Georges-Henri Couture v. Minister of National Revenue, [1978] CTC 2687, [1978] DTC 1511

Guy Tremblay [TRANSLATION]:—The case at bar was heard at Quebec City, Quebec, on April 7 and May 2, 1977.

1. General Point at Issue

The Board has to decide on the existence and, if applicable, the value of the goodwill of the appellant’s business when he sold it on February 1, 1969 to G H Couture Inc, a company in which he was the principal shareholder.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment is not justified. This burden of proof derives not from any specific section of the Income Tax Act but from a number of judicial decisions, including the judgment of the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts Alleged

3.1 Facts alleged by the appellant

The appellant’s claims, as they appear in the document filed as the appeal, read as follows:

1. —I operated my business under my own name for a number of years and built up a good business, which was sold to G H Couture Inc on February 1, 1969;

2. —At the time of this sale a balance sheet was drawn up to show the real value of the business as if it had been sold to any other purchaser, and the goodwill was assigned a value of $15,000, taking into account turnover, annual net profit and various other factors such as the exclusive rights to certain lines;

3. —I acted as a broker and commission representative and continued to do business with G H Couture Inc in view of my many years of good service in selling their products;

4. —The exclusive right to sell several products and lines was at the time of the sale, and still remains, a positive asset to G H Couture Inc, which continues to derive income from this right;

5. —The good service and stability of the business sold to G H Couture Inc continue to exist in that company; they were and still are the reason why several manufacturers have kept the company on as their agent, thus allowing G H Couture Inc to maintain and improve the business that I sold to it.

3.2 Facts alleged by the respondent

In its reply to the notice of appeal, the respondent makes the following claims regarding the facts:

A. STATEMENT OF FACTS

1. He knows nothing of the allegations contained in paragraph 1 of the appellant’s notice of appeal and does not admit them;

2. He denies paragraphs 2, 3, 4, and 5 of the appellant’s notice of appeal;

3. The respondent based his assessment of the appellant for the taxation years 1969 to 1972 on the following facts:

a. in 1969 the appellant operated a brokerage business;

b. on or about January 24, 1969, the appellant incorporated a company with the name G H Couture Inc;

c. on or about February 1, 1969, the appellant sold his brokerage business to his company, G H Couture Inc;

d. when the business was sold to the company, the sale price took into account $15,000 for “goodwill”;

e. the company assumed the purchase price of the business by issuing shares and. an acknowledgment of indebtedness in the amount of $12,328.13 in favour of Georges-Henri Couture, the principal shareholder in G H Couture Inc;

f. at the time of the sale, the appellant’s business did not include any goodwill;

g. if the appellant’s business did include goodwill, this goodwill belonged to the appellant on a strictly personal basis and consequently had no market value;

h. during the years under appeal, the appellant received the following amounts from his company, G H Couture Inc:

1969 — $5,175.54;

1970 — $1,155.20;

1971 — $ 350;

1972 — $1,350.

4. Facts Proven—the Appellant’s Evidence

The parties have substantially proven the facts alleged. However, a number of clarifications were given.

4.1 From 1955 to 1969 the appellant was a broker in the candy trade, serving as a middleman between various candy manufacturers and wholesalers.

4.2 The appellant’s first witness was Mr Raymond Roy, who did the bookkeeping from 1955 until the date of the incorporation, and who continues to keep the books for G H Couture Inc. He explained, with the aid of figures, that the value of $15,000 placed on the goodwill of the appellant’s business at the time of incorporation was based on the net profit for the past three years (1967: $13,228; 1968: $16,291; 1969 (six months): $10,053).

According to the witness, the calculation was based on the net rather than the gross income to take account of the fact that part of the goodwill was personal and consequently not transferable.

4.3 It was proved to the Board’s satisfaction that the appellant represented various brokers, as appears, moreover, from the financial statements. In addition, two contracts were filed (Exhibit A-3) to prove this relationship. The companies involved were North American Candy Co and Chocolate Novelties Co Inc. According to Mr Roy, the contracts are exclusive even though this fact is not stated: this means that all sales made in the territory described in the contract benefit the appellant, who receives a fixed percentage on these sales whether they are made through him or not. With regard to this point another witness, Mr Marier Fried, president of a brokerage company dealing in fats and edible oils, maintained that the exclusivity clause is never written into an agent’s contract. Mr Fried, a former manager of Northern Packers, has been selling manufactured products for ten years. He said that the unwritten exclusivity clause is a custom, a Current practice, and that manufacturing companies always respect it as if it were written. The one-year contracts are not transferable.

4.4 In May 1969, that is three months after the company was incorporated, Mr Fried asked the appellant to become partners with him in a brokerage company. He offered the appellant $15,000. He would not have bought the appellant’s business, however, unless the latter had become his partner.

4.5 According to the appellant’s testimony, four contracts signed with the company on February 1, 1969, the date of its incorporation, and filed as exhibit A-5, are similar to those that had previously been signed with him. They are for one year with automatic renewal. They contain no exclusivity clause but do contain a description of a territory, which generally consists of the eastern part of the province. According to the appellant, however, the fact of the incorporation meant an increase in his previous territory, that of northern New Brunswick. The contracts are not transferable.

4.6 According to Mr Roy, the goodwill of $15,000 was attached to Mr Couture personally, since he was the one who was acquainted and had a personal relationship with the suppliers and wholesalers. According to Mr Couture, it was because he had a good reputation in the trade as a broker that several firms offered to make him their agent. On the other hand, some well-known products have their own goodwill. In that case the wholesalers will buy the product even if there is a new agent or one who is not well known. Sales are better, however, if the salesman is well known.

4./ Mr Couture explained that his business required no inventory. In fact, his office was in his home. He simply forwarded orders from wholesalers to manufacturers. In addition to taking orders, the appellant investigated customers’ credit and took care of the more difficult collection problems. Eighty to 85% of the business was done outside the office that he maintained in his home. He had no employees.

4.8 The appellant stated that manufacturers entered into the same kind of. contracts with the company as they had had with him before the incorporation. Counsel for the appellant at first objected to the production of these contracts, alleging that they concerned facts. that occurred after the date of the incorporation. When he realized that they were dated February 1, 1969, that is the date of the incorporation, he admitted the documents, which were produced as exhibit A-5. The contracts are valid for one year and are automatically renewed unless one of the parties gives 30 days’ notice.

5. Facts Proven—the Respondent’s Evidence

5.1 The respondent’s principal witness, Mr Gerald St-Pierre, filed an evaluation report at exhibit 1-1. The appellant objected to the fact that photocopies of two letters dated January 17, 1967 and February 1, 1967 were included in the report. One of the letters is from the chief appraiser of the death taxes section in Ottawa to the Associated Canadian Travellers, asking for an opinion on goodwill. The other letter is signed by Mr C H Barnes, general manager of the Commercial Travellers’ Association of Canada. The Board took the objection raised by counsel for the appellant under advisement. A decision on this matter is given below.

5.2 The witness’ experience consists mainly in having worked on thirty-five or forty goodwill cases. He makes a distinction between commercial and non-commercial goodwill. His reference manual is The Principles and Practice of Business Valuation, by lan R Campbell, published in 1975 by Richard De Boo Limited.

5.3 According to exhibit A-1, in 1968, that is the year prior to the incorporation, the appellant received 65% of his commissions from five manufacturers, namely: North American Candy Co, World Wide Gum Co, Kent Nut Products (Krispy Kernels), St Lawrence Candy Co and Leeds Candy Corp. The appellant represented approximately 15 companies.

5.4 The appellant’s gross income was as follows for the years ending

5.5 Applying the definitions of the various kinds of goodwill described by lan R Campbell in his above-mentioned book, the witness classified the goodwill of the appellant’s business as personal.

5.6 The respondent called a second witness, Mr Pier Furness, Vice- president of François Fournier Inc, which represents eighteen manufacturers and has an annual turnover of $5 million. The witness is also Vice-president of the “Association professionnelle des conseillers en vente”, an educational and social association with eight hundred members.

5.7 According to Mr Furness, a clientele attached to a broker personally cannot give rise to commercial goodwill in favour of the. broker. Instead, the goodwill would be in favour of the manufacturer. He admitted, however, that people do sometimes pay for this goodwill.

5.8 From 1969 to 1972, the appellant received the following amounts from G H Couture Inc:

5.9 In assessments issued on April 19, 1974 for each of the years concerned, the respondent included the above amounts in computing the appellant’s income.

5.10 On July 5, 1974 the appellant filed notices of objection in accordance with the Act.

5.11 On April 9, 1975 the Minister notified the appellant of his decision to confirm the earlier assessments, explaining that the amounts had been included in his income [TRANSLATION] “in accordance with the provisions of subsection 8(1) of the old Act for the years 1969, 1970 and 1971, and of subsection 15(1) of the new Act for the year 1972”.

5.12 On June 10, 1975 the appellant appealed to the Tax Review Board.

6. Act, Principles and Precedents

6.1 Subsection 15(1) of the new Act, which is to the same effect as subsection 8(1) of the old Act, reads as follows:

15. Appropriation of property to shareholder

(1) Where in a taxation year

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

otherwise than

(d) on the reduction of capital, the redemption of shares or the winding- up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which sections 84, 88 or Part II applies,

(e) by the payment of a dividend, or

(f) by conferring on all holders of common shares of the capital stock of the corporation a right to buy additional common shares thereof, the amount or value thereof shall be included in computing the income of the shareholder for the year.

6.2 Particular Points at Issue

The sections of the Act referred to above, apply only if the goodwill sold to G H Couture Inc by the appellant is not transferable.

The appellant claims that the goodwill involved is personal rather than commercial and that it is therefore not transferable.

6.2.1 The Board must first determine, therefore, what goodwill is in general.

6.2.2 What is the nature of the goodwill in the case at bar? Is it transferable?

6.2.3 If the goodwill is transferable, what is its value?

In evaluating the goodwill, can one take into account facts subsequent to February 1, 1969, the date on which G H Couture Inc was incorporated?

6.3 What is goodwill in general?

6.3.1 The first book that should be consulted in order to find the ordinary meaning of a word is the dictionary.

According to Le Petit Larousse Illustré, “achalandage” means:

“action d’achalander. Ensemble des clients.”

According to the Petit dictionnaire canadien de la langue française by Louis-A Belisle, “achalandage” means:

“action d’achalander; clientèle d’un marchand.”

According to the Concise Oxford Dictionary, 1964 edition, “goodwill” means:

“established custom or popularity of business.”

According to The Living Webster Encyclopedic Dictionary of the English Language, 1971 edition, “goodwill” means:

“Intangible value of a business; projected earning’ power . . _.”

6.3.2 In Herbert Wallace Losey v MNR, [1957] CTC 146; 57 DTC 1098, Thorson, P, of the Exchequer Court of Canada provides us with the results of his research on this subject. He states that the word “goodwill”:

. . . IS not free from difficulty. Lindley on Partnership, 10th edition, at page 523, states that “the term goodwill can hardly be said to have any precise signification’’. The new English Dictionary defines goodwill in the commercial sense of the term as follows:

b. Comm. The privilege, granted by the seller of a business to the purchaser, of trading as his recognized successor; the possession of a ready formed “connexion” of customers, considered as an element in the saleable value of a business, additional to the value of the plant, stock-in-trade, book-debts, etc.

As early as 1810 Lord Eldon in Cruttwell v Lye (1810) 17 Ves Jun 335 at 346, said of the goodwill of the business which was the subject of sale in the case before him:

“The goodwill . . . is nothing more than the probability, that the old customers will resort to the old place,”

And it is somewhat in that sense that Cripps on Compensation, 8th Edition, page 185, defines goodwill as “the probability of the continuance of a business connection.

But the later cases indicate that Lord Eldon’s definition was too narrow. Thus in Trego v Hunt (1896), AC 7, Lord Herschell emphasized that it was the connection with its customers that made the goodwill of a business. At page 1/7, he said:

“It is the connection thus formed, together with the circumstances, whether of habit or otherwise, which tend to make it permanent that constitutes the goodwill of a business. It is this which constitutes the difference between a business just started, which has no goodwill attached to it, and one which has acquired a goodwill. The former has to seek out his customers from among the community as best he can. The latter has a custom ready made.”

And Lord Macnaghten said, at page 23:

“What ‘goodwill’ means must depend on the character and nature of the business to which it is. attached. Generally speaking, it means much more than what Lord Eldon took it to mean in the particular case actually before him in Cruttwell v Lye (1810), 17 Ves 335 at 346, where he says: ‘the goodwill which has been the subject of sale is nothing more than the probability that the old customers will resort to the old place”. Often it happens that the goodwill is the very sap and life of the business, without which the business would yield little or no fruit. It is the whole advantage, whatever it may be, of the reputation and connection of the firm which may have been built up by years of honest work or gained by lavish expenditure of money.”

I respectfully express the opinion that the last sentence of what I have cited more accurately sets out the meaning of goodwill than the sentence that precedes it.

And in Inland Revenue Commissioners v Muller & Co’s Margarine, Limited (1901), AC 217, another House of Lords decision, Lord Macnaghten said, at page 223:

“What is goodwill? It is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connection of 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.”

Furthermore, relying on Austen v Boys, (1858), 11 De G & J 626, at 635, Lindley on Partnership, 10th Edition, page 523, Thorson P states:

‘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.”

Before ending his examination of goodwill, the learned judge concludes:

“But two things are clear. One is that the sale of the goodwill of a business does not include a convenant by the vendor that he will not compete against the purchaser. If the purchaser wishes the benefit of such a convenant 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.”

6.3.3 In his book La comptabilité supérieure, 1948 edition, Vol 1, p 474 et seq, Brother Irénée EC writes:

[TRANSLATION]

Goodwill is a reputation which a business firm has acquired after many years of operation by its honest and prudent dealings, and which raises the net profits of the firm above the normal percentage on invested capital . . . It is thus an excess of profits that determines the existence of goodwill. There must be a reasonable probability that these excess profits will continue in the future; otherwise, a person buying a business would not agree to pay for goodwill in addition to net assets.

The Internal Revenue Service of the United States in its bulletins (US Revenue Ruling 59-60) gives a definition very similar to that given by Brother Irénée:

In the final. analysis, goodwill is based upon earning capacity. The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets.

This is equivalent to saying “over and above the normal net earnings of the business concerned’’.

6.3.4 The fact that earning capacity can result from a number of factors has led in'recent years to a distinction between several kinds of goodwill.

In his book “The Principles and Practice of Business Valuation” 1975 edition, p 77, lan R Campbell lists the following four kinds of goodwill:

—goodwill of location (achalandage de la situation des lieux);

—goodwill of product or service (achalandage du produit ou service);

—personal goodwill (achalandage personnel);

—general business goodwill (achalandage général de l'entreprise).

This last type of goodwill results mainly from the length of time the business has been in operation; past profits; the competence of employees; good relations with lenders and investors, who have a favourable opinion of the business; long-standing relationships between the business and its suppliers and customers; and a competent team of managers who are familiar with the competition, current contracts and so on.

As may be seen, the distinction recently made between different kinds of goodwill, on the basis of the various factors, grounds and sources that produce the goodwill of a particular business, gives an overall view and a better understanding of this complex concept. Certain definitions previously given by the courts, including some that were cited by Thorson, P in Losey, often limited the entire concept of goodwill to a single factor such as location or contact with customers.

6.4 What is the nature of the goodwill in the case at bar?

6.4.1 First, the goodwill in question is not goodwill of location. This type of goodwill applies mainly to retailers. In the case at bar, the appellant’s clientele was made up of wholesalers. Moreover, his office was in his own home, a fact which, while not constituting a liability for his business, was nevertheless not an asset capable of producing goodwill.

6.4.2 With regard to the goodwill that might result from the trade marks of the products being sold, the Board feels that if this kind of goodwill exists for the confectioneries sold by the appellant, it is attached to the businesses of the manufacturers who supplied the appellant rather than to the appellant’s business.

6.4.3 In order to determine whether we are dealing with personal goodwill or general business goodwill, we should begin by considering what the courts have already said on the question.

In the past twenty years the courts, the old Tax Appeal Board and the present Tax Review Board have decided a number of cases, which in general have this much in common with the case at bar: they almost all involve setting a value on goodwill, when a business is sold to a newly formed company whose principal shareholders are the owners of the business being sold. The Board feels it would be useful to summarize the principal judgments, though not without a word of warning about the dangers of summaries.

6.4.4 Summary of sixteen judgments

(1) Herbert Wallace Losey v MNR, [1957] CTC 146, 57 DTC 1098, Exchequer Court, by Thorson, P.

Mr Losey, a former commission salesman who had been running his own advertising business for eighteen months, sold this business to Alliance Advertising & Applied Arts Inc, a newly formed company of which he was the president and principal shareholder. The price was $85,000, which was made up of $10,000 for tangible assets and $75,000 for goodwill. The basis for this figure of $75,000 was a past net profit of $15,000, multiplied by five to reflect future net income producing capacity.

Decision

Because the only evidence was a list of former clients, with no fixed contract to bind them to the company and give something permanent to the transfer; and because the relations with the clients were strictly personal (the appellant’s two main witnesses admitted that without the appellant’s personal participation the value of the goodwill would have been minimal), Thorson, P concluded that the transferable value of the goodwill was negligible and dismissed the appeal.

Earlier decisions and Thorson, P’s comments about the nature of goodwill were cited above.

(2) Consolidated Laundry & Cleaning Services Limited v MNR, 21 Tax ABC 168; 59 DTC 45, Tax Appeal Board, by C L Snyder, Chairman.

In 1952 the appellant company sold its assets to Affiliated Laundry & Cleaning Services for $87,706.74, assuming current liabilities of $131,245.07. The financial statements included $170,428.45 for goodwill; this was established by allowing under this item all the amounts not allowed by the Department of National Revenue as depreciation. The Department’s assessment of the company stated that the depreciable assets had been sold for $101,500, allowed $10 for goodwill and added $46,793.43 to the income as recovery. The appellant maintained that the sale resulted in a loss of $116,883.77, and that consequently no amount could be allowed as recovery, particularly since the equipment had become obsolete. The appellant company (which owned 90% of the laundries and 40% of the dry cleaning businesses in Windsor, Ontario) maintained that its goodwill should be valued at approximately $80,000.

The appellant’s principal witnesses pointed out that a service business must evaluate its goodwill on the basis of sales volume and argued that since the gross weekly turnover was $7,700, the goodwill could not exceed $77,000 but that this figure was reasonable. The Department’s witness, on the other hand, taking into consideration the lack of working capital, the state of the equipment, the possibility of competition and the likelihood that the operation would soon have to undergo changes, found $15,000 to be a reasonable value for the goodwill. On cross-examination, he increased his estimate to $19,000.

Decision

Chairman Snyder, also taking into consideration the percentage-of work in relation to the volume of sales, assigned a value of $25,000 to the goodwill. With regard to recovery, Mr Snyder, taking into consideration the fact that the equipment was still in good working condition even though it was old, found that recovery was applicable but that the amount should be established on the basis of the difference between the sale price and the undepreciated cost of the equipment after taking into consideration the figure of $25,000 for goodwill, the agreed price of the current assets, land, buildings, vehicles and improvements to be made by the tenant.

(3) Harry Rabow v MNR, 26 Tax ABC 445; 61 DTC 346, Tax Appeal Board, by R S W Fordham, Member of the Board.

In 1953, after running a business that sold electrical appliances for seven years, the appellant and his partner decided to sell their business to a newly formed company in which they were the principal shareholders. The sale price was $126,000, including $48,000 for goodwill. The amount paid to the appellant by the company for goodwill was regarded as a benefit received by a shareholder and included in the appellant’s income in accordance with subsection 8(1) of the Income Tax Act.

Decision

Because during the inquiry the respondent made an admission regarding the existence of the goodwill, and showed that it amounted to $14,187.27; and because the method used by the appellant to prove the figure of $48,000 for goodwill was somewhat empirical (three times the income for the last three years) in comparison with the method used by the appellant (the average net profit for the last five years minus the average annual withdrawals by shareholders, minus taxes at twenty per cent was capitalized at ten per cent and the amount invested by the shareholders subtracted, leaving $14,187.27 in goodwill), Mr Fordham allowed this amount as goodwill.

(4) Joseph Reiss v MNR, 27 Tax ABC 412; 61 DTC 604, Tax Appeal Board, by R S W Fordham, Member of the Board.

After the incorporation of Gylyn Investments Limited as a private company, the appellant and two partners sold to this company a piece of farmland they had recently acquired. More than a year later, the vendors concluded that they had sold their land at too low a price. In order to remedy the problem, they had the company issue a promissory note for $7,500 to each of the partners, and explained these amounts as goodwill.

Decision

Because the contract was not entered into at arm’s length, the appellant and his partners were able to change it to give themselves an additional $22,500.

The appellant, who had the burden of proof, did not show that this amount represented goodwill. The parties in question had not even operated the farm: they had simply bought and resold. The appeal was dismissed.

Case cited: Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(5) Nelson T Adair v MNR, 29 Tax ABC 324; 62 DTC 356, Tax Appeal Board, by four members.

Because of his success in selling chain saws, the appellant was known as “Mr Chain Saw of Canada’’. In 1952, as a result of this reputation, a chain saw company gave him a franchise to. sell its product throughout Canada. After running the business for two years, he sold it to a company which had been formed for the purpose and in which he was the principal shareholder. The selling price was $48,000, including $20,000 for goodwill. The Department regarded this $20,000 as an advantage conferred on a shareholder.

Decision

Because the contract with the chain saw company was a contract of employment and therefore a personal contract; and because after the incorporation, that is in 1957 and 1958, the appellant’s illness caused the company to lose money, Board member Weldon concluded that the goodwill involved was almost entirely personal. He allowed only $1,000 as transferable goodwill and dismissed the appeal for the remainder.

Board members Snyder, Fisher and Fordham, who had heard the case with Mr Weldon, concurred in his judgment.

Case cited: Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(6) Irvin Charles Schacter v MNR, [1962] CTC 437; 62 DTC 1271, Exchequer Court of Canada, by A L Thurlow, J.

The appellant, a chartered accountant practising his profession in Winnipeg, bought from another accountant, who wanted to retire, “all the rights, titles and interests of the vendor in and to the goodwill of the accounting firm’’ operated by the vendor under the name George Loos & Co. The agreement also gave the purchaser the right to use the firm name George Loos & Co.- The purchase price was set on the basis of a list of the fees paid to the vendor by his 124 clients in a year, the total being $24,505. The goodwill was valued at 70% of this amount, or $17,153.50.

When the appellant filed his tax return he claimed this expenditure as an ordinary expense incurred for the purpose of gaining income under paragraph 12(1)(a) of the old Act. The Minister refused to allow this expense, alleging that under the terms of the agreement the purpose of the expenditure was the purchase of goodwill, and it was therefore a capital outlay under paragraph 12(1)(b) of the same Act.

Alternatively, the appellant alleged that though the contract provided for the purchase of goodwill, he had never purchased any goodwill, and the only thing he had received in addition to the agreement was the list of clients’ accounts. In his view, what he had received was allowable as a deduction under paragraph 12(1)(b) and under class 8 (tangible assets not depreciable in another class).

Decision

On the basis of a long line of authority, Thurlow, J decided first that the payment was made once and for all in order to procure a lasting advantage, and that consequently the amount could not be deducted under paragraph 12(1)(a) of the old Act. The expenditure involved came under paragraph 12(1)(b) of the same Act. Secondly, he decided that the rule concerning class 8 did not apply, since it concerns tangible assets whereas the contract concerns goodwill. Even the list of accounts cannot be regarded as a tangible asset since according to the agreement, it is simply a part of the payment mechanism. The subject of the contract is goodwill, which is an intangible asset. The appeal was dismissed.

(7) Harold E Croteau v MNR, 36 Tax ABC 299; 64 DTC 643, Tax Appeal Board, by W O Davis, Member.

In 1954, the appellant and three associates, all highly qualified employees of the Provincial Engineering Company, left their employer to join with a fifth person, Mr Sydney L Albert, in forming a new company, company M, to engage in work similar to that done by the Provincial Engineering Co: installing machinery, electrical equipment and so on. Mr Albert supplied the capital and owned 51% of the shares; the remaining 49% was divided among the other four.

In 1957, when company M encountered financial difficulties and Mr Albert refused either to supply additional capital or to sell any of his shares, the appellant and his three associates formed a new company, company R, to engage in work similar to that done by company M.

An entry of $38,000 for goodwill appears in the new company’s books. The value of this goodwill was established on the basis of the previous income of company M. Promissory notes were issued to the four shareholders of company R.

In 1958 Mr Albert, who owned 51% of the shares in company M and who was displeased by the formation of the new company, brought an action for damages on behalf of company M against company R and the four shareholders jointly. The case was settled out of court in 1959, with the defendant paying $21,000 in damages and $2,600 in court costs. For the year 1959, the Department of National Revenue assessed the appellant and his three associates on the $21,000 paid to company M by company R, basing this assessment on the fact that since the shareholders were co-defendants in the action, company R in paying the $21,000 had conferred upon them an advantage that was taxable under subsection 8(1) of the old Act as an advantage received by a shareholder.

The appellant maintained that the money was received as capital, since it constituted partial payment of the promissory note for the goodwill transferred when company R was incorporated.

Decision

Because the evidence did not demonstrate the existence of goodwill resulting from the income of company M, which continued to exist; and because, if such goodwill existed, it came from the four associates as individuals and not from company M, Mr Davis dismissed the appeal.

Cases cited: Rabow v MNR, 26 Tax ABC 445; 61 DTC 346; Losey v MNR, [1957] CTC 146; 57 DTC 1098; Reiss v MNR, 27 Tax ABC 412; 61 DTC 604; Consolidated Laundry and Cleaning Services Limited v MNR, 21 Tax ABC 168; 59 DTC 45.

(8) Jack Young v MNR, 38 Tax ABC 73; 65 DTC 242, Tax Appeal Board, by C L Snyder, Chairman.

Mr Young had been selling dry goods for twenty-nine years and operating his own business for fourteen years when, in 1961, he decided to incorporate himself and sell his business to the new company of which he was president and principal shareholder. The sale price was $54,974, which included $50,000 for goodwill. When this amount was paid by the company, the Department of National Revenue included it in Mr Young’s income as an advantage conferred on a shareholder.

Decision

Because the evidence showed that Mr Young’s business was based on a single person, namely Mr Young himself; and because the list of names of retailers who had been Mr Young’s customers since 1932 could not constitute goodwill in favour of Mr Young (any goodwill involved would be a result of the merchandise sold and this would be in favour of the manufacturer), Mr Snyder dismissed the appeal.

Cases cited: Consolidated Laundry and Cleaning Services Limited v MNR, 21 Tax ABC 168; 59 DTC 45; Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(9) MNR v Ian G Wahn, [1969] CTC 61; 69 DTC 5075, Supreme Court of Canada, by five judges.

In 1962, the appellant, who was a lawyer, left the law firm of which he was a member and opened his own firm. This change was the cause of two tax problems, which formed the subject of this case.

(a) In 1962 the appellant’s new law firm suffered a loss of $6,092, which he applied against his 1961 income in accordance with paragraph 27(1)(c) of the old Act. The Minister applied it against his other income for 1962.

(b) Upon leaving his old law firm he was granted a sum of $39,589, payable over four years from 1963 to 1966, at the rate of $9,897.50 per year. In his tax return the appellant treated these payments as non-taxable, since in his view they constituted income from capital resulting both from the sale of his share of the old law firm and from the firm’s goodwill, which he had helped to build up over the years. The Minister included the $9,897.50 in 1963, alleging that, according to the agreement, the amount received referred to accumulated profits from work in progress or other work. Since the appellant calculated his income on a cash basis, the $9,897.50 received under the agreement was taxable in the year in which it was received and not in the year of the agreement.

Decision

The five judges of the Supreme Court of Canada allowed the appeal by the Minister of National Revenue, reversed the judgment of the Exchequer Court and reinstated the judgment of the Tax Appeal Board delivered by J O Weldon, a Member of the Board.

1— Losses sustained by a business during a given year must first be applied against other income for the same year. Only if the end result is a loss can paragraph 27(1 )(a) of the old Act apply.

2— The provision in the partnership agreement of the law firm concerning departure of a partner and monies to be paid to the departing partner refers, inter alia, to “undrawn profits from years preceding the year of withdrawal”, and explains how these profits are shared. No sale of goodwill or of shares in the company is involved. The court held that the provision accurately described the transaction as it occurred, and that the money received was taxable in the year in which it was received.

(10) Roine E Larsen v MNR, [1970] Tax ABC 267; 70 DTC 1171, Tax Review Board, by R St-Onge, Member of the Board.

From 1950 to 1965, the appellant operated an electrical contracting business. In 1965, when he decided to incorporate the business, he had fifteen employees. Liabilities exceeded tangible assets by $10,944. The appellant estimated the value of the firm’s goodwill at $25,000. After subtracting the deficit, the company credited the difference of $14,036 to the appellant. The Department of National Revenue regarded this amount as an advantage conferred on a shareholder under paragraph 8(1)(c) of the old Act.

According to the appellant’s principal witness, the $25,000 figure was not based on any mathematical formula. This witness stated, in short, that after fifteen years of operation it was normal to have $25,000 worth of goodwill.

Decision

Mr St-Onge concluded that the appellant had failed to discharge the burden of proof that he bore. The appeal was dismissed.

Case cited: Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(11) William H Crandall v MNR, [1974] CTC 2289; 74 DTC 1204, Tax Review Board, by K A Flanigan, Chairman.

After working as a consulting engineer in Moncton, N B for ten years, the appellant sold his business in 1961 to the new company W H Crandall & Associates (Management) Limited. He owned 61% of the shares while his associates, H and R, owned thirty-four per cent and five per cent respectively. The appellant’s professional activities consisted mainly in providing services to municipalities. Mr H had an MSc degree in sanitary engineering, and Mr R had worked with him as his assistant since 1951 while studying for a degree in engineering. After Mr R graduated, the appellant transferred ten per cent of his shares to him.

When the professional business was sold, a sum of $53,000 was entered on the company’s books as goodwill. This figure was arrived at by multiplying by a factor of ten a super profit calculated by subtracting the appellant’s salary, taxes and the value of the equipment being transferred from average net income for the last four years. According to the Department of National Revenue, however, the value of the goodwill could be no higher than $9,000. This figure was also based on the average net income for the last four years but the amounts to be subtracted were increased and the super profit was multiplied by a factor of five. The Department maintained, moreover, that this goodwill was personal and therefore non-transferable.

Decision

Because the appellant had very special qualifications and because he had given his name to the company, Mr Flanigan concluded that there was a transfer of goodwill to the company and assigned this goodwill a value of $33,080, which he arrived at by accepting and using some of the Department’s figures while retaining the factor of ten.

Furthermore, on the basis of the judgments of Walsh J in Produits LDG Products Inc v MNR, [1973] CTC 273; 73 DTC 5222, and of Gibson J in James v MNR, [1973] CTC 457; 73 DTC 5333, in which facts subsequent to the assessment date were taken into consideration in judging the taxpayer’s ‘intent, Mr Flanigan took into account Crandall’s conduct after the incorporation, namely the fact that he had remained in the company, in confirming the existence of the goodwill.

(12) Jack Richard Thomas v MNP, 75 DTC 37, Tax Review Board, by R St-Onge, Member of the Board.

In 1969, the appellant sold his radiology practice to Watwell Services Limited, a newly formed company of which he was the president and principal shareholder. An entry of $30,000 appeared on the company’s books for goodwill.

The appellant had practised for three years prior to the sale. He had two offices, one near the Kitchener-Waterloo Hospital and the other in Guelph, fifteen miles away. In each office he employed two qualified and trained technicians working part-time, a full-time secretary and a clerk. At the time of incorporation the appellant made over to the company two long-term leases. More than fifty doctors sent patients to the Kitchener-Waterloo office for X-rays, which could be taken whether the appellant was present or not.

In 1970, the company paid $30,000 to the appellant. The Department of National Revenue included this amount in the appellant’s income as an advantage to a shareholder under subsection 8(1) of the old Act.

Decision

It was decided on the basis of the evidence presented that the goodwill involved was not only personal, but was also and especially goodwill of location and goodwill of services due to the well-established organization of the employees. The company’s income of. $200,000 in 1969, increasing to $256,000 by 1973, showed, in Mr St-Onge’s opinion, the earning capacity represented by the organization of the business. Even if the appellant had become ill or died, this income would have continued since the company would simply have had to hire another radiologist.

The figure of $30,000 was held to be reasonable.

(13) The Saskatoon Drug & Stationery Company Limited v MNR, [1975] CTC 2108; 75 DTC 103, Tax Review Board, by A J Frost, Member.

In 1959, the appellant bought seven pharmacies. The purchase agreement included all the undertakings (leasehold interests and so on) and all assets used in the business. The purchase also included a total of $290,000 for goodwill. The appeal concerned only three of the pharmacies, involving a total cost of $207,500 for goodwill. The buyer wanted to treat this amount as subject to depreciation, whereas the vendor wished to treat it as goodwill.

Decision

Since the evidence suggested no appropriate method of calculation, Mr Frost made an arbitrary decision to allow fifty per cent of the amount as a “premium on leases purchased”, and to regard the remainder as goodwill.

(14) Robert McDonnell v MNR, unpublished (75-722), Tax Review Board, by R St-Onge, Member of the Board.

After obtaining his degree in engineering from St Francis Xavier University in Antigonish, Nova Scotia in 1964, the appellant continued to work for the Nova Scotia Department of Transport, which had been his employer since 1957. From 1966 to 1970 he worked part time as a consulting engineer in Antigonish, while also teaching part time at the university there. His main clients were the provincial Department of Highways, municipalities and various architects. As far as organization is concerned, he had no employees other than students who assisted him. He sublet the services of sub-contractors, mainly A H Roy & Associates, which offered services in mechanical, electrical and structural engineering and in road building. In fact, the appellant had his office in the same building as A H Roy & Associates.

In 1970, he decided to sell his business to a newly formed company, McDonnell Engineering Company, of which he was the president and principal shareholder. The total selling price was $26,500, all of which was for goodwill. This figure was established by multiplying the average net income for the last five years by ten.

No tangible assets were transferred from the business to the company.

Decision

Mr St-Onge decided that there was no goodwill of location or service and no general goodwill, but only personal goodwill. The assets of A H Roy & Associates could not be taken into consideration in evaluating the goodwill.

In his view, this decision was justified by. the fact that no stable organization existed. Nemo dat quod non habet, “no one can give what he does not have”. A third party would not have paid for the goodwill of this “one-man show” type of business.

(15) Donald L Neuls v MNR, [1975] CTC 2215; 75 DTC 170, Tax Review Board, by K A Flanigan, Chairman.

The appellant began as a carpenter’s apprentice in 1958 and worked for various construction companies until 1967, when he began working for himself by securing a contract to build a church. He continued to run his own business until 1970, increasing the number of his employees from two in the spring of 1967 to twenty. He did construction work for Shell and for Imperial Oil. On January 1, 1971, a company called Neuls Construction Limited was formed, and the appellant sold his business to it. An entry of $24,000 appears on the books as goodwill. When this sum was paid, the Department of National Revenue regarded it as an advantage conferred on a shareholder under subsection 15(1) of the new Act. The figure of $24,000 had been arrived at as follows:

Multiplied by factors of three and four, this excess profit gives an average of $30,000 for goodwill.

On the advice of his advisers, the appellant reduced this amount to $24,000, which was considered more normal.

Decision

Taking into consideration the organization of the business before the incorporation, which on a three-year basis gave an equity of $8,000 per year according to the figures submitted, Mr Flanigan concluded that goodwill did exist.

In calculating the amount, he took into consideration the fact that the appellant was living in a company house, and that a fair average salary for the appellant would be $12,000 rather than $7,200. Subtracting this salary plus taxes from the average net income of $19,800 gave approximately $5,000, according to the Member of the Board. Because of the nature of the business, he felt that a factor of two was a fair multiplier and arrived at a figure of $10,000.

(16) Jacques Lecompte, Philip A McNeely v MNR, [1976] CTC 2127; 76 DTC 1104, Tax Review Board, by A W Prociuk, Member of the Board.

The appellants were civil engineers who had formed a company and run a business providing professional services in Rockland, Ontario since 1966. At first, they had one full-time and three or four part-time employees; in 1967, four full-time and four part-time employees; and in 1968, nine full-time employees. Eighty per cent of the business’ clients were governments and para-governmental agencies, and this clientele had been built up by means of a great deal of promotion and work well done. At the end of 1968, they had contracts in hand capable of producing fees of $200,000 spread over three years. McNeely, Lecompte & Associates Limited was then incorporated, with the appellants as principal shareholders. The business was sold to the company for $76,477, including $50,000 for goodwill. The latter figure was calculated as follows: for two years the two partners had spent twenty-five hours per week promoting the business. At $5 an hour this comes to $26,000, to which was added $5,000 spent for promotional purposes and $20,000, or 10% of the $200,000 in fees from current contracts, for a total of $51,000.

According to the Department of National Revenue’s witness, the figure of $20,000 accepted by the Department was reasonable in view of the fact that professional services were involved. In its assessment, the Department had accepted $20,000 as goodwill. The appellants appealed to obtain more.

Decision

Mr Prociuk found the appellants’ figures to be exaggerated and concluded that they should be happy that the Department had accepted $20,000. He held that the Department had in fact been “more than generous”, and dismissed the appeal.

7. Comments

7.1 In view of these precedents and of the principles stated in paragraph 6.3, the Board must determine whether, in the case at bar, the appellant’s business had any personal goodwill, goodwill of location or product, or general business goodwill. The Board must first decide whether to accept or reject the documents filed by the respondent and described in paragraph 5.1.

7.2 The Board accepts the reasons given by the appellant in his objection: the authors of the letters containing the opinions cannot be cross-examined so that they may explain or give the reasons for their decisions. The Board therefore refuses to take into consideration the contents of these letters, which form part of the report made by the respondent’s appraiser, referred to in paragraph 5.1.

7.3 Personal goodwill is goodwill that has its source and cause in an individual, without whom the business would lose a large part, if not all, of its intangible assets. One of the basic principles concerning intangible assets is that they must be lasting, stable and durable. Goodwill that springs from an individual cannot have this quality of permanence. In short, it is incorrect to speak of “personal goodwill” since it does not possess one of the qualities necessary to make it “goodwill” in the first place. At least, it lacks a quality necessary to make it a commercial or transferable goodwill. And, as Thorson P said in Losey, cited above: one thing that is clear is ‘‘that the sale of the goodwill of a business does not carry with it a right to the per- sonal services or the business ability of the former proprietor of the business”.

In the case at bar the Board feels that the majority of the appellant's goodwill is personal. The appellant’s principal witness stated that the goodwill was attached to Mr Couture as an individual. He was the one who was acquainted with the suppliers and the wholesalers, and he was the only one who had a personal relationship with them. A second witness for the appellant, Mr Fried, said that he would even have paid the appellant $15,000 for goodwill, but only on the condition that the appellant became his partner. In short, what interested Mr Fried was the appellant himself, because he knew that without him he would in fact have to start over again almost from scratch.

7.4 The Board dismisses any possibility of goodwill of location. As for goodwill stemming from the product being sold, the evidence did not show that such goodwill existed for any particular product, although the evidence in general showed that the products involved were made by reputable manufacturers. Even if this was the case, however, should not this goodwill go to benefit the manufacturer? In principle, yes. In practice, however, if the manufacturer is contractually bound to an agent, does not the good reputation of a product also benefit the agent’s business?—and if the agent is entitled to transfer his contract to another party, does not the goodwill of the product form part of the general goodwill of the business?—and can it not be assigned a dollars-and-cents value if the agent decides to sell the agency to a third party?

The Board replies in the affirmative to all of these questions. In the case at bar, however, the agency contracts between the manufacturers and the appellant were not transferable to a third party. The supplying manufacturers signed new contracts with G H Couture Inc.

May the fact that the supplying manufacturers agreed to sign contracts with G H Couture Inc be regarded as indicating the existence of goodwill in favour of the appellant’s previously existing business? If so, it must be regarded as part of the general business goodwill which is considered below.

7.5 If Mr Couture had died at the beginning of February 1969, would the organization then existing, that is the contracts with manufacturers, have contained a source of general business goodwill?

The organization of the business was limited to the appellant himself, since he had neither secretary nor salespeople. Even though he made use of the professional services of an accountant to prepare his tax returns and financial statements, this accountant could not be said to be part of the immediate organization of a confectionery agent’s business.

The Board must therefore conclude that there was no source whatever of goodwill in the organization of the business.

With regard to the contracts signed by the new company with the Suppliers and dated February 1, 1969, the respondent admitted that these contracts did not have to be rejected because of the theory of hindsight. This theory, which has been applied in a number of judicial decisions, (Ho/t v IRC, [1953] 2 All ER 1499; Estate of Doris Kathleen Chipman Taylor v MNR, [1967] Tax ABC 555; 67 DTC 405) and disregarded in a number of others, Nelson Adair v MNR, 29 Tax ABC 324; 62 DTC 356; W H Crandall v MNR, [1974] CTC 2289; 74 DTC 1204; J R Thomas v MNR, 75 DTC 37, consists in not allowing factors subsequent to the date on which shares were evaluated to be taken into account in determining the value of the shares, and in not allowing factors subsequent to the date on which goodwill was evaluated to be taken into account in determining whether such goodwill existed and if so what it was worth. In the case at bar the Board is bound by this evidence, which is to the effect that the contracts (dated February 2, 1969, the date on which the company was incorporated, and involving G H Couture Inc and the various candy manufacturers) may be examined in order to find out whether or not they constitute assets that may be used in deciding whether or not there was any goodwill attached to the appellant’s business, and if so what it was worth.

These agency contracts undoubtedly constitute important assets for the new company, which would have had no reason to exist without them. It must be realized, however, that the agency contract was not between the appellant and G H Couture Inc, but between the supplying manufacturers and G H Couture Inc. If the company had received its agent’s commission from the appellant himself, there is no doubt, in the Board’s view, that this factor would have revealed a source of goodwill for the business that was sold. We know, however, that the contract between the appellant and the supplying manufacturers was not transferable. Only the supplying manufacturers, therefore, could give an agency contract to G H Couture Inc.

At this point the question posed at the end of paragraph 7.4 must once again be examined. Should the fact that the supplying manufacturers agreed to have G H Couture as their agent be seen as indicating goodwill in favour of the appellant’s previously existing business?

In order to answer this question it would be necessary to know whether the contracts would have been signed with G H Couture Inc even if the appellant had not been the principal shareholder in the company. A negative reply to this question would mean that there was no transferable goodwill in the appellant’s previously existing business.

An affirmative reply would mean that there was goodwill in the taxpayer’s previously existing business.

What might have led the supplying manufacturers to give the agency to G H Couture Inc if Mr Couture had not been there?—his organiza- tion or his qualified personnel. The evidence, however, is known to indicate that, on the contrary, there was no organization.

Approaching the problem in another way, as it was stated at the beginning of paragraph 7.5, we may ask whether the company could actually have replaced the appellant if he had died at the beginning of February 1969. Could he have been replaced by someone in the company? There was no one. By someone outside the company? If that person had possessed the appellant’s personality as well as his contacts, acquaintances and business sense, the company could no doubt have continued to run the business. Would this person not have demanded the great majority of the company’s shares, however? Otherwise, he would have made his own contacts with the supplying manufacturers and taken over the whole operation by means of new agency contracts; and unless that person had had Mr Couture’s personality, the whole process would have had to begin again from the beginning. This is the opinion of the Board.

All of this shows once again the extent to which Mr Couture himself was the only source of goodwill, the cause of the business’s excess profits.

Must the Board apply the principles put forward in W H Crandall v MNR, which was cited mainly by learned counsel for the appellant?

There is a fundamental difference between the case at bar and W H Crandall. In the latter case there was in fact an organization including two qualified persons: one had an MSc degree in sanitary engineering and the other, who had been working with Mr Crandall for ten years, was finishing his studies in engineering. Mr Crandall himself was an engineer. This fact was unquestionably a source of transferable goodwill.

In the case at bar, the Board can find nothing to indicate the existence of commercial, and therefore transferable, goodwill.

8. Conclusion

The appeal is dismissed.

Appeal dismissed.