Raymond Ducharme v. Minister of National Revenue, [1978] CTC 2562, [1978] DTC 1414

Guy Tremblay [TRANSLATION]:—The case at bar was heard at Montreal, Quebec on March 11, 1977.

1. Main Point at Issue

The issue is whether the sum of $2,000 paid for goodwill by a company in 1972 to the appellant, the principal shareholder, for a business sold in 1969, should be included in computing his income for 1972 under subsection 15(1) of the new Act, namely, as a benefit or advantage conferred on a shareholder, as was claimed by the respondent in the Notice of Reassessment issued on December 16, 1974. The respondent claimed that the goodwill transferred was personal and therefore not transferable.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results not from any particular provision of the Income Tax Act, but from several court decisions, including the judgment of the Supreme Court of Canada in R 1/1/ S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts Alleged

3.1 Facts Alleged by Appellant

Paragraphs 1 through 4 of the appellant’s Notice of Appeal read as follows:

1. On January 2, 1969 the appellant transferred his management consulting business, including contracts in progress, capital assets and goodwill, to Raymond Ducharme et Associés Inc (hereinafter referred to as “the company’’). The aforementioned goodwill was valued at $125,000 and the company issued a promissory note to the appellant in payment of this amount.

2. The acquisition of this goodwill resulted in an increase in the company’s turnover in subsequent years.

3. In 1972, the company paid the appellant $2,000 in partial settlement of the promissory note.

4. In the assessment being appealed, the respondent included the said $2,000 as a “benefit or advantage . . . conferred on a shareholder’’ in computing the appellant’s income.

3.2 Facts Alleged by Respondent

Paragraphs 1 and 2 of the respondent’s Reply to the Notice of Appeal read as follows:

1. Paragraphs 3 and 4 of the Notice of Appeal are admitted in part and all other allegations in the Notice of Appeal are denied.

2. The respondent relied on the following facts in assessing the appellant for the 1972 taxation year.

(a) From 1966 to 1969 the appellant worked as a management consultant under the name of “Raymond Ducharme et Associés Inc’’.

(b) During this period, the appellant’s income came largely from fees paid to it by the Quebec government.

(c) During this period, the appellant did not have an independent business organization allowing him to earn this income from fees.

(d) The appellant’s average net income before taxes for this period was representative of the fair market value of the services of a consulting engineer of his experience.

(e) During this period, the appellant did not create goodwill other than that attributable to his personal reputation because of the quality of his services, his competence and his good relations with the Quebec government.

(f) In 1969, the appellant formed a company under the name of “Raymond

Ducharme et Associés Inc,’’ of which he was principal shareholder.

(g) When Raymond Ducharme et Associés was incorporated, it issued a promissory note for $125,000 to the appellant for which it received no business consideration;

(h) The appellant did not transfer any goodwill to Raymond Ducharme et

Associés Inc other than that resulting from his personal reputation.

(i) No market value can be assigned to the goodwill the appellant claims to have transferred to Raymond Ducharme et Associés Inc.

(j) Raymond Ducharme et Associés Inc conferred a benefit or advantage on the appellant by paying him $2,000 in the 1972 taxation year.

(k) Raymond Ducharme et Associés Inc did not make this payment of $2,000 in 1972 in keeping with a true business transaction.

4. Facts Proven

4.1 The appellant, 43 years of age in 1972, graduated as an engineer from the University of Laval in 1955 and is a Harvard graduate in business management. He was president of the “Association des conseillers en administration du Québec’’ (Quebec management consultants association). In 1972, he described his work as that of a management consultant with Ducharme, Deom et Associés Inc.

4.2 After being a junior associate in the management consulting firm of Bélanger, Ouellet et Associés, the appellant became self-employed in 1966. On January 2, 1969 he incorporated himself under the name of “Raymond Ducharme et Associés Inc’’ and sold his business to the company for $143,320, $125,000 of which was for goodwill. Eight months later, the business was sold to Ducharme, Deom et Associés Inc, again with $125,000 for goodwill. The appellant holds sixty per cent of the shares in the new company.

4.3 The appellant defined his role as a management consultant as follows: to aid in solving business and financial problems through research into the rate of profitability and so on; manpower problems through better distribution of personnel and so on; and management problems through the introduction of new technology and so on.

4.4 The appellant stated that. according to his personal experience and knowledge as president of the Association des conseillers en administration du Québec, eighty per cent of the work comes from public agencies such as the federal, provincial and municipal governments, school boards and para-governmental agencies such as HydroQuebec and so on. In the case of the appellant’s business, ninety per cent of its turnover from 1966 to 1969 came from public contracts.

4.5 The appellant gave two examples—one with reference to the economy (wine distribution) and the other in the field of public administration (Quebec Department of Justice)—to illustrate the work of a management consultant.

4.6 The government contracts were for the most part obtained following public tenders. Written contracts were then signed.

Some contracts were obtained by telephone, where an employee of a department would inform the company of the work to be done. The document showing the existence of a contract would then be a letter from Treasury Board to the Justice Department, with a copy of the decision being sent to the appellant by an employee of the latter department.

4.7 The appellant filed as Exhibits A-1 and A-2 a list of fourteen projects which Raymond Ducharme et Associés obtained or completed in 1968, that is, before the incorporation. A total of $454,900 in fees was paid for ten of these projects. The main contracts were:

No 6801: management study regarding the reorganization of the Quebec Police Force ($107,500):

No 6806: plan—Quebec Court House ($32,000);

No 6811: organization—Court House ($50,000);

No 6812: information centre for the Quebec Police Force ($201,000).

The net income for 1968 was $160,000. According to the appellant, a good number of the contracts obtained before 1969 were completed after the incorporation.

4.8 Evidence was also presented that between 1969 and 1976, 297 contracts were obtained. During the five years following the incorporation, the company’s gross income exceeded $1,700,000. The Board must decide whether these facts should be taken into account in the valuation of the goodwill.

4.9 Before the incorporation, the appellant had 4 permanent employees and 3 “contract” employees hired through Peat, Marwick. Mitchel and Co, an international company working in the same field. In fact, the appellant’s company acted as this company’s representative for French-speaking customers following a written agreement to this effect concluded in 1966. The two companies worked in co-operation in the best interests of both parties. Their places of business were side by side, the appellant having rented 20,000 square feet from the other company.

4.10 The appellant’s average net income from 1966 to 1968 was $37,500.

4.11 According to the opening balance sheet dated January 2, 1969, a sum of $125,000 was classified as goodwill when the company was incorporated. This amount was calculated on the basis of the net income of preceding years. The accounts receivable and payable were not transferred to the company. Mr Gilles Gagné, CA stated that he believed $125,000 was very reasonable. Some buyers pay up to five times the average profit of the last five years for goodwill. According to Mr Gagne, “goodwill” can be described as profitability or the expectation of profit. The value of goodwill is not calculated according to any precise rules. In the case at bar, the capitalized value of the average net income of $37,500 calculated on the basis of a factor of four or three equals $150,000 and $125,000 respectively, as shown in Exhibit A-7. Another method of calculating the value of goodwill is also shown in Exhibit A-7:

The capitalized value of the average annual profit, calculated on the basis of a factor of four, seven or ten, equals $120,300, $168,420 and $240,600 respectively.

4.12 A letter was filed by the appellant as Exhibit A-8. The letter, dated November 10, 1971, was from Mr R C Berry, CA, who had left Peat, Marwick, Mitchel and Co in 1969. It stated that at the end of 1968, the said company had been negotiating to join Mr Ducharme’s organization, and had been willing to pay $125,000 for goodwill in the purchase of the company from the appellant, on condition that the professional team and the contracts of the Ducharme organization be included in the merger.

4.13 Government contracts can be terminated by the government at any time.

4.14 The appellant’s principal associates had the following qualifications and received the following incomes from the appellant in 1968:

—Jean-Yves Pilon, social sciences specialist—$7,500 according to the appellant; $9,750 according to the witness for the Department;

—R Panet Raymond, management and staff relations specialist— $9,200:

—Marcel Langlois, engineer—$21,400;

—Jean-Pierre Lefebvre, work methods specialist—$21,400.

The services of the last two were obtained through Peat, Marwick, Mitchel and Co.

In addition to these persons, the appellant was advised by his attorney and his accountants.

4.15 According to Mr Gilles Gagne, CA, it is clear that the appellant played an important role in the new company. Mr Real Parent, witness for the respondent; also stated that the appellant was a key figure. “He was irreplaceable. There was no team which could take over where he left off.”

4.16 Mr Michel Richard, an auditor in the Audit Directorate, Department of National Revenue, was the respondent’s main witness. According to his testimony, he had conducted over ninety audits, ten to fifteen of which related to goodwill.

4.17 According to his audit, the appellant’s goodwill was worth $2,300 and was personal. He maintained that his audit was based on the principles set out in lan R Campbell’s The Principles and Practice of Business Valuation, published in 1975 by Richard De Boo Limited, publishers, and more specifically chapter six entitled “Intangible Assets”. Relying on this author, he distinguished between, inter alia, business and personal goodwill.

4.18 According to Mr Richard, the main criteria for determining whether a company has business goodwill are generally the following:

(a) past profits;

(b) trends in past income;

(c) competition:

(d) personal ability of the manager;

(e) qualified personnel;

(f) comparison with businesses of the same type;

(g) length of time the company has existed;

(h) size and quality of clientele;

(i) sometimes location of the business.

4.19 Again according to Mr Michel Richard, the respondent’ $ witness, personal goodwill is that which results. wholly from the ability and personal effort of one individual.

4.20 According to Mr Richard, the goodwill of the appellant’s business was valued at $2,300 calculated as follows: average net income less a reasonable salary, less corporate tax, equals an amount which, multiplied by the profitability factor, equals the total value of the business. According to the witness, this factor was one (1) in the case at bar since the business provided professional services (in accordance with the principles set out by Campbell at page 50, paragraph 7).

The goodwill of a business is the total value of the business less the value of the transferred assets.

4.21 Although the respondent’s witness claimed to favour the taxpayer, he did not use the average net income. of the taxpayer’s business (set at $37,500 by the appellant) in his calculation, but the average gross income, calculated on three different bases:

(a) a “‘per diem” of $225, as established in Exhibit 1-2, multiplied by 250 working days;

(b) an hourly rate of $30, as established in Exhibit 1-1, multiplied. by thirty-five hours a week and fifty weeks a year;

(c) a per diem of $140, as established in Exhibit 1-4, this being the rate charged by the Corporation des ingénieurs professionnels (professional engineers corporation), and not management consultants’ fees.

The calculations were as follows:

4.22 According to the witness, the value of the goodwill as calculated by the. appellant’s accountant would be valid for a manufacturing company, but not for an individual whose business involved professional services.

4.23 The respondent’s second witness, Mr Real Parent, has worked in the Audit Directorate, Department of National Revenue, since 1970. He more or less confirmed Mr Richard’s testimony.

4.24 In 1972, Raymond Ducharme et Associés Inc paid Raymond Ducharme $2,000 in partial payment of the goodwill valued at $125,000.

4.25 On December 16, 1974 the respondent issued Notice of Reassessment No 361996, in which the sum of $2,000 was included in the appellant’s income for 1972.

4.26 On March 7, 1975 the appellant filed a Notice of Objection, and on April 19, 1976 the respondent sent a notification confirming reassessment No 361996 and stating that the $2,000 had been included in the appellant’s income pursuant to subsection 15(1) of the new Act.

4.27 On May 27, 1976 the appellant filed a Notice of Appeal with the Board.

5. Act, precedents and comments

5.1 Subsection 15(1) of the new Act, to which the respondent referred, reads as follows:

15. Appropriation of property to shareholder.

(1) Where in a taxation year

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation

otherwise than

(d) on the reduction of capital, the redemption of shares or the winding- up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 84, 88 or Part II applies,

(e) by the payment of a dividend, or

(f) by conferring on all holders of common shares of the capital stock

of the corporation a right to buy additional common shares thereof,

the amount or value thereof shall be included in computing the income of the shareholder for the year.

5.2 Specific Points at Issue

Subsection 15(1) only applies if the goodwill sold to Raymond Ducharme et Associés Inc was not transferable.

The appellant [sic] claims that the goodwill involved is personal rather than commercial and that it is therefore not transferable.

5.2.1 The Board must first determine, therefore, what goodwill is in general.

5.2.2 What is the nature of the goodwill in the case at bar? Is it transferable?

5.2.3 If the goodwill is transferable, what is its value?

In evaluating the goodwill, can one take into account facts subsequent to January 2, 1969, the date on which Raymond Ducharme et Associes Inc was incorporated?

5.3 What is goodwill in general?

5.3.1 The first book that should be consulted in order to find the ordinary meaning of a word is the dictionary.

According to Le Petit Larousse Illustré, “achalandage” means: “action d’achalander. Ensemble des clients.”

According to the Petit dictionnaire canadien de la langue française by Louis-A Bélisle, “achalandage” means: “action d’achalander; clientele d’un marchand.”

According to the Concise Oxford Dictionary, 1964 edition, “goodwill” means: “established custom or popularity of business.”

According to The Living Webster Encyclopedic Dictionary of the English Language, 1971 edition, “goodwill” means: “Intangible value of a business; projected earning power . . .”

5.3.2 In Herbert Wallace Losey v MNR, [1957] CTC 146; 57 DTC 1098, Thorson, P of the Exchequer Court of Canada provides us with the results of his research on this subject. He states that the word “goodwill”:

. . . is not free from difficulty. Lindley on Partnership, 10th edition, at page 523, states that “the term goodwill can hardly be said to have any precise signification’’. The new English Dictionary defines goodwill in the commercial sense of the term as follows:

‘‘b. Comm. The privilege, granted by the seller of a business to the purchaser, of trading as his recognized successor; the possession of a ready formed “connexion” 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.” .

As early as 1810 Lord Eldon in Cruttwell v Lye (1810), 17 Ves Jun 335 at 346, said of the goodwill of the business which was the subject of sale in the case before him:

‘‘The goodwill . . . is nothing more than the probability, that the old customers will resort to the old place,”

And it is somewhat in that sense that Cripps on Compensation, 8th Edition, page 185, defines goodwill as ‘‘the probability of the. continuance of a business connection”.

But the later cases indicate that Lord Eldon’s definition was too narrow. Thus in Trego v Hunt, [1896] AC 7, Lord Herschell emphasized that it was the connection with its customers that made the goodwill of a business. At page 17, he said:

‘‘It is the connection thus formed, together with the circumstances, whether of habit or otherwise, which tend to make it. permanent that constitutes the good will of a business. It is this which constitutes the difference between a business just started, which has no goodwill attached to it, and one which has acquired a goodwill. The former has to seek out his customers from among the community as best he can. The latter has a custom ready made.”

And Lord Macnaghten said. at page 23:

‘‘What ‘‘goodwill” means must depend on the character and nature of the business to which it is attached. Generally speaking, it means much more than what Lord Eldon took it to mean in the particular case actually before him in Cruttwell v Lye (1810), 17 Ves 335 at 346, where he says: ‘‘the goodwill which has been the subject of sale is nothing more than the probability that the old customers will resort to the old place”. Often it happens that the goodwill is the very sap and life of the business, without which the business would yield little or no fruit. It 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 expenditure of money.”

I respectfully express the opinion that the last sentence of what I have cited more accurately sets out the meaning of goodwill than the sentence that precedes it.

And 'in Inland Revenue Commissioners v Muller & Co’s Margarine, Limited, [1901] AC 217, another House of Lords decision, Lord Macnaghten said, at page 223:

“What is goodwill? It is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connection of a business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old established business from a new business at its first start.”

Furthermore, relying on Austen v Boys (1858), 11 De G & J 626, at 635, Lindley on Partnership, 10th Edition, page 523, Thorson, P States:

But the value of the goodwill of a business is what a purchaser would be willing to give for the chance of being able to keep the connection of which it consists.

Before ending his examination of goodwill, the learned judge concludes:

But two things are clear. One is that the sale of the goodwill of a business does not include a covenant by the vendor that he will not compete against the purchaser. If the purchaser wishes the benefit of such a covenant he must provide for it apart from the goodwill. And it is also. clear that the sale of the goodwill of a business does not carry with it a right to the personal services or the business ability of the former proprietor of the business.

5.3.3 In his book La compatabilité supérieure, 1948 edition, Vol 1, p 474 et seq, Brother Irénée EC writes:

Translation

Goodwill is a reputation which a business firm has acquired. after many years of operation by its honest and prudent dealings, and which raises the net profits of the firm above the normal percentage on invested capital _.. It is thus an excess of profits that determines the existence of goodwill. There must be a reasonable probability that these excess profits will continue in the future; otherwise, a person buying a business would not agree to pay for goodwill in addition to net assets.

The Internal Revenue Service of the United States in its bulletins (US Revenue Ruling 59-60) gives a definition very similar to that given by Brother Irénée:

In the final analysis, goodwill is based upon earning capacity. The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets.

This is equivalent to saying over and above the normal net earnings of the business concerned.

5.3.4 The fact that earning capacity can result from a number of factors has led in recent years to a distinction between several kinds of goodwill.

In his book The Principles and Practice of Business Valuation, 1975 edition, p 77, lan R Campbell lists the following four kinds of goodwill:

—goodwill of location;

—goodwill of product or service;

—personal goodwill;

—general business goodwill.

This last type of goodwill results mainly from the length of time the business has been in operation; past profits; the competence of employees; good relations with lenders and investors, who have a favourable opinion of the business; long-standing relationships between the business and its suppliers and customers, and a competent team of managers who are familiar with the competition, current contracts and so on.

As may be seen, the distinction recently made between different kinds of goodwill, on the basis of the various factors, grounds and sources that produce the goodwill of a particular business, gives an overall view and a better understanding of this complex concept. Certain definitions previously given by the Courts, including some that were cited by Thorson P in Losey, often limited the entire concept of goodwill to a single factor such as. location. or contact with customers.

5.4 What is the nature of the goodwill in the case at bar?

5.4.1 First, the goodwill does not appear to be goodwill of location. The appellant’s offices were located in the offices of Peat, Marwick, Mitchel and Co in 1968, which would appear to be a big advantage since the appellant’s business offered management consulting services, but the location was of secondary importance. This kind of factor can be very important where the clientele is large, such as in retail goods, professional medical services and so on, but not in a case such as the one at bar where the main clients were the government and para-governmental agencies.

5.4.2 The goodwill in question is clearly also not that which might result from the sale of well-known products, since no products were sold. With regard to services rendered, considering their nature, the goodwill would more likely have been general business goodwill, where the conditions were met.

5.4.3 In order to determine whether we are dealing with personal goodwill or general business goodwill, we should begin by considering what the courts have already said on the question.

In the past twenty years, the courts, the old Tax Appeal Board and the present Tax Review Board have decided a number of cases, which* in general have this much in common with the case at bar: they almost all involve setting a value on goodwill, when a business is sold to a newly formed company whose principal shareholders are the owners of the business being sold. The Board feels it would be useful to summarize the principal judgments, though not without a word of warning about the dangers of summaries.

5.4.4 Summary of sixteen judgments

(1) Herbert Wallace Losey v MNR, [1957] CTC 146; 57 DTC 1098, Exchequer Court, by Thorson, P.

Mr Losey, a former commission salesman who had been running his own advertising business for eighteen months, sold this business to Alliance Advertising & Applied Arts Inc, a newly formed company of which he was the president and principal shareholder. The price was $85,000, which was made up of $10,000 for tangible assets and $75,000 for goodwill. The basis for this figure of $75,000 was a past net profit of $15,000, multiplied by five to reflect future net income producing capacity.

Decision

Because the only evidence was a list of former clients, with no fixed contract to bind them to the company and give something permanent to the transfer; and because the relations with the clients were strictly personal (the appellant’s two main witnesses admitted that without the appellant’s personal participation the value of the goodwill would have been minimal), Judge Thorson P concluded that the transferable value of the goodwill was negligible and dismissed the appeal.

Earlier decisions and Thorson, P’s comments about the nature of goodwill were cited above.

(2) Consolidated Laundry & Cleaning Services Limited v MNR, 21 Tax ABC 168; 59 DTC 45, Tax Appeal Board, by C L Snyder, Chairman.

In 1952 the appellant company sold its assets to Affiliated Laundry & Cleaning Services for $87,706.74, assuming current liabilities of $131,245.07. The financial statements included $170,428.45 for goodwill; this was established by allowing under this item all the amounts not allowed by the Department of National Revenue as depreciation. The Department’s assessment of the company stated that the depreciable assets had been sold for $101,500, allowed $10 for goodwill and added $46,793.43 to the income as recovery. The appellant maintained that the sale resulted in a loss of $116,883.77, and that consequently no amount could be allowed as recovery, particularly since the equipment had become obsolete. The appellant company, (which owned ninety per cent of the laundries and forty per cent of the dry cleaning businesses in Windsor, Ontario) maintained that its goodwill should be valued at approximately $80,000.

The appellant’s principal witnesses pointed out that a service business must evaluate its goodwill on the basis of sales volume and argued that since the gross weekly turnover was $7,700, the goodwill could not exceed $77,000 but that this figure was reasonable. The Department’s witness, on the other hand, taking into consideration the lack of working capital, the state of the equipment, the possibility of competition and the likelihood that the operation would soon have to undergo changes, found $15,000 to be a reasonable value for the goodwill. On cross-examination, he increased his estimate to $19,000.

Decision

Chairman Snyder, also taking into consideration the percentage of work in relation to the volume of sales, assigned a value of $25,000 to the goodwill. With regard to recovery, Mr Snyder, taking into consideration the fact that the equipment was still in good working condition even though it was old, found that recovery was applicable but that the amount should be established on the basis of the difference between the sale price and the undepreciated cost of the equipment after taking into consideration the figure of $25,000 for goodwill, the agreed price of the current assets, land, buildings, vehicles and improvements to be made by the tenant.

(3) Harry Rabow v MNR, 26 Tax ABC 445; 61 DTC 346, Tax Appeal Board, by R S W Fordham, Member of the Board.

In 1953, after running a business that sold electrical appliances for seven years, the appellant and his partner decided to sell their business to a newly formed company in which they were the principal shareholders. The sale price was $126,000, including $48,000 for goodwill: The amount paid to the appellant by the company for goodwill was regarded as a benefit received by a shareholder and included in the appellant’s income in accordance with subsection 8(1) of the Income Tax Act.

Decision

Because during the inquiry the respondent made an admission regarding the existence of the goodwill, and showed that it amounted to $14,187.27; and because the method used by the appellant to prove the figure of $48,000 for goodwill was somewhat empirical (three times the income for the last three years) in comparison with the method used by the respondent (the average net profit for the last five years minus the average annual withdrawals by shareholders, minus taxes at twenty per cent was capitalized at ten per cent and the amount invested by the shareholders subtracted, leaving $14,187.27 in goodwill), Mr Fordham allowed this amount as goodwill.

4. Joseph Reiss v MNR, 27 Tax ABC 412; 61 DTC 604, Tax Appeal Board, by R S W Fordham, Member of the Board.

After the incorporation of Gylyn Investments Limited, a private company, the appellant and two partners sold to this company a piece of farmland they had recently acquired. More than a year later, the vendors concluded that they had sold their land at too low a price. In order to remedy the problem, they had the company issue a promissory note for $7,500 to each of the partners, and explained these amounts as goodwill.

Decision

Because the contract was not entered into at arm’s length, the appellant and his partners were able to change it to give themselves an additional $22,500.

The appellant, who had the burden of proof, did not show that this amount represented goodwill. The parties in question had not even operated the farm. They had simply bought and resold. The appeal was dismissed.

Case cited: Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(5) Nelson T Adair v MNR, 29 Tax ABC 324; 62 DTC 356, Tax Appeal Board, by four Members.

Because of his success in selling chain saws, the appellant was known as “Mr Chain Saw of Canada’’. In 1952, as a result of this reputation, a chain saw company gave him a franchise to sell its product throughout Canada. After running the business for two years, he sold it to a company which had been formed for the purpose and in which he was the principal shareholder. The selling price was $48,000, including $20,000 for goodwill. The Department regarded this $20,000 as an advantage conferred on a shareholder.

Decision

Because the contract with the chain saw company was a contract of employment and therefore a personal contract; and because after the incorporation, that is in 1957 and 1958, the appellant’s illness caused the company to lose money, Board Member Weldon concluded that the goodwill involved was almost entirely personal. He allowed only $1,000 as transferable goodwill and dismissed the appeal for the remainder.

Board Members Snyder, Fisher and Fordham, who had heard the case with Mr Weldon, concurred in his judgment.

Case cited: Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(6) Irvin Charles Schacter v MNR, [1962] CTC 437; 62 DTC 1271, Exchequer Court of Canada, by A L Thurlow, J.

The appellant, a chartered accountant practising his profession in Winnipeg, bought from another accountant, who wanted to retire, “all the rights, titles and interests of the vendor in and to the goodwill of the accounting firm’’ operated by the vendor under the name George Loos & Co. The agreement also gave the purchaser the right to use the firm name George Loos & Co. The purchase price was set on the basis of a list of the fees paid to the vendor by his 124 clients in a year, the total being $24,505. The goodwill was valued at seventy per cent of this amount, or $17,153.50.

When the appellant filed his tax return he claimed this expenditure as an ordinary expense incurred for the purpose of gaining income under paragraph 12(1)(a) of the old Act. The Minister refused to allow this expense, alleging that under the terms of the agreement the purpose of the expenditure was the purchase of goodwill, and it was therefore a capital outlay under paragraph 12(1)(b) of the same Act.

Alternatively, the appellant alleged that though the contract provided for the purchase of goodwill, he had never purchased any goodwill, and the only thing he had received in addition to the agreement was the list of clients’ accounts. In his view, what he had received was allowable as a deduction under paragraph 12(1)(b) and under Class 8 (tangible assets not depreciable in another class).

Decision

On the basis of a long line of authority, Thurlow, J decided first that the payment was made once and for all in order to procure a lasting advantage, and that consequently the amount could not be deducted under paragraph 12(1 )(a) of the old Act. The expenditure involved came under paragraph 12(1)(b) of the same Act. Secondly, he decided that the rule concerning Class 8 did not apply, since it concerns tangible assets whereas the contract concerns goodwill. Even the list of accounts cannot be regarded as a tangible asset since according to the agreement, it is simply a part of the payment mechanism. The subject of the contract is goodwill, which is an intangible asset. The appeal was dismissed.

(7) Harold E Croteau v MNR, 36 Tax ABC 299; 64 DTC 643, Tax Appeal Board, by W O Davis, Member.

In 1954, the appellant and three associates, all highly qualified employees of the Provincial Engineering Company, left their employer to join with a fifth person, Mr Sydney L Albert, in forming a new company, company M, to engage in work similar to that done by the Provincial Engineering Co: installing machinery, electrical equipment and so on. Mr Albert supplied the capital and owned fifty-one per cent of the shares; the remaining forty-nine per cent was divided among the other four.

In 1957, when company M encountered financial difficulties and Mr Albert refused either to supply additional capital or to sell any of his shares, the appellant and his three associates formed a new company, company R, to engage in work similar to that done by company M.

An entry of $38,000 for goodwill appears in the new company’s books. The value of this goodwill was established on the basis of the previous income of company M. Promissory notes were issued to the four shareholders of company R.

In 1958 Mr Albert, who owned fifty-one per cent of the shares in company M and who was displeased by the formation of the new company, brought an action for damages on behalf of company M against company R and the four shareholders jointly. The case was settled out of court in 1959, with the defendant paying $21,000 in damages and $2,600 in court costs. For the year 1959, the Department of National Revenue assessed the appellant and his three associates on the $21,000 paid to company M by company R, basing this assessment on the fact that since the shareholders were co-defendants in the action, company R in paying the $21,000 had conferred upon them an advantage that was taxable under subsection 8(1) of the old Act as an advantage received by a shareholder.

The appellant maintained that the money was received as capital, since it constituted partial payment of the promissory note for the goodwill transferred when company R was incorporated.

Decision

Because the evidence did not demonstrate the existence of goodwill resulting from the income of company M, which continued to exist; and because, if such goodwill existed, it came from the four associates as individuals and not from company M, Mr Davis dismissed the appeal.

Cases cited: Rabow v MNR, 26 Tax ABC 445; 61 DTC 346; Losey v MNR, [1957] CTC 146; 57 DTC 1098; Reiss v MNR, 27 Tax ABC 412; 61 DTC 604; Consolidated Laundry and Cleaning Services Limited v MNR, 21 Tax ABC 168; 59 DTC 45.

(8) Jack Young v MNR, 38 Tax ABC 73; 65 DTC 242, Tax Appeal Board, by C L Snyder, Chairman.

Mr Young had been selling dry goods for twenty-nine years and operating his own business for fourteen years when, in 1961, he decided to incorporate himself and sell his business to the new company of which he was president and principal shareholder. The sale price was $54,974, which included $50,000 for goodwill. When this amount was paid by the company, the Department of National Revenue included it in Mr Young’s income as an advantage conferred on a shareholder.

Decision

Because the evidence showed that Mr Young’s business was based on a single person, namely Mr Young himself; and because the list of names of retailers who had been Mr Young’s customers since 1932 could not constitute ‘goodwill in favour of Mr Young (any goodwill involved would be a result of the merchandise sold and this would be in favour of the manufacturer), Mr Snyder dismissed the appeal.

Cases cited: Consolidated Laundry and Cleaning Services Limited v MNR, 21 Tax ABC 168; 59 DTC 45; Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(9) MNR v Ian G Wahn, [1969] CTC 61; 69 DTC 5075, Supreme Court of Canada, by five judges.

In 1962, the appellant, who was a lawyer, left the law firm of which he was a member and opened his own firm. This change was the cause of two tax problems, which formed the subject of this case.

(a) In 1962 the appellant’s new law firm suffered a loss of $6,902, which he applied against his 1961 income in accordance with paragraph 27(1)(c) of the old Act. The Minister applied it against his other income for 1962.

(b) Upon leaving his old law firm he was granted a sum of $39,589, payable over four years from 1963 to 1966, at the rate of $9,897.50 per year. In his tax return the appellant treated these payments as non-taxable, since in his view they constituted income from capital resulting both from the sale of his share of the old law firm and from the firm’s goodwill, which he had helped to build up over the years. The Minister included the $9,897.50 in 1963, alleging that, according to the agreement, the amount received referred to accumulated profits from work in progress or other work. Since the appellant calculated his income on a cash basis, the $9,897.50 received under the agreement was taxable in the year in which it was received and not in the year of the agreement.

Decision

The five judges of the Supreme Court of Canada allowed the appeal by the Minister of National Revenue, reversed the judgment of the Exchequer Court and reinstated the judgment of the Tax Appeal Board delivered by J O Weldon, a Member of the Board.

1— Losses sustained by a business during a given year must first be applied against other income for the same year. Only if the end result is a loss can paragraph 27(1 )(a) of the old Act apply.

2— The provision in the partnership agreement of the law firm concerning departure of a partner and monies to be paid to the departing partner refers, inter alia to “undrawn profits from years preceding the year of withdrawal”, and explains how these profits are shared. No sale of goodwill or of shares in the company is involved. The Court held that the provision accurately described the transaction as it occurred, and that the money received was taxable in the year in which it was received.

(I) Roine E Larson v MNR, [1970] Tax ABC 267; 70 DTC 1171, Tax Review Board, by R St-Onge, Member of the Board.

From 1950 to 1965, the appellant operated an electrical contracting business. In 1965, when he decided to incorporate the business, he had fifteen employees. Liabilities exceeded tangible assets by $10,944. The appellant estimated the value of the firm’s goodwill at $25,000. After subtracting the deficit, the company credited the difference of $14,036 to the appellant. The Department of. National Revenue regarded this amount as an advantage conferred on a shareholder under paragraph 8(1 )(c) of the old Act.

According to the appellant’s principal witness, the $25,000 figure was not based on any mathematical formula. This witness stated, in short, that after fifteen years of operation it was normal to have $25,000 worth of goodwill.

Decision

Mr St-Onge concluded that the appellant had failed to discharge the burden of proof that he bore. The appeal was dismissed.

Case cited: Losey v MNR, [1957] CTC 146; 57 DTC 1098.

(II) William H Crandall v MNR, [1974] CTC 2289: 74 DTC 1204, Tax Review Board, by K A Flanigan, Chairman.

After working as a consulting engineer in Moncton, NB for ten years, the appellant sold his business in 1961 to the new company W H Crandall & Associates (Management) Limited. He owned sixty-one per cent of the shares while his associates, H and R, owned thirty-four per cent and five per cent respectively. The appellant’s professional activities consisted mainly in providing services to municipalities. Mr H had an MSc degree in sanitary engineering, and Mr R had worked with him as his assistant since, 1951 while studying for a degree in engineering. After Mr R graduated, the appellant transferred ten per cent of his shares to him.

When the professional business was sold, a sum of $53,000 was entered on the company’s books as goodwill. This figure was arrived at by multiplying by a factor of ten a super profit calculated by Subtracting the appellant’s salary, taxes and the value of the equipment being transferred from average net income for the last four years. According to the Department of National Revenue, however, the value of the goodwill could be no higher than $9,000. This figure was also based on the average net income for the last four years but the amounts to be subtracted were increased and the super profit was multiplied by a factor of five. The Department maintained, moreover, that this goodwill was personal and therefore non-transferable.

Decision

Because the appellant had very special qualifications and because he had given his name to the company, Mr Flanigan concluded that there was a transfer of goodwill to the company and assigned this goodwill a value of $33,080, which he arrived at by accepting and using some of the Department’s figures while retaining the factor of ten.

Furthermore, on the basis of the judgments of Walsh, J in Produits LDG Products Inc v MNR, [1973] CTC 273; 73 DTC 5222, and of Gibson, J in James v MNR, [1973] CTC 457; 73 DTC 5333, in which facts subsequent to the assessment date were taken into consideration in judging the taxpayer’s intent, Mr Flanigan took into account Crandall’s conduct after the incorporation, namely the fact that he had remained in the company, in confirming the existence of the goodwill.

(12) Jack Richard Thomas v. MNR, 75 DTC 37, Tax Review Board, by R St-Onge, Member of the Board.

In 1969, the appellant sold his radiology practice to Watwell Services Limited, a newly formed company of which he was the president and principal shareholder. An entry of $30,000 appeared on the company’s books for goodwill.

The appellant had practised for three years prior to the sale. He had two offices, one near the Kitchener-Waterloo Hospital and the other in Guelph, fifteen miles away. In each office he employed two qualified and trained technicians working part-time, a full-time secretary and a clerk. At the time of incorporation the appellant made over to the company two long-term leases. More than fifty doctors sent patients to the Kitchener-Waterloo office for X-rays, which could be taken whether the appellant was present or not.

In 1970, the company paid $30,000 to the appellant. The Department of National Revenue included this amount in the appellant’s income as an advantage to a shareholder under subsection 8(1) of the old Act.

Decision

It was decided on the basis of the evidence presented that the goodwill involved was not only personal, but was also and especially goodwill of location and goodwill of services due to the well-established organization of the employees. The company’s income of $200,000 in 1969, increasing to $256,000 by 1973, showed, in Mr St-Onge’s opinion, the earning capacity represented by the organization of the business. Even if the appellant had become ill or died, this income would have continued since the company would simply have had to hire another radiologist.

The figure of $30,000 was held to be reasonable.

(13) The Saskatoon Drug & Stationery Company Limited v MNR, [1975] CTC 2108; 75 DTC 103, Tax Review Board, by A J Frost, Member.

In 1959, the appellant bought seven pharmacies. The purchase agreement included all the undertakings (leasehold interests and so on) and all assets used in the business. The purchase also included a total of $290,000 for goodwill. The appeal concerned only three of the pharmacies, involving a total cost of $207,500 for goodwill. The buyer wanted to treat this amount as subject to depreciation, whereas the vendor wished to treat it as goodwill:

Decision

Since the evidence suggested no appropriate method of calculation, Mr Frost made an arbitrary decision to allow fifty per cent of the amount as a “premium on leases purchased”, and to regard the remainder as goodwill.

(14) Robert McDonnell v MNR, unpublished (75-722), Tax Review Board, by R St-Onge, Member of the Board.

After obtaining his degree in engineering from St Francis Xavier University in Antigonish, Nova Scotia in 1964, the appellant continued to work for the Nova Scotia Department of Transport, which had been his employer since 1957. From. 1966 to 1970 he worked part time as a consulting engineer in Antigonish, while also teaching part time at the university there. His main clients were the provincial Department of Highways, municipalities and various architects. As far as organization is concerned, he had no employees other than students who assisted him. He sublet the services of sub-contractors, mainly A H Roy & Associates, which offered services in mechanical, electrical and structural engineering and in road building. In fact, the appellant had his office in the same building as A H Roy & Associates.

In 1970, he decided to sell his business to a newly formed company, McDonnell Engineering Company, of which he was the president and principal shareholder. The total selling price was $26,500, all of which was for goodwill. This figure was established by multiplying the average net income for the last five years by ten.

No tangible assets were transferred from the business to the company.

Decision

Mr St-Onge decided that there was no goodwill of location or service and no general goodwill, but only personal goodwill. The assets of A H Roy & Associates could not be taken into consideration in evaluating the goodwill.

In his view, this decision was justified by the fact that no stable organization existed. Nemo dat quod non habet, “no one can give what he does not have’’. A third party would not have paid for the goodwill of this “one-man show’’ type of business.

(15) Donald L Neu Is v MNR, [1975] CTC 2215; 75 DTC 170, Tax Review Board, by K A Flanigan, Chairman.

The appellant began as a carpenter’s apprentice in 1958 and worked for various construction companies until 1967, when he began working for himself by securing a contract to build a church. He continued to run his own business until 1970, increasing the number of his employees from two in the spring of 1967 to twenty. He did construction work for Shell and for Imperial Oil. On January 1, 1971, a company called Neuls Construction Limited was formed, and the appellant sold his business to it. An entry of $24,000 appears on the books as goodwill. When this sum was paid, the Department of National Revenue regarded it as an advantage conferred on a shareholder under subsection 15(1) of the new Act. The figure of $24,000 had been arrived at as follows:

Multiplied by factors of three and four, this excess profit gives an average of $30,000 for goodwill.

On the advice of his advisers, the appellant reduced this amount to $24,000, which was considered more normal.

Decision

Taking into consideration the organization of the business before the incorporation, which on a three-year basis gave an equity of $8,000 per year according to the figures submitted, Mr Flanigan concluded that goodwill did exist.

In calculating the amount, he took into consideration the fact that the appellant was living in a company house and that a fair average salary for the appellant would be $12,000 rather than $7,200. Subtracting this salary plus taxes from the average net income of $19,800 gave approximately $5,000, according to the Member of the Board. Because of the nature of the business, he felt that a factor of two was a fair multiplier and arrived at a figure of $10,000.

(16) Jacques Lecompte, Philip A McNeely v MNR, [1976] CTC 2127; 76 DTC 1104, Tax Review Board, by A W Prociuk, Member of the Board.

The appellants were civil engineers who had formed a company and run a business providing professional services in Rockland, Ontario since 1966. At first, they had one full-time and three or four part-time employees; in 1967, four full-time and four part-time employees; and in 1968, nine full-time employees. Eighty per cent of the business’ clients were governments and para-governmental agencies, and this clientele had been built up by means of a great deal of promotion and work well done. At the end of 1968, they had contracts in hand capable of producing fees of $200,000 spread over three years. McNeely, Lecompte & Associates Limited was then incorporated, with the appellants as principal shareholders. The business was sold to the company for $76,477, including $50,000 for goodwill. The latter figure was calculated as follows: for two years the two partners had spent twenty-five hours per week promoting the business. At $5 an hour this comes to $26,000, to which was added $5,000 spent for promotional purposes and $20,000, or ten per cent of the $200,000 in fees from current contracts, for a total of $51,000.

According to the Department of National Revenue’s witness, the figure of $20,000 accepted by the Department was reasonable in view of the fact that professional services were involved. In its assessment, the Department had accepted $20,000 as goodwill. The appellants appealed to obtain more.

Decision

Mr Prociuk found the appellants’ figures to be exaggerated and concluded that they should be happy that the Department had accepted $20,000. He held that the Department had in fact been “more than generous”, and dismissed the appeal.

5.5 On the basis of these judicial findings and the principles set out in paragraph 5.3, the Board must decide whether the goodwill of the appellant’s business in the case at bar was personal or general business goodwill.

5.5.1 Personal goodwill is goodwill that has its source and cause in an individual, without whom the business would lose a large part, if not all, of its intangible assets. One of the basic principles concerning an intangible asset is that they must be of a lasting, nature. In other words, goodwill that originates from an individual cannot have this quality of permanence. In short, it is incorrect to speak of “personal goodwill” since it simply does not comply with one of the qualification necessary to make it “goodwill”. At least, it lacks a quality necessary to make it a commercial, a transferable goodwill. And, as Judge Thorson P said in the case cited above: one thing is clear namely “that the sale of the goodwill of a business does not carry with it a right to the personal services or to the business ability of the former proprietor of the business’’.

In the case at bar, the Board feels that a substantial part of the appellant’s goodwill valued at $125,000 was personal. The appellant was in fact the heart and soul of the company. As indicated in Exhibit A-8 (referred to in paragraph 4.12), Peat, Marwick, Mitchell and Co were willing to pay the $125,000, but only on the condition that the Ducharme team be included in the transaction. The witness for the appellant, Gilles Gagne, CA, who worked for Peat, Marwick, Mitchell and Co in 1968, stated that it was very important that Mr Ducharme be part of the group transferred if the merger of the two groups was to take place. This is a clear sign of personal goodwill.

5.5.2 On the other hand, if Mr Ducharme had died at the beginning of 1969, would the organization then existing, the contracts then in progress, have contained a source of general business goodwill?

The Board believes it would. From the point of view of the organization, Mr Jean Yves Pilon, social sciences specialist, and Mr R Panet Raymond, management and staff relations specialist, with Mr Ducharme comprised the qualified professional staff in 1968. The organization also had two secretaries. In the event of Mr Ducharme’s death immediately after the incorporation, this organization, though small, would still have been functional and was therefore part of the assets. On the other hand, it had only existed for one year. Another asset item which could be added to the first, thus strengthening it, were the contracts on hand. The evidence (given in detail in paragraph 4.7) showed that in 1968 fourteen projects had been obtained or completed. The company received $454,900 in fees for ten of these. It can therefore be presumed that the fourteen contracts would have totalled at least $500,000. In his testimony,‘ the appellant stated that most of the contracts obtained before 1969 had not been completed at the time of the incorporation. He unfortunately did not provide details, even though the burden of proof was on him. Nevertheless, in view of the fact that the appellant’s organization’s gross income in 1968 was $160,000 from current or completed contracts, it can be assumed that the contracts to be completed might bring in an additional $340,000.

Should the Board also take into account the fact that during the five years following the incorporation, the company’s gross income was $1,700,000? It does not believe so. A fairly consistent line of authority does not permit the use of facts subsequent to the valuation date for the purpose of evaluating the items in question (company’s shares, goodwill and so on). Although the courts do not allow hindsight, they do allow a look at the future as of the day of valuation, thereby relying on factors already past and those still existing at that time.

In Holt v IRC, [1953] 2 All ER 1499 at page 1501, Danckwerts J stated:

It is necessary to assume the prophetic vision of a prospective purchaser at the moment of the death of the deceased, and firmly to reject the wisdom which might be provided by the knowledge of subsequent events.

Further, in Estate of Doris Kathleen Chipman Taylor v MNR (1967), Tax ABC 555; 67 DTC 405, Mr Fordham, Member of the Tax Appeal Board, quotes with approval from a volume of the British Tax Review, 1958, at page 18:

There is a tendency for some valuators to read into retrospective valuations much material which was not actually available at the required valuation date. If a retrospective valuation is required, many court judgments have indicated that hindsight is to be excluded excepting where it applies to evidence in existence or which can be reasonably assumed to have been true as of the required valuation date.

The Board believes that as at December 31, 1968, in view of the fact that $500,000 in contracts had been obtained in a period of barely twelve months and also in view of the nature of the clientele (government and para-governmental agencies), it was not presumptuous to foresee an increase in the income of an organization providing the kind of professional services offered by Raymond Ducharme et Associés.

Lastly, the evidence showed that most of the contracts were obtained following tenders. The company incorporated in 1969 could also submit tenders and obtain contracts.

If Mr Ducharme had died shortly after the incorporation, would the company not have been able to hire another management consultant? In principle, yes, since the mechanism was already in place and the contracts simply had to be completed. In practice, however, there could have been some problems in this respect. The replacement must have been someone prepared to carry on the association with Peat, Marwick, Mitchell and Co, and would have had to be approved by this company. It was to the advantage of Raymond Ducharme et Associés Inc to maintain relationship with this. international company. Could this relationship, which was an asset, be taken into consideration in determining the existence and value of the goodwill of Raymond Ducharme et Associés Inc? The Board does not believe so, since it was because of Raymond Ducharme as an individual that this agreement was reached in 1966 when Raymond Ducharme et Associes had little; if-any, organization. If Mr Ducharme had died after the incorporation, there is no evidence to show that another person could easily have been found to replace him. The task of replacing him would have been difficult to say the least.

The Board feels that it is the different asset items with their various pros and cons which are a source of goodwill, and this is what must be put into terms of dollars and cents.

5.6 Valuation

One point regarding goodwill on which everyone agrees is that there is no exact rule to be used in determining its value.

It is difficult to arrive at a solution with the figures used by the two parties. One party arrived at $125,000, and the other at $2,300 which might be considered personal goodwill.

The Board believes that the methods used by both parties were exaggerated. The appellant, on the one hand, multiplied the average net income or excess profit by a factor of three, four, seven or ten. This is too high for professional services. In addition, the appellant did not take into account the taxes to be subtracted. Lastly, the appellant set his salary at $13,300, which is too low. On the other hand, the respondent subtracted an exaggerated amount of $43,980 as salary and taxes. In addition, the factor 1, which was applied to the excess profit in the professional services business, was also not very realistic. The appellant’s witness referred to item 7, page 50 of lan R Campbell’s The Principles and Practice of Business Valuation where the author quotes from Dewing’s Financial Policy of Corporations. This book was published in 1953, however, and Ian R Campbell himself states after the quotation that Dewing’s factors were no longer in use. In addition, according to the description given, professional services as seen by Dewing are not necessarily the same as those offered by the appellant. The Board feels that a factor of two would be more reasonable.

By adjusting both parties’ figures, the following is obtained:

Personal goodwill must still be subtracted from this figure of $38,380. How should its value be determined?

The Board believes that more than fifty per cent of the goodwill is definitely personal. Sixty per cent seems to be a reasonable figure, which would leave general business goodwill of $15,352.

Since the Board is not totally satisfied with this calculation method, it will approach the valuation from another point of view.

The Board feels that it would be best to start with the asset items mentioned in paragraph 5.5.2 which would appear to have the most value, that is, the current contracts. The Board sets a value of $340,000 on this work, although the valuation method used is not necessarily the best. The burden is on the appellant to prove the amount. The appellant himself chose a different valuation method, however, which was his right.

In view of the fact that the figure of $340,000 at which the Board arrived is not necessarily very accurate, and that the Board feels that although Raymond Ducharme et Associés was considered an asset at the time of incorporation, it was not stable enough (having existed a mere twelve months) to easily replace Mr Ducharme and successfully complete the work in progress (there was no evidence to show it could), the Board believes that the figure should be changed from $340, 000 to $200,000.

Ten per cent of this figure, that is, $20,000, could be considered part of the goodwill.

In addition, although the weaknesses in the organization great enough to have decreased the value of the current contracts as an asset, the organization as it existed, in spite of its weaknesses, was still an asset which, when seen positively in relation to the future, could be valued at $5,000, thus bringing the total to $25,000.

The average of these two figures of $25,000 and $15,352, which were arrived at by two different methods, that is $20,125, is the amount that the Board sets for goodwill. The Board does not maintain that its method of calculating the goodwill is necessarily the best or the only method, but it is as good as any other.

In view of the fact that the approval involved only the sum of $2,000 paid in partial settlement of the purchase of goodwill in 1973, the Board allows the appeal and binds both parties to the sum of $20,125 established for general transferable goodwill.

6. Conclusion

The appeal is allowed, the transferable goodwill is set at $20,125, and the matter is referred back to the respondent for reassessment in accordance. with the above reasons for judgment.

Appeal allowed.