Bomag (Canada) Ltd. v. The Queen, 81 DTC 5085, [1981] CTC 156 (FCTD), aff'd 84 DTC 6363, [1984] CTC 378 (FCA)

Mahoney, J:—The plaintiff appeals the decision of the Tax Review Board [1978] CTC 3130; 78 DTC 1787, that upheld disallowance of two outlays as expenses: (1) a $20,000 payment in 1969 to obtain releases from commitments and (2) a series of payments in 1970 totalling $108,000 to terminate a franchise agreement. As to the latter, the plaintiff asserts, in the alternative, that $108,000 was the capital cost of depreciable property within the meaning of Class 14 of Schedule “B” of the Income Tax Regulations. In lieu of viva voce evidence, the parties filed the transcript of the evidence given at the Tax Review Board hearing and the exhibits introduced there. The only witness before the Board was Walter Kuettner, general manager of the plaintiff.

The $20,000 Payment

John Long controlled three companies: Pakall Limited, Pakall Manufacturing Limited and Pakall Compaction Equipment Limited. Their separate legal identities are immaterial to this appeal; they will hereafter be referred to, jointly and severally, as “Pakall”. Pakall’s relevant business was the manufacture and sale of earth compaction machines. By bulk sale agreement dated April 29, 1969, Pakall sold its plant and inventory to Com-Pakall Construction Equipment Limited, hereinafter “Com-Pakall”. Com-Pakall had been recently incorporated to make the purchase and carry on the business; it was owned 10% by Long, 10% by Kuettner and 80% by Bopparder Maschinen- baugesellschaft Mbh — Bomag, hereafter “Bomag Germany”.

By agreement dated April 30, 1969, Com-Pakall retained Pakall as a sales agent and consultant. Pakall agreed to employ Long and to make his services available to Com-Pakall on a full time basis until December 31, 1969, and “as required” until April 30, 1970. Com-Pakall agreed to pay Pakall $10,000 in equal monthly instalments of $833.33 over the year for the consulting services. As a more or less conventional appointment of a sales agent, the agreement entitled Pakall to sell Com-Pakall’s products on a nonexclusive basis throughout North America and to be paid a commission of 4% of the selling price, net of retail sales tax, finance charges and freight. As to territory and exclusivity, it provided:

(a) Pakall shall have no defined territory within North America but shall have the right to sell the product of the Company to anyone in North America but not on an exclusive basis and shall not be able to sell to the ultimate user in a territory in which the Company may now or in the future have an exclusive dealer, in which case the sale shall be made by Pakall through the dealer and the commission hereinafter mentioned shall be at the sale price to the dealer and not to the ultimate user;

Less conventionally, the agreement provided:

(b) It is agreed that in the case of the five machines listed by type and serial number in Schedule “A” annexed hereto and the first five machines manufactured by the Company, or any person, firm, corporation, partnership, company or other legal entity on behalf of the Company, that special conditions with regard to commission only shall apply. A commission of $2,000 shall be paid to Pakall when each of the said machines is sold by the company.

It went on to provide for a scaling down of the $2,000 if a machine were sold for less than $30,000 and for its payment in pro rata instalments if the purchase price were paid in instalments. The five machines listed in Schedule “A” were machines purchased from Pakall in the bulk sale. Taking the April 30 agreement as a whole, it is apparent that the $2,000 per machine for the specified ten machines was intended to be payable to Pakall regardless of whether Pakall had done anything to effect their sale and independent of Pakall’s performance of any of its other obligations under that agreement. It was, in fact and substance, part of the consideration for the initial acquisition by Com-Pakall, its payment contingent only on the sale of the specific machines.

Com-Pakall had been deliberately named to permit it to enjoy Pakall’s goodwill. It soon found it was enjoying the bad will of its suppliers. Pakall had had a bad credit history. Long had not devoted full time to his consulting duties and the fee had, by mutual agreement, been reduced from $833.33 to $600 per month. Furthermore, Long was interfering in areas where Kuettner did not want him. Kuettner approached Long, who said he was willing to terminate the relationship if the $20,000 were paid in advance of the sale of the ten machines.

The plaintiff, Bomag (Canada) Limited, owned 10% by Kuettner and 90% by Bomag Germany, was incorporated in July, 1969. Effective October 1, 1969, the plaintiff assumed Com-Pakall’s external business operations. Employees were retained on Com-Pakall’s external business operations. Employees were retained on Com-Pakall’s payroll until December 31 to avoid double payment of employer’s premiums to the Canada Pension Plan. Assets whose transfer would attract sales tax were retained by Com-Pakall. The plaintiff established a line of credit with its bank and Com-Pakall also retained its line of credit. For a period both lines of credit were utilized by the business.

In November, before any of the ten machines had been sold, Com-Pakall, not the plaintiff, paid $20,000 against delivery of a release executed by Long personally as well as by Pakall. The release recited the agreements of April 29 and 30 described above. It also recited a second agreement of April 29 not in evidence, whereby certain patents had changed hands and yet another agreement of April 30, likewise not in evidence, whereby Long had been given “certain rights with respect to certain shares”. Then, after reciting the wish of Long and Pakall no longer to be associated with Com-Pakall and their wish to give up their rights under “the said recited Agreements”, the document, in standard form and in consideration of $20,000 paid to Long and Pakall released Karl Heinz Schwamborn and Com-Pakall from all claims, past, present or future, “arising out of the said recited Agreements or otherwise”. The plaintiff, not being a party to any of the recited agreements, is not mentioned in the release. Schwamborn is an official of Bomag Germany.

On February 2, 1970, Com-Pakall and the plaintiff executed an agreement that dealt with the plaintiff’s use of Com-Pakall’s line of credit and also with the $20,000 payment. As to the latter, it provided:

AND WHEREAS Com-Pakall has paid John Long $20,000 in lieu of commission, terminated its contract with him and allowed Bomag to sell certain of Com-Pakall’s products.

2. Bomag and Com-Pakall acknowledge that Bomag has advanced money to pay John Long the amount of $20,000 in lieu of commission and to terminate his contract and accordingly Bomag has obtained the advantage of selling the compaction equipment formerly sold by John Long and Com-Pakall.

3. This Agreement confirms the verbal arrangement made between the parties and the course of conduct of the parties with regard to the matters mentioned herein.

That is, of course, an entirely self-serving document, created after the event and of no probative value. It does, nevertheless, state succinctly the basis upon which the plaintiff asserts the deductibility of the $20,000 as an outlay for the purpose of its gaining or producing income from its business.

In my view, nothing turns on the fact that the payment was actually made by Com-Pakall but set up in its accounts by the plaintiff. The interchangeable roles of the two companies in the same business at the time was reasonably explained. Likewise, the failure of the release to mention the plaintiff is of no moment.

the $20,000 was, under the April 30 agreement, a deferred obligation on account of the initial purchase price of the assets purchased from Pakall. Its character was not altered by terming it a “commission”. It was payable whether Pakall did anything to earn it or not. That there was valuable consideration for its prepayment did not alter its character either. It was a capital outlay and not deductible. The appeal as to the $20,000 payment will be dismissed.

The $108,000 Payment

By agreement dated January 30, 1967, apparently reflecting an arrangement that had existed since September, 1965, Bomag Germany granted Wettlaufer Equipment Limited, hereafter “Wettlaufer”, a franchise

... for sale and distribution throughout Canada on an exclusive basis BOMAG self-propelled double vibratory rollers, both walk-behind and ride-on types, and related equipment and spare parts (hereafter collectively called the “Products”).

It provided:

15. This agreement shall remain in force until December 31, 1970. Thereafter it will run and operate as an agreement which may be terminated by either party on 6 months notice.

Wettlaufer became a wholly-owned subsidiary of Charterhouse Canada Limited, hereafter “Charterhouse”.

Shortly after Com-Pakall, 80% owned by Bomag Germany, commenced business in 1969, Kuettner approached Charterhouse with a view to terminating the franchise prior to December 31, 1970. Charterhouse fixed the value of the franchise to it at $9,000 per month and, in the result, it was agreed that it terminate December 31, 1969. A formal agreement, dated June 7, 1969, between Bomag Germany and Charterhouse provided:

2. Bomag shall pay to Charterhouse on the 1st day of each and every month in 1970 the sum of $9,000 . . .

The Bomag referred to in the above quotation is, of course, Bomag Germany, not the plaintiff. The plaintiff had not yet been incorporated and neither it nor Com-Pakall are mentioned in the agreement.

When the franchise terminated, the plaintiff bought Charterhouse’s inventory of “Products”, as Bomag Germany was required to do by the cancellation agreement. Charterhouse invoiced the plaintiff and the plaintiff paid Charterhouse $9,000 per month, as Bomag Germany was required to do.

A second agreement dated February 2, 1970, this between Bomag Germany and the plaintiff, provided:

WHEREAS Bomag Germany entered into an Agreement with Charterhouse Canada Limited dated the 27th of June, 1969 and the shareholders of Bomag Germany thereafter caused Bomag Canada to be created for the purpos [sic] of selling the products contemplated by the Charterhouse Agreement,

WITNESSETH that the parties agree as follows:

1. This Agreement confirms the verbal arrangements and course of conduct of the parties following the incorporation of Bomag Canada.

2. Bomag Canada shall have the right to all of the benefits contained in the

Charterhouse Agreement and shall assume the responsibilities thereunder.

3. All payments under the Agreement shall accordingly be paid by Bomag

Canada to Charterhouse for the franchise rights which Bomag Canada enjoys.

This, too, is self-serving and of no probative value. It remains that Bomag Germany did negotiate the cancellation of the franchise so that its own Canadian subsidiary, which turned out to be the plaintiff, could deal in the Products. It remains also that, in the result, the plaintiff did enjoy a franchise for the Products in Canada. That is so even though the franchise was the subject of an unwritten arrangement between the plaintiff and Bomag Germany from January 1, 1969, until February 1, 1971, when they entered into a written agreement.

The line of cases dealing with a once and for all payment to get rid of an onerous obligation, and from which no lasting capital benefit accrues to the payer, e.g. Johnston Testers v MN Fl, [1965] 2 Ex CR 243; [1965] CTC 116; 65 DTC 5069, does not apply to plaintiff’s payment of the $108,000, whatever its application might have been had Bomag Germany paid the $108,000. Notwithstanding that it was Bomag Germany that was bound to make the payment, it was the plaintiff that paid the $108,000. For purposes of this appeal the nature of the payment is to be determined from the point of view of the plaintiff.

It is no answer simply to say that the plaintiff was under no legal obligation to make the payment and made it “gratuitously” (Berman v MNR, [1961] CTC 237; 61 DTC 1151). Although not documented there was nothing artificial or unusual in the plaintiff’s assumption of the obligations under the cancellation agreement. The plaintiff obtained a valuable asset which it could not have obtained had the Charterhouse franchise not been terminated. It had a bona fide business reason to pay for the early termination.

The cost to a franchisee of procuring the surrender of a prior franchise so that it may obtain its franchise is a proper element of the capital cost of the franchise obtained (Crystal Spring Beverage v MNR, [1965] 1 Ex CR 702; [1964] CTC 408; 64 DTC 5253). That was the nature of the $108,000 payment in so far as the plaintiff was concerned. It was, however, a capital outlay, not an expense.

Both the $20,000 and the $108,000 payments were outlays of capital. The Act provided, in 1969 and 1970, that:

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

Paragraph 12(1)(b) prohibited generally any deduction for an outlay of capital.

I find no regulation which would have permitted deduction of any part of, or amount in respect of, the $20,000 payment. The regulations did permit a deduction in respect of the capital cost of property described in Schedule “B”, Class 14:

Property that is a patent, franchise, concession or license for a limited period in respect of property but not including . . .

None of the exceptions are in play. The italics are mine.

Unfortunately for it, the franchise obtained by the plaintiff was not a franchise for a limited period. If one were to accept that the result of the transactions among Charterhouse, Bomag Germany and the plaintiff, was that the plaintiff assumed the Charterhouse franchise as of January 1, 1970, it remains that the term of that franchise was expressed as follows:

15. This agreement shall remain in force until December 31, 1970. Thereafter it will run and operate as an agreement which may be terminated by either party on 6 months notice.

It was not, as I understand it, a franchise for a limited period but rather a franchise terminable by notice on or after a fixed date. I do not, however, accept that as the result of the transactions. The Charterhouse franchise was clearly terminated and a new franchise was given to the plaintiff. The term of the new franchise was indefinite and, while it is irrelevant to the issue, I note that when their arrangement was finally committed to writing in February, 1971, termination on six months notice was again provided for.

The $108,000 payment, while capital cost of the franchise obtained by the plaintiff from Bomag Germany, was not deductible because the franchise obtained was not a franchise for a limited period. The appeal as to the $108,000 will also be dismissed.

Judgment

The appeal is dismissed with costs.