Murray S Partykan v. Minister of National Revenue, [1980] CTC 2540, 80 DTC 1475

M J Bonner:—From 1964 to 1975 the appellant was an officer, director and one of a small group of shareholders of a company called “BP”, which carried on the business of a general insurance agency.

The relationship between the appellant and the other principals in BP became strained. The appellant left BP in 1975 and commenced to carry on the business of a general insurance agent on hiS own account. He attempted to solicit business from persons who had been clients of BP and the company sued the appellant claiming, inter alia, an accounting of profits received as a result of misuse of confidential information and injunctive relief restraining the appellant from soliciting its clients for business.

The action was settled by a judgment under which:

A. the appellant turned over his shares in BP to two of the other shareholders in the company;

B. computer printouts and face sheets, being the term used for photocopies of the first pages of insurance policies, were turned over to the appellant;

C. the rights of the appellant and BP in relation to seeking business from BP clients were restrained; and

D. the appellant’s surname was eliminated from the corporate name of BP.

The appellant, after the consent judgment, continued to carry on the business he had just commenced and BP continued to carry on its business.

I will note parenthetically that I have not yet, and I am not proposing to, in these reasons, make reference to Aero Marine Insurance Agency Ltd. The existence of that company does not change the result in any way.

The sole issue in this appeal from the assessment of income tax for the 1976 taxation year is whether the sum of $110,000, being the value of the BP shares turned over by the appellant, and the sum of $3,709, incurred in legal costs in connection with the law suit, are expenditures on revenue account or capital account.

The respondent assessed on the basis that the expenditures were capital. He did not contend that the deduction of the expenditures was prohibited by paragraph 18(1 )(a) of the Income Tax Act. Prior to the appellant’s departure from BP the company had approximately 8,000 clients, about one quarter of whom were personal to the appellant or served by him as op- posed to the other principals in the company. The corporate records of those 2,000 clients were identified with the code number “24”. Each month a computer printout was supplied to the appellant containing information as to the code 24 production, that is to say, the appellant’s production for the past month. The printout showed policies written and cancelled during the period in question. It contained information as to the term of the policies, the name of the insured, the type of policy, the premium for the policy, the commission rate and the amount of commission earned.

I gather from the evidence that the printouts would be of some value to a person in the position of the appellant, who was trying, after his departure from BP, to secure for his new business the clients that he had previously served. The appellant could not, save in the cases of relatively few commercial clients whom he had visited frequently, remember enough detail to make approaches to clients in order to obtain policy renewals.

If the printout could be of some help to the appellant in these circumstances, the face sheets were of much greater value. They contained the names of the clients, their addresses and details as to the type and extent of existing coverage. By using the printouts the appellant could readily contact clients, obtain authorizations directed to insurers to enter the appellant’s name as agent of record on their policies and secure policy renewals.

Under the judgment the face sheets and printouts to be turned over to the appellant were those entered under code 24, that is to say, not all those of BP, but only those relating to the appellant’s list of “personal” clients.

The judgment contained a general prohibition preventing the appellant, for three years, from accepting business from clients of BP. Code 24 clients were excepted from that prohibition.

The judgment stated further, in paragraph 10:

The plaintiff, Bate, Partykan, Ryan, Bird & Williams Ltd, is not to compete with the defendant, Murray S Partykan, in respect of any policy in respect of which is bound to turn over a face sheet until it has turned over the face sheet to the defendant, Murray S Partykan.

Finally, the judgment restricted BP from competing with the appellant in respect of policies for which the appellant had, prior to the date of the judgment, obtained letters of authorization from clients. These were relatively few, being the result of successful approaches by the appellant to those clients whom he could remember without the benefit of records received in the judgment.

In argument the appellant’s counsel referred to 21 cases. He submitted that this case is either on all fours with or stronger than a number to which he referred, being cases involving pure customer list purchases. He pointed out that in the usual case of a customer list purchased by an expenditure on revenue account information as to all the vendor’s customers is acquired and frequently some other asset of the vendor’s business as well.

He submitted on the evidence it was clear that the appellant did not buy the whole or any part of the business of BP, nor did he buy the goodwill. The absence here of an acquisition of an effective non-competition clause was said to be indicative of the absence of a purchase of goodwill.

The respondent submitted that the appellant purchased his “share” of the BP business and that the face sheets were the foundation of the structure of the new business being commenced by the appellant.

Counsel continued by asserting that, quite apart from the clients named on the face sheets on whom there would be “open season”, the appellant paid for the reasonable expectation that the goodwill which he had built up would be transferred to and continued in the new business.

I think it is worth noting that the customer list cases referred to in argument are but examples of the application of general principles enunciated in a much broader range of cases in which the courts have been called on to distinguish between expenditures on revenue account and those on capital account.

I think it is helpful to refer to the discussion in the reasons for judgment of President Jackett in Canada Starch Company Limited v MNR, [1968] CTC 466; 68 DTC 5320, at 471 [5323]:

I start from the basis indicated by Fauteux, J, delivering the judgment of the Supreme Court of Canada in MNR v Algoma Central Railway, [1968] CTC 161 [68 DTC 5096], where he says at p 162:

Parliament did not define the expressions “outlay . . . of capital” or “payment on account of capital”. There being no statutory criterion, the application or non-application of these expressions to any particular expenditures must depend upon the facts of the particular case. We do not think that any single test applies in making that determination and agree with the view expressed, in a recent decision of the Privy Council, BP Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia, (1966) AC 224, by Lord Pearce. In referring to the matter of determining whether an expenditure was of a capital or an income nature, he said, at p 264:

“The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.”

For the purpose of the particular problem raised by this appeal, I find it helpful to refer to the comment on the “distinction between expenditure and outgoings on revenue account and on capital account” made by Dixon J in Sun Newspapers Ltd et al v The Federal Commissioner of Taxation (1938), 61 CLR 337 at p 359, where he Said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

In other words, as I understand it, generally speaking,

(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and

(b) on the other hand, an expenditure in the process of operation of a profitmaking entity, structure or organization is an expenditure on revenue account.

Applying this test to the acquisition or creation of ordinary property constituting the business structure as originally created, or an addition thereto, there is no difficult. Plant and machinery are capital assets and moneys paid for them are moneys paid on account of capital whether they are

(a) moneys paid in the course of putting together a new business structure,

(b) moneys paid for an addition to a business structure already in existence, or

(c) moneys paid to acquire an existing business structure.

In my opinion, however, from this point of view, there is a difference in principle between property such as plant and machinery on the one hand and goodwill on the other hand. Once goodwill is in existence, it can be bought, in a manner of speaking, and money paid for it would ordinarily be money paid “on account of capital’’. Apart from that method of acquiring goodwill, however, as I conceive it, goodwill can only be acquired as a by-product of the process of operating a business.

By the expenditures in question the appellant did not acquire, add to or create, in my view, the profit earning engine or structure of his new business.

As a result of the judgment the appellant obtained information in such form as to be of value in selling new or renewal policies of insurance. What he acquired, however, was not goodwill, but the chance, by using the information in the ordinary course of the operation of the business, to build goodwill as a by-product. The day-to-day operation of the business involved the sale of insurance. The information acquired, which served as an aid in doing so, does not appear to have the lasting quality necessary to elevate it to the status of a capital asset.

The established connection between BP and those of its clients previously served by the appellant was not divided or even shared. Both BP and the appellant had the chance to compete for those clients and, following delivery of the face sheets, to do so the same basis arising from possession of the same information. Had the appellant bought goodwill from BP the latter would not have been able to solicit business from the former clients (or at least those named on the face sheets whose goodwill was sold). The retention by BP of the right to compete is inconsistent with the sale of goodwill. In this regard see Trego v Hunt, [1896] AC 7, at 11. It is quite plain that the appellant did not buy any part of the business of BP as a going concern. That business continued unimpaired following implementation of the judgment. Thus, cases such as Cumberland Investments Limited v The Queen, [1975] CTC 439; 75 DTC 5309, and Walter J Burian v Her Majesty the Queen, [1976] CTC 725; 76 DTC 6444, cannot assist the respondent.

The appeal is therefore allowed and the assessment referred back to the respondent for reconsideration and reassessment on the basis that the appellant is entitled to deduct the sum of $113,709.

Appeal allowed.