Lasalle Factories LTD v. Minister of National Revenue, [1979] CTC 2098, 79 DTC 91

Guy Tremblay:—This case was heard at Montreal, Quebec, on May 15, 1978.

1. Point at Issue

The Board must decide whether the appellant is correct in fact and in law in appealing the respondent’s assessment. The latter computed in the appellant’s income the amounts of $524,978 and $116,662 for the 1971 and 1972 fiscal years, respectively. These amounts are part of the price of a franchise sold by the appellant to Associated Footwear Ltd in 1969.

2. The Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof results not from any particular section of the Income Tax Act, but from several court decisions, including the judgment rendered by the Supreme Court of Canada in R IV S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. The Facts

3.01 The appellant company, incorporated originally in 1950 under the name of “H Y Cohen Inc”, changed its name in 1952 to that of “LaSalle Clothes Ltd” and again in 1957 to that of LaSalle Factories Ltd. The main purpose of the company is to carry on the business of manufacturers, contractors, wholesalers, jobbers and retailers of clothing and wearing apparel of all kinds. It operates discount stores in the provinces of Quebec and Ontario. In 1971 it operated 35 to 40 stores.

3.02 As part and parcel of its business operations the appellant grants the right to operate departments within the premises of its discount stores: lamps, fixtures, photo supplies, snack bars, shoes, jewellery, etc.

3.03 The following concessions are and were operating in LaSalle Factories Ltd’s stores: Aronelle Textiles, Edsam Textiles, Associated Footwear Ltd, Glencairn Snack Bars Ltd, L M Charbonneau, LaSalle Jewellery Pavillion Inc, Perkis Photo Supplies, Pet Enterprises Inc, Saba Lamp & Fixtures and H & R Block.

3.04 According to certain contracts filed, the concessionnaires were committed to cutting down their prices (10% to 20%) in accordance with the regular retail prices of their competitors.

3.05 The concessionnaires were committed to paying a rent of 10% of their gross sales, excluding provincial sales tax (sometimes 11% of 110% of Sales).

3.06 In 1974, as the sales of the concessions amounted to 7 million dollars, the appellant’s own sales amounted to 45.5 million dollars. In 1976, the sales of the concessions were 16.70% of the appellant’s own sales. In the same year the income from the concessions amounted to 6.4% of the appellant’s total revenue.

3.07 In June 1960, the appellant entered into a contract with Raymond Levesque (Exhibit R-1) in which Levesque was granted an exclusive franchise on shoes. The contract was for a one-year term, renewable automatically. The appellant reserved the right to sell rubber shoes, boots, skates, snow boots and handbags.

3.08 On October 1, 1969, Raymond Levesque sold the franchise granted in Exhibit R-1 to Associated Footwear Ltd (Exhibit R-2). The selling price was $300,000 ($275,000 paid by Associated Footwear Ltd and $25,000 paid by Scott-Lasalle Ltd).

3.09 That same day Associated Footwear Ltd entered into a contract with Scott-Lasalle Ltd (Exhibit A-1) in which Scott-Lasalle granted an exclusive franchise to Associated Footwear Ltd on shoes for a ten-year term without reserve.

3.10 According to Mr Jack Scott, president of Scott-Lasalle Ltd and of the appellant company, it is the only case of exclusive licence the appellant granted a concessionnaire.

3.11 Associated Footwear Ltd is affiliated with Geneseo of Canada Limited which is an affiliate of the Canadian company, Genesco Apparel Limited. The latter is itself an affiliate of Geneseo Inc, an American company which is on the New York market. Geneseo Inc owns assets worth more than one billion dollars. The above information was given by Mr James Rutherford, Vice-President of Associated Footwear Ltd and President of Genesco of Canada Limited, in his testimony.

3.12 The price paid for what is called the “Capital Licence Payment”, ie, franchise was:

The sum of $1,000,000 payable during the agreement term, in instalments of $16,666, the aggregate of the first of such instalments for each of the departments in the existing stores and for such of the departments in such of the future stores as the licensee shall have then occupied, to be paid on August 1, 1970, together with interest at current bank prime interest rates in effect at the time each department is occupied, such interest to be calculated and charged separately on each instalment from the time each department is occupied; and, thereafter, such instalments shall be paid from time to time as the licensee is granted occupancy in each of the departments in the future stores.

3.13 The payment for what is called “Licence”, ie, rent was:

(i) An amount equal to 11 % of gross department sales during each calendar week or part thereof. The Company (Scott-Lasalle Ltd) shall be entitled to deduct such amount from the gross department sales and, . . .).

3.14 In accordance with the agreement of October 1, 1969 (Exhibit A-1), the appellant was to provide to each department of Associated Footwear Ltd, inter alia, the following:

a) janitorial services;

b) heat and light;

c) advertising and promotion;

d) wrapping supplies of the type used by the appellant, and

e) cashier service.

The evidence showed that services of similar nature are provided in the contracts of other concessionnaires.

3.15 During the year 1971 the appellant received, for what is called “Capital License’’, the amount of $524,978, which amount comprised $474,980 with respect to stores already opened at the inception of the Agreement (Exhibit R-2) and $49,998 ($16,666 x 3) with respect to three stores opened during the 1971 fiscal year. In 1972 it received $116,662 ($16,666 x 7) for seven stores opened in that year. The quantum of these paid amounts is not in dispute.

3.16 The Agreement (Exhibit A-1, paragraph 16) provided that in the event that the term is less than 10 years in duration, part of the said instalments paid shall be repaid by Scott-Lasalle Ltd. In fact, because of that clause, the appellant reimbursed $12,916 to Associated Footwear Ltd in June of 1972. The said paragraph 16 reads as follows:

TERMINATION

Upon the termination of the agreement term this agreement and any and all of the licensee’s rights in and to any department shall cease and terminate and the licensee shall forthwith remove all footwear and whatever personal property belonging to it in the departments including its furniture and trade fixtures and surrender possession of the departments in good order and repair, reasonable wear and tear and damage by fire, other casualty and the elements excepted. The Company (Scott-Lasalle) shall repay to the licensee for each store term that is less than 10 license years in duration upon the date of termination, a part of the instalment paid for such department on account of the capital licence payment as referred to in paragraph 4(a) hereof, such part to be the proportion of such instalment as the aggregate number of licence years (or pro rata proportion thereof) in the period commencing from the date of this aggreement to the date of the commencement of the store term is of 10.

3.17 The Vice-President of Associated Footwear Ltd, S J Rutherford, testified that the company did not consider the amount paid for capital license as deductible in one year, but amortized over the term of the lease.

3.18 The accountant of the appellant company, Barry Clamen, CA, testified that the Department of National Revenue in the Province of Ontario has accepted the position of the appellant by considering the disbursement as a capital one.

3.19 On December 6, 1974, the respondent reassessed the appellant, including the amounts of $524,978 for the 1971 taxation year and $116,662 for the year 1972.

3.20 Following the notice of objection filed February 5, 1975, the respondent sent notification of confirmation dated May 12, 1977.

3.21 An appeal was lodged before the Tax Review Board on July 28, 1977.

4. Law—Jurisprudence—Comments

4.1 Law

The main sections involved in the present case are 3, 4, paragraphs 6(1 )(j) and 139(1 )(ag) of the old Act (sections 3, 9, paragraph 12(1)(g) and subsection 248(1) Definitions “property” of the new Act).

4.2 Jurisprudence

The parties cited the following jurisprudence:

Costantinesco v Rex, 11 TC 730; Desoutter Bros Limited v J E Hanger & Company Ltd, [1936] 1 All ER 535; Commissioners of Inland Revenue v British Salmson Aero Engines, Ltd, 22 TC 29; Mrs Catherine Spooner v MNR, [1928-34] CTC 178; 1 DTC 211; MNR v Mrs Catherine Spooner, [1928-34] CTC 184; 1 DTC 258; MacTaggart (H M Inspector of Taxes) v B& E Strump, 10 TC 17; Withers (H M Inspector of Taxes) v Nethersole, [1948] 1 All ER 400; Beare (H M Inspector of Taxes) v Carter, 23 TC 353; Margerison (H M Inspector of Taxes) v Tyresoles, Ltd, 25 TC 59; Dain (H M Inspector of Taxes) v Auto Speedway, Ltd, 38 TC 525; Strick (H M Inspector of Taxes) v Regent Oil Co Ltd, 43 TC 1; West African Drug Co Ltd v Lilley (H M Inspector of Taxes), 28 TC 140; The Saskatoon Drug & Stationery Company Limited v MNR, [1975] CTC 2108; 75 DTC 103; J Camille Harel v Deputy Minister of Revenue of the Province of Quebec, [1977] CTC 441; 77 DTC 5438; Imperial Oil Limited v MNR, [1947] CTC 353; 3 DTC 1090; Burmah Steamship Company Limited v The Commissioners of Inland Revenue, 16 TC 67; Associated Investors of Canada Limited v MNR, [1967] CTC 138; 67 DTC 5096; Atlantic Sugar Refineries v MNR, [1949] CTC 196; 49 DTC 602; MNR v Independence Founders Ltd, [1953] CTC 310; 53 DTC 1177; Tip Top Tailors Limited v MNR, [1957] CTC 309; 57 DTC 1232; Stuyvesant-North Limited v MNR, [1958] CTC 154; 58 DTC 1092; Rolls Royce Ltd v Jeffrey (H M Inspector of Taxes), [1962] 1 All ER 801; Musker (H M Inspector of Taxes) v English Electric Co Ltd, 41 TC 555; Wolf Electric Tools Ltd v Wilson (H M Inspector of Taxes), 45 TC 326; Red Barn System (Canada) Limited v MNR, [1973] CTC 2290; 73 DTC 231; Smitty’s Pancake Houses Ltd v MNR, 39 Tax ABC 297; 65 DTC 667; Russell Kidd v MNR, 17 Tax ABC 180; 57 DTC 280; Front & Simcoe Limited v MNR, [1960] CTC 123; 60 DTC 1081; No 665 v MNR, 23 Tax ABC 186; 59 DTC 632; John Andrew Dewar v MNR, 16 Tax ABC 4; 56 DTC 462; Her Majesty the Queen v Cadboro Bay Holdings Ltd, [1977] CTC 186; 77 DTC 5115, Harry Walsh and Archie Robert Micay v MNR, [1965] CTC 478; 65 DTC 5293; No 682 v MNR, 23 Tax ABC 300; 60 DTC 65; Henri Gingras v MNR, [1963] CTC 194; 63 DTC 1142; Frontenac Shoe Ltée v MNR, [1963] CTC 181; 63 DTC 1129.

4.3 Comments

4.3.1 Nature of “Capital License”: Capital Asset

In the Board’s opinion, what is called in the present case “Capital License” (in other words, franchise, concession) is itself a capital asset. The legislator provides for patents, franchises and concessions licences, a special class of depreciable property in class 14 of Schedule B to the Income Tax Regulations, not including however, among other things, a leasehold interest.

The sale of such a right is, generally speaking, a capital gain for the vendor and a capital expenditure for the purchaser.

The old British case quoted in Frontenac Shoe Ltée, Insulated and Helsby Cables Limited v >4 therion, [1926] AC 205, Lord Chancellor Cave said:

When an expenditure is made, not only once and for all, but I think with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is a very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital

In Costantinesco v Rex, 11 TC 730, Rowlatt, J said:

I have not the least doubt that you may pay a lump capital sum in lieu of royalties, or to capitalize what is really a royalty, if you like to put it that way, for the use of a patent. Now has that been done. Mr Montgomery put a case to me, an obvious case. Supposing, before the user, it is said: “Now pay $25,000—or whatever sum the parties agree to—and use it as much as you like, for a definite time or for the whole length of the patent that will clearly be a lump sum. It would not be parting with the patent, because other people might use it, but it would be clearly a capital sum in my judgment”.

In the case of MNR v Spooner, [1933] AC 684; [1928-34] CTC 184; 1 DTC 258, it was held that where land was sold and part of the consideration was a royalty of 10% of oil produced from the land, the royalty was a capital receipt and was not taxable in the hands of the vendor, it is to correct this decision that paragraph 3(1)(f) of the Income Tax War Act was introduced which is the analogous provision of paragraph 6(1)(j) of the old Act and paragraph 12(1)(g) of the new Act.

A royalty of the kind in Spooner would now clearly be included in the income of the recipient under paragraph 6(1)(j) of the old Act (paragraph 12(1)(g) of the new Act).

4.3.2 The Problem

The problem is whether in the present case the sale of the franchise is taxable as a business income, or as property income, or if paragraph 6(1 )(j) of the old Act (paragraph 12(1 )(g) of the new Act) applies.

4.3.3 Appellant’s Opinion

According to the appellant, “it is obvious that none of the governing attributes of paragraph 6(1)(j) of the old Act are present, and there is no derogation from the non-taxable characteristics of the disposition” (Exhibit A-4, pages 3 and 4).

To substantiate its opinion, the appellant cites many cases.

In the House of Lords in Withers v Nethersole, [1948] 1 All ER 400, Viscount Samuel speaking for the House of Lords said:

The relevant fact is that an owner of an asset, entitled by law to divide it into two distinct assets, has done so by selling one of those assets for an agreed consideration payable in a lump sum. A sale, not in the way of trade, or an asset does not attract tax on the consideration. Whatever else comes within the ambit of annual profits and gains, the consideration received by the taxpayer does not. Nothing turns on the fact that the taxpayer was the authoress of the play. The previous dealings are irrelevant—they, indeed, could bear only on the question whether the taxpayer was engaged in a trade or business—and she has been found not to be so engaged. The fact that the asset sold has a value only when put to commercial use is irrelevant. The fact that the same commercial result as that produced by the assignment might equally well have been achieved by an appropriately worded licence is irrelevant. It is irrelevant that the consideration may be assumed to represent the value of the whole copyright so far as it relates to motion pictures for a period of years, but the consideration was paid, not in respect of the temporary use of another’s property, but for the purchase of property with a limited life. The taxpayer may have exploited her property, but she did so only by dividing it and selling part of it.

The appellant also quoted Lord Denning, Master of the Rolls, in Strick v Regent Oil Co Ltd, 43 Tax Cases 1, at page 18:

If the company had paid an annual rent for the term of years, the payment of rent, of course, would be of a revenue nature, but a premium paid at the beginning is clearly capital expenditure. It is a sum paid once and for all so as to acquire a permanent asset.

In Bernard v MNR, 3 Tax ABC 15; 50 DTC 428, in which case is an illustration of lease accompanied by a sale of goodwill, Fabio Monet, then Assistant Chairman of the former Income Tax Appeal Board, said, as quoted by the appellant:

Just the same, it cannot be claimed that the business concerned in this appeal was only rented; it was actually sold for a fixed price. Whether the method of payment was by means of periodical instalments or otherwise in no way changes the nature of the contract and as the goodwill forms an integral part of the busines, it follows that the goodwill was also sold just as much as the business itself. I find it difficult to imagine that a business can be sold while the goodwill attaching thereto and forming an integral part thereof is only rented.

The appellant also cited recent cases:

R O Bartlett v MNR, 11971 J CTC 477; 71 DTC 5263; Cyril Joffe et al v MNR, [1972] CTC 2543; 72 DTC 1480.

4.3.4 Respondent’s Contention

According to the respondent, the appellant has two ways of making profits: a) by selling merchandise and b) by leasing part of its stores to merchants as premises. Consequently, the price paid for the franchise, being part of the lease of the premises, must be considered as income. One of the main arguments of the respondent is that the final result would be the same if the rent were a percentage of 13% in lieu of 11% of the gross revenue. The reimbursement indeed provided in paragraph 16 of the agreement, (Exhibit A-1— see paragraph 3.16 of the Facts) when the term is less than 10 years, is the evidence that the payment of the franchise is not only part of the lease but is based on the use of the premises. Paragraph 6(1)(/) of the old Act must apply. The franchise indeed is of the nature of rent.

(A) Profit arising from an operation

Among others, the respondent quoted Jackett, J of the Exchequer Court of Canada in Associated Investors of Canada v MNR, [1967] CTC 138; 67 DTC 5096;

A profit arising from an operation or transaction is an integral part of the current profit-making activities.

Respondent also quoted Kerwin, J in the case of Atlantic Sugar Refineries Ltd v MNR [supra]:

In no sense may it be said that the operations were unconnected with the appellant’s business . . . Even if it were the only transaction of that character, it should be held, in the light of all the evidence, that it was part of the appellant’s business or calling and therefore a profit from its business within section 3 of the Act.

He also cited three cases [supra] which, according to the respondent, are to the same effect as Atlantic Sugar Refineries Ltd:

MNR v Independence Founders Ltd, Tip Top Tailors Ltd v MNR, Stuyvesant-North Ltd v MNR.

(B) Profit from sale of license

The respondent quoted Lord Reid of the House of Lords in the well-known case of Rolls-Royce Ltd v Jeffrey, [1962] 1 All ER 801. Royalties were payable on engines to Rolls-Royce Ltd according to a series of agreements with different countries. The manufacturers of engines undertook to supply drawings and manufacturing and engineering data and information necessary to enable engines of a particular type to be manufactured. The royalties paid in lump sums were described in the agreement as “consideration for the rights granted”.

At page 805, Lord Elgin said:

But the appellants say that nevertheless these receipts did not come to them as receipts of their trade of manufacturing and selling aircraft engines and motor cars and for that reason should not enter the computation of the profits of that trade. I cannot agree. It is for each trader to determine the scope of his own trade. No doubt a trader can carry on two separate trades simultaneously. But the facts of this case clearly indicate that this course of granting “licences” was merely an extension of their existing trade . . . It was merely another method of deriving profit from the use of their technical knowledge, experience and ability.

The respondent cited many cases [supra] to which the same principle was applied (Musker v English Electric Co Ltd; Wolf Electric Tools Ltd v Wilson; Red Barn System (Canada) Ltd v MNR; Smitty’s Pancake Houses Ltd v MNR; Kidd v MNR).

(C) Sale of franchise: income of property

As subsidiary proposition, the respondent suggested that the payment received for the franchise be considered income from property.

He cited [supra] Front & Simcoe Limited v MNR; No 665 v MNR, Dewar v MNR; Her Majesty the Queen v Cadboro Bay Holdings Ltd; No 682 v MNR.

(D) Payment and receipt: different nature

As a related proposition, the respondent submitted that the result of a transaction can be in nature of capital for the payee and can be in nature of income for the recipient. The case of Henri Gingras v MNR [supra] was cited.

4.3.5 Findings

4.3.5.1 Income of business?

Concerning the main argument of the respondent explained in paragraph 4.3.4, the Board should consider the following:

(a) The deed (Exhibit A-1) itself makes a clear distinction between franchise and rent. The deed is passed between parties which are at arm’s length;

(b) If the franchise is of the nature of a rent, it is difficult to admit it would be paid ten years in advance;

(c) If the franchise is based on the use of the premises and the payment made for 10 years, what is the explanation when the franchise lasts 15 or 20 years?

(d) The evidence is to the effect that the franchise conceded to Associated Footwear Ltd is the only one conceded during the life of LaSalle Factories Ltd on its premises. Prima facie, there is doubt that the franchise is part of the business.

As mentioned above, the concession of a franchise is one of a capital nature.

It is only under exceptional circumstances that it must be considered income, especially after the above considerations.

The case of Atlantic Sugar Refineries Ltd, cited by the respondent, has no application in the present case. In Atlantic Sugar Refineries Ltd indeed the object of transaction (Sugar) is commercial by nature, it is a merchandise commodity. It means that if such object is not purchased for personal use, it is purchased for sale. Fruits can be produced only for sale. A franchise is not one of that nature. On the contrary, it is the nature of investment and the fruits are produced by the use, the exploitation of the franchise. Consequently, the Board thinks that, prima facie, the sale of one franchise is not sufficient to make it taxable unless there are some special circumstances as stated in Frontenac Shoe Ltée v MNR and Insulated and Helsby Cables Limited v Atherion quoted above at paragraph 4.3.1.

Do these special circumstances exist?

On one hand, the Board states that franchise is related to the appellant’s business. In fact, all franchises sold are always related to the business of the seller. It is a factual sine qua non requirement of the existence of the franchise. In the present case, the franchise is not “merely another method of deriving profit from the case of their technical knowledge, experience and ability” as it was stated by Lord Elgin in the Rolls-Royce Ltd case quoted above in paragraph 4.3.4 B). Moreover, then “rights granted” named “license” by the learned Judge, were provided in each deed of a concessionnaire.

In the other cases cited by the appellant in paragraph 4.3.4, generally each appellant had sold franchises to different concessionnaires and ordinarily with a percentage on the gross sales without furnishing premises. It was not only related to the business but part of the business.

Can we say there are different franchises because there are different premises occupied by Associated Footwear Ltd? This is not the Board’s opinion. In fact, it is the nature of a franchise to be exploited in a territory and whatever the number of premises used by the exploiter it is always the same franchise.

The Board’s opinion is that it is not an income of business.

4.3.5.2 Income from property

As underlined above (paragraph 4.3.5.1 a)) the deed (Exhibit A-1) clearly separates the franchise from the rent. Moreover, the deed is passed be- tween parties which are at arm’s length. Consequently, special circumstances must again exist to ignore the form and the language of the lease.

Those special circumstances can be that the amount paid for the franchise is only a diminution of the price of the rent as in the case of Front & Simcoe Limited cited above. The evidence is that the concessionnaires paid in general 10% of gross sales of 11% of 110% of gross sales (paragraph 3.5 of the Facts). In the present case, the price of the rent is 11 % of gross sales, (paragraph 3.13 of the Facts) in fact more than the general rule.

The special circumstances can also be payment made for services rendered as in the case No 682 v MNR cited above. The only services involved in the present case are those described in paragraph 3.14 of the Facts (janitorial services, etc) and rendered by the appellant company.

Those services in fact are also provided in the contracts of the other concessionnaires who rent the premises. Associated Footwear Ltd is the only one who pays for a franchise and also for rents. In the Board’s opinion the services described above are definitely related to the rent and not to the franchise.

The other cases cited by the respondent on that point of income from property (paragraph 4.3.4 C)) cannot apply to the case at bar.

The Board must conclude that the sale of the franchise is not an income of property.

4.3.5.3 Is the use of a franchise provided in paragraphs 6(1 )(j) of the old Act, (12(1 )(g) of the new Act?:

6.(1) Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year

(j) amounts received by the taxpayer in the year that were dependent upon use of or production from property whether or not they were instalments of the sale price of the property, but instalments of the sale price of agricultural land shall not be included by virtue of this paragraph.

Let us refer to the text cited above: .. dependent upon the use of or production from property . .

Is a franchise a property? Paragraph 139(1)(ag) of the old Act and subsection 248(1) of the new Act read as follows:

139.(1)(ag) “Property” means property of any kind whatsoever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes a right of any kind whatsoever, a share or a chose in action.

248.(1) “Property” means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes

(a) a right of any kind whatever, a share or a chose in action, and

(b) unless a contrary intention is evident, money.

Referring to the definition of property, no doubt a franchise is included in the words: . . property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes (a) a right of any kind whatever..

In the present case, however, the appellant has not used the franchise. It has sold it. Associated Footwear Ltd has used it.

It is obvious that such property (franchise) can be used only on premises (which are also included in the word “property”). Both, however, are two different properties, two different things even if the franchise cannot be used without premises.

One can say that services (janitorial, heat and light—see paragraph 3.14 of the Facts) rendered by the appellant company as provided in the contract with Associated Footwear Ltd is evidence that the payment of the franchise is for the use of the premises and consequently paragraph 6(1)(/) applies.

On that point, the conclusion at which the Board arrived above in paragraph 4.3.5.2 must apply here and the argument has no value to prove the use of premises.

The Board must conclude that the payment of franchise is not in virtue of the application of paragraph 6(1)(j).

4.3.6 The Board arrives at the conclusion that the payments received by the appellant are not income but capital gain. The amounts received in 1971 are not taxable, but because of the enactment of the new Act in 1972, section 14 of the new Act and section 21 of the Income Tax Application Rules apply and the amounts received in 1972 must be taxed accordingly.

5. Conclusion

The appeal is allowed and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed.