U.S.M. Canada Ltd. v. R., [1996] 2 CTC 2289, 97 DTC 192

Tremblay J.T.C.C.: — This appeal was heard on November 15, 1995, at Montreal (Quebec).

1. Point at issue

The point at issue is whether from the amount of purchase of $7,749,689 paid by the appellant to acquire Shoe Machinery Group Business (S.M.G.B.), Division of Emhart Canada Limited (Emhart) in April 1987, the Minister of National Revenue was correct in allocating the sum of $3,881,761 as the cost to the appellant for the purchase of goodwill and therefore reducing the amount allocated by the appellant as consideration paid of assets of Class 29 of Schedule II of the Regulations of the Income Tax Act (the Act). The appellant had allocated this amount to the value of the leased machinery.

The Minister contends that the allocation made by the appellant was not the result of an agreement or of negotiation between itself and the vendor but was rather a unilateral decision of the appellant.

The appellant contends that its decision is based on sections 6.1 and 6.2 of the Purchase and Sale Agreement and the Assets Subsidiary Agreement.

2. Burden of proof

2.01 The burden of proof is on the appellant to show that the respondent’s reassessments are incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v. Minister of National Revenue, [1948] S.C.R. 486, [1948] C.T.C. 195, 3 D.T.C. 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his reassessments were also deemed to be correct. In the present case, the assumed facts are described in paragraphs 6a) to g) of the Reply to Notice of Appeal as follows:

6. In establishing the reassessments for the Appellant’s 1987, 1988 and 1989 taxation years, the Minister of National Revenue relied, inter alia, upon the following facts:

(a) in April 1987, the Appellant acquired the Shoe Machinery Group Business (S.M.G.B.) Division of Emhart Canada Limited, in a transaction entered into by each of their parent companies;

(b) the total purchase price to the Appellant for the S.M.G.B. was $7,895,761. in Canadian funds;

(c) of the amount mentioned in subparagraph b) $3,881,761. (Canadian)

was incorrectly allocated by the Appellant to the costs of Class 29 assets;

(d) the allocation of the purchase price made by the Appellant was not reasonable;

(e) the vendor of the S.M.G.B. allocated the amount of $3,796,450.

(Canadian) of the purchase price as proceeds of disposition of goodwill;

(f) both amounts referred to in subparagraphs (c) and (d) relate to the amount of $2,900,000. (U.S.) referred to in the contracts between the buyer and seller;

(g) the cost to the Appellant for the acquisition of the goodwill amounted to $3,881,761. (Canadian).

3. Notice of Appeal

3.01 The facts alleged by the appellant in its Notice of Appeal and admitted, denied or declared no knowledge by the respondent, read as follows:

INTRODUCTION

1. The Appellant hereby appeals from a reassessment issued by the Minister of National Revenue on 3 August 1992 pursuant to the Income Tax Act (1970- 71-72 S.C., C. 63) as amended (“LT.A.”) relating to its 1987 taxation year.

2. The Appellant hereby appeals from a reassessment issued by the Minister of National Revenue on 3 August 1992 pursuant to the I.T.A. relating to its 1988 taxation year.

3. The Appellant hereby appeals from a reassessment issued by the Minister of National Revenue on 3 August 1992 pursuant to the I.T.A. relating to its 1989 taxation year.

FACTS

4. The Appellant is a corporation duly constituted under the Business Corporations Act, R.S.C. 1985, c. C-44, and has its head office at 7700 De Lamartine Street, in the City of Anjou, Province of Québec

5. The Appellant was incorporated on April 14, 1987 and commenced its operations on May 1, 1987.

6. The principal business of the Appellant consists in selling, leasing, rebuilding and repairing shoe and press cutting equipment as well as the sale of shoe merchandise and components.

7. On April 30, 1987, the Appellant purchased substantially all the assets of a division of Emhart Canada Limited.

8. More specifically, an “Assets Subsidiary Agreement” was entered into between the Appellant and Emhart Canada Limited on April 30, 1987, the whole as more fully appears from a copy of the said “Assets Subsidiary Agreement”.

9. Prior to the signature of the “Assets Subsidiary Agreement” a Resolution of the Board of Directors of USM Canada Limited was adopted on April 29, 1987, the whole as more fully appears from a copy of the said Resolution of the Board of Directors.

10. According to the said Resolution of the Board of Directors, it was more specifically resolved:

1. That the Corporation purchase from Emhart Canada Limited (“Emhart Canada”) all of the rights, titles and interest of Emhart Canada to all of the Assets related to the SMG Business;

2.

3. That the price for such sale of shares be the sum of U.S. $5,509,000, which price shall be paid and be subject to adjustments in accordance with the provisions of the Master Agreement.

11. According to the Resolution of the Board of Directors, it was specifically provided that the price of the acquisition of the Net Assets of Emhart Canada Limited was subject to adjustments in accordance with the provisions of the Master Agreement.

12. The Appellant points out that the acquisition of the Net Assets reflected in the “Assets Subsidiary Agreement” dated April 30, 1987 was concluded in the context of a worldwide acquisition entered into between Emhart Corporation and Ablekind Limited.

13. As stated herein in paragraph 12, a “Purchase and Sale Agreement” was entered into between Emhart Corporation and Ablekind Limited on February 6, 1987, the whole as more fully appears from a copy of the said “Purchase and Sale Agreement”.

14. At the time of the “Purchase and Sale Agreement”, Emhart Corporation was a corporation organized under the laws of the State of Virginia, United States of America having its principal office at 426 Colt Highway, Farmington, Connecticut.

15. At the time of the “Purchase and Sale Agreement”, Ablekind Limited was a company incorporated in England under the Companies Act 1985 and having its registered office at 6/7 Gough Square, London.

16. According to the “Purchase and Sale Agreement”, Emhart Corporation of U.S.A. and Ableking of England agreed that certain of their respective sub- sidiaries would conclude local purchase agreements, such as the “Assets Subsidiary Agreement”, for a net price and upon agreed terms and conditions.

17. It was in this context of a worldwide acquisition which is reflected in the “Purchase and Sale Agreement”, the Appellant and Emhart Canada Limited entered into the “Assets Subsidiary Agreement” dated April 30, 1987.

18. According to the “Purchase and Sale Agreement”, the purchase price to be paid in each jurisdiction was expressly determined by Emhart Corporation of U.S.A. and Ablekind Limited of England.

19. More particularly, section 6.2 of the “Purchase and Sale Agreement” stipulates as follows:

6.2 The consideration to be paid by each purchaser in respect of the acquisition under each Subsidiary Agreement shall be determined in accordance with the Final Closing Statement as provided in Section 6.6 and shall be equal to the portion of the Final Net Asset Value which relates to the part of the Transferred SMG Operations, which is the subject of the relevant Subsidiary Agreement plus the amount, if any, to be listed on Exhibit X. Each Subsidiary Agreement shall set forth a provision to the foregoing effect. The parties agree that the consideration allocated to each Subsidiary Purchase Price accurately reflects the fair market value in each case and where the Subsidiary Purchase Price is greater than book value such excess has been apportioned to the assets on the basis of fair market value with the balance if any being allocated to goodwill.

20. The said section 6.2 of the “Purchase and Sale Agreement” referred to Exhibit X of the said agreement which was entitled “By Country allocation of Premium to Book Net Asset Value”, the whole as more fully appears from a copy of the said document.

21. Pursuant to the document “By Country allocation of Premium to Book Net Asset Value”, an amount of $2,900,000 U.S. was the amount allocated to the Subsidiary Agreement in Canada.

22. In virtue of the “Purchase and Sale Agreement” and the document “By Country, allocation of Premium to Book Net Asset Value”, it was never stipulated or mentioned that the amount of $2,900,000 U.S. should have been considered on account of goodwill.

23. More precisely, section 6.2 of the “Purchase and Sale Agreement” and Exhibit X - “By Country allocation of Premium to Book Net Asset Value” demonstrate clearly and undoubtedly that the parties agreed that the purchase price payable in each jurisdiction was based on the fair market value of the assets being purchased.

24. The “Assets Subsidiary Agreement” between the Appellant and Emhart Canada Limited was subject to section 6.2 of the “Purchase and Sale Agreement”.

25. The Appellant acquired the assets from Emhart Canada Limited at a purchase price which was in accordance with a value not exceeding the fair market value of the Assets.

26. Accordingly, no amount of the purchase price had to be allocated to goodwill.

27. The acquisition costs of the assets purchased by the Appellant were reflected in its financial statement for the 1987 taxation year at the capital cost of the amount of $7,895,761 which amount never exceeded the fair market value of these assets.

28. In preparing and filing its Corporation Income Tax Return for the 1987 taxation year, an amount totalizing $7,749,689 of the capital cost mentioned in paragraph 27 was allocated to Class 29.

29. The Appellant calculated in accordance with the I.T.A. and its Regulations the capital cost allowance on an amount of $7,749,689 and claimed for the 1987 taxation year $662,584 as capital cost allowance under Class 29.

30. In preparing and filing its Corporation Income Tax Return for the 1988 taxation year, the Appellant, based on the said $7,749,689 capital cost allocated to Class 29 for the 1987 taxation year, and after having made some adjustments, claimed $884,185 as capital cost allowance - Class 29.

31. In preparing and filing its Corporation Income Tax Return for the 1989 taxation year, the Appellant, based always on the said $7,749,689 capital cost allocated to Class 29 for the 1987 taxation year, and after having made some adjustments, claimed $756,176 as capital cost allowance - Class 29.

32. During the years 1991 and 1992, a tax audit was conducted by the officers of the Minister of National Revenue concerning the acquisition of the assets by the Appellant.

33. More specifically, the officers of the Minister of National Revenue were of the opinion that the amount of $2,900,000 U.S. ($3,881,761.00 Canadian) represented the value of the goodwill of the business acquired by USM in 1987 and not the value of the equipment.

34. On or about March 13, 1992, Mr. Jason Marcovitch, tax auditor at Revenue Canada, Taxation, sent a letter to USM Canada Limited in which he explained that the Income Tax Department had the intention to make some revisions for the taxation years 1987, 1988 and 1989.

35. Without admission and prejudice to the Appellant’s contention, Mr. Jason Marcovitch’s position was that the amount of $3,881,761 ($2,900,000 U.S.) included among 1987 additions to Class 29 was goodwill, the whole as more fully appears from a copy of Mr. Marcovitch’s letter.

36. On August 3, 1992, the Minister of National Revenue issued reassessments for the taxation years 1987, 1988 and 1989, the whole as more fully appears from copies of the said reassessments.

37. On August 17, 1992, the Appellant duly objected to the reassessments issued for the taxation years 1987, 1988 and 1989, the whole as more fully appears from copies of the said Notices of Objection.

38. On July 7, 1993, the Minister of National Revenue confirmed the reassessments issued for the taxation years 1987, 1988 and 1989, the whole as more fully appears from a copy of the notification of confirmation by the Minister.

39. The Appellant completely disagrees with the reassessments and hereby appeals to the Tax Court of Canada from the reassessments issued on 3 August 1992 for the taxation years 1987, 1988 and 1989.

3.02 The respondent denied in fact and in law the following paragraphs concerning the appellant’s reasons:

41. The Appellant submits that the acquisition of the Net Assets reflected in the “Assets Subsidiary Agreement” was concluded in the context of a worldwide acquisition entered into between Emhart Corporation and Ablekind Limited.

42. The Appellant submits that, according to the “Purchase and Sale Agreement” entered into between Emhart Corporation and Ablekind Limited, the purchase price to be paid in each jurisdiction was expressly determined by the parties who were dealing at arm’s length.

43. The Appellant submits that, in reference to section 6.2 of the “Purchase and Sale Agreement”, it was expressly stipulated or agreed that the consideration allocated to each subsidiary price accurately reflected the fair market value in each case.

44. The Appellant submits that according to section 6.2 of the “Purchase and Sale Agreement” and the document “By Country allocation of Premium to Book Net Asset Value”, the consideration allocated to each subsidiary purchase price meant the portion of the final net asset value plus the amount mentioned in the document “By Country allocation of Premium to Book Net Asset Value”.

45. The Appellant submits that section 6.2 of the “Purchase and Sale Agreement” clearly shows that the parties to the “Purchase and Sale Agreement” agreed that the purchase price payable in each jurisdiction was based on the fair market value of the assets being purchased and only if a greater amount had been allocated to a particular jurisdiction there would be an allocation to goodwill, hence the terms “the balance, if any, being allocated to goodwill.”

46. The Appellant contends that, in its particular case, several of the machines being purchased from Emhart Canada had a “book value of nil”. A significant number of these machines were on lease and earning lease revenues at the time of the acquisition while a number of fully depreciated machines, previously leased, were on hand waiting to be reconditioned for resale or release.

47. The Appellant contends that the fair market value of the machines mentioned in paragraph 46 was definitely and absolutely greater than $0.00, therefore the allocation of the purchase price by USM Canada on the basis of fair market value as stipulated in the “Purchase and Sale Agreement”.

48. The Appellant submits that the intent expressed in section 6.2 of the “Purchase and Sale Agreement” relating to the local purchase price was reflected in the “Assets Subsidiary Agreement” between USM Canada and Emhart Canada.

49. In support of the Appellant’s argument stated in paragraph 47, section 6.1 of the “Assets Subsidiary Agreement” reads as follows:

6.1 The consideration to be paid by the purchaser for the Canadian transferred SMG Business shall be the individual net asset value for Canada plus U.S. $2,900,000, which together, the parties agree reflects the fair market value including goodwill, if any, of the Canadian transferred SMG Business.

50. The Appellant submits that it did not pay more than the fair market value of the assets acquired in virtue of the “Assets Subsidiary Agreement”.

51. According to the definition of goodwill, such term usually means a recognizable asset when a business is acquired at a price in excess of the value of its net assets.

52. Accordingly, the Appellant submits that it did not pay a purchase price in excess of the value of the net assets acquired in April 1987 and therefore no amount of the purchase price had to be allocated to goodwill.

53. The Appellant contends that Emhart’s own internal written policy used to determine the fair market value of leased equipment for sales purposes in effect at the date of the acquisition demonstrated that certain machines had a useful life in excess of 15 years and that the fair market value of the machines being purchased by the Appellant was far in excess of the purchase price being paid.

54. The Appellant contends that in relation to paragraph 52, many of the machines being purchased from Emhart Canada at the purchase price stipulated in section 6.1 were sold during the taxation years 1987, 1988 and 1989 at a sale price which was far in excess of the capitalized cost for the Appellant for the sold machines.

55. The Appellant submits that the reassessments issued by the Minister of National Revenue for the taxation years 1987, 1988 and 1989 were not founded in fact and law.

56. More specifically, the Appellant submits that the elimination of the amount of $3,881,761 ($2,900,000 U.S.) from Class 29 is illegal and not founded in fact and law and this amount does not constitute an amount paid for goodwill.

57. The Appellant submits that the disallowance of amortization costs of $52,664 for the 1987 taxation year, of $88,655 for the 1988 taxation year and of $92,806 for the 1989 taxation year is not founded in fact and law.

58. Subsidiarily and without prejudice to the arguments stated in the previous paragraphs, the Appellant further submits that some of the acquisition costs have not been capitalized in Class 29 and the Appellant reserves its right to produce or file in support of this contention any documentary evidence and furthermore, the Appellant submits that he did not capitalize any part of the purchase price to the plant equipment purchased.

59. The present notice of appeal is well founded in fact and law.

3.03 The reasons on which the respondent based his decision read as follows:

9. The Respondent submits that the allocation made by the Appellant of the acquisition costs was not. reasonable;

10. He submits that the allocation made by the Appellant was not the result of an agreement or of a negotiation between itself and the vendor but was rather a unilateral decision of the Appellant;

11. He submits that the Minister of National Revenue correctly established the allocation of the acquisition costs to the Appellant pursuant to section 68 of the Income Tax Act, in allocating the amount of $3,881,761. (Canadian) to the goodwill;

12. He submits that the allocation established by the Minister of National Revenue is reasonable and well founded in facts and in law;

13. The Respondent submits that the appeal is ill-founded in facts and in law.

4. Facts

In addition to the admissions above, the evidence was completed by the testimonies of Mr. Angelo Polverari, Mr. Jacques St-Amour, Mr. Roland Carlin and by numerous exhibits.

4.01 Testimony of Mr. Angelo Polverari

4.01.1 The witness is president of the appellant. He formerly was vice- president and internal controller of Emhart Canada Limited (Emhart). Therefore he was aware of the purchases, leases and sales machinery policy.

According to him the policy is well explained in paragraph 6.2 of the Purchase and Sale Agreement (Exhibit A-l, tab 6) quoted above (3.01(19)). It is important, however, to highlight the last sentence :

The parties agree that the consideration allocated to each Subsidiary Purchase Price accurately reflects the fair market value in each case and where the Subsidiary Purchase Price is greater than book value such excess has been apportioned to the assets on the basis of fair market value with the balance if any being allocated to goodwill.

This policy was applied by Emhart many years before the transaction at issue. The witness then referred to a document dated October 21, 1983 (Exhibit A-2, Tab 3). This document is part of Mr. St-Amour’s valuation report as Appendix I. It is quoted below in paragraph 4.02.3(4) second part.

Concerning the transaction at issue, he wrote (Exhibit A-3) to Mr. Gregg Thomassin of Peat Marwick Mitchell & Co. on April 21, 1987, concerning the leased machinery valuation which was the crux of the matter of the point at issue :

Following our meeting of April 20, 1987 some minor revisions have been made to the lease machinery valuation file.

The current sales value for the most active machines has been established using the attached sales schedule. For the remaining leased equipment, given its low net book values, it was felt that using current sales values, even discounted, would result in a distorted valuation and consequently we feel that 12 times monthly revenues would be a more adequate overall valuation.

4.01.2 The witness declared that before the transaction, he valued the leased machinery at around $6,000,000. The auditor’s report (Peat Marwick) in the notes of the financial report of December 31, 1987, reads as follows (Exhibit A-l, tab 6):

In April 1987, the company purchased for cash the business and net assets of a division of Emhart Corporation. Details of the net assets acquired at assigned values are as follows [Cdn money]:

Current assets: $1,683,000

Fixed assets: $6,913,761

Less current liabilities: $701,000

Purchase price: $7,895,761

The auditor wrote concerning the said financial statement:

We have examined the balance sheet of USM Canada Limited as at December 31, 1987 and the statement of loss and deficit for the period then ended. Our examination was made in accordance with generally accepted auditing standards, and acccordingly included such tests and other procedures as we considered necessary in the circumstances.

In our opinion these financial statements present fairly the financial position of the corporation as at December 31, 1987 and the results of its operations for the period then ended in accordance with generally accepted accounting principles.

Exhibit A-l, tab 6.

4.01.3 Over 1,700 leased machines at issue are listed on 48 pages (Exhibit A-2, tab 1). In regard of each machine, one can read the symbol, the model, the serial number, the product class, the month of the purchase, the status, the original cost, the depreciation, the net cost, the selling price (for the ones sold) and the rental price (for the others). One can read the totals as follows:

Original cost: $7,115,174

Depreciation: $4,388,468

Net cost: $2,726,706

Selling: $5,403,910

Rental: $1,158,051

4.01.4 Mr. Polverari said that “eighty-five percent (85 per cent) of the equipment was valued on selling prices, based on the valuation by machine model, and the discounted schedule. For convenience, the remaining machines, because we have to keep in mind that I think I had more, in other words, the fair market value, I was fairly confident that it exceeded what the company paid for it, is that we chose an easier method for the less active machines to take twelve months rentals.”

“These, in total, in the schedules, will show that they represent, roughly, if I recall, about a million dollars ($1,000.000) and the machines that were valued specifically on selling prices and supported by invoices are valued at about five and a half million dollars ($5,500,000) or in the five million dollars ($5,000,000) range.”

4.01.5 According to Mr. Polverari, the capital invested by Emhart in the machinery in the years 1985, 1986 and the four months in 1987 totalled about $2,000,000.

4.01.6 As Exhibit A-4 shows, Mr. Polverari filed Emhart’s closing netbook value and the USM opening asset value as follows:

Emhart's	USM Opening
Closing Net Book Value	Asset Value

(Fair Market Value}

Accounts Receivable	$ 805,796.02	$ 805,796.02
Stock	866,625.04	866,625.04
Prepaid	10,363.40	10,363.40
Current Assets	±682.784.46	1.682.784 46
Fixed Assets
Computer Equipment	3,854.89	3,854.89
Equipment	14,190.03	14,190.03
Furniture/F ixtures	12,427.26	12,427.26
Demo	274,843.00	274,843.00
Leased machinery	±726.706.00	6,608
Fixed Assets	-3,032.021.18	6.913.782.18
	XQ32.P21.1»
Total Assets	$4,714,808.64	$8,596,566.64
Less
Current Liabilities	(702,087.23)	1702.087.23)
Net Assets	$4.012,718.41
	*44212.718,41	$7.894,479.4]

Mr. Polverari said that the amount of $7,800,000 was paid on April 30, 1987. There was no question of breaking down the total amount into two payments, the last one being $3,800,000. The computation was made pursuant to paragraph 6.2 of the Purchase and Sale Agreement.

4.01.7 The witness also filed a letter dated March 13, 1992, from the respondent informing that the valuation of the goodwill was $2,900,000 (U.S.) ($3,881,761 Canadian) (Exhibit A-1, tab 7):

March 13, 1992

USM Canada Limited

7700 de Lamartine Our file: Notre référence

Anjou (Québec): Jason Marcovitz

H1J 2A8: Section 143-1-4

4th Floor

Attention: Mr. A. Polverari, President: Tel.: 283-5831

Re: Purchase of business and net assets of a division of Emhart Canada Limited

Dear Sir,

In connection with the subject purchase, we have been advised by our Kitchener District Office that the amount of $3,881,761, included among your 1987 additions to class 29 is, in fact, goodwill.

As a result of the preceding and following further study of your file, it is the intention of the Department to make the following revisions:

87/88/89

(A) Eliminate from class 29: $3,881,761: -

(B) Disallow amortization of acquisition costs: 52,664: 88,655: 92,806

Upon receipt of your request, we would be prepared to record the following revisions:

(A) Capitalize as an eligible capital expenditure 50 per cent of the goodwill eliminated above: 1,940,881 : -

(B) Capitalize as an eligible capital expenditure 49.163 per cent of the acquisition costs of $277,145: 136,252: —

(C) Capitalize to class 29 34.534 per cent of acquisition costs of $277,145: 95,709:-

(2,726,706 X 277,145) (7,895,761 )

(D) Capitalize as an eligible capital expenditure the remaining unallocated acquisition costs: 45,454: —

We would request that you advise the department of the following:

(A) whether you wish to vary the class 29 capital cost allowance already claimed in the years 1987 to 1989;

(B) whether you wish to amortize the eligible capital expenditures (within thelimits set out in paragraph 20(1 )(b) of the Income Tax Act).

Your reply to the above, together with any other comments you may have should be marked to the attention of Jason Marcovitz and should be mailed within thirty (30) days from the date of this letter.

Yours truly,

S.J. Marcovitz

Audit Division Revenu Canada, Taxation

4.01.8 Following a Notice of Objection, the appellant received the following Notification of Confirmation by the Minister dated July 7, 1993 (Exhibit A-1, Tab 8):

Your Notice of Objection to the income tax assessments for the 1987, 1988 & 1989 taxation years have been carefully reviewed under paragraph 165(3)(a) of the Income Tax Act.

The Minister of National Revenue has considered the reasons set out in your objections and all the relevant facts. It is hereby confirmed that the assessments have been made in accordance with the provisions of the Income Tax Act on the basis that:

under the provisions of section 68 of the Act only $2,726,706 of the cost of the net lease equipment purchased can reasonably be regarded as consideration for property of class 29 of Schedule 2 of the Income Tax Regulations and you are deemed to have acquired the property at that amount for the purposes of paragraph 20(1 )(a) of the Act.

4.02 Testimony of Mr. Jacques St-Amour

4.02.1 Mr. St-Amour is C.A., F.C.B.V. and A.S.A. He is an associate of Cooper & Lybrand, Laliberté Lanctot of Montreal. He has been in charge of the firm valuation branch since 1979. Before that, he was in the fiscal branch, from 1974 to 1979.

4.02.2 At the beginning of his testimony, Mr. St-Amour explained that he had visited the appellant’s factory. He did not check each machine but he had a file for each one.

He also testified that the word “goodwill” is translated in French by “survaleur” and means, pursuant to “Le Dictionnaire de la comptabilité et de la gestion financière de Louis Ménard, C.A.”, “excédent de la valeur globale d’une entreprise à une date donnée, sur la juste valeur attribuée aux éléments identifiables de son actif net à cette date” (Exhibit A-6).

Moreover, he quoted from “Le vocabulaire essentiel de l’évaluation d’entreprise” which adopts Ménard’s definition, and adds: “En cas d’acquisition, cette survaleur donne lieu à la constatation d’un écart d’acquisition dans les comptes de l’acquéreur.”

4.02.3 Mr. St-Amour’s Valuation Report

4.02.3(1) Preliminary information

A. LIMITATIONS, RESTRICTIONS AND ASSUMPTIONS

We reserve the right, without obligation on our part, to revise the calculations included or mentioned in this report and, should we deem it necessary, to revise our opinion in light of information which existed at the time of our valuation but which came to our attention after the production of this report.

In carrying out this engagement, we relied on the financial statements, lists of machinery and equipment, summary of sales of machinery and other documents that the representatives of USM have provided to us; we have assumed that the data such documents contained were accurate and, consequently, we have not checked their accuracy or completeness. In addition, USM’s representatives have informed us that, to the best of their knowledge, no events have occurred, other than those which we have taken into account in our report, which might, in their opinion, cause us to change our opinion concerning the fair market value of the leased machinery.

B. SCOPE OF REVIEW

In the course of our review we relied upon the following material:

(a) The audited and internal financial statements of USM for the three years (8 months in 1987) ended December 31, 1987 to 1989;

(b) USM detailed list of leased machines and stock machines as at April 30,

1987, including USM estimated fair market value of leased machines;

(c) Emhart Canada list of 1987 machine sale prices dated April 20, 1987 including pricing discount schedule;

(d) Emhart Canada internal correspondence dated October 21, 1983 concerning the selling price of leased machines;

(e) annual summary for 1987 to 1994 of actual sales of used machinery;

(f) various documentation that you provided to us including correspondence with Revenue Canada concerning the valuation of the leased machines.

We also had the benefit of discussions with Messrs. Angelo Polverari and Frank Testa, respectively president and controller of USM.

C. HISTORY

On April 30, 1987, in the context of the worldwide acquisition of the Shoe Machinery Group business of Emhart Corporation “Emhart”, a U.S. public company, by Ablekind Limited, a company incorporated in England, USM acquired the net assets of Emhart Canada.

The purchase price to be paid in each jurisdiction (12 countries) had been expressly determined by Emhart and Ablekind. The overall purchase price was equal to the net book value of assets transferred plus an amount of U.S. $50.4 million. As mentioned in Article 6.2 of the Purchase and Sale Agreement:

The parties agree that the consideration allocated to each Subsidiary Purchase Price accurately reflects the fair market value in each case and where the Subsidiary Purchase Price is greater than book value such excess has been apportioned to the assets on the basis of fair market value with the balance if any being allocated to goodwill.

An amount of U.S. $2,900,000 (Cdn $3,881,761) out of the U.S. $50,400,000 of “premium to book net asset value” was allocated to the Canadian division.

USM allocated all of this premium to the value of the leased machinery. Revenue Canada allocated all of the amount to goodwill.

D. APPROACH TO VALUATION

In order to determine whether the U.S. $2.9 million “premium” to net book value was a revaluation of fixed assets or goodwill, we have performed the following steps:

(a) obtained an understanding of the size and age of leased equipment;

(b) analyzed Emhart Canada’s depreciation policy on leased machines having regard to their useful life in order to be able to understand the significance of the net book value;

(c) reviewed Emhart Canada’s policy of selling price of leased equipment and its relationship with net book value;

(d) reviewed USM revaluation of leased equipment and allocation of the U.S. $2.9 million “premium” to individual pieces of machinery;

(e) estimated the fair market value of leased equipment as at April 30, 1987 based on actual sales of such equipment after the transaction;

(f) analyzed our estimated selling price and compared it to (i) Emhart Canada net book value as at April 30, 1987 and to (ii) USM revaluation of leased equipment as at April 30, 1987.

4.02.3(2) VALUATION

A. EMHART CANADA ’5 LEASED MACHINERY

As at April 30, 1987, Emhart Canada sold to USM 1,412 pieces of machinery of which 1,143 were classified under fixed assets on the balance sheet under the subtitle leased machinery and the rest under stock.

Number of Original Net book

	Category		machines	cost		value
				_($000's)
1)	Under fixed assets
	Leased machines		[.153	Z,] 5	2.727
(ii)	Classified under stock
	Trial machines	7		114	114
	Stock machines
	(transferred from leased
	machines)		195	972
	Stock Machines 67		628	628
			269 ..L214 742.
			1.412 8.829. 3,469.

These 1,143 leased machines had an original cost of $7,115,000 and a net book value of $2,727,000 at date of sale. USM applied all of the $3,881,761 (U.S. $2,900,000) “premium” to this class of assets.

The following analysis indicates that as at the date of sale in April 1987 the age of leased machines was on average 14.1 years.

’We understand that Emhart’s policy was to writeoff, upon their return from lease, these machines which had a net book value of approximately $160,000.

		Age as at	Nember of
	Machine age	April 1987	aachtaes
	1925 - 1937	55	3
	1938 - 194"•	45	18
	1948 - 1957	35	50
	1958 1967	25	225
	1968 >977	15	391
	1978 - 1982	7	198
	1983 - 1987	2
			58
4.02.3(3)	Weighted averag
		141.	1143

B. EMHART CANADA ’S DEPRECIATION POLICY

USM management has informed us that Emhart Canada policy had been to depreciate leased machinery on a straight-line basis over a period of seven years. This period was subsequently shortened to six years in the mid-1980. Depreciation for the year of acquisition and disposal was established at half a normal year.

We understand that the initial lease term was for a period of five years and was subject to automatic twelve-month renewals. Therefore, as at April 30, 1987, most if not all leased machines acquired after 1977 had a net book value of zero eventhough they were still earning lease income and that the weighted average age of leased machines exceeded 14 years.

4.02.3(4)

C. EMHART CANADA’S POLICY OF SELLING PRICE OF LEASED EQUIPMENT

USM management has provided us with an internal memo (Appendix I) [quoted below] from Emhart Canada dated October 21, 1983 describing the policy to determine the price at which leased machines could be converted (i.e. sold). In summary, each machine model had been classified into one of six categories. A different discount schedule had been developed for each machine which was applied to all machine models falling within the category. The conversion price, or selling price, was then calculated by multiplying the sale price at the time the machine was shipped (at date of original lease) less the initial payment, if applicable, paid at the time of installation, by the percentage factor for age selected from the appropriate discount schedule.

The discount schedule, reproduced in Appendix I, page 4 [quoted below], indicates that for machines aged six to seven years, which would nearly be fully depreciated, the discount was 23 per cent to 34 per cent from original cost, and therefore the fair market value, according to Emhart Canada, was significantly higher than their net book value. Furthermore, the discount schedule indicates that for machines older than ten years (acquired before 1978), the maximum discount from original selling price was limited to 35 per cent to 50 per cent depending on the category.

Appendix I, page I, reads as follows:

1. If the price in effect at time of conversion calculation is more than $800.00 over

the price in effect at time of shipment, three-quarters of the difference should be added to the price at time of shipment.

2. Use the formula of Category in which model is listed.

3. Letter of December 1st, 1980, reference to Initial Payment, remains unchanged.

4. If no price is published, refer to Machinery Manager for price before making conversion.

	Price at time of shipment	$3,000.00
E. g.	Price today	6,000.00
	Difference	3,000.00
	3/4 of difference, add to price at
	time of shipment	5,250.00
	4-5 yr. or 84% = transfer price	4,410.00

Appendix I, page 2, reads as follows:

LEASE TO SALE CONVERSION

Effective September 1st, 1982, the price at which leased machines may be converted will be determined as follows:

1. Each machine model has been classified into one of six categories. A different discount schedule has been developed for each machine which will apply to all machine models falling within the category. These discount schedules identified as A, Al, B, C, D and D SPEC shown on the attached table. Any model not listed, refer to Machinery Product Manager. No one except the General Manager - Machinery Division can change the discount schedules.

2. The conversion price is calculated by multiplying the sale price at the time the machine was shipped less the Initial Payment, if applicable, paid at the time of installation, by the percentage factor for age selected from the appropriate discount schedule. Exception for machines in Category B, the calculation will be on the price in effect at time of conversion.

2a. For cutting machines listed under Category Al, the conversion calculation will be made as follows:

1. If the price in effect at time of conversion calculation is more than $800.00 over the price in effect at time of shipment, three-quarters of the difference should be added to the price at time of shipment.

2. Refer to Par. 2b in reference to Initial Payment.

3. If no price is published, refer to Machinery Manager for price before making conversion.

E.g.	Price today	$ 6,000.00
	Price at time of shipment	3,000.00
	Difference	3,000.00
	3/4 of difference, add to
	price at time of shipment	5,250.00
	Less Initial Payment if
	applicable
	4-5 yr. or 84% - transfer price	4,410.00

2b. Initial Payment will only be deducted from Sale Price when machine is less than 5 years old. When machine is over 5 years old, there will be no deduction.

3. For machines shipped before July 18th, 1956, purchase price calculations will be based on the sale prices which were in effect on that date except for machines in Category B. (Refer to Par. 2)

4a. When machine shipped “rebuilt”, use the latest shipping date and the price for “rebuilt” at time of shipping to calculate transfer price except for machine in Category B.

Appendix I, page 3, reads as follows:

4b. In the case of machines shipped “as is” condition or for transferred machines, sale price will be based on the latest date the machine was shipped and the rebuilt price used unless there is a price for “as is” machines. Exception for machines in Categories Al and B which should be referred to the Manager - Machinery Division for prices.

5. All calculations of conversion prices will be made by the Machinery Department. All quotations must be obtained from this source. No exceptions from these quotations will be made without the approval of the Machinery Division General Manager.

6. The customer’s credit status will be looked into, as to whether the transfer from lease to sale will be accepted or rejected.

7. The attached form is to be filled out and sent to the General Manager - Machinery Division.

This will supersede any previous letter of instructions.

Appendix I, page 4: Discount Schedule

	‘D count 5 I I I
Machine Age
(years)	À	B.
	A-L
				-Q	D SPEC,
0-1	100% 100% 100% 100% 100%
1 - 2	96	96	96	94	94
2-3	92	92	92	88	88
3-4	88	88	88	82	82
4-5	84	84	84	76	76
5-6	80	80	80	76	76

6-7		77	77	77	66	66
7-8		74	74	74	62	62
8-9		71	71	71	58	58
9-10	68	68	68	54	54
10-11		*65	65 "65 ♦••50 50
10-11		•65
II - 12			62
12-13			59
13 - 14			56
14-15			53
15 - and over		50
A			40% of Replacing Model Price
Al			10 yrs. and over
C			10 yrs and over
D	‘“		10 yrs and over

DSPEC ***** Conversion prices must be approved

by Machinery Division General Manager."

4.02.3(5)

D. USM REVALUATION OF LEASED EQUIPMENT

We understand that USM management allocated the U.S. $2.9 million premium to each of the 1,143 leased machines acquired in April 1987.

According to USM’s management, no attempt was made to revalue other assets (i.e. 195 stock machines) as the “premium” could easily be allocated to leased machines.

Using the 1987 selling price for new machinery, an estimated selling price for used machinery was arrived at by applying a sale discount growing with the age of the leased machinery up to a maximum discount of 44 per cent.

For purchases prior to 1979, which would have been fully depreciated, USM would generally estimate the value of these pieces of machinery at 12 times the actual monthly lease.

Pricing Discount Schedule Based on 1987 Selling Prices

Year of Purchase/Sale Discount

1987: O

1986: 10 per cent

1985: 19 per cent

1984: 27 per cent

1983: 34 per cent

1982: 37 per cent

1981: 40 per cent

1980: 42 per cent

1979: 44 per cent

4.02.3(6)

E. ESTIMATED FAIR MARKET VALUE OF LEASED EQUIPMENT BASED ON ACTUAL SALES

In order to estimate the fair market value of leased equipment as at April 30, 1987, we reviewed USM’s actual sales of used machinery for the period 1987 to 1994. This analysis was done per class of machinery based on the average selling price per machine. It should be noted that USM maintains a detailed inventory to each machine with information on its class of machinery, serial number, original cost and net book value.

We have not attempted to correct the machinery actual selling price after 1987 to consider the annual leasing revenue received until disposal, not the possible reduction in value of such machinery over time.

Finally, we examined the relationship of actual selling price to 1987 annualized lease income for part of the leased machinery sold since May 1, 1987.

4.02.3(7)

F. ANALYSIS OF OUR ESTIMATED FAIR MARKET VALUE AND COMPARISONS

Appendix II to this report presents the summary of our analysis of USM leased machinery list acquired from Emhart.

The first three columns describe the class of machinery, quantity on hand and total net book value as at April 29, 1987 of the leased machinery as included in the sales contract. The net book value of $2,718,397 (page 4, Appendix II) is slightly different from Emhart Canada’s figure of $2,726,706.

Column 4 presents USM’s own estimate of the value of the leased machinery and their allocation of the $3,881,761 (U.S. $2.9 million) premium to net book value. The figure of $6,558,661 is slightly different from the figure of $6,608,467 ($2,726,706 + $3,881,761).

Column 5 presents our estimate of the fair market value of the leased machinery for classes where we had evidence of actual sales. For certain classes of machinery, we were unable to locate a sales transaction. In order to be able to draw a conclusion on the same number of machines, we used USM estimated value for such items which totalled $268,932 and added it to column 5.

Column 6 indicates that our estimate of the fair market value of the leased machinery of $6,595,685 (including certain items for which we were unable to locate sales invoices) is 242.63 per cent or $3,877,288, higher than the net book value of $2,718,397 as at April 29, 1987.

Column 7 indicates that our estimate of USM’s fair market value of leased equipment is slightly higher (100.56 per cent) than USM’s own estimate of such fair market value which considered the “premium” of $3,881,761 as a revaluation of fixed assets.

The fourth page of the Appendix II reads as follows:

USM CANADA LIMITED VALUATION OF LEASED MACHINERY In order to test the reasonableness of our estimate of the leased machinery in Appendix III, we examined the relationship of actual selling price to 1987 annualized lease income for 150 leased machines as at April 30, 1987 that were sold after that date. As indicated on page 4, Appendix III, the sum of selling prices ($716,900) divided by the sum of 1987 annualized rent ($319,230) reflected a ratio of 224.57 per cent. The application of this ratio to USM 1988 and 1987 annualized lease income for the eight months ended December 31,1987 would indicate an estimated fair market value of leased machinery of $6,573,112 and $6,169,823 respectively.

Class of	Quantity	Total net USM		Estimated	% Estimated			% Estimated
machinery	on hand	book		valuation fair market			F.M.V. / Net
F.M.V./USM
		value		04/29/87 value			book value		valuation
		04/29/87
	2	3		4	5		6		7
1							6
UPM	1	1		293	200
UPM							20000.00%		68.26%
UPO	12	3,867		26,627 114,000
UPO							2948.02%		428.14%
URR	14	6,118		18,851 133,000
							2173.91%		705.53%
US	2	1		1,393	750
US							75000.00%		53.84%
USAB	1	1,033		2,280 4,000			387.22%		175.44%
USB	1	I		229	150		15000.00%		65.50%
									65.50%
USC	2	l		1,343
	13	822		7,964	23,400				293.82%
USK							2846.72%
									293.82%
USL	11	1		9,065	26,356
							2635600.00%		290.74%
USR	1	I		357
UTSL	6	1,116		8,314
UUR	4	2,320		2,876
UWM	2	I		599
WBT	4	1		6,694
WDC	12	50,675		7,020 33,924			66.94%		483.25%
WSK	3	7,966		4,500 20,334			255.26%		451.87%
WSR	3	107		1,973	1,035		967.29%		52.46%
WTL	5	1		11,491 50,000			5000000.00% 435.12%
ZPP	1	1		249
				$6,326,753
Less:	Machinery without
	actual sales transaction
				S_26W2
	1143	$2,718,397	$6,558.661		$6,595,685		242.63%		100.56%

	1987	1988
	(annualized)
Lease revenue per USM audited financial statements
1987 - $1,831,596 x 12 8	2,747>94 2,926,977
Ratio of selling price to lease income	24.22% . _22457%
Estimated fair market value of leased machinery

These estimates represent 93.4 per cent and 99.5 per cent respectively of USM’s valuation of $6,608,467.

Page 4 of Appendix III reads as follows:

OPINION

Based on our review and subject to the limitations, assumptions and restrictions mentioned in this report, we are of the opinion that the $3,881.761 (U.S. $2.9 million) “premium” to book value was essentially a revaluation of the fixed assets and more specifically of the leased machinery, as opposed to goodwill.

4.02.3(8) Exhibit A-l 1 summarizes the methods of evaluation used by Mr. Jacques St-Amour:

USM CANADA LTÉE

Résumé des méthodes d’évaluation retenues

1. Sur la base des machines réellement vendues depuis 1987. Prix de vente appliqué aux machines non vendues Annexe II, page 46 595 685

2. Sur la base des machines réellement vendues depuis 1987 par rapport à leur revenu de location Annexe III, page 4

2,24 fois le revenu de location

(a) Revenu total de location 1987 (annualisé)

Page 10 du rapport 6 169 823

(b) Revenu total de location 1988

Page 10 du rapport 6 573 112

3. Sur la base de la méthode du double taux de capitalisation avec un rendement de 12,27 per cent 6 608 467

4.02.3(9) To confirm a statement made by Mr. Polverari that the shoe market had been going down in North America since 1985, Mr. St-Amour filed the 1987 annual report of Emhart (Exhibit A-13). At page 32, one can read under the heading “Sector Results of Operations”:

During 1986 and continuing into 1987, shoe imports into the U.S. marketplace continued their upward spiral forcing more producers to seek lower labor costs outside the U.S. adversely affecting the volume of U.S. shoe machinery sales. The United States footwear iindustry’s annual production of non-rubber footwear decreased 15 per cent in both 1986 and 1985 reflecting the continuing trend to offshore producers.

4.03 Testimony of Mr. Ronald Carlin

4.03.1 Mr. Carlin is a Certified Management Accountant (CMA) and a Chartered Business Valuator (CBV). He has approximately 20 years experience in conducting valuation assignments. Presently, among other tasks, he is Chief of Business Equity Valuations with Revenue Canada for the Ontario Region.

4.03.2 Valuation Report

4.03.2(1) Preliminary information

A. PURPOSE OF VALUATION

The Shoe Machinery Group Business was a division of Emhart Canada Limited which was a Canadian corporation whose head office was located in Montreal, Quebec.

In April 1987, the Shoe Machinery Division of Emhart Canada Limited was sold to USM Canada Limited. This was an arms length sale.

Since the overall price was established in an arms- length transaction, it can reasonably be assumed that the total price was representative of the fair market value of the business at that time.

I have been asked by the Appeals Division, as a Business Valuator, experienced in the valuation of business entities, for my opinion with regard to what would be a reasonable allocation of the value of the business assets among the various components of the business, at April 1987.

In particular, they are concerned with the allocation of the price between the intangible assets (Goodwill) of the business, and the tangible assets of the business.

They have therefore sought my opinion as to a reasonable allocation of the price in the circumstances.

B. DEFINITIONS

Fair Market Value

Fair Market Value is defined herein as the highest price available in an open and unrestricted market between informed, prudent parties, acting at arm’s- length and under no compulsion to act, expressed in terms money or money’s worth.

It is the same definition submitted by Mr. St-Amour even if I did not cite it above.

Goodwill

After giving three dictionary definitions and also Court definitions, he cites accounting definitions that I retain because they are more appropriate in the present case:

3. ACCOUNTING DEFINITIONS

(a) Guthman and Dougall, CORPORATE FINANCIAL POLICY

The capitalized value of the profits of a business which are in excess of a normal return upon properties used in the business.

(b) Leonard Spacek The Treatment of Goodwill in the Corporate Balance Sheet

In simple language, goodwill is the valuation placed on the earning power of the going concern as a whole over the amounts paid for net assets necessary to produce, market sell and administer its products and services. It is in substance, the present value placed on anticipated future earnings in excess of a reasonable return on these producing assets.

(c) Smail’s, Accounting Principles and Practice

The excess of valuation based on prospective earnings over a valuation based on the cost of reproducing the tangible assets of the business.

Intangible Asset Value

The Oxford English Dictionary defines “intangible” as follows:

Not tangible; incapable of being touched; not cognizable by the sense of touch; impalpable.

Intangible assets of a business are generally taken to include goodwill, patents, copyrights, trademarks, licences, franchises, and other similar properties.

Generally, intangible assets other than goodwill can be specifically identified and have values that can be determined separately. Examples of these are patents, copyrights, trademarks, franchises and computer software.

Canada Valuation Service, (Ian R. Campbell):

There are at least four basic principles relating to intangible assets:

(a) An intangible asset must have an enduring nature. Research and sales promotion expenditures may have an influence beyond the period in which they are incurred. However, unless they are directly related to the development of a patent, copyright or franchise, etc, they are usually treated as current costs. These costs, even if capitalized, do not necessarily represent value.

(b) Although the value of an intangible asset cannot be determined exactly, its value must relate to the expected cash flow or earnings to be generated from the intangible asset.

(c) Where identifiable intangible assets (that is, intangibles other than goodwill) have values that can be determined separately, those amounts are added to the fair market value (determined on a going concern basis) of the tangible assets.

(d) Business goodwill is often the principal intangible asset of value but it must be transferable if it is to have commercial value.

Lease

The Concise Oxford Dictionary defines a lease as:

Contract by which lessor, in consideration of rent, conveys property to lessee for a specified time.

Contract

The Concise Oxford Dictionary defines a contract as:

Business agreement for supply of goods or performance of work at fixed price; agreement enforceable by law”.

C. HISTORY AND NATURE OF BUSINESS

United Machinery Group Ltd. is one of the world’s largest suppliers of machinery and materials to the footwear industry and a significant supplier of press cutting machinery to diverse global markets. The head office is located in England and the Group companies are located worldwide.

In Canada the business is operated under the name USM Canada Ltd and it is located in Anjou, Quebec.

The Shoe Machinery Group Business (S.M.G.B.) was originally a division of Emhart Canada Limited. Emhart Canada Limited sold its Shoe Machinery Group Business to USM Canada Ltd effective April 1987. This transaction was part of a larger transaction where the SMG operations were disposed of by the Emhart Corporation to Ablekind Limited. USM Canada Ltd is a subsidiary of Ablekind.

The Shoe Machinery Group Business (S.M.G.B.) was engaged in the sale and leasing of machinery and equipment which is used in the manufacture of shoes. This was a very profitable operation since much of the equipment was older equipment subject to advantageous lease agreements which generated a steady and substantial income stream for the business.

4.03.2(2) Valuation

4.03.2(2) A. OPINION OF VALUE

In my opinion, a reasonable allocation of value for the intangible assets (or goodwill as it is more commonly referred to) of the Shoe Machinery Group Business Division was Three Million, Eight Hundred and Eighty One Thousand, Seven Hundred and Sixty One Dollars ($3,881,761).

It is my opinion therefore that a reasonable allocation of the price which was paid for the Division between the equipment and goodwill would be as follows:

EQUIPMENT: $2,726,706

GOODWILL: $3,881,761

All amounts above are expressed in Canadian dollars.

It is also my opinion that the goodwill of the business and the leases themselves are quite transferable, and thus the intangibles of the business have commercial value.

It is therefore reasonable to assume that goodwill existed and that a substantial value for goodwill was a part of the price which was paid for the business.

B. SCOPE OF WORK

In forming my opinion, I have reviewed and relied on among other things, the following:

The Financial Statements for Emhart Canada Limited and the operating results for the S.M.G.B. Division which were prepared at the time.

A copy of the Assets Subsidiary Agreement dated April 30, 1987 between USM Canada Limited (Purchaser) and Emhart Canada Limited (Vendor) Division.

Discussions with the representatives of both the purchaser and the vendor.

Resolutions of the Board of Directors of Emhart Canada Limited dated April 29, 1987 on the divestiture of the Shoe Manufacturing Group business.

Resolutions of the Board of Directors of USM Canada Limited dated April 29, 1987 on the acquisition of the Shoe Manufacturing Group Division from Emhart Canada Limited.

4.03.2(2) C. ECONOMIC OUTLOOK

The 1987 year was generally a good year economically. Some of the main indicators of the booming business climate included high automotive sales, increased housing starts, low unemployment, and reasonable interest rates. Business and corporate profits had improved significantly and values in the real estate market were also high and were increasing. Consumer spending continued to be good, especially in the merchandising sector.

The outlook for 1988 was for this trend to continue and the balance of the eighties for the most part remained encouraging, although somewhat clouded. World oil prices were declining, and unrest in the Middle East continued. Canadian interest rates had declined slightly, while the Canadian dollar weakened against the stronger U.S. dollar. Nevertheless, many analysts remained optimistic, taking the view that a low Canadian dollar would assist in the sale of Canadian goods abroad.

[Schedule 3.]

SMGB DIVISION

ECONOMIC INDICATORS IN 1987

LONG TERM INTEREST RATES 8.75%	10.25%
CONVENTIONAL MORTGAGES 10%	12%
SECOND MORTGAGES	12%	14%
INTERIM FINANCING	9 75%	10%
GIG’S	9.75%	10.25%"

4.03.2(2) D. RATIONAL FOR OPINION OF VALUE

The Shoe Machinery Group Business division of Emhart Canada Limited was a very profitable division. Pre-tax profits for the 1986 year were $1,661,234 and for the first four months of 1987 (up to the date that the division was sold) were $488,466. Since this was only for four months, by “annualizing” this amount for twelve months, the resultant pre-tax earnings for 1987 would be $1,465,398.

The earnings from operations for the 1986 and 1987 years (up to the date of the sale on April 30, 1987) are summarized as follows:

1986 1987 1987

SALES	$6,724.234	$2.105.466	$6,316,398
TOTAL EXPENSES 5,063.000		1.617.000 4.851.000
PRE-TAX INCOME $1,661,234		$ 488.466 $1,465,398

In order to determine the correct value which should be allocated to the Goodwill and the Machinery and Equipment involved, it is necessary to determine one of two things:

1. What value was assigned and agreed to by the parties to the transaction themselves? This can sometimes be determined with reference to the documents pertaining to the transaction, discussions with the parties to the transaction, or by analysing the allocation of the values by each of the parties to determine if the allocations were reasonable. Often this is done by testing the reasonableness of the values used. For example, Goodwill can be measured based on the earnings generated by the business or based on profits in excess of a normal amount.

2. In the absence of the above indicators of a reasonable allocation of values, it may be necessary to determine the values on a more formal basis.

In these circumstances however, there appears to be ample indications which help in determining a reasonable allocation of the value between the goodwill of the business and the machinery used to generate the earnings of the business.

The purchase/sale which occurred between USM and Emhart in April 1987 was part of a larger world- wide transaction between Ablekind Limited and the Emhart Corporation. Around February 1987, Ablekind and the Emhart Corp, signed a Master Agreement to this effect. As part of the Master Agreement it provided that certain of the respective subsidiaries of Ablekind and the Emhart Corp, would finalize “local” purchase/sale agreements. This agreement between USM Canada and Emhart Canada was known as the Assets Subsidiary Agreement.

The Assets Subsidiary Agreement dated April 30, 1987 between USM Canada Limited (purchaser) and Emhart Canada Limited (vendor) also contained a list of exhibits which outlines fully the assets which were transferred. These listed assets are both tangible and intangible in nature and as well as itemizing equipment also contains such items as:

EXHIBIT 6 INTELLECTUAL PROPERTY RIGHTS. These include such things as Canadian Letters Papent and Canadian Trade Marks.

EXHIBIT 7 PREMISES AGREEMENT. This includes a Facilities Supply Agreement.

EXHIBIT 8 SERVICES AGREEMENT.

EXHIBIT 9 ASSIGNMENT OF PATENTS.

EXHIBIT 10 ASSIGNMENT OF LEASE.

EXHIBIT 11 UNION CONTRACTS etc.

EXHIBIT 12 EMPLOYEE BENEFIT PLANS.

EXHIBIT 14 ASSIGNMENT OF LEASES AND EQUIPMENT UNDER LEASE.

EXHIBIT 15 ASSIGNMENT OF PURCHASE ORDERS.

EXHIBIT 16 ASSIGNMENT OF CANADIAN TRADE MARKS.

EXHIBIT 17 DISTRIBUTOR AGREEMENT.

It is evident from this that a business operation was being acquired which included all of the business assets, of both a tangible and intangible nature.

The price set forth under paragraph 6 of the agreement implies that the price paid shall be the individual Net Asset Value for Canada, plus $2,900,000 U.S. (approximately $3,881,761 Cdn.) which together the parties agreed reflect the fair market value including goodwill, if any, of the Canadian transferred SMG Business.

It is my understanding that the parties agreed in principle to the transaction and determined that the price to be paid for the assets would be the net book value of the assets plus an additional payment for the business to be determined after. This additional payment was subsequently determined to be $2,900,000 U.S. or approximately $3,881,761 Cnd.

Therefore, in view of the significant intangible assets which were transferred it is my opinion that the value to be attributed to the intangibles would be substantial.

Although equipment was transferred, this equipment was subject to lease arrangements which furthermore, were very favourable to the lessor. The profits generated by those lease agreements were substantial. It is highly unlikely that a vendor would be interested in just equipment without the lucrative earnings stream attached to the leases. This represents Goodwill value, or to express it another way, it is the value of the superior earnings for the business.

There are some tests to determine reasonableness which should be performed regarding the value to be attributed to the equipment as follows:

1. The original cost to Emhart Canada for this equipment new was approximately $7 Million. It should be noted that some of this equipment was in excess of ten years old at the time that it was acquired by USM Canada. The value which was placed on this equipment by USM Canada at the time of acquisition was $6,608,467. This is very close to the original cost new of this equipment.

2. Depreciation for accounting purposes is significantly different than Capital Cost Allowance (CCA) which is only used for income tax purposes. Depreciation for accounting purposes reflects the cost of the equipment spread over the estimated useful life of the equipment. This is management’s best estimate of the useful life of the equipment. Who is better qualified than the management of a successful business on the useful life of the machinery and equipment utilized in the business? Capital Cost Allowance on the other hand, is a prescribed rate allowed by the taxing authorities which usually allows for a faster write-off of the asset. The Undepreciated Capital Cost (UCC) to Emhart for tax purposes of this same machinery was only $810,165.

3. As a general rule, machinery and equipment depreciates faster at the beginning of its useful life. For example, a brand new piece of machinery, even used once becomes a “used” piece of equipment, and a potential buyer will not pay anywhere near the “new” price of the same equipment. This is analagous to buying a new car — once it is driven off the Dealer’s lot it becomes a used vehicle. Assuming that this equipment will continue to produce revenue well into the future, it will still depreciate faster at the start. Therefore, if we estimate that 60 per cent of its value should be written down, then it would still be worth 40 per cent of its original value. This does not seem to be unreasonable under the circumstances. Using a formula that incorporates the original cost of $7.0 Million and assuming that the equipment is sixty percent depreciated, we arrive at a depreciated value of $2.8 Million as follows:

FORMULA: 40 per cent of $7,000,000 equals $2,800,000 4.03.2(2)

E. GOODWILL VALUATION

Goodwill is often referred to as superior earnings, or the value of the earnings in excess of a normal return on an investment. Therefore, a calculation can be made based on the difference between a normal return and the return which is imputed from the price which was paid for the business.

The concept is based on the premise that a higher return would be required given the risk and effort involved in the operation of a business enterprise. Since a significant asset of a business operating as a going concern is intangible assets — i.e. Goodwill, then the risk associated with the business is greater than that of an investment which is secured or has tangible asset backing.

As can be determined from the total price paid for the SMG Business of $7,795,480 and based on the annual average earnings for the two most current years of $1,563,000, the anticipated return on the investment would be 20 per cent.

Given the economic indicators which existed in 1987, a normal or “safe” return would range between 10 per cent to 11 per cent or less. That would be for a fully secured investment, because as the investment becomes less secure the required return becomes higher. (All of these returns are stated before tax rates for the sake of consistency.)

Obviously there is risk associated with the business which was acquired and considerable intangible value for the business, based on the imputed return of 20 per cent. If the investment was fully secured by tangible asset backing of the business then the return required would be lower, since there would be less risk involved. This principle is widely recognized in valuations and in particular is demonstrated in the Dual Capitalization Approach whereby a lower rate is applied to earnings which are fully secured by tangible asset backing and a higher return is required on earnings which are unsupported by any tangible assets.

Therefore, given the spread of 9 per cent (20 per cent - 11 per cent) to 10 per cent (20 per cent - 10 per cent), the intangible value can be calculated as shown in Schedules 1 and 2 [see below].

The indicated range of value calculated for the intangible value of the business (goodwill) is between $3,948,000 to $3,553,000 - the approximate mid-point of this range of value is $3,750,000.

Therefore the value used of $3,881,761 is within this range of value and is close to the mid-point of the range of value calculated.

[Schedule 1.]

SMGB DIVISION

RETURN ON INVESTMENT CALCULATION
OPERATING INCOME	1986	$1,661,234
ANNUALIZED INCOME	1987	1,465,398
AVERAGE EARNINGS BEFORE TAX		1,563,316
ROUNDED TO		$1,563,000
PRICE		$7,895,000

THIS EQUALS AN APPROXIMATE RETURN ON INVESTMENT OF 20%.

A NORMAL RETURN RANGE IS FROM 10% TO 11%.

Schedule 2

Calculation of Intangible (Goodwill) Value

-Based on Profit in Excess of Normal

As calculated on Schedule I, normal returns range between 10-11%.

(1) Based on a normal return of 10%, the excess return would be 10% (20% - 10%).

Therefore, the equation for the intangible value is as follows:

Goodwill	10/20 x 100 = 50%
Sale Price	$7,895,480
50% of $7,895,480	$3,947,740
Rounded to	$3,948,000

(2) Based on a normal return of 1 1%, the excess return would be 9% (20% - 11%).

Therefore, the equation for the intangible value is as follows:

Goodwill	9/20 x 100	45%
Sale Price	$7,895,480
45% of $7,895,480		$3,552,966
Rounded to		$3,553,000

The indicated range of value for the intangible (Goodwill) value is between $3,553,000 to $3,948,000.

The mid-point of this range of value for Goodwill is $3.750,000.

Therefore, the value used of $3,881,761 appears to be reasonable."

4.03.2(2) F. CONCLUSION

The following are the main points previously discussed but which deserve to be itemized in point form so as to highlight their significance:

1. Goodwill is an important and significant asset of any business which is a viable going concern. The prime determinant of value for goodwill is

1996-06-30

profitability.

2. The Purchase/Sale Agreement between the parties acknowledges the probability that goodwill existed for the business.

3. The probability that all of the excess value should be allocated to the equipment is remote, since:

(a) That would place a value on the used equipment of almost the Original cost of the machinery. As noted, some of that equipment was very old.

(b) It provided for no value whatsoever for the intangible assets (goodwill). This was a viable business enterprise.

(c) There were significant intangibles involved in the transaction including highly profitable lease agreements.

4. SMGB was a very profitable business and therefore a significant value should be attributed for the Goodwill of the business which is a viable going concern.

5. The SMG Business was a very profitable business, due mainly to the lease arrangements for the machinery. The return on the investment can easily be calculated from the information available.

6. Based on the return which is implicit in the price, a reasonable estimate can be made of the Intangible or Goodwill value attributable to the business.

Therefore, having regard to all of the above, a reasonable value for the

Goodwill of the business in the sale of the business would be $3,881,761			Cdn.
as represented by the additional payment of $2,900,000 US.
Therefore the revised allocation of the Price would be as follows:
CURRENT ASSETS	$1,684,252
MACHINERY AND EQUIPMENT ON LEASE 2,726,706
GOODWILL	3,881,761
OTHER FIXED ASSETS		215,315
LEGAL COSTS	90,000
TOTAL ASSET VALUE	$8,598,034
LESS: CURRENT LIABILITIES	(702,554)
TOTAL PRICE PAID FOR SMGB DIVISION	$7,895,480
Signed
Ronald Carlin CMA, CBV.

4.04 Computation of goodwill

4.04.1 In sum the point at issue is whether there is goodwill. If there is, what is the technique to compute it?

4.04.2 It seems at first glance that the technique used by the respondent’s expert Mr. Carlin, is the dual capitalisation approach to which he refers in paragraph 4.03.2(2)E above.

This technique is explained by Mr. Ian R. Campbell in Canada Valuation Service (Carswell) at page 5-263:

THE DUAL CAPITALIZATION OF EARNINGS APPROACH

The dual capitalization of indicated after-tax earnings technique recognizes that different risk levels may attach to underlying tangible asset value versus the intangible asset value of a business operation. This technique may be used either as a primary valuation technique, or to test the conclusions derived by other techniques.

According to Mr. Carlin, “the principle is widely recognized in valuations and in particular is demonstrated in the dual capitalization approach...”

However, in cross-examination, Mr. Carlin said he did not use this technique of the dual capitalization approach on which to base his conclusion.

4.04.3 However the expert filed as Exhibit 1-2 an excerpt from Mr. Ian R. Campbell’s document entitled “The Valuation and Pricing”, pages 329-31. This excerpt concerns capitalization of indicated earnings before interest and income tax (“EBIT”).

However this technique concerning capitalization of benefits before interest is used in view of computing the fair market value of a business. It is not pertinent to the case at bar.

4.04.4 In fact the calculation of the goodwill is shown in Schedules I and II of Collin’s report cited at paragraph 4.03.2(2)E.

4.04.5 In cross-examination, Mr. Collin agreed with the following Exhibit A-17 adding that the scenario summarizes Schedules I and II of this report:

USM CANADA LTÉE

Calculation of goodwill as per Revenue Canada

Scenario 1.

PRE-TAX AVERAGE EARNINGS	$1,563,000
PRICE PAID	$7,895,000
DERIVED RATE OF RETURN	20%
NORMAL RATE OF RETURN EXPECTED	10%
GOODWILL IN %	10/20 - 50%

$3,948,000

GOODWILL IN $ (10/20 x $7,895,000)

The 20% comes from the fact that the $1,563,000 is 20% of $7,895,000.

4.04.6 In evidence in rebuttal, expert for the appellant, Mr. St-Amour, files as Exhibit A-18, adding a second scenario to the one filed as A-17:

USM CANADA LTEE

Calculation of goodwill as per Revenue Canada

		Scenario I	Scenario 2
PRE-TAX AVERAGE EARNINGS	$1,563,000		$ 1,563,000
PRICE PAID	$7,895,000		$15,630,000
DERIVED RATE OF RETURN	20%	10%
NORMAL RATE OF RETURN EXPECTED	10%	10%
GOODWILL IN %		10/20 = 50%
GOODWILL IN $(10/20 X $7,895.000)		$3,948 000

Conclusion:

If the purchase price had been $15,630,000 instead of $7,895,000 according to Schedule I and II of Revenue Canada, there would have been no goodwill as per Scenario 2.

The 10 per cent in scenario 2 comes from the fact that $1,563,000 is 10 per cent of the price paid of $15,630,000. It becomes obvious that the conclusion on Exhibit A-18 is correct and the technique used by Mr. Collin in the computation of the goodwill is not appropriate.

5. LAW — CASES AT LAW — ANALYSIS

5.01 Law

Section 68 of the Income Tax Act (the Act) is the main section involved in the case at bar. It reads as follows:

68. Allocation of amounts in consideration for disposition of property.

Where an amount received or receivable from a person can reasonably be regarded as being in part the consideration for the disposition of a particular property of a taxpayer or as being in part consideration for the provision of particular services by a taxpayer,

(a) the part of the amount that can reasonably be regarded as being the consideration for the disposition shall be deemed to be proceeds of disposition of the particular property irrespective of the form or legal effect of the contract or agreement, and the person to whom the property was disposed of shall be deemed to have acquired it for an amount equal to that part; and

(b) the part of the amount that can reasonably be regarded as being consideration for the provision of particular services shall be deemed to be an amount received or receivable by the taxpayer in respect of those services irrespective of the form or legal effect of the contract or agreement, and that part shall be deemed to be an amount paid or payable to the taxpayer by the person to whom the services were rendered in respect of those services.

However, the main other legal text involved is section is 6.2 of the Purchase and Sale Agreement, quoted above.

5.02 Cases at law

Counsel for the parties referred to the following cases at law: Appellant's list of authorities

A. Concerning definition of “goodwill” and application of Section 68 LT. A.

1. Definitions achalandage;

2. Goodwill in the law of Income Tax, John W. Durnford, Canadian Tax Journal, vol. 29, no 6. November-December 1991;

3. Malloney’s Studio Ltd. v. R. (sub nom. The Queen v. Malloney’s Studio Ltd., [1979] 2 S.C.R. 326, [1979] C.T.C. 206, 79 D.T.C. 5124;

4. Klondike Helicopters Ltd. v. Minister of National Revenue, [1965] C.T.C. 427, 65 D.T.C. 5253 (Exch.);

5. Crown Trust Co. v. R. (sub nom. Crown Trust Co. v. The Queen), [1977] C.T.C. 320, 77 D.T.C. 5173;

6. Saskatoon Drug & Stationery Co. v. Minister of National Revenue, [1975] C.T.C. 2108, 75 D.T.C. 103;

7. Dr. H.T. Robins v. Minister of National Revenue, [1978] C.T.C. 2928;

8. H. Baur Investments Ltd. v. Minister of National Revenue, [1988] 1 C.T.C. 2067, 88 D.T.C. 1024; affirmed [1990] 2 C.T.C. 122, (sub nom. H. Baur Investments Ltd. v. R.) 90 D.T.C. 6371 (F.C.T.D.)

9. Petersen v. Minister of National Revenue, [1988] 1 C.T.C. 2071, 88 D.T.C. 1040;

10. Léonard v. Minister of National Revenue, [1991] 1 C.T.C. 2353, 91 D.T.C. 545;

11. Golden v. R. (sub nom. Golden v. The Queen), [1983] C.T.C. 112, 83 D.T.C. 5138 (F.C.A.); affirmed [1986] 1 S.C.R. 209 (sub nom. R. v. Golden), [1986] 1 C.T.C. 274, 86 D.T.C. 6138;

12. Minister of National Revenue v. Clement's Drug Store (Brandon) Ltd., [1968] C.T.C. 53, 68 D.T.C. 5053;

13. Moquin v. Minister of National Revenue (1955), 12 Tax A.B.C. 415, 55 D.T.C. 259;

14. Waldorf Hotel [1958] Ltd. v. Minister of National Revenue, [1972] C.T.C. 2609, 72 D.T.C. 1503; reversed [1975] C.T.C. 162, 75 D.T.C. 5109;;

B. Concerning expert

15. R. v. Mohan, [1994] 2 S.C.R. 9, 114 D.L.R. (4th) 419;

16. Leblanc v. Ciment Québec Inc., [1987] R.R.A. 321;

17. MIUF - 12 [1988] R.D.J. 455 (C.S. Qué);

18. Québec (Sous-ministre du revenu) c. Services Industriels Tracy Inc., [1990] R.J.Q. 1697 (C.S.);

19. Québec (Procureur général) v. Marleau, no 95-269, (C.A. Que.);

20. Pure Spring Co. v. Minister of National Revenue (sub nom. Pure Spring Company Ltd. v. Minister of National Revenue, [1946] C.T.C. 171, 2 D.T.C. 844 (Exch.);

21. Provincial Paper Ltd. v. Minister of National Revenue, [1954] C.T.C. 367, 8 D.T.C. 1199 (Exch.);

22. Halpin v. Sous-ministre du revenu, [1977] R.D.F.Q. 90;

Respondent's list of authorities

23. Golden v. R. (sub nom. R. v. Golden) [1986] 1 S.C.R. 209, (sub nom. Golden v. The Queen) [1986] 1 C.T.C. 274, 86 D.T.C. 6138;

24. Schellenberg v. Minister of National Revenue, [1986] 1 C.T.C. 2608, 86 D.T.C. 1463;

25. Metropolitan Taxi Ltd. v. Minister of National Revenue, [1967] C.T.C. 88, 67 D.T.C. 5073 (Exch.); affirmed [1968] S.C.R. 496; [1968] C.T.C. 163, 68 D.T.C. 5098; —

26. Les Placements A. & N. Robitaille Inc. c. Minister du Revenu national (sub nom A & N Robitaille Inc. v. Minister of National Revenue), [1996] 1 C.T.C. 2141, 96 D.T.C. 1062;

27. Petersen v. Minister of National Revenue, [1988] 1 C.T.C. 2071, 88 D.T.C. 1040;

28. National System of Baking Alberta Ltd. v. R., (sub nom. National System of Baking Alberta Ltd. v. The Queen), [1978] C.T.C. 30, 78 D.T.C. 6018, affirmed [1980] C.T.C. 237, 80 D.T.C. 6178 (F.C.A.);

29. May son v. Minister of National Revenue, [1985] 1 C.T.C. 2395, 85 D.T.C. 341;

30. Levinter v. Minister of National Revenue, [1987] 1 C.T.C. 2385, 87 D.T.C. 318;

31. Carr v. Minister of National Revenue, [1993] 2 C.T.C. 3018, 94 D.T.C. 1067.

5.03 Analysis

5.03.1 Arm’s length transaction

It is not in dispute that the negotiations between Emhart and the appellant are at arm’s length. It is an admission by the respondent adding that there is no subterfuge, neither collusion nor fraud.

5.03.2 According to many Court decisions, when a transaction is between parties at arm’s length, the price agreed upon by the parties is one of the important circumstances to be considered.

In 1965, in Klondike Helicopters Ltd. (5.02(5)), the Exchequer Court of Canada, in interpreting paragraph 20(6)(g) of the S.C.R. 1952, which is the grandfather of the present section 68, stated at page 429 (D.T.C. 5254):

The making of a contract or agreement in the form in which it exists is, however, one of the circumstances to be taken into account in the overall enquiry and if the contract purports to determine what amount is being paid for the depreciable property and is not a mere sham or subterfuge its weight may well be decisive.

In 1968, the same Court, in Clement's Drug Store (Brandon) Ltd. (5.01(13)), said at page 64 (D.T.C. 5060):

The contract was the subject of arm’s length negotiations over a protracted period and was not a mere sham or subterfuge but represents the bargain arrived at by the parties and in my opinion is decisive in the circumstances of this case.

The same principles were referred to in the Golden case in 1983 by the Federal Court of Appeal (5.02(12)) and confirmed by the Supreme Court of Canada in 1986 (5.02(3)), dismissing the appeal of the Queen.

The latter summarized the facts as follows at page 209 (C.T.C. 274, D.T.C. 6138):

Respondents sold in an arm’s length transaction a plot of land containing apartment buildings for $5,850,000. The Agreement of Purchase and Sale expressly provided that of this total price $5,100,000 was allocated to land and $750,000 was allocated to “equipment, buildings, roads, sidewalks, etc.” Pursuant to s. 68 of the Income Tax Act, the Minister of National Revenue reassessed the respondents’ allocation of proceeds with the result that substantial amounts of recaptured capital cost allowances were added to their incomes. The respondents appealed the Minister’s assessment to the Federal Court. The Trial Division dismissed their appeal but the Court of Appeal unanimously set aside the judgment with the majority holding that s. 68 had no application to this transaction.

Case: The appeal is dismissed.

The Court ruled on two points: first, on the meaning of “something else” which appears in s. 68. A majority of the Supreme Court maintained that it should be given a very broad meaning, thereby including other assets.

The second point regards the apportionment. On this issue, a majority of the Supreme Court affirmed the Federal Court of Appeal ruling that the apportionment arrived at by the parties was a reasonable one.

5.03.3 Counsel for the respondent however contends that the appellant denied paragraph 6e) of the Reply to the Notice of Appeal (2.02). It is to the effect that the amount of $3,796,450 (Cdn) was allocated by S.M.G.B. as disposition of goodwill. The appellant did not produce any evidence concerning this fact. When it was asked of Mr. Polverari if he had consulted Emhart before making his allocation of $3,796,450 to leased machinery, he said no, because he had to decide for U.S.M., and not for Emhart.

By submitting as argument the following quotes, counsel for the respondent is essentially saying that what is goodwill for Emhart is also goodwill for the appellant.

In the Golden case, the Federal Court of Appeal referred to Herb Payne (63 D.T.C. 1075), where Noël J. set out the following rule at pages 116 (D.T.C. 5141):

Because of the reciprocal effect on purchaser and vendor of any such finding here, I am prepared to accept, as suggested by counsel for the respondent, that the matter should be considered from the viewpoint of the purchaser as well as from the viewpoint of the vendor.

There is also no question that if the purchaser and vendor acting at arm’s length, reach a mutual decision as to apportionment of price against various assets which appear to be reasonable under the circumstances, they should be accepted by the taxation authority as accurate and should be binding on both parties.

Somewhat later, referring to another decision by Noel, J. at page 116 (D.T.C. 5142):

In 1968, Mr. Justice Noel was called upon to again make a determination under paragraph 20(6)(g) in the case of Emco Ltd. v. Minister of National Revenue. Here also, in making the necessary determination, the learned Justice considered the evidence as to the bargaining between the parties and the evidence as to the meeting of minds on both sides in the relevant transactions.

5.03.4 In Saskatoon Drug Ltd. (5.02(7)), the Tax Review Board stated that the reallocation in respect of one party also applies with respect to the other even though this might on occasion lead to injustices.

Professor John W. Durnford (5.02(2)) at pages 799 and 800 said after referring to the Tax Review Board’s decision above:

The accuracy of the last statement above is open to question.

After some comments he said:

In any event it would appear that, in strict law, two taxpayers can quite conceivably end up with different allocations of a purchase price, if such may reasonably be inferred from the following words of Estey, J., speaking for the majority of the Supreme Court of Canada in the case of Malloney’s Studio:

Mutuality of tax treatment of parties to the same transaction, or even the avoidance of double taxation have never been principles which the draftsmen of taxing statutes have ever regarded themselves as saddled.

5.03.5 In the present case, the two contractors arrived at the same sale price of $7,749,689. It is useful to point out that U.S. $2,900,000 out of U.S. $50,400,000 of “premium to book net asset value” was allocated to the Canadian Division, which was one out of 12 countries (4.02.3(1) History). After the transaction was completed, this amount was allocated by the appellant to the cost of class 29 assets and was allocated by Emhart to goodwill.

Each one was independent from the other. Each one had the right to make the allocation according to the reality of its business provided it was within the Act.

5.03.6 The respondent referred the Schellenberg case (5.02(25)). In that case a principal residence and an adjoining parcel of land was sold for $375,000. The Agreement of Purchase and Sale did not allocate the sale price between the two properties. The taxpayer reported taxable capital gains on the basis that $221,000 of the sale price was attributable to the principal residence and thus exempt from capital gains tax, and that the balance of $154,000 was attributable to the adjoining parcel. The Minister’s appraiser valued the property from the viewpoint of the purchaser alone allocating $258,200 to the parcel of land.

Justice Christie, Associate Chief Judge of this Court, after studying the Golden case, adopted the principles of Stubart Investments Ltd. referred to by the Supreme Court of Canada (at page 210 (C.T.C. 274, D.T.C. 6138) giving to the expression “something else” in section 68 “the widest meaning reasonably assignable”.

The Judge, before allowing the appeal, made the following comments at page 2613 (D.T.C. 1467):

I believe it is clear that in allocating $258,200 to Lot 11, Meadow did this by treating the matter from the point of view of the purchaser alone. It is equally clear from the passage previously quoted from the reasons for judgment delivered by Heald J. in Golden and from reading the authorities cited by him in coming to the conclusions therein that in making a determination under section 68 the matter is to be considered from the viewpoint of both the vendor and the purchaser. The consequence is that, even if it could be said that section 68 was taken into account in making the reassessments, it was misconstrued and misapplied.

[N.B.: Meadow is the Minister’s appraiser. I

In the present case, both parties arrived at the same amount of $2,900,000 (U.S.) - $3,881,761 (Cdn) as provided in section 68. Indeed, in this case the allocation is not unreasonable. The nature of the item to which it is allocated depends on the particular circumstances of each party. Each one had the right to make the allocation to the item which is the most advantageous from a fiscal point of view.

5.03.7 Counsel for the respondent referred also to the Petersen case (5.02(10)). The facts and decision are summarized as follows at page 2071 (D.T.C. 1040):

The taxpayer sold a day care centre, including land, building and equipment, for $157,000. The taxpayer and the purchaser agreed in writing to allocate $45,000 of this amount to goodwill and the taxpayer reported his income on that basis. The business had suffered losses in each of the five years of operation since its inception in 1975. In 1979, an inspection by a government official disclose serious problems and the day care was granted only a six-month licence instead of the usual one-year licence. This licence was not transferable. The Minister assessed the taxpayer on the basis that it was not reasonable to allocate any of the sale price to goodwill. The taxpayer appealed to the Tax Court of Canada.

Held: The taxpayer’s appeal was dismissed. The Court found that while the taxpayer successfully established that goodwill in the business existed, he had failed to establish its value. The Minister, on the other hand, submitted two appraisal reports which supported his position that there was no element of goodwill in the consideration paid for the business. In these circumstances, it was not possible to conclude that the Minister’s allocation was unreasonable.

Judge Rip of this Court, at the end of his decision (page 2081 (D.T.C. 1047)), made the following appropriate comments:

The onus is on the appellant to prove the Minister’s allocation under section 68 is unreasonable; it is incumbent on the appellant to provide the Court with evidence which not only supports a conclusion that the Minister’s allocation is unreasonable, but also to provide evidence to establish, with some degree of certainty, the allocation which the appellant submits is correct.

5.03.8 According to counsel for the respondent, the allocation made by neither company was reasonable and the Minister was therefore correct to use section 68 to make an allocation.

He reproachs the parties of having valued only 1143 leased pieces of equipment and of having forgotten 195. The latter, he concedes however, may have had only nominal value.

5.03.9 In reply, counsel for the appellant argued that, among the 1143 leased pieces of equipment, 700 had only nominal value.

5.03.10 Concerning Exhibit A-10, the respondent argues that Mr. St- Amour, by using the determination of goodwill under the dual capitalization of earnings, suggests that there is a goodwill of $2,638,310. Therefore there is a possibility of goodwill.

This figure in Exhibit A-10 appears in the book value column. However it is the fair market value that is involved. By using the same method of dual capitalization of earnings on the same Exhibit, he arrives at a nil fair market value. This Exhibit reads as follows:

USM CANADA LTEE

Calculation of net earnings as per Revenue Canada

Indicated pre-tax earnings as per Schedule I	1,563,000
Tax thereon - 38%	593,940
Net earnings	$ 969,060

Determination of goodwill under the

Book value	Fair
	market
	value

Return on tangible assets
After-tax earnings	969,060		969,060
Less: 11% return on tangible assets
At book value $4,012,718	441,398
At fair market value $7.894.479
Excess earnings	527,662		527,662
100,667
Goodwill - (13.6%) (20.0%)	7,35	x 5
Goodwill	$3,882,282	$2,638,310		$
203,335
After-tax earnings	969,060		969,060
Less: 12.27% return on tangible assets:
At book value			492,360
At fair market value			969,060
			476,700
Goodwill		$2,383,500

As mentioned above, Mr. Carlin, testifying about this method, said that he did not use it to reach the conclusion of the valuation report (4.04.2 in fine).

5.03.11 Counsel for the respondent stressed the fact that the appellant’s appraisal must be rejected because it was hindsight.

Indeed the computation of the value is based on facts dated from May 1987 on.

The evidence is to the effect that a premium to book net asset value of $2,900,000 (U.S.) out of the U.S. $50,400,000 was allocated to the Canadian Division. The problem for the appellant was to verify whether the fair market value of the assets purchased from Emhart was around the value of the allocated premium plus the total net book value of the leased pieces of equipment.

The net book value from Emhart Canada’s figure was $2,726,706 and the net book value reached by Peat Marwick Mitchell & Co., the accountants of U.S.M., was $2,718,397. Let us add to each of these figures the allocated premium:

Emhart/U.S.M.

$2,726,706: $2,718,397

$3,881,761: $3,881,761

$6,608,467: $6,600,158

The figures are only slightly different.

On April 29, 1987, the valuation of the leased pieces of equipment made by Peat Marwick Mitchell & Co. was $6,558,661. This figure had been computed pursuant to the Emhart Canada’s policy selling price of leased equipment described in the letter dated October 21, 1983 by Mr.

C. Brindamour to Mr. A. Polverari (Exhibit A-2, Tab 3) cited as Appendix I in the valuation report of Mr. St-Amour (4.02.3(4)).

The interest of Mr. St-Amour was to check the reasonableness not only of the figure $6,608,467 against other sources of information, but also of the figure $6,558,661. There was a difficulty in trying to find figures from other sources than the appellant. Indeed, Emhart had only one competitor and not a very important one. The only existing source was actual sales after April 1987.

In addition, the pieces of equipment involved were all manufactured by Emhart.

In my view, the result of $6,558,661 was the actual valuation of the leased pieces of equipment with the appropriate items existing before May 1987. It would not have been of interest to the appellant’s appraiser to verify the calculation of the same figures made by the accountants for U.S.M.

The result of $6,595,685 is slightly different from the figure $6,608,467 ($2,726,706 + $3,881,761) and from the figure $6,558,661.

Concerning the objection of counsel for the respondent because hindsight is not admissible, I refer to “The Principles and Practice of Business Valuation” (Richard DeBoo Limited) of Ian R. Campbell, 1975, page 20:

Although information such as a sale occurring after the valuation date should not be considered in determining notional values, it is proper to use such information to assist in deciding whether a notional valuation conclusion is reasonable. For example, in W.H. Crandall v. Minister of National Revenue the chairman of the Tax Review Board said that he was entitled to take advantage of hindsight in arriving at his decision, citing the case of Produits L.D.G. v. Minister of National Revenue as his authority to do this. In the Produits L.D.G. case it was held proper to review what went on following the organization of a deferred pension plan when assessing the intent of the parties at the time the plan was established. This is consistent with the conclusions of the court in Baxter v. F.W. Gapp & Co. where evidence of a resale price two years after a notional valuation date was considered to be prima facie evidence that the notional valuation was too high.

As the interest of Mr. St-Amour was to check whether the conclusion arrived at from the figures of Emhart and from those of U.S.M. were reasonable and as there were no other sources of information existing before May 1987 comparable to those of the appellant which had been used by the appellant’s accountants in their computation, I accept the evidence adduced by Mr. St-Amour concerning the computation of the valuation of the leased machinery.

5.03.12 In addition, Mr. St-Amour counterchecked his own estimate of $6,595,685 (4.02.3(7)) and arrived at an estimated fair market value of leased machinery of $6,169,823 (1987) and $6,573,112 (1988).

Finally, taking into account the fact that the shoe market had been going down in North America since 1985 (4.02.3(9)), the after 1987 figures used in the valuation report by no means exagerate the estimated figures of April 1987.

5.03.13 Goodwill

The point is whether the allocation of $3,881,761 allocated to the Canadian Division is a goodwill for the appellant. It is appropriate to quote the following passage from Professor John W. Durnford (5.02(2)) at pages 774-75:

In valuing goodwill, it must be kept in mind that when goodwill is valued as being the excess of the price paid for the business over the values of the tangibles and identifiable intangibles, one must be careful that the real source of the excess does not simply arise from the assets being erroneously listed on the basis of historical cost or book values. Thus when the buyer pays $125,000 for a business, the excess of $25,000 over the supposed value of the identifiable assets fixed at $100,000 may arise from the increased value of well-situated real estate that may command a higher price than formerly. Care must be taken to make sure that current fair market values are used. This is, of course, an area calling for the expertise of valuators who must then select the principles of valuation that are the most appropriate in the circumstances.

In my view, in the instant case, the price paid for the business is not over the value of the tangibles taking in account their fair market value. It is not even necessary to consider the identifiable intangibles as listed in Carlin’s Valuation Report (4.03.2(2)D)).

5.03.14 The appellant’s evidence has reversed the burden of proof.

The reasoning of Mr. Collin’s report does not convince the Court of the respondent’s position.

5.03.15 Counsel for the appellant objected to the testimony of Mr. Carlin, stating that the latter had participated in the issuing of the assessment against the appellant and that he was therefore not a suitable expert witness.

However, given the conclusion that I have reached, it becomes unnecessary to address this point.

6. Conclusion

The appeal is allowed with costs including those of the expert’s appraisal.

Appeal allowed.