Michele Hardy De Loppinot v. ‘Minister of National Revenue, [1976] CTC 2454, 76 DTC 1334

Guy Tremblay:—This case was heard at Montreal, Quebec on September 7, 1976.

1. Summary

it is is necessary to ascertain whether payment made pursuant to the execution by an accountant of a contract transferring his customers is allowable as a a deduction the calculation of income of the person who made the payment.

2. Burden of Proof

The appellant has the burden of demonstrating that the respondent’s assessment was not justified. This burden of proof is not based on any particular section of the Income Tax Act (SC 1970-71-72, c 63, as amended) but on several judicial decisions, among them a decision of the Supreme Court of Canada rendered in Johnston v MNR [1948] CTC 195; 3 DTC 1182.

3. Facts

3.1. On May 19, 1971 Mr Jean G Peloquin, CA, who had practised the profession of accountancy since 1948, entered into the following comtract:

AGREEMENT concluded on the nineteenth day of May, 1971

between

JEAN G. PELOQUIN, chartered accountant,

Party of the first part —and—

NOISEUX, LYONNAIS, GASCON, BEDARD, LUSSIER, SENECAL & ASSOCIES, chartered accountants, a partnership duly constituted under a contract of partnership signed on August 1, 1968, and N.L.G.B.L.S. COMPAGNIES, a partnersip duly constituted under a contract of partnership signed on September 11, 1969, thesaid partnerships having their business office at 215 St- Jacques Street, in the city and district of Montreal, province of Quebec, and MARCEL LECOURT, chartered account . ..,

Party of the second. part

The party of the first part transfers. to the: party of the second part the present and future clients of his chartered accountant practice, in consideration of a share equal to twenty per cent of the fees generated by these clints (list attached) and received over the five (5) years following the date of this agreement for present clients, and over the five years following the date on which professional activity begins, for future clients.

FURTHERMORE, THE PARTIES AGREE AS FOLLOWS:

1. That the share of the party of the first part shall be paid to him monthly, that it shall be equal to twenty per cent of the fees collected during the preceding month, and that this remittance shall be accompanied by a summary of invoicing and collections for the month;

2. That the party of the first part shall have the right to check the account books relating to fees received b ythe party of the second part, so as to oversee his own interests;

3. That everything shall be done by the two parties to ensure that the transfer of clients takes place without inconvenience to the latter. In order to do this, the party of the second part undertakes to:

(a) serve the clients acquired under the company name of JEAN G. PELOQUIN & CIE—NOISEUX, LYONNAIS, GASCON, BEDARD, LUSSIER, SENECAL & ASSOCIES;

(b) name the party of the first part consulting partner, with no rights and privileges other than those listed herein;

(c) assign to the party of the first part office space, which shall not necessarily be for his exclusive use, so that he can receive clients, if the need arises, or attend to certain professional duties connected with the clients involved herein;

(d) allow the party of the first part, generally and like every other partner, to make use of the services provided in the office;

4. That MARCEL LECOURT, chartered accountant, shall be responsible for serving clients transferred by the party of the first part;

5. That the party of the first part shall be entitled to terminate this contract during the two years following the date this agreement is signed, provided that twenty-five per cent (25%) of the sum paid up to that time for the transfer of clients is repaid to the party of the second part;

6. That the party of the first part shall be paid by the party of the second part at the rate of $25.00 per hour for all professional work done at the request of the party of the second part and chargeable to the clients involved herein.

7. That the aforementioned professional work shall be work that is to be billed to the clients, and excludes all work connected with the transfer of clients and the administrative aspects thereof.

SIGNED:

A list of 49 clients was attached to this contract.

3.2. In his evidence Mr Peloquin stated that the transfer of his clients was made so that he could prepare for retirement. In fact, he subsequently sold his home in Mount Royal and bought a summer home at Lac Marois. During the winter Mr Peloquin goes south.

3.3. The contract was drawn up by the accounting firm following two or three meetings between the parties concerned.

3.4. It was thus the intention of the parties to entrust to Mr Lecourt the administration of the accounts purchased. Mr Lecourt had already met Mr Peloquin around 1965, and had replied in 1967 to a request by Mr Peloquin to form a partnership, with the possibility that accounts would be transferred. It was that in 1971, Mr Lecourt received a reply to his letter in the form of a telephone call from Mr Peloquin in which the latter offered to sell him his practice.

3.5. The transfer of his clients had a special significance for Mr Peloquin. He wished his customers, almost all of whom had become his friends, to be satisfied with their new accountants and not reproach him for making the transfer. This is the explanation for the inclusion of clauses 2 and 5 in the contract and for the particular care taken with regard to the transfer. In fact, a letter was written to each client explaining, inter alia, the merger of “my accounting practice with the aforementioned firm, and that we are in a position to provide ail accounting services in all fields”. He also introduced Mr Lecourt as his direct associate. From time to time, he asked clients to recommend “our office” to other people “for auditing” their businesses. A series of seven letters was introduced as Exhibit A-4. In one particular case. it appears that Mr Peloquin had helped Mr Lecourt at a meeting with a representative of the Department of National Revenue concerning a client’s tax problem.

3.6. According to Mr Peloquin, the contract was prepared by the other party, the effect of the contents of the aforementioned letters was to “sweeten the pill”. He even used the same expression with regard to paragraphs (b) and (c) of clause 3 of the contract, and claimed that he had never used the office provided under paragraph (c). However, Mr Lecourt, a witness for the appellant, recalled that Mr Peloquin had insisted that an office be at his disposal for possible future clients.

3.7. No “future” clients within the meaning of the opening paragraph of the contract (not numbered) have been added to the list of 49 clients which was attached to the contract.

3.8. Furthermore, Mr Peloquin has not done any work for remuneration in accordance with clause 6 of the contract.

3.9. A special letterhead of the accounting firm, on which Mr Peloquin’s name appeared in the list of partners, was printed. Mr Peloquin claims he never used it. The accounting firm used this letterhead only when writing to the clients transferred by Mr Peloquin.

3.10. One of the transferred clients who knew the appellant well asked that she take charge of his file. On the basis of the fees received by the accounting firm, the sum of $390 was paid to Mr Peloquin in 1972. This amount, because of the accounting firm’s internal administration, was subtracted from or applied against the appellant’s income from her share of the percentage collected on the fees received from this particular client.

3.11. The respondent disallowed the deduction of this sum of $390 made by the appellant in calculating her income for 1972.

3.12. The appellant appealed to the Board on August 29, 1975.

4. Problem

Is the sum of $390 paid by the appellant to Mr Peloquin in 1972 allowable as a deduction in the calculation of her income in accordance with the Act?

5. Comments

Given the importance of the contract executed on May 19, 1971, the true nature of the contract concluded between the parties must be determined.

In fact, on the face of it, in brief and according to the terms used to describe it, it is a transfer of present and future clients on condition that the assignor be assured of a 20% share of all fees received within the next five years.

Furthermore, again in accordance with the terms of the contract, the assignor is to become a consulting partner of the assignee entitled, inter alia, in so far as the assigned clients were concerned, to have his name included in the company name of the aossignee and to have office space at his disposal.

In view of the statements of the assignor to the effect that the contract was prepared by the other party, and that the contents of the letters sent to clients, as well as the contents of paragraphs (b) and (c) of clause 3, existed merely to “sweeten the pill”, and in view of the fact that once the contract was signed there were no future clients and the assignor never needed to use the office placed at his disposal, never did any work in the office of his partners, and never did any work for remuneration within the terms of clause 6 6 of the contract, and in view of the theory of form and substance of a contract, should it be concluded that this was not a contract of partnership but of the sale, pure and simple, of goodwill, payment for which is not considered to be an ordinary business expenditure made to earn income but a capital expense?

The Board concludes, rather, that the contract must be given its legal effect, since there is nothing in the Act or in the facts which contradicts this legal effect. In the opinion of the Board the substance of the contract is identical to its legal effect, that is to say, this is a contract of partnership.

The contract was signed freely by two parties in full knowledge of the facts. According to testimony submitted, the contract, even if it was drawn up by the party of the second part, was nonetheless preceded by two or three meetings with Mr Peloquin, the party of the first part, in the course of which agreement was reached on the clauses

to be included in the contract.

The fact that some clauses proved subsequently to have no application in practice in no way changes the legal reality and the true substance of the contract. In almost any contract, many clauses, among them so-called “preventive” clauses such as penalty clauses and resolutory clauses, are almost never applied. They nevertheless retain their legal validity.

The letters written to clients to “sweeten the pill”, according to Mr Peloquin, were nevertheless in keeping with the situation at that time, that is, the transfer of the existing clientele, and confirmed the terms of the contract of the effect that this was a partnership.

The same expression, “sweeten the pill”, when applied to paragraphs (b) and (c) of clause 3, is even less understandable, as the contract was made neither for publication nor for showing to clients, but merely for the use of the two parties.

The contract was a contract of partnership, and it is beyond doubt that the fees received by the partnership Noiseux, Lyonnais et al must be included in the income of this partnership. According to the internal agreement, the latter partnership was entitled to deduct. the share remitted to the appellant, just as the appellant was entitled to deduct the share remitted to Mr Peloquin, in accordance with generally recognized accounting principles.

This was merely a sharing of fees. Assuming all fees are in the nature of income, it is difficult to treat one share of these fees differently from another.

The Board feels that there has been in fact a a redistribution of fees in this case. The parties cited a a number of cases, the chief being Butler et al v MNR, [1967] CTC 7; 67 DTC 5019: Schacter v MNR, [1962] CTC 437; 62 DTC 1271; McCray v MNR, [1975] CTC 2255; 75 DTC 204; Crandall v MNR, [1974] CTC 2289; 74 DTC 1204; James v MNR, [1973] CTC 457; 73 DTC 5333; MNR v Gault, [1965] CTC 261; 65 DTC 5157. 1

In none of the cases cited by the parties did the facts involve a contract in which the terms of partnership between the parties were as clear as in the case at bar, so the Board has no alternative but to apply the legal effect of the contract and to grant the request of the appellant.

For an explanation of the rule of form and substance, we would refer the reader to the study by George T Tamaki, “Form and Substance Revisited”, Canadian Tax Journal, 1962, vol 10, at pages 179 et seq.

6. Conclusion

The appeal is allowed.

Appeal allowed.