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Docket: UT02104
Order UT03-01

IN THE MATTER of an appeal by 100108 P.E.I. Inc. against a decision of the Provincial Tax Commissioner, dated February 19, 2002.

BEFORE THE COMMISSION

on Tuesday, the 28th day of January, 2003.

Maurice Rodgerson, Vice-Chair
Weston Rose, Commissioner
Norman Gallant, Commissioner
Kathy Kennedy,  Commissioner

Order

Contents

Reasons for Order

1.    Introduction

2.    Facts and Issue

3.    Discussion & Findings

4.    Disposition

Order

Reasons for Order

1.  Introduction

[1]      This is an appeal filed by 100108 P.E.I. Inc. ("100108" or "Appellant") against decisions of the Provincial Tax Commissioner ("Tax Commissioner" "Commissioner" or "Respondent"), dated February 19, 2002. The appeal relates to taxes assessed pursuant to Notice of Assessment No. 3592, dated October 31, 2001 issued by the Department of Provincial Treasury.

[2]      Notice of Assessment No. 3687 covers the assessment period from November, 1997 to March, 2001 and involves tax of $42,141.43 on purchases and a penalty of $2,830.18 and interest of $32,385.13 for a total of $77,356.74 to October 31, 2001.

[3]      The appeals were heard in Charlottetown on September 9, 2002. Post-hearing briefs were filed on October 4, 2002 and reply briefs were filed in late October, 2002.

[4]     The contributions of counsel and the witnesses in this proceeding are acknowledged.

2.    Facts and Issue

[5]   The parties have agreed upon, or not seriously disputed, certain facts leading up to the Notice of Assessment. The principal background facts may be found primarily in the prefiled evidence of Jerry MacDonald, the President and sole shareholder of the Appellant (Exhibit A-2).

[6]  Jerry MacDonald and his brother-in-law, David Bell, formed The Island Pizza Company Limited to operate the Domino's franchise in Charlottetown, P.E.I.  Financing for the acquisition and operation of the franchise was put in place with the Royal Bank of Canada with the principal shareholders and their spouses signing personal guarantees.

[7]   Subsequently, Jerry MacDonald sold his shares in the company to David Bell, although he remained liable on his personal guarantee or guarantees.  Jerry MacDonald testified that, in the fall of 1997, both David Bell and Steve Lowe of the Royal Bank of Canada contacted him to advise him that The Island Pizza Company Limited was insolvent.  Mr. MacDonald testified that the Bank had security against all of the assets of the company and that his personal exposure from the guarantee was approximately $52,000.00.

[8]   Mr. MacDonald also testified that The Island Pizza Company Limited had opened a second Domino's franchise in Saint John, New Brunswick, the financing for which was with the Toronto-Dominion Bank.  In addition to liability to both banks, The Island Pizza Company Limited had collected, but not remitted, provincial sales tax for 11 months of the 12 months between November 1996 and October 1997.

[9]   David Bell stopped operating The Island Pizza Company Limited on or about October 31, 1997, at which point operations were taken over by Jerry MacDonald.  On October 30, 1997, Jerry MacDonald incorporated the Appellant, 100108.

[10]   During the course of the audit—which preceded the issuance of Notice of Assessment No. 3687—the Province obtained an Agreement of Purchase and Sale (the "Agreement") dated October 31, 1997. The Agreement provides for 100108, as purchaser, to purchase the assets of both franchises from The Island Pizza Company Limited, as vendor. The Agreement [Exhibit R-1, Attachment 4(ii)—as supplemented by Exhibit A-3] was the source of some dispute before the Commission. Jerry MacDonald testified that, although the Agreement is dated October 31, 1997, it was not signed until February 1998 and was prepared only for the purpose of providing Bank financing with the Royal Bank of Canada for 100108.

[11]   Mr. MacDonald stated during the hearing that I was subrogated to the security to the Royal Bank and that I stepped into the shoes of the Royal Bank. The Appellant submitted that, despite the Agreement, he did not purchase from The Island Pizza Company Limited but was exercising his subrogated rights as a result of his having paid off the debt, which he had guaranteed.

[12]   The Commissioner asserts that, on October 31, 1997, the Appellant purchased the assets of The Island Pizza Company Limited in a bulk sale and is thus responsible for sales tax on the purchase.

[13]   Section 56 of the Revenue Tax Act reads as follows:

56. (1) For the purposes of this section,

(a) "sale in bulk" means

(i) any sale, transfer, conveyance, barter or exchange of a stock or part thereof, out of the usual course of business or trade of the vendor, 2001,c.49,s.6
(ii) a sales, transfer, conveyance, barter or exchange of substantially the entire stock of the vendor, 2001,c.49,s.6
(iii) a sale, transfer, conveyance, barter or exchange of an interest in the business of the vendor; and 2001,c.49,s.6

(b) "stock" includes any goods which are ordinarily the subject of trade and commerce, and the goods ordinarily used in connection with any business. 2001,c.49,s.6

(2) No person shall dispose of stock through a sale in bulk without first obtaining a certificate from the Commissioner that all taxes collected by such person or payable by such person have been paid to the Minister. 2001,c.49,s.6

(3) Every person purchasing stock through a sale in bulk shall obtain a copy of the certificate issued under subsection (2) from the person selling the stock and, failing to do so, is responsible for payment to the Minister of an amount equal to all unremitted taxes collected and all other taxes collectable or payable by the person thus disposing of the stock though a sale in bulk. 2001,c.49,s.6

(4) The liability of a person purchasing stock though a sale in bulk is limited to the lesser of 2001,c.49,s.6

(a) an amount equal to the unremitted taxes collected and all other taxes collectable or payable by the person disposing of the stock; and 2001,c.49,s.6

(b) the value of the stock purchased. 2001,c.49,s.6

[14]    The applicable wording of Section 56 in October 1997 was as follows:

56. (1) No person shall dispose of his stock, through a sale in bulk as defined by the Bulk Sales Act R.S.P.E.I. 1988, Cap. B-6 without first obtaining a certificate in duplicate from the Commissioner that all taxes collected by such persons or assessed as payable by such persons have been paid.

(2) Every person purchasing stock through a sale in bulk as defined in the Bulk Sales Act R.S.P.E.L 1988, Cap. B-6 shall obtain from the person selling the stock the duplicate copy of the certificate furnished under subsection (1) and, if he fails to do so, he is responsible for the payment to the Minister of an amount equal to all unremitted taxes collected and all other taxes collectable or payable by the person thus disposing of his stock through a sale in bulk.

(3) The liability of a person purchasing stock through a sale in bulk is limited to the lesser of:

(a) an amount equal to the unremitted taxes collected and all other taxes collectable or payable by the person disposing of the stock; and,

(b) the value of the assets purchased.

[15]   In October, 1997, the definition of a bulk sale in the Bulk Sales Act was as in the present section 56(1)(a) above.

[16]   It is agreed between the parties that the Appellant did not obtain a certificate as required under section 56(1). 

[17]   In its Notice of Objection to the Commissioner, 100108 stated that no consideration was paid to David Bell and that Jerry MacDonald acquired the assets directly from the Royal Bank of Canada, by paying out the indebtedness of The Island Pizza Company Limited [paragraphs 12 & 15 of Attachment #2, Exhibit R-1].

[18]   The Commissioner rejected this argument stating:

Whether the Royal Bank of Canada had an interest in the goods on the date of transfer is irrelevant. The owner of the assets was The Island Pizza Company Ltd., which company was the vendor in this transaction.

[Attachment #3, Exhibit R-1]

[19]  The Appellant appeals that decision re-stating its arguments in the Notice of Objection and stating that the assets had no value or a negative value as more was owed to the Royal Bank of Canada against the assets than their fair market value.

[20]  The issues before the Commission are factual.  We must determine the nature of the transaction by which the Appellant acquired the Dominos Pizza assets in P.E.I., from whom the Appellant acquired them, and what was their value.

3.    Discussion & Findings

[21]   The Appellant submits that the Commissioner has misunderstood the nature of the acquisition by 100108.  The Appellant's view is that there were two phases to the acquisition by 100108.  The first was the distribution from the secured creditor bank to Jerry MacDonald by virtue of his personal guarantee of the debt of The Island Pizza Company Limited to the Royal Bank. [paragraph 4, tab 2 Appellant's Post Hearing Brief]  This was not a bulk sale, but was a realization by the Royal Bank and a transfer of assets to Jerry MacDonald. [paragraph 7, tab 2, Appellant's Post Hearing Memorandum]  The Appellant submits that this is not a sale in bulk, as contemplated by the Bulk Sale Act, but rather a realization by a secured creditor and is thus subject to Section 17 of the Revenue Tax Act.  Section 17 reads as follows:

17. (1) Every person who, as assignee, liquidator, administrator, receiver, receiver-manager, trustee or other like person, other than a trustee appointed under the Bankruptcy Act R.S.C. 1985, Chap. B-3, takes control or possession of the property of any vendor or carries on or manages the business of the vendor shall, before carrying on or managing the business or before distributing the property or proceeds from the realization thereof under his control or possession, obtain from the Minister a registration certificate prescribed by section 14 and shall be deemed to be a vendor for all purposes of this Act.

(2) Any person referred to in subsection (1) who takes control or possession of the property of any vendor or who carries on or manages the business of any vendor shall remit to the Minister an amount equal to all unremitted taxes collected by and deposits made with the vendor at such time or times and in such manner as may be prescribed by the regulations.

(3) Any person referred to in subsection (1) who takes control or possession of the property of a vendor or who carries on or manages the business of a vendor and

(a) distributes the property or proceeds from the realization thereof under his control or possession without having obtained the registration certificate required under subsection (1); or
(b) distributes any unremitted taxes collected by and deposits made with the vendor, is personally liable to the Government for any amount that is due and payable to the Government by the vendor to under this Act.

(4) The personal liability of a person referred to in subsection (3) is limited to the lesser of

(a) an amount equal to the unremitted taxes collected by and deposits made with the vendor; and
(b) the value of the property or proceeds from the realization of the property, notwithstanding any charges, liens or other security taken against or affecting the vendor's assets. 1980,c.47,s.4; 1990,c.56,s.4; 1990,c.54,s.29 {eff.} July 6/91.

[22]   The Appellant contends that Jerry MacDonald is an other like person within the meaning of Section 17 (1) of the Act and thus, even though he did not obtain the certificate prescribed by Section 14, his liability is limited to:

(a) lesser of an amount equal to the lesser of the unremitted taxes or;
(b) the value of the property; or
(c) the proceeds from the realization of the property.

[23]   The Appellant maintains that, although the value of the unremitted taxes was $77,000.00, the value of these assets under distress was estimated to be 25% of their appraised value of $24,080, or $6,020.00.  The Appellant further argues that there were no proceeds from realization as there was merely an extinguishment of The Island Pizza Company Ltd.'s debt to the Royal Bank of Canada.

[24]   The Appellant's view is that the second phase of the asset transfer was from Jerry MacDonald, an other like person under Section 17 of the Act to 100108.  The Appellant admits that this second phase is a sale in bulk but states that Jerry MacDonald was selling the stock and, as it was a bulk sale, that Section 56 applies to the second phase of the transaction.  However, as the vendor was Jerry MacDonald and as the amount of unremitted taxes for which Mr. MacDonald is responsible under Section 56 (3) is an amount equal to the proceeds from the realization of the property—which amount is zero dollars—then there is no liability on the purchaser, 100108.

[25]    The Commissioner rejects this innovative argument:

(a) by stating that the transfer to 100108 did not take place on February 18, 1998 by way of an Agreement of Purchase and Sale backdated to October 31, 1997.  The Commissioner points out that 100108 commenced business in November 1997 and that it purchased from Island Pizza; and,

(b) by filing a letter [Exhibit R-4] dated November 14, 1997 from the Royal Bank of Canada (S. J. Lowe)  to counsel for the Appellant which refers to the Agreement of October 31, 1997. 

[26]   These facts, according to the Tax Commissioner, indicate that the Agreement was negotiated earlier than February 1998. [Tax Commissioner's Reply Brief, paragraph 7].

[27]   While the letter of November 14, 1997 certainly appears to point to the existence of the Agreement prior to February of 1998, its existence prior to the alleged execution date of February 18, 1998 does not invalidate Mr. MacDonald's evidence that it was signed in February 1998.  In our view, the letter points to a more important fact, which is that the Royal Bank of Canada did not view itself as the vendor of the assets but rather viewed The Island Pizza Company Limited as vendor.

[28]   Jerry MacDonald testified at the hearing that, although the Agreement for the purchase of assets was dated October 31, 1997, it was not signed until February 1998 and was only executed for the purposes of securing financing for 100108 with the Royal Bank of Canada.  Exhibit R-4 seems to corroborate that Mr. MacDonald was required to produce certain documentation to obtain the bank loan. However, the letter also seems to lead to the conclusion that the assets did not flow from the Royal Bank, as secured creditor, to Jerry MacDonald and then to 100108.  Mr. Lowe's letter of November 14, 1997 indicates that the Royal Bank wished to have a receipt from the vendor for funds paid in accordance with the Agreement for the purchase and sale of assets dated October 31, 1997.  It would seem apparent from this that the Royal Bank did not view itself as the vendor of the Domino's assets based upon a subrogation. Therefore, the Commissioner's opinion that the assets were purchased from the previous owner, Island Pizza Company Limited, seems reasonable. Whether the assets were purchased from Island Pizza Company Limited by Jerry MacDonald and transferred to the Appellant, or were purchased directly by the Appellant, is irrelevant as Section 56 of the Revenue Tax Act applies to the transaction rather than Section 17 as alleged by the Appellant.

[29]   The Commission accepts the evidence of Mr. MacDonald that the goods were not purchased until February 1998, although it seems clear that possession changed hands on or about November 1, 1997. The only direct evidence before us that the time of closing of the transaction was later than October 31, 1997 and was February of 1998 is that of Mr. MacDonald. This is corroborated by both the Statement of Adjustments of February 18, 1998 [Exhibit R-1, Attachment 4(iv)] and Mr. Lowe's letter [Exhibit R-4].  The latter announces bank loan approval as of November 14, 1997. In these circumstances, a closing date of February 18, 1998 would seem a reasonable conclusion.

[30]   The Commissioner pre-filed [Exhibit R-2] a lengthy description of how it had valued the assets purchased by the Appellant.  In addition, Andrew Burt testified at the hearing on this valuation process.  The essence of the valuation method involved a division of the sale price set forth in the Agreement. The division was necessary as both Prince Edward Island and New Brunswick assets were purchased and the New Brunswick assets would be exempt from the provisions of the Revenue Tax Act of Prince Edward Island. Several different calculations were made based upon both the total price paid of $77,854.82, which was the amount set forth as being paid to the two banks in the Statement of Adjustments.  In addition, a second series of calculations was made based upon the values set out in the financial statements of 100108 prepared after closing.  While it is difficult to disagree with the logic by which the allocation was made by the tax auditors, it appears that both are based on certain assumptions, which seem questionable.

[31]   An allocation based upon a total price paid of $77,854.82 assumes that the price paid as set forth in the Statement of Adjustments was equal to the value of the goods.  Based upon Mr. MacDonald's evidence and upon the Statement of Adjustments itself, this does not appear to be true.  The Statement of Adjustments quite clearly sets forth that the sum of $77,854.82 was the sum of two payments—one to the Royal Bank of $52,537.00 to retire fixed debt there and the second of $25,317.82 to retire fixed debt at the Toronto-Dominion Bank.  Mr. MacDonald's evidence is that he paid these sums to avoid his guarantee liability at the banks.  Whether these sums equaled the value of the assets purchased is quite another matter. Moreover, a division of the values recorded in the financial statements of 100108 is based on the assumption that the values recorded on the financial statements correctly reflect the values of the goods purchased.  In fact, the values stated on the company financial statements appear to have been created after the fact by the company's accountants based upon the debts extinguished by Mr. MacDonald.  Again, while these numbers in total may have reflected the values of the assets purchased it is, in our opinion, far more likely that they merely replicated the total paid by Mr. MacDonald and/or 100108 on closing to extinguish the debts to both the Royal Bank of Canada and the Toronto-Dominion Bank. 

[32]   Exhibit R-1, Attachment 4 contained appraisals of the Domino's Pizza chattels in Saint John and Charlottetown.  The appraisals were conducted by Byron Ferguson of Byron Ferguson Sales Inc. and set the value of the equipment in the Charlottetown Domino's store at $24,080.00.  Both Mr. Ferguson and Frank Driscoll, Sheriff of Queens County, gave pre-filed evidence that this value would be decreased if the assets were not sold as a package and as a going concern.  Mr. Driscoll, who has been Queens County Sheriff for ten years, indicated that he was of the opinion that equipment seized and sold under a distress rarely results in returns in excess of 50% of market value and often such sales yield as little as 25% of the value of the equipment.  As no cross-examination was proposed of either of these witnesses, neither witness appeared to supplement or explain what was written in his pre-filed evidence.

[33]   We accept Mr. Ferguson's evidence on the value of the assets as a going concern.  We believe the evidence of Mr. Driscoll to be persuasive in the matter of the reduction to be applied to a distress or forced sale. We accept the Sheriff's estimate that the value of the chattels would not exceed 50% of the appraised value of $24,080.00 and might probably sell for as little as $6,020.00. Accordingly, we are of the view that the value of the assets transferred to 100108 was $9,030.00, or 37½% of the value of the equipment as a going concern.

[34]    Based on the evidence presented by the Tax Commissioner, however, the calculation of leasehold improvements was based on the general ledger and year-end financial statements of 100108 prepared sometime after the commencement of business. In our view, the calculation represents an allocation of the residual consideration paid to the banks and not the actual value.

[35]   We accept the evidence of Mr. MacDonald that 100108 negotiated a new lease for the Charlottetown store. Therefore, in the Commission's view, the leasehold improvements were not purchased from Island Pizza Company Limited.

[36]   The evidence of Ms. Hawes disclosed that the inventory purchased was not included in the purchase price of $77,854.82. The Tax Commissioner determined the inventory value to be $9,292.93. With respect, we disagree. In our view, this value would be similarly affected by a distress or forced sale. As a result, for revenue tax purposes, we will place a value on inventory of $3,484.85, which is 37½% of $9,292.93.

[37]   Accordingly, we would establish the value of the stock purchased for the purposes of Section 56 (3)(b) of the Revenue Tax Act to be $9,030.00 plus $3,484.85 for a total of $12,514.85.

4.  Disposition

[38]    An order varying the December 12, 2001 decision of the Tax Commissioner and establishing a revenue tax liability of the Appellant in the amount of $12,514.85 as of February 18, 1998 will therefore be issued.

Order

UPON the appeal by 100108 P.E.I. Inc. against a decision of the Provincial Tax Commissioner, dated February 19, 2002;

AND UPON hearing the evidence adduced as well as what was alleged by counsel at a hearing conducted in Charlottetown on September 9, 2002;

NOW THEREFORE, for the reasons given in the annexed Reasons for Order;

IT IS ORDERED THAT

1.    the decision of the Provincial Tax Commissioner, dated February 19, 2002, is varied; and

2.   the revenue tax liability of the Appellant as of February 18, 1998 is established at $12,514.85.

DATED at Charlottetown, Prince Edward Island, this 28th day of January, 2003.

BY THE COMMISSION:

Maurice Rodgerson, Vice-Chair

Weston Rose, Commissioner

Norman Gallant, Commissioner

Kathy Kennedy, Commissioner

NOTICE

Section 12 of the Island Regulatory and Appeals Commission Act reads as follows:

12. The Commission may, in its absolute discretion, review, rescind or vary any order or decision made by it or rehear any application before deciding it.

Parties to this proceeding seeking a review of the Commission's decision or order in this matter may do so by filing with the Commission, at the earliest date, a written Request for Review, which clearly states the reasons for the review and the nature of the relief sought.

Sections 13.(1) and 13(2) of the Act provide as follows:

13.(1) An appeal lies from a decision or order of the Commission to the Appeal Division of the Supreme Court upon a question of law or jurisdiction.

(2) The appeal shall be made by filing a notice of appeal in the Supreme Court within twenty days after the decision or order appealed from and the Civil Procedure Rules respecting appeals apply with the necessary changes.