Richstone v. MNR, 72 DTC 6232, [1972] CTC 265 (FCTD), briefly aff'd 74 DTC 6129 (FCA)

Collier, J:—This is an appeal from the Tax Appeal Board, reported [1969] Tax ABC 928. There is another appeal from the Board by Harry Richstone, a brother of the present appellant. Harry Richstone died during the intervening period, but by agreement these appeals were heard together because the facts and issues are the same. It was also agreed the evidence before this Court would be the transcript of the oral testimony given before the Board and the documents filed as exhibits at that hearing.

The respondent reassessed the appellants for the years 1964 and 1965 by adding to their incomes for those years certain payments made to them by certain companies in which they once had an alleged interest. The question is whether these payments are caught by section 25 of the Income Tax Act, RSC 1952, c 148, as amended. That section reads as follows:

25. An amount received by one person from another,

(a) during a period while the payee was an officer of, or in the employment of, the payer, or

(b) on account or in lieu of payment of, or in satisfaction of, an obligation arising out of an agreement made by the payer with the payee immediately prior to, during or immediately after a period that the payee was an officer of, or in the employment of, the payer,

shall be deemed, for the purpose of section 5, to be remuneration for the payee’s services rendered as an officer or during the period of employment, unless it is established that, irrespective of when the agreement, if any, under which the amount was received was made or the form or legal effect thereof, it cannot reasonably be regarded as having been received

(i) as consideration or partial consideration for accepting the office or entering into the contract of employment,

(ii) as remuneration or partial remuneration for services as an officer or under the contract of employment, or

(iii) in consideration or partial consideration for covenant with reference to what the officer or employee is, or is not, to do before or after the termination of the employment.

To be more precise, the issue turns on whether the payments received fall within subparagraph (iii).

The Tax Appeal Board confirmed the reassessments.

I adopt the statement of facts as set forth in the reasons for judgment of the Board, as reported at page 928 to the end of the first paragraph on page 940. It appears a somewhat different argument was advanced by the appellants in this Court from that put before the Board, and in order to make these reasons understandable, I find it necessary to summarize the essential facts.

For many years prior to 1963 the appellants Harry and Louis and their brothers Saul and George had been associated in a bakery business carried on in the city of Montreal under the name Richstone Bakeries Incorporated. The Richstone name and its products were well known. The bakery had originally been started by their father but on the incorporation in 1927 he discontinued his interest. The sons thereafter had equal interests.

Around 1950 serious disagreements arose among the brothers, the protagonists being George and to some extent Saul on one side, and Louis and Harry on the other. These disputes led to the ousting by George Richstone, through a voting trust agreement, of Louis as a director and officer of the company, and the termination of his employment. When Harry shortly afterwards attempted to intervene, the same fate befell him.

Complicated and bitter civil litigation by Louis and Harry ensued which was ultimately resolved in October of 1953 by an agreement which purported to restore Louis and Harry to their original positions in Richstone Bakeries Incorporated. In the agreement reference is also made to Richstone Realties Inc, Richstone Sales Inc and Richstone Corporation Ltd. I mention these other companies chiefly because of the use of the name Richstone in each one; the evidence indicates each brother held 204 shares in Richstone Bakeries Inc, 88 shares in Richstone Realties Inc, but Louis and Harry held no shares in the remaining two companies.

This agreement also set out the duties and salaries of the four brothers.

Harmony prevailed until 1956 when Louis and Harry took the position their promised restoration as directors and officers had not been carried out. The acrimony developed to the point that by 1958 the two groups of brothers ceased speaking to each other. Communications were channelled through the controller of the company. According to Louis, he and Harry were stripped of all their powers and neither did any actual work for the business thereafter.

Louis and Harry consulted lawyers and criminal proceedings were instituted against George in 1958, charging common law conspiracy. A preliminary inquiry was held but not completed. Attempts were made by their advisers to have the brothers somehow resolve their differences and finally on May 10, 1963, Louis and Harry sent to George the following offer:

We, the undersigned, LOUIS RICHSTONE and HARRY RICHSTONE, . . . offer to sell to you all our shares, rights, titles and interest in RICHSTONE BAKERIES INC, RICHSTONE REALTIES LTD, RICHSTONE CORPORATION LTD, and RICHSTONE SALES INC, for and in consideration of a total sale price of Three Hundred Thousand Dollars ($300,000.00), payable cash upon the execution of the necessary documents.

This offer is open and good for acceptance until the 7th day of June, 1963, at 5:00 PM, in default of which it shall lapse and become null and void by the mere efflux of time.

Louis did not feel the sum of $300,000 represented the true value of his and Harry’s 50% interest; he estimated the true value to be at least half a million dollars. He testified his brother Harry was quite ill: his own wife was sick and for her health reasons they were going to move from Montreal to the Maritimes; neither he nor Harry intended to go back into business. The object of the offer was in Louis’ view, to settle the whole matter, and get out.

George, on May 15, 1963, sent to his two brothers what was entitled an “Acceptance of Offer to Sell’. This document, which was really a counter-offer, had quite different terms and was refused by Louis and Harry. It provided for an immediate cash payment of $50,000 and a balance of $100,000 payable at $10,000 per year for 10 years for the shares and whatever other rights Louis and Harry had in the four Richstone companies. It further provided that Louis and Harry agree not to use the name “Richstone” in any form of bakery business in Quebec and Ontario for 25 years. The consideration for the latter agreements was to be an additional cash payment of $50,000 and a balance of $100,000 payable at $10,000 a year for 10 years.

As I have said, this counter-offer was refused.

On June 4, 1963, another “Acceptance of Offer to Sell” was tendered by George to his two brothers. As the Board said in its reasons for judgment, this is a crucial document in respect to its effect on the tax position of the parties. it reads as follows:

I, George G Richstone and/or my nominees (hereinafter called the Purchaser), do hereby accept your offer, dated May 10, 1963, to sell to me all your shares, rights, title and interest in Richstone Bakeries Inc and Richstone Realties Inc, and all your alleged rights, title and interest in Richstone Sales Inc, and Richstone Corporation Ltd (hereinafter called the Companies), the whole as therein contained and subject, moreover, to the following terms, clauses, Stipulations and conditions, namely:—

1. The purchase price for the above shares, rights, title and interest in all the said four (4) Companies, including all your rights, title and interest, if any, with respect to the five (5) Common shares of the capital stock of Richstone Bakeries Inc presently owned by and registered in the name of James Richstone, Bakery Executive, residing at 9532 Cresta Drive, Los Angeles, California, shall be the sum of ONE HUNDRED FIFTY THOUSAND DOLLARS ($150,000.00), payable in cash at the time of the signing of the Deed of Sale;

2. Your approval of the present Acceptance shall comprise the immediate termination of your employment with Richstone Bakeries Inc and of your employment, if any, with all the remaining Companies, without indemnity or the necessity of any further notice or writing whatsoever and ali your Salaries, remuneration and other benefits of any kind shall cease immediately upon the execution of the Deed of Sale and the payment of the aforesaid sum of ONE HUNDRED FIFTY THOUSAND DOLLARS ($150,000.00);

3. You shall undertake, in favour of the Purchaser and the Companies, jointly and severally, as follows:—

(a) Not to own, operate and/or engage in, directly or indirectly, the business of manufacturing, distributing and/or selling bread, rolls, cakes, pastry, confectionery, and/or all other bakery products, or a business of the same or similar nature as that carried on by any one of the said Companies (except Richstone Realties Inc) or any other business related or allied thereto, either as principal, director, shareholder, manager, agent or employee, during a period of Twenty-five (25) years within the territory comprising the Provinces of Quebec and Ontario; and,

(b) Furthermore, you shall not use or authorize the use of, directly or indirectly, the name “Richstone”, or variation thereof in appearance, sound or otherwise, or a word or words or representations similar thereto, as part of a trade or corporate name for the purpose of owning, operating and/or being engaged in any business whatsoever, in any of the capacities and during the same period of time and within the same territorial areas, the whole as stipulated herein before in subparagraph (a) of the present Clause 3;

4. In consideration for your undertaking contained in Clause 3 hereof, I warrant that the said Companies, jointly and severally, will pay you the additional sum of ONE HUNDRED FIFTY THOUSAND DOLLARS ($150,000.00), payable in and by TEN (10) equal, annual instalments of FIFTEEN THOUSAND DOLLARS ($15,000.00) each, the first whereof to become due and payable One (1) year after the signing of the Deed of Sale and the unpaid balance at any time to bear interest at the rate of SIX PERCENT (6%) per annum, payable semi-annually; however, the Companies will have the right to anticipate payment of the said sum of $150,000 by prepaying the whole or any part of the outstanding balance, at any given time and without indemnity, provided that each such prepayment shall never be less than FIVE THOUSAND DOLLARS $5,000.00);

The payment of the aforesaid sum of $150,000.00, or such balance thereof remaining unpaid at any time, shall be properly guaranteed either by a first hypothec on immoveable property to be executed before a notary chosen and paid for by the said Companies or by a surety bond issued by a recognized Bonding Company, whichever the Companies herein will elect;

5. In the event of your violation of any of the obligations contained in the Deed of Sale to be signed in consequence hereof, I and the said Companies, jointly and severally, shall be entitled to claim, as liquidated damages, the sum of ONE HUNDRED FIFTY THOUSAND DOLLARS ($150,000.00), and to demand forfeiture of any sums not yet paid in virtue of the said Deed of Sale, the whole without prejudice to the rights of myself and the Companies, jointly and severally, to institute injunction or other proceedings, with or without damages, to enforce the provisions violated;

6. All pending litigation, civil or criminal, shall be declared settled out of court concurrently with the signing of the Deed of Sale, all parties concerned paying their own legal costs;

7. In addition, a mutual and reciprocal release and discharge will be given by the interested parties, namely the Vendors, the Purchaser and the said Companies, for all claims, demands, rights of action, costs and expenses, arising directly or indirectly from your association with the said four (4) Companies and/or for any other cause or reason whatsoever;

8. You will sign all such documents as may be required or necessary in order to give full force and effect to the spirit and intent of the present Acceptance of Offer, either at the time of the Deed of Sale or subsequently when called upon so to do and, upon your failure to sign when requested, I or any person appointed by me will have express authority to sign such documents in your place and stead and with equal effect;

9. The Deed of Sale and all other legal documents for its completion shall be prepared by Mtre George I Harris, QC, and shall be signed by the parties hereto not later than July 9th, 1963, each party to pay his own legal costs throughout;

10. All your obligations herein, in the said Deed of Sale and all other documents relating thereto shall be joint and several and indivisible; the breach of such obligations by either one of you is to be construed as a breach by both of you and, consequently, such breach shall engage the responsibility of both, jointly and severally and indivisibly;

11. The rights and obligations arising from the document referred to in Clause 10 herein shall enure for the benefit of and be binding upon the respective heirs, legatees, executors, administrators, successors, and assigns of the parties hereto;

12. The present Acceptance of Offer to Sell is open for your approval not later than June 7th, 1963, at 5:00 o’clock pm after which time it shall be considered null and void and nonexistent.

Louis and Harry approved and signed this document on June 6, 1963.

In respect to the remaining facts in this case, I adopt the findings of the Board which are as follows:

Mr Louis Richstone testified that it had never been suggested to him that there was a difference beween the $300,000 consideration referred to by the two vendors in their original “Offer to Sell” of May 10, 1963, (Ex A-15) and the $300,000 which made up the total consideration in the “Acceptance of Offer to Sell” (Ex A-17) which was not only the final document, but also the only one agreed to and signed by all of the parties. The witness said:

“I was anxious to get out; as a matter of fact I was willing to settle for less, provided I could get cash, and get out, and forget about the whole thing because we were anxious to get away.”

The witness said he had seen the first document (Ex A-16) which George Richstone had submitted in respect of their original offer to sell (Ex A-15) and, although the said Exhibit A-16 had contained restrictive covenants which had not appeared in the initial offer (Ex A-15) and had allocated a separate amount of consideration to shares and rights and had ascribed another specific amount as consideration in respect of the restrictive covenants, he had considered it as nothing more than a matter of form for selling the shares and rights “because I only had one thing in mind—to sell our shares and get out”’.

The principal difference between the proposition contained in Exhibit A-16, which was never accepted by the appellants, and the proposals contained in Exhibit A-17 which were accepted by all the parties, consisted of the provisions for payment. In the proposal accepted, the entire consideration for the shares, etc, was to be paid in cash rather than only one-third in cash and the rest on terms; and the consideration for the restrictive covenants was to be paid in ten equal instalments of $15,000 each with interest at 6% per annum rather than one-third in cash with the balance spread over ten years in equal annual instalments of $10,000 each, suggested in the earlier proposal.

On June 6, 1963, following their approval of George Richstone’s acceptance of their offer to sell (Ex A-17), Louis Richstone and his brother Harry entered into an agreement between themselves (Ex A-20) which reads in part as follows:

“NOW THEREFORE THE PARTIES HERETO AGREE AS FOLLOWS:

1) The parties hereto shall share the purchase price arising out of the foregoing and be responsible for any liabilities arising out of the foregoing, such as legal fees, notarial fees, etc on the following basis:—

Louis Richstone	66-2/3%
Harry Richstone	33-1/3%

2) This agreement shall inure for the benefit of and be binding upon the respective heirs, legatees, executors, administrators, successors and assigns of the parties hereto.”

On June 28, 1963, the three Richstone brothers reduced their negotiations to a formal Notarial Deed of Sale passed before Notary Harry Kolber, in which Louis and Harry Richstone are referred to as the Vendors and George G Richstone as the Individual Purchaser, while Richstone Bakeries Inc, Richstone Sales Inc, and Richstone Corporation Ltd are referred to as the Company Purchasers and as being represented by their president, George G Richstone. This document sets out that the parties thereto have agreed, in part, as follows:

“FIRST: The Vendors do hereby sell . . . unto the Individual Purchaser . . . the following assets, namely:—

a) All the Vendors’ common and preferred shares in the capital stock of Richstone Bakeries Inc and Richstone Realties inc, and all their other rights, title and interest in and to both the said Companies;

b) All the Vendors’ alleged rights, title and interest in and to Richstone Sales Inc and Richstone Corporation Ltd;

c) All the Vendors’ rights, title and interest, if any, with respect to the FIVE (5) common shares in the capital stock of Richstone Bakeries Inc presently owned by and registered in the name of James Richstone . . .

SECOND: The consideration for the sale of the assets described ... is the total price and sum of ONE HUNDRED AND FIFTY THOUSAND DOLLARS . . . payable by the Individual Purchaser unto the Vendors in cash, which amount the Vendors do hereby acknowledge to have received in full at the execution of the present Saie . . . and which amount shall be distributed between the Vendors in the manner that they themselves shall determine;

THIRD: The Vendors do, in addition to the foregoing, sell, transfer, convey, make over and assign, unto the Individual Purchaser and the Company Purchasers, jointly and severally, the following assets, namely:—

a) All the Vendors’ rights, title and interest to own, operate and/or engage in, directly or indirectly, the business of manufacturing, distributing and/or selling bread, rolls, cakes, pastry, confectionery and/or other bakery products, or a business of the same or similar nature as that carried on by any one of the Company Purchasers (except Richstone Realties Inc) or any other business related or allied thereto, either as principal, director, shareholder, manager, agent or employee during the period of TWENTY-FIVE (25) years from the date hereof and terminating on the Twenty-Eighth day of June, Nineteen Hundred and

Eighty-Eight and within the territory comprising the Provinces of Quebec and Ontario; and,

b) All the Vendors’ rights, title and interest to use or authorize the use of, directly or indirectly, the name ‘Richstone’, or any variation thereof in appearance, sound or otherwise, or a word or words or representations similar thereto, as part of a trade or corporate name for the pur- pose of owning, operating and/or being engaged in any business whatsoever, either as principal, director, shareholder, manager, agent or employee during the period of TWENTY-FIVE (25) years from the date hereof and terminating on the Twenty-Eighth day of June, Nineteen Hundred and Eighty-Eight and within the territory comprising the Provinces of Quebec and Ontario;

FOURTH: The consideration for the sale of the assets, described in Clause Third (a) and Third (b) hereinabove, is the total price and sum of ONE HUNDRED AND FIFTY THOUSAND DOLLARS ($150,000.00), which the Individual Purchaser and the Company Purchasers oblige themselves, jointly and severally, to pay unto the Vendors, and which amount shall be distributed between the Vendors in the manner that they themselves shall determine, in and by TEN (10) equal, consecutive and annual instalments of FIFTEEN THOUSAND DOLLARS ($15,000.00) each, the first whereof to become due and payable ONE (1) year from the date hereof and to

continue annually thereafter until the 28th day of June, 1973 . .

The Deed is elaborate in its provisions and stipulates, among other things, for prepayment of the said instalments, the immediate transfer of title to assets sold, and a warranty as io title of the said assets. In Clause Seventh, there appears the following agreement:

“As further consideration for the price and sum provided in Clause Fourth herein, the Vendors do hereby expressly covenant and undertake, in favour of the Individual Purchaser and the Company Purchasers, jointly and severally:—

a) Not to own, operate and/or engage in, directly or indirectly, any of the businesses set out in the above Clause Third (a), in any of the capacities, during the period of time and within the territorial area, as more fully stipulated in the said Clause Third (a); and,

b) Not to use or authorize the use of, directly or indirectly, the name ‘Richstone’, as more fully defined and described in Clause Third (b) hereof, for the purposes, in the capacities, during the same period of time and within the same territorial area as stipulated in the said Clause Third (b).”

On the same day as the Notarial Deed was executed, and concurrently therewith, ie, on June 28th, 1963, Louis and Harry Richstone each signed and delivered to Richstone Bakeries Inc and the directors thereof a notice of resignation reading as follows:

“I hereby tender my resignation as Director and/or Officer of Richstone Bakeries Inc, to take effect immediately upon acceptance by the Board.”

Also produced and filed at the hearing were copies of transfers from Louis and Harry Richstone respectively to George G Richstone, each for 204 shares of common stock of Richstone Bakeries Inc. By way of date, these transfers bear only the year “1963” but the witness Louis Richstone said these transfers were also signed contemporaneously with the execution of the Notarial Deed and their respective resignations on June 28, 1963.

The first of the ten equal consecutive annual instalments of $15,000 to be made under the terms of the said Deed of Sale (Ex A-18) fell due and was paid on June 28, 1964, together with interest on the outstanding balance calculated at 6% per annum, and was not declared as income by either appellant.

Harry I Grossman, the comptroller as well as a director of Richstone Bakeries Inc, testified that Louis and Harry Richstone were on the bakery payroll until June 29, 1963, the date on which the last salary cheques were issued in their names and forwarded with a covering letter to their then solicitor, Murray Lappin, Esquire, QC.

George G Richstone appeared under subpoena as a witness for the respondent and gave evidence that for some time prior to the final settlement effected in 1963 there had been “an actual feud or a vendetta” between the two appellants and himself, both in business and socially. He added: “As a matter of fact, they left in 1963 and prior to that, five years prior to that, we were not even on speaking terms . . . although they were at that time directors and officers of the company plus shareholders and also employees.” All communications between the parties were carried on through the comptroller of the bakery company, who was a distant relative and had remained on speaking terms with both factions.

The witness George Richstone testified that, within the five years or more during which the criminal proceedings were pending, there had been a series of attempts to establish a basis of settlement between the parties. The consideration first demanded had been $600,000 which was finally reduced to $300,000 to be divided into $150,000 to be paid by the witness for the appellants’ shares and $150,000 to be paid by Richstone Bakeries Inc et al in respect of the restrictive covenants which had been inserted to prevent the appellants from establishing themselves in the bakery, pastry-making or confectionery business in competition with Richstone Bakeries Inc or using the name “Richstone” in connection with any business similar to any of those carried on by the bakery company and the other two subsidiaries. According to the witness they had attempted something of this nature in 1950 and 1951 when the earlier civil litigation was proceeding by cutting prices and using the name “Richstone” to compete with the business from which Louis had been ejected. George Richstone rejected any suggestion that the restrictive covenants were an afterthought which was unnecessary or that they were not made with any serious purpose in mind. In fact he insisted strongly to the contrary and said the payments to be made in respect thereof by the company purchasers were deliberately spread over a ten- year period with the intention of subjecting them to deduction as business expenses made to protect the income of the bakery business and have in fact been so claimed.

The respondent relies on clauses 3 and 4 of exhibit 17 and clauses fourth and seventh of exhibit 18, as well as the evidence of George Richstone that Louis and Harry, between 1950 and 1951, had been competitors and had used the Richstone name. Counsel for the respondent submits the payments in question fall squarely within paragraph 25(b) of the Aci, that is, these were amounts received “on account . . . of an obligation arising out of an agreement made by the payer with the payee . . . during or immediately after a period that the payee was an officer of, or in the employment of, the payee . . .”,

and further must reasonably be regarded as “. . . having been received . . . in consideration or partial consideration . . .” for the covenants not to compete.* [1]

The appellant, on the other hand, asserts that on the true construction of the material documents, particularly the notarial deed, the transaction in question was fundamentally a sale of assets: the shares and whatever other interests Louis and Harry had in the four companies, their rights to carry on a bakery business for 25 years, and their rights to the use of the name Richstone in any business (see clauses first, second, third and fourth of the notarial deed) for 25 years. I have no doubt that clauses first and second deal with a sale of assets. Clauses third and fourth describe the rights (to engage in bakery businesses and to the Richstone name) being sold as a sale of assets, and I am prepared to accept that description. If the notarial deed ended there, any payments received pursuant to clause fourth, in my opinion, could not be reasonably regarded as having been received in consideration for an agreement not to compete.

There remains the problem as to the meaning or effect of clause seventh having regard to subparagraph 25(b)(iii) of the Act. As I understood them, the appellant’s contentions were as follows:

(1) The covenant not to compete nor to use the name Richstone is a mere appendage to what is really a sale of assets.

(2) The total consideration of $300,000 could only refer to the sale of those assets because the value of the shares alone far exceeded that amount.

(3) The covenant not to compete is unenforceable in law and therefore must be disregarded.

(4) There was no intention on the part of Louis or Harry ever to go into business again, and from their side of the matter, no consideration or payments were received in respect to the covenant not to compete.

(5) There were five “payers” according to the notarial deed, and Louis and Harry were certainly never employees of four of them, and were not at the material times “employees” of Richstone Bakeries Inc.

I shall deal with these contentions in the order I have set them out.

(1) I cannot regard the covenant not to compete as a mere appendage. The evidence is uncontradicted that George Richstone stipulated for it because of the competition which, in fact, took place in 1950 and 1951. The covenant had value to him, and while Louis and Harry may have thought it valueless to them they nevertheless agreed to it. In my view the agreement reached covered more than a sale of assets. The notarial deed, by clause seventh, expressly supports this view.

(2) The evidence as to the value of the interest of Louis and Harry in Richstone Bakeries Inc and the other companies is, to my mind, unsatisfactory and it is impossible to come to any firm conclusion as to overall value. There is no doubt Louis felt the value of his and his brother’s interest far exceeded $300,000; on the other hand, George felt it was too much. The other evidence in respect to values is, as I have said, unsatisfactory.

(3) I will accept, without deciding, that the covenant not to compete would probably be held to be unenforceable if it were the subject of litigation in the Province of Quebec. That, however, does not solve the problem for the purposes of the section of the Income Tax Act in question. The covenant is a subsisting one: no one has yet challenged it and until that is done it is binding on the parties.

(4) I do not think the future intention of Louis and Harry not to enter business again is relevant. In my opinion, one cannot go behind the express words in clause seventh. To put the matter another way, I do not think it would be any defence by Louis if he violated this clause to say it was not binding on him because at the time he signed the agreement he had no intention to violate it.

(5) It is established that Louis and Harry were never employees of the other payers under the notarial deed, other than Richstone Bakeries Inc. In my view, the conclusion from the evidence is irresistible that Louis and Harry were employees (within section 25) of Richstone Bakeries Inc until the end of June 1963. They were paid up until the end of that month by that company. It is true they had not done any work for several years but they nevertheless had been paid as employees right up to the date I have just mentioned.

In my view, the decision of the Tax Appeal Board was correct as was the reassessment made by the respondent.

The appeal is therefore dismissed with costs.