Citation: 2011 TCC 390
Date: 20110916
Docket: 2011-154(IT)I
BETWEEN:
CANADIAN WINESECRETS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Angers J.
[1]
This is an appeal of
the reassessment of the appellant for its 2005 taxation year. In reassessing
the appellant, the Minister of National Revenue (the "Minister")
assessed a 15% withholding tax pursuant to subsection 215(1) of the Income
Tax Act (the "Act"). The withholding tax was assessed as a
result of a rollover (“rollover”) done in accordance with the provisions of
section 85 of the Act. The Minister takes the position that the appellant
did not acquire any goodwill when one Eric T. Dahlberg, a non-resident, rolled
his assets over into the appellant. The Minister is of the view that the goodwill
amount in question is a deemed dividend pursuant to section 212.2 of the Act
and that the appellant is subject to withholding tax pursuant to subsection
215(1) of the Act.
[2]
The appellant was
incorporated on November 8, 2004. Prior to the incorporation, Eric T. Dahlberg, a non-resident, had been operating the
business as a sole proprietorship since 2002. On January 1, 2005, the appellant
acquired the proprietorship assets of Mr. Dahlberg. At that time, the
proprietorship had assets in the form of cash, short-term investments and
accounts receivable for a total of $118,342, and accounts payable totalling
$181,357. It was claimed by the appellant that, at the time of the rollover,
the difference of $63,015 was goodwill.
[3]
It was admitted at
trial that prior to the rollover, the appellant had no proprietary process, nor
did it have any long-term contracts in place. The Minister assumed as a fact that
there was no attempt to value the goodwill in the business prior to the rollover.
Although that assumption was denied by the appellant at trial, no evidence was
led by the appellant to contradict the assumption and it must accordingly be
accepted as accurate.
[4]
It was also admitted
that, prior to the rollover, the proprietorship reported continuous losses.
[5]
While those facts were admitted,
it must be said that the appellant did not call any witnesses to substantiate
the information relied upon by its expert witness who was called to establish
the existence of goodwill at the time of the rollover. The respondent's only
witness was also an expert witness on whom the respondent relied to show that the
goodwill amount of $63,015 claimed by the appellant was unreasonable or that no
goodwill at all, or that matter, existed prior to the rollover.
[6]
From the evidence of both
experts in business valuation and their respective reports with attachments, it
can be seen that the appellant is in the business of providing mobile wine
finishing technologies in various forms to wineries or wine producers in order to
improve the quality of their wines. The appellant provides to its clients the
equipment needed to ensure this improved quality.
[7]
The issue is basically
whether the appellant acquired any goodwill when the proprietorship assets were
rolled over into the appellant pursuant to section 85 and what the value of the
goodwill, should there be any, is. Put differently, does the evidence of the appellant’s
expert rebut the Minister’s assumption and the respondent's expert evidence that
there was no goodwill or that it had no value?
[8]
As mentioned earlier,
the only evidence heard was that of the parties’ respective expert witnesses.
In order to prepare their reports, both experts were provided with documents
concerning the business prior to and after the rollover. Some of those
documents were attached to the respondent’s expert report but none were
produced with the appellant’s expert report, although I must say that some of
the documents used by the appellant's expert were similar to those used by the respondent’s
expert.
[9]
Goodwill is not defined
in the Act. In Black’s Law Dictionary, “goodwill” is defined as:
A business’s reputation, patronage, and other in
tangible assets that are considered when appraising the business, esp. for
purchase; the ability to earn income in excess of the income that would be
expected from the business viewed as a mere collection of assets.
[10]
The Supreme Court of
Canada in Gifford v. Canada, [2004] 1 S.C.R. 411, identified goodwill as
an asset which can be treated as being capital in nature if it is an asset of enduring
benefit that provides a lasting advantage. Vern Krishna, in his work entitled The
Fundamentals of Income Tax Law, at page 347, states that goodwill may
result from “location, reputation, brand loyalty, competent management, good
labour relations and trademarks”. Finally, Lord Eldon, L.C., in Cruttwell v.
Lye, 34 E.R. 129, at page 134, said that goodwill is “the probability, that
the old customers will resort to the old place.”
[11]
Black’s Law Dictionary also defines what is called personal
goodwill as goodwill attributable to an individual’s skills, knowledge,
efforts, training or reputation in making a business successful. It is also
termed professional goodwill, separate goodwill and individual goodwill. That
kind of goodwill is not necessarily transferable.
[12]
I also note that
goodwill has a different definition in accounting in that it does not require that
the asset be of enduring value or that there be any promise of continued
relations with customers. Barry J. Epstein, Ralph Nach and Steven M. Bragg
(Wiley GAAP 2007 – Interpretation and Application of Generally Accepted
Accounting Principles, at page 444) define goodwill as “the excess of the cost
of the acquired interest in an investee over the sum of the amounts assigned to
identifiable assets acquired less liabilities assumed”, which translates into
the difference between the value of a business and what is actually paid for
it.
[13]
The appellant has the
burden of proof. It must establish, on a balance of probabilities, the value
attributed to goodwill on the rollover from Eric Dahlberg and the appellant.
[14]
In Marcon v. Canada,
2008 TCC 116, Justice Favreau held that an appellant has the burden of showing
the existence of significant goodwill in the appellant's business. He further
said that this must be done using reliable and precise methods and that if the respondent
produces an expert report supporting the respondent's valuation of goodwill,
the appellant must provide evidence that at least contradicts the report's
findings.
[15]
The appellant’s expert
came to the conclusion that at the time of the rollover there was commercially
marketable goodwill inherent in the unincorporated operations of Mr. Dahlberg
such that the amount of $63,015 for goodwill is reasonable and within the range
between nil value and fair market value. In arriving at that conclusion, the appellant’s
expert used one of the three generally accepted approaches for determining the
value of an investment in a privately held corporation, namely, the income or
cash flow approach, in which the appellant’s expected future normalized
after-tax cash flow or earnings are discounted to present value using an appropriate
capitalization rate. Relying on documents provided to him for the preparation
of his report — in particular the appellant’s business plan and its management's
forecast of after-tax earnings of approximately $75,000 for 2005 — and applying
discount rates of 30% and 40% appropriate for an early-stage investment in a
similar business, the expert arrived at a valuation of between $187,500 and $250,000,
and therefore concluded that the $63,015 value assigned in this instance to commercially
marketable goodwill is reasonable as it is within the allowable range, that is,
between $0 and the estimated fair market value of the appellant’s business ($187,500
to $250,000). None of the documents relied upon and used by the appellant’s
expert were introduced in evidence.
[16]
The respondent’s expert
clearly makes the distinction between commercial goodwill and personal
goodwill. The expert defines those terms as follows:
Commercial goodwill concerns clients’
favourable attitudes toward a business. Its value often reflects the benefits
it provides certain prospective purchasers in allowing them to enter business
quickly and economically by acquiring the existing practice’s reputation,
established client base, in-place and operational organization, trained and
experienced staff, locational advantages, office facilities, and other
advantages of an established practice. It is generally recognized that
commercial goodwill follows the business, can be transferred to different
owners, and therefore, can have material value.
Personal goodwill relates to the
ability, skills, experience, contacts, and reputation of individuals. It
resides with the individual, is not transferrable per se, and has little or no
commercial value.
[17]
The expert then goes on
to conclude that the goodwill in the business was personal to Mr. Dahlberg and
that it could therefore not be transferred to the appellant. The expert’s
conclusion is based on conclusions drawn from documents (some of which were
attached to the report) or information provided by the appellant. It was found in
the report that there was no trained and experienced office staff, no
established client base, no office facilities, no evidence of an exclusive contract
between Mr. Dahlberg's business and its suppliers that could be transferred to
the appellant. It was further found that the services provided were neither
novel nor exclusive and were easily obtainable from other providers, that the
sole proprietorship of Mr. Dahlberg had no skilled staff or substantial fixed assets
before the rollover, that the sole proprietorship had an accumulated loss of
over $61,000 prior to the rollover, and that this loss was before drawing any
reasonable salary for the previous three years, so the business was not in a good
financial position. Finally the expert relied on a statement by the appellant’s
accountant that:
At the time of incorporation, value in excess of assets transferred
was provided by the proprietor to allow continued operations under the new
structure. This was derived from two primary concerns, (i) those being
reasonable access to the equipment required and (ii) the technical and
management ability to introduce, operate and sustain this service business.
The equipment at that time was provided primarily on a piece-work
basis from sources developed through Dahlberg’s existing relationships with
owners of equipment available for back rental.
The expert came to the following conclusion:
There does not appear to be any evidence that discernable or
quantifiable business goodwill existed prior to the rollover, and merely the
continuity of the business activity of the taxpayer without noticeable
interruption, at the time of the transfer of business, created of itself no
goodwill.
It is my view that Mr. Eric T. Dahlberg’s sole proprietor
Winesecrets operation had no commercial goodwill on the day of the transfer.
Though the taxpayer sent in documents to show some repeat business from three
clients for 2004 and 2005, they are insufficient to show saleable goodwill. On
this basis, the goodwill of $63,015 claimed by the taxpayer is unreasonable.
[18]
As mentioned earlier, the
burden of proof is on the appellant. It must be established on a balance of
probabilities that commercial goodwill was transferred from Mr. Dahlberg to the
appellant. In this instance, the appellant’s expert's calculation of goodwill
simply came down to determining the value of the assets and liabilities of Mr.
Dahlberg's sole proprietorship based on the estimate of earnings for 2005 given
by the appellant, and applying discount rates of 30% and 40% to produce a value
for the business which enabled the expert to conclude that the value of $63,015
assigned to goodwill is reasonable because it is within the range between nil value
and fair market value. Such a valuation, in my opinion, would have been more
reliable had the expert used the figures for the proprietorship before the rollover
in order to estimate the range of values within which goodwill could reasonably
fit, instead of relying on the estimated projected earnings of the appellant.
[19]
The appellant’s expert
report also states that it is not a formal opinion on value or a formal estimate
of value. The appellant’s expert admitted that such an estimate would have
required more thorough investigation, including inspecting the facilities and studying
the market for these particular services. The appellant’s expert report did not
consider whether Mr. Dahlberg had transferred to the appellant any assets that constitute
commercial goodwill in the sense that they are of an enduring nature and will
ensure continued business. There is no information concerning a client’s list
or regarding reputation, location or brand loyalty. Reference was made to an
exclusivity agreement but there is little if any evidence to support the
existence of any such agreement.
[20]
The appellant’s expert
report is of no assistance in determining, for the purposes of this appeal, if
there was commercial goodwill sold to the appellant. It fails to rebut the respondent’s
assumption that no goodwill passed from Mr. Dahlberg to the appellant.
[21]
As can be seen from Les placements A & N Robitaille Inc. v. M.N.R., 96 DTC 1062, the question to ask to determine whether
goodwill is personal is this: if the person withdraws from the business will
any goodwill remain? The respondent’s expert report suggests to one the
following way of putting the question in this instance: if Mr. Dahlberg had
passed away, retired, lost interest in the business or left it for some other
reason, would there be any business left? The expert’s answer was no. Any
goodwill that did exist, such as his business know-how and his access to
equipment would have gone with Mr. Dahlberg. In my opinion, if there was any
goodwill, it was personal in nature and could not be transferred.
[22]
The appellant has failed to rebut either
the Minister’s assumption or the expert opinion showing that no goodwill was
transferred from Mr. Dahlberg to the appellant. The appeal is dismissed.
Signed at Ottawa, Canada, this 16th day of September 2011.
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