McNair,
J.:—This
is
an
appeal
by
the
plaintiff
from
the
reassessment
of
income
for
its
1977
taxation
year
whereby
the
sum
of
$92,795
claimed
as
a
deduction
for
deferred
and
unearned
franchise
income
was
added
to
the
plaintiff's
active
business
income
for
that
year.
The
plaintiff
appealed
the
assessment
to
the
Tax
Review
Board
which,
in
a
judgment
delivered
on
September
24,
1981,
disallowed
the
deduction
of
the
sum
of
$92,795
as
a
reserve
but
partially
allowed
the
taxpayer's
appeal
with
respect
to
a
second
issue
of
capital
cost
allowance
on
a
building.
The
present
action
by
way
of
appeal
is
concerned
only
with
the
reassessment
of
$92,795.
The
plaintiff
is
a
duly
incorporated
company
under
the
laws
of
the
Province
of
New
Brunswick,
having
its
head
office
therein
at
the
City
of
Camp
bellton.
At
all
material
times,
the
plaintiff
was
engaged
in
the
business
of
selling
franchises
and
equipment
and
supplies
to
its
franchisees.
During
this
time,
the
company
had
the
exclusive
right
to
the
use
of
the
trade
mark
"Dixie
Lee"
associated
with
its
take-out
food
stores
and
restaurants
throughout
Atlantic
Canada
and
the
eastern
part
of
the
Province
of
Quebec.
In
the
course
of
its
business,
Dixie
Lee
(Maritimes)
Ltd.
(the
"company")
entered
into
franchise
agreements
with
persons
wanting
to
operate
individual
stores.
The
agreement
is
in
standard
form.
In
consideration
of
the
payment
of
a
franchise
fee,
the
company
grants
to
the
franchisee
the
exclusive
right
and
license
to
operate
a
food
take-out
store
at
a
specified
location
with
permission
to
use
in
connection
therewith
the
company's
name
"Dixie
Lee"
and
other
distinctive
labels
and
materials
for
a
fixed
period
of
time,
usually
ten
years.
Under
the
terms
of
the
agreement,
the
company
agrees
to
supply
the
franchisee
with
specified
equipment
and
supplies,
to
promote
the
new
franchised
outlet
by
a
vigorous
advertising
campaign
and
the
distribution
of
3,000
take-home
menus
in
advance
of
opening
day,
to
ship
promptly
all
flavour
spices
and
packaging
supplies,
and
to
give
the
franchisee
a
first
option
renewal
for
a
further
term
of
ten
years.
Paragraph
2(e)
of
the
agreement
provides:
(2)
The
Company
agrees:
—
(e)
To
make
available
to
the
Operator
supervisory
personnel,
who
shall
assist
and
train
the
operator
in
the
operation
of
the
take-out
store,
and
to
help
train
the
operator's
employees
before
the
store
is
open,
any
assistance
rendered
after
opening
day
will
be
at
the
operator's
expense
at
the
company's
option;
Paragraph
3
of
the
agreement
obligates
the
franchisee
to
prepare
Dixie
Lee
products
strictly
according
to
the
company's
methods,
to
co-operate
in
maintaining
high
standards
of
quality
in
respect
thereof,
and
to
use
only
flavour
spices
and
packaging
materials
as
supplied
by
the
company.
Paragraph
3(k)
of
the
agreement
requires
that:
(k)
The
Operator
shall
keep
the
premises
and
equipment
at
all
times
in
a
clean,
sanitary
and
attractive
condition,
and
in
such
condition
as
shall
meet
the
requirements
of
the
Company,
shall
maintain
the
quality
of
foods
sold
at
a
level
that
shall
be
required
by
the
Company,
and
shall
permit
the
Company's
representatives
to
enter
and
remain
on
the
premises
to
inspect
the
premises,
equipment
and
to
inspect
the
quality
of
food
sold
by
the
operator,
and
the
manner
of
the
operator's
operation
during
business
hours.
When
a
franchise
agreement
is
renewed
for
a
further
term
of
ten
years,
the
renewal
fee
charged
by
the
company
is
the
same
as
what
would
be
charged
for
a
newly
franchised
outlet
at
the
same
location.
The
company
is
not
obliged
to
provide
the
promotional,
advertising
and
supervisory
services
required
for
the
opening
of
a
new
franchise,
and
the
standard
franchise
agreement
is
adapted
accordingly.
The
franchise
fee
is
payable
by
the
franchisee
to
the
company
on
the
signing
of
a
franchise
agreement.
Sometimes
the
franchisee
pays
down
half
with
the
balance
being
provided
on
or
shortly
after
opening
day.
When
a
franchise
agreement
is
terminated
by
the
company
before
the
expiry
of
the
ten
year
period
by
reason
of
the
franchisee's
default,
no
portion
of
the
franchise
fee
is
refundable.
In
one
case,
the
company
paid
$500
to
expedite
the
cancellation
of
a
franchise
agreement
so
that
the
franchise
could
be
sold
to
a
new
franchisee.
The
company's
business
practice
with
respect
to
the
granting
of
a
franchise
is
as
follows.
Following
receipt
of
an
inquiry
by
a
prospective
fran-
chisee,
preliminary
discussions
are
held
between
company
management
and
the
franchisee.
When
a
decision
to
enter
into
a
franchise
agreement
is
made,
pre-opening
assistance
is
given
by
the
company
to
the
franchisee
in
many
areas,
including
layout
of
the
premises,
construction
matters,
equipment
requirements,
financial
managements,
operational
planning
and
employee
training.
The
company
attends
to
the
advertising
and
publicity
necessary
to
the
successful
launching
of
the
franchisee’s
take-out
store
and
as
well
provides
supervisory
personnel
for
up
to
three
weeks
following
the
opening
to
ensure
that
things
are
running
smoothly.
All
this
pre-opening
and
launching
activity
on
the
part
of
the
management
of
the
company
could
span
a
period
from
the
time
of
the
initial
inquiry
by
a
prospective
franchisee
up
to
three
weeks
after
the
franchised
outlet
opened.
The
franchise
agreement
contains
no
specific
terms
for
the
provision
of
ongoing
services.
Following
opening
of
a
franchise
outlet,
company
representatives
conduct
periodic
inspections
to
ensure
that
the
franchisee
is
operating
his
business
according
to
the
standards
prescribed
by
the
franchise
agreement
and
at
times
suggestions
are
made
with
a
view
to
assisting
the
franchisee
in
improving
the
profitability
of
his
operation.
Such
counselling
advice
is
given
without
charge.
The
company
from
time
to
time
also
assists
the
franchisees
in
carrying
out
their
advertising
and
promotional
activities,
such
as
arranging
for
television
commercials
which
are
produced
and
broadcast
at
the
expense
of
the
franchisees
and
buying
promotional
goods
for
resale
to
the
franchisees
at
a
mark-up
over
cost.
The
company
charges,
separately
from
the
franchise
fee,
for
the
equipment
sold
to
the
franchisees
and
the
packaging
materials
and
spices
supplied
to
them
on
an
ongoing
basis.
All
equipment
and
supplies
so
provided
are
separately
invoiced
to
the
franchisees.
The
company's
sales
of
equipment
to
franchisees
represent
approximately
90
per
cent
of
their
equipment
needs
by
reason
of
the
company's
favourable
mark-up
of
cost
plus
20
per
cent.
In
sum,
the
company
is
ever
vigilant
in
protecting
the
trade
name
Dixie
Lee
and
the
quality
of
foods
and
services
associated
therewith.
Failure
to
adhere
to
acceptable
standards
can
lead
to
the
cancellation
of
the
franchise.
Since
its
inception,
the
company
has
consistently
followed
the
accounting
practice
of
treating
the
franchise
fees
received
as
being
deferred
and
unearned
income
over
the
life
of
the
franchise
agreements
with
the
result
that
only
10
per
cent
thereof
is
brought
into
income
during
each
year
of
the
ten
year
term.
To
the
extent
that
the
franchise
fees
are
not
included
as
revenue,
they
are
classified
on
the
company's
balance
sheet
as
"unearned
franchise
income".
The
whole
case
of
the
plaintiff,
as
it
seems
to
me,
rests
on
the
premise
that
the
franchisee
fee
revenue
was
entitled
to
deferment
on
a
straight
line
amortization
basis
over
the
life
of
the
franchise
agreement
because
the
revenue
was
attributable
in
large
measure
to
the
obligation
of
the
franchisor
to
protect
its
trade
mark
“Dixie
Lee"
for
the
benefit
of
its
franchisees
and
to
provide
as
well
to
the
latter
ongoing
services
as
part
of
the
franchise
relationship.
The
plaintiff's
principal
submission
is
simply
this.
If
the
franchise
fee
revenue
is
required
to
be
included
in
income
under
paragraph
12(1)(a)
of
the
Income
Tax
Act
then
it
is
entitled
by
virtue
of
paragraph
20(1)(m)
of
the
Act
to
deduct
the
amount
of
$92,795
as
a
reasonable
reserve
in
respect
of
its
reasonably
anticipated
ongoing
obligation
to
deliver
goods
and
render
services
for
the
benefit
of
its
franchisees
over
the
life
of
the
franchise
agreements,
including
the
use
by
them
of
its
trade
mark.
Alternatively,
the
plaintiff
submits
that
if
the
amount
of
$92,795
is
to
be
included
in
its
income
for
the
1977
taxation
year
under
subsection
9(1)
of
the
Act,
the
plaintiff
is
entitled
in
accordance
with
generally
accepted
accounting
principles
to
treat
that
franchise
fee
revenue
as
unearned
income
and
claim
a
corresponding
deduction
in
respect
thereof.
The
defendant's
submissions
can
be
summarized
as
follows:
(1)
The
franchise
fee
revenue
of
$92,795
was
properly
assessed
as
income
from
the
plaintiff's
business
within
the
meaning
of
subsection
9(1)
of
the
Income
Tax
Act.
(2)
The
amount
of
$92,795
is
not
deductible
as
a
reserve
under
paragraph
20(1)(m)
of
the
Act
in
respect
of
goods
or
services
which
were
reasonably
anticipated
would
have
to
be
delivered
after
the
end
of
the
taxation
year.
Rather,
it
is
an
amount
transferred
by
the
plaintiff
to
a
reserve
or
contingent
account,
the
deduction
of
which
is
prohibited
by
paragraph
18(1)(e)
of
the
Act.
(3)
In
any
event,
the
amount
of
$92,795
sought
to
be
deducted
is
not
"a
reasonable
amount
as
a
reserve"
within
the
meaning
of
said
paragraph
20(1)(m).
Subsection
9(1)
of
the
Act
provides:
9.
(1)
Income
from
business
or
property.
—
Subject
to
this
Part,
a
taxpayer's
income
for
a
taxation
year
from
a
business
or
property
is
his
profit
therefrom
for
the
year.
Subparagraph
12(1)(a)(i)
of
the
Act
reads:
12.
(1)
There
shall
be
included
in
computing
the
income
of
a
taxpayer
for
a
taxation
year
as
income
from
a
business
or
property
such
of
the
following
amounts
as
are
applicable:
(a)
any
amount
received
by
the
taxpayer
in
the
year
in
the
course
of
a
business
(i)
that
is
on
account
of
services
not
rendered
or
goods
not
delivered
before
the
end
of
the
year,
or
that,
for
any
other
reason,
may
be
regarded
as
not
having
been
earned
in
the
year
or
a
previous
year
.
.
.
Paragraph
20(1)(m)
of
the
Act
reads
in
part
as
follows:
20.
(1)
Notwithstanding
paragraphs
18(1)(a),
(b)
and
(h),
in
computing
a
taxpayer's
income
for
a
taxation
year
from
a
business
or
property,
there
may
be
deducted
such
of
the
following
amounts
as
are
wholly
applicable
to
that
source
or
such
part
of
the
following
amounts
as
may
reasonably
be
regarded
as
applicable
thereto:
(m)
reserve
in
respect
of
certain
goods
and
services.
—
subject
to
subsection
(6),
where
amounts
described
in
paragraph
12(1)(a)
have
been
included
in
computing
the
taxpayer's
income
from
a
business
for
the
year
or
a
previous
year,
a
reasonable
amount
as
a
reserve
in
respect
of
(i)
goods
that
it
is
reasonably
anticipated
will
have
to
be
delivered
after
the
end
of
the
year,
(ii)
services
that
it
is
reasonably
anticipated
will
have
to
be
rendered
after
the
end
of
the
year,
(iii)
periods
for
which
rent
or
other
amounts
for
the
possession
or
use
of
land
or
chattels
have
been
paid
in
advance,
or
The
plaintiff's
accountant,
William
Osmond,
testified
that
the
practice
consistently
followed
was
to
defer
the
recognition
of
franchise
fee
revenue
by
apportioning
it
over
the
ten
year
period,
regardless
of
whether
it
was
income
under
subsection
9(1)
or
unearned
income
under
paragraph
12(1)(a)
of
the
Act.
Essentially,
this
revenue
was
not
brought
into
income
for
accounting
purposes
because
it
was
regarded
as
unearned
and
not
subject
to
tax
by
reason
that
the
franchisees
were
paying
for
the
use
of
the
franchisor's
trade
mark
and
the
ongoing
services
provided
by
the
franchisor
over
the
life
of
the
agreements.
Mr.
Osmond
felt
that
the
deferral
of
franchise
fee
revenue
by
this
method
had
the
same
end
result
as
bringing
such
revenue
into
income
for
taxation
purposes
and
then
taking
a
reserve.
The
total
deferred
amount
of
$92,795
in
1977
was
not
determined
by
estimating
the
actual
costs
incurred
or
likely
to
be
incurred
in
servicing
the
franchise
agreements
because
of
the
impracticability
of
estimating
these
costs.
Mr.
Osmond
categorized
these
ongoing,
post-opening
services
as
comprehending
what
was
generally
expected
by
the
franchise
operators,
although
largely
conceding
that
there
was
no
express
provison
requiring
their
performance
in
the
franchise
agreement
itself.
The
plaintiff's
accounting
expert,
J.A.F.
Cook,
C.A.,
concluded
that
the
methodology
employed
by
the
company's
accountants
to
calculate
its
profit
was
in
accordance
with
generally
accepted
accounting
principles
(GAAP).
The
basic
tenet
for
this
conclusion
lies
in
paragraph
1(b)
of
the
franchise
agreement
which,
in
Mr.
Cook's
view,
raised
an
implied
obligation
to
protect
the
value
of
the
company's
trade
mark
by
providing
ongoing
services
over
the
life
of
the
agreement.
He
was
also
strongly
influenced
by
the
following
statement
contained
in
s.
3400.14
of
the
CICA
Handbook:
.
.
.
For
practical
purposes,
when
services
are
provided
by
an
indeterminate
number
of
acts
over
a
specified
period
of
time,
revenue
would
be
recognized
on
a
straight
line
basis
over
the
period
unless
there
is
evidence
that
some
other
method
better
reflects
the
pattern
of
performance.
Another
bastion
of
support
was
the
fact
that
the
franchise
renewal
fees
were
fixed
at
the
current
price
of
initial
franchises
even
though
no
preopening
services
are
required.
In
Mr.
Cook's
view,
it
is
immaterial
whether
the
amount
of
$92,795
is
treated
as
deferred
revenue
or
regarded
as
unearned
income
entitled
to
a
reserve
by
the
interaction
of
paragraphs
12(1)(a)
and
20(1)(m)
of
the
Act
—
in
terms
of
actual
effect
there
would
be
no
difference
in
the
result.
Mr.
Cook
concluded
in
his
Report
as
follows:
Opinion
In
my
opinion,
the
practice
followed
by
Dixie
Lee
(Maritimes)
Ltd.
of
recognizing
franchisee
fee
revenue
in
equal
monthly
amounts
over
the
term
of
the
franchise
is
an
appropriate
application
of
generally
accepted
accounting
principles
and
is
the
most
accurate
method
available
within
those
principles
for
the
calculation
of
period
profits.
Mr.
Cook
admitted
on
cross-examination
that
the
basic
tenet
of
his
opinion
rested
on
the
correctness
of
his
conclusion
that
the
indeterminate
number
of
acts
performed
by
the
franchisor
over
the
ten
year
period
were
referable
to
the
earning
of
the
initial
franchise
fee
and
were
not
related
to
the
revenue
generated
from
the
sales
of
equipment,
packaging
materials
and
spices.
He
agreed
that
in
numerical
terms
the
revenue
generated
from
the
sale
of
these
last
mentioned
items
was
the
predominant
part
of
the
plaintiff's
business.
He
also
conceded
that
a
determination
of
the
average
costs
of
providing
such
ongoing
services
for
earning
franchise
fee
revenue
would
produce
a
more
accurate
result
than
a
straight
line
apportionment.
Nonetheless,
he
stuck
to
his
guns
that
any
ongoing
services
provided
during
the
life
of
the
franchise
agreements
were
referable
to
initial
franchise
fees
as
opposed
to
earning
sales
revenue.
As
so
often
happens,
the
defendant's
accounting
expert,
D.G.
Henry,
C.A.,
disagreed
with
Mr.
Cook's
conclusion
that
the
company's
accounting
practice
of
deferring
and
apportioning
franchise
fee
revenue
as
unearned
income
over
the
life
of
the
franchise
agreement
was
an
appropriate
deferral
of
income
in
accordance
with
GAAP.
The
reason
given
was
that
all
material
conditions
relating
to
the
sale
of
a
franchise
had
been
substantially
performed
by
the
franchisor
not
later
than
three
weeks
following
the
opening
of
a
franchised
outlet,
that
the
costs
properly
allocable
to
the
earning
of
the
initial
franchise
fee
had
been
incurred
by
then,
and
that
there
was
no
requirement
for
refund
or
repayment
of
the
initial
franchise
fee
in
any
event.
In
short,
the
franchise
fee
was
irrevocably
vested
in
the
franchisor
and
all
services
attributable
to
earning
it
had
been
substantially
performed
within
three
weeks
of
the
opening.
Hence,
there
was
no
reason
according
to
generally
accepted
accounting
principles
to
defer
the
recognition
of
franchise
fee
revenue
beyond
that
three
week
period.
Mr.
Henry
relied
on
the
CICA
guideline
of
July
1984
to
support
his
conclusion
that
the
cost
of
any
ongoing
services
of
policing
and
providing
advice
and
assistance
to
franchisees
must
be
matched
against
the
franchisor’s
main
business
activity
of
selling
equipment
and
supplies
to
its
captive
franchise
network,
which
he
calculated
as
representing
92.5
per
cent
of
gross
sales.
In
other
words,
any
ongoing
services
were
for
the
benefit
of
the
franchisor
in
the
way
of
its
business
of
selling
equipment
and
supplies
and
protecting
and
enhancing
the
value
of
the
Dixie
Lee
name
with
a
view
to
future
business
expansion.
Accordingly,
the
cost
of
providing
ongoing
services
was
not
properly
matchable
to
the
earning
of
franchisee
fee
revenue,
contrary
to
Mr.
Cook's
viewpoint.
Hence,
there
was
no
reason
to
defer
recognition
of
franchise
fee
revenue
beyond
the
period
of
three
weeks
following
opening
day
in
each
case.
Moreover,
Mr.
Henry
was
of
the
view
that
the
extensive
services
provided
by
the
franchisor
throughout
the
whole
launching
period
would
be
likely
to
consume
a
large
part
of
the
initial
franchise
fee.
With
respect
to
the
renewal
of
an
existing
franchise,
he
took
the
view
that
GAAP
required
that
the
renewal
fee
be
recognized
as
having
been
earned
at
the
commencement
of
the
renewal
term
in
each
case.
Based
on
the
foregoing,
Mr.
Henry
came
to
the
following
conclusion
in
his
Report:
.
it
is
my
opinion
that
the
Company's
practice
of
deferring
the
franchise
fee
revenue
to
be
recognized
as
earned
over
the
life
of
the
franchise
agreement
is
an
inappropriate
deferral
of
income
and
not
in
accordance
with
generally
accepted
accounting
principles,
inasmuch
as
the
obligations
of
the
Company
(the
franchisor)
under
the
agreement
had
been
substantially
performed
by
the
end
of
the
third
week
following
the
opening
of
the
restaurant
involved.
As
I
see
it,
the
basic
issues
in
the
case
are:
(1)
whether
the
amount
of
$92,795
is
unearned
income
within
the
meaning
of
subparagraph
12(1)(a)(i)
so
as
to
qualify
as
a
reasonable
reserve
under
paragraph
20(1)(m);
and,
or
alternatively,
(2)
whether
that
sum
represented
a
proper
deduction
for
franchise
fee
revenue
deferred
and
apportioned
over
the
life
of
the
franchise
agreements
in
accordance
with
generally
accepted
accounting
principles,
pursuant
to
subsection
9(1)
of
the
Act.
The
plaintiff's
initial
position
was
directed
to
qualifying
the
sum
of
$92,795
as
a
legitimate
reserve
but
this
aspect
was
played
down
to
some
extent
during
the
course
of
argument
in
favour
of
income
deferral
in
accordance
with
generally
accepted
accounting
principles
and
its
recognition,
whether
implicitly
or
otherwise,
by
subsection
9(1)
of
the
Income
Tax
Act.
I
will
deal
firstly
with
the
second
issue.
By
subsection
9(1)
of
the
Act,
a
taxpayer's
income
for
a
taxation
year
from
a
business
or
property
is
his
profit
therefrom
for
the
year.
Mr.
Justice
Cartwright
alluded
to
the
predecessor
provision
[section
4]
in
Dominion
Taxicab
Assn.
v.
M.N.R.,
[1954]
C.T.C.
34;
54
D.T.C.
1020
(S.C.C.),
stating
at
page
37
(D.T.C.
1021):
.
.
.
The
expression
"profit"
is
not
defined
in
the
Act.
It
has
not
a
technical
meaning
and
whether
or
not
the
sum
in
question
constitutes
profit
must
be
determined
on
ordinary
commercial
principles
unless
the
provisions
of
the
Income
Tax
Act
require
a
departure
from
such
principles.
.
.
.
It
is
well
settled
that
in
considering
whether
a
particular
transaction
brings
a
party
within
the
terms
of
the
Income
Tax
Act
its
substance
rather
than
its
form
is
to
be
regarded.
Edwin
C.
Harris,
Canadian
Income
Taxation,
4th
ed.,
makes
the
following
statement
in
reference
to
subsection
9(1)
at
page
430:
.
.
This
rule
has
been
interpreted
to
mean
that
the
taxpayer
must
adopt
the
method
for
computing
his
annual
income
that
most
nearly
accurately
reflects
his
profit
—
which
is
essentially
a
question
of
following
“generally
accepted
accounting
principles"
except
where
the
Act,
or
a
limited
number
of
court
decisions
that
follow
no
clear
principle,
requires
otherwise.
Speaking
in
accounting
terms,
the
rule
requires
that
there
be
a
reasonable
"matching"
of
revenues
and
related
expenses
in
any
fiscal
period.
Generally
speaking,
an
amount
received
by
a
taxpayer
in
a
taxation
year
is
taxable
as
income
in
his
hands
if
his
right
to
it
is
absolute
and
subject
to
no
restriction
as
to
its
disposition,
use
or
enjoyment,
regardless
of
whether
or
not
it
is
earned
in
that
particular
year:
Kenneth
B.S.
Robertson
Ltd.
v.
M.N.R.,
[1944]
C.T.C.
75;
[1944]
Ex.
C.R.
170;
2
D.T.C.
655.
It
is
always
useful
in
cases
where
there
is
an
argument
over
the
applicability
of
any
particular
system
of
accounting
from
the
standpoint
of
ordinary
commercial
principles
to
recall
the
statement
of
President
Thorson
in
M.N.R.
v.
Publishers
Guild
of
Canada
Limited,
[1957]
C.T.C.
1;
57
D.T.C.
1017
(Ex.
Ct.)
at
page
17
(D.T.C.
1026):
.
.
.
What
the
court
is
concerned
with
is
the
ascertainment
of
the
taxpayer's
income
tax
liability.
Thus
the
prime
consideration,
where
there
is
a
dispute
about
a
system
of
accounting,
is,
in
the
first
place,
whether
it
is
appropriate
to
the
business
to
which
it
is
applied
and
tells
the
truth
about
the
taxpayer's
income
position
and,
if
that
condition
is
satisfied,
whether
there
is
any
prohibition
in
the
governing
income
tax
law
against
its
use.
If
the
law
does
not
prohibit
the
use
of
a
particular
system
of
accounting
then
the
opinion
of
accountancy
experts
that
it
is
an
accepted
system
and
is
appropriate
to
the
taxpayer's
business
and
most
nearly
accurately
reflects
his
income
position
should
prevail
with
the
Court
if
the
reasons
for
the
opinion
commend
themselves
to
it.
We
have
here
the
common
situation
of
two
eminently
qualified
accountants
expressing
contradictory
opinions
based
on
their
differing
analyses
of
the
application
of
generally
accepted
accounting
principles.
Mr.
Cook
perceived
the
franchise
agreement
in
the
context
of
raising
an
implied
obligation
on
the
part
of
the
franchisor
to
provide
ongoing
services
over
the
life
of
the
franchise
which,
by
applying
the
matching
principle
in
reverse,
led
him
to
conclude
that
the
franchise
fee
revenue
could
justifiably
be
apportioned
over
the
ten
year
period.
Mr.
Henry
saw
matters
in
another
light
and
came
to
the
conclusion
that
the
practice
of
deferring
franchise
fee
revenue
over
the
life
of
the
franchise
agreement
was
an
inappropriate
deferral
of
income
and
not
in
accordance
with
generally
accepted
accounting
principles,
inasmuch
as
the
obligations
of
the
franchisor
under
the
agreement
had
been
substantially
performed
by
the
end
of
the
third
week
following
the
opening
of
the
franchised
outlet.
Based
on
the
totality
of
evidence,
I
consider
that
Mr.
Henry's
opinion
is
the
more
reasonable
and
acceptable
one
under
the
circumstances.
I
find
therefore
that
the
plaintiff
has
not
met
the
onus
of
establishing
on
balance
of
probability
that
its
method
of
recognizing
franchise
fee
revenue
by
straight
line
apportionment
over
the
ten
year
period
is
cognisable
according
to
generally
accepted
accounting
principles
within
the
purview
of
subsection
9(1)
of
the
Income
Tax
Act.
Having
failed
on
its
submission
for
a
deduction
of
the
amount
of
$92,795
under
subsection
9(1)
of
the
Act,
the
plaintiff
is
brought
back
to
the
square
one
position
of
its
main
submission
as
initially
pleaded,
that
is,
that
it
is
entitled
to
deduct
the
amount
of
$92,795
as
a
reasonable
reserve
under
paragraph
20(1)(m)
of
the
Act
by
reason
of
having
to
include
in
income
the
unearned
portion
of
franchise
fee
revenue
under
paragraph
12(1)(a)
of
the
Act.
I
cannot
take
too
seriously
the
plaintiff's
argument
that
it
never
in
fact
treated
the
unearned
and
apportioned
franchise
fee
revenue
as
a
reserve.
The
notice
of
objection
stated,
inter
alia,
as
follows:
We
object
to
the
inclusion
in
income
of
franchise
revenue
of
$92,795
previously
deferred
because
sub-paragraph
20(1)(m)(ii)
provides
for
the
deduction
of
a
reserve
in
respect
of
services
that
it
is
reasonably
anticipated
will
have
to
be
rendered
after
the
year
end.
We
disagree
that
the
Company
is
merely
selling
franchises
rather
than
providing
an
ongoing
service.
Paragraph
20(1)(m)
does
not
require
that
the
franchise
agreement
provide
for
an
obligation
to
provide
a
service,
merely
that
the
service
is
reasonably
anticipated.
Further
correspondence
between
the
parties
arising
from
the
notice
of
objection
makes
it
abundantly
clear
that
they
were
treating
the
reassessment
of
$92,795
as
coming
within
the
ambit
of
a
paragraph
20(1)(m)
reserve.
It
might
be
useful
to
briefly
review
the
statutory
scheme
prescribed
by
the
relevant
sections
of
the
Income
Tax
Act
applicable
to
the
issue
of
the
reserve.
The
starting
point
is
subparagraph
12(1)(a)(i)
which
provides
for
the
inclusion
in
income
of
amounts
received
by
a
taxpayer
in
the
course
of
his
business
in
a
taxation
year
that
is
on
account
of
services
not
rendered
or
goods
not
delivered
before
the
end
of
the
year
or
that,
for
any
other
reason,
may
be
regarded
as
not
having
been
earned
in
the
year
or
a
previous
year.
Such
amounts
must
be
treated
as
having
been
received
or
receivable
in
that
taxation
year.
Paragraph
18(1)(e)
of
the
Act
provides
that
no
deduction
shall
be
permitted
in
computing
the
income
of
a
taxpayer
from
a
business
in
respect
of
an
amount
transferred
or
credited
to
a
reserve,
contingent
account
or
sinking
fund
"except
as
expressly
permitted
by
this
Part".
Subparagraph
20(1)(m)(iii)
of
the
Act
allows
a
taxpayer
to
claim
a
reasonable
reserve
for
prepaid
rent
on
account
of
the
possession
or
use
of
land
or
chattels.
While
the
subparagraph
was
pleaded
in
the
plaintiff's
statement
of
claim
in
reference
to
the
allegation
that
the
franchise
fee
revenue
might
somehow
be
deemed
to
constitute
rent
for
the
franchisees'
use
of
the
trade
mark
“Dixie
Lee",
little
was
made
of
this
contention
during
the
course
of
argument.
Indeed,
the
whole
weight
of
evidence
runs
counter
to
any
suggestion
that
the
franchise
fees
were
ever
considered
or
treated
as
prepaid
rent.
Under
the
circumstances,
I
find
that
subparagraph
20(1)(m)(iii)
of
the
Act
is
of
no
assistance
to
the
plaintiff.
Neither
was
it
forcefully
argued
by
the
plaintiff
that
any
promotional
materials
provided
from
time
to
time
by
the
franchisor
after
the
initial
opening
were
goods
having
to
be
delivered
after
the
year
end
within
the
meaning
of
subparagrah
20(1)(m)(i).
The
evidence
shows
that
these
materials
were
resold
to
the
franchisees
at
their
cost
to
the
franchisor
plus
modest
mark-up
and
the
prices
therefor
would
normally
be
recoverable
within
a
reasonable
period
after
the
rendering
of
invoices.
Consequently,
I
find
that
the
promotional
goods
were
not
the
sort
of
goods
that
would
qualify
for
a
reasonable
reserve
under
subparagraph
20(1)(m)(i)
of
the
Act.
Thus,
we
are
left
with
the
remaining
question
of
whether
the
amount
of
$92,795
qualifies
for
deduction
under
paragraph
20(1)(m)(ii)
for
ongoing
services
reasonably
anticipated
by
the
franchise
agreements
as
having
to
be
rendered
over
the
life
thereof
in
consideration
of
the
payment
of
the
franchise
fees.
It
seems
to
me
that
the
evidence
establishes
the
following
salient
facts
bearing
on
this
issue,
namely:
—
The
lion’s
share
of
Dixie
Lee's
business
related
to
the
sales
of
equipment
and
supplies,
which
in
1977
generated
gross
sales
revenue
of
$604,680
as
opposed
to
franchise
revenue
of
$20,852.
—
The
costs
of
providing
ongoing
services
on
the
part
of
the
franchisor
are
recouped
in
its
yearly
expenses
offset
against
revenue.
—
The
plaintiff
made
no
attempt
to
estimate
the
average
yearly
costs
of
providing
ongoing
services
to
franchisees,
the
reason
being
that
these
costs
were
considered
to
be
variable
from
store
to
store
depending
on
the
extent
of
profitability
of
individual
franchises.
In
the
result,
I
am
of
the
opinion
that
the
plaintiff's
practice
of
deferring
the
recognition
of
franchise
fee
revenue
by
straight
line
apportionment
over
the
ten
year
period
is
inappropriate
and
improper
in
the
circumstances
by
reason
that
the
services
required
of
the
franchisor
under
the
franchise
agreements
were
substantially
performed
within
three
weeks
of
the
initial
openings
and
that
any
ongoing
obligations
thereafter
were
clearly
referable
to
the
predominant
activity
of
selling
equipment
and
supplies
and
the
enhancement
and
future
expansion
of
the
franchise
chain.
It
seems
to
me
that
any
such
ongoing
services
were
clearly
intended
to
benefit
the
overall
business
of
the
franchisor.
I
find
therefore
that
the
plaintiff
has
failed
to
show
its
entitlement
to
deduct
the
amount
of
$92,795
as
a
reasonable
reserve
within
the
meaning
of
paragraph
20(1)(m)
of
the
Income
Tax
Act
and
conclude
that
the
Minister
has
rightfully
added
that
amount
to
the
plaintiff's
active
business
income
for
the
1977
taxation
year.
For
the
foregoing
reasons,
the
plaintiff's
action
is
dismissed
with
costs.
Action
dismissed.
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