Robert E Lester v. Minister of National Revenue, [1981] CTC 2410, 81 DTC 353

The Assistant Chairman:—The appellant, who is a general insurance agent, in 1974 and 1975 acquired, in total, three customer lists and files and, when preparing his income tax returns for those years, charged the amounts paid for those lists as an expense against his commission income to arrive at his net profit for each year believing that the expenditures were within the ambit of paragraph 18(1 )(a) of the Income Tax Act after tax reform.

The Minister of National Revenue, when he assessed each of the returns, was of the view that the outlays were not within the ambit of that paragraph but were within the ambit of paragraph 18(1)(b). Accordingly his assessments did not allow the deductions claimed by the appellant but took the position that, while they were capital expenses, they were eligible capital expenditures which became part of the cumulative eligible capital of the appellant, and gave him the appropriate deductions.

The parties agree that, if the assessments are correct in principle, the computations are correct. They also agree that if the Minister is incorrect then the position taken by the appellant is correct and he should be reassessed as filed in so far as these items are concerned.

In the course of the hearing the three purchases were designated by using the vendors’ names, namely, Brown, Atkinson and Harvey. The purchase prices were $18,973.77, $9,600 and $77,500 respecitvely. At the commencement of proceedings, counsel for the appellant advised the Board that his client was no longer disputing the Minister’s treatment of the Atkinson purchase, leaving the other two transactions the only items before the Board.

As stated, the appellant is a general insurance agent licensed to sell ali types of insurance. He stated that his firm would not sell one life policy in five years. The business which he now carries on was started many years ago. He joined his father’s firm as an employee in 1949 and, about 1958, took over from his father. The name of the firm was then W A Lester & Son. He stated that the firm’s business consisted of about 60 to 70% automobile, 20 to 25% home and theft and the balance commercial. In the main, insurance policies were usually for one year but automobile insurance was only for six months. He is an agent for about 10 or 12 companies. The firm’s clientele would reside, generalizing, in the metropolitan Ottawa area. There are now, including himself, five people in the office, three of whom are licensed agents. Historically there was generally a loyalty of client to agent in the insurance business, however this general loyalty has weakened since the advent of direct writers; that is, employees of the insurance firm selling the insurance at a reduced premium. This is a major factor in the change in the client-agent relationship. In the days gone by it was usual for the children to use the agent their father had used. It is not so today. There is quite an annual attrition of clients. The appellant stated that he had made a count of his clients and, in the period 1974 to 1979, 2,100 clients had left. The client count at the time of the purchase of the lists was 3,000 but his clients reached a low of 2,600 in 1978. While attrition always existed, with normal advertising an even balance was usually kept. When purchasing lists of clients, it was his hope to keep about 80% but he was never that successful.

His first acquisition in 1974 related to the Brown Agency. Brown’s business was similar to the appellant’s but smaller. His office was in his apartment and there was no staff. An insurance company representative told the appellant about a week after Brown’s death that there was no one to look after it and it was for sale. Brown’s clients could be lost to the insurance companies if they had to service the clients. The appellant approached Brown’s daughter who was the executrix of his estate and, about two weeks after Brown’s death, made his purchase. The appellant prepared, without legal advice, the conditions of purchase (Exhibit A-1) which read as follows:

1. Purchase price shall be 1 1 /2 times annual commission, (12,649.18 X 1.5 = $18,973.77).

2. Payment of purchase price to be carried over 1 year as follows:

1 / Down	1/3 6th Month	1 / 12 Month
(6,324.59)	(6,324.59)	(6,324.59)

3. Use of Agency name (BROWN) for 3 years if required (ie Lester & Brown).

4. Collection of Accounts Receivable and Réconciliation of Accounts Payable, (Insurance Company Accounts), up until June 30, 1974.

5. Provide up dated copy of monthly statement of Accounts Receivable and Accounts Payable, prior to June 30, 1974.

6. Necessary notification to clientele of agency merger. (Sale).

7. Immediate Operation of agency and transfer of files to Lester Agency, (One- Two Weeks), so that proper service can be provided to clients and value of agency does not diminish.

8. Companies must agree to continue portfolio with Lester Agency.

9. Set up telephone answering service if required, to direct business calls to Lester office for full and complete service. (re: Item 4, 5, 6 & 7).

After the purchase and until he could move the files, he spent about two hours a day at Brown’s apartment. This was done in about two weeks time. When he took the files he took all the information which Brown had relating to each of his clients. Nothing else was taken. He cleaned up the Brown business for the estate and charged a fee for those services. He wrote clients who were in arrears, paid the insurance company when the money came in etc, all on behalf of the Brown Estate.

Shortly after the transaction the appellant, on his own letterhead, sent a letter to each of Brown’s clients (Exhibit A-3), which letter reads as follows:

It is with regret that I inform you of the passing of Mr Thomas Brown, of the Thomas Brown Insurance Agency.

The Executors of the Estate of Thomas Brown, in order to continue the personalized service, have arranged a merger with the insurance Agency of Wallace A Lester & Son, effective July, 1, 1974.

On July 15, 1974, the transfer of all records to the Wallace A Lester Agency will be completed and for future prompt and helpful service, please call Mr Bob Lester or Mrs Kathy Neville, at 236-7146.

In the meantime I have arranged for a telephone answering service at Mr Brown’s office, and I will be picking up messages twice daily to ensure that everyone is looked after promptly.

Thank you for your anticipated co-operation, and future years of friendly association.

The word “merger” as used in this letter (as well as in the Harvey matter) was the subject matter of evidence both in chief and in cross-examination. The appellant stated it was used as it was a “softer” word than sale and he hoped it would assist in keeping the Brown clients with his agency. As to the use of the name “Brown”, it was never used by him except in Exhibit A-3 and was only asked for in order to be in a position to prevent someone else from doing so. The appellant estimated there were about 500 names on the Brown client list and he believes just fewer than 50% stayed with him. In his opinion Brown’s business was very personal — the clients seemed to be his friends and also he gave unlimited credit.

While the appellant accepted the assessment with respect to the Atkinson purchase, the letter sent to the Atkinson clients was filed as Exhibit A-4. It was on the appellant’s letterhead but Atkinson signed it. Likewise it was prepared by the appellant without professional assistance. It reads as follows:

I take pleasure in announcing the merger of my Insurance Agency with the firm of Wallace A. Lester & Son, effective May 1, 1975.

On April 28th, 1975, my files and records will be transferred to Mr Lester’s office and should you require any assistance please do not hesitate to contact him, as I know you will receive friendly and prompt service.

Due to my incapacity as the result of a recent operation my personal activities will be restricted to handling insurance sales only, and this will not commence for possibly another 2 months.

In the meantine I heartily recommend Bob Lester and his staff, Mrs Kathy Neville and Mrs Shirley Goudie, as being most capable and eager to handle all your insurance needs.

One again, through an insurance company representative, he heard of the illness of Harvey and the fact that his business might be for sale. It was carried on in the name of Lew Harvey Insurance Limited. Harvey had just had his second open heart operation and had been out of his office for about six months. Since his staff consisted of himself and his secretary, there had been no agent in the office. The appellant had never met Harvey. Lester approached Harvey’s solicitor and got a customer list showing hte number of clients and negotiated for about two weeks as to the sale. He received advice from his auditors as to the form of the agreement, but he had no legal advice. The agreement (Exhibit A-5), including recitals, reads as follows:

WHEREAS, the Vendor, LEW HARVEY INSURANCE LIMITED, carries on business as a general insurance agent in the Township of Nepean.

AND WHEREAS the Vendor, LEW HARVEY INSURANCE LIMITED, has agreed to sell to the Purchaser, W. A. LESTER & SON, and W. A. LESTER & SON has agreed to purchase the attached list of customers with related information for the price hereinafter set forth.

WITNESSETH that the parties hereto agree as follows:

1. LEW HARVEY INSURANCE LIMITED doth agree to sell and W. A. LESTER & SON doth agree to purchase from LEW HARVEY INSURANCE LIMITED the list of customers and related information attached as Schedule “A”.

2. The purchase price to be paid by W. A. LESTER & SON to LEW HARVEY INSURANCE LIMITED for the list of customers and related information agreed to be sold, shall be the sum of SEVENTY-SEVEN THOUSAND FIVE HUNDRED DOLLARS ($77,500.00) which shall be payable as follows: the sum of THIRTY-EIGHT THOUSAND SEVEN HUNDRED AND FIFTY DOLLARS ($38,750,00) on the signing of this agreement, and the balance of THIRTY-EIGHT THOUSAND SEVEN HUNDRED AND FIFTY DOLLARS ($38,750.00) on the 1st day of October, 1976.

This transaction shall be closed as of the 1st day of August, 1975.

4. This agreement shall be binding upon the parties hereto, their heirs, executors, administrators, successors and assigns respectively.

A letter was sent by Lew Harvey Insurance Limited to all clients on the letterhead of the appellant but over the signature of Harvey (Exhibit A-6) as follows:

“TO MY CLIENTS’’

I take pleasure in announcing the merger of my Insurance Agency with the firm of Wallace A. Lester & Son effective August 1, 1975.

On September 30, 1975, my files and records will be transferred to Mr Lester’s Office and should you require any assistance please do not hesitate to contact him, as I know you will receive friendly and prompt service.

I am also very pleased to advise you that my secretary, Mrs Alma Lapierre will continue in the business with Bob Lester.

I would like to heartily recommend Bob Lester and his staff, Mrs Joyce Gilmour and Mrs Lee Brown as being most capable and eager to handle all your insurance needs.

Thank you for the confidence you have placed in me over the many years of our association.”

The appellant supplied information to his auditor as to certain facts by letter of November 28, 1978, (Exhibit A-7) as follows:

The total number of customers cancelled since 1974 is 1,551.

With reference to purchase of client lists from other agency’s results are as follows:

LEW HARVEY
Total accounts	517
accounts cancelled	201
accounts retained	316
CLIFF ATKINSON
Total Accounts	209	Total accounts	1316
Total Accounts	209
accounts cancelled	105	accounts cancelled	619
accounts cancelled	105
accounts retained	104	retained	697
accounts retained	104
THOMAS BROWN
Total accounts	590
accounts cancelled	313
accounts retained	277

As to the acquisition from Harvey, there was no other collateral agreement. The appellant prepared the customer list from the Harvey files. The Harvey office was kept open for about 30 days, after which time the files were moved to his office. He did point out that another person tried to buy the customer list but was unsuccessful. Mrs Lapierre, an employee of Harvey, wanted to work for two more years until she was 65 and the appellant engaged her for that time, when she retired. Harvey, the appellant advised, is alive today, but not back in business.

To arrive at his purchase price re Brown, the appellant checked around and found the price range between one to two times the annual commission. He decided on one and one-half. As to Brown, the appellant did not know his average commission but he did know his volume. He arrived at the Brown commission by applying his own average rate to Brown’s volume. There was no review of the financial statements. The appellant agreed that after the sale of the list there was nothing of value left to the vendor; only the physical assets remained. After the purchase of the list, the appellant stated he had a list of potential customers. The appellant never expected that Harvey, should he recover from his illness, would ever be a competitor. As to the letter of announcement to Harvey’s clients (Exhibit A-6), the appellant stated he believed he discussed it with Harvey’s lawyer, had it typed in his office and turned it over to Harvey’s solicitor who had Harvey sign it. Harvey had been an agent for 20 years at the time of the transaction. The appellant did not know how long Brown had been in business.

Counsel for the appellant’s submission was that, if one purchased a business as a going concern, the outlay would be on account of capital. If, however, only a customer list were purchased, then it would be an outlay on account of revenue. His submission here was that, since only a customer list was acquired, it was a revenue expenditure. One must consider what was acquired and the type of operation from which it was acquired. In reality all that was acquired was the right to solicit business from the vendor’s former clients at the appropriate time and with precise information. He had the client’s file, he knew when the renewal date was coming up and he knew what type of coverage the person had pursuant to the soon expiring policy. He was acquiring, in each case from both vendors, an asset of unpredictable value which was not really enduring. The fall off of those clients was around 50%. Exhibit A-7 indicates that there were in total 1,107 names on the Brown and Harvey lists and, as of November 28, 1978, or thereabouts, 514 had been lost. Also it should be noted that both the Brown Agency and the Harvey Agency were not what one would call competitors or on-going businesses. Both were in the process of being wound up: Brown was deceased and his daughter, the executrix, who came from British Columbia wanted to return there as soon as she could; and the Harvey Agency had not had an agent for about six months and it was not expected Harvey would return. He submitted that the purchase of a customer list consists of several items; namely, the name and address of the client, the agency’s file for that client and permission to use the vendor’s name on solicitation or as the appellant stated on the announcement.

While the appellant’s counsel made reference to several cases, including Simon, Voyer & Castelli Inc v MNR, [1979] CTC 2503; 79 DTC 41; Harbord Investments Limited v MNR, [1970] Tax ABC 717; 70 DTC 1488; Halliday Fuels Limited v MNR, 25 Tax ABC 186; 60 DTC 541; and Francis David Moyls v MNR, 41 Tax ABC 411, 66 DTC 553, his main reliance was on the case of Farquhar Bethune Insurance Limited v The Queen, [1981] CTC 35; 81 DTC 5028.

It was his submission that this appeal was virtually on all fours with the Farquhar case. He submitted it was like the Brown transaction and his position with respect to Harvey was much stronger. In the Farquhar case (supra) there was a restrictive covenant but the presiding judge said it was not operable and there was no acquisition of a business or a capital asset. He said with respect to the letter sent by the vendor to his clients as well as the newspaper advertisement in the Farquhar case that, “neither of these two facts are material in the determination of the issue in this case.” The judge held that only customer lists and access to the vendor’s files were acquired, and so the outlay was an expense within the meaning of paragraph 18(1 ) (a).

The Crown’s position is that, by the two transactions, the appellant acquired an enduring benefit. His submission was that, if one considered all the circumstances surrounding each transaction and the commercial reality of the transactions, the only conclusion one could come to was that each expenditure was on account of capital. The Brown agreement was drawn up without any advice, whereas there was advice from his accountant on the Harvey agreement. Yet when one considers the terms of the Brown agreement, it was suggested that the written agreement for the Harvey purchase was not the full agreement or understanding.

The purchase price in Brown was 1 Z> times the annual commission (#1 in Exhibit A-1). Even if all of Brown’s customers renewed with the appellant in the first year, he could not recover the full purchase price. In order to recover what he had paid, the benefit acquired must last at least more than one year if not several years as some clients would not renew. The appellant also acquired the right to use the Brown name for three years (#3 of Exhibit A-1 ). Clause 6 of Exhibit A-1 is only consistent with the sale of a business. With resepect to clause 7 of Exhibit A-1, really what did the Brown agency have to sell besides its customer list? Clause 9 of Exhibit A-1, when coupled with all the preceding clauses, only indicates that what was purchased was a going concern.

With Harvey, what was supposedly acquired was only a list of customers, yet after the acquisition the appellant and his daughter went to the Harvey office to check the customer list after the appellant’s business hours. Later they transferred the files to the appellant’s office and then at Harvey’s nothing was left but the physical assets. His submission continued that the letter of announcement which had been prepared by the appellant clearly showed the nature of the transaction. The reference to Harvey’s former secretary in the letter of announcement would leave the impression in the client’s mind that the business had been purchased. Counsel culminated his submission by submitting that neither vendor had anything left to sell after the customer lists had been sold and so in fact he had sold his business.

In rebuttal counsel for the appellant submitted that it is the purchaser who has appealed and it is he to whom one should look and say, what did he get? He received only the customer list. This was different from the case of The Queen v Baine, Johnstone & Company Limited, [1977] CTC 556; 77 DTC 5394, where he submitted the findings were different.In that case, the vendor agreed not to compete and to do liaison work for the purchaser, which led to a finding that a competitor had been eliminated.

In considering this matter, while a finding of fact is necessary, it would appear that the two deciding cases of the Federal Court are in conflict, namely, Farquhar, Bethune Insurance Limited v The Queen (supra) and The Queen v Baine, Johnstone & Company Limited (supra). As to competing with the purchaser after the purchase, in so far as the Brown purchase was concerned, Brown was dead and the agreement gave the appellant the right to use the name for three years. In the case of Harvey it was not expected that Mr Harvey’s health would improve. It appeared most likely there would be no competition from either. As Mr Justice Addy stated in the Baine case (supra), the fact that one vendor “probably [was] anxious to sell and to withdraw gradually from the business does not in my view affect the basic nature of the transaction.” In the same case, Mr Justice Addy also noted, “It appears also that the Defendant determined the amount of its offer in each case by employing the earnings approach that is, it based the offers on the earning records of the vendors and calculated the amount on a multiple of two or three times the past annual earnings.” As previously indicated, Mr Justice Gibson in the Farquhar case (supra) did not consider the letters to the clients and the newspaper advertisement as being material in the determination of the issue.

To decide this case one should consider the words of Mr Justice Addy in the Baine case (supra): “In considering the issue one must look at the true nature and substance of the transaction not merely at the words used by the parties in describing it.“ To this I would add “as well as the words not used.” In this respect it clearly should be noted that the appellant drew up the agreement with the Brown agency, but had assistance with the Harvey agency. A letter was sent to the former clients in each instance but such was not required by the Harvey agreement although the appellant believed it was discussed with the vendor’s solicitor. I find, all things being considered, that each vendor sold to the appellant everything he could have sold in so far as his business was concerned. If the letters which used the word “merge” instead of sale do not at least endeavour to pass the goodwill of the vendor to the appellant, then the letters are useless.

The result is I find that the appellant purchased the business of each vendor and as such the expenditure was within the ambit of paragraph 18(1 )(b) of the Income Tax Act, with the result that judgment will go dismissing the appeal.

Appeal dismissed.