Montreal Trust Company v. Minister of National Revenue, [1972] CTC 422, 72 DTC 6369

The Associate Chief Justice:—This is an appeal from the decision of the Tax Appeal Board, dated April 27, 1970, dismissing the appellant’s appeals from its income tax assessments for 1963 and 1964 taxation years whereby amounts of $867,365.76 and $95,287.49 for the respective years which had been deducted by the taxpayer, were added to its income.

The appellant company operates a trust business in all ten provinces of Canada. As part of its objects and functions it services mortgages for certain clients for which it charges a fee. One such client, the Metropolitan Life Insurance Company, utilized the appellant’s services in all provinces in Canada except for the province of British Columbia, where it used the services of two companies called Gillespie Investments Ltd and Gillespie Mortgage Corporation. The latter also acted as agent of Central Mortgage and Housing Corporation for the purpose of servicing certain mortgages. The appellant purchased all the assets of the Gillespie companies for a price based largely upon a percentage of the value of the mortgages and loans being serviced for the insurance company or Central Mortgage and Housing Corporation by the two Gillespie companies.

The appellant entered into agreements with both of the Gillespie companies which carried on business in the city of Vancouver, in the province of British Columbia, and through these agreements acquired specified assets of the above companies. These assets consisted essentially of the vendor’s interest in a mortgage correspondent’s agreement with Metropolitan and with Central Mortgage under which the Gillespie companies were appointed and agreed to act as servicing agent of mortgage loans and the files of the Gillespie companies, including all rights and obligations of said companies with respect to the following four categories of mortgage loans namely:

(a) completed loans on service;

(b) committed and approved loans not yet purchased by Metropolitan;

(c) incompleted loans expected to be taken up but not yet committed or approved by Metropolitan; and

(d) proposed loans being negotiated by the Gillespie companies as at November 30, 1962.

Under the agreements, the purchase price was specifically related to the four categories of mortgage loans and to certain tangible assets consisting of property in management agencies, furniture, fixtures, office equipment and business machines and leases or leasehold rights and was payable at the following times:

(a) completed loans — on the closing date (January 21, 1963);

(b) committed and approved loans — within 5 days after payment was received by the appellant;

(c) incompleted loans — within 5 days after payment was received by the appellant;

(d) proposed loans — within 5 days after payment was received by the appellant;

(e) office equipment — on the closing date;

(f) leasehold rights — on the closing date.

The fee is determined in paragraph 2, page 4 of the contract as follows:

The total purchase price for the assets shall be the aggregate of the amounts determined, namely

(1) an amount equal to 1 4% of the total principal balance unpaid on all Metropolitan mortgages on service at December 31st, 1962;

(2) the same amount of 1%% of the total balance of all Metropolitan mortgages in process;

(3) an amount equal to 1 A% of the total principal amount of all the Metropolitan incompleted loans which shall have been assigned and delivered to and purchased by Metropolitan;

(4) an amount equal to 1 /4% of the total principal amount of all Metropolitan listed proposals for which application has been filed with the vendor or with the purchaser by January the 31st, 1963 and has been received by the purchaser on or before 5:00 p.m. on February the 4th 1963 and which thereafter shall have been assigned and delivered to and purchased by Metropolitan.

The value of the principal assets are then dealt with as follows:

(a) an amount for the office and equipment equal to the fair market value thereof as appraised and as agreed between the parties thereto;

(b) an amount of the leasehold improvements of the vendor equal to the depreciated book value thereof on the books of the vendor as of December 3ist, 1962 as determined by the auditors of the vendor;

(c) an amount of $19,000 was paid by Montreal Trust for various classes of physical assets taken over by it as described in various schedules to the agreement.

The above amount of $19,000 was not deducted by the taxpayer but the amounts established as a percentage of the mortgage loans of $867,365.76 for the 1963 taxation year and $95,287.49 for the 1964 taxation year were deducted by the appellant as being expenses incurred for the purpose of earning income.

The respondent in reassessing the appellant disallowed the said amounts as claimed on the basis that such expenses incurred were capital expenditures made for the buying of an enterprise and, therefore, were not deductible in computing income for tax purposes. The position taken by the respondent is that the buying of the enterprises of Gillespie Mortgage Corporation and Gillespie Investments Ltd was, on the one hand, the buying of enterprises as a going concern and, on the other hand, the sale of enterprises in order to go out of business, that the purchaser therefore acquired capital assets and the amount paid was so paid on capital account.

The appellant submits that part of the appellant’s business prior to the date of the agreements consisted of servicing mortgage loans and acting as a mortgage correspondent. The substance of the major portions of the assets purchased, it says, consisted of four types of mortgage loans comprising many individual loans and that each mortgage loan constituted a single entity. The price paid was calculated as a percentage of the amount to be collected in respect of each mortgage loan after Metropolitan had purchased or would in the future purchase a particular mortgage loan. The appellant points out that Metropolitan could cancel the mortgage agency agreement transferred and assigned to the appellant by simply giving written notice to this effect. For three of the four categories of mortgage loans purchased by the appellant (“committed and approved”, “incompleted” and “proposed”) Metropolitan could indeed unilaterally refuse to purchase any loans and thus deprive appellant of any income as a result of such refusal. Metropolitan also had the right to transfer back to appellant any mortgage loan within six months of the date on which Metropolitan had purchased such loan. The price paid by the appellant under the agreement was directly related to the value of the mortgage loans and for three of the four categories of loans, no price was payable until Metropolitan had purchased the loan, that is until appellant was entitled to receive payment from Metropolitan for the loans, which payments were included in its income for such years. The appellant says that the payments made by it to the Gillespie companies were analogous to a monetary levy on the production of a given year and they therefore constituted a properly deductible expense under the provisions of paragraph 12(1)(a) of the Income Tax Act.* [1]

Counsel for the appellant says that what must be primarily considered is the nature of the payments effected by Montreal Trust Company to Gillespie Investments Ltd and Gillespie Mortgage Corporation under the provisions of paragraph 2 of the agreement (p 41 of the book of documentary evidence) between Gillespie Investments Ltd and Montreal Trust, of January 7, 1963 and paragraph 2 of a similar agreement (p 122 of the book of documentary evidence) between Gillespie Mortgage Corporation and Montreal Trust, of even date. Under these agreements, neither Gillespie Investments nor Gillespie Mortgage had any property rights in the mortgages that they were servicing. Furthermore, these agreements could be terminated at any time and could not be assigned without the consent of Metropolitan or Central Mortgage and Housing Corporation (letter of November 27, 1961, p 39 of the book of documentary evidence, and paragraph C of the agreement of January 23, 1963).

The mortgages under service by Gillespie Investments or Gillespie Mortgage were not assets of these companies as they did not belong to them. Furthermore, the agreements between Gillespie Investments and Gillespie Mortgage with Metropolitan and Gillespie Mortgage with Central Mortgage did not constitute assets of Gillespie Investments Ltd or Gillespie Mortgage of an enduring nature. The only assets these corporations owned were those described in paragraphs (e) and (f) of the agreement between Gillespie Investments and Montreal Trust dated January 7, 1967 for which the appellant paid $19,000 and which it has not attempted to deduct. Under the above agreements, Gillespie Investments and Mortgage were simply authorized to service certain mortgages belonging to Metropolitan and Central Mortgage and Housing Corporation and this as long as Metropolitan and Central Mortgage and Housing were prepared to allow them to do so.

Counsel for the appellant also pointed out that the appellant assumed its obligations of servicing the Metropolitan mortgages as if the loans from which these mortgages originated had been sold to Metropolitan under the provisions of the original mortgage loan correspondent’s agreement between the two parties dated November 6, 1953 (pp 136 and 141, paragraph 3 of the book of documentary evidence) which means that the appellant serviced the mortgages pursuant to the agreement already in force between it and Metropolitan. The evidence discloses that it was the custom of the appellant, being in the business of servicing mortgages throughout Canada, to pay commissions or finders’ fees to persons who referred lenders or borrowers to its attention and the appellant paid $145,000 as commissions or finders’ fees in 1963 alone and this, counsel for the appellant points out, was allowed as a deduction. From this he argues that the payment to investments and mortgages of sums aggregating $962,653.25 during the taxation years in 1963 and 1964 were, he says, of exactly the same nature, ie, the payment of a commission or finders’ fee to acquire further business or stock in trade for the appellant.

The position taken by counsel for the appellant is quite clear. The appellant, he says, never acquired from Gillespie Investments or Gillespie Mortgage any kind of assets other than those for which it paid approximately $19,000, either tangible or intangible. The appellant did not even acquire the right to service the mortgages. Such right, he says, could only be given by Metropolitan and the appellant merely paid a fee to the Gillespie companies as was its practice to do so for obtaining more stock in trade.

The position taken by the appellant would appear to be persuasive were it not for the decision rendered in Southam Business Publications Ltd v MNR, [1966] CTC 265; 66 DTC 5215, confirmed by the Supreme Court of Canada May 10, 1967 without written reasons (67 DTC 5150), and Seaboard Advertising Co Ltd v MNR, [1965] CTC 310; 65 DTC 5188; where in this last case I stated, at page 319 [5193], when dealing with the argument advanced by counsel for the appellant, that “there is essentially no difference between sending out salesmen to acquire contracts, charging the costs thereof to operations or going to an agency such as SignKraft which had accumulated contracts and purchasing them in block for a price . . .”. And at the bottom of the same page I added:

The difficulty here is that because the contracts so purchased represent the services the appellant renders and sells as a business and the expenditure of $100,000 paid for these contracts bears a fair comparison with a monetary charge on the business production of a given year in view of the definite accounting periods during which these contracts respectively matured and produced income, they could, therefore, be treated as analogous to stock in trade. However, it would seem that it is not possible to treat them as such, where they are acquired by an expenditure made in the process of purchasing a business with the consequent procurement of enduring benefits such as we have here. Such an expenditure must be considered not as part of the cost of carrying on a business, but as part of the cost in acquiring a business. In City of London Contract Corporation Limited v Styles, 2 TC 239, which decision was rendered in 1887 and which was referred to in John Smith & Son v Moore, 12 TC 266, by Lord Sumner as never having been questioned, and where a company acquired a business including unexpired income producing construction contracts, that part of the purchase price being allocated to the cost of these contracts was not permitted to be deducted from profits on the basis that it was not deductible as it was part of the capital invested in the business.

There is no question that the agreement for the servicing of the mortgage contracts could be cancelled at any time and that the mortgage contracts were not assets that belonged to the Gillespie companies. The evidence discloses, however, notwithstanding Metropolitan’s right to cancel, that the appellant had been the agent of Metropolitan Life Insurance Company since 1953 on the basis of a similar agreement which contains an identical cancellation clause and yet it is still today the servicing agent for Metropolitan Life Insurance Company. Now although the agreements entered into could not be considered as perpetual, Mr Telfer, the appellant’s manager, stated that his company had accepted to pay the purchase price on the basis that it would be reimbursed in twenty years. I would think that such a consideration indicates that the appellant’s advisers considered that the deal would be conducted and completed over a sufficiently long time to give it a certain character of permanence. It is also true that the agreements cover the servicing of loans on mortgages which were owned by Metropolitan Life Insurance Company and not by the Gillespie companies. The latter did not, however, sell the mortgages to the appellant but the right to service them and this servicing of the contracts is the asset which the appellant purchased from the Gillespie companies (and the only valuable asset the latter had to sell) and used to make the profits it derived from its operations. The appellant indeed purchased, as appears from page 42 of the blue volume produced:

(a) The Metropolitan Agreement together with

(i) the right to act as servicing agent for all of Metropolitan’s completed mortgage loans;

(ii) the interest of the vendor and the right to act as servicing agent for the mortgage loans which have been committed and approved by Metropolitan;

(iii) the interest of the vendor and the right to act as servicing agent for any incomplete mortgage loans expected to be taken up by Metropolitan for which an application has been filed;

(iv) the interest of the vendor and the right to act as servicing agent for the proposed mortgage loans expected to be taken up by Metropolitan which were in negotiation;

(b) all property management agencies, including in particular the real property;

(c) all the furniture, fixtures, office equipment and business machines; (d) the leases or leasehold rights — all of the assets described in paragraphs (a), (b), (c) and (d) of this clause 1 are hereafter collectively referred to as “the assets”.

In view of the above, it is not possible for the appellant to say that the only assets it has purchased were those valued at $19,000. How, indeed, as pointed out by counsel for the respondent can it be said that assets valued at $19,000 only were purchased when an additional amount of $962,653.25 was also expended. The only conclusion one can reach is that more valuable assets or rights than the tangible assets were acquired in the process and this was, of course, the highly desirable right to act as servicing agent in British Columbia not only for the mortgage contracts involved in the transaction and for the transfer of these rights, but also for the purpose of ensuring that it would replace the Gillespie companies as servicing agent for Metropolitan and Central Mortgage for further contracts. In purchasing the Gillespie companies, the appellant ensured that it would represent Metropolitan throughout Canada.

It is true that Montreal Trust assumed the obligation of servicing the mortgages as if the loans from which these mortgages originated had been sold to Metropolitan Life Insurance under the provisions of the Agreement between the two parties of November 1963 but this appears to be merely a reference to the original document for the purpose of describing the appellant’s obligations for the servicing of the mortgage contracts. It does not, in my view, affect the agreements entered into with the Gillespie companies, nor does it establish that the mortgage contracts are not covered by the contracts entered into with the Gillespie companies or that they are covered by the original agreement only. This was, in my view, merely a means whereby the parties, by reference, defined the obligations of Montreal Trust as to the investments described in the agreement which were to be serviced by the appellant.

Counsel for the appellant submitted that the amount of $962,653.25 paid to the Gillespie companies is analogous to the amount of $145,000 paid for “finders’ fees” for the year 1963 with regard to their operations in provinces other than British Columbia. As pointed out by counsel for the Minister, there would be, if such were the case, quite a discrepancy between the amounts paid as finders’ fees in British Columbia, as compared to the rest of the country. Furthermore, none of the agreements entered into can, in my view, be equated to the payment of finders’ fees. I must, on the basis of the evidence submitted in this case, come to the conclusion that what was bought here were businesses as going concerns. Put succinctly, the appellant, on January 7, 1963, acquired all the rights of the Gillespie companies and also assumed all their obligations. The purchase agreements indeed clearly indicate that the appellant acquired two businesses. lt is true that the purchase price is based on the total value of the loan contracts but this is merely because the revenue comes from the servicing of these contracts and it also happens to be a good yardstick to establish the value of the rights purchased. Furthermore, the agreements clearly indicate that Metropolitan assigned to the appellant not only the right to service the loans guaranteed by mortgages purchased or to be purchased by Metropolitan but also all the facilities including the sellers’ personnel necessary to service them as well as those necessary to solicit contracts, which, of course, indicates that the purchaser was merely continuing the business of the seller. It also appears to me that by purchasing the two Gillespie companies, the appellant was obtaining a substantial advantage of being in a position to obtain the right to service Metropolitan’s mortgages in British Columbia and in so doing, it acquired what in the circumstances of this case, I must still call an endurable right even if the agency was not exclusive and could be cancelled by Metropolitan at any time. Appellant’s experience with Metropolitan in the past had been good and had persisted for over 10 years without cancellation and there was no reason for it to consider or apprehend that the British Columbia operations would be dealt with differently.

There may well be, as pointed out by counsel for the appellant, some distinctions to be drawn on the facts between Seabord Advertising Co Ltd v MNR (supra) and Southam Business Publications Limited v MNR (supra) and this case but, in my view, they are merely distinctions without differences in so far as the deductibility of the amounts expended are concerned.

It therefore follows that when all the circumstances of this case are considered and as long as the authorities are to the effect that amounts expended to acquire a business cannot be deducted as operating expenses, the deductions of such amounts whether they correspond or not to a monetary charge on the business production of a given year, will have to be denied.

The appeal is dismissed with costs.