28 July 1997 External T.I. 9711425 - GOODWILL WRITE-OFF

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

								971142
XXXXXXXXXX										B. Kerr

Attention: XXXXXXXXXX

July 28, 1997

Dear Sirs:

Re: Goodwill Write-Off

This is in response to your letter of April 11, 1997, requesting our views on the premature write-off of goodwill in a sole proprietorship.

The situation described in your letter involves the purchase by a lawyer of another lawyer's law practice in 1989. The sale agreement provided for the transfer of active files and client lists, including all open, unfinished claims, cases and files forming part of the law practice and all goodwill. It was also agreed that the vendor would be entitled to a percentage of the fees received from new clients introduced to the purchaser within two years. The sale agreement provided that an amount of $115,000 was for goodwill. In 1993, the taxpayer concluded that the goodwill was worthless since the expected referrals never materialized. You have requested our views on whether the undeducted balance of the amount paid for the goodwill could be written off in 1993.

Our Comments

Many expenditures commonly called "nothings" of which the cost of goodwill is the most notable are given special treatment under the Income Tax Act (the "Act") as "eligible capital expenditures".

As stated in paragraphs 5 and 6 of Interpretation Bulletin IT-143R2, entitled "Meaning of Eligible Capital Expenditure", the courts have referred to several definitions of goodwill, two of which are:

(a) "Goodwill 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 expenditures of money."

(b) It is "the privilege, granted by the seller of a business to the purchaser, of trading as his recognized successor; the possession of a ready-formed "connection" 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."

Goodwill cannot be divorced from the business itself. It follows the business, and may be sold with the business, but it cannot be sold separately. Generally, goodwill arises as a recognizable asset only when a business is acquired at a price in excess of the value, as a going concern, of its net assets.

As stated in paragraphs 1 and 2 of Interpretation Bulletin IT-187, entitled "Customer Lists and Ledger Accounts", a taxpayer who acquires lists or ledger accounts of clients must determine whether the cost of acquisition is a capital expenditure or a deductible expense of the year. This must be done on the basis of general income tax law, having regard to the principles established by the courts and to the provisions of the agreement to acquire the lists or accounts. Where the taxpayer, in fact, acquires the business of the vendor as a going concern rather than just a list of customers, the amount of the purchase price attributable to the list is regarded as a capital outlay to acquire an enduring benefit. As stated in paragraph 8 of IT-143R2, the cost of a list bringing enduring benefit to the business of the purchaser is an eligible capital expenditure.

In our view, the amount of $115,000 was in fact expended on account of capital and, by virtue of paragraph 18(1)(b) of the Act, is not deductible in computing income. However, the amount expended would qualify as an eligible capital expenditure and 75% of that amount could be included in computing the taxpayer's "cumulative eligible capital", as defined in subsection 14(5) of the Act. Therefore, by virtue of paragraph 20(1)(b) of the Act, in computing income for a particular taxation year, the taxpayer may claim an amount not exceeding 7% of the cumulative eligible capital in respect of the business at the end of the particular year.

Although, subsection 24(1) of the Act allows a taxpayer to deduct the entire balance of cumulative eligible capital in computing income for a particular taxation year, this provision only applies where, a taxpayer has ceased to carry on a business and no longer owns any eligible capital property in respect of the business. In the situation you describe, the taxpayer has not ceased to carry on the business, nor has he disposed of that business. Therefore subsection 24(1) of the Act would not apply.

Accordingly, in our view, the taxpayer's claim for the 1993 taxation year would be limited to 7% of the taxpayer's cumulative eligible capital at the end of that year.

We trust that these comments will be of assistance.

Yours truly,

C. Chouinard
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch