Jean-Paul Rouleau Estate v. Minister of National Revenue, [1991] 1 CTC 2055, 91 DTC 115

Garon, T.C.J. [Translation]:—This case involves appeals from tax assessments dated June 8, 1983 for the taxation years 1977 through 1981. In these assessments, the respondent added to the declared income for those taxation years the following amounts:

In general, the facts are not at issue. Mr. Jean-Paul Rouleau exercised the profession of chartered accountant for many years and was a member in good standing of the "Ordre des comptables agréés de la province de Québec’ during the years in question.

On October 21,1974, Messrs. Raymond Trottier and Michel Viau, chartered accountants then exercising their profession under the corporate name of Trottier Viau Associes C.A., referred to in the agreement as the Party of the First Part, signed an agreement with Mr. Jean-Paul Rouleau, referred to in the contract as the Party of the Second Part, concerning the exercise of their professional activities as chartered accountants.

This agreement provided for a second agreement, as appears in the second whereas of the agreement dated October 21, 1974 which reads as follows:

[Translation]

Whereas after an unspecified period to allow the Parties to become better acquainted with each other and their respective clienteles, a period of not less than one year from signature of this Agreement and not to extend beyond June 1, 1976, another agreement shall be signed between the Parties, should they wish to extend it.

The purpose of the first agreement was to ensure, in the wording of the first whereas:

[Translation]

. . . an immediate semi-merger or association in name, to be followed possibly by a full merger and/or purchase of the clientele of the Party of the Second Part. . .

The agreement also settled a number of administrative questions, including those relating to receptionist and telephone services, stationery, secretarial services, offices, share expenses, trainee salaries, etc.

Clause 12 of the agreement is particularly significant and reads in part as follows:

[Translation]

12—Should the Party of the Second Part become unable to exercise his profession as a result of death, serious illness or accident, or should he decide to give up the practice and sell his clientele for any reason, the Party of the First Part undertakes to buy and the Party of the Second part undertakes to sell his clientele at the following price and on the following terms and conditions:

(a) On [sic] the date of death or retirement, the Party of the First Part shall establish the amount of accounts receivable, of work in progress that it undertakes to complete at the earliest possible date, to pay them to the heir [s/c] or beneficiaries [sic] of the Party of the Second Part as they are received, less ten per cent (10%) as compensation for its work and collection costs [sic].

(b) During the five taxation years following the aforesaid death or retirement, the Party of the First Part shall deliver to the Party of the Second Part and/or his beneficiaries [sic] an amount equal to twenty per cent (20%) per annum of all the fees received [sic] on the clients of the Party of the Second Part, within a period of one month of their receipt. Any fees in arrears by 60 days or more shall bear interest at the maximum bank rate at the time. Such payments shall, after the aforesaid five years, constitute final payment in full for the clientele and files of the Party of the Second Part;

About 15 months later, on January 29, 1976, a second agreement was signed between Messrs. Raymond Trottier, Michel Viau and Roland Taillefer and Trottier, Viau, Rouleau, Brosseau, Taillefer Inc., referred to in the agreement as the Party of the First Part or T.V.R.B., and in these reasons as T.V.R.B., and Mr. Jean-Paul Rouleau, referred to in the agreement as J.P.R. or the Party of the Second Part.

Clause 1 (A) of the second agreement provides for the purchase of Mr. Rouleau's clientele by T.V.R.B. on the following terms:

[Translation]

1. Commencing February 1, 1976, T.V.R B. shall purchase the goodwill or clientele of JPR at the following price and on the following terms and conditions:

(A) The purchase price for the clientele or goodwill shall be twenty per cent per annum, over a five-year period from the date of this Agreement, of the amount of gross fees earned on J PR's clientele, with payment of the aforesaid twenty per cent not falling due until one month after their receipt.

No interest shall be owed for any payment made before the end of the month following receipt.

Any payment in arrears shall bear interest at the rate required of T.V.R.B. by their bank.

It is admitted that, that pursuant to the two contracts, Mr. Rouleau received the following amounts:

Other clauses in the second agreement cover, for example, the division of accounts receivable between the parties, procedures for collecting such accounts, the division of income from work in progress completed but not yet billed and the procedure for completing such work, the retention of Mr. Rouleau’s services on a part-time basis after February 1, 1976 and a number of administrative questions covered in the first agreement.

In filing his income tax returns for the years in question, Mr. Rouleau treated the amounts received as eligible capital amounts within the meaning of section 14 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), including the taxable portion of these amounts in accordance with the aforesaid section and his interpretation of subsection 21(1) of the Income Tax Application Rules, 1971.

The following amounts were included in his income for the years mentioned hereinafter:

This represents a total of approximately $50,000.

On December 12, 1982, Mr Rouleau provided the respondent with a waiver of the four-year limitation on reassessment with respect to the 1977 taxation year.

On February 2, 1983, Mr. Rouleau passed away.

In assessing the appellant, the Minister of National Revenue relied on paragraph 12(1)(g) of the Income Tax Act and included in Mr. Rouleau's income all amounts received by the latter under the aforesaid contracts for the sale of his clientele or goodwill.

The principal question on which I must rule is whether paragraph 12(1)(g) of the Act applies to the amounts received in this way by Mr. Rouleau over the five years in question.

According to one possible interpretation of paragraph 12(1)(g), it may be argued that the payments to be made by T.V.R.B. to Mr. Rouleau for the sale of his goodwill or clientele related to the use of property, that is, the clientele and goodwill in question.

The purchase price of the clientele or goodwill depended on the extent to which T.V.R.B. would use the goodwill or clientele held by Mr. Rouleau at the time of the agreement dated January 29, 1976. If, for example, T.V.R.B. spent little time or effort offering its services to Mr. Rouleau's clientele over the five- year period in question, the gross fees that could be earned from this clientele would obviously be less significant. If the clientele or goodwill is considered property within the context of paragraph 12(1)(g), it may then be said that the amounts received by Mr. Rouleau will vary, either increasing or diminishing as the case may be, depending on the services rendered to his former clientele.

On the one hand, I believe that the amounts received by Mr. Rouleau may be said to have depended on the use made of Mr. Rouleau’s goodwill or clientele.

On the other hand, it may also be argued that the amounts received by Mr. Rouleau under clause 1(A) of the agreement dated January 29, 1976 constituted amounts that became payable to Mr. Rouleau as part of a business that he carried on prior to the agreement of January 29, 1976, so that half of these amounts had to be included under the fourth element of the definition of the expression “ cumulative eligible capital", covered in subparagraph 14(5)(a)(iv).

Whether these amounts represented eligible capital expenditures for T.V.R.B. is not the issue. In any case, they represented the sale of goodwill or clientele for Mr. Rouleau. This was never seriously in doubt.

We may therefore also conclude that at first glance section 14 covering both amounts payable and expenditures made or incurred to acquire property described in subsection C of Part I of the Income Tax Act, such as eligible capital property; see in particular subsection 54(d).

From the foregoing, it appears that the tax treatment of the amounts received by Mr. Rouleau may be governed either by paragraph 12(1)(g) or by section 14 of the Income Tax Act, supplemented by section 21 of the Income Tax Application Rules, 1971.

If paragraph 12(1)(g) is applicable to the amounts received by Mr. Rouleau, these amounts in full, as we have seen, must be included in computing his income.

On the other hand, if section 14 of the Income Tax Act is applicable, only a fraction of these amounts must be included in Mr. Rouleau’s income. This fraction may vary over the years in question or may be an equal percentage for each year, depending on the interpretation to be given to section 21 of the Income Tax Application Rules, 1971. I shall discuss the interpretation that should, in my opinion, be given to section 21 of the Rules later in my reasons.

Given the different tax treatment provided by paragraph 12(1)(g) of the Act on the one hand and by section 14 of the same Act along with section 21 of the Income Tax Application Rules, 1971, on the other, we must choose the section of the Act that is applicable in the present case.

Subsection 4(4) of the Act orders us, in a sense, to make this choice, since it states that no provision of the Act shall be read or construed to require the inclusion, in computing the income of a taxpayer for a taxation year, of any amount to the extent that it has been included or deducted under any other provision of Part I of the Act.

For guidance in making this choice, it is helpful to turn to the rules of construction applied to tax laws that have been recognized by the courts.

In Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; [1984] C.T.C. 294; 84 D.T.C. 6305, the Supreme Court of Canada provided invaluable information on the subject. Estey, J., speaking for the Court, cited with approval the following passage from Construction of Statutes, 2nd ed., (1983), by the renowned author Elmer Driedger (page 207):

Today, there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

This new method of interpreting tax laws was followed by the Federal Court of Appeal in Bristol-Myers Canada Inc. v. M.N.R. (Customs and Excise), [1985] 1 C.T.C. 23; 85 D.T.C. 5024, at 24 (D.T.C. 5025), and the Québec Court of Appeal in Sous-ministre du revenu du Québec v. Lafontaine, [1988] R.L. 1049 (C.A.), at 108.

In view of these guidelines for the construction of statutes and, specifically, tax laws, it seems clear to me that if paragraph 12(1)(g) of the Income Tax Act is applied to the amounts received leading to unexpected consequences that cannot logically be explained.

In order to be convinced of this, we need only consider a few situations likely to arise at least on occasion, if not frequently.

Let us take the case of a taxpayer who acquires the goodwill of a business for a certain price, as was the case here for T.V.R.B., and later disposes of it in return for compensation based entirely on a percentage of the fees to be received by the vendor over a period of time.

Given the provisions of the Income Tax Act in effect during the years with which we are concerned, the taxpayer in question would have to include under the first element, then referred to as " cumulative eligible capital”, half of his purchase price but could not, in disposing of this goodwill, include under the fourth element, half of the proceeds of disposition of the said goodwill, because of the manner in which the compensation was payable.

The full amount of the compensation would instead be included in computing the taxpayer's income under paragraph 12(1)(g). As a result, no amount would be included in the fourth element under cumulative eligible capital, suggesting that the goodwill had not been disposed of. On the other hand, the annual deduction of ten per cent of the cumulative eligible capital, of which one element would be half the purchase price, would be allowed, while upon disposal of the goodwill, the proceeds of disposition would be included in full in the taxpayer's income, presumably disregarding the purchase price, since it would be included under the cumulative eligible capital.

By following this interpretation in a case where compensation is established solely on the basis of a percentage of future gains from the goodwill, we achieve a situation in which the purchaser must include part of the purchase price and yet the same taxpayer cannot include any part of the proceeds of disposition of the goodwill.

This interpretation also leads to unexpected results that cannot be explained logically in cases where the compensation is partly in the form of a minimum lump-sum payment and partly inthe form of future revenues from the disposition of the goodwill.

According to the interpretation supported by counsel for the respondent, in such a case paragraph 12(1)(g) would apply to the portion of the disposition consisting of a percentage of future gains, and the lump-sum payment, though representing only part of the compensation, would be included in the cumulative eligible capital.

This interpretation, whereby paragraph 12(1)(g) would apply to situations in which the amount of compensation depended in full or in part on future gains from the use of the eligible capital property, leads to absurdity and is unacceptable, at least where it is riot evident that such is the clear, unambiguous intention of Parliament.

On the other hand, if section 14 is applicable in all cases, the form of compensation is unimportant; the result is a logical, easily explained tax treatment.

It could, in fact, then be said that in 1972 the Parliament of Canada established a "code" with respect to the tax treatment of expenditures and amounts payable upon acquisition or disposition of that category of property referred to as "nothings" under the former Act.

This class of disposition is covered by section 14 of the Act, supplemented temporarily by section 21 of the Income Tax Application Rules, 1971, paragraph 20(1)(b) and section 24 of the Income Tax Act in certain cases.

This interpretation, whereby section 14 applies in all circumstances, regardless of the form of compensation, has the particular advantage, in my view, of providing a similar tax treatment to related or analogous situations in economic terms.

According to this interpretation, the tax treatment of the amounts received in the present case by Mr. Rouleau, a total of close to $150,000 spread over a five-year period, would be identical to the tax treatment of similar amounts received by another taxpayer where compensation was expressed in the form of a lump-sum payment of the same order, payable, let us say, over an equal five-year period.

I accordingly conclude, on the basis of the rules of construction examined earlier, that paragraph 12(1)(g) does not apply to the amounts received by Mr. Rouleau over the years in question.

In this regard, it may be significant that prior to 1972 the equivalent of paragraph 12(1)(g), which was paragraph 6(1)(j) at the time, was never, to my knowledge, applied to cases of the type with which we are concerned here.

Counsel drew my attention to the decision of this Court in Raymond Brosseau v. M.N.R., [1986] 1 C.T.C. 2558; 86 D.T.C. 1412. It appears in that case that the Court did not have the benefit of comments on principles of construction and, specifically, information on new trends in interpreting tax law, initiated, in my opinion, by Stubart, to which I referred earlier.

I was also referred to another decision of this Court in 289078 Ontario Ltd. v. M.N.R., [1987] 1 C.T.C. 2095; 87 D.T.C. 38. I believe that case may be distinguished from the present case by substantially different facts.

My conclusion that paragraph 12(1)(g) does not apply to the amounts received by Mr. Rouleau is compatible with the decision of Strayer, J., in The Queen v. Mel-Bar Ranches Ltd., [1989] 1 C.T.C. 360; 89 D.T.C. 5189, which restricted the application of paragraph 12(1)(g) of the Income Tax Act, admittedly in a different context in certain respects.

There remains the question of how to apply section 21 of the Income Tax Application Rules, 1971.

On this issue, I also share the view of counsel for the appellant that the applicable percentage is the one indicated in that section for the year in which the agreement was signed, in point of fact, 1976, as the agreement was dated January 29, 1976. At the time, the rate was 60 per cent.

The word “operation” in the French version of section 21 of these rules refers, for example, to the contract whereby a taxpayer disposes of an intangible asset. The use of the word "transaction" in the English version supports this interpretation.

No valid reasons were given to this Court, in my view, to justify a different tax treatment where amounts payable were paid, as in the present case, according to a predetermined percentage of future gains over a fixed period of time or whereby the compensation consisted of amounts known in advance and also staggered over a period of time.

In my opinion, this interpretation does not conflict with the view expressed in Interpretation Bulletin 123R4.

In light of my conclusion in this case, there is no need to discuss other questions raised in the preliminary hearings of these appeals, such as whether goodwill is an asset within the meaning of the Act or the effect of the waiver dated December 12, 1982 signed by Mr. Rouleau.

For these reasons, the appeal is allowed with costs and the assessments for the five years in question are referred back to the respondent for reconsideration and reassessment, in accordance with the reasons for this judgment.

Appeal allowed.