Irving Erenberg, Joseph Isenman v. Minister of National Revenue, [1981] CTC 2138

M J Bonner:—The appeals of Irving Erenberg and Joseph Isenman from assessments for their 1974 taxation years were heard together on common evidence. For many yeas prior to 1974 the appellants, in partnership, carried on the business of a public house and hotel under the name “Eton Tavern”. The tavern was located at 710 Danforth Avenue in Toronto. By agreement formed on January 10, 1974. the appellants sold their business as a going concern to S. Waxman.

In the agreement of purchase and sale the $590,000 purchase price was allocated as follows:

The respondent, in assessing tax in each case, added to declared income the sum of $35,764.75 as “Eligible capital amount — goodwill”, that action being based on section 14 of the Income Tax Act and on the premise that the purchaser paid $294,000 for goodwill and $25,000 for the liquor licence without which the business could not have been lawfully operated.* [1]

The position taken by the appellants in their notices of appeal was that:

. . . the value of goodwill of the said business sold by the partnership was represented entirely by the intangible value of the licence issued by the Liquor Licence Board of Ontario and that there was no appreciable commercial goodwill of the Said business independent of the licence or other intangible value in the said business other than the value of the licence.

It was common ground that the liquor licence was a “government right” within the meaning of subsection 21(3) of the Income Tax Application Rules, 1971. Both parties to the agreement of purchase and sale treated the licence as being transferable and it was not suggested at the hearing that the licence was not a thing capable of being transferred.

The only witness called by the appellant was Paul J Martin, chief appraiser of John R Marsh & Co Limited, a firm of hotel brokers and appraisers. Mr Martin expressed the opinion that both on December 31, 1971, and on the day of sale, 75% of the value of the goodwill of the business (being market value of the business as a going concern less the sum of the values of the tangible assets) was attributable to the liquor licence. The remaining 25% was attributable to what Mr Martin described as “secondary factors”, namely, management, location and reputation. The essence of Mr Martin’s approach is set forth from the following passages taken from his report, Exhibit A-2:

The nature of goodwill peculiar to beverage taverns is consumer or customer goodwill and is represented by certain intangible factors of production that create and enhance product turnover.

Goodwill as an asset is the end measureable product or benefit which arises from some causes. The intangible factors of production referred to above are the “causes” and the product turnover is the “result”. These intangible factors of production or causes are categorized:

1. Primary or root causes

2. Secondary factors.

The Primary or Root Cause of goodwill in the Eton Tavern is the quasi- monopolistic power or licence to sell beverage alcohol.

The Secondary Factors include the composite effect of locality, management and reputation.

The composite effect of both the primary cause and the secondary factors is the benefit of product turnover. These benefits lead to the possibility or power of earning extra profit, and creating an extra asset, namely goodwill. In the subject case, however, we are not so much concerned with the overall measurement of goodwill, as with the source from which such benefits flow. This must be searched out in a Subjective manner relative to the particular business at hand.

CHARACTERISTICS AND COMPONENT CAUSES OF GOODWILL IN BEVERAGE TAVERNS

General Facts — Licence

The licence is the primary or root cause in the development of goodwill. Without the licence to sell beverage alcohol, there would be no patronage, no product turnover and goodwill would not develop as a residual asset. It is not only the root cause it is the principal agent of production holding the assets together for the generation of revenue.

The licence has no separate or distinguishable value because it is not marketable. It has value only within the context of goodwill value. It could be said that the licence is akin to a stream running through a parcel of land. In itself, the stream has no distinct marketable value but enhances the value of the asset with which it is associated.

One of the witnesses called by the Minister was Mitchell A Smith, CA, of the firm of Laventhol & Horwath, management consultants. It was his view that none of the consideration was allocable or attributable to the licence. The value of the business, he said, was a function of profitability, and profitability was a function of plant, location, product and management. It was his view that the liquor licence in question here, like many other licences necessary to the lawful operation of various businesses, did not in itself possess value. Rather, he thought it was the use of the licence along with management, product and physical assets constituting plant that gave rise to the profits and thus to the value of the business in excess of the value of the tangible property.

In relation to Mr Martin’s characterization of the licence as a quasi- monopolistic right and the primary or root cause of goodwill value, Mr Smith pointed out that there were 21 establishments in the immediate area in direct competition with the Eton Tavern. Further, he testified that on occasion licenced public houses sell for the net value of tangible assets. He said that when such an establishment was made to run profitably it took on greater value in the market place on a sale as a going concern and thus possessed a valuable intangible asset, goodwill. He reasoned that the licence, being an asset present both when the value of the business as a going concern did not exceed tangible asset value and later when it did, was not the source of the increase in value of the business.

While I have referred in these reasons to a licence, the Eton Tavern in fact operated under licences of several classes. There were three different public house licences, for men, for women and for men and women and, in addition, a dining room licence. The public house type of licence was not available on fresh application in 1974 but an existing licence could be transferred to a purchaser of the real property for which the licence had been originally issued. Although it was clear from the evidence of Larry Zahara, manager of the licencing branch of the Liquor Licencing Board, that licences of other classes were available on fresh application in 1974, the “grandfather rights” which the appellants had and could transfer may very well have been of considerable value if they permitted the operation of a business likely to yield more profit than the sort of business which could be carried on under the licences available on fresh application.

The extreme position taken by the appellants in their Notices of Appeal, that is to say, that the licences were the source of all value in excess of tangible asset value, was not supported by the evidence. The 75% position taken by Mr Martin was, he admitted, a “subjective” allocation and was not based on observation of the operation of the market place. As I understood Mr Martin’s evidence, the work which he engaged in as a broker and appraiser of hotels did not involve him in allocation of the purchase price among its various component elements.

The position taken by Mr Smith ignores the fact, which I think is obvious, that the market will pay for a licence at least as much as it would cost to obtain it on a fresh application. In a case such as this where licences of the type held by the appellants were not available on fresh application, the market would pay at least as much as the cost of obtaining, on fresh application, either a licence which would offer the operator equivalent economic advantages or the cost of obtaining the most advantageous licence plus a premium for an additional advantage inherent in the licences held. Unfortunately there was not direct evidence as to what that cost would be.

There was evidence that, under the management of the new purchaser, the tavern lost money in the three-year period following the sale. In such circumstances I must conclude that other factors such as location, product and licences having remained the same during that three-year period, management must have had a much greater weight in the production of income than was attributed to it by Mr Martin and the licences must have had considerably less weight.

On all of the evidence I am unable to conclude that the value of the licences exceeded the $25,000 figure attributed to them by the Minister. The appellants have therefore failed to establish, on the balance of probabilities, the factual proposition on which the appeals rest. The appeals will therefore be dismissed.

Appeals dismissed.