A J Frost (orally: June 3, 1975):
1 I shall now give my decision in respect of the 1970 and 1971 taxation years.
2 The question at issue is whether or not the amounts claimed as business deductions in respect of payments made under an agreement executed in March of 1968 relating to the purchase of the law practice of one A J McNab were of a capital or a revenue nature.
3 The purchase price stated in the agreement under which the McNab law practice was purchased included X dollars in cash plus the reservation of an amount equal to 25% of the net profits which was covenanted to be set aside and paid to the Estate of A J McNab. The agreement reads in part as follows:
It is agreed that in addition the Estate shall, subject to paragraph 10 hereof, reserve to itself an amount equal to 25% of the net profits of the law practice carried on by McCray, over a period of four (4) years commencing on the 1st day of April, 1968, and ending on the 31st day of March, 1972. It is understood that the said amount reserved by the Estate shall be excluded from the sale of the said law practice and that McCray shall act as agent for the Estate in transferring the said reserved amount to the Estate. At no time will McCray have any beneficial interest in the said reserved amount.
4 The nature of the asset acquired is that of a professional business. The price paid was X dollars plus an amount equivalent to 25% of the net profits, not 25% of the net profits per se. All earnings were the property of the appellant but were subject to the claim of the estate under the agreement.
5 The amounts required to be set aside are a measure of the net worth or value of the business, unascertained at the time the agreement was entered into but neverthless part of the purchase consideration.
6 An amount equivalent to 25% of the net profits was not the appellant's to deal with as it was “reserved by the Estate”. The words “excluded from the sale” are difficult to understand as, in my opinion, future earnings are not normally excluded or separated from the business which is sold. The words mean, in my opinion, the same as “reserved by the Estate”.
7 A vendor, under normal circumstances, sells what in fact exists at the time of the sale. As a rule, one does not sell a business and retain future profits, or accept stock as part of the proceeds of sale and claim a portion of future dividends.
8 The substance in this case is that the future earning power was simply used as the measure for determining the value of the business and payment was deferred until the actual profits were ascertained.
9 As previously stated, a purchaser does not usually pay a price based on future earning powers. He projects future earnings, using past performance as a guide. A price is normally arrived at by the capitalization of past earnings adjusted for equity values.
10 In this case it seems clear to me that the reservation was in fact part of the purchase consideration, and that all payments pursuant to the agreement in essence relate to the acquisition of the business as a capital asset.
11 For these reasons the Board has no alternative but to dismiss the appeals.
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