The Queen v. Saskatoon Drug & Stationery Co. Ltd., 78 DTC 6396, [1978] CTC 578 (FCTD)

Mahoney, J:—This action results from the plaintiff’s disallowance of the defendant’s claim of $207,500 “goodwill” as property, namely a leasehold interest, for purposes of capital cost allowance under paragraph 11 (1)(a) of the Income Tax Act as it stood in 1969 and 1970.

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;

The deduction is claimed under paragraph 1100(1)(b) of the Income Tax Regulations.

1100. (1) Under pragraph (a) of subsection (1) of section 11 of the Act, there is hereby allowed to a taxpayer, in computing his income from a business or property, as the case may be, deductions for each taxation year equal to

(b) such amount, not exceeding the amount for the year calculated in accordance with Schedule H, as he may claim in respect of the capital cost to him of property of class 13 in Schedule B;

Class 13 property is “Property that is a leasehold interest except . . .” None of the exceptions are in play. The primary issue is thus whether or not the $207,500 ought to be characterized as having been paid for a leasehold interest. The secondary issue is whether or not the legal and other expenses incurred by the defendant in the transaction in question were properly disallowed as deductions from income as having been incurred on account of capital or whether their deduction ought to be allowed or, alternatively, whether the amount thereof ought to be added to the capital cost of the leasehold interests.

During 1967, the defendant entered into negotiations with a group of individuals and companies, which will be collectively referred to as “McNeill”, for the purchase from McNeill of three retail drugstores in Regina, Saskatchewan, one in premises owned by McNeill, the Broad Street store, and two in premises leased by McNeill, the Pharmaceutical Centre and the South Albert Street store. McNeill operated other retail drugstores, as well as wholesale operations serving them, in Regina and Calgary, which the defendant was not interested in buying. The defendant then had three retail stores of its own in Regina and others in Saskatoon. The defendant thought it had a deal but McNeill refused to close early in 1968. In November, 1968, Cunningham Drug Stores Ltd made McNeill an offer for all of its retail stores which was unacceptable. McNeill then indicated to the defendant that it was prepared to negotiate the sale of all of its Regina operations.

In the circumstances, the defendant insisted on a written offer from McNeill before investing time and money in further negotiation. The original draft offer to sell, apparently prepared by the defendant, contemplated the payment of a “premium” in addition to the price of inventories and fixtures. The premium was to be divided between “Amount for purchase of leasehold interest to be . . .” and “Balance of premium amounting to . . . to be paid in form of Good Will”. The next draft offer to sell was submitted by letter of December 2, 1968, by MeNeill to the defendant. It proposed “Goodwill shall be . . . $300,000 . . .”’ It proposed no amount for purchase of leasehold interests. The executed offer to sell, dated December 6, 1968, contemplated the sale of the “A Inventory . . .” at a variety of discounts off retail prices, “B Fixed Assets . . .” at book value and ‘‘C Goodwill.” Payment for the inventory and fixed assets was to be within three days of the contemplated January 31, 1969, closing and it went on:

(c) The sum of $290,000 on account of good will repayable over a period of 5 years at the rate of $58,000 per year . . .

with interest. It then went on to provide:

3. This offer shall be subject to further conditions and provisions as follows:

(1) That the purchaser is able to obtain satisfactory leases to the premises to be acquired and the vendor takes the necessary steps for the assigning of its leases now held by the vendor to the purchaser.

(2) That leases will be given to the vendor [sic] of property owned by the vendors and upon which certain of its drug store businesses are located and such leases shall be in like terms (excepting for rent, options for renewals, and term of lease) as the lease existing between Humford Realty Ltd and McNeill’s Drug Stores Ltd dated November 22, 1965. It is further understood that in such leases if due to operation of business, the purchaser’s rent due falls to the basic rate of $2.50 per square foot, then in that event, there shall be added to the basic rent of the premises any increase in taxes over the 1968 level on a pro rata basis to the area occupied by the purchaser and to be paid on a monthly basis.

There are additional conditions and provisions enumerated but (1) and

(2) are the only ones material to this action.

The Humford lease was the lease of the South Albert store. Considering the exceptions of rent, term and renewal options, it is plain that at this stage no agreement had been reached as to the leases to be concluded between McNeill and the Defendant in respect of the three premises owned by McNeill.

By January 8, 1969, when McNeill’s solicitor transmitted a draft lease, the essential terms had been agreed upon. The Broad Street store was to be subject to a five-year lease with five successive five- year renewal options and the other two were to be five-year leases with four successive five-year renewal options. All renewal leases were to be on the same terms and conditions as the original leases. A minimum rent of $2.50 per square foot per annum against 4% of annual gross sales was proposed and, as contemplated in the offer to sell, the tax escalator would become operative only when gross sales were so low that no percentage rent was payable. While the proposed term of the Broad Street lease changed during negotiations, the proposed rent did not.

By letter of January 24, 1969, the defendant’s solicitor sent it a draft of an agreement intended to reflect the entire transaction. It provided, in its material parts, as follows:

1. .the vendor agrees to sell and the purchaser agrees to purchase all the undertakings, property and assets belonging to or used in connection with the said businesses of the vendor, as a going concern, . . . including without limiting the generality of the foregoing:

(a) The goodwill of the said businesses, together with the exclusive right to the purchaser to represent itself as carrying on the said businesses in continuation of and in succession to the vendor and the right to use any words indicating that the said businesses are so carried on including the right to use the name “McNeill’s Drugstores Ltd” or any variation thereof as part of the name of or in connection with the said businesses or any part thereof carried on or to be carried on by the purchaser;

(c) The full benefit of all unfilled orders received by the vendor in connection with the said businesses and all other contracts, engagements, benefits and advantages which have been entered into by the vendor or to which it is or can be entitled on account or in respect of the said businesses.

3. The purchase price payable for the assets hereby agreed to be purchased and sold shall be the aggregate of the values of all classes of assets as hereinafter set forth.

(a) The assets described in paragraph 1(a) and 1(c) hereof for the sum of $290,000.

The draft also reflects an apparent agreement postponing the closing date.

A memorandum prepared by Mr H C Pinder, the defendant’s secretary-treasurer, and communicated by telephone on February 7, 1969, to its solicitor contains the following material comments.

(a) Draft Agreement

2. have inserted in price section page 2(a) [‘‘and leasehold interest in leased properties, and the right to lease in owned properties at a rental rate not to exceed 4% of sales”] (intangibles)

(b) Lease—5th & Pasqua

6. Page 14—FIRE, if lease is terminated under total destruction—tenant should recover pro rata portion of purchase price

NB over full lease and option periods—(ie cannot insure the premium paid on purchase over and above value of assets,

—or new lease on rebuilding

—or option to buy property.

On January 30, 1969, having apparently considered the draft after amendment to reflect Mr Pinder’s instructions, McNeill’s solicitor wrote the defendant’s solicitor. He stated, inter alia,

5. Page 4, paragraph 3, sub-paragraph (a)

The vendor requires that the sum of $290,000 be referable exclusively to the term good will and nothing else.

In the margin, apparently in Mr Pinder’s handwriting is an underlined “no”. On February 28, the defendant’s solicitor reported by letter on a series of meetings with McNeill’s solicitor including, in reference to the January 30 letter, the following:

Paragraph 5—refused.

It also appears that McNeill had agreed in principle to Mr Pinder’s suggestion as to the fire clause. They were prepared to commit themselves, at their option, to rebuild within 12 months of destruction or to repay a pro rata portion of the goodwill payment.

At this point, Mr Pinder wrote himself the following memorandum:

Inserting “Leasehold Interest’’ in para 1 of agreement only, before (a) of that paragraph. Check with auditor.

The auditor was consulted and, it appears, the specific inclusion of the leasehold interests in the consideration for the $290,000 payment was no longer pressed by the defendant but the idea reflected in the memorandum was accepted by McNeill.

Negotiations did continue as to the fire clause. This defendant wanted the provision to apply for ten years; McNeill held out for five. The basis of their position was explained by their solicitor to the defendant’s, as reported in his letter of March 3rd, 1969, to his client:

Mr Goetz explained this to me on the grounds that after five years you would have recovered the total amount of the goodwill out of profits; and that the formula for determining the goodwill was based n two and one-half times the average profits for the immediate proceeding two years.

In the result, on March 28, 1969, the agreement was executed providing for the sale effective April 1, The material provisions follow:

1. . . the vendor agrees to sell and the purchaser agrees to purchase all the undertakings. (leasehold interests and right to enter into leases as set forth on page 7 hereof), (emphasis added) and assets belonging to or used in connection wit hthe said businesses of the vendor, aS a going concern, . . . Including without limiting the generality of the foregoing:

(a) The goodwill of the said businesses, together with the exclusive right to the purchaser to represent itself as carrying on the said businesses in continuation of and in succession to the vendor and the right to use any words indicating that the said businesses are so carried on including the right to use the name “McNeill’s Drug Stores” or any variation thereof as part of the name of or in connection with the said businesses or any part thereof carried on or to be carried by the purchaser;

3. The purchase price payable for the assets hereby agreed to be purchased and sold shall be the aggregate of all classes of assets as hereinafter set forth.

(a) The assets described in paragraph 1(a) hereof for the sum of $290,000.

6. The purchase price . . . shall be paid . . . as follows:

(a) The sum of $10,000 shall be paid to the firm of Goetz & Murphy, Regina, Saskatchewan, in trust to be retained by it until the time of closing, upon the Vendor providing the purchaser with valid and binding assignments of leases in favour of the purchaser with proper consents of the lessors to such assignments covering the following real properties:

(i) McNeill’s North Plaza Drug . . .

(ii) McNeill’s Pharmaceutical Centre . . .

(iii) McNeill’s South Albert Drug . . .

(iv) McNeill’s Highland Park Drug . . .

and the vendor providing the purchaser with leases of the following real property owned by the vendor at:

(i) McNeill’s Rexall Drug . . .

(ii) McNeill’s Broad Street Drug . . .

(iii) McNeill’s Lome Drug . . .

on the terms and subject to the conditions set in the draft leases hereunto attached and marked as schedules “A”, “B” and “C”.

The foregoing seven locations, and I have omitted only municipal addresses, are the “leasehold interests and right to enter into leases as set forth on page’’ 7 which are referred to in the bracketed addition to clause 1. That addition substituted in the executed agreement, those words for the word “property”, which appeared in the earlier drafts of clause 1.

In addition to the tangible assets, inventory and fixtures, for which $353,980 was paid, the defendant acquired a number of rights and intangible assets, to which no portion of the $290,000 balance of the purchase price was specifically attributed. There were, of course, the leases assigned or granted by McNeill. The vendors severally agreed not to compete for five years. There was a right of first refusal, apparently for five years, to buy convenience stores known as “The Happy Shopper” operated in Regina by McNeill. There were non- assignable rights of first refusal, in the leases, during their terms including renewals, to buy the real property leased, in whole or part, as the Rexall, Broad Street and Lome stores.

As to the so-called “fire clause”, the agreement stipulated that, in the event of termination due to total destruction prior to April 1974, provided the defendant was still carrying on the business purchased on the premises,

. . . the vendor shall pay to the purchaser by way of liquidated damages in respect of any such lease the following:

(a) (i) Lease

Covering McNeill’s Rexall Drug . . .

(ii) Damages to be Paid

The proportionate share of $30,000 . . .

(b) (i) Lease

Covering McNeill’s Broad Street Drug . . .

(ii) Damages to be Paid

The proportionate share oî $120,000 . . .

(c) (i) Lease

Covering McNeill’s Lorne Drug . . .

(ii) Damages to be Paid

The proportionate share of $35,000 . . .

The “proportionate share’’ was the number of whole months remaining in the term at the date of total destruction divided by 60.

Immediately upon closing, the defendant sold the inventories and fixed assets of the Lome, Rexall and Highland Park stores for the price paid and, in addition, for goodwill an aggregate of $82,500, thus reducing its outlay for goodwill from $290,000 to the $207,500 in issue. It got $40,000 in respect of the Lome store rather than the $35,000 assigned to it in the fire clause; $30,000 in respect of Rexall, the same as the assigned amount and $12,500 in respect of Highland Park. As the end of 1969, the defendant sold the North Plaza store which was leased on a month to month basis and, in respect of which, no goodwill was recovered. In addition to the seven retail stores, two wholesale operations, one for pharmaceuticals and the other for other merchandise, were bought. These operated in the premises of the Lome store. The defendant had no use for the operations per se and Simply. absorbed the inventories into its own wholesale operations. There was no leasehold interest attached to them. Thus, by the end of 1969, the defendant retained only the three retail stores it had originally wanted.

The Pharmaceutical Centre had opened during 1967. The annual rental (there was no percentage rent) was well over $10 per square foot. It is not argued that any part of the $207.500 was paid for a leasehold interest in respect of it. The Broad Street and South Albert stores remain.

Before dealing with them, I should note that the defendant, which Operates its own drug stores under the name “Pinder”, did not really want to use the McNeill name although ii clearly wanted it removed from the Regina marketplace. It continued to use the McNeill name only until the next telephone directory was issued, apparently about a year after the purchase. In the interval, it advertised its own Regina stores and those retained from the McNeill purchase, under the joint name “Pinder-McNeill”. With the new telephone directory, signs were changed and the McNeill name disappeared completely.

The plaintiff called, as an expert witness, James P Catty, and the defendant called Clifford W Worden. Both are chartered accountants and Catty is an experienced business valuer. Their conclusions are totally contradictory. Worden concluded that the earnings of the McNeill operations sold would not justify payment of any part of the $290,000 while Catty concluded that the earnings did justify a payment for goodwill he calculates at $283,000. While an earnings based valuation was Worden’s only approach, Catty took other approaches to the valuation of the goodwill attaching to the subject matter of the sale, all of which led him to conclude that $290,000 was a fair figure for goodwill. Neither report is of assistance in resolving the initial question of whether or not any part of $290,000 was paid, not for goodwill, but for the Broad Street and/or South Albert leases. Worden’s report is of no assistance in answering any of the other questions that appear pertinent to me. $290,000 was paid for something and I am satisfied, after hearing Mr Pinder, that the defendant wouid not have paid it for something not approaching $290,000 in value.

The South Albert store, of approximately 2500 square feet, is located in a shopping centre, the anchor tenant of which is a national chain supermarket, on the main north-south artery through Regina. The term of the lease assigned was for ten years from January 1, 1966. The minimum annual rent was $6,000 ($2.40 per square foot) against 5% of gross sales. Sales of tobacco products, soft drinks, magazines, utility collections and sub post-office transaction are excluded. Sales in 1967 and 1968 had been sufficient to bring the percentage rent provision into operation. A single five-year renewal option required renegotiation of the rent. The document is a standard shopping centre lease calling for the tenant to pay, in addition to rent, for such things as utility charges, common area maintenance and municipal tax increases over 1966.

Mr Pinder testified that he considered the South Albert lease to be a favourable one, from the tenant's point of view, in the market at the time. The only solid evidence before the Court in support of that conclusion is that, in a very similar shopping centre directly across Albert Street, the drugstore lease of approximately 4280 square feet stipulated a percentage rent of 6% of gross saies without exclusions. It was for a twenty-year term from March 1, 1961 and provided for two successive five-year renewal leases at rents to be negotiated. On the other hand, there is evidence in the report of Howard P Hamilton, one of the plaintiff’s expert witnesses, of shopping centre drugstore leases entered into in Regina in the latter half of the 1960’s calling for percentage rents of both 5% and 6% of gross sales. These leases are not themselves in evidence and, without them, one cannot really compare the respective deals. I might also observe that even a comparison of shipping centre leases without knowledge of the antecedent building agreements can be misleading since the rent is bound to be influenced by such factors as who paid for what by way of finishing the premises. In the result, while I accept Mr Pinder’s judgment that the South Albert. lease was a relatively favourable lease from a tenant’s point of view, the evidence does not establish that it was so favourable, in relation to the market, that a prospective tenant would pay anything for it over and above the assumption of the tenant’s obligations under it.

In the result of the negotiations, the lease of the Broad Street store was for a term of ten years from April 1, 1969 with options in favour of the defendant to renew for three successive five-year terms on the same conditions including rent and a non-assignable right of first refusal to buy the building. The annual rent, as originally proposed, was $2.50 per square foot against 4% of gross sales, subpost-office transactions and utility collections being excluded. The tax escalator was operative only if no percentage rent was payable, a situation not anticipated in view of the store’s sales record and not, in fact, encountered. Indeed, the first year’s monthly rental instalments were fixed on an annual rental forecast well above the $2.50 figure. The defendant was responsible only for telephone, electricity and water Supplied the premises.

I accept the evidence cf Jack M Warren, an expert witness called by the plaintiff, as to the character of the Broad Street store and its neighbourhood. It occupies the entire ground floor and, for storage, part of the basement of a free-standing building on the east side of Broad Street. The ground floor area is approximately 3,462 square feet and the basement 1044 square feet. There are apartments in the upper floors. The front, three storey, portion was built in 1912; a two storey addition at the rear was built in 1938. It has been well maintained and extensively renovated from time to time. Its condition is average for its age. There is parking on the lot.

That portion of Broad Street is a four lane north-south traffic artery on the easterly fringe of Regina’s downtown business area. Development fronting on it is mainly commercial while neighbouring streets are high density residential. The Regina General Hospital is two blocks east of the Broad Street store. It is the closest drugstore to the hospital and the closest public transit stops to the hospital are directly in front of and across Broad Street from the store. This appears to be a particular advantage in terms of sale of gift items, rather than prescriptions.

Sales at the Broad Street store, during McNeill’s fiscal years ended January 31, 1966, 1967 and 1968, of the sort that would be subject to percentage rent, had been $364,612, $427,251 and $477,483 respectively, in the order of one quarter of McNeill’s total sales each year and, obviously, growing at a very satisfactory rate. Sales for the year ended January 31, 1969 were not ascertained when the agreement was concluded and are not in evidence; however, the defendant’s sales from the store for the nine months April 1 to December 31, 1969, were $373,459.

Howard P Hamilton, a Calgary real estate appraiser called as an expert by the plaintiff, concluded that the base rate of $2.50 was about typical for the type of property, that the potential 25 year term was longer than typical, and that the 4% rate of percentage rental would not have produced any premium on an assignment of the lease in 1969. In conclusion, he was of the opinion that no measurable premium should be attributed to the Broad Street lease. Mr Hamilton considered only shopping centre outlets in comparing Broad Street to other drugstores.

While it is likely that Hamilton had to turn to shopping centres in order to find any number of drugstore leases with percentage rent provisions there are obvious costs and, no doubt compensating, benefits to a business in a shopping centre that do not pertain to a business like the Broad Street store. In the circumstances, it seems to me that the approach of the plaintiff’s other expert, Jack M Warren, who included other free-standing buildings in his comparables, is to be preferred. Warren is a real estate appraiser employed by Revenue Canada, formerly resident at Saskatoon, now of Ottawa. Warren also compared, as best he could, tenant’s occupancy costs in the Broad Street store with those of his other comparables. I will refer only to the free standing locations, all in Regina.

1. McGregor’s Drugs, 2100 square feet, leased November 29, 1971, for five years with one five-year renewal at a renegotiated rent. Initial rent $400 per month for first thirty months, $450 thereafter, average annual rental $2.43 per square foot. Gross sales in 1972— $169,090: in 1973—$174,522. Average annual rent is 2.84% of average gross sales. Tax escalator over 1971 base. After taking into account taxes, insurance, licenses, cleaning, repairs and maintenance, heat and utilities, Warren calculated the tenant’s average occupancy cost, including rent, at $9,278 or 5.48% of gross sales for those years.

2. Harris’ Drugs, 1606 square feet, leased September 1, 1965, for ten years with one five-year renewal at a renegotiated rent. Rent is $4,134 or $2.57 per square foot annually. Gross sales in 1970— $125,795; in 1971—$130,731 and in 1972—$137,439. Tax escalator over 1965 base. Warren calculated the total tenant’s average occupancy cost, including rent, at $6,731 at 5.35% of gross sales for those years.

3. Duncan’s Drugs, 1211 square feet, leased on a month to month tenancy for $3,100 per year, or $2.56 per square foot, with the tenant paying all expenses except taxes. Gross sales in 1969 were $89,496 and the estimated total tenant’s occupancy costs, including rent, were $5,657 or 6.32% of gross sales that year.

For the Broad Street store, taking into account nine months operation in 1969, Warren’s calculation of the defendant’s total annual occupancy costs, including rent, was 5.32% of gross sales for 1969 and 5.63% for 1970. None of Warren’s comparables were subject to payment of percentage rent and all were obviously much smaller stores. It is also true, as was brought out in cross examination, that expenditures characterized under the accounting titles Warren adopted as reflecting occupancy costs may properly vary significantly in both amount and content from one business operation to another. That said, Warren’s approach does seem to me the only practical basis for comparing the costs to the tenant of the Broad Street lease, with those of other drugstores not in shopping centres. As in the case of the South Albert lease, the evidence does not establish that the Broad Street lease was so favourable to the tenant, relative to the market, that a prospective sub-lessee would pay anything for it beyond assumption of the tenant’s obligations under it.

Halsbury is sufficient authority for the proposition that the law has long recognized the distinction between personal and local goodwill.* [1]

A distinction has been drawn between personal goodwill, which is merely the advantage of the recommendation of the owner of a business and of the use of his name, and local goodwill which is attached to premises, and must be taken into account in calculating the value of such premises.

The only evidence I have as to the local goodwill attaching to the south Albert store is the opinion of the plaintiff’s expert, Catty, that it was $67,500. That figure was arrived at by a calculation that accepted $120,000 as the proper amount for the Broad Street store’s local goodwill and took account of relative sales. In the circumstances, I accept $67,500 as the correct figure.

I should note that, in his report, Catty referred to “‘Goodwill of location and continuity”. The emphasis is mine. Nowhere did he elaborate on the particular significance of “continuity” as distinct from location. At page 6 he wrote:

5. Location and Continuity

Goodwill of location, in particular for retailers, is often confused with lease value. They are not the same. Goodwill of location relates to traffic patterns about an outlet. This traffic and the related business can be enhanced or diminished by many external factors such as residential development in the area, the opening of a competitor across the street, and so on.

Continuity is, I take it, the aspect of location involving the carrying on by a new owner of a going concern in its established place of business.

As to the Broad Street store, the evidence establishes clearly that there was, in fact, a particular advantage to its location. That advantage had a value. While McNeill and the defendant did not expressly quantify that value it seems to me they did so implicitly. If the store had been totally destroyed a moment after closing and, in consequence the lease had terminated, the defendant would have been entitled to recover $120,000 of the $290,000 paid for goodwill. That $120,000 was intended to compensate the defendant for something intangible it had bought from McNeill and would lose as a result of the lease’s termination. It would not have lost its exclusive right to trade under the McNeill name nor its right to enforce the restrictive covenant. It would not have lost the Happy Shopper first refusal. It would have lost only two intangible assets: its right of first refusal on the sale of the Broad Street property and its right to operate its drugstore at that location for the next 25 years.

The $120,000 figure had been arrived at in a process of hard bargaining between parties dealing at arm’s length, both professionally advised and both knowledgeable of the location and of the business conducted and to be conducted thereon. The agreement is conclusive that $120,000 was the value of those two intangible assets.

That the value of the right of first refusal was, at best, nominal is confirmed by the fact that, again in arm’s length transactions between knowledgeable parties, the defendant sold the goodwill attaching to the Lome and Rexall stores for as much or more as it paid for it without being able to assign the right of first refusal. I accept, as did Catty, that the $120,000 paid for goodwill in respect of the Broad Street store was paid entirely for local goodwill or goodwill of location.

The essence of the question is, as stated by Kearney, J, in Plouff v MNR, [1965] 1 Ex CR 781 at 797; [1964] CTC 580 at 596; 64 DTC 5351 at 5359.

To what extent, if any, does goodwill which is attached to the premises, as opposed to personal goodwill, form part and parcel of a leasehold interest?

Regrettably, it was found unnecessary to answer the question then because, it was found as a fact, there was no goodwill of value involved in the transaction and, it followed, the amount in issue was indeed the capital cost of the leasehold interest. The question has not been posed since.

A number of English cases, applying the provisions of the Landlord and Tenant Act, 1927* [2] were cited to me. They are not particularly helpful but do call attention, for what it is worth, to a determination by the Parliament at Westminster that local goodwill created by a tenant enhances the value of the realty, as do physical improvements. It is something for which the tenant may be entitled to compensation by the landlord upon termination of the tenancy.

The Australian cases are somewhat more apt. There, the federal income tax statute! [3] provided that premiums or like consideration “demanded and given in connection with leasehold estates” should, as the case may be, either be included in or deductible from taxable income, to adopt Canadian terminology. The High Court of Australia has held that consideration for local goodwill was paid and received “in connection with leasehold estates” in sales of going concerns where the vendor granted a lease of the subject premises.! [4] In the first case, the vendor-landlord who sold the goodwill of location was the unsuccessful appellant; in the second, the purchaser-lessee who bought was the successful respondent.

An anology, which was not drawn in argument but seems pertinent to me, is to be found in the expropriation of interests in real estate. Whether that interest be fee simple or leasehold, the value of the goodwill of location, if a business is conducted upon it, is accepted as one of the elements making up the value of the expropriated interest.

Referring specifically to the present federal legislation^, [5] the only thing authorized to be expropriated is an interest in land and the only compensation authorized to be paid is the value of the expropriated interest. It expressly recognizes that where the owner of the expropriated interest is dispossessed, its value includes “the value to the owner of any element of special economic advantage to him arising out of or incidental to his occupation of the land”’.

An owner dispossessed might well be entirely compensated for local goodwill in being paid the market value of the property. However, a tenant dispossessed is equally entitled to such compensation. Since, under the Act, the only thing that can be taken and paid for is an interest in land and since the tenant’s only interest is leasehold, it must be concluded that, in the scheme of the Expropriation Act, local goodwill is part and parcel of the leasehold interest.

In tax cases, it is the substance of a transaction that is to be regarded.* [6] The issue raised in this action is, so far as counsel and the Court were aware, novel in the context of Canadian income tax law. While the question has been asked before, it appears not to have been answered. I doubt that this will be the last word on it.

Chissum v Dewes (1828), 38 ER 938, was decided well before the form of commercial transactions came to be dictated by the provisions of modern taxing statutes and before goodwill had been sliced into as many subdivisions as, it appears from the evidence, is the case today. The goodwill referred to in the decision is obviously what would today be called goodwill of location or local goodwill. In that case, the unexpired term of a lease, subject to an equitable mortgage, was sold as a package with the goodwill of the business carried on in the premises in the realization of the estate of the deceased tenant. The aggregate sum realized was insufficient to satisfy the debt secured and it was sought to apportion the consideration and to pay the mortgagee only that part attributable to the unexpired term. The Master of the Rolls, Sir John Leach, held:

The good-will of the business is nothing more than an advantage attached to the possession of the house; and the mortgagee, being entitled to the possession of the house, is entitled to the whole of that advantage. I cannot separate the good-will from the lease.

Like the learned Master of the Rolls, I am unable to divorce the goodwill of a location from the other advantages accruing to the person entitled to possession of that location. When it accrues under a lease, it is part of the leasehold interest and the price paid for it is part of the capital cost of that leasehold interest.

There is no basis for disturbing the assessment disallowing the claimed deduction of the expenses incurred in negotiating the McNeill transaction. While raised in the pleadings this matter was not dealt with in argument.

The defendant’s 1969 and 1970 income tax returns will be referred back to the Minister for reassessment on the basis that $187,500 was the capital cost of the leasehold interests in the Broad and South Albert Street stores in respect of which the defendant is entitled to claim capital cost allowance. The remaining $20,000 in issue was not proved to have been paid for any leasehold interest.

The decision of the Tax Review Board, [1975] CTC 2108; 75 DTC 103, apparently rendered without the benefit of much of the evidence before the Court, was that 50% of the $207,500 be assumed to have been paid for leasehold interests. In the result, therefor, the defendant has been entirely successful in its defense and largely successful in its counterclaim and is entitled to its costs of both to be taxed on the basis of having been a Class III action.

Counsel for the plaintiff argued for a disposition of costs, in the event of the defendant’s success, as was done in Herb Payne Transport Ltd v MNR, [1964] Ex CR 1 at 16; [1963] CTC 116 at 129; 63 DTC 1075 at 1082, where the taxpayer. while successful in the action, was found to have been the principal author of a largely unnecessary dispute. I have considered that representation but do not think the circumstances are more than superficially comparable and, accordingly, reject it.