The Queen v. Baine, Johnstone & Co. Ltd., 77 DTC 5394, [1977] CTC 556 (FCTD)

Addy, J:—The plaintiff is appealing a decision of the Tax Review Board under which the Minister’s assessment was reversed and a claim for expenses by the defendant company in the amount of $128,000 was allowed for the taxation year 1971.

The company, as part of its many operations, had been doing business in the general insurance retail field in St John’s, Newfoundland. During the year in question the defendant purchased what it alleges to be two lists of clients’ files from two existing insurance businesses. As a result, it claims that the expenditures were chargeable against revenue. The plaintiff on the other hand claims that the amounts paid effectively included the goodwill of the two businesses and, therefore, constituted expenditures in the nature of a capital outlay.

In 1971 the defendant paid $75,000 to Stan Fowler Insurance Agencies Limited (hereinafter referred to as the ‘‘Fowler Agency’’) and another $53,000 to a firm of solicitors, namely, Stirling, Ryan, Goodridge, Caule, Guchus & Goodridge (hereinafter referred to as “Stirling & Ryan’’) both of St John’s Newfoundland.

At the hearing before me, neither party adduced any evidence but agreed to resort to the transcript of evidence and the exhibits filed at the hearing before the Tax Review Board and to certain admissions as well as extracts from the examination for discovery of an officer of the plaintiff company.

The facts are fairly straightforward. In 1971 the defendant decided to increase its insurance business in St John's. It had at that time an insurance portfolio of approximately 4.000 clients. The Fowler Agency was totally owned and operated by Stan Fowler in St John’s and its portfolio consisted of some 1.718 clients. After some negotiations with Fowler, the defendant wrote to him on June 30, 1971 and made an offer to purchase the portfolio for $75,000 with effect from August 1, 1971. These matters were, on July 2, confirmed in writing by letter addressed by the defendant to the Fowler Agency and on the same day Fowler confirmed in writing his acceptance of the offer of the defendant made in its letter of June 30, 1971. The parties had agreed that as part of the transaction Stan Fowler would be employed for a period of one year at a salary of $100 per week in order to retain and further promote the accounts purchased from the Fowler Agency. He was not to report to the defendant’s office on a regular basis but was to continue to work out of his own office and to liaise closely with the defendant. There was a further provision for a sub-agency agreement whereby he would be paid, on a monthly basis, certain percentages on any new business obtained by him and a further provision that, except for his activities pursuant to the sub-agency agreement, neither he nor his company would carry on any business as either an insurance agent, sub-agent or aS a broker or in any way become involved in the placing of insurance business in the Province of Newfoundland and Labrador for a period of ten years. There were also some other conditions regarding a possible extension of employment at the end of the year and provisions regarding disability. These latter provisions are not relevant to the issue.

In so far as Stirling & Ryan were concerned, they had developed, in conjunction with their law practice, an insurance portfolio of some 870 insurance client files.

On May 17, 1971 the defendant made a tentative written offer of some $53,000 for the portfolio, subject to further negotiations. Negotiations ensued and, by letter dated May 28. 1971, the defendant requested confirmation of a sub-agency agreement between it and Mr Ryan to the effect that the latter would continue to act as liaison between the defendant and certain specially named insurance clients of Stirling & Ryan such as school boards and hospitals and that there would also be commissions payable on any new business brought in under the Sub-agency agreement. The letter also requested confirmation of the undertaking that no member of the legal firm, except as provided for in the sub-agency agreement, would re-enter the insurance business in any way in the Province of Newfoundland for a period of ten years.

On the same day, that is, May 28, 1971, a letter of acceptance of the offer was sent by Stirling & Ryan to the defendant accepting the offer of $53,000 mentioned in the letter of May 17. The letter from Stirling & Ryan did not specifically refer to the defendant’s letter of May 28 but I do not hesitate in finding as a fact that all these letters comprised the agreement between the parties.

Both amounts of $75,000 and $53,000 were eventually paid.

It has been held previously that in certain cases where the only thing purchased is a portfolio list of clients and file copies of current insurance policies in force in the name of the clients, the cost of same is deductible as a current operational expense. (Refer Harbord Investments Limited v MNR, [1970] Tax ABC 717; 70 DTC 1488.) However, whether or not, as stated in that case, it is to be considered as settled law that an expenditure for a list of customers, which includes file copies of current insurance policies, is nevertheless to be considered as a current operational expense, it is clear that, where the goodwill of the business is included as part of the assets transferred, the transaction is regarded as the sale of a business as a going concern and the whole expenditure is considered to be of a capital nature. In considering the issue one must look at the true nature and substance of the transaction not merely at the words used by the parties in describing it.

In neither of the cases before me were the accounts receivable, the use of the trade name, any business property or chattels other than the files and copies of the policies, included in the purchase price. This, of course, does not by itself prevent the expenditure from being of a capital nature. (Refer Wa/ter J Burian v Her Majesty the Queen, [1976] CTC 725 at 728; 76 DIC 6444 at 6446.)

Where the transfer of a list of customers includes the goodwill of a business, the expenditure made for the purchase of these assets is considered at law not only to be made once and for all but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. Such an expenditure is normally to be attributed to capital and not to revenue. (Refer to British Insulated and Helsby Cables, Limited v Atherton, [1926] AC 205 at 213.)

With regard to the Fowler Agency, as it was a corporation owned and operated solely and exclusively by Stan Fowler, who had been in the business most of his lifetime, it matters little that, at law, it possesses a separate legal entity, because in essence the insurance agency was a strictly personal one and any goodwill generated in the business or created in the business would be that of Stan Fowler himself.

For that reason, in determining the true character and nature of the transaction from the defendant’s standpoint, I draw no distinction between Stan Fowler in his personal capacity and in his capacity as president of his company, although it is interesting to note that, in accepting the offer of the defendant, two letters dated July 2, 1971 were signed by Stan Fowler. The letters were identical in content except that one purported to be an acknowledgement and acceptance by Stan Fowler personally and the other by the Fowler Agency signed by Stan Fowler as director of his company. Both letters were on company letterhead. I am certainly not prepared to find that the defendant has established that it would have made the expenditure had it not been assured that Stan Fowler would not be competing with it for the files sold or for future business.

The mere fact that Stan Fowler was 66 years of age and probably anxious to sell and to withdraw gradually from the business does not in my view affect the basic nature of the transaction. He did in fact eventually render his services under the agreement from the defendant’s premises rather than from his company’s former place of business as mentioned in the agreement.

In so far as the agreement with Stirling & Ryan is concerned, although there was no contract of employment at a fixed rate as in the case of the Fowler Agency, there was the same provision against competition for ten years, a definite undertaking to continue to act (with no provision as to any time limit) in their capacity as liaison between themselves and the defendant regarding certain specified special clients of the vendor and a similar sub-agency agreement regarding any new insurance.

It is no answer that in effect, over a period of time, much of the business from the special clients of Stirling & Ryan did go elsewhere notwithstanding the agreement with them and their presumed efforts to preserve that business for the purchaser. The mere fact that a contract might not have proved lucrative does not affect its nature at the time the contract was entered into.

In both cases, the covenants and undertakings extend into the future and, in my view, include all goodwill that could exist with the exception of whatever goodwill could be generated by the use of the name of each vendor. In so far as the use of the places of business was concerned, although no right thereto was purchased, the purchaser, in effect, could not help but receive the benefits flowing therefrom by reason of the sub-agency agreements which granted the defendant a right to any new business so generated subject only to the payment of specified commissions thereon. It appears also that the defendant determined the amount of its offer in each case by employing the earnings approach that is, it based the offers on the earning records of the vendors and calculated the amount on a multiple of two or three times the past annual earnings. The amount paid was not calculated on a fixed number of dollars per file or client.

The mere fact that work was required on the part of the purchaser subsequent to the purchase to generate income from the portfolios purchased, does not prevent the assets purchased from being of a capital nature for it is very seldom that any capital asset will of itself generate income without additional time, effort and money being expended by the owner. In both cases, tne vendors were eliminated as competitors with a covenant not to do business and their help was enlisted for the future by reason of the sub-agency agreements.

In conclusion, the defendant has failed to discharge the onus cast upon it of establishing in either case that the expenditure did not include assets and advantages for the enduring benefit of its trade in insurance and was therefore not in the nature of a capital expenditure.

The case, in my view, is actually much more favourable to the taxing authority from a factual standpoint than the case of Cumberland Investments Limited v Her Majesty the Queen, [1973] CTC 821: 74 DTC 6001, wherein my brother Heald held against the taxpayer. His decision in that case was Unanimously upheld by our Federal Court of Appeal (refer [1975] CTC 439; 75 DTC 5309).

For the above reasons the appeal will be allowed with costs and the original assessment reinstated.