T-2501-75
The Queen (Plaintiff)
v.
Saskatoon Drug & Stationery Company Limited
(Defendant)
Trial Division, Mahoney J.—Saskatoon and
Toronto, June 12-14, and 20-22; Ottawa, July 20,
1978.
Income tax — Income calculation — Deductions — Capital
cost allowance — Amount claimed for value of goodwill as
property included in leasehold interest — Whether or not sum
should be characterized as having been paid out for leasehold
interest — Secondarily, whether or not legal and other
expenses incurred in transaction properly disallowed —
Income Tax Act, S.C. 1970-71-72, c. 63, s. 11(1 )(a) — Income
Tax Regulations, SOR/54-682, s. 1100(1) as amended by
SOR/64-483.
Defendant negotiated with a group of companies and
individuals, collectively known as McNeill, to buy its drug store
operations in Regina. Several of the businesses were located on
rented premises. The executed agreement for purchase and
sale, in describing the assets being passed, set out the goodwill
of the businesses together with certain rights and intangible
assets in a separate clause for more particularity. A subsequent
clause set the value of those assets at $290,000, but did not
attribute the value among the assets described. Defendant,
after closing, sold the inventories and fixed assets of three of
the stores acquired for the price paid and goodwill, reducing its
outlay for goodwill to $207,500. Plaintiff disallowed defend
ant's claim of $207,500 "goodwill" as property, a leasehold
interest, for the purpose of capital cost allowance under para
graph 11(1)(a) of the Income Tax Act. The primary issue is
whether or not that sum should be characterized as having been
paid out for a leasehold interest. The secondary issue is whether
or not the legal and other expenses incurred by the defendant in
the transaction were properly disallowed as deductions from
income as having been incurred on account of capital or
whether the deduction ought to be allowed, or alternatively,
whether the amount ought to be added to the capital cost of the
leasehold interests.
Held, the action is dismissed. The Court is unable to divorce
the goodwill of a location from the other advantages accruing
to the person entitled to possession of that location. When it
accrues under a lease, it is part of the leasehold interest and the
price paid for it is part of the capital cost of that leasehold
interest. Defendant's 1969 and 1970 income tax returns will be
referred back to the Minister for reassessment on the basis that
$187,500 was the capital cost of the two stores in respect of
which defendant is entitled to claim capital cost allowance. The
remaining $20,000 in issue was not proved to have been paid
for any leasehold interest. There is no basis for disturbing the
assessment disallowing the claimed deduction of the expenses
incurred in negotiating the McNeill transaction.
Chissum v. Dewes (1828) 38 E.R. 938, referred to.
ACTION.
COUNSEL:
W. A. Ruskin for plaintiff.
F. J. Matthews and G. R. Baker for
defendant.
SOLICITORS:
Deputy Attorney General of Canada for
plaintiff.
Robertson, Lane, Perrett, Toronto, for
defendant.
The following are the reasons for judgment
rendered in English by
MAHONEY J.: This action results from the
plaintiff's disallowance of the defendant's claim of
$207,500 "goodwill" as property, namely a lease
hold interest, for purposes of capital cost allowance
under paragraph 11(1) (a) of the Income Tax Act,
R.S.C. 1952, c. 148, as it stood in 1969 and 1970.
11. (1) Notwithstanding paragraphs (a), (b) and (h) of
subsection (1) of section 12, the following amounts may be
deducted in computing the income of a taxpayer for a taxation
year:
(a) such part of the capital cost to the taxpayer of property,
or such amount in respect of the capital cost to the taxpayer
of property, if any, as is allowed by regulation;
The deduction is claimed under paragraph
1100(1)(b) of the Income Tax Regulations.
1100. (1) Under paragraph (a) of subsection (1) of section
11 of the Act, there is hereby allowed to a taxpayer, in
computing his income from a business or property, as the case
may be, deductions for each taxation year equal to
(b) such amount, not exceeding the amount for the year
calculated in accordance with Schedule H, as he may claim
in respect of the capital cost to him of property of class 13 in
Schedule B;
Class 13 property is "Property that is a leasehold
interest except ...". None of the exceptions is in
play. The primary issue is thus whether or not the
$207,500 ought to be characterized as having been
paid for a leasehold interest. The secondary issue
is whether or not the legal and other expenses
incurred by the defendant in the transaction in
question were properly disallowed as deductions
from income as having been incurred on account
of capital or whether their deduction ought to be
allowed or, alternatively, whether the amount
thereof ought to be added to the capital cost of the
leasehold interests.
During 1967, the defendant entered into
negotiations with a group of individuals and com
panies, which will be collectively referred to as
"McNeill", for the purchase from McNeill of
three retail drugstores in Regina, Saskatchewan,
one in premises owned by McNeill, the Broad
Street store, and two in premises leased by
McNeill, the Pharmaceutical Centre and the
South Albert Street store. McNeill operated other
retail drugstores, as well as wholesale operations
serving them, in Regina and Calgary, which the
defendant was not interested in buying. The
defendant then had three retail stores of its own in
Regina and others in Saskatoon. The defendant
thought it had a deal but McNeill refused to close
early in 1968. In November, 1968, Cunningham
Drug Stores Ltd. made McNeill an offer for all of
its retail stores which was unacceptable. McNeill
then indicated to the defendant that it was pre
pared to negotiate the sale of all of its Regina
operations.
In the circumstances, the defendant insisted on a
written offer from McNeill before investing time
and money in further negotiation. The original
draft offer to sell, apparently prepared by the
defendant, contemplated the payment of a "premi-
um" in addition to the price of inventories and
fixtures. The premium was to be divided between
"Amount for purchase of leasehold interest to be
." and "Balance of premium amounting to .. . to
be paid in form of Good Will". The next draft
offer to sell was submitted by letter of December
2, 1968, by McNeill to the defendant. It proposed
"Goodwill shall be ... $300,000 ...". It proposed
no amount for purchase of leasehold interests. The
executed offer to sell, dated December 6, 1968,
contemplated the sale of the "A. Inventory ..." at
a variety of discounts off retail prices, "B. Fixed
Assets ..." at book value and "C. Goodwill."
Payment for the inventory and fixed assets was to
be within three days of the contemplated January
31, 1969, closing and it went on:
(c) The sum of $290,000 on account of good will repayable
over a period of five (5) years at the rate of $58,000 per year
with interest. It then went on to provide:
3. This offer shall be subject to further conditions and
provisions as follows:
(1) That the purchaser is able to obtain satisfactory leases to
the premises to be acquired and the vendor takes the neces
sary steps for the assigning of its leases now held by the
vendor to the purchaser.
(2) That leases will be given to the vendor [sic] of property
owned by the vendors and upon which certain of its drug
store businesses are located and such leases shall be in like
terms (excepting for rent, options for renewals, and term of
lease) as the lease existing between Humford Realty Ltd.
and McNeill's Drug Stores Ltd. dated November 22, 1965.
It is further understood that in such leases if due to operation
of business, the purchaser's rent due falls to the basic rate of
$2.50 per square foot, then in that event, there shall be added
to the basic rent of the premises any increase in taxes over
the 1968 level on a pro rata basis to the area occupied by the
purchaser and to be paid on a monthly basis.
There are additional conditions and provisions
enumerated but (1) and (2) are the only ones
material to this action.
The Humford lease was the lease of the South
Albert store. Considering the exceptions of rent,
term and renewal options, it is plain that at this
stage no agreement had been reached as to the
leases to be concluded between McNeill and the
defendant in respect of the three premises owned
by McNeill.
By January 8, 1969, when McNeill's solicitor
transmitted a draft lease, the essential terms had
been agreed upon. The Broad Street store was to
be subject to a five-year lease with five successive
five-year renewal options and the other two were
to be five-year leases with four successive five-year
renewal options. All renewal leases were to be on
the same terms and conditions as the original
leases. A minimum rent of $2.50 per square foot
per annum against 4% of annual gross sales was
proposed and, as contemplated in the offer to sell,
the tax escalator would become operative only
when gross sales were so low that no percentage
rent was payable. While the proposed term of the
Broad Street lease changed during negotiations,
the proposed rent did not.
By letter of January 24, 1969, the defendant's
solicitor sent it a draft of an agreement intended to
reflect the entire transaction. It provided, in its
material parts, as follows:
1. ... the Vendor agrees to sell and the Purchaser agrees to
purchase all the undertakings, property and assets belonging to
or used in connection with the said businesses of the Vendor, as
a going concern, ... including without limiting the generality of
the foregoing:
(a) The goodwill of the said businesses, together with the
exclusive right to the Purchaser to represent itself as carrying
on the said businesses in continuation of and in succession to
the Vendor and the right to use any words indicating that the
said businesses are so carried on including the right to use
the name "McNeill's Drugstores Ltd." or any variation
thereof as part of the name of or in connection with the said
businesses or any part thereof carried on or to be carried on
by the Purchaser;
(c) The full benefit of all unfilled orders received by the
Vendor in connection with the said businesses and all other
contracts, engagements, benefits and advantages which have
been entered into by the Vendor or to which it is or can be
entitled on account or in respect of the said businesses.
3. The purchase price payable for the assets hereby agreed
to be purchased and sold shall be the aggregate of the values of
all classes of assets as hereinafter set forth.
(a) The assets described in paragraph 1(a) and 1(c) hereof
for the sum of $290,000.00.
The draft also reflects an apparent agreement
postponing the closing date.
A memorandum prepared by Mr. H. C. Pinder,
the defendant's secretary-treasurer, and com
municated by telephone on February 7, 1969, to its
solicitor contains the following material comments.
(a) Draft Agreement
2. have inserted in price section page 2(a) ["and lease
hold interest in leased properties, and the right to lease
in owned properties at a rental rate not to exceed 4% of
sales"] (intangibles)
(b) Lease-5th & Pasqua
6. Page 14—FIRE. if lease is terminated under total
destruction—tenant should recover pro rata portion of
N.B. purchase price over full lease & option periods—(i.e.
cannot insure the premium paid on purchase over and
above value of assets,—or new lease on rebuilding—or
option to buy property.
On January 30, 1969, having apparently con
sidered the draft after amendment to reflect Mr.
Pinder's instructions, McNeill's solicitor wrote the
defendant's solicitor. He stated, inter alia:
5. Page 4, Paragraph 3, Sub-paragraph (a)
The Vendor requires that the sum of $290,000.00 be refer-
able exclusively to the term good will and nothing else.
In the margin, apparently in Mr. Pinder's hand
writing is an underlined "no". On February 28, the
defendant's solicitor reported by letter on a series
of meetings with McNeill's solicitor including, in
reference to the January 30 letter, the following:
Paragraph 5—refused.
It also appears that McNeill had agreed in princi
ple to Mr. Pinder's suggestion as to the fire clause.
They were prepared to commit themselves, at their
option, to rebuild within 12 months of destruction
or to repay a pro rata portion of the goodwill
payment.
At this point, Mr. Pinder wrote himself the
following memorandum:
Inserting "Leasehold Interest" in para 1 of agreement only,
before (a) of that paragraph. Check with auditor.
The auditor was consulted and, it appears, the
specific inclusion of the leasehold interests in the
consideration for the $290,000 payment was no
longer pressed by the defendant but the idea re
flected in the memorandum was accepted by
McNeill.
Negotiations did continue as to the fire clause.
The defendant wanted the provision to apply for
ten years; McNeill held out for five. The basis of
their position was explained by their solicitor to
the defendant's, as reported in his letter of March
3rd, 1969, to his client:
Mr. Goetz explained this to me on the grounds that after five
years you would have recovered the total amount of the good-
will out of profits; and that the formula for determining the
goodwill was based on two and one-half times the average
profits for the immediate preceeding [sic] two years.
In the result, on March 28, 1969, the agreement
was executed providing for the sale effective April
1. The material provisions follow:
1. ... the Vendor agrees to sell and the Purchaser agrees to
purchase all the undertakings, (leasehold interests and right to
enter into leases as set forth on page (7) hereof),* and assets
belonging to or used in connection with the said businesses of
the Vendor, as a going concern, ... including without limiting
the generality of the foregoing:
(a) The goodwill of the said businesses, together with the
exclusive right to the Purchaser to represent itself as carrying
on the said businesses in continuation of and in succession to
the Vendor and the right to use any words indicating that the
said businesses are so carried on including the right to use
the name "McNeill's Drug Stores" or any variation thereof
as part of the name of or in connection with the said
businesses or any part thereof carried on or to be carried by
the Purchaser;
3. The purchase price payable for the assets hereby agreed to
be purchased and sold shall be the aggregate of all classes of
assets as hereinafter set forth.
(a) The assets described in paragraph 1(a) hereof for the
sum of $290,000.00.
6. The purchase price ... shall be paid ... as follows:
(a) The sum of $10,000 shall be paid to the firm of Goetz &
Murphy, Regina, Saskatchewan, in trust to be retained by it
until the time of closing, upon the Vendor providing the
Purchaser with valid and binding Assignments of Leases in
favour of the Purchaser with proper consents of the Lessors
to such assignments covering the following real properties:
(i) McNeill's North Plaza Drug .. .
(ii) McNeill's Pharmaceutical Centre ...
(iii) McNeill's South Albert Drug ...
(iv) McNeill's Highland Park Drug...
and the Vendor providing the Purchaser with leases of the
following real property owned by the Vendor at:
(i) McNeill's Rexall Drug ...
(ii) McNeill's Broad Street Drug ...
(iii) McNeill's Lorne Drug ...
on the terms and subject to the conditions set in the draft
leases hereunto attached and marked as Schedules "A", "B"
and "C".
The foregoing seven locations, and I have omitted
only municipal addresses, are the "leasehold inter
ests and right to enter into leases as set forth on
page (7)" which are referred to in the bracketed
addition to clause 1. That addition substituted, in
the executed agreement, those words for the word
"property", which appeared in the earlier drafts of
clause 1.
*Emphasis added.
In addition to the tangible assets, inventory and
fixtures, for which $353,980 was paid, the defend
ant acquired a number of rights and intangible
assets, to which no portion of the $290,000 balance
of the purchase price was specifically attributed.
There were, of course, the leases assigned or grant
ed by McNeill. The vendors severally agreed not
to compete for five years. There was a right of first
refusal, apparently for five years, to buy con
venience stores known as "The Happy Shopper"
operated in Regina by McNeill. There were non-
assignable rights of first refusal, in the leases,
during their terms including renewals, to buy the
real property leased, in whole or part, as the
Rexall, Broad Street and Lorne stores.
As to the so-called "fire clause", the agreement
stipulated that, in the event of termination due to
total destruction prior to April, 1974, provided the
defendant was still carrying on the business pur
chased on the premises,
... the Vendor shall pay to the Purchaser by way of liquidated
damages in respect of any such lease the following:
(a)(i) Lease
Covering McNeill's Rexall Drug ...
(ii) Damages to be Paid
The proportionate share of $30,000.. .
(b)(i) Lease
Covering McNeill's Broad Street Drug ...
(ii) Damages to be Paid
The proportionate share of $120,000.. .
(c)(i) Lease
Covering McNeill's Lorne Drug ...
(ii) Damages to be Paid
The proportionate share of $35,000..
The "proportionate share" was the number of
whole months remaining in the term at the date of
total destruction divided by 60.
Immediately upon closing, the defendant sold
the inventories and fixed assets of the Lorne,
Rexall and Highland Park stores for the price paid
and, in addition, for goodwill an aggregate of
$82,500, thus reducing its outlay for goodwill from
$290,000 to the $207,500 in issue. It got $40,000
in respect of the Lorne store rather than the
$35,000 assigned to it in the fire clause; $30,000 in
respect of Rexall, the same as the assigned amount
and $12,500 in respect of Highland Park. At the
end of 1969, the defendant sold the North Plaza
store which was leased on a month to month basis
and, in respect of which, no goodwill was recov
ered. In addition to the seven retail stores, two
wholesale operations, one for pharmaceuticals and
the other for other merchandise, were bought.
These operated in the premises of the Lorne store.
The defendant had no use for the operations per se
and simply absorbed the inventories into its own
wholesale operations. There was no leasehold in
terest attached to them. Thus, by the end of 1969,
the defendant retained only the three retail stores
it had originally wanted.
The Pharmaceutical Centre had opened during
1967. The annual rental (there was no percentage
rent) was well over $10 per square foot. It is not
argued that any part of the $207,500 was paid for
a leasehold interest in respect of it. The Broad
Street and South Albert stores remain.
Before dealing with them, I should note that the
defendant, which operates its own drugstores
under the name "Pinder", did not really want to
use the McNeill name although it clearly wanted
it removed from the Regina marketplace. It con
tinued to use the McNeill name only until the next
telephone directory was issued, apparently about a
year after the purchase. In the interval, it adver
tised its own Regina stores and those retained from
the McNeill purchase, under the joint name
"Pinder-McNeill". With the new telephone direc
tory, signs were changed and the McNeill name
disappeared completely.
The plaintiff called, as an expert witness, James
P. Catty, and the defendant called Clifford W.
Worden. Both are chartered accountants and
Catty is an experienced business valuer. Their
conclusions are totally contradictory. Worden con
cluded that the earnings of the McNeill operations
sold would not justify payment of any part of the
$290,000 while Catty concluded that the earnings
did justify a payment for goodwill he calculates at
$283,000. While an earnings based valuation was
Worden's only approach, Catty took other ap
proaches to the valuation of the goodwill attaching
to the subject matter of the sale, all of which led
him to conclude that $290,000 was a fair figure for
goodwill. Neither report is of assistance in resolv
ing the initial question of whether or not any part
of $290,000 was paid, not for goodwill, but for the
Broad Street and/or South Albert leases. Wor-
den's report is of no assistance in answering any of
the other questions that appear pertinent to me.
Two hundred and ninety thousand dollars was paid
for something and I am satisfied, after hearing
Mr. Pinder, that the defendant would not have
paid it for something not approaching $290,000 in
value.
The South Albert store, of approximately 2,500
square feet, is located in a shopping centre, the
anchor tenant of which is a national chain super
market, on the main north-south artery through
Regina. The term of the lease assigned was for ten
years from January 1, 1966. The minimum annual
rent was $6,000 ($2.40 per square foot) against 5%
of gross sales. Sales of tobacco products, soft
drinks, magazines, utility collections and sub-post-
office transaction are excluded. Sales in 1967 and
1968 had been sufficient to bring the percentage
rent provision into operation. A single five-year
renewal option required renegotiation of the rent.
The document is a standard shopping centre lease
calling for the tenant to pay, in addition to rent,
for such things as utility charges, common area
maintenance and municipal tax increases over
1966.
Mr. Pinder testified that he considered the
South Albert lease to be a favourable one, from
the tenant's point of view, in the market at the
time. The only solid evidence before the Court in
support of that conclusion is that, in a very similar
shopping centre directly across Albert Street, the
drugstore lease of approximately 4,280 square feet
stipulated a percentage rent of 6% of gross sales
without exclusions. It was for a twenty-year term
from March 1, 1961 and provided for two succes-
sive five-year renewal leases at rents to be nego
tiated. On the other hand, there is evidence in the
report of Howard P. Hamilton, one of the plain
tiff's expert witnesses, of shopping centre drug
store leases entered into in Regina in the latter
half of the 1960's calling for percentage rents of
both 5% and 6% of gross sales. These leases are
not themselves in evidence and, without them, one
cannot really compare the respective deals. I might
also observe that even a comparison of shopping
centre leases without knowledge of the antecedent
building agreements can be misleading since the
rent is bound to be influenced by such factors as
who paid for what by way of finishing the prem
ises. In the result, while I accept Mr. Pinder's
judgment that the South Albert lease was a rela
tively favourable lease from a tenant's point of
view, the evidence does not establish that it was so
favourable, in relation to the market, that a pros
pective tenant would pay anything for it over and
above the assumption of the tenant's obligations
under it.
In the result of the negotiations, the lease of the
Broad Street store was for a term of ten years
from April 1, 1969 with options in favour of the
defendant to renew for three successive five-year
terms on the same conditions including rent and a
non-assignable right of first refusal to buy the
building. The annual rent, as originally proposed,
was $2.50 per square foot against 4% of gross
sales, sub-post-office transactions and utility col
lections being excluded. The tax escalator was
operative only if no percentage rent was payable, a
situation not anticipated in view of the store's sales
record and not, in fact, encountered. Indeed, the
first year's monthly rental instalments were fixed
on an annual rental forecast well above the $2.50
figure. The defendant was responsible only for
telephone, electricity and water supplied to the
premises.
I accept the evidence of Jack M. Warren, an
expert witness called by the plaintiff, as to the
character of the Broad Street store and its neigh
bourhood. It occupies the entire ground floor and,
for storage, part of the basement of a free standing
building on the east side of Broad Street. The
ground floor area is approximately 3,462 square
feet and the basement 1,044 square feet. There are
apartments in the upper floors. The front, three
storey, portion was built in 1912; a two storey
addition at the rear was built in 1938. It has been
well maintained and extensively renovated from
time to time. Its condition is average for its age.
There is parking on the lot.
That portion of Broad Street is a four lane
north-south traffic artery on the easterly fringe of
Regina's downtown business area. Development
fronting on it is mainly commercial while neigh
bouring streets are high density residential. The
Regina General Hospital is two blocks east of the
Broad Street store. It is the closest drugstore to the
hospital and the closest public transit stops to the
hospital are directly in front of and across Broad
Street from the store. This appears to be a particu
lar advantage in terms of sale of gift items, rather
than prescriptions.
Sales at the Broad Street store, during
McNeill's fiscal years ended January 31, 1966,
1967 and 1968, of the sort that would be subject to
percentage rent, had been $364,612, $427,251 and
$477,483 respectively, in the order of one quarter
of McNeill's total sales each year and, obviously,
growing at a very satisfactory rate. Sales for the
year ended January 31, 1969 were not ascertained
when the agreement was concluded and are not in
evidence; however, the defendant's sales from the
store for the nine months April 1 to December 31,
1969, were $373,459.
Howard P. Hamilton, a Calgary real estate
appraiser called as an expert by the plaintiff,
concluded that the base rate of $2.50 was about
typical for the type of property, that the potential
25-year term was longer than typical, and that
the 4% rate of percentage rental would not have
produced any premium on an assignment of the
lease in 1969. In conclusion, he was of the opinion
that no measurable premium should be attributed
to the Broad Street lease. Mr. Hamilton con
sidered only shopping centre outlets in comparing
Broad Street to other drugstores.
While it is likely that Hamilton had to turn to
shopping centres in order to find any number of
drugstore leases with percentage rent provisions
there are obvious costs and, no doubt compensat
ing, benefits to a business in a shopping centre that
do not pertain to a business like the Broad Street
store. In the circumstances, it seems to me that the
approach of the plaintiff's other expert, Jack M.
Warren, who included other free standing build
ings in his comparables is to be preferred. Warren
is a real estate appraiser employed by Revenue
Canada, formerly resident at Saskatoon, now of
Ottawa. Warren also compared, as best he could,
tenant's occupancy costs in the Broad Street store
with those of his other comparables. I will refer
only to the free standing locations, all in Regina.
1. McGregor's Drugs, 2,100 square feet, leased
November 29, 1971, for five years with one
five-year renewal at a renegotiated rent. Initial
rent $400 per month for first thirty months,
$450 thereafter, average annual rental $2.43 per
square foot. Gross sales in 1972—$169,090; in
1973—$174,522. Average annual rent is 2.84%
of average gross sales. Tax escalator over 1971
base. After taking into account taxes, insurance,
licences, cleaning, repairs and maintenance,
heat and utilities, Warren calculated the ten
ant's average occupancy cost, including rent, at
$9,278 or 5.48% of gross sales for those years.
2. Harris' Drugs, 1,606 square feet, leased Sep-
tember 1, 1965, for ten years with one five-year
renewal at a renegotiated rent. Rent is $4,134 or
$2.57 per square foot annually. Gross sales in
1970—$125,795; in 1971—$130,731 and in
1972—$137,439. Tax escalator over 1965 base.
Warren calculated the total tenant's average
occupancy cost, including rent, at $6,731 at
5.35% of gross sales for those years.
3. Duncan's Drugs, 1,211 square feet, leased on
a month to month tenancy for $3,100 per year,
or $2.56 per square foot, with the tenant paying
all expenses except taxes. Gross sales in 1969
were $89,496 and the estimated total tenant's
occupancy costs, including rent, were $5,657 or
6.32% of gross sales that year.
For the Broad Street store, taking into account
nine months' operation in 1969, Warren's calcula
tion of the defendant's total annual occupancy
costs, including rent, was 5.32% of gross sales for
1969 and 5.63% for 1970. None of Warren's com-
parables was subject to payment of percentage
rent and all were obviously much smaller stores. It
is also true, as was brought out in cross examina
tion, that expenditures characterized under the
accounting titles Warren adopted as reflecting
occupancy costs may properly vary significantly in
both amount and content from one business opera
tion to another. That said, Warren's approach does
seem to me the only practical basis for comparing
the costs to the tenant of the Broad Street lease,
with those of other drugstores not in shopping
centres. As in the case of the South Albert lease,
the evidence does not establish that the Broad
Street lease was so favourable to the tenant, rela
tive to the market, that a prospective sub-lessee
would pay anything for it beyond assumption of
the tenant's obligations under it.
Halsbury is sufficient authority for the proposi
tion that the law has long recognized the distinc
tion between personal and local goodwill. »
A distinction has been drawn between personal goodwill,
which is merely the advantage of the recommendation of the
owner of a business and of the use of his name, and local
goodwill, which is attached to premises, and must be taken into
account in calculating the value of such premises.
Halsbury's Laws of England, 3rd ed., Volume 29, p. 362,
par. 718.
The only evidence I have as to the local goodwill
attaching to the South Albert store is the opinion
of the plaintiffs expert, Catty, that it was $67,500.
That figure was arrived at by a calculation that
accepted $120,000 as the proper amount for the
Broad Street store's local goodwill and took
account of relative sales. In the circumstances, I
accept $67,500 as the correct figure.
I should note that, in his report, Catty referred
to "Goodwill of location and continuity". The
emphasis is mine. Nowhere did he elaborate on the
particular significance of "continuity" as distinct
from location. At page 6, he wrote:
5. Location and Continuity
Goodwill of location, in particular for retailers, is often
confused with lease value. They are not the same. Goodwill
of location relates to traffic patterns about an outlet. This
traffic and the related business can be enhanced or dimin
ished by many external factors such as residential develop
ment in the area, the opening of a competitor across the
street, and so on.
Continuity is, I take it, the aspect of location
involving the carrying on by a new owner of a
going concern in its established place of business.
As to the Broad Street store, the evidence estab
lishes clearly that there was, in fact, a particular
advantage to its location. That advantage had a
value. While McNeill and the defendant did not
expressly quantify that value it seems to me they
did so implicitly. If the store had been totally
destroyed a moment after closing and, in conse
quence the lease had terminated, the defendant
would have been entitled to recover $120,000 of
the $290,000 paid for goodwill. That $120,000 was
intended to compensate the defendant for some
thing intangible it had bought from McNeill and
would lose as a result of the lease's termination. It
would not have lost its exclusive right to trade
under the McNeill name nor its right to enforce
the restrictive covenant. It would not have lost the
Happy Shopper first refusal. It would have lost
only two intangible assets: its right of first refusal
on the sale of the Broad Street property and its
right to operate its drugstore at that location for
the next 25 years.
The $120,000 figure had been arrived at in a
process of hard bargaining between parties dealing
at arm's length, both professionally advised and
both knowledgeable of the location and of the
business conducted and to be conducted thereon.
The agreement is conclusive that $120,000 was the
value of those two intangible assets.
That the value of the right of first refusal was,
at best, nominal is confirmed by the fact that,
again in arm's length transactions between knowl
edgeable parties, the defendant sold the goodwill
attaching to the Lorne and Rexall stores for as
much or more as it paid for it without being able
to assign the right of first refusal. I accept, as did
Catty, that the $120,000 paid for goodwill in
respect of the Broad Street store was paid entirely
for local goodwill or goodwill of location.
The essence of the question is, as stated by
Kearney J., in Plouffe v. M.N.R. 2 :
To what extent, if any, does goodwill which is attached to the
premises, as opposed to personal goodwill, form part and parcel
of a leasehold interest?
Regrettably, it was found unnecessary to answer
the question then because, it was found as a fact,
there was no goodwill of value involved in the
transaction and, it followed, the amount in issue
was indeed the capital cost of the leasehold inter
est. The question has not been posed since.
A number of English cases, applying the provi
sions of the Landlord and Tenant Act, 1927 3 were
cited to me. They are not particularly helpful but
do call attention, for what it is worth, to a determi
nation by the Parliament at Westminster that local
goodwill created by a tenant enhances the value of
the realty, as do physical improvements. It is
something for which the tenant may be entitled to
compensation by the landlord upon termination of
the tenancy.
2 [1965] 1 Ex.C.R. 781 at 797.
3 17 & 18 Geo. V, c. 36 (U.K.).
The Australian cases are somewhat more apt.
There, the federal income tax statute 4 provided
that premiums or like consideration "demanded
and given in connexion with leasehold estates"
should, as the case may be, either be included in or
deductible from taxable income, to adopt Canadi-
an terminology. The High Court of Australia has
held that consideration for local goodwill was paid
and received "in connexion with leasehold estates"
in sales of going concerns where the vendor grant
ed a lease of the subject premises. 5 In the first
case, the vendor-landlord who sold the goodwill of
location was the unsuccessful appellant; in the
second, the purchaser-lessee who bought was the
successful respondent.
An analogy, which was not drawn in argument
but seems pertinent to me, is to be found in the
expropriation of interests in real estate. Whether
that interest be fee simple or leasehold, the value
of the goodwill of location, if a business is conduct
ed upon it, is accepted as one of the elements
making up the value of the expropriated interest.
Referring specifically to the present federal
legislation 6 , the only thing authorized to be expro
priated is an interest in land and the only compen
sation authorized to be paid is the value of the
expropriated interest. It expressly recognizes that
where the owner of the expropriated interest is
dispossessed, its value includes "the value to the
owner of any element of special economic advan
tage to him arising out of or incidental to his
occupation of the land".
An owner dispossessed might well be entirely
compensated for local goodwill in being paid the
market value of the property. However, a tenant
dispossessed is equally entitled to such compensa
tion. Since, under the Act, the only thing that can
be taken and paid for is an interest in land and
since the tenant's only interest is leasehold, it must
be concluded that, in the scheme of the Expro-
4 The Income Tax Assessment Act, 1922, s. 16(d). Act No.
37 of 1922.
5 Daniell v. The Federal Commissioner of Taxation (1928)
42 C.L.R. 296. The Federal Commissioner of Taxation v.
Williamson (1943) 67 C.L.R. 561.
6 Expropriation Act, R.S.C. 1970 (1st Supp.), c. 16.
priation Act, local goodwill is part and parcel of
the leasehold interest.
In tax cases, it is the substance of a transaction
that is to be regarded.' The issue raised in this
action is, so far as counsel and the Court are
aware, novel in the context of Canadian income
tax law. While the question has been asked before,
it appears not to have been answered. I doubt that
this will be the last word on it.
Chissum v. Dewes 8 was decided well before the
form of commercial transactions came to be dic
tated by the provisions of modern taxing statutes
and before goodwill had been sliced into as many
subdivisions as, it appears from the evidence, is the
case today. The goodwill referred to in the decision
is obviously what would today be called goodwill
of location or local goodwill. In that case, the
unexpired term of a lease, subject to an equitable
mortgage, was sold as a package with the goodwill
of the business carried on in the premises in the
realization of the estate of the deceased tenant.
The aggregate sum realized was insufficient to
satisfy the debt secured and it was sought to
apportion the consideration and to pay the mort
gagee only that part attributable to the unexpired
term. The Master of the Rolls, Sir John Leach,
held:
The good-will of the business is nothing more than an
advantage attached to the possession of the house; and the
mortgagee, being entitled to the possession of the house, is
entitled to the whole of that advantage. I cannot separate the
good-will from the lease.
Like the learned Master of the Rolls, I am unable
to divorce the goodwill of a location from the other
advantages accruing to the person entitled to
possession of that location. When it accrues under
a lease, it is part of the leasehold interest and the
price paid for it is part of the capital cost of that
leasehold interest.
There is no basis for disturbing the assessment
disallowing the claimed deduction of the expenses
incurred in negotiating the McNeill transaction.
' Firestone Tire and Rubber Company of Canada, Limited v.
Commissioner of Income Tax [1942] S.C.R. 476.
8 (1828) 38 E.R. 938.
While raised in the pleadings this matter was not
dealt with in argument.
The defendant's 1969 and 1970 income tax
returns will be referred back to the Minister for
reassessment on the basis that $187,500 was the
capital cost of the leasehold interests in the Broad
and South Albert Street stores in respect of which
the defendant is entitled to claim capital cost
allowance. The remaining $20,000 in issue was not
proved to have been paid for any leasehold
interest.
The decision of the Tax Review Board, 9 appar
ently rendered without the benefit of much of the
evidence before the Court, was that 50% of the
$207,500 be assumed to have been paid for lease
hold interests. In the result, therefore, the defend
ant has been entirely successful in its defence and
largely successful in its counterclaim and is en
titled to its costs of both to be taxed on the basis of
this having been a Class III action.
Counsel for the plaintiff argued for a disposition
of costs, in the event of the defendant's success, as
was done in Herb Payne Transport Limited v.
M.N.R., 10 where the taxpayer, while successful in
the action, was found to have been the principal
author of a largely unnecessary dispute. I have
considered that representation but do not think the
circumstances are more than superficially compa
rable and, accordingly, reject it.
9 75 DTC 103.
1° [1964] Ex.C.R. 1 at p. 16.
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.