Citation: 2011 TCC 461
Date: 20110929
Docket: 2009-1863(IT)G
BETWEEN:
GEORGE SMITH,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Favreau J.
[1]
The appellant appeals,
by way of the general procedure, the reassessments dated March 1, 2007 made by
the Minister of National Revenue (the "Minister") pursuant to
the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.), as amended
(the "Act") in respect of his 2003, 2004 and 2005
taxation years.
[2]
The issues to be
decided concern the tax treatment of (i) amounts received by the appellant
pursuant to a price adjustment clause in a sale agreement of the appellant’s
clientele to B.F. Lorenzetti & Associates Inc. ("BFL") and (ii)
the interest payments received by the appellant on the balance of the sale price.
[3]
In determining the appellant’s
tax liability for the 2003, 2004 and 2005 taxation years, the Minister made the
following assumptions of fact set out in paragraph 9 of the Reply to the Notice
of Appeal:
(a) BFL carries on an active insurance
brokerage business and related insurance activity from and located in the Province of Quebec.
(b) The Appellant has practised for a number
of years as a licensed insurance broker domiciled in Quebec and is registered
in the Province of Quebec.
(c) BFL and the Appellant entered into an
Agreement of Referral effective November 1, 1995 whereby BFL provided the Appellant
with the use of BFL’s office facilities and services in consideration of
splitting the commission/fee income earned and paid on any premiums paid by the
Insurer’s policyholder during the term of this Agreement of Referral.
(d) The Agreement of Referral also provided
BFL with the option to purchase the Appellant’s Clientele.
(e) BFL and the Appellant entered into a Sale
Agreement effective January 1, 2002 whereby the Appellant agreed to sell his
Clientele and BFL agreed to purchase the Appellant’s Clientele.
(f) On January 1, 2002, the Appellant had a
Clientele in the Province of Quebec which represented current annual base commission revenue of $156,000.
(g) Based on annual commissions generated of
$156,000 times an acquisition factor of 2.25, BFL agreed to purchase the Appellant’s
Clientele for a total purchase price of $351,000 commencing as of the date of
the Sale Agreement and adjusted each year for the period based on actual
commission revenue for the past year Purchase Price.
(h)
Subject to an adjustment, the Purchase Price was
payable as follows:
(i) January 1, 2002: $142,000 representing
40.70% of the purchase price;
(ii)
January 1. 2003: $69,500 representing 19.77% of
the purchase price;
(iii)
January 1, 2004: $69,500 representing 19.77% of
the purchase price; and
(iv)
January 1, 2005: $69,500 representing 19.76% of
the purchase price.
(i) It was understood that the Purchase Price
was based on represented annual revenue of $156,000 and that the subsequent
payment due on January 1, 2003, 2004 and 2005 would be calculated by applying
the percentage mentioned above (see paragraph 9(h) of this Reply) to the actual
year’s revenue from the Appellant’s Clientele times the acquisition factor of
2.25.
(j) The balance of payment due to be paid was
subject to an interest rate calculated at prime at then prevailing interest
rates.
(k) The Appellant warranted and represented
that his Clientele, as at January 1, 2002, yielded for the benefit of BFL
and would continue to yield to BFL, in the future, annualized commission
revenue of at least $156,000.
(l) If the annualized commission revenue at
anniversary payment date was greater or lesser than the amount warranted and represented
then the annual payments contemplated above (see paragraph 9(h) of this Reply)
would be adjusted upwards or downwards accordingly.
(m) Pursuant to the Sale Agreement, BFL made
the following down payment to the Appellant:
|
Date
|
Actual Year’s
Revenue
|
2.25 Factor
|
Percentage
|
Down
Payment
|
|
April 18, 2002
|
$156,000
|
$351,000
|
40.70%
|
$142,500
|
(n) Pursuant to the
Sale Agreement, BFL made the following subsequent adjusted payments to the Appellant:
|
Date
|
Previous Year’s
Revenue
|
2.25 Factor
|
Percentage
|
Subsequent
Down
Payment
|
|
January 15, 2003
|
$166,160
|
$373,860
|
19.77%
|
$73,912
|
|
February 26, 2004
|
$208,098
|
$468,221
|
19.77%
|
$92,568
|
|
January 10, 2005
|
$192,370
|
$432,833
|
19.76%
|
$85,571
|
(o) Pursuant to the Sale Agreement, BFL made
the following interest payments to the Appellant:
|
Date
|
Interest Payments
|
|
January 15,
2003
|
$9,383
|
|
February 26,
2004
|
$3,125
|
|
January 10,
2005
|
$4,429
|
[4]
The appellant included
in his income for the 2002 to 2005 taxation years, the total consideration
received for the sale of the clientele, including the interests, as eligible
capital amounts in accordance with subsection 14(1) of the Act.
[5]
The Canada Revenue
Agency ("CRA") reassessed the appellant and included the subsequent
adjusted payments received in 2003, 2004 and 2005 as income from the sale of the
business in accordance with paragraph 12(1)(g) of the Act and the
interest payments as investment income in accordance with paragraph 12(1)(c)
of the Act.
[6]
Paragraphs 12(1)(c)
and (g) of the Act read as follows:
(c) Interest – subject to subsections
(3) and (4.1), any amount received or receivable by the taxpayer in the year
(depending on the method regularly followed by the taxpayer in computing the
taxpayer’s income) as, on account of, in lieu of payment of or in satisfaction
of, interest to the extent that the interest was not included in computing the
taxpayer’s income for a preceding taxation year;
…
(g) Payments based on production or use
– any amount received by the taxpayer in the year that was dependent on the use
of or production from property whether or not that amount was an instalment of
the sale price of the property, except that an instalment of the sale price of
agricultural land is not included by virtue of this paragraph;
[7]
The relevant clauses of
the sale agreement, bearing an effective date of January 1, 2002, are the
following:
1. […]
2. GS has a loyal and personal book of
property/casualty portfolio of clients in the Province of Quebec which
represents current annual base commission revenue of One Hundred and Fifty Six
Thousand Dollars ($156,000.00); the client list is appended hereto as a
Schedule "A" ("Clientele").
3. GS agrees to sell his Clientele and BFL
agrees to purchase the Clientele for a total purchase price of Three Hundred
and Fifty One Thousand Five Hundred Dollars ($351,000) (based on annual
commissions generated of 156,000 times an acquisition factor of 2.25)
commencing as of the date of this Agreement and adjusted each year for the
period based on actual commission revenue for the past year Purchase Price
("Purchase Price")
Subject to Section 5 below, the Purchase
Price shall be payable over three (3) years as follows:
i.
January 1st, 2002: $142,500
representing 40.70% of the purchase price;
ii.
January 1st, 2003: $69,500
representing 19.77% of the purchase price;
iii.
January 1st, 2004: $69,500
representing 19.77% of the purchase price;
iv.
January 1st, 2005: $69,500
representing 19.76% of the purchase price.
4. It is understood that the Purchase Price
shall be based on represented annual revenue of One Hundred and Fifty Six
Thousand Dollars ($156,000), and that the subsequent payments due on January 1,
2003, 2004 and 2005 will be calculated by applying the percentage mentioned
above to the actual year’s revenue from GS’s Clientele times the acquisition
factor of two point two five (2.25). The balance of payment due to be paid will
be subject to an interest rate calculated at prime at then prevailing interest
rates.
5. GS warrants and represents that the
Clientele, as at January 1st, 2002, yielded for the benefit of BFL
and now yields and shall continue to yield to BFL, in the future, annualized
commission revenue of at least One Hundred and Fifty Six Thousand Dollars
($156,000). If the annualized commission revenue at any anniversary payment date
are greater or lesser than the amount warranted and represented, then the
annual payments contemplated in Section 3 will be adjusted upwards or downwards
accordingly.
The Appellant’s Position
[8]
In the Notice of Appeal,
the appellant invoked the following reasons:
18. In the hands of the Appellant, the
clientele was an asset with an enduring benefit. Accordingly, the sale of the Appellant’s
clientele in 2002 constituted a disposition of an eligible capital property.
19. Subject to the Price Adjustment Clause, the
Purchase Price was established at the time of the sale at fixed amount of
$351,000 and was not dependent upon the use or production.
20. In accordance with subsection 14(1) of the Act,
the Appellant included in his income for the taxation years 2002 to 2005 the
total consideration received for the sale of the clientele as eligible capital
amounts.
21. It is submitted that the formula set in the
Price Adjustment Clause did not change the nature of the above-mentioned
instalments received by the Appellant in the taxation years 2003, 2004 and
2005.
22. Even if the above-mentioned instalments
were viewed as dependent upon the use or production, it is submitted that
section 14 of the Act takes precedence over paragraph 12(1)(g) of
the Act.
23. In alternative, it is submitted that
paragraph 12(1)(g) of the Act is only applicable to the amounts
received in excess of the Purchase Price.
Analysis
[9]
Income from property is
included in a taxpayer’s total income for the year under section 3 of the Act.
By virtue of subsection 9(1) of the Act, a taxpayer’s income from
property for a taxation year is the taxpayer’s profit from that property for
the year. So, income derived from the ownership of property, in the form of
rents or royalties, clearly falls into the taxpayer’s income under the general
provisions of sections 3 and 9 of the Act. Paragraph 12(1)(g) of
the Act includes incomes that are dependent on the use of or production
from that property, although expressed as instalments of the sale price of the
property. Paragraph 12(1)(g) of the Act applies to any kind
of property except agricultural land in certain circumstances. The term
"property" is broadly defined in subsection 248(1) of the Act
to mean "property of any kind whatever whether real or personal or corporeal
or incorporeal and, without restricting the generality of the foregoing,
includes a) a right of any kind whatever, a share or a chose in action; b)
unless a contrary intention is evident, money; c) a timber resource
property, and d) the work in progress of a business that is a
profession."
[10]
In this instance, the
property sold was clearly the appellant’s list of clients. Section 2 of the
sale agreement specifically referred to the client list that is appended as
Schedule "A" to the sale agreement and that was defined as being the
"Clientele". The appellant owned proprietary rights to his client
list and transferred those rights to BFL and was paid for it.
[11]
In Gifford v. R.,
[2002] 4 C.T.C. 64 (Fed. C.A.), Rothstein J.A. reviewed the
jurisprudence respecting client lists and came to the following conclusion:
… the jurisprudence has consistently concluded, in a variety of
situations, that payment for a client list is a capital expenditure.
Frequently, the acquisition is accompanied by a non-compete clause and the
vendor endorses the purchaser to his clients. …
[12]
The fact that the
client list of the appellant was the subject of a "business"
transaction to which section 14 of the Act would normally apply, can
nevertheless become the subject of further review as "property" under
paragraph 12(1)(g) of the Act (see 289018 Ontario Ltd. v.
Minister of National Revenue, 87 D.T.C. 381 (Tax Court of Canada)).
[13]
In considering the
application of paragraph 12(1)(g) of the Act, it is necessary to
determine whether the amounts received were dependent upon use or production of
the property. In the present case, the parties entered into the sale agreement
made effective as of January 1, 2002, in which they fixed the purchase price at
$351,000 (based on annual commissions generated of 156,000 times an acquisition
factor of 2.25) payable over a three-year period. They agreed to adjust the
purchase price each year for the period based on actual commissions received for
the previous year's purchase price (the "Purchase Price"). With such
conditions, it cannot be said that the Purchase Price was fixed and determined
in advance since the annual payments to the appellant were calculated each year
based on commissions received for the previous year. The initial price of
$351,000 was only an estimate and the Purchase Price was not fixed and did not
constitute a guaranteed minimum price. The total purchase price of $351,000
could fluctuate depending upon the annualized commissions received on any
anniversary payment date. The client list was also variable as new clients
referred by the appellant could be added to the list and existing clients on
the list could be removed as well.
[14]
The appellant’s counsel
contends that the Purchase Price was not entirely dependent upon the production
or use of the client list since it was also dependent upon the profitability of
the insurance company which was based on the experience of claims of the
portfolio of the insurance policies subscribed by the appellant’s clients. I do
not accept this argument. Pursuant to the sale agreement, the Purchase Price
and the adjustments to the Purchase Price were all computed and determined by
the annual commissions received from the appellant’s client list and nothing
else.
[15]
The source of the
commissions received was indeed the client list, all amounts received by the appellant,
although expressed as instalments of the sale price of the client list, were
dependent entirely on the use of or production from that property and were
taxable under paragraph 12(1)(g) of the Act.
[16]
The interest payments
received by the appellant in respect of the balance of payment due to be paid
pursuant to the sale agreement are taxable by virtue of paragraph 12(1)(c)
of the Act and not by virtue of section 14 of the Act as
submitted by the appellant. Considering that, pursuant to the sale agreement, no
part of the adjusted payments received by the appellant from BFL are taxable
under section 14 of the Act, the interest payments, which are accessories
to the principal, cannot also be taxed under that section of the Act.
[17]
Consequently, the
appeals are dismissed with costs.
Signed at Ottawa, Canada, this 29th
day of September 2011.
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