T-342-82
Tomenson Inc. (Plaintiff)
v.
The Queen (Defendant)
INDEXED AS: TOMENSON INC. V. R.
Trial Division, Rouleau J.—Toronto, October 22,
1985; Ottawa, May 2, 1986.
Income tax — Income calculation — Deductions — Pay
ment by insurance broker for customer lists and related docu
ments of insolvent group of agencies — Whether deductible as
current expense to produce income or payment on account of
capital — Taxpayer arguing not obtaining goodwill or going
concern — Reassessment confirmed — Accretion to income
earning structure of business — Enduring benefit — Indica
tors transaction of capital nature: (1) taxpayer's deal with
trustee in bankruptcy based on commissions for four years; (2)
Auditors' Report revealing acquisition costs charged against
revenue for four years; (3) acquisition of partners of insolvent
group eliminating competition — Income Tax Act, S.C. 1970-
71-72, c. 63, s. 18(1) (b).
The plaintiff is a Toronto insurance broker with subsidiaries
across Canada. The O'Bryan Group of insurance agencies,
which operated in Alberta and British Columbia, experienced
financial difficulties. The O'Bryan Group's credibility deteri
orated to the point where it could no longer place customers'
insurance with underwriters. Plaintiff was concerned that this
situation could have a negative impact on the entire insurance
industry. Initially Tomenson rejected approaches in respect of a
merger or acquisition but later agreed to purchase client lists of
certain offices of the O'Bryan Group. Plaintiff was to collect
outstanding receivables and remit 30% of net commission
income to the trustee in bankruptcy. Some of the lists were sold
by the trustee to competitors of plaintiff. Competitors were also
seeking out business of persons on the lists acquired by
plaintiff.
The issue herein is as to the characterization of the sum of
$322,461 paid by plaintiff for the customer lists and related
documentation. The plaintiffs submission is that it was a
current expense incurred to produce income and therefore
deductible in calculating taxable income. Plaintiff contends
that it neither acquired the O'Bryan brokerage business as a
going concern nor the goodwill formerly possessed by O'Bryan.
In support of the Minister's contention, that the payment was
on account of capital, it was argued that acquisition of the
customer lists constituted an addition to plaintiff's business
structure of enduring benefit. The Minister noted that valuable
documents, in addition to the customer lists, had been obtained
and that key O'Bryan employees had been taken on to maintain
customer contact.
Held, the reassessment should be confirmed and the action
dismissed.
There is authority for the proposition that for the outlay to
be characterized as being on account of capital, it is essential
both that the vendor be eliminated as a competitor and that the
purchaser acquire a going concern, including goodwill. Since
goodwill is dependent on a going concern, it is difficult to
conclude that the acquisition of some assets of a business in
liquidation imports the securing of goodwill.
The tests for classifying transactions as expense or capital
adopted by the courts have been "accretion to the income
earning structure of the business" and "enduring benefit". A
distinction was to be drawn between acquisition of the means of
production and the use of them. An expense can not be
considered as on account of capital if it is properly chargeable
against the receipts of the year.
In the case at bar, purchase of the lists was an outlay of
capital to the extent that it represented an asset of enduring
benefit. Since the purchase of customer lists and related docu
ments constituted the essence of an insurance agent's business,
the taxpayer would have to get over a high threshold to
establish the outlay as a current expense. Several indicators
pointed to the transaction as one of a capital nature. In
particular, plaintiffs agreement with the trustee was based on
the commissions for insurance placed over a four-year period.
The inference to be drawn was that the lists were considered a
profit-yielding asset. The plaintiffs Auditors' Report revealed
that acquisition costs were to be charged against revenue over a
four-year period. Accordingly, plaintiff could not be heard to
say that the payment was for a benefit entirely consumed in the
taxation year that the expenditure was incurred.
A further indicator of the capital nature of the transaction
was the acquisition of former O'Bryan Group partners. They
were facing personal insolvency and by agreeing to satisfy their
personal debt obligations, plaintiff was able to eliminate them
as competitors.
CASES JUDICIALLY CONSIDERED
APPLIED:
Cumberland Investment Ltd. v. The Queen (1975), 75
DTC 5309 (F.C.A.); Inland Revenue Commissioners v.
Muller & Co.'s Margarine, Limited, [1901] A.C. 217
(H.L.); Burian, W. J., et al v The Queen, [1976] CTC
725 (F.C.T.D.); The Queen v. Baine, Johnstone & Com
pany Limited (1977), 77 DTC 5394 (F.C.T.D.); British
Insulated and Helsby Cables v. Atherton, [1926] A.C.
205 (H.L.); Hinton (Inspector of Taxes) v Maden and
Ireland Ltd, [1959] 1 W.L.R. 875 (H.L.).
DISTINGUISHED:
Partykan, M.S. v. M.N.R. (1980), 80 DTC 1475
(T.R.B.); Harbord Investments Ltd. v. M.N.R. (1970),
70 DTC 1488 (T.A.B.).
CONSIDERED:
Sun Newspapers Ltd. v. Federal Commissioner of Taxa
tion (1938), 61 C.L.R. 337 (Aust. H.C.); Hallstroms
Pty. Ltd. v. Federal Commissioner of Taxation (1946),
72 C.L.R. 634 (Aust. H.C.); Comr. of Taxes v. Nchanga
Consolidated Copper Mines Ltd., [1964] A.C. 948
(P.C.); Vallambrosa Rubber Co., Limited, v. Inland
Revenue, [ 1910] S.C. 519; Tucker (Inspector of Taxes) v
Granada Motorway Services Ltd, [1979] 2 All ER 801
(H.L.).
REFERRED TO:
Canada Starch Co. v. Minister of National Revenue,
[1969] 1 Ex.C.R. 96; (1968), 68 DTC 5320.
COUNSEL:
S. E. Edwards, Q.C. and I. V. B. Nordheimer
for plaintiff.
J. Paul Malette and Nancy J. Ross for
defendant.
SOLICITORS:
Fraser & Beatty, Toronto, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
ROULEAU J.: This is an action brought by the
plaintiff who disputes the reassessment by the
defendant for the taxation year 1975. At issue in
these proceedings is the nature of a payment made
by the plaintiff in the amount of $322,461 for the
acquisition of some general insurance agency lists
of customers. The plaintiff contends that the pay
ment was an expense item properly deductible in
the calculation of its taxable income. The defend
ant submits that the expenditure was a capital
outlay and therefore not deductible in computing
the taxable income. All this pursuant to paragraph
18(1)(b) of the Income Tax Act, S.C. 1970-71-72,
c. 63 as amended and applicable in 1975:
18. (1) In computing the income of a taxpayer from a
business or property no deduction shall be made in respect of
(b) an outlay, loss or replacement of capital, a payment on
account of capital or an allowance in respect of depreciation,
obsolescence or depletion except as expressly permitted by this
Part;
The plaintiff Tomenson Inc. is an insurance
broker with its head office in the City of Toronto
and subsidiaries across Canada. It carried on busi
ness in eleven offices across Canada, including
Edmonton, Calgary, Vancouver and Prince George
in western Canada. In 1975 it acquired from the
O'Bryan Group of insurance agencies some lists of
clients along with their files for a limited number
of their offices located in the Provinces of British
Columbia and Alberta. In filing its return for the
1975 taxation year, it deducted against revenue
the monies advanced to acquire these lists. The
Minister reassessed and found that this expendi
ture was in the nature of capital.
The O'Bryan Group, loosely interrelated, was
made up of the following entities: J.T. O'Bryan &
Co., a British Columbia partnership, J.T. O'Bryan
Company, a separate Alberta partnership and the
Estate of Bass Insurance Agencies Limited; collec
tively they operated approximately sixteen offices
in the two western provinces.
During 1974 it was common knowledge within
the insurance industry that J.T. O'Bryan & Co.
was experiencing financial difficulties. The plain
tiff, because of its reputation in the industry,
having acquired numerous other agencies in the
past, was approached in early 1974 by the O'Bry-
an Group to consider a merger or an acquisition.
This offer was declined. The President of the
plaintiff company testified that it was their view
that they did not, at that particular time, have in
their employ a sufficient number of qualified per
sonnel, nor the available capital to acquire another
substantial operation. In mid-November of 1974,
because of the acute financial problems facing the
O'Bryan Group, and at the request one of the
plaintiff's officials located in the Vancouver office,
it reassessed its position. They were gravely con
cerned with a bankruptcy and the impact this
could have on the industry as a whole. At this
stage, the O'Bryan Group had lost credibility as
well as their credit with underwriters and were no
longer able to place any of their customers'
insurance.
Tomenson Inc., together with some of the major
underwriters, looked into the situation with the
ultimate aim of preventing a financial disaster
from occurring. As a result, a loose arrangement
was entered into; new premiums that were being
collected by the O'Bryan Group were transferred
to the plaintiff who in turn would place the insur
ance with underwriters. All this to avoid bankrupt
cy, provide coverage for the customers and pre
serve the industry's reputation.
This procedure could not go on forever and,
after some weeks, a Vancouver Vice-President of
Tomenson Inc. met with the principals of J.T.
O'Bryan and the underwriters, the major creditors,
to work out an arrangement and submit a proposal
to creditors. An agreement was entered into and a
trustee in bankruptcy in the service of Clarkson
Gordon & Co. was retained to oversee the
administration.
The financial statement of the O'Bryan Group
as at December 31, 1974 indicated that they had
assets and cash in the bank in the amount of
approximately $2,533,000 of which some
$2,400,000 was cash or receivables. Their liabili
ties were $4,500,000 of which some $3,775,000
were premiums payable to insurance companies.
Though they did not all go bankrupt, it is obvious
that without the proposal and the consent of the
underwriters, the various entities would have col
lapsed and the customers insured by the O'Bryan
Group would have been faced with serious
problems.
The plaintiff agreed to purchase the lists of
clients of the O'Bryan Group for the operations
that were being conducted in certain offices, three
in British Columbia and two in Alberta. They
included the major producers from the approxi
mately sixteen offices operated by the O'Bryan
Group.
A letter of intent, issued by the plaintiff on
January 17, 1975 (Exhibit P-2), undertook to take
over the lists of insurance customers, their files,
copies of issued insurance policies, expiration slips
as well as other documents relating to the custom
er. Tomenson Inc. was to collect the outstanding
receivables and in the future would pay to the
trustee 30% of the net commission income (less
return commissions) for the years 1975, 1976,
1977 and 1978 of all new and renewal insurance
premiums received from existing customers who
continued to do business with them. All of these
undertakings became part of the proposal submit
ted by the trustee and were eventually approved by
the creditors as well as the Court.
Other lists were sold by the trustee to other
companies who were competitors of the plaintiff.
The President of the plaintiff company testified
that by obtaining these lists they did not acquire
exclusive rights to deal with the customers because
competitors were also seeking them out.
The plaintiff undertook to offer some of the
partners and employees positions. Particulars of
these offers can be found in the proposal submitted
to the trustee in bankruptcy as well as the credi
tors (see Exhibits P-2 and D-3). Essentially, a
considerable number of equity holders of the
O'Bryan Group were personally liable for substan
tial sums of money. The plaintiff, through its offer,
induced the various partners to join them and if
they did so their personal obligations would be
diminished if not dissipated entirely.
Some of the employees were retained, others
went into business on their own account and some
were hired by other brokers. Some remained for a
while and left. There were no non-competition
clauses with any of the O'Bryan Group. Out of all
the offices that the former owners had occupied,
only two small spaces were rented and renegotiat
ed directly with the landlords, one in Port William
and the other in Prince George where the plaintiff
already had an office. However, because of the
increased personnel, they required additional
space.
During the subsequent years, the trustee
received approximately $1,000,000 based on the
30% net commission derived from the existing
customers that remained for the period; Tomenson
Inc. retained 65% of the clients from the original
lists.
The President of the plaintiff company testified
that success in the general insurance business was
derived from personal contact and acquisition of
lists of customers; that knowledge of an expiry
date of existing coverage was not crucial in deter
mining if one was to retain an insured.
From the evidence I have concluded that, when
acquiring an ongoing insurance agency, it is cus
tomary in the trade to pay between 1 and 1.5 times
one year's net commissions.
Plaintiff's Principal Arguments
The substance of plaintiffs argument is that the
annual payments made for the customer lists were
a current expense incurred for the purpose of
gaining or producing income and thus were not a
payment on account of capital.
In support of this submission it was argued that
all it acquired under its agreement with the trustee
was customer lists. Specifically, it contended that
the acquisition of the lists did not give the plaintiff
the exclusive right to represent any of the O'Bryan
Group customers. In fact, the plaintiff was
required to solicit the insurance business of the
customers named on the lists in competition with
other insurance brokers. It was further submitted
that the O'Bryan Group was not contractually
bound to assist the plaintiff in maintaining the
customers nor was it to refrain from competing.
Finally, plaintiff contends that it did not acquire
the insurance brokerage business as a going con
cern, nor, as a result, the goodwill formerly held by
the O'Bryan Group.
To support the contention, the plaintiff cited
several cases and articles as authority. The case
law submitted that dealt specifically with customer
lists was Partykan, M.S. v. M.N.R. (1980), 80
DTC 1475 (T.R.B.) and Harbord Investments
Ltd. v. M.N.R. (1970), 70 DTC 1488 (T.A.B.).
In Partykan (supra) the taxpayer, an officer of
a general insurance company, left the company to
start his own insurance business and in doing so
relinquished his shares in the company in return
for a copy of his customer list and related informa
tion concerning their policies. Taxpayer purchased
neither the goodwill nor the company as a going
concern. Of significance is the distinguishing
factor that both the taxpayer and his former com
pany were free to compete for the clients on that
list and on the same basis: both taxpayer and
company possessed the same information in rela
tion to the clients on the purchased list.
In the case at bar, it is clear that the O'Bryan
Group was in the process of liquidation and had
relinquished its proprietary right to its customer
lists, and was not in open competition with the
plaintiff in respect of the policies or the lists
acquired by Tomenson Inc. It is also clear that
competitors were not favoured with the particulars
and details concerning the customers' coverage.
In Harbord (supra), a general insurance agency
purchased lists of clients and copies of policies
from another insurance agency. The taxpayer did
not purchase the other company as a going con
cern. This latter point was crucial in the Tax
Appeal Board's determination that the expenditure
constituted a deductible business expense, having
been paid out for the purpose of earning income.
But of note and some importance, the vendor
offered to refrain from carrying on business for
five years in the province where the taxpayer
operated. Although this offer was gratuitous, the
taxpayer tacitly accepted the restrictive covenant.
Thus the purchase of the customer list was the
direct cause of and resulted in the effective elimi
nation of a competitor.
Harbord (supra) is open to question in light of
the Federal Court of Appeal decision in Cumber-
land Investment Ltd. v. The Queen (1975), 75
DTC 5309 (F.C.A.). Although the material facts
in that case are distinguishable from those in
Harbord, Mr. Justice Thurlow [as he then was]
stated that the effective elimination of a competi
tor was one of the critical factors in deciding
whether the acquisition of a customer list was a
capital outlay (i.e., having eliminated the competi
tor through the absorption of the business as a
going concern). Nevertheless he did not stipulate
that eliminating competition was the sole condition
to the characterization of a purchase being on
account of capital.
Defendant's Principal Arguments
In assessing the plaintiff for its 1975 taxation
year, the Minister of National Revenue submitted
that the payment of $322,461 in 1975 constituted
a payment on account of capital. He argued that
the sum represented a payment to acquire the
insurance brokerage business of the O'Bryan
Group, as well as the goodwill formerly held by the
Group; that the acquisition of the customer lists
not only constituted an addition to the business
structure of the plaintiff but was for the plaintiffs
enduring benefit.
The Minister further claimed that Tomenson
Inc. not only acquired lists of customers, but also
relevant information pertaining to the insurance
coverage, binders, applications for insurance,
renewal dates, etc. It hired key employees and
equity holders from the O'Bryan Group to main
tain contacts with the former customers.
Conclusion
Although defendant cited several cases as au
thority for its submission, in my view the Federal
Court of Appeal's decision in Cumberland (supra)
establishes the criteria in determining such cases.
In Cumberland (supra) the agency acquired a
going concern, a list of the competitor's sub-
agents, particulars of the policy holders, a cove-
nant not to compete, and paid a price based on
volume.
Although Mr. Justice Thurlow and Mr. Justice
Urie emphasized different factors in characteriz
ing the outlay as capital, both Justices seem to
consider that the elimination of the vendor as a
competitor and acquiring a going concern, which
would include goodwill, were both essential to
their characterization of the outlay as being on
account of capital.
In contrast, the plaintiff submits that the
present dispute discloses that one of the agencies
from the O'Bryan Group was bankrupt and no
doubt the others would also have met the same
fate had it not been for the proposal. It cannot be
argued that payments made by the plaintiff elimi
nated a competitor, nor can it be substantiated
that the purchase of some of the customer lists
resulted in the absorption of the O'Bryan Group as
a going concern, and thus support any transfer of
goodwill.
In Inland Revenue Commissioners v. Muller &
Co.'s Margarine, Limited, [1901] A.C. 217 (H.L.)
Lord Lindley commented on the connectivity be
tween the concept of "goodwill" and that of "busi-
ness as a going concern"; at page 235 he noted:
Goodwill regarded as property has no meaning except in
connection with some trade, business, or calling. In that con
nection I understand the word to include whatever adds value
to a business by reason of situation, name and reputation,
connection, introduction to old customers, and agreed absence
from competition, or any of these things, and there may be
others which do not occur to me. In this wide sense, goodwill is
inseparable from the business to which it adds value, and, in my
opinion, exists where the business is carried on. [Emphasis
added.]
Goodwill appears to be dependent upon a going
concern. Therefore, it is difficult to accept the
proposition that the acquisition of some assets of a
business, in the process of liquidation, imports the
acquisition of goodwill.
Counsel for both the plaintiff and the defendant,
through their respective submissions, have
attempted to extract from the facts certain fea
tures that would categorize this transaction as
being either one of expense or one of capital. This
appears to be an almost insurmountable task.
Indeed, as Mr. Justice Collier noted in Burian,
W. J., et al y The Queen, [1976] CTC 725
(F.C.T.D.) in relation to the characterization of an
outlay incurred to acquire a customer list (at page
730):
The appellations "purchase of a business as a going concern",
"purchase of goodwill", or purchase of a "list of customers"
neither clarify the dispute nor provide the solution.
This is particularly true when one is dealing with
the acquisition of a customer list from a group of
agencies in the process of liquidation. It is one
thing to use appellations and characterize them as
a purchase of a customer list; it is another matter
to apply the terms to the purchase of some custom
er lists of a business that is in the process of
liquidation. On the other hand one cannot simply
disregard them because the transaction involves an
insolvent business.
It becomes relevant to examine those general
principles enunciated in several cases where the
courts have established guidelines to distinguish
expenditures on revenue account as opposed to the
capital account.
The Nature of Capital
In an examination of the jurisprudence classify
ing transactions as being either an expense or
capital, it appears that the courts have adopted
either an "accretion to the income earning struc
ture of the business" test or an "enduring benefit"
test.
The concept that a capital outlay is that which
is expended to acquire a substance (tangible or
intangible) inherently productive of income, i.e., a
substance from which income arises, has its origin
in the classic dictum of Mr. Justice Dixon in Sun
Newspapers Ltd. v. Federal Commissioner of
Taxation (1938), 61 C.L.R. 337 (Aust. H.C.) (at
pages 359-360) wherein he noted:
The distinction between expenditure and outgoings on reve
nue account and on capital account_ corresponds with the
distinction between the business entity, structure, or organiza
tion set up or established for the earning of profit and the
process by which such an organization operates to obtain
regular returns by means of regular outlay, the difference
between the outlay and returns representing profit or loss. The
business structure or entity or organization may assume any of
an almost infinite variety of shapes and it may be difficult to
comprehend under one description all the forms in which it may
be manifested [...] But in spite of the entirely different forms,
material and immaterial, in which it may be expressed, such
sources of income contain or consist in what has been called a
"profit-yielding subject", the phrase of Lord Blackburn in
United Collieries Ltd. v. Inland Revenue Commissioners,
(1930) S.C. 215, at p. 220. [Emphasis added.]
This characterization of capital expenditure was
held to be applicable to the Canadian Income Tax
Act in Canada Starch Co. v. Minister of National
Revenue, [1969] 1 Ex.C.R. 96; (1968), 68 DTC
5320.
Mr. Justice Dixon elaborated on the dichotomy
between that which is an outlay on account of
capital and that which is a revenue expenditure. In
his dissenting judgment in Hallstroms Pty. Ltd. v.
Federal Commissioner of Taxation (1946), 72
C.L.R. 634 (Aust. H.C.) (at page 647) he wrote:
[T]he contrast between the two forms of expenditure
corresponds to the distinction between the acquisition of the
means of production and the use of them; between establishing
or extending a business organization and carrying on the
business; [...] between an enterprise itself and the sustained
effort of those engaged in it. [Emphasis added.]
In the decision of the Privy Council in Comr. of
Taxes v. Nchanga Consolidated Copper Mines
Ltd., [1964] A.C. 948, Viscount Radcliffe indicat
ed his approval of the test enunciated by Dixon J.
in Sun Newspapers (supra) and Hallstroms
(supra) when he stated (at page 960):
Again, courts have stressed the importance of observing a
demarcation between the cost of creating, acquiring or enlarg
ing the permanent (which does not mean perpetual) structure
of which the income is to be the produce or fruit and the cost of
earning that income itself or performing the income-earning
operations. Probably this is as illuminating a line of distinction
as the law by itself is likely to achieve .... [Emphasis added.]
The second test of characterization that has
been adopted by the courts — the "enduring bene
fit" test — has its source in the decision of the
House of Lords in British Insulated and Helsby
Cables v. Atherton, [1926] A.C. 205 wherein Vis
count Cave L.C. enunciated (at pages 213-214)
the "enduring benefit" test:
But when an expenditure is made, not only once and 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. [Emphasis
added.]
Although Viscount Cave did not elaborate on
the meaning of the expression "enduring benefit",
in commenting on the "once and for all" test
enunciated by Lord Dunedin in Vallambrosa
Rubber Co., Limited, v. Inland Revenue, [1910]
S.C. 519, at page 525, he did determine (at page
213) that, notwithstanding the lump sum method
of payment in securing an asset or advantage, such
payment would not be characterized as an expen
diture on capital account if that sum "would be
properly chargeable against the receipts for the
year".
One can infer from Viscount Cave's dictum that
if the benefit or value derived from the acquisition
of an asset is consumed in the year in which it was
acquired, or over at least a two-year period, the
cost of the acquisition of the asset or advantage
might reasonably be considered as a revenue
expenditure.
This line of reasoning was pursued in the deci
sion of the House of Lords in Hinton (Inspector of
Taxes) v Maden and Ireland Ltd, [1959] 1
W.L.R. 875 wherein Lord Reid, in commenting on
the demarcation between an expenditure on reve
nue account and a capital outlay, stated (at page
886):
I claim no expert knowledge of accountancy or of business
methods, and the only practical difference that occurs to me—
and none other was suggested in argument—is that if you treat
a sum as capital expenditure you do not write it all off in one
year or set it all against the income of one year, whereas if you
treat it as revenue expenditure the whole of it is set off against
the revenue of the year when it is expended.
I would suppose that accounts are intended to have as close a
relation as is reasonably practicable to reality. If you buy plant
which still has a substantial value at the end of the year I would
suppose that that value ought to be reflected somewhere in the
accounts. If the cost is treated as capital expenditure there
seems to be no difficulty in writing off that cost year by year as
the plant wears out or becomes obsolete, but if the cost is
treated as revenue expenditure I do not know what item in the
next year's accounts would reflect the continuing value of the
plant. I do not suggest that this distinction is or should be an
inflexible rule. There may, for all I know, be good reasons for
not following it in particular cases, but in the absence of any
indication of any specialty in this case I am inclined to
approach this case in that way. [Emphasis added.]
In relation to the case at bar, it may therefore
be stated that to the extent that the plaintiff's
acquisition from the trustee of selected customer
lists of the O'Bryan Group constitutes an accretion
to the income earning structure of plaintiff's busi
ness, or constitutes an asset that is of an enduring
benefit within the meaning of Viscount Cave's
dictum in the Atherton case, the purchase price of
the acquisition is not merely a revenue expenditure
but is an outlay of capital within the meaning of
paragraph 18(1)(b) of the Income Tax Act.
Analysis of Transaction
As stated previously, the characterization of the
acquisition of a customer list as being on capital or
on revenue account is not furthered—in the case of
lists purchased from a business in the process of
liquidation—by the mechanical application of such
concepts as: "Purchase of Business as Going Con
cern", "Presence of Restrictive Covenant", etc.
Indeed, the jurisprudence indicates that the sub
stance, and not the form of the transaction is the
critical factor in determining the characterization
of an outlay. Thus in The Queen v. Raine, John-
stone & Company Limited (1977), 77 DTC 5394
(F.C.T.D.) (at page 5396) Addy J. noted, in con
sidering the issue of whether or not the purchase of
a customer list was on capital account, that:
In considering the issue one must look at the true nature and
substance of the transaction not merely at the words used by
the parties in describing it. [Original emphasis.]
In applying the law to the facts of plaintiff's
transaction it is relevant to note the pronounce
ment by Lord Wilberforce in Tucker (Inspector of
Taxes) v Granada Motorway Services Ltd, [1979]
2 All ER 801 (H.L.) (at page 804) wherein he
stated:
It is common in cases which raise the question whether a
payment is to be treated as a revenue or as a capital payment
for indicia to point different ways. In the end the courts can do
little better than form an opinion which way the balance lies.
[Emphasis added.]
Given the fact that the purchase of customer
lists together with relevant insurance policies and
other related documents constitutes the very
essence of an insurance agent's business, the
threshold that must be crossed by the taxpayer in
having the balance tip in favour of characterizing
the outlay as revenue is necessarily high.
Examining the substance of the transaction be
tween plaintiff and the trustee, one may note
several indicators that point to the determination
of the transaction as being of a capital nature
within the meaning of the "enduring benefit" or
"profit-yielding subject" test.
The plaintiff purchased several customer lists at
an agreed upon valuation of 30% of the net com
mission earned per annum relating to new and
renewed insurance placed for customers on those
lists for the four-year period commencing March
19, 1975 and ending April 29, 1979. Thus, the
plaintiff chose to assess the value of the customer
lists secured in the agreement with the trustee on
the basis of a four-year open format wherein 120%
of the future net commission earned constituted
consideration for the purchased lists—payments
being deferred until actual commissions (profits)
per annum were ascertained.
Indeed, it is not open to the plaintiff to argue
the contrary. The method of payment chosen was a
reflection of its inability to anticipate whether in
fact the customer lists were a source of future
earning capability since it proposed to contribute
an amount of 30% of net commission income from
clients on purchased customer lists over the agreed
four-year period on the basis of estimated commis
sions of $7,000,000 (Exhibit D-3).
In effect the plaintiff appears to have employed
a capitalization multiple of 1.2 as the basis for
establishing a value for anticipated or prospective
earnings to be derived from the acquisition. In
fact, William E. Toyne, President of the plaintiff
company, did testify that it was standard practice,
in purchasing an insurance agency, to apply a
multiple of 1.0 to 1.5 of the prospective earnings of
an agency in submitting a proposal of acquisition.
The proposed and agreed method of payment
provides an indicator, or at least an inference that
the purchased customer lists were considered in
the nature of a profit-yielding asset capable of
projected earning capacity.
The calculation of consideration on the basis of
total anticipated future earnings over the duration
of the agreement with the trustee provides a
second indicator that the nature of the asset
acquired was capital. As stated in the Auditors'
Report of the plaintiff's organization—as of
December 31, 1975—expenditures associated with
the acquisition of the customer lists (i.e. 30% net
commission earned) were to be charged against
related revenue over the four-year period of the
agreement as and when those expenditures became
due. While the reporting of revenues gained and
related expenses incurred in the same accounting
period as a means of determining net income for
that period is merely the application of the gener
ally accepted accounting principle of "matching",
it is significant to note that the procedure
employed "effectively amortizes the cost of such
lists over their estimated four-year useful life". In
effect the cost of acquiring the customer lists in
1975 was to be ascertained in and allocated to
future accounting periods when the benefits
associated with the purchase of those assets were
to be realized.
Consequently it is not open to the plaintiff to
argue that the sum of $322,461 payable to the
trustee as consideration for the O'Bryan Group
customer lists for the 1975 taxation year constitut
ed a revenue expenditure that brought a benefit
that was entirely consumed in the taxation year
that the expenditure was incurred.
Thus, to the extent that only part of the benefit
associated with the acquisition in 1975 of the
customer lists was consumed in that taxation year,
it is clear that the plaintiff's agreement with the
trustee resulted in the purchase of an asset of
"enduring benefit" within the meaning of that test
as enunciated by Viscount Cave in the Atherton
case (supra) and by Lord Reid in Hinton y Maden
(supra).
A third indicator that it was a capital outlay can
be noted by the significant importance the plaintiff
placed on the addition, to its team, of a number of
former equity holders in the O'Bryan Group. The
evidence supports the notion that it was crucial to
the acquisition of the customer lists that former
partners of the O'Bryan Group be retained.
Although the plaintiff anticipated several millions
of dollars in insurance commission revenues over
the four-year period, this could only be accom
plished and assured by the cooperation of those
former O'Bryan Group partners selected to remain
in the on-going operations (Exhibit D-3).
As noted in testimony by the President of the
plaintiff corporation, it placed a high priority in
securing the addition of certain equity holders
from the O'Bryan Group. Business connections are
maintained and developed in the insurance busi
ness by personal contact with various clients. To
this end, insurance agencies attempt to hire agents
with good reputations as well as skills and abilities
in the insurance field.
It is clear that the acquisition of key personnel
of the insolvent O'Bryan Group was a crucial
factor to complete the transition of the customer
lists and related insurance policies into a profit-
yielding subject of the plaintiff company.
As a means of obtaining their services the plain
tiff offered—which offer was subsequently accept
ed and incorporated into the terms of the agree
ment between the plaintiff and the trustee—to
redistribute 5% (i.e., 1/6 of 30%) of the net com
missions earned over the duration of the agree
ment to those key personnel desired. Of signifi
cance is the fact that the equity holders sought by
the plaintiff were personally in debt to an amount
equal to approximately $875,000. In fact several of
the partners were facing personal insolvency. Thus
pursuant to the proposal in bankruptcy (Exhibit
D-6)—which proposal formed the basis of the net
commission income distribution scheme found in
the agreement between plaintiff and the trustee—a
loan not in excess of $900,000 was extended to the
desired equity holders of the O'Bryan Group to
satisfy their personal debt obligations in consider
ation of which those former partners would repay
$100,000—the remainder to be forgiven over the
four-year duration of the agreement. In turn, the
debt of $100,000 would be extinguished over the
duration of the agreement with the trustee on the
basis of the receipt of 5% of net commission
income from new and renewed insurance placed or
arranged with the acquired customers.
A substantial majority of the equity holders,
crucial to the acquisition, accepted the plaintiffs
offer of employment as proof of the success of this
part of the proposal.
Although the former partners were not contrac
tually liable to accept employment and remain
employees of the plaintiffs organization, their per
sonal financial liabilities as well as an attractive
financial package aimed at substantially reducing
their personal debt load afforded the plaintiff an
effective mechanism with which to eliminate the
competition of former O'Bryan Group partners
and a means of absorbing the personnel for the
advantage of the Tomenson group.
All these factors taken together indicate to me
that the sum of $322,461 constituted a payment on
account of capital.
I hereby confirm the reassessment by the Minis
ter of National Revenue for taxation year 1975.
The action is dismissed with costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.