Reply to Väino Einola: Regarding letter entitled “Financing for the Estonian Centre”
We need clarification on two points
1. What price has been agreed with the Estonian Foundation for the sale or transfer of its properties to Estonian House. AND Is the contracted price for the EFC properties proportional to the sale price that has been contracted with Revera.
2. Will the transfer or sale of the EFC properties occur as a straight transaction between Estonian House Ltd, or will the sale be as a re-assignment of the purchase agreement to Revera.
If the EFC properties are sold to Estonian House prior to the sale to Revera, then Estonian House will have to pay the land transfer tax which decreases our net monies available from the sale. If ownership of the EFC houses is held by an individual as opposed to directly by the EFC then the registered owners would have to pay the resulting capital gains tax. Does Estonian House have any obligation to reimburse EFC members for this tax liability?
We are also aware that a rezoning application on behalf Estonian House and the EFC properties was submitted on February 16, 2018 to the City of Toronto. The cost of the re-zoning application submitted on behalf of the owners of these properties was $55,706.80. It was not submitted by Revera. Was this then paid for by Estonian House from the advance deposit paid by Revera? The submission was incomplete and was turned down by the city. The submission was prepared by Bousfields Inc. consultants. What was the consulting fee and who paid for it? Is there an additional charge for resubmitting this application, and who is responsible for any additional costs?
The risk factor presented in the due diligence report states that” it is unlikely that Revera would not achieve its proposed zoning”. Given the rejection of the initial zoning application and the rejection of much lower densities by the city for properties east 958 Broadview Ave. approval for the zoning required by Revera is questionable. The city is adamant about maintaining the height restrictions developed for the Broadview corridor.
I think it would be prudent to show a detailed best-case cash flow from the expected sale, including the EFC houses that are part of the deal, as well as all the liabilities and costs that would be incurred by Estonian House to consummate the sale. These include but are not limited to the discharge of the HELOC liability with the Estonian Credit Union, as well as various other legal, consulting, and administrative charges.
Financial Shortfall
If net proceeds from the sale of Estonian House (net of the EFC Properties) and all other liabilities yields $12,.0 million toward the development and construction of the Estonian Centre we will still be short $13.0 million dollars.
You have identified that the three organizations will support the development with $5.0 million dollars. You state that this is in the form of “loans to be repaid upon certain events including should the new Estonian Centre be sold” This is a prudent business practice that protects their investment, but presumes a risk factor on their part.
There is, in my opinion, a high likelihood that the project will require additional capital before completion. Ironically the support given by the three organizations will be detrimental to securing further mortgage capital. The $5.0 million-dollar committed by the three organizations is technically a mortgage liability. Financial institution constraints may prevent them from increasing the mortgage liability should our cost over-runs require additional capital.
Capital Campaign
It is hoped that the capital campaign will raise the $8.0 million-dollar shortfall that remains. The lead donor has executed a non-binding agreement in return for naming rights to give a donation of $2.0 million dependent on matching funds from other donors.
Capital campaign funds will only be given if there are tax advantages to the donor in doing so. The recipient organization must have a “charitable” designation by Revenue Canada. This is especially desirable if the donations are in the form of investments that have accrued capital gains.
You have proposed establishing a not for profit charitable organization as a subsidiary of Estonian House Ltd in order to avoid paying capital gains on the sale of 958 Broadview Ave.
I sought clarification from Revenue Canada as to whether the capital gain we would derive from the sale of Estonian House would be subject to a capital gains tax. The opinion from the Audit Business Enquiries Senior Specialist was that “not for profits are exempt from income tax as long as they conform to their charter.” However, she referred me to the Income Tax Rulings Directorate for a corroborating opinion. The Income Tax Rulings Directorate has forwarded to me documentation which gives specific guidance on whether there will be capital gains tax payable on the sale of 958 Broadview Ave.
“ provided the Society is organized and operated as a non-profit organization it will not be subject to tax on the capital gain from the sale of real property that it owns in order to carry out its stated purposes”
In summary, Estonian House does not have to pay capital gains tax on the capital gain made on the sale of 958 Broadview Ave. The establishment of a not for profit charitable organization for this purpose is completely unnecessary.
Cash flow and Timing
The proposal to establish an NFP charitable organization is a major change to the Estonian House structure and organization. The amendment to the by-laws would have to be approved by the share holders by two thirds vote at either a special meeting called for that purpose or at the annual general meeting. Proceeding without the approval of the shareholders would be unlawful.
After the NFP has been established it needs to apply for a charitable status from Revenue Canada which may take up to one year. Under your proposal, the NFP was to assume the purchase obligations to acquire 9 Madison and ultimately acquire 11 Madison. This cannot be done until the NFP is established as a charitable organization. The transfer of monies from the sale of 958 Broadview and the legal transactions will not occur until the zoning is in place and sale of 958 Broadview closes.
Your timeline shows that you cannot close the deal on 9 Madison until all events have taken place. You have projected this to take place no earlier than January 2020.
Concurrent with the sale of Estonian House we must raise money through a capital campaign. To do this we need a charitable organization to be in place. You have suggested that this would not be in place before Jan. 2020. How will you run a successful capital campaign without the ability to issue tax receipts?
Alternative Strategy
The project can only be undertaken if we have the financial resources to do so. You have a financial shortfall that is untenable. The project manager has used the word “hopeful” too many times. Owners deal with reality. It is very simple …. No money … no project.
Now you have a 13.0 million-dollar shortfall. You cannot establish a not for profit charitable organization without the approval of the Estonian House Shareholders. Without the NFP charitable organization it becomes impossible to bank donations.
With an existing mortgage of $5.0 million it will be difficult to secure additional mortgage financing.
This leaves you with two alternatives:
1. Walk away from the project. Experienced developers do this when they recognize that the financing does not work.
2. Redefine the scope of the project to fit our financial limitations. You have already considered a version of this in your risk assessment. It would make even more sense to forego all development on 11 Madison Ave. You eliminate both the land cost $3.0 million and the development cost of 11 Madison ( both the restoration and the Annex). The ETCU as the owner of 11 Madison can develop it themselves or sell it.
Redefining the project due to financial constraints is not news in the development business. Experienced and successful developers do this all the time. It is far better to take this initiative while the project is on paper, than have it forced on you in the middle of construction.
Väino Einola, Toronto
President : Estonian Businessmen’s Club in Canada
