Cumberland Investments Limited (Formerly Douglas, Rogers, Limited) v. Her Majesty the Queen, [1973] CTC 821, 74 DTC 6001

Heald, J:—This is an appeal by the plaintiff from its income tax assessment by the defendant for its 1971 taxation year. At issue, in these proceedings, is the nature of a payment made by the plaintiff in the sum of $150,000. The plaintiff contends that said payment was an expense item properly deductible in the calculation of taxable income. The defendant submits, on the other hand, that the said expenditure of $150,000 was a capital outlay and therefore not deductible in computing the plaintiff’s taxable income.

Douglas, Rogers, Limited (hereafter Douglas Rogers) is a Nova Scotia corporation and has for many years carried on the business of a supervising general insurance agency with its head office at Amherst, Nova Scotia. On January 25, 1972 the name of Douglas Rogers was changed to the name of the plaintiff. This company has some 92 employees employed in its Amherst and Halifax offices and is the largest supervising general insurance agency in the Maritimes.

The company’s president, Richard VanSnick, described the company’s activities and functions as follows: to function as a branch office for a number of the companies it represents; selecting of risks; appointment of agents; developing and getting business; and supervision of the underwriting.

This company, as a supervising general agent, did no insurance business itself directly with members of the public—all of the company’s business was done through local agents or sub-agents who dealt directly with the public. In 1971 the plaintiff had some 300 subagents throughout the Maritimes and, in 1971, it had insurance premium volume in the order of $8 million.

In March of 1971 Mr VanSnick, on behalf of the plaintiff, approached one Austin E Hayes of Halifax, who was carrying on a business similar to that of the plaintiff’s under the firm name and style of W R Maclnnes & Co (hereafter Maclnnes), a sole proprietorship. Mr Hayes was a prominent and highly respected Halifax citizen, a director of the Canadian National Railway and a member of the Board of Governors of St Mary’s University. He had been president of the Insurance Association of Nova Scotia and, as such, had a continuing contact with insurance agents all over the Province. He was also the president and owner of a general insurance business in Halifax known as Hayes Insurance Limited which fell into the category of a local agent or sub-agent as above described.

Mr VanSnick described the Macinnes business as being one of plaintiff’s smaller competitors in the supervising general agency business. Where the plaintiff had some 300 sub-agents, Maclnnes had 48 sub-agents. The plaintiff’s largest competitor was Bell and Grant having premium volume in the order of $6 million annually. The. plaintiff and Bell and Grant represented many of the same insurance companies in the Maritimes. Thus, a situation had developed which Mr VanSnick described as being somewhat unique—that is, the plaintiff and Bell and Grant were competing for the same business, through many of the same sub-agents and, in many cases, they were using the same insurance companies. Each of these competitors represented about ten insurance companies, six of which were the same insurance companies. Both competitors paid the same commission to sub-agents, their premium rates were the same, hence the product being offered to the public was essentially the same. Thus it was necessary to compete on the basis of better service to the customer and by the calibre of field agents employed and by associations and contacts built up over the years.

In March of 1971 VanSnick, being aware that Hayes might be interested in selling the Macinnes business, inquired about the possibility of purchasing same. Hayes indicated he might be interested in selling the business and that he had been approached by another insurance company concerning same. Further discussions between VanSnick and Hayes took place a few weeks later. Hayes apparently offered to sell all the physical assets of W R Maclnnes & Co as a going concern, Hayes to remain as manager of the business at an annual salary of $40,000 for a period of five years, the existing Maclnnes staff to be retained in the business.

VanSnick said that he discussed this proposal with the other directors of the plaintiff corporation and that after some consideration, they decided not to accept Mr Hayes’ offer as above described. He said that he and his fellow directors felt such an acquisition would jeopardize the relationship with their insurance companies because “insurance companies are suspicious about changes in ownership”.

However, plaintiff’s interest in the Macinnes business continued because, in September or October of 1971, Mr VanSnick had another meeting in Amherst with Mr Hayes. Mr VanSnick made some calculations at that meeting of a possible purchase price and those calculations were introduced in evidence at the trial (Exhibit P1-7). Exhibit P1-7 shows a total suggested purchase price of $150,000 to be made in six payments of $25,000 each. Exhibit P1-7 shows that the 1970 premium volume in the Maclnnes company was $687,000 for 1970 and on this basis, and on the basis of the early indications for 1971, Mr VanSnick says that he projected premium volume for all of 1971 at $800,000. Based on a 10% commission, the normal rate, VanSnick says he projected premium income for 1971 at $80,000. He then said that the general rule in the industry for price was to take anywhere from 1% to 3 /2 times annual commissions.

In this instance he says that he offered slightly less than twice the annual commissions, thus explaining how the offer of $150,000 was arrived at. At this meeting in Amherst, said purchase price was agreed upon between the parties. It was also agreed that plaintiff corporation was only buying the sub-agency accounts of Maclnnes & Co. VanSnick said that the plaintiff was not interested in acquiring the Maclnnes company as a business, and thus was not interested in perusing the financial statement of the company nor was it interested in the Maclnnes employees or details of their salaries or employment.

The formal agreement of purchase between the parties was executed on October 25, 1971 (Exhibit P1-10). The pertinent portions thereof read as follows:

1. In this Agreement,

(a) “Sub-Agency Accounts” means a list of all of the Vendor’s sub-agents, (other than Hayes Insurance Limited), a copy of each current policy of insurance placed with the Vendor by any of its sub-agents and the card index system of policy renewal dates; and

(b) “Closing Date” means November 1, 1971 at 10:00 a.m.;

2. The Vendor agrees to sell to the Purchaser and the Purchaser agrees to buy from the Vendor the Sub-Agency Accounts for the price of $150,000 payable as follows:

(a) $25,000 on the Closing Date; and

(b) $25,000 on the first day of November in each and every year thereafter, the first such payment to be made on November 1, 1972 and the last such payment to be made on November 1, 1976;

3. (a) On the Closing Date

(i) The Vendor will deliver those Sub-Agency Accounts requiring renewal during the balance of 1971 to the Purchaser; and

(ii) The Purchaser will pay the amount of $25,000 in cash to the Vendor;

(b) As to the balance of the Sub-Agency Accounts, the Vendor will deliver the same to the Purchaser on or prior to November 30, 1971.

4. If any policy of insurance forming part of the Sub-Agency Account is cancelled prior to the date of its expiration, any unearned commission in respect thereof will be repaid by the Purchaser and the Purchaser covenants and agrees to indemnify and save harmless the vendor in respect thereof;

5. The Vendor covenants that on and after the Closing Date he will cease carrying on the business of a provincial general insurance agent under the firm name and style of W R Maclnnes & Co;

6. For the purpose of greater certainty the parties hereto declare that the accounts receivable of the Vendor’s business are not the subject matter of this sale and that the Purchaser is not assuming payment of any of the accounts payable of the Vendor;

On the same day, and as part of the same transaction, another agreement was entered into (Exhibit P1-11), this agreement being between Hayes Insurance Limited and the plaintiff.

In that agreement, Hayes Insurance Limited is referred to as the “Hayes Company” and the plaintiff is referred to as the “Douglas Rogers Company” (since subject agreement was executed prior to the change of name of the plaintiff company).

The pertinent portions of that agreement read as follows:

1. The Hayes Company shall offer to the Douglas Rogers Company 75% of the total dollar amount of all insurance applied for through the Hayes Company.

2. If the Hayes Company offers Insurance to the Douglas Rogers Company and the Douglas Rogers Company refuses to accept the same, then the face amount of such Insurance shall not be included in the base on which the 75% referred to in paragraph 1 is calculated.

3. The rights and duties of the Hayes Company and the Douglas Rogers Company and the remuneration to be paid by the Douglas Rogers Company to the Hayes Company shall be those established by the Nova Scotia Board of Insurance Underwriters for a Class A agency.

4. (a) If the Hayes Company purchases another insurance agency business, then any applications for insurance arising directly out of the business so purchased shall not be included in the base on which the 75% referred to in paragraph 1 is calculated;

(b) If the Hayes Company sells its insurance brokerage business, it will require the purchaser to assume the obligations of the Hayes Company under this Agreement in respect of applications for insurance arising directly out of the business so sold.

5. This Agreement shall remain in full force and effect for a term of five years from the date hereof and shall then continue from year to year unless terminated by three calendar months notice given prior to November 1, 1976 or November 1 of any subsequent year.

Mr VanSnick acknowledged that the plaintiff gave no separate consideration for the advantages accruing to it under the agreement with Hayes Insurance Limited (Exhibit P1-11).

After the sale was completed on October 25, the plaintiff carefully reviewed the list of the Macinnes sub-agents (Exhibit P1-8) which contained some 48 names in all. It was discovered that 28 of the 48 sub-agents were new agents, that is, new to the plaintiff. The other 20 sub-agents on the list had apparently been sub-agents both of the plaintiff and the Macinnes company. The plaintiff then arranged, through its field and management personnel, to call on these former agents of Macinnes & Co to secure the portfolio business. Mr VanSnick explained that this was necessary because the insurance business is subject to raids by competitors. He related an earlier instance of one general insurance agency buying out another and in that case, the purchaser did not take the trouble to follow-up the purchase with the new sub-agents. In that case, a number of the competitors “raided” and acquired a substantial portion of the vendor’s business. In fact, VanSnick admitted that the plaintiff had participated in that “raid” to the extent of acquiring some $300,000 per annum in premium volume.

He explained that it would have been a simple matter for the new sub-agents to have transferred to plaintiff’s major competitor because they represented most of the same companies. Apparently plaintiff’s efforts to secure and retain the business were successful because VanSnick estimated that the plaintiff retained about 90% of the Maclnnes business.

VanSnick said that plaintiff’s purpose in the transaction was to secure new business, that an alternative way would have been to hire additional fieldmen which would have cost them $25,000 to $30,000 each annually to keep in the field, and that the company had made a judgment decision that the Maclnnes purchase would be a better way in which to expand their operations.

On October 15, 1971, a few days prior to the execution of the formal agreement, Mr Hayes wrote a letter to all of the Macinnes sub-agents advising them of the sale to the plaintiff. This letter reads as follows:

TO ALL OUR AGENTS:

Gentlemen:

Re: OUR SUB-AGENCY BUSINESS

Following long and much serious thought, we have concluded that we should give up our Provincial Agency appointments with our various Companies and, as a result, cease doing business with our many sub-agents. Since our fiscal year ends October 31st, we propose making this decision effective as of that same date.

Ironically, our very successful agency operations in recent years, and especially this current year, has hastened our decision. Frankly, the market that we have available to us, as a General Agent, is not sufficiently large to accommodate the business flowing to us from all sources. This last year particularly, we needed more companies with major capacity, than we now have, and they just are not available.

We cannot continue to provide you with the level of service you have come to expect from us, and which your accounts require.

We cast about to seek out a single facility to replace us as General Agent and we believe we have found this in Douglas, Rogers Limited, of Amherst, N.S. This office has larger market capacity, good service, adequate field staff, a large service office in Halifax, and, very importantly, represents almost completely the same companies that we have been using. We have therefore entered into an arrangement with them to commence writing your business effective November 1, 1971. This of course, assumes your consent and will not be done should you direct otherwise.

Our own direct business will be written through our other agency, Hayes Insurance Limited, and this now requires our full attention.

To further facilitate matters, some of our people will transfer to Douglas, Rogers Limited office in Halifax in order to ensure a smooth and orderly changeover. Since they will almost always be using the same Company Groups, you will note little, if any, differences

The major change will be in the accounts. Your last account with us will be dated October 31, 1971. All transactions of any kind, on and after November 1, 1971, will be reflected in Douglas, Rogers Limited accounts. Since they and we have the same credit terms of 60 days, you should be through with payments due to us in time to commence paying their account in the regular way.

In closing, and on a personal note, I want to say how much I enjoyed our association over so many years. I have had the privilege of developing many wonderful friendships, both past and present, and I intend to try and maintain as much contact as possible.

I ask your acceptance of, and cooperation with, the representatives of Douglas, Rogers Limited when they call on you shortly, and I wish you every success in the future.

Yours sincerely,

W R MacINNES & CO.

A E Hayes

A copy of this letter was sent to the plaintiff. VanSnick says that Hayes wrote the letter on his own initiative, that the letter was accurate excepting the reference to the Maclnnes employees being transferred to the plaintiff. VanSnick said that in fact, Hayes terminated the employment of all the Macinnes employees and that the plaintiff rehired only two clerk typists from the Maclnnes operation.

VanSnick said that what was received from Macinnes pursuant to the sale agreement was:

(a) the list of sub-agents (Exhibit P1-8);

(b) the card-index system showing the name of the policyholder, the expiry date, the name of the insurance company and the name of the sub-agent; and

(c) the actual insurance policies.

VanSnick further acknowledged that W R Macinnes & Co did not, in fact, carry on the general insurance business after October 25, 1971.

It also appears from the evidence that the Macinnes transaction was not the first instance where the plaintiff had acquired a competitor’s business. In April of 1969 the plaintiff purchased from Thompson Adams & Company Limited “the vendor’s sub-agency business and the goodwill thereof throughout Nova Scotia June 1st, 1969” for $90,000 ((said agreement was Exhibit P1-16 at the trial).

in December of 1969 plaintiff also purchased from Major Brothers, Limited, also a Halifax firm, “certain phases of the Major Brothers business” as more particularly described in the agreement between the parties (Exhibit P1-17 at the trial). The purchase price in this case was $100,000.

Apparently Hayes Insurance Limited continued to operate after the sale of Maclnnes & Co as a sub-agent and 75% of their business was and is being offered to the plaintiff pursuant to the agreement of October 25, 1971 (Exhibit P1-11).

On these facts, plaintiff’s counsel asks the Court to conclude that in purchasing “the Sub-Agency Accounts” of Maclnnes the plaintiff was purchasing only information and data, and not the sub-agency business of Maclnnes as a going concern, and that accordingly, the cost of such information and data in the sum of $150,000 is an expense properly chargeable against the plaintiff’s income.

Plaintiff contends that subject expenditure was not a “once and for all expenditure”; that the Maclnnes company did not really own any goodwill which could be sold; that the goodwill of the Maclnnes business was really the goodwill of its principal, Austin Hayes; that while the Maclnnes company had covenanted in the sale agreement not to carry on as a provincial general insurance agent, there was no such covenant on behalf of Austin Hayes as an individual and there was nothing to prevent Mr Hayes from immediately commencing to operate a general insurance agency under any name other than that of the Maclnnes company and finally, that all of the documentation substantiated its submission that the plaintiff did not purchase a business or the goodwill attached thereto.

With every deference, I am unable to accept the plaintiff’s submissions as to the true nature of subject transaction.

Plaintiff’s general insurance business in the Maritimes was a successful and expanding business. It was fortunate enough to have a competent and aggressive management team headed by Mr VanSnick who impressed me as being highly knowledgeable and competent in the insurance field. In 1969 the plaintiff had bought out two smaller competitors at a total cost of $190,000 and these ventures had proved to be successful. In the first of these transactions the agreement describes as the subject matter of the sale, ‘the vendor’s sub-agency business and the goodwill thereof throughout Nova Scotia”. In the second transaction, the subject matter is described as “certain phases of the Major Brothers business”.

The same formula appears to have been used in all three transactions, that is, the purchase price is determined by multiplying annual commissions by roughly 1 /2 to 2-times. Another common denominator running through. all three agreements was a vendor’s covenant to continue writing a certain percentage of its direct sub-agency business through the plaintiff company. In the case of the Thompson Adams agreement, the percentage was 85% in the case of Major Brothers it was 95% and in the Macinnes agreement, it was, as noted earlier herein, 75%.

I have the view that in their essential characteristics these agreements are practically identical and that they all represent the sale of a business and the goodwill of a business. In the case at bar there is the additional circumstance of the letter to all sub-agents of Macinnes & Co sent out by Mr Hayes. In paragraph 1 thereof, Mr Hayes is advising the sub-agents that Maclnnes & Co is ceasing to do business. In paragraph 4, the sub-agents are informed that the plaintiff is going to replace Macinnes as general agent. The last paragraph of the letter is, in fact, a request that the sub-agent continue to do business with the plaintiff. To me, this is additional evidence that the plaintiff did not merely purchase lists and data but in fact bought a business as a going concern which was continued by the plaintiff as a going concern as a part of its larger operation of the same nature.

Plaintiff’s counsel submitted strenuously that the fact that Mr Hayes did not give a personal restrictive covenant to the plaintiff was evidence that the plaintiff did not buy any goodwill since the goodwill of the business was in fact the goodwill of Mr Hayes as a person. I do not agree that the business did not have goodwill separate and apart from the goodwill of Mr Hayes as a person. The business of Macinnes & Co was an old-established and successful general agency business in Nova Scotia.

It had a considerable amount of goodwill which was transferred to the plaintiff. The plaintiff used this goodwill to retain 90% of Maclnnes’ former customers, no doubt aided to some extent by the letter sent to the Maclnnes sub-agents by Mr Hayes.

President Thorson (as he then was) said in the case of Losey v MNR, [1957] CTC 146 at 152; 57 DTC 1098 at 1101:

But the value of the goodwill of a business is what a purchaser would be willing to give for the chance of being able to keep the connection of which it consists. . . . But two things are clear. One is that the sale of the goodwill of a business does not include a covenant by the vendor that he will not compete against the purchaser. If the purchaser wishes the benefit of such a covenant he must provide for it apart from the goodwill. And it is also clear that the sale of the goodwill of a business does not carry with it a right to the personal services or the business ability of the former proprietor of the business.

In the case at bar, it is clear that the plaintiff purchased the Mac- Innes connection” and the goodwill attaching thereto together with a partial restrictive covenant (Hayes’ covenant not to carry on a general insurance business as Macinnes & Co).

In discussing the meaning of the expression “goodwill”, Lord Macnaghten said in C/R v Muller, [1901] AC 217 at 223-4:

. .. It is the benefit and advantage of the good name, reputation, and connection to a business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old-established business from a new business at its first start.

In the case at bar, the plaintiff purchased and received the goodwill of the Maclnnes business, an old-established business.

The fact that Hayes, as an individual and a highly respected businessman, may also have goodwill which was not transferred to the plaintiff in this transaction is, in my view, irrelevant to the issues here. In my view, the situation at bar is similar to that discussed by Noël, J (now Associate Chief Justice) in the case of Southam Business Publications Ltd v MNR, [1966] CTC 265 at 278; 66 DTC 5215 at 5222, where the learned Judge concluded that, apart from two smaller assets, the only valuable thing the vendor had to sell was goodwill. In that case the appellant had paid $50,000 for the circulation records and subscription lists of the Financial Times. Another case to come before this Court on similar facts was the case of Dominion Dairies Limited v MNR, [1966] CTC 1; 66 DTC 5028. In that case, the appellant paid $344,000 for “lists of customers, records, information and data relating to customers as set forth in route books, drivers’ record books and the like and goodwill”. The appellant sought to deduct some $209,000 of the total of $344,000 as an expense for the year on the basis that said $209,000 was the estimated cost of acquiring customers by the appellant’s own internal methods of promotion, an activity that represented recurring expense. Mr Justice Gibson rejected the appellant’s argument, holding that the whole of the $344,000 was paid for the goodwill, a capital asset, and accordingly, that no part thereof was deductible as an expense.

This case is of particular interest here because, in the case at bar, plaintiff’s counsel made the same argument in light of Mr VanSnick’s evidence that the plaintiff had to send out fieldmen to “secure” the business.

In the case of Schacter v MNR, [1962] CTC 437; 62 DTC 1271, Thurlow, J also held that the purchase of an accountant’s list of accounts in the course of the purchase of his business was also goodwill and not deductible.

I have accordingly concluded, in light of all the circumstances in this case and the applicable jurisprudence, that the plaintiff purchased the Maclnnes business as a going concern including the goodwill of said business, and that said acquisition was a capital asset. The cost thereof is therefore not deductible from income.

The appeal is therefore dismissed with costs.