Douglas Zeller and Leon Paroian Trustees of the Estate of Margorie Zeller v. The Queen

Douglas Zeller and Leon Paroian Trustees of the Estate of Margorie Zeller v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2008-07-30
Neutral citation
2008 TCC 426
File numbers
2003-2892(IT)G
Judges and Taxing Officers
Diane Campbell
Subjects
Income Tax Act
Decision Content
Docket: 2003-2892(IT)G
BETWEEN:
DOUGLAS ZELLER AND LEON PAROIAN,
TRUSTEES OF THE ESTATE OF MARJORIE ZELLER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on February 27, 28, March 1 and 2, 2006, October 23, 24, 25, 26 and 27, 2006, March 26, 27, 28 and 29, 2007 and July 17 and 18, 2007 at Windsor, Ontario
Before: The Honourable Justice Diane Campbell
Appearances:
Counsel for the Appellant:
Bruck R. Easton, Q.C.
Counsel for the Respondent:
Michael Ezri and Roger LeClaire
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1998 taxation year is allowed and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.
The matter of costs is reserved. The parties have 60 days from the date of my Reasons to reach an agreement on costs but if they are unable to agree within the timeframe, they will provide written submissions on the issue of costs within 30 days of the expiration of the initial 60 day period.
Signed at Charlottetown, Prince Edward Island, this 30th day of July 2008.
“Diane Campbell”
Campbell J.
Citation: 2008 TCC 426
Date: 20080730
Docket: 2003-2892(IT)G
BETWEEN:
DOUGLAS ZELLER AND LEON PAROIAN,
TRUSTEES OF THE ESTATE OF MARJORIE ZELLER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
[1] On October 20, 1998, Marjorie Zeller, the sole shareholder of 701221 Ontario Limited (“701”), died. In filing the terminal tax return, the Trustees of her estate determined that the fair market value (“FMV”) of 701 was $958,548, pursuant to the deemed disposition provisions contained in subsection 70(5) of the Income Tax Act (the “Act”). Canada Revenue Agency (“CRA”) reassessed the estate’s return and increased the FMV of 701 to $5,524,548. This value was based on an expert report by Mike Albert (the “Albert Report”). In response, the Appellant enlisted the firm of Wise, Blackman to do a valuation. The Wise, Blackman Expert Report (Exhibit A-26) concluded that 701 had an en bloc value of $2.2 million, being the mid-point of an overall range of $2.1 to $2.3 million assigned to 701. The Respondent had a second expert report prepared by Tim Dunham, which assigned a FMV to 701 of $6.38 million, on the valuation date of October 20, 1998. Although both the Wise, Blackman & Dunham Reports used the same valuation methodology, the Earnings Method, to determine the FMV, the outcomes are markedly different.
[2] The Albert Report also used the same method to determine the FMV of 701. However, no expert witness was called to testify on the findings in the Albert Report and I had little evidence respecting the underlying rationale behind that report’s conclusions. Mr. Dunham, who authored the Respondent’s second report, testified that he did not read or consult with the earlier Albert Report when he prepared his own report. Consequently, I am giving no weight to the Albert Report.
[3] The sole issue is the FMV of the shares of 701 on October 20, 1998.
The Facts
[4] 701 has no assets or liabilities other than its interest in Thompson Emergency Freight Systems (“Thompson”). Thompson is in the expediting trucking industry, delivering a niche service as an emergency freight carrier to support “just-in-time” delivery of inventory and parts in the automobile manufacturing industry. In the 1980s, when large trailers failed to deliver the requisite freight, expediting trucking companies, such as Thompson, filled this niche in the automotive industry and sent smaller trucks to ensure on‑time delivery. If inventory or parts were required on short notice to keep automotive assembly lines moving, Thompson contracted to transport those items as quickly as possible to minimize downtime at a plant. Mike Ouellette, the President of Thompson, aptly described the business as “… a fireball service or an ambulance service in the trucking industry” (Transcript page 297). Thompson was formed in the summer of 1985 by George Zeller and Michael Ouellette. A third shareholder, Jerry Thompson, joined them to provide the transport licenses, which were essential prior to deregulation in the industry. The capital investment of each shareholder was $42,000. 701 was the corporate vehicle through which George Zeller held his interest in Thompson. Douglas Zeller, George’s son, was involved with Thompson from its inception as its general manager.
[5] Thompson operated through two companies, 890557 Inc. (“890”) and its American affiliate, a Michigan corporation, known as 123 Inc. (“123”). Despite these different companies, Thompson maintained only one office and central terminal located in Windsor, although it serviced eastern Ontario, Québec and the eastern United States. Items delivered and remaining within Canada were handled by 890 while 123 looked after the United States branch of the business. Revenue was allocated between 890 and 123 depending on whether the income was derived from an American or Canadian based truck. The revenue in 890 was approximately two to three times larger than that of 123.
[6] Thompson owned no trucks. Instead it engaged independent owner/operators known as brokers or 100s. These brokers supplied their own trucks to move the freight. Thompson supplied the temporary license plates, together with the information pertaining to pick up and delivery of the freight. Michael Ouellette described these brokers as migratory in that they worked with the expediting company that could give them the best deal or the most work. Since there was no binding contract, once a broker moved freight he could hand in his license plate and move freely to provide services to a competing expediting company. If Thompson contracted to transport freight, it was essential that brokers were available, otherwise, third-party dispatchers had to be engaged, a practice known as interlining freight. Depending on the rates charged by these third-party dispatchers, compared to the brokers, Thompson could incur a profit or loss. Interlining freight also brought with it an increased exposure to liability. The Canadian brokers were unionized and were represented initially by the Brotherhood of Railway Workers until the early 1990s when it was taken over by Canadian Auto Workers Union (“CAW”).
[7] In the early 1990s, a number of events occurred that would have significant impact on Thompson’s activities. Thompson’s primary and most important client, General Motors National Logistics (“GM”), provided 75 to 85% of its business base. Thompson was under contract as the first call provider of emergency freight services to GM. However, because GM retained the right to cancel on thirty days notice, Thompson remained in a precarious position. In addition, George Zeller, one of the founding shareholders and the President of the company, retired and several months later died on May 18, 1991. His interest in Thompson, held via 701, was bequeathed to his spouse, Marjorie Zeller. At the time of his death, 701 owned a third interest in 890 and a third interest in 123, the remaining interests belonging equally to Mike Ouellette and Jerry Thompson. The following year, in November 1992, the third shareholder in Thompson, Jerry Thompson, went bankrupt. His one‑third interest in 890 was sold to the two holding companies owned by the two remaining shareholders, Mike Ouellette and Marjorie Zeller for $75,000. Mr. Thompson retained his one‑third interest in 123, along with the other two shareholders. As a result, 701 owned a 50% interest, along with Mike Ouellette’s holding company, in 890 and a 33 1/3% interest in 123 with Mike Ouellette and Jerry Thompson.
[8] With the death of George Zeller and the Thompson bankruptcy, Douglas Zeller became an officer and director of 890 and 123 and since Marjorie Zeller, his mother, was never actively involved in the business, he was designated as her representative in Thompson. Michael Ouellette took George Zeller’s position as President. In June 1991, Thompson was able to re‑establish its foothold in the automotive industry by obtaining a large contract with GM in Detroit. According to the evidence of Michael Ouellette, during the 1990s a strong expediting freight business required a core account such as the GM account. He explained that the GM contract designated Thompson as its first call provider for expediting GM freight. This allowed Thompson to spread broker vehicles over a large geographical area, resulting indirectly in increasing its exposure to the possibility of moving other freight in addition to GM’s freight. He stated that “…the reason why Thompson became, you know, a real player in the international expedite industry between Canada and the US, was the GM business” (Transcript page 315).
[9] Although GM was at the core of most of Thompson’s revenues, the fact that the relationship could be terminated by GM upon 30 days notice, gave GM a strong bargaining tool which it used periodically to “strong arm” Thompson into reducing mileage rates. Several occurrences respecting this GM contract significantly impacted upon Thompson’s business in 1998 but first I want to review the relationship between Douglas Zeller, Michael Ouellette and Marjorie Zeller, the three key players immediately following the death of George Zeller.
[10] The evidence of both Douglas Zeller and Michael Ouellette was basically that their working relationship in Thompson was, to put it mildly, full of strife. It was clear from Mr. Zeller’s evidence that he found himself in a no‑win situation because Marjorie Zeller rarely supported his decisions as her representative in Thompson. Added to this mix, he and Mr. Ouellette had a very strained working relationship. Patrick Kennedy, Marjorie’s son-in-law, who eventually replaced Douglas Zeller as Marjorie’s representative in Thompson, testified that Marjorie Zeller would withhold her support for Douglas Zeller’s business decisions based on family issues. According to Mr. Kennedy’s evidence, Marjorie Zeller was always on the “outs” with one of her children. He stated that “She would turn you off like a light switch…” (Transcript page 632). “It seemed like she just couldn’t love all her children at once” (Transcript page 631). It is not surprising that Douglas Zeller informed his mother that he intended to leave the business. Patrick Kennedy replaced him in March 1997 as Marjorie’s representative in Thompson.
[11] Douglas Zeller and three employees of Thompson established Genesis Express, a competing company in the expediting freight industry. Genesis Express was established with a total investment of $48,000 approximately six weeks after his departure from Thompson. Douglas Zeller possessed insider knowledge respecting Thompson’s mileage rates, sensitive information which could enable Genesis Express to undercut Thompson for future contract bids. In March 1997, Michael Ouellette believed this threat serious enough that he instituted legal proceedings to prevent Genesis Express from soliciting Thompson’s clients, employees and brokers. Settlement was reached in April 1997. One of its primary terms provided for an eighteen month injunction against Genesis Express soliciting the GM expedite work, Thompson’s main client. In return, Thompson agreed to use Genesis Express for a six month period as its first expediting back-up call, although this rarely occurred.
[12] Patrick Kennedy came to Thompson with very little knowledge of the expediting business and no prior management experience. Despite this fact, he negotiated a salary with Marjorie Zeller that was comparable to that of Douglas Zeller and Michael Ouellette. Mr. Ouellette described Thompson’s executive compensation package as incentive based and consisting of a base salary and bonuses. In addition to the “… craziness of what was going on with the family” (Michael Ouellette’s evidence, Transcript page 343) and the legal wranglings and confidentiality issues with Douglas Zeller, he was wary of the inexperienced newcomer, Patrick Kennedy. In the summer of 1998, the GM contract was also nearing its termination date and would be up for renewal in January 1999. In addition GM was in the midst of a 57 day strike which inevitably affected Thompson’s revenue. Throughout the summer of 1998, Mr. Ouellette was also involved with renegotiating a contract with CAW. The union negotiations concluded in November 1998, subsequent to the valuation date, and the new CAW contract increased broker expenses for Thompson. This new rate system, based on a fixed rate per mile for brokers, increased Thompson’s risks to foreign exchange fluctuations, according to Mr. Ouellette’s evidence.
[13] With all of these events playing out, Mr. Ouellette considered terminating his business relationship with Marjorie Zeller and eventually made what Appellant counsel characterized as a binding offer through the corporate solicitor, Gerald Trottier. A follow-up counter offer was made by Arthur Weingarden, solicitor for Marjorie Zeller. Mr. Ouellette did not accept this counter offer. Respondent counsel characterized these events as discussions entered into by Mr. Ouellette respecting a possible offer to buy Marjorie Zeller’s share of the business or to sell his interest in Thompson to her. However, the Respondent contends that these negotiations did not constitute a formal offer.
[14] By a letter dated July 13, 1998, Mr. Trottier forwarded a draft Agreement of Purchase and Sale of Shares to Mr. Ouellette in which it was proposed that Mr. Ouellette purchase 701’s shares in both 890 and 123 or sell his interest in Thompson to Marjorie Zeller for $600,000 plus the repayment of the other shareholder’s loans. This draft offer excluded the usual representations and warranties typical of a share purchase agreement and contained no provision for a non-competition agreement. It was never finalized or forwarded to anyone but on August 11, 1998 Mr. Trottier telephoned Arthur Weingarden, Marjorie Zeller’s solicitor, in respect to this share purchase. According to Mr. Weingarden’s evidence, Marjorie Zeller had also talked to him about the possibility of purchasing Mr. Ouellette’s interest in Thompson in the month or so prior to the August 11, 1998 call from Mr. Trottier. According to Mr. Weingarden, Mrs. Zeller wanted to purchase Mr. Ouellette’s interest and obtain a non‑competition agreement from him, with the intention of turning the company over to her son, Douglas Zeller. These events culminated in a letter dated September 29, 1998 (Exhibit A-1, Tab 42) from Mr. Weingarden to Mr. Ouellette, enclosing a draft share purchase agreement. Mrs. Zeller was offering to purchase Mr. Ouellette’s shares but, unlike Trottier’s draft agreement, this one included the typical representations and warranties, as well as a requirement for a non-competition agreement. By letter dated October 6, 1998 Mr. Ouellette advised that he no longer wished to pursue this transaction. Mrs. Zeller died on October 20, 1998, just several weeks after these events. According to her medical records, she was diagnosed with terminal lung cancer around September 5, 1998.
The Expert Reports
[15] The authors of both reports are all highly qualified, experienced business valuators. Richard Wise has had numerous publications. In fact, Timothy Dunham in his expert report referenced one of Mr. Wise’s co‑authored publications. He has appeared as an expert in this Court on numerous occasions as well as other Courts, including the U.S. Tax Court. Drew Dorweiler is a principal with Wise, Blackman and has been with this firm for 17 years. He has been testifying as an expert witness in various Courts in Québec, Ontario and the U.S., although this was the first appearance as an expert witness in this Court.
[16] Timothy Dunham has designations as both a Chartered Business Valuator and Chartered Financial Analyst and has been with CRA in the valuation section for 17 years. He has given evidence as an expert witness before this Court on one other occasion. I conclude that the Respondent’s argument that Mr. Wise was not directly responsible for the Wise, Blackman Report is unfounded. I accept Mr. Wise’s evidence in this respect because I believe, based on what he told the Court, that his expertise, experience and judgment were utilized throughout, in collaboration with Mr. Dorweiler, in producing their expert report.
[17] There are three generally accepted approaches used in valuing a business or a business interest on a “going concern basis”: the asset based approach, the income approach and the market approach.
[18] 701 is a holding company, not an active business. Therefore its interest in the operating companies, 890 and 123, which together comprise Thompson’s activities, must be determined as of October 20, 1998. The Respondent described the approach as an asset approach to valuing 701, using the capitalized earnings method to determine the value of the operating companies, 890 and 123. Essentially, it was this approach that was utilized in both expert reports, as 701’s value lies in its interest in 890 and 123. This method determines the level at which the earnings on valuation day can be maintained in the future by applying various discounts for risk factors that could affect the constant future growth rate. The capitalized earnings approach bases the FMV on the perceived ability of a business to generate future earnings or a cash flow stream to provide a fair return on invested capital. It is this future indicated cash flow stream that a notional purchaser would want to acquire. A notional purchaser, in addition to the potential future yield to the investment, would also weigh this factor against a number of internal and external factors, such as the future prospects of the business, the rates of return on alternative investments, the business and financial risks involved and the liquidity of the investment.
[19] Although both reports use the same valuation methodology, to determine the FMV of 701’s shares, each report reached surprisingly different results in respect to the capitalization of those earnings and the risk that would attach to those earnings on a going forward basis. The key differences, between these two reports, arise in the determination of the maintainable earnings, the build up rates of capitalization and multiplier, the discounts applied for minority and marketability and finally whether or not a discount should be taken for trapped-in tax liabilities. In addition, the Dunham Report calculated a single multiplier for combined Canadian and U.S. operations. The Wise Report, however, calculated two multipliers, one for 890 and another for 123. Finally, it should be noted that Mr. Dorweiler interviewed the corporate management team but Mr. Dunham did not.
[20] The Earnings Method, used to valuate 890 and 123, involves three steps. First, a determination is made to establish the maintainable after tax income that Thompson could generate in the future after adjusting for discretionary, non‑operational, non‑recurring or non‑arm’s length income and expense items. This determination provides an estimate of the future earning potential of the company. Second, the figure from the first step, the maintainable earnings, is multiplied by an appropriate factor, known as the inverse of the “capitalization rate” or the price/cash flow multiplier, which reflects the various risks to the earnings potential and rates of return on the investment in Thompson in comparison to those in alternative investments in publicly traded companies. Third, 701’s pro-rata interest in 890 and 123 is determined after minority and marketability discounts are applied, which reflect inherent risk, such as lack of control and illiquidity. The Appellant took additional discounts for embedded tax liabilities that a potential purchaser might be responsible for in respect to capital gains, personal taxes due to dividend payout and a contingent asset in the form of refundable dividend tax on hand.
[21] The Dunham Report utilized the fiscal years, 1997, 1998 and 1999 in its calculations of maintainable earnings while the Wise Report used the 1996, 1997 and 1998 fiscal years. The use of different years resulted in an overall FMV difference of $1.7 million for Thompson. Mr. Dorweiler’s sensitivity analysis showed that the selection of the 1999 fiscal year by the Dunham Report had a $760,000 impact on the FMV of 701. He described the use of the 1999 fiscal year as an inappropriate use of hindsight. The Dunham Report gave equal weight to the earnings in each of the fiscal years 1997 to 1999. The inclusion of 1999 meant that the Dunham Report relied on seven months of post valuation day information. This included events such as the CAW negotiations, which concluded in November 1998, the emergence of internet contract bidding, the outcome of the GM strike, the ongoing management and shareholder dissension, and the negotiations for the GM contract renewal, which remained unresolved at the valuation date.
[22] The Respondent argued that the Appellant’s inclusion of 1996 would not be appropriate because Thompson was still growing and was in a very different position in 1996 than in subsequent years. Revenues jumped 21% from 1996 to 1997. The Respondent criticized the Wise Report for its use of post valuation date information such as deducting costs for the CAW contract, the use of Ibbotson size premium data from a 2001 survey, the comparison with trucking salaries in 1999 to adjust for executive salaries and the use of stock market data from the 1998 calendar year.
[23] The reports also took different approaches to the shareholder loans. The Dunham Report considered the 10% interest rate paid on these loans to be excessive. In addition, the Dunham Report considered that management compensation and dividend payment policies were excessive and that, coupled with the interest amounts, they were simply mechanisms for the shareholders to extract profits from the company. The Respondent criticized the Wise Report because it failed to take into account interest amounts which the Dunham Report considered redundant cash balances which could be used to pay off the shareholder loans of $2 million. The Dunham Report normalized the interest expenses on the loans by comparing Thompson’s working capital ratios to other trucking companies. This had an overall impact in their report of increasing the FMV of 701 by $380,000.
[24] The Dunham Report also adjusted the maintainable earnings for excessive management compensation which increased the FMV of 701 by $330,000. The Dunham Report arrived at this conclusion by comparing the salaries to other executives in a trucker survey published in 2002 entitled “Executives and Middle Management, Greater Toronto Area (GTA) Salaries Guide”. Mr. Dunham began with the 90th percentile executive salaries from the survey, adjusted for inflation, and then applied a 78% reduction to account for general salary disparities between Toronto and Windsor.
[25] The Appellant argued that the Dunham Report ignored the specific nature of the company and the emergency freight industry in general and failed to interview and consult with Thompson’s management team as to the reasons the shareholder loans, interest ratio and dividend policies were structured in this way. The Wise Report analyzed executive salaries of public companies as guidelines to determine that Thompson’s compensation package was appropriate. Consequently, no adjustment was made. The Respondent criticized the use of data respecting public companies as inappropriate because those companies all had revenue much greater than Thompson’s revenue by a factor of 10.
[26] Each of these reports also utilized different capitalization rates. A capitalization rate reflects the overall risks and rate of return inherent to a particular investment and compares the risks involved with investing in a private firm to trading in a public company. The aim is to give a forecast of future maintainable earnings. The multiplier is the reciprocal of the capitalization rate.
[27] The capitalization rate used in the Dunham Report was 19.7% and the multiplier was 5.08. The Wise Report applied two different capitalization rates for each of the operating companies, 890 and 123, to reflect the inherent investment differences in the Canadian and American environments. The Wise Report, after its analysis of internal and external factors, concluded that the capitalization rate was between 24.4% and 27%, with a median of 25.7, and therefore yielding a multiplier at the valuation date in the range of 3.7 to 4.1 for both 890 and 123. In applying a multiplier of 3.7 to 4.1 to the maintainable earnings of 890 ($1,465,000) and to the maintainable earnings of 123 ($292,000), the en bloc FMV on the valuation date was determined to be $5,420,000 to $6,010,000 for 890 and U.S. $1,080,000 to U.S. $1,200,000 for 123. The Wise Report then took a pro-rata portion of the en bloc value for each operating company as follows:
701’s - 50% interest in 890 = $2,710,000 to $3,005,000; and
701’s - 33 1/3% interest in 123 = U.S. $360,000 to U.S. $400,000.
[28] The primary differences between the capitalization rates in the two reports relate to three factors used in determining the rate of return required by a notional purchaser: size risk premium, company specific risk premium and growth rate adjustment. The remaining components of the build‑up rate followed standard valuation practices, with few differences between the reports. The size risk premium, the extra return that an investor might require to compensate for the increased risk of investing in a smaller sized company, was 7% in the Wise Report as compared to 3% in the Dunham Report. The Dunham Report selected 3% based on an analysis of similar trucking companies, noting their maintainable earnings and data from the 2001 Ibbotson reference materials [Ibbotson Associates, Stocks, Bonds, Bills and Inflation: Valuation Edition 2001 Yearbook (Ibbotson, 2001) at 109-117]. The size premium reflects issues that small companies, as opposed to publicly traded companies, face in accessing capital and dealing with competition in the market. Since Thompson maintained adequate financing through its shareholder loans and, because double counting or overlapping can occur between size premium and company specific risk factors, Mr. Dunham chose and applied a conservative factor of 3%. Mr. Dorweiler testified that the use of 3% by Mr. Dunham may have occurred because of the erroneous use of the micro-cap which, according to the documentation, aggregates the stocks in group deciles 9 and 10 [Ibbotson Associates at page 97]. The micro-caps for decile 9-10 have a range of 2.62 to 3.01 (Ibbotson Associates, pages 117, 123). The Wise Report used the 1999 Ibbotson reference materials, with tables dated September 20, 1998, which reference the increased risk and volatility for smaller sized companies on the New York Stock Exchange. The Ibbotson materials separated the smallest group decile 10 into two further classifications 10A and 10B. The 10B group accounted for the smallest companies, those under the $48 million range with a size premium for the 10B decile of 8.42%. The Wise Report chose what it believed to be a conservative 7% size premium to avoid what it perceived as a problem of hindsight in using the 2001 Ibbotson reference materials.
[29] The experts each testified as to how and why various judgments were made in arriving at the company specific risks. The Dunham Report applied an 8% factor to the rate of return required by a notional purchaser while the Wise Report used 15% for 890 and 12.28% for 123. The Respondent claimed that the Wise Report’s analysis overstated or double counted the industry specific risks, the financial risks and the CAW contract risks. In respect to 890, the Wise Report added 3% of premium because of 890’s high level of current indebtedness and thus weak working capital ratio, while deducting 2.34% of risk from 123 because it had a better ratio of current assets to current liabilities. Unlike the Wise Report, Mr. Dunham found no particular financial risk to 890. Each viewed the shareholder loans differently. Mr. Dunham considered these loans to be quasi equity that posed no financial risk to the company, whereas Mr. Wise accepted the Thompson accountants’ classification of these loans as short-term debt.
[30] The Wise Report also added a 1.5% risk premium to 890 due to the increased costs relative to the CAW negotiations. The Respondent argued that this represented another double counting by the Appellant’s experts because they had already applied $79,000 per year on a go forward basis and reduced the maintainable earnings of Thompson to account for anticipated increased costs in the CAW contract. By adding another 1.5% premium to 890, this reduced its value by over $300,000. In determining the company specific risks, the Wise Report looked at various internal and external factors which impacted upon Thompson such as reliance on the GM contract with its 30 day cancellation clause, foreign exchange fluctuations, management experience, industry trends, competitors and the cyclicality of the industry.
[31] In respect to growth rate, the Dunham Report combined the revenues of 890 and 123, converted the US dollar amount to Canadian dollars, and then compared the annual growth rate and compound annual growth rate from the end of fiscal year 1995 to the end of fiscal year 1999 to its industry peer group, according to an S&P Industry Survey dated January 28, 1999. It concluded that the Thompson freight operations had grown historically at a faster rate when measured against the larger trucking industry data. A sustainable growth rate of 4% discount was therefore applied to the rate of return. The Wise Report selected a more conservative growth factor of 2%.
[32] There were also major differences in how the two Reports treated minority and marketability discounts. The minority discount will be applied as necessary in the circumstances to reflect a minority shareholder’s lack of control in a company as opposed to that of a majority shareholder. The Dunham Report did not apply a minority discount in respect to 701’s interest in 890 and 123 while the Wise Report applied a 15% discount for lack of control. In the case of 890, although 701 controlled a 50% pro-rata share in 890, Mr. Wise discussed a number of authorities supporting a discount where a 50/50 shareholding exists. Mr. Dunham rejected the application of a discount because, in his opinion, a minority discount is warranted only in cases where the shareholder has less than a 50% interest. Mr. Dunham felt that such a discount was out of step with other authorities that state little, if any, discount should be taken in valuing a 50% interest. In addition, the Appellant’s discount overlooked 701’s ability to block corporate actions, one of the very factors Mr. Wise ignored here but which was included in a paper authored by Mr. Wise.
[33] In respect to 123, the Wise Report also applied a 15% minority discount where 701’s interest in 123 was clearly a 33 1/3% minority interest. Another reason Mr. Dunham refused to apply a minority discount in respect to 123 was because he viewed 890 and 123 as forming one single operation, that is, he viewed Thompson as one entire entity and because of this a notional purchaser would not buy only 890’s interest. Consequently, the special purchaser market would offset any discount for lack of control. Mr. Dunham viewed the two other shareholders of 123 as representing an internal market for 701’s one-third interest in 123 who would pay the full pro-rata value.
[34] The two reports also applied very different marketability discounts. This discount represents the cost of selling 701’s interest in Thompson. It is taken to compensate for illiquidity issues involved in purchasing a private company as compared to a publicly traded company. Private companies tend to require longer time periods to complete a sale and receive liquid funds. Mr. Dunham accorded a 3% marketability discount based on the size of the interest, the pool of potential buyers, the size of dividends, any restrictive transfer provisions, prospects for public offering, and transaction costs associated with the sale. The Dunham Report considered that Thompson’s long-term investment horizon and a stable dividend stream mitigated the marketability discount. Mr. Dorweiler considered that this 3% discount would cover only transaction fees and sale commissions incurred in a sale.
[35] The Wise Report applied four distinct marketability discounts: 10% each for 890 and 123, in calculating the earnings capitalization rate for each operating company, and then at the level of 701’s interest a further 20% discount for 890 and 25% for 123. These discounts were defended on the basis that at the level of the operating companies a 10% discount was appropriate given the sale of a private company. At the level of the en bloc enterprise, a further discount was applied to reflect the difficulty of selling a 50% shareholding. 123’s marketability discount is even greater to reflect the increased risk and difficulty in the sale of a one-third interest. The Respondent argued that the Appellant’s approach resulted in a double‑counting of both the marketability and minority discounts, once when valuing Thompson’s en bloc and once when valuing 701’s pro-rata share of Thompson.
[36] The last major difference in these reports originates with the application by the Wise Report of a discount to reduce the FMV of 701 for embedded or trapped‑in tax liabilities. These contingent liabilities are a controversial issue within the valuation community and CRA. The Wise Report estimated the taxable capital gain on the disposition by 701 of its interests in 890 and 123 at $1,621,746. The income tax rate was then discounted by 50% (51.29% x 50%) or 25.65% to account for any uncertainties, which resulted in an estimated capital gain tax liability of $416,000 on a notional disposition. The Wise Report then determined the personal tax rate of Marjorie Zeller and, noting that the capital dividend account was nil on the valuation date, the personal income tax rate was discounted by 50% (33.7% x 50%) or 16.87% to again account for uncertainties. This resulted in an estimated personal tax liability on the dividend of $243,670.
[37] Finally the Wise Report calculated the RDTOH as a contingent asset following this notional dividend payout by 701. A 50% discount was applied to the RDTOH estimated rate of 26.67%. The opening RDTOH balance was $51,619. The RDTOH decreased the tax liability of 701 by $242,000. According to the Wise Report, the final impact of the embedded capital gains tax, tax liability on distribution and RDTOH is a reduction in the FMV of 701 by $417,670. The Respondent did not consider that any discount would be appropriate here because a prudent buyer and seller would use one of several available tax planning options to defer or avoid paying the potential trapped‑in capital gains taxes.
Analysis
[38] The determination of FMV, although based on expert opinion, is a question of fact that the Court must ultimately decide. There is ample authority for the proposition that as the trier of fact I am not bound to accept the evidence of any expert witness or to accept one expert’s report over another. It is entirely open to me to accept neither report in its entirety but to accept the best from both reports and to draw my own conclusions. I must conduct an analysis of the evidence of each of the experts and their respective conclusions to assist me in coming to a determination of the value of 701’s shares on October 20, 1998. In discussing the role of an expert in valuation appeals, Chief Justice Bowman in Hallatt et al. v. The Queen, 2001 DTC 128, at paragraph 43 quoted Robertson, J.A. as follows:
In cases where the determination involves questions of fact, law and opinion (as, for example, in scientific research cases such as Northwest Hydraulic Consultants Limited v. The Queen, 98 D.T.C. 1839) the matter becomes even more complex. It is important to recognize what the role of the expert is. Robertson J.A. in RIS-Christie Ltd v. The Queen, 99 D.T.C. 5087, put it as follows at p. 5089:
(11) As a preliminary matter, the parties raised the issue of the proper role of expert witnesses in interpreting the scientific research provisions of the Act. In light of Dr. Razaqpur's conclusion that repeatability is an essential element of scientific research, some guidance on this issue is required.
(12) What constitutes scientific research for the purposes of the Act is either a question of law or a question of mixed law and fact to be determined by the Tax Court of Canada, not expert witnesses, as is too frequently assumed by counsel for both taxpayers and the Minister. An expert may assist the court in evaluating technical evidence and seek to persuade it that the research objective did not or could not lead to a technological advancement. But, at the end of the day, the expert's role is limited to providing the court with a set of prescription glasses through which technical information may be viewed before being analyzed and weighed by the trial judge. Undoubtedly, each opposing expert witness will attempt to ensure that its focal specifications are adopted by the court. However, it is the prerogative of the trial judge to prefer one prescription over another. (Emphasis added)
[39] This summarizes the proper role of the expert witness. However, it is important to remember that valuation is, by its very nature, not an exact science and experts may often have an inclination, although unintentional, to become advocates of the party that engages them to complete the report. Chief Justice Bowman in Western Securities Limited v. The Queen, 97 DTC 977, at page 979 stated:
One further problem arises in valuation cases of this type. Typically both parties call expert witnesses. In many cases, these witnesses are not divided on any serious question of principle, although occasionally they may differ on the highest and best use of the property being appraised. The major difference usually lies in the choice of comparables used and the positive or negative adjustments to be made to particular comparables based on such factors as location, the timing of the sale, or other physical characteristics of the property. It frequently happens that the judge determines a value somewhere between the opposing positions of the experts, not because of any desire to reach a Solomonic compromise, but because of a recognition that the positions adopted by the experts represent the polarized extreme ends of value. There is a danger that experts, albeit in good faith, may become advocates and their positions may become adversarial. For this reason a disinterested arbiter must often conclude that it is unwise to adopt entirely the position of one or the other and that it is more likely that a fair -- I hesitate to use words such as “right” or “correct” in the necessarily imprecise area of valuation –value is likely to be somewhere between the two extremes. (Emphasis added)
It is this point between the two expert valuations of $2.2 million and $6,389,000 that I must determine the highest price for 701’s shares that willing and informed vendors and purchasers freely negotiating at arm’s length in the open marketplace would have settled upon on October 20, 1998. Provi