The Queen v. Sunstrum, 78 DTC 6300, [1978] CTC 421 (FCTD)

Smith, DJ:—The issue in this case is whether $19,000 expended by the defendant and his partner, J I Kjeldsli, was a deductible expenditure as claimed by the defendant, in his income tax return for the year 1969, made for the purpose of earning income, or was an expenditure on account of capital and therefore not deductible. As always in such cases the solution is to be derived from the facts and the surrounding circumstances. It is thus desirable to set out the facts in some detail.

At all times relevant to this matter the defendant was a lawyer practising his profession at Kindersley, Saskatchewan, and other smaller centres in the Kindersley area. Kjeldsli carried on a real estate business, insurance agency and income tax consulting business at Eatonia, a smaller centre some twenty-seven miles southwest of Kindersley. This business was carried on under the name of Dawn Realty. A few of Kjeldsli’s clients were located in or near Kindersley and by arrangement with the defendant, Kjeldsli sometimes used part of the defendant’s office to conduct some of his business.

In Kindersley there was also an incorporated company, T & T Agencies Ltd, owned and operated by Mr Harlen Thompson, which carried on several kinds of business, including real estate, insurance, tax consulting, sale of automobile licenses and travel agency.

In the summer of 1969 Thompson approached Kjeldsli, offering to sell to him all the business of T & T Agencies Ltd. Kjeldsli consulted the defendant. They did not wish to purchase the whole of the business, but were interested in the insurance and tax consultant parts of it. Kjeldsli stated (Transcript p 13) that he was not interested in the travel or motor license plates parts of the business. Negotiations were carried on over a period of months between Kjeldsli and Thompson, the defendant being present at only one meeting where Thompson was present. Finally an agreement in writing, dated the 31st day of October, 1969 (Exhibit 2 at the trial) was entered into between T & T Agencies Ltd as vendor and Kjeldsli as purchaser. By its terms the agreement states:

Now therefore it is agreed between the parties hereto that the Vendor shall sell and the Purchaser shall purchase the list of customers with whom the Vendor has done Insurance business during the past and the list of Policy renewal date [sic] for a total purchase price of $17,000 and the Vendor shall self and the Purchaser shall purchase the list of customers with whom the Vendor has done Income Tax Consulting work during the past for the sum of $2,000.

The balance of the written agreement set out the terms of payment of the total purchase price of $19,000.

At the same time, by what the defendant spoke of as a second agreement, Kjeldsli purchased from T & T Agencies. Ltd, certain office furniture and furnishings for $1,000. The total amount to be paid to T & T Agencies Ltd, was thus $20,000. Whether this second agreement was in writing is uncertain. No copy of it was produced in evidence.

Kjeldsli and the defendant entered into partnership as equal partners under the name of Dawn Realty (the name under which Kjeldsli had previously conducted his own business). The new partnership was to carry on the business of selling insurance and income tax consulting, using inter alia the said lists. The defendant paid one half, ($10,000 of the total purchase price.)

In his income tax return for the taxation year 1969 the defendant claimed a deduction of $19,000, the whole amount paid under the agreement, Exhibit 2. The Minister disallowed the deduction and reassessed the defendant accordingly. In re-assessing the defendant the Minister assumed, inter alia:

(a) That the defendant and Kjeldsli, in entering into the agreement of October 31, 1969, with T & T Agencies Ltd, purchased the property insurance and income tax consulting business of T & T Agencies Ltd, as a going concern.

(b) That the memorandum of October 31, 1969, contains only a portion of the agreement reached between T & T Agencies Ltd, and Kjeldsli and the defendant.

(c) That of the total consideration of $20,000 paid for the above business, $19,000 was a payment on account of capital, being a payment for the goodwill.

The defendant objected to the Minister’s re-assessment and appealed to the Tax Review Board. By judgment dated February 11, 1976 the Board allowed the appeal, holding that the $19,000 was inventory and a deductible expense to the partnership. He referred the matter back to the Minister for re-assessment, the defendant being entitled to deduct his portion of the $19,000.

The plaintiff brings this action as an appeal from the judgment of the Board to this Court, where it is heard as a trial de novo.

At the opening of the trial counsel for both parties agreed that no new witnesses were being called and no new exhibits filed, and that if the witnesses heard by the Board were called for examination at this trial, counsel were satisfied their evidence would be the same as that given before the Board. Counsel expressed their consent that no witnesses be called and that the transcript of the evidence before the Board and the exhibits filed there be filed as exhibits in this trial. This was done.

Counsel for the plaintiff submitted that the agreement of October 31, 1969 was only a portion of the whole agreement between the parties. For the defendant it was submitted that the agreement speaks for itself. However, on its face it appears to be incomplete in some respects. In the first place it speaks only about lists of customers and policy renewal dates, and says nothing about turning over copies of the customers’ insurance policies or customers’ files, both of which would be important to the purchaser in seeking to make effective use of the lists to gain renewals of policies and new business. The policies and files were, in fact, turned over to the purchaser. Secondly the agreement says nothing about the vendor competing with the purchaser, let alone containing a covenant not to compete within a certain distance for a certain length of time. Whether the agreement was only for the purchase of lists of customers’ names, as contended by the defendant, or was for the purchase of the insurance and income tax portions of T & T Agencies Ltd’s business, as contended by the plaintiff, one would expect to find some provision of this kind in the agreement as a protection to the purchaser. In fact Kjeldsli stated (Transcript p 36) that he had not thought of it when Exhibit 2 was being made, but that afterwards he asked Thompson about it and Thompson said he would refrain from selling insurance and income tax services within a distance of 50 miles, apparently for 5 years. Kjeldsli did state (Transcript pp 36 to 38) that he found out a little later that Thompson was continuing to deal with a few customers, both insurance and income tax. This does not affect the fact that he had Stated he would not do so. Even if we assume, as contended by the defendant that it was a gratuitous promise, not a part of the real agreement, it does indicate that it was something he might properly be expected to do. There is nothing in the evidence to indicate whether Kjeldsli or the defendant either objected or agreed to Thompson or T & T Agencies Ltd retaining a few customers in each category, though the agreement appears to cover all customers.

Another matter about which it would normally be expected something would be said in the agreement is whether the Vendor would advise his customers that Dawn Realty (or alternatively Kjeldsli and the defendant) were taking over their insurance policies or tax consulting files. The agreement is silent on this point also. Kjeldsli was cross-examined about it. See p 38 of Transcript:

Q I understand as well that after this transaction took place that Mr Thompson wrote to each one of these clients advising them of the transaction and advising that the Dawn Realty would be taking over the business. Is that fair?

A Yes. I believe he wrote before advising them.

And p 39:

Q Do you recall what he said?

A To the effect that he was to—his customers were to come and see me for any future income tax returns to file and if they required any insurance or renewals or additional insurance.

Well, he said that—something to that effect—that I was going to acquire his list of customers, or not list but he was going to—I was supposed to service them anyway.

The Chairman: That you would be doing business with his customers as of a certain date. Wouldn’t that be it?

A Yes.

(Mr Hynes): Q Now, I take it as well that this would be a very important thing for you to have Mr Thompson write this letter. Is that fair?

A Yes.

From the evidence it appears that Thompson wrote some 800 letters to clients and customers to the effect stated in the foregoing extracts.

Still another matter which one might expect to find mentioned in the agreement, but about which it was silent, is insurance agency rights. Kjeldsli was cross-examined about this also. See p 41 of Transcript:

Q . . . I understand as well that Mr Thompson made arrangements necessary with the companies that he wrote business for to transfer that business to you and allow you to be the agent. Is that fair?

A That’s normal, yes.

Kjeldsli admitted that Mr Thompson had a much broader range of companies to write business for than he had. Particularly Kjeldsli did not act for the Saskatchewan Government Insurance Office (SGIO). Of this organization he said (Transcript p 42):

A Well, SGIO is the biggest and that’s the one that—the one company I wanted to sell for, yes.

He then said Mr Thompson made arrangements with SGIO to have him pick up his agency business for SGIO, and that he, Kjeldsli, had to file the agreement (Exhibit 2) with SGIO before he could get that business; also that without that agreement he would not expect to get the SGIO agency for Kindersley.

The evidence of the defendant’s witnesses, viz: Kjeldsli and Sunstrum himself, to the effect that all they sought and all they obtained were lists of the customers of T & T Agencies Ltd, was not weakened directly by cross-examination. On the other hand I have difficulty in accepting as the full story that Thompson did all the things described above, all of which were for the benefit of the purchaser, but none of which were required of him by the agreement. Why would he perform such services, unless there was an understanding that he would do so. Writing some 800 letters to customers and taking steps to assist the purchaser to obtain agency licenses from five or six insurance companies are much more than casual matters. All the foregoing actions taken by the Vendor to assist the purchaser are things that are commonly found in agreements for the sale of a business as a going concern. They are inserted to insure, so far as possible, that the purchaser will get the goodwill of the business that is being sold to him.

In the circumstances of this case I am of the opinion that Thompson did everything he could reasonably be asked or expected to do to assist the purchaser to secure and hold the insurance and income tax consulting business of the persons whose names were contained in the lists. Sunstrum was asked (p 67 of Transcript) if he could think of anything else that Thompson could possibly have done. He replied (see top of page 68):

Well, we could have got his telephone number, if that had some—if that had been something that we were interested in. We could possibly have got the trade name which we didn’t get and didn’t want..

From this answer I assume that not only did the purchaser not want these things but did not ask for them. In any event, I consider it would not have been reasonable to ask Thompson for them, since the vendor was retaining his real estate and automobile license business and also his travel business. Kjeldsli stated (p 29 of Transcript) that the vendor did a lot of travel business. Under these circumstances the vendor would certainly need his telephone number and trade name and would likely insist on keeping them.

It was submitted by counsel for the defendant that the purchaser did not, by the purchase of the lists, obtain any enduring asset or advantage. I do not agree. On cross-examination Kjeldsli agreed (p 34 of Transcript) that the purchase price of $19,000 was determined on the basis of a multiple of the gross commissions for one year. He did not remember what the multiple was but said the price was greater than the gross commissions for one year. Obviously the costs of doing business would reduce the net profit to a level considerably below the amount of the gross commissions. In addition it was a practical certainty that Dawn Realty would not be able to secure renewals of all the policies or of all income tax consulting fees. As things turned out Dawn retained about 75% of both categories of business. It is therefore clear that Dawn would need several years to recoup the price paid and begin to show a profit overall on the deal. Clearly the lists were intended to be an asset which would give the purchaser an advantage in securing business over a period of years. The purchase was intended to enable him to and did enable him to obtain an immediate expansion of his business. Counsel for the defendant contended that there was no real advantage and that the retained business was only secured by dint of much hard work on the part of the purchaser. In view of all the help given by the vendor I cannot agree with this submission. In any event the purchaser of a business, as of a list of customers, always has to work to secure as much as possible of the trade he has purchased. Otherwise he will lose more of that trade than need be the case.

A considerable volume of jurisprudence has developed on the subject of determining when an expenditure is truly an expense incurred for the purpose of gaining income, from property or a business of the taxpayer, within the meaning of paragraph 12(1)(a) of the Income Tax Act, or is properly to be regarded as an outlay or payment on account of capital, within the meaning of paragraph 12(1)(b) of that Act.

I refer first to British Insulated and Helsby Cables Ltd v Atherton, [1926] AC 205, where Viscount Cave, at p 213, gave expression to what has often been called the classic test on this issue:

. . . But when an expenditure is made, not only once for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

This statement of Lord Cave must not be regarded as a hard and fast rule, but only as a general principle, as is in fact indicated in the statement. Forty years later, Lord Pearce commented, in BP Australia Limited v Commissioner of Taxation of the Commonwealth of Australia, [1966] AC 224, at 264, on this general principle:

Those words are useful as an expression of general principle on prima facie indications, but the benefit in the particular case was the foundation of a fund that would endure for the whole life of the company and provides no analogy to the present case.

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree.

Lord Pearce then quoted a few lines for the judgment of Dixon, J in Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946), 72 CLR 634, at 648:

That answer:

“depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.”

All of the above cases were referred to and the above passages quoted by Urie, J in the Federal Court of Appeal, in Cumberland Investments Limited v The Queen, [1975] CTC 439; 75 DTC 5309, his judgment being concurred in by MacKay, DJ. The appellant company in that case was a supervising general insurance agent, all of its business being handled through local agents or sub-agents. The appellant entered into an agreement with one of its smaller competitors, which was also a general agent, whereby the appellant purchased for $150,000 a list of the smaller company’s sub-agents, a card-index system showing the names of all its policy holders and its covenant not to compete against the appellant in the future. In the Trial Division of the Federal Court it was held that the expenditure was a capital outlay and not a deductible expense. The appeal of the appellant was dismissed unanimously.

In the course of his judgment, in addition to the cases already mentioned herein, Urie, J quoted from another judgment of Dixon, J in Sun Newspapers Ltd v Federal Commissioner of Taxation, (1938) 61 CLR 337, where Dixon J discussed the nature of certain sums spent in buying up the competition of a rival, and said at p 363:

three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it: that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

Urie, J said, at p 5313 of the Cumberland appeal report:

In my view, the key to ascertaining the nature of the expenditure in this instance lies in the knowledge that the appellant through its acquisition enlarged its potential income earning structure by about 10%. To turn this potential into actuality required the further expenditures necessary to ensure that the sub-agents whose names were acquired would do business with the appellant. The latter undoubtedly would be outlays made for the purpose of earning income from the enlarged income earning structure and thus deductible in calculating the appellant’s taxable income. Viewed in this way it is quite apparent the acquisition was a capital asset capable of increasing the appellant’s income and the respondent was, therefore, correct in disallowing the deduction pursuant to paragraph 12(1)(b) of the Act.

In my opinion what is stated in the paragraph just quoted may be applied with equal force to the situation in the present case, which is remarkably similar to that in the Cumberland case. True, there is no formal restrictive covenant in the present case, a point already dealt with in these Reasons. From a realistic point of view the purchase in this case contained an element of goodwill and must be attributed to capital. Even if it was not strictly a purchase of goodwill it would still be attributable to capital, for the following reasons, among others:

1 The purchase was a single one for all expenditure.

2 It enlarged the income earning structure of the defendant and Kjeldsli, by giving them access, under favourable conditions, to a substantial number of insurance policy holders with whom the respondent had not. previously done business. The same applies to the list of income tax customers.

3 The actions of the vendor following execution of the agreement of October 31, 1969, coupled with his verbal promise not to compete, indicate that the vendor would cease to be a competitor of the purchaser.

4 The acquisition of the lists conferred a lasting business advantage upon the purchaser.

I have read the judgments in all the cases cited by counsel for the defendant. The first of these, Murray v City of Saskatoon, [1951] 4 WWR 234 was not concerned with any of the issues in this case, being related only to the question whether Thompson, the vendor of the lists, should have been called by one of the parties as a witness. He was not called and the trial proceeded without evidence from him.

The second case was Williams Brothers Canada Limited v MNR, [1962] Ex CR 375; [1962] CTC 448; 62 DTC 1276. In that case a company, incorporated for the purpose of obtaining and carrying out contracts for the construction of pipelines, purchased from another company the interest which that other company had acquired in a joint venture contract to construct a pipeline. It also purchased from the same company some equipment, but the amount paid for the interest in the construction work was $230,000. The company claimed a deduction of this sum from income. The Minister disallowed the claim. Cattanach, J in the Exchequer Court allowed the appeal. He held that the $230,000 was laid out for the purpose of earning income within the meaning of paragraph 12(1 )(a) of the Income Tax Act, since a pipeline contractor, in order to earn a profit must first acquire construction contracts before it could earn any profits by performing the contract work. He held also that no asset or advantage of an enduring nature was acquired by the purchase and that such an acquisition by a construction company was not the acquisition of a capital asset, because the company was in the business of acquiring such interests in construction contracts.

In my view this case is clearly distinguishable from the present case, where, as we have seen, an enduring advantage was acquired by the defendant and where the defendant was not “in the business” of acquiring the business of other agencies.

The third case cited was Walter J Burian et al v The Queen, [1976] CTC 725; 76 DTC 6444. This case was also cited by counsel for the plaintiff and in my view is favourable to the plaintiff. A firm of accountants, whose members became the plaintiffs before the Court, purchased the interest of one of two partners in another firm of accountants, the other partner then becoming a partner in the purchasing firm. Of the purchase price, $20,000 was paid at the time of execution of the agreement of sale. The purchasing partners each claimed, in his income tax return, a deduction of his share of the $20,000. The claims were disallowed, and the appeals to this Court were dismissed. Collier, J said, at page 730 [6447-8]:

In my opinion, when one views the “practical and commercial” aspects of this purchase, the plaintiffs were in reality acquiring, or endeavoring to acquire, an opportunity for potential future custom or business. . . . The purpose, to my mind, was to bring into the existing a further asset or advantage with the expectation of lasting benefit. The transaction, as I view it, was to strengthen and expand the plaintiffs’ business entity, the profit yielding subject. It therefore affected the capital structure and the expenditure of $20,000 was rightly treated as an outlay of capital.

The words quoted from Collier, J’s judgment can be applied in toto to the present case.

The fourth case cited by the defendant’s counsel was The Queen v Baine, Johnstone & Company Limited, [1977] CTC 556; 77 DTC 5394. This case also was cited by counsel for the plaintiff, and in my opinion, is favourable to the plaintiff. In this case the defendant, an insurance agency company, purchased from another insurance agency an insurance portfolio of 1718 client files for $75,000, and from a firm of solicitors an insurance portfolio of 870 client files for $53,000. The defendant deducted the purchase price of both from its income as shown on its income tax return. The Minister disallowed the deduction on the basis that the amounts paid included an amount for the goodwill of the two businesses and therefore constituted a capital expenditure since the taxpayer had received an enduring benefit. The defendant appealed successfully to the Tax Review Board, and the Minister further appealed to this Court. Addy, J allowed the appeal, on the following grounds, as summarized in the headnote:

The taxpayer failed to discharge the onus upon it of establishing that the expenditure, in either transaction, did not include amounts for the purchase of assets and advantages which were an enduring benefit to its insurance business. The mere fact that the taxpayer was required to provide services on the files which were purchased before they could generate income, did not in itself indicate that the purchase was not capital in nature. The taxpayer had eliminated two competitors. . ..

In my view the grounds given by Addy, J as stated above, can also be applied to the present case.

Two Other cases were cited by counsel for the defendant. They are: Francis David Moyls v MNR (1966), 41 Tax ABC 411; 66 DTC 553 and Harbord Investments Limited v MNR, [1970] Tax ABC 717; 70 DTC 1488.

Both of these are decisions of the Tax Appeal Board. As such they are not binding on this Court. Both were cases involving the sale of lists of insurance policy holders and some supporting material. In both cases the Board found on the facts that nothing but lists of policy holders had been purchased. In the Moyls’ case the Board also found that the purchaser (Moyls) did not obtain any enduring benefit or advantage. In both cases it was held that the cost of the lists was a deductible business expense. The findings of fact in the two cases differ significantly from those in the present cases.

I agree with the “general principles” and “guidelines” enunciated and described by judges in the highest appellate tribunals in England and in both the Exchequer Court of Canada and the Federal Court of Canada, both Trial division and Court of Appeal, as quoted earlier in these Reasons. Although the present case lies close to the borderline, when I relate the facts and Reasons for Judgment in the cases in those Courts that have been quoted above to the facts and circumstances of this case, I come to the firm conclusion that the plaintiff is entitled to succeed on this appeal. The appeal is allowed. The assessment of the Minister is restored. The plaintiff is entitled to costs on the basis of a Class 1 action, the amount of tax in dispute being less than $5,000.