Hugh & McKinnon LTD v. Minister of National Revenue, [1982] CTC 2419, 82 DTC 1425

John B Goetz:—This is an appeal by the appellant with respect to its assessments for the 1975 and 1976 taxation years whereby the appellant purchased a customer list from J T O’Bryan & Co (hereinafter referred to as “O’Bryan”), a partnership carrying on an insurance brokerage business in the Province of British Columbia. The respondent treated the expenditures of $19,012.15 for the 1975 taxation year, and $30,635.39 for the 1976 taxation year as “elgible capital expenditures”. The appellant, in filing its tax returns for the relevant years, treated these payments on account of the purchase of the customer list as being expenses incurred for the purpose of gaining and producing income from its business, and therefore claimed that they were deductible pursuant to paragraph 18(1)(a) of the Income Tax Act, SC 1970- 71-72, c 63, as amended.

In assessing the appellant, the respondent relied inter alia, upon sections 3, 4, 9, 14, 18 and 20 of the Income Tax Act.

O’Bryan ran into severe financial difficulties in failing to establish a trust account to which premiums were deposited; failing to pay premiums to their insurance companies; and using the “premiums” money to finance their business as a result of expanding too rapidly. As a result, they were unable to obtain insurance coverage for their customers from the insurance companies which set up a creditors’ committee in December 1974 and thereafter O’Bryan was no longer in charge of its business, although some of its offices and various branches were still open.

A large insurance broker, Thomason & Saunders, approached Clarkson, Gordon & Co, Trustees in Bankruptcy, with respect to the purchase of the list of customers and negotiated with one Donald Gardner, CA, of the bankruptcy division of Clarkson & Gordon, who was appointed official Trustee in Bankruptcy as a result of a Proposal filed on February 4, 1975. This was approved by a Court Order in March 1975. Thomason & Saunders attempted to, and did purchase the list of customers of various branches of the bankrupt company, but was not interested in the New Westminster branch. The customer list at issue in this case is the customer list of the New Westminster branch. Mr Gardner says that after long negotiations with one Allan Davidson, head of the appellant company, an agreement was approved by the creditors’ committee on February 17, 1975, whereby Donald Gardner, the Trustee, under the Proposal for bankruptcy of O’Bryan, agreed to sell to the appellant the New Westminster customer list of O’Bryan.

Paragraph 1 of the Agreement (Exhibit A-2) reads, in part, as follows:

1. Subject to the terms and conditions of this Agreement, the Purchaser agrees to buy from the Trustee and the Trustee agrees to sell to the Purchaser all the Trustee’s right, title and interest in the following customer lists or interest therein of the Debtor:

(a) all lists of customers of the insurance business of the Debtor’s branch at Suite 2 — 601 Royal Avenue, New Westminster, BC, as at the 19th day of March 1975; and

(b) a list of customers set forth in the Schedule annexed hereto,

including all records, documents, files and other information relating to such customer lists (hereinafter referred to as “the said lists”).

There was no “up front money” but the purchaser agreed to pay the Trustee not less than 30% of the commission income with respect to new and renewed insurance, including addition to the existing insurance policy placed or arranged for customers on the said list for a four-year period. This Agreement was formalized on April 16, 1975. This Agreement is of vital importance in deciding the issue before me, in particular with respect to the terms in the said Agreement giving the Trustee supervision of the purchaser’s (appellant) records and files relating to the customer list and, further and more important, the undertaking by the appellant to “use its best efforts to collect, as agent, for and on behalf of the Trustee, the accounts receivable as at the 19th day of March 1975, of the said debtor’s branch, at Suite 2 — 601 Royal Avenue, New Westminster, BC”, and to give regular accounting of premiums received monthly, commencing June 1, 1975.

By April, most of the employees of O’Bryan had disappeared and the key employee at the New Westminster branch, one Michael Thompson, who, knowing as early as October 1974 that the company was going bankrupt, contacted every insurance broker he could and finally met with Mr Davidson of the appellant company, who was impressed with him and hired him. It was only after Davidson had decided to purchase the so-called customer list of O’Bryan that Thompson was hired. He was the gentleman, who with another employee, attempted to keep the doors of the New Westminster office open, knowing that they were having great trouble in getting the insurers to give coverage to their customers. Thompson actually joined the appellant company on March 16. Davidson was impressed with him as a salesman and hired Thompson and a remaining co-employee (Johnston) of O’Bryan at the request of Thompson. As it turns out, Davidson’s judgment was correct as Thompson is now vice-president and manager of the appellant company.

Mr Davidson stated that the employment of Thompson and of Brian Johnston was not contingent on getting the list. The Crown, however, introduced two letters: one dated March 21, 1975, on O’Bryan’s letterhead, which letter was signed by Brian Johnston and Mike Thompson, and composed by Mike Thompson, whereby they wrote to all the customers on the customer list, telling them that they had “elected to merge our office with a large, well- respected, BC based insurance firm, namely Hugh & McKinnon Ltd”. This letter was written without the knowledge of Mr Davidson. There was a subsequent letter, however, written on April 22, 1975, on Hugh & McKinnon Ltd letterhead, with the knowledge and approval of Mr Davidson, whereby the people on the customer list were again contacted and requested to direct their inquiries to Mike and Brian “now located at Hugh & McKinnon Ltd, 5678 — 176th Street, Surrey, BC”. The letter ends up as follows:

Your continued loyalty is appreciated and we look forward to taking care of all your insurance requirements from our new location.

I can only see that the two aforementioned letters were to assure that the business of O’Bryan be firmly ensconced within the framework of the appellant company. Although Davidson stated that they would have purchased the list without Thompson and Johnston, he also stated that “having them would have been a ‘plus’”. In my view, it was indeed a “plus” as it assured that the so-called “loyalty” of customers to their agents, Thompson and Johnston, be played upon to ensure that they would be continuing to do business with the appellant.

Davidson testified that after four years, he had only retained about 30% of the commission from the customer list as opposed to his first year after acquisition of same in April 1975. In actual fact, Johnston and Thompson had acquired 80% of the purchased customer list under Exhibit A-2.

In the decision of Ronald Rooke v MNR, [1976] CTC 2412; 76 DTC 1307, at 2413 and 1308 respectively, the Honourable L J Cardin, PC, QC, Chairman, of the Board, states as follows:

In my opinion, there can be instances in which the purchase of a customer list and nothing else might in itself be considered to be an operational expense made by an agent to acquire new customers and to produce more income. However, the circumstances and the facts surrounding the purchase of such a list must be very carefully examined, because the customers lists and the insurance policies of those customers constitute the very essence of an insurance agent’s business.

Thompson had permitted Davidson to examine the files of O’Bryan prior to purchase. He met with Davidson on at least three occasions before he was hired on salary by the appellant. In spite of Davidson’s evidence that he would have purchased the customer list without the hiring of Thompson and Johnston, I feel that the succession of meetings and especially the two letters written to O’Bryan’s customers and signed by Thompson and Johnston as employees of the appellant, conveyed to the appellant the only asset of O’Bryan’s, namely, the customer list and the goodwill as represented by the loyalty of most of the customers on the list. Goodwill was indeed involved. Goodwill is the “benefit and advantage of the good name, reputation and connection to a business. It is the attractive force which brings in customers. It is the one thing which distinguishes an old-established business from a new business at its first start”. See CIR v Muller, [1901] AC 217 at 223-224, as quoted in Cumberland Investments Ltd v The Queen, [1973] CTC 821, at 826; 74 DTC 6001 at 6006.

The acquisition enlarged the potential income earning strength of the appellant herein by 10%. See also Walter J Burian v The Queen, [1976] CTC 725; 76 DTC 6444. At 730 and 6447 respectively, Collier, J states:

In my opinion, when one views the “practical and commercial aspects”* [1] of this purchase, the plaintiffs were in reality acquiring, or endeavouring to acquire, an opportunity for potential future customers or business — the trade of the clients of C F Graves & Co. The purpose, to my mind, was to bring into the existing business a further asset or advantage with the expectation of lasting benefit. The transaction, as I view it, was to strengthen and expand the plaintiff’s 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.t [2]

The fact that the business from the customer list did fall after the taxation years in question is irrelevant. What matters is the nature of the advantage the appellant sought to acquire as opposed to the actual benefit obtained.

The terms of the Purchase Agreement between the Trustee and the appellant, referred to above, ie supervision by the Trustee; the collection of accounts receivable owing to O’Bryan, etc, lend further weight to my conclusion that the expenditures of $19,012.15 in 1975, and $30,653.39 in 1976 by the appellant were “eligible capital expenditures” and not expenses on account of income.

For the above reasons, the appeal is dismissed.

Appeal dismissed.