Gaétan Brodeur v. Minister of National Revenue, [1987] 2 CTC 2049

Couture, C.J.T.C. [Translation]: —In the 1983 taxation year, M. G. Brodeur (the appellant) reported $24,000 as proceeds from the sale of his clientele, half of which was a taxable capital gain. The respondent, for his part, considers that the amount paid was really fees and accordingly is completely taxable. The issue in this dispute is limited to determining the nature of the payment received by the appellant.

On October 20, 1980, the appellant, a certified accountant, joined the firm of Bélanger, Hebert & Associés. A partnership agreement was signed but, according to the appellant, certain clauses were never observed. He referred in particular to a clause providing that he would receive a share of the firm's profits amounting to $50,000 after two years of service and a share of between three and eight per cent on his capital, which he never received.

In December 1982, the appellant decided to leave the firm of his own accord. On December 7, 1982, he signed an agreement concerning his withdrawal from the firm beginning on December 31,1982, despite a provision in the partnership agreement which specified the procedures to follow on the departure of a partner. The relevant clauses of this "agreement relating to the departure of a partner" (the agreement) read as follows:

1. MR. BRODEUR will leave THE FIRM as a partner and employee, beginning on December 31, 1982.

4. The parties hereto declare that the departure of MR. BRODEUR from THE FIRM is to be considered voluntary and MR. BRODEUR is entitled at that time to receive his share of the capital as described specifically in his capital account in the books and journals of THE FIRM on February 1, 1982, plus interest to December 31, 1982, at the Bank of Canada’s prime rate on that date, plus 1%.

6. In consideration of MR. BRODEUR'S undertaking concerning the transfer of his clientele to THE FIRM, the latter shall employ MR. BRODEUR as an adviser to THE FIRM for a term of twelve months at a monthly fee of $2,000, in addition to a fee of $5,000 for January 1984. The fees shall be paid once a month, on the last day of each month. MR. BRODEUR'S contribution as adviser to THE FIRM in return for the transfer of his clientele shall be made in particular in the following manner but is not restricted to that manner:

6.1 MR. BRODEUR promises to provide THE FIRM member designated by the partner who is specifically responsible for the transfer of his clientele with all relevant information so that this designated member may be able to handle each file appropriately;

6.2 MR. BRODEUR further promises to have each of his clients entrust the handling of his accounts to THE FIRM;

6.3 MR. BRODEUR promises to make himself available at all times during business hours (and during the thirteen-month period described above) in order to provide either personally, by telephone or otherwise, any information required to achieve the objectives described above of transferring his clientele and providing help in supplying information in respect of each of his previous clients.

The agreement also provided for a non-competition clause and a release clause against the firm. As had been provided, the appellant received an amount totalling $24,000 in 1983.

Finally, it should be noted that the firm did not withhold any amounts for taxes from the monthly payments remitted to the appellant although it was provided with a T-4A form for the taxation year under appeal.

The appellant states that he received no compensation for his clientele when he joined the firm in 1980 and that in 1983, when he was registered as a full-time student at the university, he did no work as an adviser or consultant, and also that he only worked for a few hours in 1982 to help with the transfer of his files to other partners before he left.

In the Minister’s opinion, these are payments of fees, which should be viewed as income.

No evidence was led by the respondent to contradict or refute the appellant's claims that certain provisions of the partnership agreement were never observed by the firm even though the firm's senior partner was present at the hearing when the appellant testified and also testified himself.

In his argument, the respondent's representative relied on the provisions of Article 1234 of the Quebec Civil Code to the effect that the appellant could not use testimony to contradict a valid written instrument, namely the agreement of December 7, 1982 between the firm and the appellant. He argued that since this agreement provided for the payment of fees to the appellant, as an adviser of the firm, the latter was bound by this provision and could not submit evidence to the Court to the effect that the said payments represented in fact and in law the proceeds of disposition of his clientele.

Is Article 1234 applicable in the circumstances?

Art 1234. Testimony cannot in any case, be received to contradict or vary the terms of a valid written instrument.

This problem was exhaustively analysed by the Federal Court of Appeal in M.N.R. v. R. P. Ouellette & J. FE. Brett, [1971] C.T.C. 121; 71 D.T.C. 5094 and I adopt the reasoning of Walsh, J. at 134 (D.T.C. 5102) when he answered the question in the following terms:

The matter was studied at some length by Mr. Justice Owen of the Quebec Court of Appeal in an article in the McGill Law Journal, vol. 4, No. 1, in which he concludes that Article 1234 of the Civil Code is of English origin.

Consequently, since a party to a deed is not estopped from contradicting or varying the terms of a valid written instrument against a stranger, e.g., the Minister of National Revenue, in common law jurisdictions the same rule should apply to deeds entered into in the Province of Quebec.

The question is dealt with by Dumoulin, J. in the case of M.N.R. v. Albani Thibault, [1962] C.T.C. 137, which held that the provisions of the Civil Code limiting the mode of proof of facts covered by a deed was applicable only between the parties to it and that the deed was res inter alios acta quoad the Minister. In this judgment he states, at page 145:

[Translation]

. . . This issue does not amount to much; it can be disposed of in a few words. In arguing against the use of testimony, the appellant relies on art 1234 which prohibits the use of oral testimony to contradict or vary the terms of a valid written instrument. It would seem elementary to point out that this limitative provision applies only to the parties to the deed and in no way applies to third parties for whom such an instrument would come under the category of res inter alios acta.

In support of this he quotes (at page 146) from Mignault, Droit Civil Canadien, vol. VI, page 86, the following sentence:

[Translation]

Let us add that third parties may allege any kind of evidence against an instrument that is being raised against them.

It must be remembered that in the present appeals, although they were argued as if Brett and Ouellette on the one hand, and Blauer on the other were adversaries, in actual fact it is the Minister of National Revenue who is the appellant and, as such, the adversary in the cases of Ouellette and Brett, and the respondent and adversary in the case of Blauer. To hold that the Minister is bound by the terms of an agreement entered into between Brett and Ouellette on the one hand and Blauer on the other, and cannot introduce evidence to show that use of the term “goodwill” in the agreement did not represent the true consideration for which the payment was made could open the door for all sorts of agreements to be drawn up in avoidance of taxation, though I do not suggest that this was deliberately done in the present case, and to hold further that this is a situation which only applies in the Province of Quebec because of the existence of Article 1234 in the Quebec Civil Code is a proposition which I cannot entertain. While Article 1234 of the Quebec Civil Code would have its full application in any litigation between Brett and Ouellette on the one hand, and Blauer on the other, arising out of the interpretation of the dissolution agreement, it can have no application in the present proceedings between the three parties respectively and the Minister of National Revenue and I therefore hold the verbal evidence introduced in an attempt to interpret the agreement to be admissible.

[Emphasis added.]

The preceding comments thus dispose of the argument advanced by the Minister's representative in respect of the validity of testimony against a written instrument in the circumstances described above.

In the agreement, the term "fees" is used to describe the payments received by the appellant in 1983. It is undeniable that such a description offers an indication of how the transaction should be classified. Nonetheless, this indication is certainly not conclusive. The substance of the transaction must be analysed and not its form, as Walsh, J. held in M.N.R. v. Ouellette & Brett (supra):

The jurisprudence is very clear that it is not what parties call a payment in a contract which determines the nature of it but the real character of the transaction. Simon's Income Tax 1964-65, vol. 1, has this to say at page 59 in connection with the case of C./.R. v. Duke of Westminster, [1936] A.C. 1, quoting from the judgment of Lord Russell of Killowen on the contrast between the form and the substance of an arrangement:

If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good . . . If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine.

He also quotes from the judgment of Viscount Simon in the case of C./.R. v. Wesleyan and General Assurance Society, [1948] 1 All E.R. 555, at 557, as follows:

It may be well to repeat two propositions, which are well established in the application of the law relating to income tax. First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it. Secondly, a transaction which, on its true construction, is of a kind hat would escape tax is not taxable on the ground that the same result could be brought about by a transaction in another form which would attract tax.

Again, at page 60, he states:

The true principle governing ''substance" and "form" is that the taxing Acts are to be applied in accordance with the legal rights of the parties to a transaction. It is those rights which determine what is the "substance" of the transaction in the correct usage of that term. Reading "substance" in that way, it is still true to say that the substance of a transaction prevails over mere nomenclature.

An example, referred to by Lord Russell of Killowen in the Westminster case ([1936] A.C. 1, 25; 19 T.C. 490, 510, 524, H.L.) of the proper disregard of the name given to a transaction is furnished by the decision of the House of Lords in Secretary of State in Council of India v. Scoble, [1903] A.C. 299. What was called in a contract for acquisition of a railway "an annuity” was there held to consist largely of a sum of purchase money payable by instalments. So to hold was simply to give effect to the “indisputable rule that the surrounding circumstances must be regarded in construing a document” (Per Lord Tomlin in the Westminster case, supra). Another instance of a case in which the Court did not restrict itself to the actual terms of a document in ascertaining the true character of the transaction which it evidenced is /. R. Comrs. v. Mallaby-Deeley, [1938] 4 All E.R. 818). The covenantor had bound himself by deed to pay certain sums under deduction of tax, thereby replacing a previous undertaking to finance the completion of a literary work. Although the undertaking was not referred to in the deed, the Court of Appeal had regard to the whole history of the transaction, and held that the true nature of the payments was capital.

In the case of /. R. Comrs. v. Fleming & Co. (Machinery), Ltd., [1952] S.C. 120 shows that the principle of the Duke of Westminster's case (supra) applies to refute a taxpayer's argument, which ignores the true legal character of a transaction, as well as to protect the subject against an attempt to read a non- taxable transaction as taxable.

We must therefore examine further whether the payment of $75,000 was made to Blauer for his goodwill in the partnership or whether it was really a distribution to him of his estimated share of the fees from the Sherbrooke and Boucherville tunnel contracts as Brett and Ouellette contend and, hence, deductible by them and taxable in his hands, and that the designation of it in the dissolution agreement as goodwill does not represent the true substance of the agreement.

The issue has now been narrowed down to whether the appellant received fees, which would be considered as income, or whether proceeds from the disposition of a clientele were involved, which are taxable as capital gains. The question has given rise to much debate from which we can take the principle that every situation must be analysed on its own facts, as the stormy controversies between the concepts of income and capital gain make clear.

Accordingly, I find that the point at issue, as in In re Spira et al. v. M.N.R., [1975] C.T.C. 2158; 75 D.T.C. 83, is one of form and substance wherein the Court is obliged to have regard for the real intent of the parties. For all these reasons, I am therefore of the opinion that the said $24,000 is a gain arising from the disposition of a clientele.

One provision of the partnership agreement which was not observed by the parties according to the written evidence is clause 52 concerning ownership of the files. It reads:

52. By accepting this partnership agreement, each partner renounces all rights of ownership in any of the clients’ files and the firm becomes the sole owner thereof. Only in the case of the dissolution and liquidation of the firm can the ownership of the files revest in the partners personally; in all other cases, the ownership of these files shall remain in the Firm.

If that provision was binding on the appellant when he joined the firm, why did the parties in the agreement include a special provision regarding the transfer of the said files to the firm upon his departure?

The appellant testified that, on entering the firm of Bélanger, Hébert & Associés he had brought about a hundred files with him which generated fees amounting to $60,000 or $70,000 a year for the firm. He also testified that he had received no consideration either in cash or otherwise for this contribution.

In connection with his negotiations with his former associates as to the details of his departure, I cite from his testimony:

Like a good boy, I decided to accept what Bélanger, Hébert offered me on my departure, and I told them:

Listen, I’m going to settle every thing; give me the equivalent of about one year of retirement, keep all the files, and I'll go. And that is what was done.

According to his income tax return, his income from the firm amounted to $29,022.

Another piece of evidence that supports the appellant’s contention as to the nature of the amount that he received from the firm is also to be found in the agreement. The clauses in which the expressions "clientele" and "clients" appear are all in relation to the appellant and "his clientele” and "his clients". Such a reference seems to confirm the position taken by the appellant that the subject-matter of the agreement in question was primarily his ownership of the clientele.

Thus if the appellant transferred ownership of his files to the firm by means of this document, it seems more in keeping with the evidence as a whole and closer to reality to accept his argument and to regard the $24,000 that he received in 1983 as the proceeds of disposition of his clientele rather than fees for services rendered to the firm for work which he was never asked to perform.

The appeal is therefore allowed and the whole referred back to the respondent for re-examination and reassessment, on the basis that the $24,000 received by the appellant in 1983 represented the proceeds of disposition of his clientele.

The appellant will be entitled to party-and-party costs.

Appeal allowed.