A J Frost:
1 This is an income tax appeal in respect of the appellant's 1969 and 1970 taxation years.
2 The appellant company was incorporated to carry on business in the Province of Saskatchewan. On March 28, 1969, O J McNeill and others signed an agreement with Saskatoon Drug & Stationery Company Limited whereby McNeill (the Vendor) sold to the Saskatoon Drug & Stationery Company (the Purchaser) 7 drug stores, as going concerns. The sale included “all the undertakings, (leasehold interests and the right to enter into leases as set forth in the agreement), and assets belonging to or used in connection with the said businesses of the Vendor, as a going concern”. A further specification of the object of the sale indicated that without limiting the generality of the said description, the following was included:(a) the goodwill of said businesses, together with the exclusive right of the purchaser to use the trade name under which the stores were known to the public,
(b) the inventory of stock-in-trade owned by the vendor, and
(c) the fixed assets, like furniture and fixtures, etc, used in connection with the businesses.
3 For all the assets mentioned under (a) a price of $290,000 was agreed upon. The price paid for the other assets is not relevant for the present appeal. Three of the 7 stores were transferred to former employees who had worked in those stores and one was sold within a period of 9 months.
4 The stores retained were:1. McNeill's Pharmaceutical Centre formerly owned by McNeill Drug Stores Ltd.
2. McNeill's South Albert Drug formerly owned by McNeill Drug Stores Ltd.
3. McNeill's Broad Street Drug formerly owned by McNeill Drug Stores Ltd.
5 The Broad Street store was an established outlet and operated on premises owned by the McNeills. The other store premises were under lease from third parties. The leases with third parties were assigned ot the appellant by the vendor and a new lease arrangement was entered into with respect to the Board Street store.
6 Of the three stores acquired and integrated by the appellant, the Broad Street store was the most valuable and was uniquely suitable as a merchandising outlet. It had excellent visibility in a high traffic area with good parking facilities, and was a high volume store which lent itself to good quality merchandising on a personal service basis. Due to its unique location, the store was a very productive unit. Its operations combined personal service with a discount operation. The appellant paid a price for these unique features. The other stores were good value but not so outstanding. The annual turnover of the Broad Street store was approximately $500,000 per year.
7 Of the amount of $290,000 paid for the assets already mentioned, $207,500 was applicable to the three stores retained. The question is whether this $207,500, or any part of it, was paid for “goodwill”. It appears that the vendor based his income tax calculations on the assumption that the said goodwill was worth the said amount, which meant that for the vendor the $207,500 constituted a non-taxable capital gain. Referring to the provisions of paragraph 20(6)(g) of the former Act, I would like to point out that, in cases in which the nature of such an amount is in issue and the court decides that the purchase price in question has to be allocated to depreciable and/or non-depreciable assets, the re-allocation in respect of the vendor also applies with regard to the purchaser.
8 It is true that on occasion this leads to injustices, but it is obvious that the legislature did not want to have two different asset valuations which were the subject-matter of an agreement between two or more parties.
9 In tax litigation, it is always a delicate question whether and to what extent a court should intervene in restating or re-editing the terms of a contract between two or more taxpayers on the ground that the terms of the contract show no resemblance to what the parties really agreed upon and in fact purported to achieve.
10 A business deal is always based on individual valuations of what one obtains and what one gives up in exchange for it. Income tax may therefore play an important role, and although the Minister is not bound by arrangements of taxpayers which could result in a redistri bution of income tax liabilities, it is obvious that a court should only intervene if such an arrangement was clearly concocted in violation of what really took place.
11 In the case at bar, the contract has used the word “undertakings”, and then described it as goodwill. After the word “undertakings”, the leasehold interests and the right to enter into leases are mentioned in parenthesis. It certainly is a very ambiguous way to indicate what was meant by “undertakings”. The way the contract reads, it would appear that the $290,000 was paid for assets in the nature of what is commonly called goodwill. On the evidence, however, the $290,000 was an overpayment. However, if both parties wanted it that way, that is how it should be left, unless there was an intentional and obvious misstatement of facts. The vendor certainly wanted it that way, but the purchaser (the appellant company) did not. However, a point was reached during the negotiations where the appellant was willing to go along with the wishes of the vendor and sign anything in order to conclude the deal and get the stores. The appellant wanted the deal finalized. It was a real tug-of- war between parties, with taxes a major consideration. When the deal was closed, the appellant, in recording the transaction on its books of account, used the terminology “Premium on leases purchased” to reflect the capitalized value of $207,500 for the leases purchased, rather than the terminology “goodwill” which appeared in the agreement of purchase and sale. Accordingly, in computing its income for its 1969 and 1970 taxation years, it claimed capital cost allowance in respect of the said $207,500 in the amounts of $4,800 and $6,400, respectively. The auditors' footnote attached to the Balance Sheets of the appellant as at December 31, 1969 and 1970, reads as follows:
Premium on leases purchased arised [sic] from the assignment of favourable leases to the company on the acquisition of McNeill Drug Stores in Regina. It is being transferred to expense on a basis which will amortize the cost over the terms of the leases which cover a minimum of 10 to a maximum of 24 years.
12 The Board is concerned with the facts of the case and with the legal significance of the terms “goodwill” and “premium on leases purchased”. It is not concerned with the question of estoppel, as the Board is entitled to go behind the agreement and look at the facts. The use of the word “goodwill” in the agreement automatically obliges the Board to consider the nature of goodwill and the elements which comprise it. The concepts of “goodwill” and “premium on leases” are here tied together making the problem, in part at least, one of semantics.
13 In theory, goodwill is the capitalized value of super-earning power and cannot be separated from those sources which generate that extra earning power. If a purchaser pays a price for extra earning power, the amount so paid normally appears on the purchaser's books of account as an intangible capital asset and, depending on the source of the earnings and the nomenclature used, the value so established could be in the nature of a depreciable asset. Goodwill elements are rooted in income sources and are generally considered to be (a) personal or management goodwill; (b) goodwill of location; and (c) goodwill of product or service. Goodwill may be a combination of all these source elements but it cannot be separated from them.
14 The purchaser took over two existing store leases and the contract was made conditional on the assignment of those leasehold interests and the granting of a new lease on the Broad Street store. I can understand that, with regard to the other two stores, a premium could be involved for the right to succeed to the said leasehold interests if the rent payable was substantially below the fair market value and if the lease still had several years to run. In such a case, I would not hesitate to speak of a premium on the leases purchased. However, with respect to the store on Broad Street, there was no reason for a premium, as the leasehold interest which the purchaser had to obtain from the vendor could well have been reflected in rates acceptable to both parties.
15 Goodwill of service or product, or personal or management goodwill, could well have been attached to the Broad Street store but, strictly speaking, not goodwill of location or premium on leasehold interests purchased, as the McNeills owned the land and building. “Goodwill” as commonly used could only arise from the drug store business itself. Goodwill of location is a rental proposition. With respect to any goodwill of location, the Board states unequivocally that goodwill of location is synonymous with leasehold interest, despite the fact that leasehold interests represent a depreciable asset and goodwill of location does not.
16 What happened in this case was that the contract was worded so ambiguously that the vendor could say: I sold the goodwill and made a capital gain, while the purchaser could contend that he bought a depreciable leasehold interest. This type of gimmick should not be encouraged.
17 I feel reasonably certain, however, that, in the total picture, the goodwill aspect of the three businesses was not ignored. The purchaser did take over the businesses of the McNeills as going concerns, and there is no doubt in my mind that some goodwill other than goodwill of location could have attached to the Broad Street store. It would be difficult for an impartial observer to conclude that the opportunity to step into an existing business under the same trade name, even though the name was only used for a few months, did not generate something of substantial value in the nature of goodwill.
18 On the facts before me, and not being in a position to make a detailed evaluation, I allow the appeal in part and hold that, ex aequo et bono, an amount equal to 50% of the $207,500 is assumed to have been a premium paid for leasehold interests that may be written off in accordance with the provisions of paragraph 1100(1)(b) and Class 13 of Schedule B to the Income Tax Regulations.
Email this Content