Wolfgang Schubert v. Minister of National Revenue, [1978] CTC 2033, 78 DTC 1039

Delmer E Taylor:—This is an appeal against income tax reassessments for the years 1972 and 1973 in which the Minister of National Revenue increased the taxable income of the appellant by amounts of $19,434 and $17,711 respectively for the years in question, providing an identical explanation for each increase: “Add: Benefit conferred on shareholder under subsection 15(1).” Both the appellant and the respondent relied upon the provisions of subsection 15(1) of the Income Tax Act, RSC 1952, chapter 148 as amended by SC 1970-71-72, chapter 63.

Facts

The appellant is the president and controlling shareholder of Magnaplate Products Limited (hereinafter referred to as “Magnaplate”), which was incorporated in 1965 and carries on the business of supplying special equipment and parts to the newspaper industry from offices in Toronto, Ontario. During the appellant’s 1969 taxation year, he purchased from a certain Henning Lau a business known as “Henning Graphics”, which unincorporated company carried on the business of supplying stripping tables and light tables for the printing trade. Under the terms of a contract dated March 1, 1971, the appellant sold the business of Henning Graphics to Magnaplate, for a net consideration of $26,000. During the years 1972 and 1973, as a result of this sale, the appellant withdrew from Magnaplate the amounts of money involved in this appeal.

Contentions

The appellant contended that:

—in the sale of Henning Graphics to Magnaplate, the amount of $36,461.35 had been accepted by Magnaplate to represent the goodwill valuation in Henning Graphics:

—the goodwill of Henning Graphics was based on the enlarged dealer force which had been established for the benefit of Henning, particularly the substantial dealer and purchaser relationship with a US company, Chroma Graphics (hereinafter referred to as “Chroma”).

The position of the respondent was that:

—at the time of sale of Henning Graphics to Magnaplate there did not exist saleable goodwill of any value;

—the amount of loans owing by [s/c] the appellant to [sic] Magnaplate was reduced by the amounts in contention in this appeal;

—benefits in these amounts were conferred on the appellant qua Shareholder in the 1972 and 1973 taxation years respectively.

At the commencement of the hearing, counsel for the appellant moved that the notice of appeal be amended by the insertion therein of the following:

6. The Appellant says that in the alternative, if there was no goodwill applicable to the business of Henning Graphics which the Appellant does not admit but denies, the benefit to the Appellant occurred in his 1971 taxation year at which time Magnaplate Products Limited incurred its liability to him.

Counsel urged upon the Board the views expressed on this subject in James F Kennedy v MNR, [1972] CTC 429; 72 DTC 6357; Her Majesty the Queen v William G Phillips, [1975] CTC 250; 75 DTC 5188 (FCTD); [1976] CTC 126; 76 DTC 6093 (FCA); and Her Majesty the Queen v Frank Leslie, [1975] CTC 155; 75 DTC 5086. He referred in particular to two quotations from the Leslie decision (supra), at page 156 [5087]:

It is uncontested and was freely admitted by the defendant at trial that, in fact, there was no value whatsoever to the goodwill.

And at page 158 [5088]:

By the express terms of the agreement, there is therefore no distinction made between the goodwill and the other assets in so far as payment for the transfer of same is concerned. The promissory note of $15,300 is not expressed in the agreement to be given for any part of the goodwill but merely for part of the balance of the purchase price of all of the assets sold. It is not a question, therefore, of there being no consideration for the note, which might very well have been the case if the note has been expressed in the agreement to be given in payment of the goodwill, in which case the promise to pay being a promise to pay something for nothing, would constitute a nullum pactum by reason of total failure of consideration.

However, counsel for the respondent urged upon the Board that the case be heard based upon the pleadings shown in the original notice of appeal to which the Minister had responded in the reply to notice of appeal. These original pleadings dealt in a major fashion with support for the existence of goodwill and its calculation.

In my opinion, the change which counsel suggested to the notice of appeal presumed that a liability to the appellant would have been incurred by Magnaplate irrespective of whether or not goodwill had been transferred. The net effect of the proposition made by counsel for the appellant, if it had been accepted, might have been to imply restrictions on the Board in ruling on the validity of any such alleged liability, or in dealing with the appeal in all of its aspects. It was the opinion of the Board that the matter should be heard based upon the original notice of appeal. This appeared to provide adequate scope for the appellant to pursue his case, including relevant views on the appropriate taxation years, and placed no special restraint upon counsel. I am unaware of any rules of practice applicable to this Board, other than those of professional courtesy, which would deny to an appellant an avenue for conduct of an appeal on the grounds that it had not been ventilated in advance of the hearing through the accepted exchanges between counsel.

The Minister’s assessments, as cited earlier, were for “Benefit conferred on shareholder under subsection 15(1)”. That subsection is quoted in its entirety for reference purposes, and it is noted that it appears to be identical to its predecessor subsection 8(1), which would be applicable to the taxation year 1971:

15. (1) Where in a taxation year

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

otherwise than

(d) on the reduction of capital, the redemption of shares or the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 84, 88 or Part ll applies,

(e) by the payment of a dividend, or

(f) by conferring on all holders of common, shares of the capital stock

of the corporation a right to buy additional common shares thereof,

the amount or value thereof shall be included in computing the income of the shareholder for the year.

Evidence

The appellant gave evidence regarding the development of his present business, and provided the Board with his reasons for including goodwill in the sale agreement, but leaving the precise valuation of such goodwill to his accountants. He introduced several documents, two of which were the separate agreements wherein he purchased Henning Graphics in 1969 (Exhibit A-1) and that by which he sold it to Magnaplate in 1971 (Exhibit A-5). From these papers, the following excerpts are taken:

Exhibit A-1 :

WHEREAS the vendor desires to sell and the purchaser wishes to buy all the undertaking; goods, chattels, goodwill and name of the vendor’s firm known as Henning Graphics which carries on business from the City of Toronto.

2. The purchaser agrees to pay to the vendor the purchase price of FIFTEEN THOUSAND DOLLARS ($15,000.00) as follows:

(a) by assumption by the purchaser of up to but not in excess of EIGHT

HUNDRED DOLLARS ($800.00) worth of trade liabilities of the vendor;

(b) by payment, within three (3) days of execution and delivery of these presents, of the balance amounting to FOURTEEN THOUSAND AND TWO HUNDRED DOLLARS ($14,200.00) to the vendor.

Exhibit A-5:

2. The purchase price is to include all the goodwill (including name), equipment, trade marks and rights thereto, fixtures and furnishings, of the Said business and, without limiting the generality of the foregoing, more particularly those items listed in Schedule “A” attached hereto.

3. The said sum of TWENTY SIX THOUSAND DOLLARS ($26,000.00) shall be paid by way of promissory note in the said sum made by Magnaplate Products Limited payable on demand in favour of Wolfgang Schubert without interest. The said promissory note shall be dated 1 March, 1971.

Although no precise reconciliation was provided, the list of fixed assets and inventory purchased from Henning Graphics and attached as Schedule A (filed with the Board as Exhibit A-6) generally supported the proposition that $11,596 out of the $15,000 was paid for intangibles. Neither in Exhibit A-1 nor in Exhibit A-5 was any specific value assigned to goodwill. The promissory note referred to in Exhibit A-5 was not tendered as evidence, the witness stating it had not been retained after payment.

Mr G E Riley, Chartered Accountant, although qualifying his remarks by stating that he had not been the accountant for the appellant during the years in question, nevertheless gave evidence on his approach to the calculation of goodwill.

Argument

Counsel for the appellant largely concentrated his argument on the technicality. of the wording of the explanation in the reassessment, which explanation has already been given, and he dealt only briefly with the nature, extent and value of the goodwill transferred. Counsel for the respondent, perhaps as a result of the determination of the Board not to accept the amendment proposed, concentrated almost exclusively on the point that the evidence to support the existence of goodwill at the time of sale to Magnaplate was either not presented or insufficient, and he treated in only a minimal way the position of counsel for the appellant regarding the correctness of the reassessment under subsection 15(1). Counsel did assert that the Minister was not agreeing that there necessarily had been any goodwill in Henning Graphics (stated in the pleadings at $11,596) at the time of its purchase by the appellant, but if any goodwill had existed at that time, it had disappeared before the subsequent sale of Henning to Magnaplate. He further asserted that the goodwill, alleged in the sale to Magnaplate in the amount of $36,461.35, certainly did not exist.

Findings

The Board is not impressed with the evidence of either the appellant or Mr Riley in attempting to give some validity to the calculation of goodwill in Henning Graphics at the date of its sale by the appellant to Magnaplate. The production of a mathematical formula can establish only general parameters in assigning value to an intangible asset such as goodwill, the existence of which must have already been demonstrated. Such a formula cannot serve vicariously for the prerequisite demonstration of such existence nor can it, by itself, bring that asset into existence. In the instant case, at the date of sale there were no skilled employees in Henning Graphics, little or no equipment, no long-term contracts, nothing special or distinctive about the process or product, no evidence of earnings, and no external offers to purchase the business. No accretion to goodwill between 1969 and 1971 could be supported merely because the appellant had negotiated a contract with a company with which Henning Graphics had not previously done business. The assertion that the goodwill to which the appellant was entitled as a result of the sale of his personal interest in Henning Graphics to Magnaplate, which he controlled, amounted to $36,461.35 is therefore without foundation.

This, however, does not dispose of the total question. The Board is not satisfied that no goodwill was transferred to Magnaplate. There remains the fact that the appellant, at least according to the evidence available, had paid $15,000 for Henning Graphics as a going business in 1969, and had apparently received only $3,404 in physical assets, considering the balance of $11,596 as goodwill. It would require more information than has been provided to the Board at this hearing to support the conclusion that this goodwill (if such it was) had entirely disappeared before the sale to Magnaplate in 1971.

Giving due recognition to the comments provided by Judge Heald in The Queen v Phillips (supra), it is highly improbable that even the absence of goodwill at all would materially affect the acceptability of the sale transaction for income tax purposes. To this extent the Board must consider that any challenge to the validity or the enforceability of the contract for sale to Magnaplate, based on lack of consideration, would be on very tenuous grounds. Counsel for the respondent further argued that the only evidence of any “liability” to the appellant would probably be a suitable accounting book entry rather than some form of negotiable instrument. Although the Board is only too aware of the paucity of support for the alleged liability, there has been no challenge raised to the instrument of sale itself (Exhibit A-5) which asserts the existence of goodwill and establishes a basis for payment to the appellant for all the assets while merely assigning no particular value in that instrument to goodwill.

The matter finally comes down to whether or not a benefit was received, and in what year—there may indeed have been a benefit to the appellant in at least the year 1973 and probably in the year 1972, depending on how much value, if any, should be attributed to goodwill transferred to Magnaplate flowing from the original purchase of Henning Graphics by the appellant. The question to be answered is whether or not such a benefit was “conferred” upon the appellant. The Board would have reviewed with interest a viewpoint that funds or property were appropriated for the benefit of the shareholder since the consideration received by Magnaplate (goodwill) might have been insufficient in any calculation to warrant the amount credited to the appellant for such goodwill. No such argument was advanced by counsel for the respondent. In any event, the comments made by Heald, J in Phillips (supra) at page 256 [5193] are enlightening on this point:

In my view, paragraph 8(1 )(b) does not apply to the facts of this case because the $22,000 in funds paid by the Company in 1966 were not “appropriated” for the “benefit of a shareholder”. The $22,000 was paid by the Company to Beaupré to relieve the Company of its obligations under the contract of services of March 28, 1964 between the Company and Beaupré (italics are mine).

Accordingly, I do not feel called upon to make any finding with regard to the possible applicability of paragraph 15(1)(b) of the Act in this matter. The explanation in the notice of reassessment clearly determines the significant words—“conferred on’’—and that explanation can only be operative under paragraph 15(1)(c) of the Act. The evidence does not support a conclusion that any benefit, to whatever extent available to and even accepted by the appellant, was “conferred . . . . by a corporation’’.

Decision

The Board holds that the appellant has discharged the onus placed upon him to show that the reassessment made by the Minister was in error, in that no benefit was conferred on him as a shareholder by the corporation in either of the taxation years 1972 or 1973. The appeal is allowed and the matter is referred back to the respondent for reassessment.

Appeal allowed.