Gary J. Chatfield v. Minister of National Revenue, [1988] 1 CTC 2173

Bonner, T.C.J.: —[Orally]: This is an appeal from an assessment of income tax for the 1980 taxation year. In computing his income for the year the appellant deducted $40,000 in respect of management fees arising out of two agreements between him and Vancouver Taxsavers. He also deducted capital cost allowance in the amount of $10 in respect of the cost to him of two licences granted under the agreements. In making the assessments under appeal the respondent disallowed both deductions.

The appellant's claim to deduct the $40,000 rests on the premise that the amount was the cost to him of, and I quote from the agreement, Exhibit A-3:

. . . Management support in the form of advertising, planning, organizing, controlling, directing, marketing, obtaining financing, promoting, and monitoring the business of the Licencee within the defined territory, during the first fiscal year of the Licencee's operations . . .

pursuant to clause 2 of the agreements. The appellant’s claim to deduct the $10 rested on the premise that the amounts paid by him for the licences were the capital cost to him of licences acquired for exploitation in carrying on the business.

The business said to have been intended involved providing tax preparation services and financial planning and advice in two areas of Canada designated by reference to the area of a telephone exchange, that is to say, the area code and first three digits of a telephone number.

The appellant was the only person to give evidence at the hearing. He was and is a senior executive of a company called Extendicare. He did not plan to operate the Taxsavers business personally. His intention, he said, was from the outset to appoint the licensor as his agent to “service” the two purchased territories pursuant to clause 5 of the agreements. He said that he signed something to accomplish this end, but did not produce the document.

It is difficult to reconcile the events which did take place with what was called for by the documents which were produced. It would seem that it was intended that only $5,000 of each of the two $20,000 licence fees be paid in cash. The balance was intended, apparently, to be covered by a promissory note. No explanation was given as to why the notes were in the amount of $20,000 each and not $15,000. Provision was made in clause 3 of the agreements for delivery by the Licensor to the Licensee of a $15,000 cash performance bond for each licence. It does not appear that any such bond was ever delivered. The documents, including the notes, were signed by the appellant on October 29, 1980. They were returned executed by the Licensor where required early in November of 1980. The promissory notes were returned at the same time bearing a “PAID” stamp. The appellant admitted that he had expected that the notes would be returned to him forthwith. A form of letter of undertaking seen by the appellant with other documents before entering into the transaction contemplates the immediate return to the Licensee of the notes. Provision is made in clause 3 of the agreements for tender by the Licensor to the Licensee of a cash performance bond conditioned on the generation in each defined territory of $150,000 in gross revenues over a ten-year period. The bonds were never delivered, possibly because of the return of the notes. It is apparent that the parties to the transaction did not intend that the documents govern their relationships with each other.

Another strange feature of the transaction is the $20,000 fee put forward as the consideration for "management support" during the first fiscal year of the Licensee's operations. That year ended, the appellant admitted, on December 31, 1980, only two months after signing the documents. No provision is made for management support after 1980, either for further consideration or for nothing. The explanation cannot be that the management fee was not required where the Licensor was to act as the Licensee's agent because that was what was intended from the outset and the $20,000 would never have been payable by the appellant at all if such were the case. The adverse practical consequence of the absence of any such obligation on the part of the Licensor would have been alarming if the documents were genuine in light of the appellant's admissions:

(1) that he is not a tax expert;

(2) that tax returns are too complex for him to prepare; and

(3) that it would be unreasonable and unrealistic to expect the services to be provided in 1980 by the Licensor.

All this reinforces my conclusion that the documents were not intended to govern the relationship between Licensor and Licensee.

The appellant made no prior investigation of the ability of the Licensor to perform its ostensible obligations under the Agreements. It was not suggested that the Licensor's “financial planning systems and tax preparation systems for clients" referred to in clause 1 of the Agreements were ever developed. The business which was said to be intended was never carried on. The appellant explained that Vancouver Taxsavers' prime thrust in 1981 and 1982 was marketing the concept, whatever concept that was, and developing the system.

Clause 12 of the agreements reads:

12. It is furthermore agreed between the Licensor and the Licencee that in the event that the deduction for tax purposes of the management fee is disallowed, the Licensor or his agents shall have the first right to represent the Licencee before the appropriate department of Revenue Canada and/or the Courts, and if such representation or representations fail to uphold the deduction, then the parties hereto agree that the sale price will be adjusted accordingly or the Licencee may at his option deem this Agreement to be void ab initio and the parties will then refund and return each to the other all monies, promissory notes and any and all documents arising from the licencing arrangement.

Therein, it would seem, lies the only explanation for the whole affair. The appellant, who admitted he was in a high tax bracket, paid $10,000 in cash and owed nothing more to the Licensor by virtue of the cancellation of the indebtedness on the notes. He ended up in circumstances in which he was intended to be able to assert that he had made a deductible $40,000 expenditure. The securing of a tax advantage was not, as the appellant suggested, one of the reasons for entering into the transaction. All of the objective evidence supports the conclusion which I have reached that it was the only meaningful reason.

The $10,000 expenditure was not made for the purpose of gaining or producing income from a business within the meaning of paragraph 18(1)(a) of the Income Tax Act. There was no business. The appellant incurred no further liability because the notes were never intended to create liability in the first place. Even if he did, there was no business enabling him to bring any such liability within paragraph 18(1)(a). Paragraph 1102(1)(c) of the Income Tax Regulations prohibits the deduction of capital cost allowance in respect of the capital cost of the licence.

I need only add that there is no meaningful distinction to be drawn between the facts in this case and those before my brother, Judge Taylor, in

L. Farrell v. M.N.R., [1985] 2 C.T.C. 2222. There is no basis, therefore, for arriving at a different result. The appeal will be dismissed.

Appeal dismissed.