Guy Tremblay:—This case was heard at Montreal, Quebec, on May 8, 1978.
1. Point at Issue
The point at issue is to determine the fair market value of the common shares of Cameron Factors Ltd on December 31, 1971, with a view to computing the capital gain or capital loss in the 1974 taxation year.
The shares owned by the appellant were sold in 1974 for $110 each. The fair market value of the common shares on December 31, 1971 was $210 according to the appellant and $80 according to the respondent.
2. Burden of Proof
The appellant has the burden of showing that the respondent’s assessment was not justified. This burden of proof is based not on a particular section of the Income Tax Act but on several judicial decisions, among them a decision of the Supreme Court of Canada rendered in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.
3. The Facts
3.01 In December 1971, the appellant owned 13% of the common shares of Cameron Factors Ltd. This company, as other factoring companies, is a service company which provides the two following major services: the guarantee of credit risks and the discounting of accounts receivable.
3.02 This company was incorporated in 1964 by the appellant. In his notice of objection (which is attached to the notice of appeal) he described the following facts that he proved at the hearing:
In 1964, I formed Cameron Factors Ltd, a federally incorporated Company, to engage in the Factoring business. The paid in capital at the beginning and throughout the period ending 1972 consisted of 45,000 preferred shares at $5 each and 2,500 common shares at $10 each. On January 1, 1972, V Day, I held 4,050 preferred shares and 225 common shares. In June 1973, I severed my connection with the Company, and the shares were sold the following year.
On January 1, 1972, there were 8 Factoring companies in Canada. The Factoring business is a highly specialized branch of the finance industry, involving the guarantee of third party credit risk and the financing of commercial accounts receivable. It is a high risk business, and requires a good deal of expertise. It is a difficult and costly business to get into.
In 1970 and 1971, three of the Factoring companies in Canada were sold as follows:
1. Continental Financial Corporation was sold to Industrial National Corporation of Providence, Rhode Island for $5,000,000. Of this amount, $2,348,000 represented goodwill, which involves a goodwill factor as a percentage of net worth of 88.5%. In other words, Industrial National Corporation, an American Bank Holding Company paid 88.5% over and above the book value of Continental. For the acquisition of that Company, the goodwill figure is gleaned from a press release published by Industrial National Corporation on January 31, 1975, page 2, copy attached. The purchase price was published in the daily press at the time of acquisition. (At the hearing the copy was filed as Exhibit A-5).
2. In 1970, Virginia Commonwealth Bank Shares, an American Bank Holding Company, acquired the common shares of Affiliated Factors Corporation for a sum of $3,400,000, as reported in the annual report of Virginia Commonwealth Bank Shares for 1970, page 16 (Exhibit A-6). The 1971 report of that Company indicates that agreement was reached in 1971, and that “the cost of investment exceeded equity in related net assets of date of acquisition of $1,644,992.’’ This represents a goodwill factor over net equity of 93.7%.
3. In 1971, Virginia Commonwealth Bank Shares purchased all the outstanding shares of Canadian Factors Corporation Ltd for a total investment of $3,477,567 in cash. According to the annual report of Virginia Commonwealth Bank Shares for 1971, page 23, ‘‘the cost of investment exceeded equity in related net assets at date of acquisition by $1,625,776.” This represents a goodwill factor as a percentage of net worth of 87.8% (Exhibit A-6).
4. In the Summer of 1972 certain shareholders of Cameron Factors Ltd initiated negotiations with Walter E Heller International Co, the world’s largest Factoring company, based in Chicago. These negotiations resulted in an offer for the purchase of Cameron Factors Ltd for $900,000, of which $225,000 represented Preferred Stock at par, and the balance of $675,000 the value of Common Stock, or $300 per share. This deal did not go through, as it was discovered late in the negotiations that it was barred under the Investment Companies’ Act. The offer was not a final offer, as it was subject to final audit, but it was nonetheless genuine, and represents the only evaluation of the value of Cameron Factors Ltd available. That offer, based on Cameron Factors Ltd Balance Sheet of August 31, 1972 would represent a goodwill factor of 116.8% of the net equity in Cameron Factors Ltd goodwill. This figure is somewhat higher than those quoted above, but at the same time Cameron Factors Ltd was operating in a highly profitable manner. The net after tax profit for the year ending August 31, 1972 represented a return on investment at the Start of the period of 24.34%. It may be accepted therefore that Cameron Factors Ltd was looked upon by prospective purchasers as a highly desirable acquisition.
3.03 To prove the above facts, the appellant produced many documents as exhibits:
A-1 The offer of Walter E Heller International Corporation (a draft dated
11/20/72) to buy all the preferred and common shares for $900,000.
A-2 A letter dated January 27, 1976 from Franklin A Cole, Chairman of
the Board of Walter E Heller International Corporation, concerning the offer made in the fall of 1972.
A-3 The Statistical Summary of the Financial statements of Walter E
Heller International Corporation and subsidiaries for the years 1968 to 1977.
That document was filed to prove the seriousness of that company whose shareholders’ equity was as follows:
1968 1972 1977 $113,258,000 $161,752,000 $263,151,000 A-4 A letter dated March 17, 1976 from the respondent refusing the
figures contained in the offer (A-1) made by Walter E Heller & Company.
A-5 and A-6 were indicated above.
A-7 A speech given by the appellant on February 25, 1975, concerning the
nature of factoring business.
A-8 Financial Statements of Cameron Factors Ltd as at August 31, 1971.
A-9 Profit and loss of Cameron Factors Ltd for four months ending
December 31, 1971. Balance sheet of the same company as at December 31, 1971.
A-10 Financial Statements of Cameron Factors Ltd as at August 31, 1972.
3.04 The appellant said at the hearing substantially what he wrote in the notice of objection:
I was the president and general manager of the company with almost a quarter of a century experience in the business in 1973. The company, like many others, is highly responsive to management talent. Had I remained president, the shares of the company were worth, at least, in my opinion, Substantially more than they would be with management by other and inexperienced hands. Indeed, the following years’ profits fell substantially.
3.05 At the hearing, the appellant said that he participated in appraising shares of 22 companies. He added that a share of factor company cannot be appraised like another one because of the special nature of the company.
3.06 The witness for the respondent, Mr Michael Richard, is a member of the Certified General Accountant Association. During the 2 /2 years he had been working for the respondent, he had participated in 150 appraisals of company shares.
3.07 He explained in detail his appraisal report filed as Exhibit I-1. The conclusion is that the fair market value of a common share of Cameron Factors Ltd on December 31, 1971, was $80.
3.08 The computation to arrive at that conclusion can be summarized as follows:
| The annual average income before tax | ||
| from the years 1970, 1971 and 1972 | $ 78,741 | |
| Less—tax | 26,871 | |
| $ 51.870 | ||
| Capitalized at 121/2% (x 8) | 414,960 | |
| at 11% (x 9) | $466,830 | |
| Less | ||
| Value of priviledge shares | 225,000 | 225,000 |
| Value of 2500 common shares | $241,831 | $189,960 |
| Value of one common share | 97 | 76 |
| Less | ||
| or discount of minority shares | ||
| or 20% | 19.40 | 15.20 |
| Fair market value | $78 | $61 |
| or 30% | 29 | 22.80 |
| Fair market value | $68 | $53 |
The conlusion is that the fair market value of a minority common share of Cameron Factors Ltd on December 31, 1971 was somewhere between $53 and $78.
The appraiser, Mr Richard, put the figure at $80.
3.09 It is admitted by the parties that in 1974 the shares owned by the appellant were sold at $110 each.
3.10 In filing his tax return for 1974, the appellant valued the common shares at $210 per share on December 31, 1971 and claimed a capital loss of $22,500 (225 x 100 (210-110)).
3.11 By notice of reassessment issued on September 24, 1976, the respondent changed the capital loss of $22,500 ($225 x (210 - 110)) by a capital gain of $6,750 ($225 x (110- 80)).
3.12 Following a notice of objection filed Gn September 28, 1976, the respondent confirmed on March 25, 1977 the notice of reassessment issued on September 24, 1976.
3.13 An appeal was lodged on April 4, 1977, before the Tax Review Board.
4. Law - Comments
4.1 Law
The sections of the Act are not in dispute.
4.2 Comments
4.2.1 In the Board’s opinion, the evidence given by the respondent’s appraiser was honest and learned considering the basis of the report: earning value. The amount of $80 per share seems right.
4.2.2 The evidence given by the appellant, however cannot be ignored especially the tender made in the summer of 1972 to purchase the shares of Cameron Factors Ltd at $300 per share.
The evidence of the appellant showed that goodwill has an important part in the appraisal of factoring companies. It is probably the reason why in his testimony the appellant says that a factor company cannot be appraised like another company (paragraph 3.05 of the Facts). During the years 1970 and 1971, three factoring companies were sold in Canada. The goodwill factor over net equity was in each case 88.5%, 93.7% and 87.8%. The tender in 1972 of Walter E Heller International Co to purchase the shares of Cameron Factors Ltd at $300 per common Share represented a goodwill factor of 116.8% of the net equity, considering the balance sheet of August 31, 1972 (see paragraph 3.02 of the Facts).
Must the Board consider the fact that the appellant in 1972 was the general manager of Cameron Factors Ltd. and that he left in 1973?
After the testimony he gave (see paragraph 3.04 of the Facts) there is no doubt that the business (and consequently the goodwill) rested, in great part, on the appellant’s shoulders. It is useful to repeat the testimony:
I was president and general manager of the company with almost a quarter of a century experience in the business in 1973. The company, like many others, is highly responsive to management talent. Had I remained president, the shares of the company were worth, at least in my opinion, substantially more than they would be with management by others and inexperienced hands. Indeed, the following years’ profits fell substantially.
The Board cannot ignore the personal goodwill brought by the appellant to Cameron Factors Ltd. The personal goodwill indeed is not commercial and transferable. The problem is to state a percentage. The Board thinks it is equitable to value the personal goodwill of the appellant at least at 40%.
4.2.3 Another element must also be considered: the minority of the common shares owned by the appellant. The Board thinks that 20% (as in the appraisal report of the respondent’s witness) is fair.
4.2.4 The computation of the value of the shares owned by the appellant at the date of the tender in August 1972 is as follows:
| Tender | $300 | |
| Less | ||
| Personal goodwill 40% | $120 | |
| Minority 20% | $60 | $180 |
| Value | $120 | |
The Board thinks that to evaluate the shares as of December 31, 1971, the amount of $110 seems equitable.
5. Conclusion
The appeal is allowed in part and the respondent’s assessment is vacated and the matter is referred back to the respondent for reassessment in accordance with the above Reasons for Judgment.
Appeal allowed in part.