I. G. Wahn v. Minister of National Revenue, [1968] CTC 5, 68 DTC 5023

Gibson, J.:—The re-assessments of the appellant for the taxation years 1961 and 1963 are the subject matters of this appeal.

The appellant had been for about 20 years prior to January 1, 1962, firstly as a solicitor and later, namely from 1956 on, a partner of the well-known, long-established and affluent law firm of Borden, Elliot, Kelley and Palmer. As of January 1, 1962 he voluntarily ceased to be a partner of that firm and entered into a partnership with a number of other solicitors to form a new law firm.

During the taxation year 1962 the new law firm suffered a loss in carrying on its business and the appellant’s share of that loss was $6,902.89.

The appellant filed an amended income tax return for his 1961 taxation year and in it deducted this loss of $6,902.89 from his substantial business income from his old law firm, purportedly pursuant to the enabling authority of Sections 2(3) and 27(1) (e) of the Income Tax Act.

The respondent by notice of re-assessment dated August 16, 1965 disallowed the deduction of this 1962 business loss of $6,902.89 in the computation of the appellant’s 1962. taxable income on the ground that Section 27(1) (e) of the Income Tax Act was. not applicable in that this 1962 business loss must be first deducted from the non-business 1962 income of the appellant which exceeded the business loss of $6,902.89 and consisted of his parliamentary indemnity, certain directors fees and investment income.

That is the first issue with respect. to which the parties join in this appeal.

As to this, I am of the opinion that the appellant was entitled to the benefit of Section 27(1) (e) of the Income Tax Act and had the right to carry back and deduct the 1962 business loss Of $6,902.89. from his 1961 business income. By reason of. Section 139(1) (x) of the Income Tax Act the appellant had the option to deduct this 1962 business loss from his 1962 nonbusiness other income but it was not mandatory for him to do so and he did not do so.

The other issue between the parties on this appeal concerns the 1963 taxation year of the appellant and is whether the payment of $9,897.30 received by the appellant in 1963 from his former law firm Borden, Elliot, Kelley and Palmer pursuant to paragraph 14(b) of the written partnership agreement among the partners of: that firm, consequent upon his. retirement from that firm, was (a) a capital receipt or income, or (b) alternatively, if an income receipt, whether it was income for the taxation year 1962 and not for the taxation year 1963.

The appellant and his former partners in the old law firm at all material times prior to 1962 had computed their income in accordance with the cash method as permitted by and pursuant to Section 85F of the Income Tax Act.

The resolution of this second issue involves a consideration of the much debated matter of what is the interest in a law practice of a retiring partner of a law firm.

Speaking generally, there is usually a reluctance on the part of any of the remaining partners' of a law firm to label any part of the interest of a retiring partner in a law practice as goodwill, and such reluctance obtains in this case as the evidence disclosed.

In my view, this is legally wrong. In addition, in my view, what the partners may call such an interest either orally or in a partnership agreement is not necessarily the test of what it is; and this is of some relevance in this case.

In my view, goodwill i is the most important asset of a law practice such as the subject law practice and partnership agreements are executed as was done in this subject case as the evidence clearly discloses, to provide a method whereby partnerships may continue without dissolution on the death or retirement of any partner so that the asset goodwill may be preserved. If any partnership such as the subject partnership had to be wound up and goodwill and other assets sold, goodwill in the main would be lost and the respective total interests of all partners in such a law partnership as this would be most substantially diminished. In this case this did not happen because the partnership agreement clearly provided that the partnership would not be wound up but would continue and it did continue and thereby the goodwill could be and was transferred or surrendered to the continuing and remaining partners.

In this case, in the partnership agreement there were no restrictive covenant provisions to prevent any retiring partner carrying on the practice of law in the same area immediately after retiring from the old partnership and as a consequence, as did happen in this case, not all of the goodwill remained with the old law firm but the appellant and one of the other partners who also retired at the same time as stated continued to practise law in a new law firm and did take ‘with: them some of the goodwill that the former. partnership had, but the substantial part of the goodwill of the former firm remained with it as the evidence clearly discloses. A witness; a remaining partner, was called by the respondent, and his evidence on cross-examination clearly indicated that the. substantial part of the goodwill of the old firm remained with it and'that what happened in 1962 did not seriously ffect: the asset goodwill of that firm but on the contrary the continuing partners received the advantage of it and did use it and as a result the firm flourished and the practice increased and that situation obtained up to the present time.

It follows therefore that what goodwill remained is of the essence in the determination of this matter.

As I understand it, the concept of goodwill generally encompasses almost any intangible factor of economic value to any enterprise and such includes a law partnership such as the subject one in this case. Goodwill is the master valuation account. It adjusts and modifies virtually all the recognized assets and liabilities of a firm. As applied to the subject law practice such assets. and liabilities include the law practice as a going concern, the name of the firm, the excellent client connection, the trained staff of junior lawyers and employees, the equipment, the favourable lease of the office premises, and so forth; all of which assets and liabilities were built up over the period of the appellant’s years of practice with this firm, and with his help, first as a solicitor employee and from 1956 as a partner.

The quantum or amount of goodwill in any enterprise, including this subject law practice, represents not only an unallocated but also an unallocable adjustment in any precise manner of such assets and liabilities and therefore it is impossible to dispose or transfer the goodwill without disposing of the items it modifies or adjusts.

The quantum or the amount of the goodwill also is always difficult to measure but on the evidence in this case it is fair to say that it was most substantial at the material time.

Goodwill in my view was the main assets surrendered to the remaining partners pursuant to the provisions of paragraph 14(b) of the said partnership agreement.

Therefore in my view the instalment payment made in 1963 to the appellant of $9,897.30 by the law firm of Borden, Elliot, Kelley and Palmer was part of a capital payment for the appellant’s interest in the goodwill of that law practice at the time the appellant ceased to be a partner and in the circumstances the remaining partners in the firm, as was their right contained under paragraph 14(b) of the partnership agreement, were able to and did succeed by a minimum payment in having this goodwill transferred to them at a relatively low capital cost to them. In other words, the goodwill of this firm at the material time had a most substantial value according to the evidence and the goodwill transferred to the remaining partners had a credit value to them over and above what they had to pay the appellant for the share of it transferred to them on his ceasing to be a partner. Such goodwill, of course, as always, is a capital asset.

Any right, title and interest in the other assets surrendered by the appellant were of a capital nature also, and had a value over and above the value of goodwill, but their value was much less relatively than the value of the goodwill transferred and surrendered.

In short, therefore, in the result, the payment in 1963 of $9,897.30 (together with the payments of a similar amount in the four years following) was for the release, transfer or surrender of the interest of the appellant in goodwill in the law practice of Borden, Elliot, Kelley and Palmer to the remaining partners, the corollary of purchased goodwill, a capital asset, and also to a small degree for the surrender of all the right, title and interest of the appellant in the other capital assets less his responsibility for the liabilities of this firm, and therefore the receipt of this sum for such by the appellant was not income to him within the meaning of the Income Tax Act.

In the result therefore, the appeal is allowed with costs, the re-assessments are set aside and referred back for further assessments not contrary to these reasons.