Date: 20011130
Docket: 1999-2167-IT-G
BETWEEN:
TOD T. MANRELL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Counsel for the Appellant: Werner H.G. Heinrich
and David Graham
Counsel for the Respondent: Peter M. Kremer and
Rosemary Fincham
____________________________________________________________________
Reasonsfor
Judgment
(Delivered orally from the Bench at Vancouver,
British Columbia, on October 25, 2001)
McArthur J.
[1]
These appeals are from assessments of tax for the 1996 and 1997
taxation years. The issue is whether payments under a
non-competition agreement are taxable on capital account or
whether they constitute a non-taxable receipt. I commend counsel
for the parties for narrowing the issues in an Agreed Statement
of Facts, the relevant paragraphs of which are as follows:
1.
The Appellant is a businessman.
2.
The Appellant is the sole shareholder of Llernam Holdings Ltd.
("Llernam Holdings").
3.
Llernam Holdings is the sole shareholder of Allwest Industries
Incorporated ("Allwest") and an 80% shareholder of
322597 BC Ltd. ("322597).
4.
Allwest was the sole shareholder of BC Plastic Industries Ltd.
("BC Plastic") prior to June 16, 1995.
5.
322597 was a 50% shareholder of Canada Cap Snap Corporation
("Cap Snap") prior to June 16, 1995.
6.
The Appellant was also a 70% shareholder in Alberta Plastic
Industries Ltd. ("Alberta Plastic") prior to June 16,
1995.
7.
...
8.
BC Plastic and Alberta Plastic manufacture plastic moulds while
Cap Snap manufactures caps for those moulds.
9.
The Appellant, Allwest, 322597, Bob Williamson, and Bruce Gallop
(collectively, the "Vendors") entered into an agreement
dated June 16, 1995 (the "Share Purchase Agreement") to
sell their respective shares (the "Shares") in Alberta
Plastic, BC Plastic and Cap Snap (collectively, the
"Companies") to 3154823 Canada Inc. (the
"Purchaser").
10.
The Vendors and the Purchaser dealt at arm's length.
11.
...
12.
The Share Purchase Agreement (section 2.2) specified, inter
alia, that the Vendors be paid the sum of $14,626,000 for
their shares and shareholder loans.
13.
The Appellant received total proceeds of $3,927,078 for his
shares and on account of amounts due to the shareholders under
the Share Purchase Agreement.
14.
It was a condition of the sale of the Shares that the Appellant,
Gallop, Williamson, Llernam Holdings, Allwest and 322597 BC Ltd.
enter into non-competition agreements with the Purchaser and the
companies being sold. ...
15.
The $3,438,699 consideration received by the Appellant for
entering into the Non-Competition Agreement was allocated as
follows:
(i)
Appellant
$979,575
(ii)
Allwest
2,193,193
(iii)
322597
265,932
16.
The Appellant's $979,575 in non-competition payments were
paid to him in four annual instalments of $244,894 beginning on
June 16, 1995.
17.
The Appellant reported the non-competition payments as proceeds
of disposition of shares in accordance with paragraph 6 of
Revenue Canada's Interpretation Bulletin IT-330R.
...
18.
The Appellant reported the amount of $244,894 of the $979,575
payable under the Non-Competition Agreement as a capital gain in
his return of income for his 1995 taxation year and claimed a
$734,681 capital gain reserve in respect of the balance of the
instalments payable.
19.
The Appellant included the instalment payments of $244,894
received in each of his 1996 and 1997 taxation years in income
and debited his capital gain reserve by the said amounts in each
of the said years.
20.
...
21.
The Minister of National Revenue (the "Minister")
initially assessed the Appellant by notices of assessment dated
May 20, 1997 for his 1996 taxation year and June 18, 1998 for his
1997 taxation year on the basis the returns were correct as
filed.
22.
The Appellant objected to the said assessments by notices of
objection. ...
23.
The Minister confirmed the said assessments by notice of
confirmation dated January 22, 1999. ...
The exhibits referred as attachments to the Agreed Statement
of Facts have not been reproduced but relevant extractions are
quoted later.
[2]
The facts having been agreed to, the parties provided written
arguments and made oral submissions at the hearing. The relevant
provisions of the Income Tax Act are subparagraph
3(b)(i)(A), section 38, subsections 39(1) and 248(1) -
definition of "property", and section 54
-definition of "disposition". These sections read
in part as follows:
3
The income of a taxpayer for a taxation year for the purposes of
this Part is the taxpayer's income for the year determined by
the following rules:
(a)
...
(b)
determine the amount, if any, by which
(i)
the total of
(A) all
of the taxpayer's taxable capital gains for the year from
dispositions of property other than listed personal property,
and
...
38
For the purposes of this Act,
(a)
a taxpayer's taxable capital gain for a taxation year from
the disposition of any property is 3/4 of the taxpayer's
capital gain for the year from the disposition of that
property;
39(1) For the purposes of
this Act,
(a)
a taxpayer's capital gain for a taxation year from the
disposition of any property is the taxpayer's gain for the
year determined under this subdivision (to the extent of the
amount thereof that would not, if section 3 were read without
reference to the expression "other than a taxable capital
gain from the disposition of a property" in paragraph
3(a) and without reference to paragraph 3(b), be
included in computing the taxpayer's income for the year or
any other taxation year) from the disposition of any property of
the taxpayer other than
...
54
In this subdivision,
"disposition" of any property, except as expressly
otherwise provided, includes
(a)
any transaction or event entitling a taxpayer to proceeds of
disposition of property,
...
248(1) In this Act
"property" means property of any kind whatever
whether real or personal or corporeal or incorporeal and, without
restricting the generality of the foregoing, includes
(a)
right of any kind whatever, a share or a chose in action,
(b)
unless a contrary intention is evident, money,
(c)
timber resource property, and
(d)
the work in progress of a business that is a profession;
[3]
In a nutshell, the relevant facts are that in 1995, the Appellant
and others entered into a share purchase agreement for the sale
of their share interests in a plastic bottle manufacturing
business. They also gave up their right to earn income under
certain conditions from any competitive business. Section 1.5 of
the share purchase agreement described the vendor corporate
assets as follows:
"Assets" shall mean all of the
Acquired Companies' assets at the Closing (excluding (i)
cash, (ii) the Leased Assets and (iii) the Insurance Claims),
including, without limitation, all of the Acquired Companies'
right, title and interest in accounts receivable, choses in
action, rights under agreements, trademarks, trade names,
patents, patent applications, patent licenses, computer software,
shop rights, goodwill, customer lists, equipment, furniture and
fixtures, raw materials, work in process, inventory and all other
property both tangible and intangible, including without
limitation the Equipment. ...
The share purchase agreement provided that, in exchange for a
non-compete agreement, the purchaser would pay the vendors $4
million. I shall refer to the amounts as "payments". A
payment of $1 million was payable on closing and the balance of
$3 million was payable in three equal annual instalments. These
payments were included in the purchase price of the shares. The
share purchase agreement was executed in conjunction with the
non-compete agreement. Section 3.1 of the non-compete
agreement reads as follows:
Non-Compete Agreement Sellers agree that they
will not at any time during the Term directly or indirectly
engage in the Territory, or have any interest in any Conflicting
Organization or other entity (whether as an employee, officer,
director, agent, security holder, partner, creditor, consultant,
licensor, licensee, or otherwise) that engages in the Territory,
or is preparing to engage in the Territory, any activity in which
the activity is the same as, similar to, or competitive with any
business now carried on by any Acquired Company or Parent. The
restrictions contained in this Section 3.1 shall not prohibit
Sellers from holding not more than five percent (5%) in the
aggregate of the securities of a corporation with a class of
securities registered with the United States Securities and
Exchange Commission under the Securities Exchange Act of
1934 or listed for trading on a recognized Canadian stock
exchange, provided that Sellers do not engage in any other
prohibited conduct under this Section 3.
[4]
Originally, the Appellant declared his share of the payments
received as capital gains. Having become aware of the decision in
Fortino v. The Queen,[1] the Appellant now argues that the payments are
not taxable. Ironically, the issues in the Fortino
decision are easily distinguished from the present ones and
Fortino is more of a liability than an asset to the
Appellant's position.[2]
[5]
The Appellant's position is that the agreement to not
exercise the Appellant's right to compete does not constitute
"property" for the purposes of the Income Tax
Act. The payments under the non-compete agreement, therefore,
are not taxable on account of capital as the payments do not
constitute a gain from the disposition of property. The Appellant
advances three arguments in support of this position.
[6]
First, subsection 248(1) defines "property" to mean
property. This section restricts the definition of
"property" under the Act to the common law
concept of property. The Appellant asserts that, at common law,
the ability to compete is not considered property. In support of
this, he states that courts of England and Australia, in the
cases of Kirby (Inspector of Taxation) v. Thorne EMI
plc (1987)[3]
and Hepples v. Federal Commissioner of Taxation[4] have considered
this issue and have determined that the ability to compete is not
property at common law. These cases considered whether
non-competition payments were equivalent to property
pursuant to the Finance Act 1965 in England and the
Income Tax Assessment Act 1936 in Australia. Both courts
came to the conclusion that the payments did not constitute
property at common law or within the meaning of their
Acts. The Appellant submits that the reasoning of these
courts should be followed in the interpretation of property under
section 248 of the Income Tax Act.
[7]
He further states that, apart from the English and Australian
jurisprudence, Canadian courts also support this position. He
asserts that Canadian courts have determined that at common law
the skills possessed by the Appellant which give him ability to
compete, do not constitute property. The Appellant submits that
if the Canadian courts have decided that skills, training,
knowledge, information, experience and background are not
property at common law, then the Appellant's ability to use
them would not constitute property either.
[8]
The second argument is that the phrase "right of any kind
whatever" in subsection 248(1) has not expanded the common
law definition of "property" so as to include the
ability to compete as property under the Act. The
Appellant adds that if the legislature had intended to expand the
ordinary meaning of the word property, it would have said
"property shall be deemed to mean", (and I emphasize
the word "deemed"), rather than "property"
means "property of any kind". Further, the use of the
word "includes" does not expand the definition of
"property" beyond its ordinary meaning, but merely sets
out for the purposes of clarity, that the items listed in
paragraphs (a) to (d) are, in the view of
Parliament, property at common law. The Appellant submits that
the rights referred to in the phrase "right of any kind
whatever" refer to rights contained in the common law
"bundle of rights" theory of ownership. The need to
include the individual bundle of rights as part of the definition
of "property" was to avoid the argument that while one
of the bundle of rights of a particular property had been
disposed of, the property in its entirety had not been disposed
of.
[9]
Third, and in the alternative, the Appellant states that if the
phrase "right of any kind whatever" does expand the
common law definition, it does so only to include rights which
have similar characteristics to property which the ability to
compete does not have. The Appellant asserts that for a right to
be characterized as property, it must be a right in respect of
other property, or a right which could be legally enforced
against a specific person. A right, by its nature, places an
obligation on someone else. The right to work and compete is not
an existing right forcible against others and, therefore, capable
of disposition, but rather the agreement not to compete is the
creation of a right of property in the hands of others. The
creation of a right is not synonymous with the existence of a
right in the first place.
[10] If the
court finds that the Appellant's ability to compete is
"property" within the meaning of the Act, the
Appellant submits that he has done nothing to dispose of his
property. The Appellant states that he has done nothing which
would fall within the dictionary meaning of
"disposition" and that the only portion of the
definition of "disposition" in the Act which
could apply would require the Appellant to have sold the rights.
The Appellant submits that he has not sold his rights, but simply
covenanted not to exercise them.
[11] Finally,
I shall address the Appellant's rebuttal concerning windfall.
While the Appellant is confident that the payment under the terms
of the non-compete agreement was a windfall, he submits that
whether it is a windfall is completely irrelevant. He adds that
having shown that the payment was neither income from a source, a
taxable capital gain from the disposition of property, nor a
taxable net gain from the disposition of listed personal
property, he need do no more. The payment, whether it is a
windfall, must be a non-taxable capital receipt.
[12] The
Respondent argues that the Appellant's assertion that the
non-compete agreement payments are a non-taxable receipt is
equivalent to arguing that the receipt is a windfall. The
Respondent states that windfalls can be described as receipts
from a source in respect of which the recipient does not have,
nor does it not have reason to have expectation of return. The
Respondent adds that the payments received by the Appellant may
not be categorized as windfalls pursuant to the factors discussed
by Le Dain J. of the Federal Court of Appeal in the decision of
The Queen v. Cranswick.[5] The Respondent contends that
the payments are properly characterized as proceeds of
disposition of property resulting in a capital gain. This finding
results from the fact that the Appellant disposed of a variety of
rights, including right, title and interest to the innovations,
right to the use of confidential information, right to compete in
a way within a specified territory for at least five years, and
right to solicit employees.
[13] The
Respondent states that to dispose of the above rights, the
Appellant made a promise not to do something in connection with
these rights and then sold these promises. The Respondent further
submits that the payments are not only proceeds of disposition
from the sale of the Appellant's rights, they may also be
characterized as proceeds of disposition from the sale of shares
of the associated business under the share purchase agreement
and, therefore, on account of capital. In support of this, the
Respondent states that the payments were negotiated as part of
the share purchase agreement and were part of the purchase
price.[6] The
Respondent adds that, unlike the Australian and English
Acts, property as defined in subsection 248(1) is broad
enough to include the non-compete payments, and relies on the
cases of the M.N.R. v. Dominion Natural Gas Co.[7] and Golden v.
The Queen.[8]
[14] The
Respondent submits that although the term "property"
has been found not to include a taxpayer's personal skills
and knowledge, it has been found to include the right to enter
into a business and the promise to do or not to do certain
things. The difference between personal skills and knowledge, and
the right to enter into business and compete, or the promise not
to compete, is that the latter can be bought, sold and disposed
of by agreement between parties. He further concludes that the
Appellant sold a package of rights. These rights were property
within the broad meaning of subsection 248(1)of the Act
and the proceeds of disposition, the sale price is subject to tax
by virtue of sections 38 and 39 of the Act.
Analysis:
[15] Counsel
for the Appellant presented a creative argument, however, I
cannot accept it. The Appellant states that the word
"property" be given its common law definition because
subsection 248(1) defines "property" to mean property,
which imports the common law concept of property. He concludes
that the ability to compete is not property at common law. I
believe this may be accurate but not relevant. Property is
defined in subsection 248(1) as "property of any kind
whatsoever, whether real or personal or corporeal or incorporeal,
and without restricting the generality of the foregoing, includes
a right of any kind whatsoever". These words cannot simply
be ignored.
[16] The
definition provided for in subsection 248(1) does not restrict
the word "property" to a common law definition. The
word "property" cannot be read without the remainder of
the section. It is not necessary to resort to the definitions of
"property" in the English and Australian Acts
and courts. The English Act does not refer to rights as
being property, although the Australian Act does refer to
any other right. It does not include the very broad Canadian
Income Tax Act definition. There is no need to look
further than the Canadian jurisprudence.
[17] I accept
the Respondent's position with respect to whether the right
to compete is property. The following argument was provided:
... As the Supreme Court of Canada held in Golden v.
R.,
This extremely broad definition of "property" leaves
very little in the non-property classification. It would appear
to include a contract right, and might in circumstances include a
right to assert the covenant by a vendor to deliver know-how.
When considering the Act's broad definition of
"property", the Federal Court of Appeal, cited Lord
Langdale as having stated in Jones v. Skinner[9] that the word property is
the "most comprehensive of all terms which can be used
inasmuch as it is indicative and descriptive of every possible
interest which the party can have".
Kieboom v. M.N.R.[10]
Property includes "practically any type of economic
interest, and covers practically any sort of interest that a
person may have. The generality of the expression may be
understood in the context of this Act which deals with the
taxation of any form of business income to a taxpayer, whatever
its source".[11]
The term "property" has been found not to include a
taxpayer's personal skills and knowledge,[12] but it has been found to
include the right to enter into a business, and the promise to do
or not to do certain things.[13] The difference between personal skills and
knowledge, and the right to enter into a business and compete or
promise not to compete, is that the latter can be bought and sold
and disposed of by agreement between parties.
The Supreme Court of Canada has held that the right to supply
gas in a specified area is a capital asset.[14] Similarly, payments made on
account of non-competition agreements have been found to be
payments expended for the purchase of a capital asset.[15] As such, the
disposition of this property is to be considered on account of
capital and taxable under subsections 38(1) and 39(1) of the
ITA.
The applicability of the Act's capital gains
provisions to non-competition payments was considered in
Fortino, supra, where Judge Lamarre stated:
In fact, the Appellants received an amount not to operate
their business in certain areas for a certain period of time.
By accepting such a covenant, the Appellants surrendered a
potential source of profit. Loblaws was, in a sense, acquiring a
right from the appellants that they had previously held against
it. The appellants' capital assets were, in a sense,
sterilized.
I therefore conclude that the NCA payment received by the
appellants from Loblaws were more in the nature of a capital
receipt and were not income from a productive source under
section 3.[16] (Emphasis added)
I agree with the above reasoning and adopt it as my own in the
present appeals. The fact situation in Fortino mirrors the
present one.
[18] The
Appellant further argued that the phrase "right of any
kind" does not expand the definition of
"property". As stated earlier, the phrase
"property means property", cannot be interpreted
without the expanded subsection 248(1) definition. It is
clear that the legislature intended defining the word
"property" as broadly as possible. The "bundle of
rights" theory of property refers to the incidence of
ownership and is not helpful as to the definition of property
itself. The context of a right of any kind whatsoever, used in
the definition of "property" in the Act, does
not support the Appellant's theory that this phrase does not
define the property itself, but the rights of ownership. The
complete phrase is "a right of any kind whatever, a share or
chose in action". If a "right of any kind
whatever" was referring not to the definition of
"property" but to the rights of ownership, it would not
be grouped with other defining words of property.
[19] The
Appellant did not dispose of his personal talent, aptitude and
knowledge that were used to operate a bottle manufacturing
business. I believe this would be contrary to public policy. He
disposed of many rights including his right to compete. He sold
these rights. The proceeds for these rights also included payment
for the shares, for his interest in innovations, confidential
information and his right to solicit former employees. The
purchaser acquired the Appellant's promise not to compete
and, in doing so, his capital asset being ultimately the bottling
manufacturing business. The share purchase agreement established
an enforceable legal obligation in favour of the purchaser. The
payments under the non-competition agreement were part of the
share purchase agreement price. The first $1 million was treated
as part of the purchase price for the shares. How can these
payments not be considered on account of capital account? A right
to conduct business has been treated as a capital asset and I
refer to M.N.R. v. Dominion Natural Gas Co., supra.
[20] The
Appellant further argued that alternatively, if the phrase
"right of any kind whatever" does expand the common
law, it does so only to include those rights that have the
characteristics of property. Counsel refers to approximately 15
cases wherein courts have interpreted the phrase "right of
any kind whatever" in the definition of "property"
in subsection 248(1) and the Income Tax Act. He concludes
that the "right" was either property or a legally
enforceable right against a specific person.
[21] I
believe, as stated earlier, that the subsection 248(1) definition
of "property" is not founded on or restricted by the
common law. The Appellant did not dispose of or sell his right to
work. He disposed of his right to compete with the purchaser.
This is a very real capital asset and he entered a legally
enforceable contract.
[22] The
Appellant's final submission is that if the right to compete
is "property", the Appellant did not dispose of it. I
find that the Appellant did not give up or dispose of his right
to work and earn income. He did dispose of his right to make
plastic bottles in competition with the purchaser. In return for
disposing that right, he received the payment that is
inextricably connected to the payment for the shares and other
rights mentioned earlier, although this is irrelevant in that the
parties have agreed that section 42 does not apply. The Appellant
has disposed of his right to compete through the means of a
covenant restricting his actions. A right can generally not be
disposed of in any other way. To restrict the definition of
"disposition" in the way suggested by the Appellant
would have the effect of finding that, although rights are
included as property, this property could never be disposed of
pursuant to the Act.
[23] I believe
that the reason there is so little helpful jurisprudence on this
subject is because of Interpretation Bulletin IT-330R which
states that a receipt from a non-compete agreement is capital and
taxpayers have been treating it as a capital gain.
[24] I find
that the Appellant disposed of property within the meaning of
sections 38 and 39 and the payments are taxable capital gains.
The appeals are dismissed, with costs.
Signed at Ottawa, Canada, this 30th day of November, 2001.
"C.H. McArthur"
J.T.C.C.
COURT FILE
NO.:
1999-2167(IT)G
STYLE OF
CAUSE:
Tod T. Manrell and Her Majesty the Queen
PLACE OF
HEARING:
Vancouver, British Columbia
DATE OF
HEARING:
October 23, 2001
REASONS FOR JUDGMENT
BY:
The Honourable Judge C.H. McArthur
DATE OF
JUDGMENT:
October 30, 2001
APPEARANCES:
Counsel for the
Appellant:
Werner H.G. Heinrich and David Graham
Counsel for the
Respondent:
Peter M. Kremer and Rosemary Fincham
COUNSEL OF RECORD:
For the
Appellant:
Name:
Werner H.G. Heinrich
Firm:
Koffman Kalef
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
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