William H Crandall v. Minister of National Revenue, [1974] CTC 2289

Judge K A Flanigan (orally: July 25, 1974):—This is an appeal by William H Crandall against the reassessment by the Minister of National Revenue for the 1969 and 1970 taxation years.

William H Crandall is a professional engineer and, in or about the year 1951, he began to practise his profession with the City of Moncton. He is a graduate in mechanical engineering, and has specialized since the beginning in sewer, water, road and gutter, and associated services required generally by municipalities. He left the employ of the City of Moncton in 1951 to open his own consulting firm as he believed there was a need in New Brunswick, Nova Scotia and Prince Edward Island for such a firm which would advise municipalities that were not sufficiently large to be able to afford their own resident engineer. Apparently he made a very astute move because over the years his business progressed. After the first year, I think he said, and for the next four or five years his gross revenues doubled almost yearly until they levelled off at about $120,000 gross fees a year.

In or about 1960, or earlier, he experienced some medical problems and was advised by his doctor to either slow down or, if he was to continue in his operation, to take in additional help. He began by setting up an accounting section of his business and subsequently brought in Mr Hiscock who, I believe, was a Master of Science in sanitary engineering, and subsequently Mr Richard who had worked with him from the beginning as a rod man in 1952. When Mr Richard graduated as an engineer, he became part of the company.

At the beginning of February 1961 the partnership or proprietorship —call it what you will—that was carried on by Mr Crandall was incorporated under the name of W H Crandall & Associates (Manage- ment) Ltd. As I recall, Mr Crandall originally had 61% of the shares, Mr Hiscock 34%, and Mr Richard 5%. After Mr Richard’s graduation he received another 10% which came from the holding of Mr Crandall, and the shareholdings then became 51%, 34% and 15%.

The problem arises in that in setting up the opening balance sheet of the limited company there was included in the assets a sum in excess of $53,000 for goodwill. The Department takes the position that there is no goodwill applicable to such a transfer of assets from a professional to a limited company of which the professional is the controlling shareholder, or, if there is any goodwill, it is limited in this particular case to $9,000.

Evidence was called on behalf of the appellant. In addition to Mr Crandall, Mr Richard gave evidence, as did Mr Touchie of the firm of Lee and Martin who were the auditors of this incorporated company from its beginning. From about 1966 on Mr Touchie was in charge of this company’s audit, having taken over from Mr Flewelling who retired in 1967 as a result of ill health. He explained how the figure for goodwill was arrived at, and the calculation is included in Exhibit R-1. He has taken four years’ earnings, averaged them, deducted a salary of $8,000 per annum for Mr Crandall, taken off tax at the rate of 21% as was then applicable, taken off 10% of the value of equipment transferred to the company, and arrived at a figure, known by the strange name of “super profits’’, of $5,408. To this he has applied a multiple of 10 to arrive at a figure of $54,080 for goodwill, which was finally taken as $53,760.

Mr Touchie explained the manner, with which I was not familiar, in which the multiple of 10 is the number of years which he expected it would take Mr Crandall to recover his goodwill from the operation of this business. I am more familiar with the procedure whereby a multiple times the earnings provides a figure, as is done perhaps more frequently in the valuation of shares. However, in this case it matters not really whether I take it in the form of Mr Touchie’s explanation or as a multiple based on the risk factor of 10-times earnings.

It is interesting to note from Exhibit A-1—this is also more specifically set out in Exhibit A-3, a letter from the Department of National Revenue Taxation Division to the company’s accountants—that the accounts receivable and work in progress were retained by Mr Crandall, and only the current assets, fixed assets, and liabilities were transferred into the company.

The Department, ‘in arriving at its figure of $9,000, increased the salary of Mr Crandall to $10,000. It also increased the tax factor, and added $2,100, bringing to $4,000 the value of the equipment, and to $47,000-odd the value of the liabilities that were transferred to the company. It has used a multiple Of 5 in arriving at its figure of $9,000.

The question is: ts there any goodwill that is ascertainable, valuable and payable to this appellant? It is urged upon me that the two minority shareholders were satisfied with the calculation, although’ Mr Richard said he felt at first it was a bit high but they decided to go ahead, and it was, to use his words, the best move he ever made. They had very little invested, of course, having paid only a nominal amount for their shareholdings, as is the usual practice in such an incorporation. Nevertheless, they did have an interest in the opening statement in that before they could obtain greater benefits for themselves out of the company the indebtedness of the company to Mr Crandall. would have to be extinguished.

The respondent called Mr David Allan Jones, a certified general accountant, who is a valuator employed by the Department of National Revenue. He is the group head of valuation of private companies in the Atlantic provinces stationed, I believe, at Halifax. He has held this position for the last three years, and prior to that time he was a valuator with the British Columbia succession duties department for six years. He is presently embarked on a Master of Business Administration course, and is a man whose qualifications greatly impressed me.

I cannot help but comment at this time that I am also extremely impressed by the very dogmatic, unyielding and firm approach to all aspects of his valuation in this case that he took on the witness-stand. There appear, in my assessment of his evidence, to be no shades of grey; things are either black or white. That may very well be a sound way to look at figures, but I think it is a very unrealistic approach to day-to-day business operations.

I should say that Mr Jones has been put in an unenviable position. Only in the last week or so was he given instructions, and asked to come up with a figure on goodwill in this instance. He filed, through counsel, two reports—Exhibit R-3, which is really a treatise on personal goodwill and professional engineering practices, and a more specific one on goodwill on incorporation of W H Crandall & Associates (Management) Ltd.

In referring to his evidence I suppose it is trite to say that if I were addressing a jury I would tell them they can assess the evidence of the witness, accept all of the evidence, accept none of the evidence, or accept some of the evidence, and so I should charge myself in the same manner. There is no doubt whatsoever in my mind, from the answers to questions put to Mr Jones by myself, that he does not accept under any condition that there is goodwill in a professional man that can be transferred to a body corporate or any other business. As he put it in his own words, “it is something that is personal to the individual; it is in his body, in his ability, and cannot be transferred”.

He points out in Exhibit R-3 at page 4:

D. Criterlons for determination of goodwill element.

If goodwill is to be recognized In the accounts of professional people at all, other than as an excess price over tangible assets (and probably then a > premium to: eliminate competition), then there must be some criteria for

And then he sets out ten criteria that. he considered and i suppose they are not exhaustive. Some of them are: reputation for reliable work in a variety of: problem: areas; ability to attract and maintain a large group of clients? a staff of: professionals capable of handling divergent problem areas; nature of the work—whether recurrent or non-recurrent; nature of clientele and their likelihood to introduce further business; the trend of profits; and so on. I find a great many of those criteria to have been set out in the evidence of Mr Crandall.

He also quoted from the well respected author and valuator, Mr George Ovens, in which he says, in effect, that goodwill of an individual cannot be transferred in a professional capacity. I think that is a general statement that can well be accepted, but unfortunately in tax matters, as in most litigation, one cannot generalize to the nth degree. One must deal with the facts that are placed before one, and try to arrive at the most rational conclusion.

In looking at page 1 of Exhibit R-4, notwithstanding the dogmatic and firm approach taken by Mr Jones, one sees an element of fairness permeating his approach to these matters, because he is the first to admit, in the second to last paragraph on that page, that it is impossible for him to reconstruct the situation that existed on February 1, 1961.

In his report he shows that the salary of $8,000 allocated to Mr Crandall is unrealistic in that it does not come close to any statistics that are available for that period respecting the wages of engineers and architects. Yet he has no evidence, no experience, nor any figures, to show what the going rate for engineers was in the Moncton area, or in Prince Edward Island, in the years in question, namely, the late fifties and early sixties. Without wishing to become embroiled in any regional discussion, I think it would be almost possible to take judicial notice of the fact that wages in the Atlantic provinces in those years were well below the national average. However, the evidence clearly indicates that not only were people of great ability available but they were hired by Mr Crandall at $7,500 a year. In my view, this is the best evidence that could be available to show that the figure of $8,000, low though it may seem on the evidence before me, is not an unreasonable figure to use in calculating the earnings or “super profits” of the business as set out in Exhibit R-1.

I may have suspicions, as does Mr Jones in his Exhibit R-4, that the appellant would not have the private means to guarantee the company’s line of credit had he been earning only $8,000 a year, yet I cannot speculate, I cannot guess; I can only draw inferences from the evidence, and I think it is a reasonable inference to draw from the evidence of Mr Richard and Mr Crandall that the figure of $8,000 is a figure that can be accepted. I am certain that the respondent would have been quick to produce evidence to show that the appellant’s income from the business was far greater if that were in fact the case.

I come back now to the question of whether goodwill can or cannot be translated into dollars and cents, and passed from the individual to a limited company. As I have said, I accept the general comment of Mr Ovens, as adopted by Mr Jones, that generally speaking you cannot pass personal goodwill from one person to another. 1 think that is more evident when one considers a doctor or a lawyer selling his practice. As Mr Touchie said, in arriving at the purchase price to be paid it is based generally on how much of the practice will be retained.

I think it is very unlikely that any goodwill in such a set of circumstances can be valued and transferred, but here I feel there is a different situation. The evidence is very strong that William H Crandall was a highly respected engineer who had an entrée to most of the municipalities in New Brunswick, Nova Scotia and Prince Edward Island that required his services. As Mr Richard put it, years after they were still asking to speak to “Bill” about matters that would not be worked out by him in any event. When there is a transfer from a professional business to a limited company bearing almost the same name there is little or no recognition of the legal entity change that has taken place so far as the customers or clients of that business are concerned. I feel that in such a circumstance there is goodwill that can be transferred, and which does flow into the limited company in a case such as this.

Learned counsel for the respondent pointed out that there was no guarantee that Crandall would stay, or that the business would stay if Crandall left, but the fact is that Crandall did stay, and as we look back now we see that the business has prospered. The question is: Am I entitled to take advantage of hindsight in arriving at my decision? I think I am.

The law is well settled. I refer to the decision of Mr Justice Walsh in the case of Produits LDG Products Inc v MNR, [1973] CTC 273; 73 DTC 5222, which was a case dealing with the old section 76 pension provisions, in which he said it was perfectly permissible for a court to look past the date of the reassessment to see what course the appellants had followed to assist it in determining their true intent at the time of setting up the pension plan. In that case, as soon as the pension plan was questioned, they had ceased to make contributions, and from this Mr Justice Walsh deduced, I think rightly, that one of the main reasons for trying to utilize section 76 was to reduce taxes and not really to set up a pension plan.

Also in James v MNR, [1973] CTC 457; 73 DTC 5333, Mr Justice Gibson, in dealing with whether or not Mr James was engaged in the business of farming, clearly made use of the facts before him that in the years subsequent to those under appeal Mr James had been extremely successful in his farming operation. There is no doubt in my mind, from reading that decision, that those facts clearly influenced the final decision of the learned judge. So I feel I am entitled to look past the year 1961, and see what transpired in this instance.

I find that the company has continued to prosper. The book value of the shares, upon which I place very little weight, does show that the company continued to move upward in its revenue-producing ability. I have come to the conclusion that the appellant was entitled to goodwill on the incorporation of the company in question.

I am not, however, prepared to accept the figure set forth in the opening balance sheet. There is only one figure with which l quarrel, and that is the figure of $1,900 book value for equipment transferred with complete disregard for the $47,000 debt that was taken over by the limited company. I do not know how one can arrive at a figure at this stage without indulging in pure speculation, so I am prepared to accept the Minister’s figure of $4,000 that he arrived at after calculation some time ago.

The only other question left to be determined is whether or not the 10-times multiplier is correct, or whether it should be the 5-times multiplier as used by the Department. The evidence of Mr Touchie is that at that time the 10-times multiplier was the one in vogue with respect to professional businesses. Mr Jones referred to it as “the 10- times syndrome” which dates back to the twenties, and which has little or no application in modern-day accounting principles and practice. Yet Mr Jones admits that this is not a high-risk business in the sense that that term is usually associated with business enterprises. He says, however, that in his mind it was high risk in that it was subject to such variables as change of governments, weather conditions, and other imponderables. He said also that the company was heavily indebted to the bank, and this fact made it a high risk.

With great respect, I do not think that that is the approach that an accountant would take in determining, if acting for a purchaser, the question of risk involved and the value of a business, and I think the 10-times multiplier is a fair and reasonable one in all the circumstances.

Therefore, in recalculating the figure that should be allowed for goodwill I have changed the amount found in Exhibit R-1 of book value of equipment from $1,900 to $4,000, and have calculated the goodwill, subject to a check on my arithmetic, at $33,080.

The appeal will, therefore, be allowed in part, and referred back to the Minister for reassessment on the basis that the goodwill was $33,080 on February 1, 1961.

Appeal allowed in part.