In making the reassessment for $80,000 under section 160 of the Income Tax Act, the Minister of National Revenue relied inter alia on the following facts:
(a) On or about May 27, 1993, Jacques Lafond sold the appellant an immovable property (land and a building) at 200 Rue St-Georges in Trois-Rivières for $125,000, of which $100,000 was paid in cash.
(b) The property was valued at $242,600 for municipal taxation purposes, and its fair market value on May 27, 1993, was at least $205,000.
(c) The value of $242,600 entered on the municipal roll produced in November 1994 for 1995 was not contested by the appellant.
(d) At the time of the sale, Jacques Lafond was indebted to the Minister of National Revenue for his 1993 and preceding taxation years.
(e) In a written mortgage application made to the Caisse Populaire de Notre-Dame-de-Trois-Rivières (“the credit union”), the appellant described himself as the co-owner, along with Jacques Lafond, of the Les Ailes Piquantes Buffalo restaurant in Cap-de-la-Madeleine.
(f) At the time he applied for the mortgage, the appellant was only marginally solvent. He had reported income of $10,640 in 1990, $6,800 in 1991 and $3,964 in 1992 in his annual tax returns. The credit union was not provided with an appraisal of the property.
(g) Les Ailes Piquantes Buffalo was the firm name used in the district of Trois-Rivières by 2868-8521 Québec Inc., a corporation established by Jacques Lafond. Its directors were Jean Lafond, Sophie Lafond and Estelle Simon, who were, respectively, Jacques Lafond’s son, daughter and de facto spouse.
(h) At the time the above firm name was registered and when assets were purchased for the purpose of operating a restaurant in Trois-Rivières in January 1992, Jean Lafond was the president of the said company.
(i) On his 1992 T-1, the appellant stated that he was an employee of Les Ailes Piquantes Buffalo.
(j) On November 30, 1992, the appellant and Jacques Lafond applied jointly to the credit union for a $25,000 loan to open a new restaurant in Cap-de-la-Madeleine. Jean Lafond gave $19,000 in savings as security and the appellant stood surety.
(k) A second loan for $30,000 that incorporated the first loan and that was for the operation of the Les Ailes Piquantes Buffalo restaurant in Cap-de-la-Madeleine was made by the same credit union to 2868-6772 Québec Inc. on July 26, 1993. The appellant and Jacques Lafond both stood surety for that loan.
(l) The credit union agreed to loan money to the appellant basically because Jacques Lafond agreed to stand surety.
(m) 2868-6772 Québec Inc. had been incorporated on November 8, 1991, with the appellant as a shareholder and director. The other directors were Jean Lafond, Sophie Lafond and Estelle Simon.
(n) On December 31, 1989, Jacques Lafond’s assets had a net value of $273,000, but he claimed that in 1993 he had to liquidate those assets to support himself and that he had only a part-time job at Les Ailes Piquantes Buffalo.
(o) During the period prior to its sale, the property was not listed with any real estate broker and no advertising was done even though the vendor could thereby have informed and interested a greater number of potential purchasers and thus obtained the best possible price.
(p) At the time of the sale, Jacques Lafond owed more than $133,039.28 in income tax for 1986 to 1989. Notices of assessment to that effect were issued on November 4, 1992, and no notice of objection was served by Jacques Lafond.
(q) At the time the sale of the property in question was being negotiated and closed, the appellant and Jacques Lafond were not dealing with each other at arm’s length, and the agreed price of $125,000 was at least $80,000 lower than the fair market value of the property.
(r) During the discussions prior to the notice of assessment being issued, the appellant refused to allow the Department of National Revenue official responsible for making an appraisal of the building to go inside.
[4] Jacques Lafond testified at length. Although it was he who initiated the transaction, he did not provide much of an explanation of the reasons for the sale. He basically indicated that the property involved in the transaction to which this case relates had been bequeathed to him by his mother.
[5] When he inherited the two-storey building in 1988, one of the two premises was rented. The second premises were then rented to the same tenant, who later sublet them until the lease ended in March 1993.
[6] At the time of the transaction in May 1993, both premises were vacant, although one of them had only been vacant since March of that year.
[7] According to Mr. Lafond, the last occupant of the building left it in an appalling state, a point to which I will return below.
[8] Mr. Lafond said that the sale price of the property was $125,000 because of the very substantial damage; the municipal assessment was much higher at $200,000.
[9] Mr. Lafond explained that the principal tenant had always paid him; he therefore did not see fit to visit the premises before signing a release stating that he was satisfied with their condition at the end of the lease.
[10] Mr. Lafond also said that he was very familiar with the construction industry; he had himself rebuilt the building after a fire in the late 1970s.
[11] He maintained that the inconveniences and problems associated with renting the property were what made him decide to sell it.
[12] Since the property’s sale price is one of the fundamental aspects of this case, it would have been interesting and above all relevant to hear an explanation of why the property was not repaired and why no attempt was made to find other tenants; these are two points that could have had a major impact on the property’s market value, since a commercial property in which the premises are occupied does not have the same value as an unoccupied property.
[13] The property could have been fixed up to make it more attractive to potential purchasers and tenants; or, assuming that the cost was prohibitive—which could not be shown since no estimate was prepared—an effort could have been made to find one or more tenants who would have taken it upon themselves to fit out and/or repair the premises to suit their needs.
[14] Nothing of the sort was done; Mr. Lafond simply maintained that he told his own network of acquaintances that he wanted to sell his property, adding that word of mouth was the quickest, most effective and most economical way to sell property in Trois-Rivières.
[15] As regards the price, he indicated that he had asked for what it was worth, no more and no less. The evidence showed that he did not have the property appraised by experts or consult real estate brokers to find out its value.
[16] He determined the price based essentially on his own knowledge of the market and on the fact that the property was unoccupied and, so he said, in an appalling state.
[17] According to Mr. Lafond, absolutely everything had to be redone; he testified that the walls, ceilings, stairs and partitions had to be rebuilt and that the electricity, the plumbing and the heating system were so damaged that they had to be completely overhauled. The cost of the repairs would have been several tens of thousands of dollars.
[18] Given the magnitude of the damage described, which will be commented on below, the Court said that it was sceptical about the explanation given to justify doing absolutely nothing to obtain compensation from the tenants for the restoration of the premises.
[19] Mr. Lafond said that he trusted the principal tenant completely and therefore blindly signed a release preventing him from bringing court proceedings to claim compensation for the damage; yet the premises were occupied by a subtenant at the end of the lease, which should have raised some concerns.
[20] Moreover, given the scope and significance of the damage described, it would have behooved Mr. Lafond not to throw in the towel so easily.
[21] I see no point in going any further on this issue, since the evidence as a whole is illuminating, enabling one to better understand certain conduct.
[22] Those are the various factors on the basis of which Mr. Lafond set the price of his property at $125,000.
[23] How did he go about finding one or more interested persons? He did absolutely nothing except tell those around him that he intended to sell so that the grapevine could do its work. He did not hire a real estate agent or broker; he did not pay for any advertising or put up a sign indicating that his property was for sale.
[24] The appellant purchased the property for $125,000. Why did he purchase it? In his testimony, he explained in a vague and ambiguous way that he did so for speculative purposes. He said that he knew the owner of the McDonald’s restaurant franchises in the Trois-Rivières area and hoped to resell the property to him for the purpose of setting up a restaurant. Although the surface area of the land was not sufficient to carry out such a plan, the appellant took no steps to present the promoter of the project with an attractive proposal. Indeed, the Court doubts that the appellant even offered his property.
[25] The appellant was not very explicit about his project, which no doubt never got beyond the imagination stage. Since the appellant was not very well off and his income was very modest, it was totally unreasonable and unrealistic for him to venture into a project that was so poorly defined and that for all practical purposes had no chance of success.
[26] What is more, the appellant was unaware of something that, in the circumstances, was very important: the area of the lot. The property was moreover a substantial asset, to say the least, for someone whose income was so small. Despite that reality and the fact that he had to make large monthly payments, he as good as did not visit the property before purchasing it. He did not try to negotiate a lower price; he accepted the state of the premises and the price asked by the vendor unconditionally.
[27] After the purchase, he did not begin any work or take any concrete steps to minimize the cost of the obligations he had to meet. He did absolutely nothing to try to rent the property, if only for an amount that would have enabled him to make his mortgage payments. Despite all these facts, the appellant had no fallback plan in case he was unable to sell his property for the purpose of setting up a restaurant.
[28] Why did he agree to pay $125,000 to purchase the property? He never really explained this. Despite the uncertainty of his goal, his rather unrealistic plans, the totally appalling state the property was obviously in (according to him), his limited ability to pay, his low income and his lack of cash, he did not turn to a consultant to determine the real extent of the damage, the condition of the property and its actual relative value.
[29] He agreed to pay what was, in view of his ability to pay, a substantial amount, and he did so without negotiating or seriously visiting the property to find out how severe the damage was.
[30] The account of the circumstances surrounding the sale and purchase of the property, as given by the parties to the transaction, is totally illogical, and there is absolutely nothing reasonable or rational about it in terms of the realities of a commercial transaction between two serious individuals.
[31] The striking difference between the municipal assessment and the sale price aroused some suspicion; it therefore became essential—even though a municipal assessment is not a primary reference but is basically just an interesting indication—to expand on why it was appropriate to set the consideration at $125,000.
[32] The appellant and his vendor justified the low value by pointing to the major depreciation at the time of the purchase and the significant damage to the building; in addition, neither of the premises was rented.
[33] These are certainly real, objective facts that had a direct impact on the market value of the property. However, each component of the alleged loss in value had to be analyzed thoroughly to assess its relevance and its real impact on the property’s value.
Damage
[34] A significant portion of the evidence was devoted to the issue of damage and the depreciation of the property. The bailiff, Stéphane Carpentier, visited the property and testified on this point; in support of his testimony, he filed a series of photographs showing the premises.
[35] The parties’ respective experts reached very different conclusions: there is a substantial difference of $83,500 between the two appraisals. That difference is especially large considering the value of the property.
[36] As regards the importance attached to the damage, the Court reviewed the photographs taken by the bailiff, Mr. Carpentier, very carefully.
[37] They clearly show that the damage affected mainly the furniture and movable effects. The damage to the movable property that had become immovable by destination was minor and had little or no impact on the value of the property. The photographs taken by the bailiff do not show any serious damage to the property such as that described by Mr. Lafond and the appellant.
[38] That assessment is moreover confirmed by the description of the damage for which compensation was claimed by Pub Place du Marché Inc., the principal tenant of the property at issue, from Alain Brindle, Gaétan Brindle and Bar Le Garage Enr., the subtenants of part of the premises.
[39] The damage was described in an action brought in the Court of Quebec, district of Trois-Rivières (file no. 400-02-000480937). Paragraphs 4 and 5 of the statement of claim were worded as follows:
[TRANSLATION]
4. On April 2, 1993, the plaintiff had this situation recorded by a bailiff, whose report is filed in support hereof as Exhibit P-2;
5. The cost of repossessing the rented premises, replacing or repairing the missing or damaged property and repairing the damage caused to the rented premises totals $9,869.91 and can be broken down as follows:
A. COST OF REPOSSESSING THE RENTED PREMISES
- cost of reprogramming the alarm system $ 66.77
- cost of locksmith 60.00
SUBTOTAL $ 126.77
B. COST OF REPLACING MISSING PROPERTY
- round arborite table $ 60.00
- nine (9) electronic plugs 150.00
- boiler, dryer and toilet seat 257.12
- one (1) 5-lb. fire extinguisher 40.50
- stools (4), chairs (3), ceiling lights (2), refrigerator
(repairs), compressor (repairs), ice machine (repairs) $2,833.87
SUBTOTAL $3,342.29
C. COST OF REPAIRING (REPLACING) DAMAGED PROPERTY
- FISHER amplifier $ 12.87
- ZENITH 26" television 228.00
- ZENITH 26" television 106.00
- QUASAR 20" television 150.00
- two (2) cable TV converters 418.00
- blinds 236.77
- acoustic tiles 193.63
- mahogany table 200.00
- mahogany standing bar 175.00
SUBTOTAL $1,720.27
D. DAMAGE TO THE RENTED PREMISES
- dance floor $ 876.54
- sliding door and mirror 3,538.83
SUBTOTAL $4,415.37
E. MISCELLANEOUS EXPENSES
- bailiff’s report $ 185.00
- valuation costs 44.51
- cost of photocopies (colour photographs) 35.70
SUBTOTAL $ 265.21
GRAND TOTAL $9,869.91
[40] The bailiff acknowledged that the description of the damage in the action corresponded with what he himself had stated in his report. Since Pub Place du Marché Inc. was liable to the owner, Mr. Lafond, for all the damage caused to the rented premises, it would have been surprising, to say the least, if it had not claimed compensation from the subtenants (the Brindles) for all the damage caused to those premises.
[41] Moreover, the specific mandate given to the bailiff related to all the breakage and damage caused while the premises were occupied; he was therefore instructed to thoroughly examine the premises and to make a detailed, exhaustive list of everything that was in need of repair.
[42] In such a context, if damage of the kind described by the vendor and the purchaser had been real and so serious, there is no doubt that it would have been described fully and in detail.
[43] I therefore conclude that the damage to and deterioration of the property were not as serious as the appellant claimed; moreover, I am satisfied that the repairs did not require outlays as substantial as those referred to. However, the photographs do show that the premises in the building were neither appealing nor inviting.
[44] Mr. Lafond and Mr. Descormiers both said that they had the skills and talent to fix up buildings. In light of that, it is quite surprising that they did not undertake to thoroughly clean the property and do certain repairs in order to make it rentable again; they would have thus increased the value of their asset during the time they owned it.
[45] To lease commercial premises, I believe that it is helpful, indeed necessary, that the premises be fitted out so that they seem pleasant and promising to anyone who might be interested. So why were the premises not fixed up?
[46] There was evidence that was an attempt to show that the cost would have been prohibitive. In this regard, the evidence is totally unconvincing, especially given the complete absence of an independent estimate. Moreover, for the reasons set out above, the evidence from the bailiff’s report supplemented by the photographs he took shows the opposite.
[47] Why was the necessary work not done? The evidence does not really provide any answer to that question, which itself raises yet more questions.
[48] The vendor, and subsequently the appellant as the purchaser, owned a property that appeared depreciated. In spite of that circumstance, which was liable to drive away any tenant or potential purchaser, they took absolutely no action to improve the condition of the property. The appearance of a property and whether or not its premises are occupied have a direct impact on its value. In view of this, why did neither Mr. Lafond nor the appellant take steps to improve the condition of the premises or interest potential tenants?
[49] Neither of them did anything at all to find tenants; the available premises were not advertised in any way. The appellant even asserted that he did not know when, how and why the municipality had cut off the water. He said that he learned of this from someone who wanted to store some goods. Is it possible that he could have been so indifferent and casual about a piece of property that represented, to say the least, a significant part of his assets and that also required him to make monthly payments so substantial that all of his income was insufficient to meet that obligation? Such an attitude totally discredits the explanations given by the appellant.
[50] The property was left in a state of total neglect even though the transaction called for monthly payments of more than $900 and the appellant still owed a $25,000 balance on the sale price.
[51] I will digress here to consider the $25,000 balance of the sale price. There was no evidence to show whether that amount was repaid either in part or in full. The nature and size of the amounts paid could not be precisely determined. Reference was made to litigation resulting from problems with water leaking through the roof, but the evidence on this was incomplete and did not show whether the problems led to a reduction in the price.
[52] If the appellant had shown that he had a concrete, serious, plausible and realistic plan, with a reasonable time frame, that was based essentially on the area of the lot and that had some chance of success, it would have been more understandable that he acted as he did. This is all the more important given that his income was not sufficient for him to be able to pay the balance of the sale price and make monthly payments as high as $900 potentially over a number of years.
[53] Apart from these decisive and significant facts concerning the appellant’s total lack of interest in the property, why did he not challenge the amount of the municipal assessment in order to at least reduce the taxes, which were very high in relation to his ability to pay? A reduction in the municipal assessment would not have been at all detrimental to his plan and would have had the advantage of reducing the taxes. Once again, the evidence did not provide a plausible explanation.
[54] The only explanation of the facts and circumstances surrounding the transaction is that the appellant was basically doing what the vendor wanted. He had nothing to fear or lose in the venture. He had not paid anything in cash and the bank loan was guaranteed by the vendor.
[55] What interest, benefit or profit could the appellant hope for from the transaction? This is so vague that the more plausible conclusion is that his purpose was no doubt basically to help Mr. Lafond, who was his friend, if not an attentive, highly co-operative partner who had hired him at certain points and stood surety for him a few times.
[56] The evidence amply demonstrated that the appellant was under Mr. Lafond’s influence and had benefited from his kindness and help a few times. The weight of the evidence is that Mr. Descormiers and Mr. Lafond had a special business relationship. They were definitely not dealing with each other as strangers or at arm’s length. They did business together and worked in the same field of economic activity, namely the restaurant business.
[57] Although the anonymity of numbered companies was used to confuse the nature of the business relationship between Mr. Lafond and the appellant, the fact that Mr. Lafond acted as the appellant’s surety had the effect of nullifying the efforts made to hide the nature of their relationship.
[58] The vendor and the purchaser were not only friends but also partners in their everyday business activities. They had known each other a very long time and had shared the same interests in certain business dealings. The evidence also showed that the appellant had worked for Mr. Lafond.
[59] Jean-Jacques Lafond and the appellant did try to downplay their work relationship, going so far as to deliberately hide certain inescapable realities, such as the fact that they were parties to the same transaction. Using the anonymity of numbered companies as an excuse, the appellant tried to claim that he was unaware of Jean-Jacques Lafond’s interest in certain transactions.
[60] The evidence also revealed another fact that totally discredits the position taken by Mr. Lafond and the appellant. Why did the credit union, within the space of a few hours, agree to loan $100,000 without visiting the property and without any personal security from the purchaser and knowing that the principal borrower definitely did not have the financial ability to make the monthly payments required by the loan?
[61] Moreover, the manager of the credit union pointed out that the file referred to several dozen calls made to obtain the monthly payments. The vast majority of those calls were made to the vendor, Mr. Lafond, and not the purchaser. According to the manager of the credit union, Jean-Jacques Lafond made most of the payments on the loan granted to the appellant.
[62] Why did Mr. Lafond not claim the payments he had made from the appellant? Why did he not bring proceedings to repossess the property? No evidence was adduced on these questions, which are nevertheless important ones.
[63] Three criteria are used to determine whether the parties to a transaction are dealing with each other at arm’s length:
(a) whether there is a common mind that directs the bargaining for both parties to the transaction;
(b) whether the parties to the transaction are acting in concert without separate interests; and
(c) whether there is de facto (real) control.
[64] The weight of the evidence clearly showed that Mr. Lafond had so much influence over the appellant that he alone directed the bargaining prior to the transaction; the vendor and the purchaser acted in concert in the sole interest of Mr. Lafond, who had obviously always been in control of the situation. The evidence further showed that the appellant was more of an agent than a real contracting party with respect to the transaction in May 1993.
[65] For all these reasons, it is my view that the appellant did have a de facto non-arm’s-length relationship with the vendor, Mr. Lafond, with respect to the transaction in May 1993.
[66] That being the case, the consideration given for the transaction should be looked at. Did it correspond to fair market value? Did the appellant pay the actual value of the property? What was the actual value of the property at the time of the transaction?
[67] The way in which the fair market value of property should be determined has always given rise to much discussion and many theories. The treatise entitled Droit public et administratif en droit fiscal, published by Yvon Blais Inc., sheds some interesting light on this subject at page 71:
[TRANSLATION]
Fair market value
This term is not defined in either the Act or the Regulations. The determination of market value is basically a question of fact and opinion within the purview of appraisal experts. However, fair market value must be proved to the satisfaction of the courts if the department and the taxpayer are unable to agree. It is generally felt that the concept must be assessed objectively on the basis of a normal transaction to which the parties have given their free and informed consent, regardless of any special ties between them that would be likely to create a “non-arm’s-length relationship”.
[68] For the purpose of the determination of the actual value of the property involved in the transaction, the Court was presented with two appraisals prepared by experts.
APPELLANT’S EXPERT
[69] The appellant’s expert, Louis-Georges Baril, visited the property at the appellant’s request; he prepared his appraisal using the usual methods, stressing that the only true appraisal method is the “comparables” method.
[70] He therefore made a list of three comparables, which he then adjusted and weighted so that they could serve as references. He explained all of his work and described the approach he took to reach the conclusion he reached. He determined that the value of the property at the time of the transaction was $115,000.
RESPONDENT’S EXPERT
[71] The respondent used the services of an appraisal expert, Alain Lortie. Since Mr. Lortie had not been employed by Revenue Canada for very long and since major alterations had been made to the property at issue, he had to consider certain facts of which he had no personal knowledge; he referred to a series of photographs showing the premises at specific points in time. However, he stated that he put a great deal of time into preparing his appraisal. He went to Trois-Rivières several times, met with people who had knowledge of the premises and thoroughly analyzed a number of transactions.
[72] The photographic component of the appraisal was strongly objected to by the appellant, who argued that such photographs were inadmissible since the expert did not take them and was not aware of all the circumstances in which they were taken; the appellant was consequently deprived of the opportunity to examine or cross-examine the person who took them. Having reserved my ruling on the objection, I am now disposing of it as follows.
[73] As an expert, the respondent’s appraiser had a great deal of latitude in carrying out the analysis, research and assessment enabling him to determine the actual value of the property in May 1993.
[74] However, he did not have so much freedom that part of his work could be based on photographs in respect of which he was not absolutely certain when and in what context they were taken. He could not use photographs without knowing the photographer’s name and address, the date the photographs were taken and the context and circumstances in which they were taken so that all of this could be made available to the appellant and his expert.
[75] Accordingly, I order that the copies of the said photographs be removed from the appraisal and that everything based thereon also be removed.
[76] Mr. Lortie also explained the approach he took in conducting his assessment. It was clear from his testimony that he had devoted a great deal of time and energy to that assessment. He also listed many more transactions relating specifically to the value of the land.
[77] He ruled out the comparable method for commercial properties, arguing that such comparables were not valid; there were too many differences to consider them relevant and valid comparables.
[78] He therefore limited his review of comparables to two aspects: the land and the rental value of premises located in the same area as the property at issue in this case.
[79] He concluded that the value was $198,500, which was an average of the $200,000 obtained by appraising the property using the cost approach and the $197,000 obtained using the income approach.
ANALYSIS
[80] Appraisal is, of course, an art requiring considerable knowledge, extensive experience and above all an ability to strike a balance between the objective and the subjective.
[81] Most of the time, experts reach conclusions that basically support the position of the person for whom they are working, which is why the courts try to render the parties’ appraisals objective on the basis of various facts brought out by the evidence.
[82] The appraisal by the respondent’s expert is more detailed, more thorough and most of all more plausible. Indeed, the appellant’s expert acknowledged that the comparable method of determining actual value has its limitations and imperfections in that it is totally impossible to find comparables that are absolutely identical.
[83] Comparables are useful as a guide or indication but they are not an infallible method possessing scientific rigour. While the comparables method may be considered ideal, it must be understood that the comparables are always subjective and imperfect in terms of both quantity and quality.
[84] In the case at bar, given the comments made on the quality of the available comparables, it is my view that the scarcity of comparables as well as their lack of similarity made the method so imperfect that it must be rejected.
[85] To begin with, the work done by Mr. Lortie is obviously more complete, more detailed, more thorough and thus more valid. This was clear from the testimony of the two experts, who did not do the same amount of work to reach their respective conclusions.
[86] The appellant’s expert spent one or two days on the appraisal; he used data from his own all-purpose catalogue and took other data for granted without checking them.
[87] The respondent’s expert obviously reviewed and analyzed more data and also took the trouble to render the available data objective.
[88] As very often happens in such cases, the work done by Louis-Georges Baril seems to have been guided and shaped somewhat by the appellant’s concerns; I noted certain flaws that discredit the quality of the work of the appellant's expert. I am referring, inter alia, to the following aspects.
Income approach
[89] Mr. Baril assigned totally arbitrary values to the rental premises in the building:
Ground floor 1,500/month $6.56 sq.ft. $18,000
Upstairs 900/month $4.00 sq.ft. $10,000
Those amounts seem to be based, to all appearances at least, on the rent set in the various leases for the premises. In this regard, I consider it useful to point out that the consideration for the upstairs premises was $3.84 a square foot at the end of the lease in December 1990.
[90] The rent for the ground floor was somewhere between $5.00 and $8.59 a square foot. To obtain a valid indication, the rental value of the equipment, which was included in the rent for the ground floor premises, would have had to be subtracted.
[91] Besides this shortcoming of assigning an arbitrary value to the rents even though high-quality data were available, Mr. Baril, in his calculations, entered a figure of $5,000 under the heading “MAINTENANCE AND REPLACEMENT RESERVES”.
[92] Such an amount is entirely unreasonable and unrealistic, since all tenants of immovable properties must maintain the premises they are renting. The only acceptable reserve is an amount to make up for depreciation or aging, which amount would be very far from the 20 percent assigned by the appellant’s expert.
[93] Those two major shortcomings have the effect of discrediting the conclusion reached using the income approach, through which Mr. Baril determined the value to be $115,000.
Direct comparison approach
[94] The expert argued that this approach is the most credible, the most reliable and the most appropriate. However, he acknowledged that there is a great deal of arbitrariness in the choice of comparables. He also admitted that the probative force of this approach depends on the quality of the comparables.
[95] The three comparables selected were properties that were 86, 67 and 63 years old. Two of the three had three floors and the third was described as having one and two floors. The transactions involving them occurred on March 30, 1994, April 28, 1994, and July 20, 1995, respectively.
[96] I do not think that these comparables are objectively acceptable, since the differences are such that the necessary adjustments were likely to compromise the quality of this approach.
[97] These three comparables were, beyond a shadow of a doubt, chosen because of their very low sale prices. It is equally worth noting that Mr. Baril admitted that he did not review the contracts of sale for each of the transactions so as to be sure that there were no special facts or conditions.
Cost approach
[98] Based on the cost approach, the expert concluded that the property was worth $133,500. That conclusion is totally unreasonable, since it underestimates the value of the land and, above all, attributes to the building depreciation of 75 percent, or $229,592; this is totally inconsistent with the description on page 5 of his appraisal, where it is stated that the apparent age corresponds to the actual age of 24 years.
[99] I do not think that a 24-year-old building has to be depreciated by 75 percent. Even if the opposite were true, the evidence was incomplete as regards data justifying such a loss of value.
Respondent’s appraisal
[100] Although I have already found that the respondent’s appraisal was done more carefully, I believe it is necessary to avoid making the mistake of drawing hasty conclusions based only on the fact that that appraisal is more voluminous and incorporates a number of documents and references.
[101] As regards the depreciated replacement cost method, it is my view that the approach taken by Alain Lortie is a more reasonable reflection of reality; not having noted anything that might compromise the quality of that approach, I therefore accept his conclusion that the value of the property based on the replacement cost approach was $200,000.
[102] As regards the income approach, although presented and dressed up better by the respondent’s expert, its use has one major shortcoming.
[103] Mr. Lortie analyzed a number of comparables and reviewed the leases on the property, which does him credit. However, I feel that he attached too much importance to the listed comparables in comparison with the actual leases, which provided genuine objective data whose quality was indisputable.
[104] Those data were real data which were highly relevant, since they represented rent actually paid by and to people dealing with each other at arm’s length. It should therefore have been noted that the amount of the rent was set without any constraints whatsoever and was guided essentially by the quality of the premises in terms of their area, their condition and especially their location.
[105] However, it is to the credit of the respondent’s expert that he did review and analyze those data. Where the Court disagrees with Mr. Lortie is as regards the value per square foot assigned to the two rental premises.
[106] Mr. Lortie assessed the potential of the two premises as follows:
2,600 sq.ft. x $9.00 = $23,490
2,610 sq.ft. x $5.00 = $13,050
Grand total $36,540
[107] The expert provided the following explanation of the calculations he did to arrive at those unit costs:
[TRANSLATION]
The ground floor of the property under review was not leased at the time of the transaction. Considering its potential and its location in comparison with other premises, it is our opinion that a unit rent of $9.00 a square foot should be assigned to it. This is the minimum rent observed on the market. The services provided out of that rent would be property taxes, structural maintenance . . . and management.
The upstairs premises were also vacant at the time of the transaction. The last lease entered into indicated that the rent was $6.07 a square foot. The rents we found for upstairs premises show that there is a great deal of variation because of different features, such as floor area and services provided.
By matching up leases for the same building (6 and 9), we find that the upstairs rent corresponds to about 60 percent of the ground floor rent ($14.49 vs. $8.51). By applying that standard to the property under review, based on the $9.00 rent, we obtain a rent of $5.40 a square foot, which we will round off to $5.00 for the purposes of this appraisal. Again, this is a minimum rate in relation to the market.
[108] However, the lease for the upstairs premises, which ended on December 31, 1990, provided for a unit cost of $3.84 a square foot at the end of the lease. The increases between year 1 and year 5 of the lease were on average $0.15 a square foot.
[109] By extrapolating, we arrive at a cost of about $4.30 a square foot for 1993.
[110] The figures for the ground floor rent are more contemporaneous, since the lease ended in March 1993, a few months before the transaction in question.
[111] The principal tenant sublet the premises for which it was responsible for a consideration much higher than that set out in the original lease. The expert first determined the unit rate under the lease for years 4 and 5 and arrived at a rent of $14,088 or $5.40 a square foot and $14,352 or $5.50 a square foot for the last two years involved. He completed his analysis with the appraisal based on the sublease and arrived at a unit rate of $22,430 ($8.59 a square foot). He increased that price to $9.00 a square foot.
[112] However, I do not think that the $8.59 figure, much less that of $9.00, is reliable; the fact that the consideration set out in the lease included all the equipment left there by the subtenant distorts the conclusion reached.
[113] How should the actual value of the rent for the ground floor premises be determined? I do not think that that value could be determined through the comparables used by the respondent; comparables relating to rent are much less reliable than those relating to transfers of ownership. Moreover, the components of rent are generally more numerous and more specific than those that enter into the determination of the price of immovable property.
[114] The quality of the premises, accessibility, location, surface area, scarcity, custom, convenient parking, etc., are all factors that determine the value of rent, which is why it is important that experts use actual leases for the property whenever possible.
[115] In this regard, I believe it is worth citing a passage from the judgment of the Honourable Judge Pierre Dussault of this Court in Les Immeubles Chal Inc. v. Her Majesty the Queen, 96-1172(IT)G (July 20, 1998), where he stated the following at page 12:
[42] There is no ambiguity as to the actual rental negotiated and paid for the first two premises. Since this was rental agreed upon between parties dealing with each other at arm’s length, and in the absence of evidence that there was anything artificial or unusual about the leases concluded, in my opinion this rental should be the basis for an appraisal using the capitalized income approach. (On this point reference may be made to Jean-Guy Desjardins, Traité de l’évaluation foncière, Montréal, Wilson & Lafleur, 1992, p. 281, No. 9.4.2.1.) In the circumstances, it seems clear to me that actual income is a better yardstick for determining the value of the appellant’s property than a theoretical potential income based on approximations derived from an average or median income, using allegedly comparable data which often prove however to be questionable, as is the case here.
[116] In view of the amounts paid by the tenants to occupy the premises in the property at issue, it is my opinion that the respondent’s expert overvalued the reference amounts, which he determined to be $5.00 and $9.00 a square foot.
[117] Moreover, the method used to arrive at those estimates is questionable. Given the objective information provided by the actual leases, I think that $4.25 and $7.65 a square foot would have been more realistic and especially more consonant with reality.
[118] I have also noted that the experts anticipated very different rates of return on investment. The appellant based his calculations on an anticipated return of 8 percent, while the respondent used a rate of 12 percent. The reasonable rate is probably somewhere between the two, and I set it at 10 percent.
[119] I have therefore redone the calculations in the light of these new data and using all the other factors and information used by the respondent’s expert; the result is $176,500 according to the income approach, which strikes me as realistic.
[120] Accepting the approach that the appraisal amount in the case of immovable property is to be obtained by averaging the results from the usable methods, I set the value of the property at $188,000, calculated as follows:
Value determined using replacement cost $200,000
Plus - Value from income approach $176,500
Total = $376,500
Divided by 50% = $188,250
Rounded off to = $188,000
[121] This is a realistic appraisal that is also consistent with a statement made a few times by the appellant’s expert himself, namely that financial institutions generally lend 60 percent of the value of a commercial property. Moreover, Mr. Baril used that same percentage in his calculations to determine the value using the income approach.
[122] In this regard, I consider it important to point out that the credit union granted a $100,000 mortgage on the property in question.
[123] The Court therefore finds that Jacques Lafond was not dealing at arm’s length with the appellant, Jean-Yves Descormiers, at the time of the transaction of May 27, 1993, relating to the property at 200 Rue St-Georges in Trois-Rivières; the Court also sets the market value of the said property at $188,000 at the time of its transfer on May 27, 1993.
[124] As a result of the foregoing, the appeal is allowed and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that Jean-Yves Descormiers and Jacques Lafond were not dealing with each other at arm’s length when the property worth $188,000 was sold. Since the decision has only a minor impact on the validity of the assessment, which is being upheld in large part, the Court awards costs to the respondent.
Signed at Ottawa, Canada, this 22nd day of January 1999.
“Alain Tardif”
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 29th day of September 1999.
Erich Klein, Revisor