Goodwin Johnson (1960) Ltd. v. The Queen, 83 DTC 5417, [1983] CTC 389 (FCTD), aff'd 86 DTC 6185, [1986] CTC 448 (FCA)

Collier, J [ORALLY]:—The appeal of the plaintiff is allowed. In 1977 the plaintiff company received an amount of $830,000. It was paid by Naden Harbour Timber Ltd (Naden), to the plaintiff as “damages for termination or cancellation” of an agreement dated March 6, 1970.

The plaintiff, in its 1977 tax return, treated this sum as a disposition of capital property. It claimed there had been no taxable capital gain. Its position was: the value of the agreement, as of December 31, 1971 (Valuation Day), was, in fact, the amount paid in 1977, $830,000.

The Minister of National Revenue, in a reassessment, agreed there had been a disposition of capital property. But the Minister calculated a V-Day value of $280,425. This, of course, resulted in the inclusion, in the plaintiff's income, of a taxable capital gain.

The main dispute at the trial was essentially a factual one: the V-Day fair market value of the agreement of March 6, 1970. That agreement covered the carrying out of logging operations on timber sale 866695 in the Naden Harbour area of the Queen Charlotte Islands.

A brief history of the relevant facts is necessary.

The timber sale had been originally granted by the British Columbia Minister of Lands, Forests and Water Resources (The Minister) to Prince Rupert Sawmills Limited. Its life was 15 years, to 1977. The evidence indicated the Forestry Service, prior to 1971, was projecting the operation into 1979. The practice in British Columbia was to permit renewals after the original term (here 1979) expired.

By 1967, the operator had let the sale get into a default position. The Forest Service suspended the licence.

The plaintiff came to a joint venture agreement with Kanematsu-Gosho (USA) Inc (Kanematsu) for the acquisition and management of the timber sale. There was, at first, no written contract covering the operation of the Sale.

Prince Rupert Sawmills Limited agreed to sell the timber sale contract to Kanematsu for $1 million. The plaintiff was to manage the logging operations on behalf of Naden.

But the timber sale contract remained in the name of Prince Rupert Sawmills. The plaintiff was given, through the Forest Service, a power of attorney to deal with the sale. Gradually the defaults under the licence were corrected. On March 6, 1970 the Minister approved an assignment of the timber sale from Prince Rupert Sawmills Limited to the plaintiff. As between the plaintiff and Kanematsu, the latter was the beneficial owner.

An operations agreement was finally negotiated, in May 1970, between Kanematsu and the plaintiff. It was actually dated March 6, 1970, the date of the assignment of the timber sale.

Naden had been created to log the timber sale. Its shares were transferred to Kanematsu. The plaintiff was appointed manager at the operational level of Naden, “to administer, manage and operate the business of (Naden) as it relates to the timber sale contract”. The plaintiff was to be paid $300,000, in instalments, for its services to March 6, 1970. Then for the future:

(a) $1 for every 1,000 feet board measure of timber cut. This was estimated to be a total of $260,000.

(b) If the agreement, or the timber sale contract, was terminated, $260,000, less any amounts already paid pursuant to (a), would be paid forthwith to the plaintiff.

(c) Kanematsu gave an interest free loan of $260,000 to the plaintiff, repayable in 10 annual instalments.

(d) A management fee of one-half the annual net profits of Naden, or $75,000 per annum, whichever turned out to be the greater. The $75,000 minimum was net after all expenses.

The agreement went on to provide for possible increases in annual cut quotas on the sale. The parties agreed to: . . negotiate in good faith to provide for equal or other mutually agreed upon benefits and obligations on such excess of the annual allowable cut . . . in accordance with the respective contributions and efforts made by them and resulting in such increase’.

Finally, the agreement set out a termination provision: six months’ notice by either party. I add this comment. Disputes later arose between the parties, resulting in litigation over the agreement, and the settlement I have referred to. But neither the plaintiff nor Kanematsu ever invoked the termination procedure.

I go back somewhat in time.

In March of 1968, the then Minister, Ray Williston, had, in allowing the operation to continue, imposed a number of conditions on the licencee. The cut requirements were to be brought into balance by December 31, 1971. A mill was to be established in the Prince Rupert area. By letter dated February 4, 1971, the Minister stipulated construction of the mill had to begin by the end of 1971.

By December 31, 1971, the following is clear from the evidence, particularly that of Mr Williston. The timber cut, while still technically a bit low, had been brought up to the satisfaction of the Minister. In respect of the mill, the Minister wrote (see Exhibit 35) to the plaintiff, in part:

You have fulfilled the mill part . . . in that you have acquired a site and have, before December 31, started construction.

Because of all this, the plaintiff and its co-adventurer had been virtually assured of an increase in the allowable cut as follows: an additional 10,000 M B F, over the 20,000 MBF F quota; by reason of a changeover to close utilization, an additional 5,200 mcf from third band wood. The latter was to be the reward for the construction of the mill.

According to Mr Johnson, the principal of the plaintiff company, the operation was going reasonably well as of December 31, 1971. There was one difficulty with Kanematsu. There was hesitation on its part in making any firm commitment in respect of the financing of the required mill.

Eventually, for that and other reasons, litigation between the parties ensued. The settlement, earlier referred to, was reached.

I turn then to the matter of valuing the plaintiff’s operations contract, as of December 31, 1971. Before Mr Williston gave evidence, the defendant had taken the firm position the timber sale contract could not be assigned or transferred from the plaintiff to anyone else. That position was taken because of statements to that effect in correspondence from the Forest Service.

I am satisfied, however, from the evidence of Mr Williston that the timber sale contract could undoubtedly have, probably by a power of attorney process, been transferred from the plaintiff to another reputable operator. I make that a finding of fact.

The valuator for the defendant, Mr Blair, had initially put a market value of $240,000 to $280,000 on the operations agreement. That was on the basis the agreement was not transferable. Mr Blair agreed that if the agreement were in fact transferable, then the going concern approach to fair market value was appropriate. On that approach, he, using the methods used by the plaintiff's expert, Mr Marshall, arrived at a value of approximately $574,000.

Mr Marshall, in his evidence, estimated the V-Day fair market value to be $1,296,000.

The estimate of $574,000 by Mr Blair, is, in my opinion, too low. He assigned no value, by a purchaser from the plaintiff, to the $75,000 minimum management fee. I am satisfied on the evidence of Mr Marshall and Mr Laishley, some value, and not a nominal one, must be assigned.

In respect of the management production fees, estimated at $260,000, it was agreed that, as of December 31, 1971 approximately $243,000 remained to be earned in future years. Mr Blair discounted that amount to approximately $150,000. There was, to my mind, no persuasive reason for such a large reduction.

I turn now to the valuation in respect of increased quota. The two valuators were in disagreement as to the risk values to be taken into consideration in respect of the increased quotas from close utilization and third band timber. In my view, Mr Blair’s outlook was too pessimistic. I accept the opinion of Mr Marshall.

In fairness to Mr Blair, and indeed to the other witnesses as well, the valuation of this operations agreement was, and is, a novel and unusual problem. Opinions, including the various factors to be taken into account, and the weight to be given to them, did, understandably, vary.

Very persuasive testimony was given by Mr Laishley. He is a knowledgeable consultant in the forest industry. He took part in advising Kanematsu as to the amount to be paid in settlement of the plaintiff’s claim. I set out the following extract from his evidence in chief:

The inability of the parties to agree on various matters with respect to the development of the Naden Harbour operation ultimately resulted in litigation which was settled in 1976. The settlement of this litigation involved the payment by Kanematsu to Goodwin Johnson in the amount of $830,000 for breach of contract. In this regard a release agreement was signed. I was involved in the settlement of this civil litigation, and I was one of the persons who recommended the settlement.

I have read the appraisal report prepared by Mr Allan John Marshall dated September 16, 1983 and in fact I provided him with certain background information with a view to his preparing this report.

In my opinion, and based upon my knowledge of the so-called quota system, transactions in the forest industry involving various forms of timber tenure as well as quota, his comparable quota values are accurately reflected and his assumptions are reasonable.

In my opinion, and recognizing the fact that the valuation of Goodwin Johnson’s interest in the said contract is extremely difficult to determine, it was worth at least $830,000 in 1976 and was worth at least that amount as at December 31, 1971.

Indeed, if the litigation referred to above had been commenced earlier, such that a settlement could have been effected on December 31, 1971, I would have recommended to Kanematsu, all things being equal, a settlement such as that reached in 1976. Similarly, in my opinion, if I had been engaged on December 31, 1971 to advise a client, knowledgeable in the forest industry, as to a fair price to be paid to Goodwin Johnson for all its rights in and to this management contract, I would have been prepared to recommend a price of at least $830,000.

I accept Mr Laishley’s evidence. I adopt his opinion as my own. In my view, the plaintiff’s interest in the agreement had, as of December 31, 1971, a value of at least $830,000.

It is unnecessary to fix a precise figure.

That finding does not, however, dispose of this matter.

The defendant raised an alternative position, one not taken by the Minister of National Revenue in his reassessment.

The defendant asserted the $830,000 payment was a receipt of an “eligible capital amount” within the meaning of subsection 14(1) and paragraph 14(5)(b) of the Income Tax Act.

Subsection 14(1), and its allied provisions, are very difficult. In this case, it is said, one looks at the situation as if the plaintiff had made the $830,000 payment in respect of its business (the “mirror image” of the receipt). Then, one must determine if that notional payment would have been an eligible capital expenditure. “Eligible capital expenditure” is murkily described, and proscribed, in paragraph 14(5)(b) of the statute.

The payment here by Kanematsu was damages in respect of a claim by the plaintiff under the contractual arrangement. Using the mirror image, the notional payment by the plaintiff was, equally, damages. Was it also an eligible capital expenditure? I am not persuaded it was. In any event, the onus was on the defendant to show, in fact and law, on a balance of probabilities, this payment falls within subsection 14(1). That onus has not been met.

The appeal is allowed. The reassessment by the Minister for the 1977 taxation year is referred back to the Minister for reassessment on the basis that the adjusted cost base (V-Day value) was $830,000 rather than $280,425.

The plaintiff is entitled to its costs.

Thank you very much.