James H Sunstrum v. Minister of National Revenue, [1976] CTC 2354, 76 DTC 1262

A W Prociuk (orally: February 5, 1976):—The appellant, James H Sunstrum, formerly for Kindersley, Saskatchewan and presently of Yellowknife, Northwest Territories, appeals from the respondent’s reassessment dated February 13, 1973 in respect of his income for the taxation year 1969, wherein the appellant’s claim of a loss in the sum of $17,659.44 was disallowed by the Minister on the ground that the expense claimed, to which I shall make reference later, was a a capital outlay within the meaning of paragraph 12(1 )(b) of the Income Tax Act, RSC 1952, c 148, as amended. The appellant claims that the loss constituted an expense, or was made up in the main of an expense, for the purpose of earning or producing income as provided for and allowed in paragraph 12(1)(a) of the Act and for the purpose of convenience I shall quote the relevant section of the Act.

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property Or a business of the taxpayer,

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part,

At the outset of the hearing, counsel for the appellant conceded that, as the appellant was a 50-50 partner with one John Iver Kjeldsli, he would be entitled only to a deduction in the sum of $9,559.43, if my arithmetic is correct, being one-half of the total loss to which I shall make reference later.

The facts of the case are as follows. The appellant was a barrister and solicitor by profession and conducted a successful practice in the districts of Kerrobert and Kindersley, with offices at one time in both centres, for some years in the sixties. He also served as a provincial judge in that area and from the evidence I gathered that he was well known to the people in those districts. In the year in question, the appellant practised his profession in the town of Kindersley, with his office on the main street of the said town.

The other witness in support of this appeal was the appellant’s onetime partner, John Iver Kjeldsli, who, prior to the material time, was manager of the Royal Bank of Canada in Kerrobert and later in Eatonia. in 1957 Kjeldsli resigned from his position and entered into the business of real estate insurance and accounting consultant under the firm name and style of Donn Realty, which business he conducted in Eatonia, a town approximately 30 miles from Kindersley. In the late sixties he conducted part of his business in Kindersley and used a portion of the offices of the appellant’s law practice for his purposes, where he attended two or three times a week. Some time in 1969, T & T Agencies Limited, owned and operated by one Harlen Thompson of Kindersley, Saskatchewan, being in the business of real estate insurance, income tax consulting, travel agency and sale of motor licences, approached Kjeldsli with a view to selling to him all the business of T & T Agencies Limited. Kjeldsli at this time consulted the appellant and both agreed that it would be beneficial to buy or enter into an agreement to buy customer lists in respect of the insurance business carried on by T & T Agencies as well as the income tax list but apparently they were not prepared to buy the entire business as a going concern. I need not go into the reasons why they arrived at that decision except to Say that both were not impressed with the general reputation that T & T Agencies enjoyed at that time in the area. Both witnesses testified that they were satisfied that, if if they were able to buy the customer lists relating to insurance and income tax consulting, they were sufficiently known in the area to be able to carry on a a fairly beneficial practice arising out of these lists. Accordingly, after some consultation or negotiation between Kjeldsli and Thompson of T & T Agencies Limited with the appellant participating on at least one occasion, an agreement was entered into by Kjeldsli and T & T Agencies which was filed as Exhibit A-1 and which reads as follows:

AGREEMENT MADE IN DUPLICATE THIS 31st DAY OF OCTOBER, A D 1969 BETWEEN:

T & T AGENCIES LIMITED, a body corporate carrying on business in the Province of Saskatchewan, hereinafter called the Vendor of the First part.

—and—

JOHN IVAR KJELDSLI, of the Town of Eatonia, in the Province of Saskatchewan, hereinafter called the Purchaser of the second part.

Whereas the Vendor has for some time past carried on business at the Town of Kindersley, in the Province of Saskatchewan as a general Insurance agent and an Income Tax Consultant.

And whereas the said Vendor has a list of customers with whom it has done Insurance business during the past together with a list of policy renewal dates.

And whereas the said Vendor has a list of customers for whom it has done Income Tax Consulting work during the past.

Now therefore it is agreed between the parties hereto that the Vendor shall sell and the Purchaser shall purchase the list of customers with whom the Vendor has done Insurance business during the past and the list of Policy renewal date for a total purchase price of Seventeen Thousand Dollars ($17,000.00) and the Vendor shall sell and the Purchaser shall purchase the list of customers with whom the Vendor has done Income Tax Consulting work during the past for the sum of Two Thousand Dollars ($2,000.00).

The said sum of Nineteen Thousand Dollars ($19,000.00) will be payable as follows: that is to say the sum of Ten Thousand Dollars ($10,000.00) on the day of the date hereof (receipt whereof is hereby by the Vendor acknowledged) and the remaining sum of Nine Thousand ($9,000.00) as follows; that is to say the sum of Five Thousand Dollars ($5,000.00) on or before the fourth day of November, A D 1969 and the balance of Four Thousand Dollars ($4,000.00) as follows; that is to say the sum of Two Hundred Dollars ($200.00) on or before the 31st day of December, A D 1969, and a similar sum of Two Hundred Dollars ($200.00) on the last day of each and every month thereafter until fully completed and paid for, with interest at the rate of Eight percent (8%) per annum payable monthly the first payment of interest to be due and to be paid on or before the 31st day of December, A D 1969.

IN WITNESS WHEREOF THE SAID T & T AGENCIES LIMITED has caused its corporate seal to be hereunto affixed attested by the signature of its proper officer in its behalf this 31st day of October, A D 1969.

At this point in time, I am satisfied, from the evidence, that the appellant and Kjeldsli entered into a partnership with respect to this portion of the business which they were setting up under the firm name and style of Donn Realty, so that if the appellant is successful in his appeal he would then be entitled to deduct one-half of the loss claimed as reported in the Statement of Profit and Loss for the year, and not the amount that he originally claimed and which was disallowed. In addition to purchasing the customer lists for the sum of $19,000, as stated in the agreement, that is, $17,000 for the insurance list and $2,000 for the income tax consulting list, the partnership purchased equipment consisting of a typewriter and some filing cabinets from T & T Agencies for the sum of $1,000. The evidence is clear on this point that this equipment was surplus in the hands of T & T Agencies and had not been used, as that firm had at least four furnished offices and this equipment was standing idle. The partnership’s acquisition of the customer lists and the files naturally required more equipment than the appellant then had in his law office, and this deal was entered into shortly after, or at the same time as Exhibit A-1.

I am told that there was a separate agreement with regard to the purchase of the equipment but it is not known whether it was a verbal or written agreement; evidence is uncertain on that point. There is also evidence that Mr Thompson of T & T Agencies, at the request of Kjeldsli, or following a discussion with Kjeldsli, wrote to the various customers that were on the lists that were filed as Exhibits R-1 and R-2, R-1 being the insurance list and R-2 being the income tax list, indicating that Mr Kjeldsli, or Donn Realty, had acquired the business formerly conducted by T & T Agencies Limited with these people and presumably asking them to continue their business with the purchaser. It is also in evidence that T & T Agencies, or Mr Thompson, assisted the appellant and his partner, Kjeldsli, in obtaining the agencies for some insurance companies, and the Saskatchewan Government Insurance Office in particular. On cross-examination the appellant stated that their approval of the purchasers as agents on the transfer of the agency from Thompson to Kjeldsli and in the opinion of the appellant, was a decision that rested, in any event, with the insurance company concerned.

For the year 1969, that is from the time when they commenced business on December 1 until the year ended on December 31, the Statement of Profit and Loss indicates that there were receipts totalling $205 and expenses, which included the cost of the insurance list ($17,000) and the income tax list ($2,000), depreciation on the equipment purchased ($200), licences ($5), commissions ($18.87) totalling $19,323.87, or a net loss for the period in question of $19,118.87.

The main issue here is whether or not the outlay of $19,000, that is, the purchase price of the insurance and income tax lists, is to be treated as an acquisition of a capital asset of an enduring benefit or advantage or whether this is an expense for the purpose of producing income in the business of real estate insurance and income tax consulting.

lt was argued by counsel for the respondent that this was an acquisition of an actual business from T & T Agencies and, as such, the operation of the insurance business and income tax consulting business was a Capital acquisition and, therefore, the sum paid therefor is not deductible pursuant to paragraph 12(1)(b) of the Income Tax Act.

I refer to the Reply to Notice of Appeal where the respondent states:

3. On October 31, 1969, T & T Agencies Ltd entered into an agreement with John Iver Kjeldsli pursuant to which T & T Agencies Ltd sold to Kjeldsli for $20,000 its insurance and tax consulting business. As part of that transaction the Purchaser was provided with a list of insurance policy customers and renewal dates, and a list of customers for whom T and T Agencies Ltd had handled income tax work.

Dealing with this for the moment, the evidence satisfies me that not all the files were turned over by T & T Agencies Ltd to the partnership; that in each list there were at least 10 to 15 files retained by Thompson, some special clients of T & T Agencies, which included two churches in the town of Kindersley and some people that had been friends of Mr Thompson for years. The appellant, when asked why he did not consider that he and Kjeldsli purchased the insurance business and the income tax consulting business of T & T Agencies, stated in cross- examination that they purchased the lists only; they did not purchase the trade name; they did not purchase the telephone, that is, they did not take over the telephone number; and that all that they wanted was the insurance and income tax consulting lists. T & T Agencies continued in business in its own premises for about two or three years thereafter, conducting the remainder of its business, that is, some limited insurance and income tax consulting, as stated earlier, in respect of the files retained, as well as its real estate and motor licence and travel agency business.

It is also in evidence that Mr Thompson gave a personal covenant to Kjeldsli, not to compete in insurance or income tax consulting within a 50-mile radius of Kindersley for a period of five years. There is also nothing in writing in that regard. Although I have no reason to question the accuracy of that statement, I should think that anybody buying the files and the lists, if this is the right terminology at the present time, would want to have some assurance that the vendor would not be competing for the business with the same customers whose names and files he had turned over.

I have been referred to a number of cases and I might say that in this area, that is paragraphs 12(1)(a) and (b), the cases are almost as numerous as they have been in the so-called trading cases under paragraph 139(1)(e) of the former Income Tax Act.

In considering the case of Cumberland Investments Ltd v Her Majesty the Queen, [1975] CTC 439; 75 DTC 5309, to which counsel for the respondent referred me, I have read the case very carefully and compared the situation therein with the situation in the instant appeal and I find that there is a considerable distinction between them on the facts. I find furthermore that had the appellant and his partner Kjeldsli not actively pursued the lists that were turned over to them, this enterprise would have been much less successful than it later turned out to be. Even so, the evidence is that they lost at least 25% of the customers that were on the list and Mr Kjeldsli, in his evidence, stated that this is quite normal in situations of this kind; customers leave to go to someone else to get insurance and someone else’s customers sometimes come to you.

I am of the opinion that what the appellant and his partner purchased here was nothing more than customer lists on which they had to do a considerable amount of work to retain the continued business of these customers with their firm. There was nothing of an enduring benefit assured them in the turnover of the lists, and they did not acquire a lasting capital asset. All they acquired was inventory with which they could work and hopefully continue to do business. That they were successful in this enterprise does not of necessity mean that it constituted a capital acquisition. The success followed some substantial hard work with the inventory which they acquired.

Accordingly, I would allow the appeal on the basis, as indicated by counsel at the commencement of the proceedings, that the appellant is entitled to deduct one-half of the loss as stated in the Statement of Profit and Loss for this business. If my arithmetic is correct, I believe his share of the loss is in the sum of $9,559.43, which the appellant is entitled to deduct from his other income for the 1969 taxation year, and the matter is referred back to the respondent for reassessment accordingly.

Appeal allowed.