WALSH, J.:—By virtue of an Order made before me at Montreal on June 10, 1970 it was decided that the above two appeals should be tried at the same time, together with an appeal in the case of Aaron Blauer v. M.N.R. ([1971] C.T.C. 154), using only the evidence adduced before the Tax Appeal Board, subject to argument and decision of the Court as to the admissibility of certain evidence objected to at the hearings of these cases before that Board, and an Agreed Statement of Facts.
At the opening of the hearing on the merits before me, the parties in all three cases, through their respective counsel, filed an Agreement that the only evidence for the purpose of the hearing of the three appeals would be that referred to therein, which consisted of eight volumes of evidence taken before the Tax Appeal Board in the separate hearings of the three actions (reported [1968] Tax A.B.C. 226, 247, 273), transcripts of which were filed before me as Exhibits C-1 to C-8, a volume of documentary evidence containing various exhibits which was filed before me as Exhibit C-9, and three additional volumes of documentary evidence consisting of the Examinations on Discovery of Aaron Blauer, Robert P. Ouellette, and John Edward Brett, respectively, during the course of Superior Court proceedings instituted by Aaron Blauer against J. E. Brett and R. P. Ouellette in Montreal under number 537905 of the records of that Court, which examinations were given Exhibit numbers C-10 to C-12. Also filed, pursuant to Section 100(2) of the Income Tax Act, were books of documents relevant to the assessments in each of the three cases. This voluminous evidence amounting to some 1,200 pages was referred to, and the Court’s attention directed to the more relevant parts thereof, in the oral arguments of counsel for the respective parties lasting for three days, in addition to which some written notes and argument were filed at the hearing by Mr. Raymond G. Decary, Q.C., counsel for Messrs. Brett and Ouellette, and subsequent thereto, with permission of the Court, by Mr. Decary and Mr. Jean Claude Sarrazin, counsel for the Minister of National Revenue.
The facts giving rise to the issue in all three cases are identical, but the situation is complicated by the fact that the Minister has, no doubt as a matter of caution, taken a contradictory position in the eases of Brett and Ouellette from that taken in the case of Blauer in that he contends that the payment made by Brett and Ouellette to Blauer on the dissolution of their partnership was a capital payment and not deductible by them from their income for the year in question, whereas in the case of Blauer he contends that the amount so received was not capital but was income received by him and taxable as such. In effect, therefore, although the Minister was an adverse party in all three appeals, the issue was mainly between Ouellette and Brett on the one hand and Blauer on the other, and was so argued, with Brett and Ouellette claiming that the payment made to Blauer was a payment in distribution of income of the partnership, and Blauer on the other hand contending that it was a capital payment made to him on dissolution of the partnership, while counsel for the Minister was able to adopt a neutral position, which he did on this principal issue. The issues in the appeals by the Minister in the cases of Ouellette and Brett are identical and can be dealt with in one judgment, but since the issues in the appeal by Blauer against the decision of the Tax Appeal Board in favour of the Minister, although in most respects identical with the other two cases, also involve the question of whether the assessment should have been made for the 1962 taxation year, as the Minister did, rather than for the 1961 taxation year, and since a payment which may be a capital payment by the payor may nevertheless in some circumstances constitute an income receipt for the payee (as, for example, legal fees paid for the incorporation of a company, which are a capital expense by the company but an income receipt for the attorney to whom they are paid) a separate judgment will be rendered in the Blauer appeal. This procedure was agreed to by counsel for all the parties. The present reasons for judgment therefore have reference to the Ouellette and Brett appeals.
In order to determine the true nature of the payment made by Brett and Ouellette to Blauer on the termination of their partnership with him it is, unfortunately, necessary to go at some length into the history of the partnership, the reasons for its formation and eventual dissolution, the nature of the partnership during its existence, and the previous litigation in other courts between the parties which led to the eventual dissolution of the partnership, and other matters which throw some light on the matter. In this connection we have the evidence of Messrs. Brett, Ouellette and Blauer, with Blauer and Ouellette testifying three times in each of the three cases, the evidence of Morton Bell, Blauer’s attorney at the time of the dissolution of the partnership, though not acting for him in the present appeals, the evidence of Charles Gélinas and Pierre Bourque, counsel for Brett and Ouellette at the time the dissolution of the partnership agreement was prepared, although also not representing them in the present appeals, both of whom testified twice before the Tax Appeal Board, the evidence of Jack Richer, a chartered accountant, called as a witness by Blauer in his appeal, of Jacques Raymond and Clément Primeau, chartered accountants, called as witnesses by Ouellette in his appeal, and of Gilles Murray, called as a witness by the Minister of National Revenue in the Ouellette appeal, all in connection with the valuation of goodwill, and we also have the evidence of Adjutor Menard, the auditor of the partnership.
Dealing with the formation of the partnership, we have two versions, that of Brett and Ouellette on the one hand and that of Blauer on the other which. contradict each other in many important respects. Blauer’s version is that at the time the Place Ville Marie building development in Montreal was under consideration nearly all the engineers in Montreal wanted the opportunity of participating in such an important project. He was an engineer practising alone at the time, having graduated from McGill University in 1948, and in 1956 he approached the Webb and Knapp concern who told him that he should communicate with the consulting engineers in New York. As a consequence he met Mr. Severud who had come to Montreal to interview various engineers who had indicated a desire to be associated with the project, and also the architect, Mr. I. M. Pei, discussed the work with him, and subsequently he had a telephone call from Mr. Severud who stated that he was interested in what Blauer had shown him about his previous work, but that it would be necessary for him to associate himself with a larger engineering firm in order to carry out a project of this size. Blauer then thought of Mr. Brett, whom he had known previously as a lecturer at McGill from whom he had taken courses when a student. He went to see him and the next day a partnership agreement was drawn up between him and Messrs. Brett and Ouellette, and Mr. Ouellette and he then went to New York to see Mr. Severud, showing him this partnership agreement.
The Brett and Ouellette version. is substantially different. They had both graduated in engineering from MeGill University in 1942 and Brett had done postgraduate work at Harvard and Columbia and had subsequently taught at Harvard. In 1954 they had formed a partnership under the name of Brett and Ouellette and in the autumn of 1956 they had communicated with Mr. Zeckendorf in New York to offer their services in connection with the Place Ville Marie project. They were subsequently interviewed in Montreal and called to New York by the architect and engineers there and Mr. Severud suggested to them that they associate Blauer with them in the project. They were reluctant but agreed to do so and, according to Ouellette, Severud told them he could be used to make the trips between Montreal and New York.
It is evident that even if Blauer cannot claim the principal credit for getting them the contract, as his version would indicate, they were given it only on condition of taking Blauer into partnership. Subsequent events proved that, if the partnership cannot be accurately described as a shot-gun marriage it was at least a marriage of convenience and not of affection as Brett and Ouellette in due course made clear to Blauer.
The partnership agreement, which was. drawn up dated October 22, 1957, clearly specified that it was
. . for the, sole and exclusive purpose of. rendering professional services as Consulting Engineers on and for the building project entitled “Ville Marie Project” in the City of Montreal, as promoted and undertaken by the Real Estate Development Firm of Webb & Knapp (Canada) Ltd.;
The partnership was made conditional on the engagement of the parties by Webb & Knapp (Canada) Ltd. or the firm of Severud, Elsted, Krueger Associates of New York for the purpose of rendering professional services as consulting engineers on and for the said building project. The agreement further provided that Brett and Ouellette would continue their independent partnership and Blauer his independent practice as consulting engineers for any projects other than the Place Ville Marie project. Provision was made that in the event of the death of one of the partners, the remaining partners would continue the business and purchase the interests of the deceased partner, the price to be determined by making an inventory in which the goodwill of the partnership should not be taken into consideration. Provision was also made for arbitration in the event of any dispute, difference or question arising between the parties.
Early in 1958 the parties decided to vacate both their offices and take up common premises in the Dominion Square Building close to the Webb & Knapp offices which were there at the time. They took on additional staff and discussed accounting systems. According to Blauer, it was Brett who suggested to him that it was impractical to set up separate accounting systems for smaller jobs, and of course all their jobs w ere small in comparison to the Place Ville Marie project, and that it might be better if they finished the jobs they had already started under their original names, and apportioned expenses for them, but that new work should all be done on a joint equal partnership basis, which Blauer said was the manner in which they carried on thereafter. After about a year and one-half, they had fifty men in their employ and were one of the largest engineering firms in Montreal and were carrying on the largest project in Canada.
Ouellette’s version is somewhat different. He states that, because of the complicated accounting which would be involved when a number of employees were working on smaller projects at the same time as the Place Ville Marie project, it was more practical to put them all into the partnership as long as the Place Ville Marie project continued. This inclusion of a number of smaller projects in the partnership was in most cases by verbal agreement. Blauer testified that originally, in 1958, they had their three names on the door, namely, Aaron Blauer, then Brett and Ouellette, and then the third name Brett, Ouellette and Blauer Associates, but subsequently, at the request of Brett, the first two names were removed and only the name Brett, Ouellette and Blauer Associates remained. Ouellette testified that he may have noticed this change though he did not direct it, but made no comment about it at the time.
Blauer testified that he was instrumental in setting up a branch office for the firm in Halifax through an architect whom he knew there. Public relations experts were retained and arranged for the publication of certain of their projects in technical magazines and for speaking engagements and matters of that sort which brought the partnership’s name to public attention. In correspondence with third persons, the firm name of Brett, Ouellette and Blauer was emphasized. In a letter of December 18, 1957 to F. T. Wood, assistant to the president of Trans-Canada Air Lines, seeking work in connection with extensive building projects at Dorval Airport, Ouellette, who wrote the letter, says :
Mr. Blauer has just recently associated with our firm formerly known as Brett and Ouellette. A new partnership has thus been created under the name of Brett Ouellette Blauer Associates which is being used for the first time on the Ville Marie Project.
In another letter by Ouellette dated December 23, 1957, to the Iron Ore Company of Canada, seeking additional work from them, he refers to the Place Ville Marie project and states:
On this latter occasion, the former firm of A. Blauer & Associates has merged with our own to form the new partnership of Brett Ouellette Blauer Associates, under which we are now operating.
In à letter to the Quebec Cartier Mining Company, also on December 23, 1957, Ouellette states:
As for ourselves, we have just taken in a new partner and accordingly changed the name of our firm to Brett Ouellette Blauer Associates under which we are presently retained for Webb & Knapp’s Ville Marie Project.
Ouellette admits that they got out a publicity sheet attempting to profit by the fact that they had done the Place Ville Marie Job which they used in attempts to get the contracts for RadioCanada and subsequently Place Victoria. Moreover, Ouellette and Brett wrote Blauer as follows on February 17, 1961 :
Dear Sir,
At your request we hereby wish to confirm that should we obtain a contract or engagement for professional engineering services from Société Immobiliaire Générale or P. L. Nervi for the Building Project known as Place St. Jacques and/or from the Canadian Broadcasting Corporation or their duly appointed Architect for the Building Project known as CBC Radio & T.V. Centre (Montreal), it is understood and agreed that the services to be performed shall be performed jointly by J. E. Brett, R. P. Ouellette and A. Blauer and the fees or proceeds therefrom shall be divided between the said Messrs. Brett Ouellette and Blauer.
It is evident that although the partnership agreement did not provide for it, the partners during this period conducted their business as if they were full partners on all projects and held themselves out to the public as being full partners.
It was not until 1960 that the trouble began. At that point it was decided that Ouellette would represent the partnership in approaches to the Provincial Government in an effort to get large government contracts. He made several trips to Quebec City, charging these up to the partnership expense account and met various department heads but it was only after the 1960 elections when the Liberal Government came to power there that his contacts showed signs of success. Following one of these trips, according to Blauer, Ouellette returned to Montreal and said that, due to certain nationalistic policies which were evi- dent, the use of the name Blauer created a problem and would have to be dropped, but although the jobs would be taken in the name of Brett and Ouellette, the profits would be divided on a three-way basis as heretofore. Ouellette strongly denies this. Blauer goes on to explain, however, that they had encountered a similar situation before when they did some engineering work for the City of Montreal on the Ahuntsic Bridge under the name of Brett and Ouellette but that the proceeds were divided among the three of them. The first contract from the Provincial Government obtained under the name of Brett and Ouellette was for the Pavillon St. Georges in Sherbrooke which was a large hospital, and this was followed by a much larger project, the Boucherville tunnel complex. In connection with the Sherbrooke contract, a bank account was opened at the Bank of Montreal there through Ouellette, using partnership funds, and cheques were issued against it. Subsequently, Ouellette, without consulting him, replaced these sums in the partnership master account in Montreal and changed the name of the Sherbrooke account from Brett, Ouellette and Blauer to Brett and Ouellette. Ouellette admits in his evidence that, with respect to the Sherbrooke contract, at a given moment part of the financing had been done by Blauer up to a certain point by the use of partnership funds.
About this time, Blauer began to notice that he was being ignored by his partners. A friend of his, a member of another engineering firm in Montreal, told him that he understood that his firm was doing the Boucherville tunnel project. He was not even aware of this and got evasive answers or no answers at all from his partners. He subsequently learned that some of the employees of the firm had been transferred to another area in the same building which had been rented without his knowledge by Brett and Ouellette and were working there on the tunnel and other projects. He had a confrontation with his partners early in 1961 and after this the situation deteriorated. The office help became antagonistic towards him and he did not see all the mail that was addressed to Brett, Ouellette and Blauer Associates which had formerly been circulated. According to him, certain files and books disappeared. There were no more regular conferences between the partners and he was left alone in his office.
Ouellette’s evidence as to this period of their relationship conflicts with that of Blauer. He admits that Brett made a trip to Europe to make contacts in connection with the forthcoming Place Victoria development and that his travelling expenses were charged to the partnership. Political contributions were also made and charged up to the partnership. The initial con- tract for a feasibility study of the Boucherville tunnel led eventually to participation in a consortium for the main contract for it although this was subsequent to the dissolution of the partnership, and this main contract was larger even than the Place Ville Marie project. His position is clear that the partnership was formed for the Place Ville Marie project alone and, although as a matter of accounting convenience they included certain smaller contracts in it during the period that the Place Ville Marie project was continuing, he and Brett had no intention of retaining Blauer in permanent partnership with them, although Blauer had proposed this to them and had even drafted a full partnership agreement. No clear indication was given as to why he did not wish Blauer to become a full partner. It was suggested by him that they just used him as a go-between between their firm and New York during the earlier stages of the Place Ville Marie contract and that later he was replaced in this capacity by one Nicolet who apparently was satisfactory to the principals in New York because subsequently, after Nicolet left their employ, Nicolet himself received certain of the subsequent contracts for later buildings in the Place Ville Marie complex, whereas they themselves received no further work from Webb & Knapp. There is no suggestion, however, that Blauer did not pull his weight or bring in a certain amount of business himself during the. existence of the partnership.
When Blauer found himself being ignored by his partners, who apparently intended to shut him out from participation in the Boucherville tunnel and Sherbrooke contracts, he consulted his lawyer, Morton Bell, who instructed him to pick up certain documents from the office including, among others, expense accounts of Ouellette for trips to Quebee. He got the file for travel vouchers and his lawyer photostated them before he returned them. Subsequently, he found that certain documents had disappeared from this file and later he brought certain books and ledgers and had them looked at by.an independent accountant. In due course he consulted Joseph Cohen, Q.C. (possibly the best known criminal lawyer in Montreal at that time) and on his advice a search warrant was taken out and, according to Blauer’s evidence, certain books and loose papers from the ledgers indicating that certain pages had been redone and certain items omitted, with the original page being there plus the new page, were seized. On the same date, September 1, 1961, Blauer signed separate criminal complaints against Ouellette and Brett alleging that between November 1, 1960 and the date of the complaint, by deceit, falsehood and other fraudulent means they did defraud him of the sum of $5,000 being his share of profits on engineering work done for the erection of the Pavillon St. Georges Hospital in Sherbrooke and $6,000 being his share of the profits for engineering work done for the survey of the St. Lawrence crossing at Boucherville, the whole contrary to Section 323 of the Criminal Code (fraud). On the same date, he also laid separate complaints against each of them charging that they did conspire with each other in that. by deceit, falsehood or other fraudulent means they did defraud him of the sum of $25,000 being his share of the profits on engineering work done for the erection of the Pavillon St. Georges Hospital in the City of Sherbrooke and the sum of $150,000 being his share of the profits for engineering work done for the survey of the St. Lawrence crossing at Boucherville contrary to Section 408(d) of the Criminal Code (conspiracy to commit an indictable offence). No explanation was given as to why different amounts were used in the conspiracy charges from those used in the charges for the substantive offence, but it is, of course, evident that at that stage the amounts had to be merely guessed at, as he knew little, if anything, about the nature or extent of these contracts.
Prior to this and after a letter from his attorney, Mr. Bell, suggesting the appointment of a neutral attorney, Mr. Leon Crestohl, as an arbitrator, had brought negative results, civil proceedings were brought by him in the Superior Court in Montreal against Brett and Ouellette in which the declaration bears the date May 2, 1961. In these proceedings he prayed for judgment declaring as follows:
(a) That a full partnership as professional engineers has existed since the 1st day of March 1959, still exists and will continue to exist between Plaintiff and Defendant, and in particular with respect to the projects known as Pavillon St. Georges and the St. Lawrence River Crossing at Isle de Boucherville;
(b) That the aforesaid partnership is legally applicable and has full force and effect whether under the name of Brett, Ouellette, Blauer Associates, or Brett & Ouellette;
(c) That the aforesaid partnership is legally applicable and has full force and effect both with respect to work completed, work in process of completion or work that may be completed hereafter until such time as the partnership between the parties is legally terminated ;
(d) That as a consequence of the partnership which has existed since the 1st day of March 1959, is presently in existence and continues to be in existence, all actions, deeds and things done by the partnership must be done in accordance with the laws applicable thereto and in particular be done with the mutual consent of Plaintiff and Defendants.
These proceedings were contested by Brett and Ouellette and during the course of an Examination on Discovery in connection with these proceedings, Ouellette testified that he had changed the travelling expense vouchers from the name Brett, Ouellette and Blauer to Brett and Ouellette ‘‘au fur et à mesure’’ (progressively). These were the vouchers which Mr. Bell, Blauer’s lawyer, had had photostated previously before any changes had been made on them. As a result of this there was a threat made of a further complaint against Ouellette for perjury (evidence of Mr. Bourque, Exhibit C-5, pages 19-20).
Finally, Brett and Ouellette instituted proceedings in the Superior Court in Montreal in which the declaration bears the date August 2, 1961 for libel, demanding $50,000 damages for alleged defamatory statements which Blauer had made about them to third parties by telling these third parties that he was instituting criminal proceedings against Brett and Ouellette. These proceedings were also contested.
All these proceedings were withdrawn or settled out of court, as the case may be, as a result of the agreement made between the parties on November 28, 1961 which dissolved the partnership, ahd it is the nature of the payment made by virtue of this agreement which is the issue in the present case. It must be clearly understood that in reciting the background which led to these various proceedings and threatened proceedings and giving the details of these proceedings, I am not in any way expressing an opinion as to whether any of them were well founded or not, but it is necessary to refer to them, as it is against the background of these proceedings and at least partially in view of them that the settlement which we have to interpret was made. Certainly, the accused in criminal proceedings is deemed to be innocent until found guilty and this applies even more forcefully with respect to proceedings which are merely threatened but not actually brought. Similarly, no court can hazard an opinion as to the probable outcome of civil proceedings which are settled out of court before trial. Nothing in this judgment, therefore, should be taken as suggesting that either Brett or Ouellette was guilty of fraud or conspiracy, or that Ouellette was guilty of perjury, nor can I express any opinion as to whether, by a fairly continuous course of conduct in dealing with small contracts, charging expense accounts for travel and political donations to the partnership, publicity, and various attempts to obtain additional work in the name of the partnership, and holding themselves out to third parties and the public in general as full partners, Brett and Ouellette had converted the partnership formed for the specific purpose of the Place Ville Marie project into a general partnership, thereby entitling Blauer to share in the Sherbrooke and Boucherville tunnel and any other projects which Brett and Ouellette wished to exclude from the three-way partnership. Neither can I find that Blauer would have been held civilly liable for damages for alleged slander of Brett and Ouellette. The settlement agreement (I use this for want of a better term) provided in clause 12 :
12. Save and except as herein provided, each of the parties hereto grants to each other full, final and complete receipt, release and discharge for any and all claims of whatsoever kind or nature, past, present or future, that they have or may have or pretend to have, or might in future have, the one against the other;
On the same day, declarations of settlement out of court, with each party paying his own costs, were signed in connection with the two civil proceedings. A further document was signed by Brett and Ouellette reading as follows:
We, the undersigned, John E. Brett and Robert P. Ouellette, both of the District of Montreal, do hereby declare that the proceedings herein instituted by Aaron Blauer as Complainant in causes Nos. 11350, 11351, 11352, 11353 and 11349, were laid by the said Aaron Blauer in good faith and for reasonable and just cause, and we hereby declare that we have no cause, grounds or reason of any kind or nature for any claims in damages as a result thereof.
Moreover, we hereby release and discharge, in any case, the said Aaron Blauer and/or his nominees and preposees from any and all claims of whatsoever kind or nature that we may have, pretend to have, or may in future have, arising from the laying of separate complaints against ourselves in the Court of the Sessions of the Peace under the numbers 11350, 11351, 11352, 11353 and 11349.
During the course of the discussions, the criminal proceedings had been postponed to the following day. According to the evidence of Mr. Bell, after the settlements were signed, Mr. Cohen, acting on behalf of Blauer, went to see the judge in chambers with Messrs. Gélinas and Bourque, representing Brett and Ouellette, and the Court agreed to allow the withdrawal of the complaints.
Dealing further with the settlement agreement which counsel for Brett and Ouellette claim to be a ‘‘transaction’’ within the meaning of Article 1918 of the Quebec Civil Code, which reads as follows:
1918. Transaction is a contract by which the parties terminate a law-suit already begun, or prevent future litigation by means of concessions or reservations made by one or both of them.
I find that, while it is true that the agreement did have the effect of terminating the lawsuits which had already begun and of preventing future litigation between the parties and that all parties made concessions in connection with the agreement, so that it certainly partakes of the nature of a transaction, the agreement was something more than a mere transaction. It had the effect of dissolving the partnership between the parties and settling the claims of Blauer against the partnership, whatever the nature of such claims might be. Moreover, the agreement makes no reference as such to the pending litigation, and only refers in a general way in clause 12, already quoted, to the mutual release and discharge of any claims, although it is undoubtedly true that the litigation was terminated contemporaneously with the signing of the agreement, and certainly the terminating of it was one of the considerations inducing the parties to enter into this agreement.
The agreement (Exhibit C-9, page 81) terminates the partnership except for certain projects set out in Schedule A annexed thereto, which are admitted by the parties to be relatively small projects entering into the three-way partnership. The parties agreed to divide undistributed income, including moneys in the bank, materials, equipment and other physical assets and to distribute any further sums of money due or to become due in connection with the projects described in Schedule A. Provision is made for auditing these accounts and for settlement of the disputes by arbitration between attorneys representing the parties. Originals of design drawings, briefs, plans, contracts and correspondence for any of the projects set out in Schedule A are declared to be the common property of the three parties and open for inspection by any of them. Blauer undertakes to quit the partnership by December 31, 1961 and the lease to the premises will be assumed by Brett and Ouellette to the exoneration of Blauer from January 1, 1962. Expenses until the termination of the projects set out in Schedule A will be apportioned in proportion to the hours spent by technical personnel on these projects compared to projects of Brett and Ouellette themselves. Provision is made that should any of the parties be awarded the C.B.C. Headquarters engineering work and if Brett and Ouellette are so engaged they shall pay Blauer 6% of the gross or total fee, and if Blauer is engaged he shall pay Brett and Ouellette jointly 12% of the gross or total fee. Blauer declares that he has no claims of any kind or nature past, present or future against Brett and Ouellette for fees earned by them from the Government of the Province of Quebec for professional services rendered on those projects known as the Pavillon St. Georges and the St. Lawrence River Crossing at Ile de Boucherville.
The most important clause and that which is in issue before me is clause 6, which reads as follows:
6. The concurrently with the signing of these presents, the first two parties shall pay, by way of a post-dated cheque dated January 2, 1962, to the Third party, the sum of Seventy-five Thousand Dollars ($75,000.00), as compensation for loss of goodwill of the said Third party, the payment of which sum of money shall be guaranteed by any chartered bank of Canada, to the satisfaction of the Solicitor of the Third party;
The use of the term “goodwill” in the agreement, if this were to be taken at its face value as the consideration given by Blauer for the $75,000 payment he received, would result in this being considered as a. capital payment by Brett and Ouellette and not deductible by them on the one hand, and a capital receipt by Blauer on which he would not be taxed on the other hand. Counsel for Blauer argued that by virtue of Article 1234 of the Quebec Civil Code, which reads as follows:
1234. Testimony cannot in any case, be received to contradict or vary the terms of a valid written instrument.
no testimony could be properly introduced to contradict this and show that it was not for the sale of goodwill that the payment was made. I cannot accept this argument. It is true that in the case of Seven-Up of Montreal Limited v. M.N.R., [1952] C.T.C. 75, Cameron, J. decided that this article applied and refused to admit verbal evidence to contradict the written agreement. This decision seems to be in conflict with his earlier judgment in the case of Percy John Salter v. M.N.R., [1947] C.T.C. 29, but that case was a British Columbia case so Article 1234 of the Quebec Civil Code was not in question. In that judgment, quoting from Phipson on Evidence, 8th ed., at page 567, Cameron, J. says at page 36 of his decision :
“Where a transaction has been reduced into writing merely by agreement of the parties, extrinsic evidence to contradict or vary the writing is excluded only in proceedings between such parties or their privies, and not in those between strangers, or a party and a stranger; since strangers cannot be precluded from proving the truth by the ignorance, carelessness, or fraud of the parties (R. v. Cheadle, 3 B. & Ad. 833); nor, in proceedings between a party and a stranger, will the former be estopped, since there would be no mutuality.”
The Quebec law on the point was at one time by no means clear. In the case of J. Mastai Ravary v. M.N.R., [1960] C.T.C. 228, it was held (see headnote) :
That the amount of $10,000 was properly included in the appellant’s income, as evidenced by contract of loan in authentic form and that Article 1234 of the Civil. Code prohibits the introduction of verbal testimony to vary or contradict the terms of this instrument;
The matter was studied at some length by Mr. Justice Owen of the Quebec Court of Appeal in an article in the McGill Law Journal, vol. 4, No. 1, in which he concludes that Article 1234 of the Civil Code is of English origin. Consequently, since a party to a deed is not estopped from contradicting or varying the terms of a valid written instrument against a stranger, e.g. the Minister of National Revenue, in common law jurisdictions the same rule should apply to deeds entered into in the Province of Quebec.
The question is dealt with by Dumoulin, J. in the case of MN.R. v. Albani Thibault, [1962] C.T.C. 137, which held that the provisions of the Civil Code limiting the mode of proof of facts covered by a deed was applicable only between the parties to it and that the deed was res inter alios acta quoad the Minister. In this judgment he states, at page 145:
. . . Ce débat se résume à peu de choses; quelques mots en disposeront. L’appelant invoque, à l’encontre de toute preuve testimoniale, l’article 1234, qui interdit de recourir à la preuve verbale pour contredire ou changer les termes d’un écrit valablement fait. Il paraît élémentaire de rappeler que ce texte restrictif ne vaut qu’entre les parties à l’acte et ne s’applique nullement aux tiers pour qui tel écrit tombe dans la catégorie de la res inter alios acta.
In support of this he quotes (at page 146) from Mignault, Droit Civil Canadian, vol. VI, page 86, the following sentence:
“Ajoutons que les tiers peuvent prouver à l’encontre d’un écrit qu’on leur oppose par tout genre de preuve.”
It must be remembered that in the present appeals, although they were argued as if Brett and Ouellette on the one hand, and Blauer on the other were adversaries, in actual fact it is the Minister of National Revenue who is the appellant and, as such, the adversary in the cases of Ouellette and Brett, and the respondent and adversary in the case of Blauer. To hold that the Minister is bound by the terms of an agreement entered into between Brett and Ouellette on the one hand and Blauer on the other, and cannot introduce evidence to show that use of the term “goodwill’ in the agreement did not represent the true consideration for which the payment was made could open the door for all sorts of agreements to be drawn up in avoidance of taxation, though I do not suggest that this was deliberately done in the present case, and to hold further that this is a situation which only applies in the Province of Quebec because of the existence of Article 1234 in the Quebee Civil Code is a proposition which I cannot entertain. While Article 1234 of the Quebec Civil Code would have its full application in any litigation between Brett and Ouellette on the one hand, and Blauer on the other, arising out of the interpretation of the dissolution agreement, it can have no application in the present proceedings between the three parties respectively and the Minister of National Revenue and I therefore hold the verbal evidence introduced in an attempt to interpret the agreement to be admissible.
The jurisprudence is very clear that it is not what parties call a payment in a contract which determines the nature of it but the real character of the transaction. Simon’s Income Tax 1964-65, vol. I, has this to say at page 59 in connection with the case of C.I.R. v. Duke of Westminster, [1936] A.C. 1, quoting from the judgment of Lord Russell of Killowen on the contrast between the form and the substance of an arrangement:
If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good . . . If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine.
He also quotes from the judgment of Viscount Simon in the case of C.I.R. v. Wesleyan and General Assurance Society, [1948] 1 All E.R. 555 at 557, as follows:
It may be well to repeat two propositions which are well established in the application of the law relating to income tax. First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it. Secondly, a transaction which, on its true construction, is of a kind that would escape tax is not taxable on the ground that the same result could be brought about by a transaction in another form which would attract tax.
Again, at page 60, he states :
The true principle governing “substance” and “form” is that the taxing Acts are to be applied in accordance with the legal rights of the parties to a transaction. It is those rights which determine what is the “substance” of the transaction in the correct usage of that term. Reading “substance” in that way, it is still true to say that the substance of a transaction prevails over mere nomenclature.
An example, referred to by Lord Russell of Killowen in the Westminster case ([1936] A.C. 1, 25; 19 T.C. 490, 510, 524, H.L.) of the proper disregard of the name given to a transaction is furnished by the decision of the House of Lords in Secretary of State in Council of India v. Scoble [1903] A.C. 299). What was called in a contract for acquisition of a railway “an annuity” was there held to consist largely of a sum of purchase money payable by instalments. So to hold was simply to give effect to the “indisputable rule that the surrounding circumstances must be regarded in construing a document” (Per Lord Tomlin in the Westminster case, supra). Another instance of a case in which the Court did not restrict itself to the actual terms of a document in ascertaining the true character of the transaction which it evidenced is I.R. Comrs v. Mallaby-Deeley ([1938] 4 All E.R. 818). The covenantor had bound himself by deed to pay certain sums under deduction of tax, thereby replacing a previous undertaking to finance the completion of a literary work. Although the undertaking was not referred to in the deed, the Court of Appeal had regard to the whole history of the transaction, and held that the true nature of the payments was capital.
In the case of I.R. Comrs. v. Fleming & Co. ( Machinery), Ltd. ([1952] S.C. 120) shows that the principle of the Duke of Westminster's case (supra) applies to refute a taxpayer’s argument, which ignores the true legal character of a transaction, as well as to protect the subject against an attempt to read a non-taxable transaction as taxable.
We must therefore examine further whether the payment of $75,000 was made to Blauer for his goodwill in the partnership or whether it was really a distribution to him of his estimated share of the fees from the Sherbrooke and Boucherville tunnel contracts as Brett and Ouellette contend and, hence, deductible by them and taxable in his hands, and that the designation of it in the dissolution agreement as goodwill does not represent the true substance of the agreement.
Counsel for Brett and Ouellette argued that the object of all proceedings brought by Blauer against them was to collect payment of his share of the profits from the Sherbrooke and Boucherville tunnel projects which he believed that he was entitled to on the basis of his contention that the particular partnership, created in the first place for the Place Ville Marie project only, had by tacit agreement of the parties as indicated by their course of conduct been converted into a general partnership. I do not believe, however, that strictly speaking the collection from Brett and Ouellette of a sum of money can properly be said to be the object of any of the proceedings, although it may have been the end result of them, and perhaps even this result might have been anticipated or intended at the time they were brought. The criminal proceedings, even if Blauer had succeeded in getting convictions against Brett and Ouellette, and it certainly cannot be assumed that this would have been the result had they been carried to a conclusion, could only have resulted in the imposition of the penalties provided for in the sections of the Criminal Code in question and not in the collection of a sum of money by Blauer. Although sums of money were mentioned as they had to be in both the fraud and conspiracy charges, the fraud charges refer to the sum of $5,000 in connection with the Sherbrooke project and $6,000 in connection with the Boucherville project, while the conspiracy charges refer to $25,000 in connection with the Sherbrooke. project and $150,000 in connection with the Boucherville project. Both are indictable offences and there is no provision in the Code for the Court to order reimbursement to the complainant as part of the penalty for either offence. Turning to the civil proceedings, they were not brought as an action to account, but as an action to declare that the partnership still existed and, in particular, with respect to the projects known as the Pavillon St. Georges (Sherbrooke) and the St. Lawrence River Crossing at Ile de Boucherville. In these proceedings, Blauer reserved his right to claim damages and to demand an accounting from defendants of the profits accruing from these projects as well as from any other projects obtained by either him or Brett and Ouellette until the termination of the existing partnership, but the judgment in the proceedings as brought would not and could not have condemned Brett and Ouellette to pay Blauer any specific sum of money. If these proceedings had been carried to a conelusion and had Blauer succeeded in them the effect would have been to recognize that a general partnership existed between the parties; this could not have forced. Brett and Ouellette to remain in partnership with Blauer indefinitely, however. The original partnership agreement had contained no clause calling for the termination of the partnership except in the event of death, because it was apparently assumed by all the parties at the time it was entered into that it was for the Place Ville Marie project only and would therefore become automatically terminated when that project was completed. If a judgment had been rendered in favour of Blauer, therefore, in his proceedings to declare that a general partnership existed, Brett and Ouellette would no doubt have availed themselves of the provisions of Article 1895 of the Quebee Civil Code with respect to the dissolution of such partnerships, which reads as follows :
1895. Those partnerships only which are not limited as to duration can be dissolved at the will of any one of the partners, by a notice to all the others of his renunciation. Such renunciation must be in good faith, and not made at a time unfavorable for the partnership.
Blauer would then not have shared in any projects following such dissolution, but in view of the foreseeable delays in carrying the litigation to its conclusion, this dissolution would have been at a much later date than the dissolution agreed to in the settlement between the parties on November 28, 1961, and it is possible therefore that Blauer might have shared in the second stage of the Boucherville. tunnel project which is the main contract involving some $3,000,000 in fees (though not, of course, net profit). This is, of course, highly speculative, but would be one of the many complex possibilities which the parties and their counsel at the time would have had to give consideration to in arriving at a settlement.
Counsel for Brett and Ouellette also argued that the figure of $80,000 which was paid to Blauer in settlement ($75,000 to him and $5,000 for his legal fees, which latter sum was not mentioned in the dissolution agreement but which the parties agreed was paid) was arrived at by calculating the amount Blauer would have received as his share of the earnings from the Sherbrooke and preliminary Boucherville tunnel projects and that this estimate could readily have been made by Ouellette at the time the settlement was made, as the Boucherville contract was on an hourly basis so it would not be difficult to make a rough calculation of the anticipated net fees. In support of this he refers to Exhibit C-9, page 30, being a summary of profits and losses of Brett and Ouellette for the fiscal years from July 1, 1960 to June 30, 1963. This document is on a form with the name of the partnership’s accountant, D. A. Menard, C.A., printed on it, although it is not a signed statement and it was, of course, prepared after the conclusion of the partnership’s 1962-63 tax year terminating on June 30, 1963 and hence long after the settlement, so it certainly cannot be said to represent figures on which the settlement was based. If we examine the figures in it, however, we find that for the fiscal year ending June 30, 1961 (which was the only year of which the parties had any knowledge at the time of the dissolution in November of that year) there was a profit of $17,878.85 on the Sherbrooke contract but a loss of $20,518.51 on the Boucherville project, representing a net loss on those two projects for the year. In the following year, ending June 30, 1962, there was a profit of $4,544.33 on the Sherbrooke contract and a profit of $151,683.37 on the Boucherville tunnel and in the year ending June 30, 1963 there was a profit of $81,139.39 on the Sherbrooke project and of $20,958.66 on the Boucherville tunnel. Adding the three years together the total profit on the Sherbrooke contract was $103,562.57 and on the Boucherville tunnel $152,123.52, or a total of about $255,000. Brett and Ouellette’s counsel claims that the $80,000 settlement represented approximately one-third of this, which he considers gives support to Ouellette’s estimate at the time on which he claims the amount of the settlement was based. The same statement shows a net loss of $90,776.49 on other contracts, however, during the same three year period, and even the loss in the first year ending June 30, 1961 when Blauer was still a partner amounting to $5,376.11 does not seem to have been taken into consideration in calculating the estimate of the amount allegedly payable to him on the Sherbrooke and Boucherville projects. This document was only prepared for internal use according to the evidence of Ouellette, and evidently in connection with the litigation before the Tax Appeal Board, so I do not consider that much reliance can be placed on it as a basis for showing that the settlement with Blauer in 1961 was calculated on the basis of the share which he might have received from these two projects if he were considered to be in partnership with Brett and Ouellette in them; rather it appears that it is somewhat coincidental that the amount of the settlement made approximates this share.
Blauer, for his part, relied strongly on the use of the word “goodwill” which was used in the dissolution agreement which was only signed after approval by the attorneys of all the parties, and in support of this called an expert witness on the valuation of goodwill (Jack Richer, C.A.). He evaluated the goodwill at $250,000 using standard accounting methods based on an average of the net revenue method and the gross revenue method for the two years of the partnership ending in 1960 and 1961. He said that he made this estimate, however, without including the profits from the Boucherville tunnel or Sherbrooke contracts and if they had been included this would have increased his valuation of the goodwill considerably. On the other hand, Jacques Raymond, C.A. called as a witness by Brett and Ouellette would place no value on the goodwill, based on his interpretation of the contract as being a partnership for a specific enterprise, namely, the Place Ville Marie project, and hence considering the possibility that other work might be attracted to the partnership as a result of the prestige resulting from this project was not subject to valuation as goodwill since on this interpretation the partnership would not be carrying on as such with this other work. He makes the distinction between a professional firm and a commercial firm, considering that goodwill for professionals is represented only by the clientele. Another expert witness, Clément Primeau, C.A. agreed with the evidence of Mr. Raymond. A fourth expert witness, Gilles Murray adopted a neutral viewpoint and considered the $80,000 as a settlement for the loss of earnings for a number of years which he considers to be in part loss of goodwill in the sense that it represents also the value of the organization and office staff that have been built up.
It is evident from a careful reading of the evidence of all of these experts that the existence of goodwill in an accounting sense depended in its turn on whether there was a particular partnership only for the Place Ville Marie project to terminate as soon as it was finished, or a general partnership between the parties, which was, of course, the subject matter of the dispute between them. In attempting to support his argument that the sum of $80,000 which he received was entirely for goodwill, Blauer based himself solely on the evidence of the witness Richer, and if it is coincidental that Ouellette’s explanation of this figure is that this was the amount Blauer would be entitled to on the Boucherville and Sherbrooke projects if he shared in them, Blauer’s contention that this figure represents the true value of the goodwill based on the ex post facto determination of same by his witness Richer, is also certainly coincidental.
Whether or not the term goodwill is used in its strict accounting sense, it is clear that the name Brett, Ouellette and Blauer had become prominent and well known in the engineering world as the result of their association with the Place Ville Marie project, which was at that time the largest ever undertaken in Canada. This would undoubtedly attract the attention of developers, architects and others who were planning similar major projects and cause their submissions for these projects to be welcomed and given careful consideration. Even though the partnership had been formed only for this on project and there was, therefore, no question of the establishment of a steady clientele of customers who would come back year after year, as in the case of an established commercial business or perhaps an auditing or legal firm, there was, nevertheless, a very valuable reputation acquired which could be expected to attract major new business in the future years, and had Blauer been able to establish his contention that the partnership had been converted by course of conduct into a general partnership, he would have expected to share in this. Nor is this new business something entirely personal to the partners. Prospective clients would look on the partnership as an entity, including the entire organization that had been built up consisting of junior engineers, draftsmen, estimators, inspectors, and so forth rather than to the ability of any one of the partners as an individual. This reputation (I avoid the use of the term ‘‘goodwill” in its accounting sense since none had ever been set up on the books of the partnership) had a very considerable value which would attach almost entirely to the partners continuing in the organization to the exclusion of the partner who had withdrawn. It is common knowledge that any professional firm involving several partners, whether it be a legal firm or an accounting firm, or as in the present case an engineering firm, is often currently referred to by the name of the first partner or the first two partners and thought of in this manner. As one witness stated, the name ‘‘Brett, Ouellette and Smith’’ or ‘‘ Brett, Ouellette and Jones’? or simply “Brett, Ouellette and Associates ’ would convey to a prospective customer much the same as the name “Brett, Ouellette and Blauer’’, namely, that this was the firm which had successfully handled the Place Ville Marie project. The name “Blauer” alone or “Blauer and Smith”? or ‘‘Blauer and Jones’’ would not be thought of in connection with this project. Nor do I believe that this reputation was destroyed as a result of the criminal and civil proceedings brought by Blauer against Brett and Ouellette. It may have been diminished somewhat, but it is doubtful whether the general public had much knowledge of these proceedings which, in the case of the criminal proceedings, were withdrawn before preliminary enquiry and, in the case of the civil proceedings, withdrawn before trial. These conclusions are borne out by the evidence as to the income of the various partners following the dissolution. According to the evidence of Mr. Richer, the first year after the dissolution of the partnership when Mr. Blauer carried on as a sole proprietor, he suffered a net loss of $5,300 and the following year a loss of $8,500. On the other hand, Brett and Ouellette prospered and made even more money than during the years of the three-way partnership as the result of the consortium for the second phase of the Boucherville tunnel, and other projects. In the cross-examination of Mr. Richer, Exhibit C-4, page 7 8, we find the following question and answer:
Q. But in a partnership which is so new, how can you establish a figure for goodwill which will project far into the future?
A. Well, I can establish it on this basis; if I were asked by a client who was a professional engineer in July of 1961, who had the money to pay for goodwill, if I were asked my opinion as to whether he should pay seventy-five thousand dollars ($75,000) to become a partner in the firm of Brett and Ouellette, or to start a professional practice on his own, assuming that he had ‘the ‘money; I would advise him very strongly to pay the seventy-five thousand: dollars for the privilege of being able to get into an established practice, with the reputation that this firm had having done the largest job in Canada, in my opinion, at that time and that he would have recovered his additional investment in a relatively ‘short period of time, and continued 'on for the balance of his: professional life as an established leader in his field rather than having to start in the basement and working his way up.
In view of the conflicting evidence as to the valuation of the goodwill, and in particular the very serious doubt as to whether the partnership had been converted into a general partnership or remained a partnership for the Place Ville Marie project only, I cannot find that the $75,000 (or $80,000 if the $5,000 legal fees are included) was paid for goodwill alone as the dissolution agreement states, but neither can I conclude, as Brett and Ouellette claim, that this formed no part of the consideration for the payment made. In the case of Herbert Wallace Losey v. M.N.R., [1957] C.T.C. 146, Thorson, P. examines the nature of goodwill. At page 151 he quotes with approval from the judgment of Lord Macnaghten, page 28 of Trego v. Hunt ([1896] A.C. 7) that goodwill 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.”
In the present case, it did not require many years to build up the reputation of Brett, Ouellette and Blauer but merely the successful undertaking of a very major project. Again, at page 192, 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.
See also the case of Irvin Charles Schacter V. M. N. R., [1962] C.T.C. 437, where Mr. Justice Thurlow states, at page 444 :
Nor in my view is the matter affected by the fact that goodwill in the case of an accountant and particularly one who practises alone is largely personal to the particular practioner and scarcely capable of being sold with any assurance that the purchaser will obtain any benefit from it. No doubt one who pays for so tenuous an advantage takes a risk but there is nothing uncommon about professional men acquiring the undertakings of established practitioners with whatever goodwill can be retained in the transfer and I know of no reason why if they see fit, as appears to have occurred in this case, they cannot in such a transaction agree upon a consideration for such goodwill. The fact that in the result no goodwill may be acquired or that the benefits of the purchase may soon disappear appears to me to be irrelevant for the present purpose for in the test referred to in the cases cited what matters is the nature of the advantage sought rather than the benefit actually obtained.
See also the case of James Marwick and Simpson R. Mitchell V. David S. Kerr (1916), 53 S. C.R. 1 which recognized the existence of goodwill in an accounting firm and that even the junior partners shared in same. In the present case, it is not a question of Brett and Ouellette purchasing from Blauer goodwill which was personal to him, but rather a question of compensating him for his share of the goodwill or good reputation, if we use the term in a non-accounting sense, of the partnership which would be lost to him when he left it and in which, on the other hand, Brett and Ouellette would now each have ¢ a one- half share instead of é a. one- one-third share.
If the payment made to Blauer was not, as I have concluded, made entirely in compensation for loss of his share of earnings on the Boucherville tunnel and Sherbrooke projects, as Brett and Ouellette claim, nor on the other hand entirely as compensation for loss of his share of the goodwill (or good reputation) of the partnership, as he claims, it is necessary to carefully examine the dissolution agreement and the evidence of the various witnesses who participated in the discussions leading up to it in an attempt to decide just what was the principal consideration for the payment. It is here that we get the greatest conflict of evidence. For his part, Ouellette contends that the term goodwill was never mentioned in discussions leading to the dissolution agreement. He made a rough calculation in his head, without reducing anything to writing, of the amount which Blauer might have received if he had been considered as a partner in the Sherbrooke and Boucherville contracts and conveyed this figure, which worked out to about $82,000, to his lawyers. He admits, however, that his lawyers had discussed with him the possibility of losing the civil proceedings and also discussed the criminal proceedings and they reached the conclusion that to settle everything they would give Blauer his share ‘‘pour s’en débarrasser’’. Blauer, on the other hand, testified that $75,000 would not even remotely be equal to one-third of the profits from the Boucherville tunnel alone which he would estimate involved a total fee of about $3,000,000 (he is here, of course, speaking of the entire project not the initial contract alone). He explained that he considered the preliminary contract and the whole project together, since unless there is something wrong with an engineer, in about 95% of the cases the engineer who prepares the preliminary plans gets the contract. Blauer left the negotiation of the settlement largely to his lawyer, but insists that the settlement payment represented compensation for his rights in the partnership, whether this is called goodwill or not, and was not for the sums he expected to make out of the Sherbrooke and Boucherville contracts.
The most significant evidence is that of the lawyers themselves. Blauer’s lawyer, Morton Bell, testified with respect to the background of the travel vouchers and accounting records and how the criminal and civil proceedings came to be brought. He said that in his settlement discussions with Mr. Bourque, Brett’s and Ouellette’s lawyer, he stressed how from very humble beginnings a very substantial firm had come into existence and that Blauer was now finding himself on the street and that he wanted compensation for it. He asked for $200,000 but admits that he took this figure out of the air. There was a counter offer of $25,000. On the morning of the first hearing in the criminal proceedings, discussions regarding settlement took place, and they were postponed until the following day, and they had further discussions and arrived at a figure of $75,000, but he insists there was no basis for the calculation of this figure and he states (Exhibit C-3, page 77) :
. . At no time did I ever go or did I ever seize the nature or extent of the fees to be received from either Pavillon St. Georges or Ile de Boucherville. I never asked for them and I don’t know whether they made a million dollars or five million dollars or twenty-five thousand dollars, I had no idea, I was never shown them, it never formed part of our discussions. It was a negotiated settlement; the fee in compensation for Blauer getting out and for what he had lost.
Again, at page 82, he states:
. . . they couldn’t go on being partners with swords pointing at one another and it became evident that Blauer would have to go out, and Blauer in order to go out would have to be paid and what would he have to be paid for and the only argument, and the only thing I ever negotiated on with Mr. Bourque and Mr. Gelinas was the shabby treatment that Mr. Blauer was getting in finding himself on the street, leaving behind to these fellows, to Brett and Ouellette, a going concern, a partnership, an image, if you will, to the public which. Mr. Blauer had as a result of his being obliged to leave was necessarily lost. That’s all, that’s all we ever discussed, Mr. Decary, I am enough of a lawyer to know that if we are dealing with a share of profits of Pavillon St. Georges and the St. Lawrence River crossing at Ile de Boucherville, I would have wanted to see contracts and I would have wanted to see figures to know how much they were getting so that we were getting a fair share. The document isn’t even drawn that way.
Mr. Gélinas, one of the attorneys representing Brett and Ouellette at the time of the settlement, in his evidence (Exhibit C-5, page 10) testified as follows:
D. Est-ce que vous étiez influencé par la position de votre client à l’égard de son témoignage à l’occasion de l’examen au préalable? R. Je n’ai pas été influencé par la position de mon client, j’ai été influencé simplement par le résultat des examens au préalable. J’ai constaté que la défense n’était peut-être pas aussi forte que nous le pensions au début et on a discuté d’un règlement,
D. Craigniez-vous la perte d’achalandage de votre client? R. Il n’a jamais été question d’achalandage et on n’y a jamais pensé.
D. Craigniez-vous la perte de réputation? R. Oui, à cause des actions ou criminel.
D. Alors, vous craigniez la perte de réputation? R. Oui, à cause des actions au criminel et c’est un des motifs qui nous a porté d’ailleurs à suggérer un règlement.
And again at page 12:
R. Je dois dire même que s’il n’y avait pas eu. de procédures au criminel, j’aurais probablement conseillé à mes. clients de continuer les procédures au civil, de prendre leur chance.
Mr. Gélinas also testifies, however, that in so far as he was concerned, he always worked on the basis of the fees due to Blauer as his share of the profits on the Sherbrooke and Boucherville contracts and that he had asked his clients to calculate these figures approximately. He says that if he had been trying to evaluate goodwill, he would have proceeded in an altogether different manner. No statements were ever furnished to Mr. Bell, however. He admits, nevertheless, that he examined the agreement and advised his clients to sign it even though it did give goodwill as the consideration for which the $75,000 referred to in the agreement was paid.
Mr. Pierre Bourque, Mr, Gélinas’ associate, gave a very frank explanation in his testimony of the reason he recommended his cilents to settle. He said (Exhibit C-5, page 20) :
R. Lorqu’il y a eu discussion de règlement, tous les faits ont été pris en ligne de compte et certainement que les procédures au criminel, je n’emploierai pas le terme “menaces”, mais la question de procédures additionnelles possibles pour parjure et le fait que nos clients pouvaient obtenir un contrat pour Boucherville, un contrat final, à ce moment-là je crois qu’il aurait été inutile de ne pas considérer tous ces faits-là. Le fait de la séparation physique et le règlement avec monsieur Blauer et je me souviens qu’ils ne s’entendaient pas tellement. Alors, tous ces éléments-la ensemble, les aléas d’un procès, la question de procédures criminelles, même si je pensais qu’il s’agissait d’une cause purement civile, et vu que toutes les répercussions tant dans le domaine professionnel qu’au point de vue pécuniaire ont été soupesées, alors ça conduisait à un règlement.
He also admitted that one of the motives was to get rid of Mr. Blauer in the following answer, on page 22 :
D. Le départ de monsieur Blauer, c’était pour se débarasser de lui? R. Il n’y a pas de doute là-dessus.
He also advised his clients to sign the agreement as drawn.
In the light of this evidence we can now return to a closer examination of the dissolution agreement and what resulted from the signing of it. As a consequence of the signing, Blauer benefited as follows :
(a) He received $75,000, plus 5,000 legal fees not provided for in the agreement ;
(b) He continued to share in the foes from the Place Ville Marie project and in some forty smaller projects listed in Schedule A to the agreement ;
(c) He was relieved from whatever jeopardy in which he had been placed by the $50,000 libel action instituted against him, which was withdrawn at the time of the signing of the dissolution agreement.
Brett and Ouellette, for their part, received the following benefits as a result of the signing of the dissolution agreement :
(a) No further claims would be made present, past or future by Blauer for fees in connection with the Pavillon St. Georges (Sherbrooke) or the Boucherville projects ;
(b) They were relieved of having Blauer continue in partnership with them ;
(c) They were relieved from whatever jeopardy in which they might have been as a result of the criminal proceedings for fraud and for conspiracy ;
(d) Ouellette was relieved from the threat of proceedings for perjury arising out of the evidence given by him in Examination on Discovery in the civil proceedings brought by Blauer against him and Brett ;
(e) Brett and Ouellette were relieved from whatever jeopardy in which they were placed by Blauer’s proceedings asking for a declaration that a general partnership existed between the parties which, if successful, would force them to share fees in all projects with him until they could get the partnership dissolved ;
(f) They would retain, as I have found, to the exclusion of Blauer, whatever advantages resulted from the good reputation acquired by the partnership as a result of having been selected as engineers for and carried out the Place Ville Marie project.
All these factors entered into the settlement which was made, and not the least of them, as is very clear from the evidence of Brett’s and Ouellette’s own attorneys, was the possible danger to them resulting from both the criminal and civil proceedings which their attorneys felt it was wise to settle. While Brett and Ouellette and their attorneys may have in good faith estimated the amount which they were prepared to offer to Blauer on the basis of what they felt his fees would amount to if they conceded to him the right to share in the Sherbrooke and Boucherville tunnel projects, which they had up to that time vigorously denied, it is also evident that to Blauer and his attorney, Mr. Bell, the settlement was in compensation for being forced out of a partnership which he had come to regard as a general partnership and had looked forward to remaining in for many years, and that in accepting the settlement for $75,000 and $5,000 legal fees, they in no way calculated or took into consideration the amount which he might have received from the preliminary Boucherville tunnel and the Sherbrooke projects as they had no figures available on which to base these calculations.
‘Some argument was adduced on behalf of Brett and Ouellette to the effect that it was not they who had brought about the termination of the partnership but rather Blauer himself as a result of the proceedings he instituted, but I cannot agree with this. The evidence is abundantly clear that conditions within the partnership had become intolerable for him. He was being ignored, partnership correspondence was withheld from him, his instructions to junior staff were being countermanded, and the other partners were even renting premises in the same building and assigning staff to work there without consulting him. The principal reason for this conduct was apparently their avowed intention to exclude him from participation in the Boucherville tunnel or Sherbrooke contracts which Ouellette had secured allegedly as a result of his political influence, and in connection with which they considered Blauer’s continued presence in the partnership would be detrimental. It may well have been that they were perfectly right in confining the partnership to the Place Ville Marie project for which the agreement had originally been drawn and such other minor projects as they were prepared to include in it, but certainly a state of affairs had been created as a result of which Blauer had only two choices—either to remain in the partnership as an unwelcome and largely ignored partner, doing such minor work as the other partners permitted him to do, and sharing only in such future projects as they were willing to permit him to share in, or institute proceedings to attempt to enforce what he believed to be his right to a full partnership, though knowing full well that these proceedings would have to eventually result in a dissolution of the partnership, as the bitterness engendered by this litigation would make it intolerable for the partnership to continue. He chose the latter course and took action very vigorously, not only by civil proceedings to declare that a full partnership existed but, on advice of eminent counsel, in the form of criminal proceedings. The fact that when these proceedings were. settled one of the conditions of the settlement was dissolution of the partnership and that the amount paid in settlement coincidentally may approximate the amount he might have received as his share of the fees in the Sherbrooke and Boucherville tunnel projects had his other partners admitted his right to share in these fees, does not mean that the settlement represented a payment of these fees and hence became taxable income in his hands.
In this connection I would refer to the case of National Paving Company Limited v. M.N.R., [1955] C.T.C. 358. In that case, the sum of $225,000 was paid for surrender of any claim for participation in a contract. The claim was settled in the opinion of counsel for the payors that ‘‘it would be proper to make a settlement” even though there might have been no legally enforceable claim. It was held that the fact that the $225,000 payment approximates one-third of the estimated income from the contract does not make it income.
Two Tax Appeal Board judgments were to the same effect. In the case of Dr. Georges Garneau v. M.N.R., [1968] Tax A.B.C. 91, the appellant was dismissed from a hospital where he had worked under an arrangement whereby fees charged to his cases were collected for him by the hospital and remitted to him. He sued the hospital for wrongful dismissal and damages and was successful. The Minister sought to tax part of the settlement identified in the action as pertaining to loss of income while he claimed it was a capital receipt. It was held that the whole pertained to loss of a privilege or advantage which is a source of income and was not an income receipt.
In the case of Edwin V. Larson v. M.N.R., [1967] Tax A.B.C. 112, an employee who was let out of his company refused to resign or to accept two months’ salary as compensation. Instead, he engaged a lawyer and in subsequent negotiations settled for $10,000 (which was equivalent to six months’ salary). The Minister claimed this was a retiring allowance while the taxpayer claimed it represented damages for wrongful dismissal and as such was not subject to tax. It was held that had he accepted his employer’s offer of two months’ salary, this might well have been taxable, but what he received was not a voluntary payment. The judment reads, at page 115 :
. . . it must be concluded that the payment was made in lieu of a court order which Farrel probably anticipated would be issued if a settlement was not reached with the appellant. This was not a payment received for loss of office. Instead it was received as damages for the arbitrary cancellation of the appellant’s employment and was paid only under threat and likely also to avoid the publicity of an action in court against Farrel.
The facts of the present case clearly distinguish it from judgments such as that rendered by Dumoulin, J. in the case of William G. Briggs v. M.N.R., [1958] C.T.C. 11, which relied on a judgment in Commissioner of Income Tax, Madras v. P.R.A.L.M. Muthukaruppan Chettiar (Gordon’s Digest of Income Tax Cases 139, page 757) and the Supreme Court case of M.N.R. v. Joseph Sedgwick, [1963] C.T.C. 571. These cases held that earned income cannot be converted into capital by the process of making an agreement whereby such income is withdrawn by a partner leaving the partnership. In particular, the Sedgwick case held that the agreement could not be construed as being one for the sale of an interest in a partnership, but that it was rather an agreement for the winding-up of the partnership and that the respondent was liable to pay tax in respect of his share of the partnership income for the fiscal year ending when the partnership was wound up. In the present case, on the contrary, Brett and Ouellette contend that there never was a general partnership entitling Blauer to share in the fees earned. in the Boucherville tunnel and Sherbrooke projects and while they, in their own minds, may have based the amount to be paid to him as a settlement on dissolution of the partnership and for withdrawal of the various proceedings he had laid, on an amount equal to what they considered his share of the profits on these two projects would amount to, it is clear that the settlement was not based on an accounting of the partnership, treating it as a general partnership, up to the date of the dissolution, resulting in a payment to Blauer of his share in the partnership income to this date, for no such accounting was made.
Neither can Brett, and Ouellette claim that the payment made to Blauer was an expense laid out by them for the purpose of earning income within the meaning of Section 12(1) (a) of the Income Tax Act. This problem was dealt with in some detail in the case of The Royal Trust Company and Emma Louise Stevens v. M.N.R., [1948] C.T.C. 21. In rendering judgment in that case, Mr. Justice Cameron held as follows, at page 30:
It may be advisable to note at this point that, as to Smart, the sum represented by the annual payment to J. E. M. Fetherston- haugh was not wholly, exclusively and necessarily laid out for the purpose of earning the income. That clause has been interpreted as meaning “expenses incurred in the process of earning the income”, (Minister of National Revenue v. Dominion Natural Gas Company Ltd., [1941] S.C.R. 17; [1940-41] C.T.C. 155); and reference thereto in Imperial Oil Limited v. Minister of National Revenue, [1947] Ex. C.R. 527 at 540; [1947] C.T.C. 355.
On the same page he refers also to the case of Pondicherry Railway Co. v. Income Tax Commissioners (58 Indian Appeals 239) in which Lord Macmillan, in delivering judgment in the House of Lords, said :
English authorities can only be utilized with caution in the consideration of Indian income tax cases owing to the difference in the relative legislation, but the principle laid down by Lord Chancellor Halsbury in Gresham Life Assurance Society v. Styles, [1892] A.C. 309 at 315, is of general application unaffected by the specialties of the English Tax System. “The thing to be taxed,” said his Lordship, “is the amount. of profits or gains. The word ‘profits’ I think is to be understood in its natural and proper sense—in a sense which no commercial man would misunderstand. But when once an individual or a company has in that proper sense ascertained what are the profits of his business or his trade, the destination of those profits or the charge which has been made on those profits by previous agreements or otherwise is perfectly immaterial. The tax is payable on the profits realized, and the meaning to my mind is rendered plain by the words ‘payable out of profits’.”
It appears to me that. this judgment applies, for the settlement with Blauer was not made by Brett and Ouellette for the purpose of earning income in connection with the Boucherville tunnel and Sherbrooke projects, which projects they were already carrying out, and the fact that one of the results of the settlement would be that they would now share in the net profits from these two contracts in the proportion of one-half each instead of one-third each does not alter this.
I therefore find that the payment made by Brett and Ouellette to Blauer is a capital payment and not a payment in distribution to him of his share of the income from the preliminary Boucherville tunnel and Sherbrooke contracts, and hence was not deductible by Brett and Ouellette as an expense in connection. with their taxation returns for 1962.
The question of legal fees paid by Brett and Ouellette during the year 1962 was also argued and there seems to have been considerable confusion on this point. They paid $6,000 to their own attorneys during the year and $5,000 ‘to the attorneys of Blauer at the time of the settlement. The judgment of the Tax Appeal Board found that the fees relating to the civil action brought by Blauer against them were a deductible expense but that the same did not apply to the criminal: cases and the libel action which were considered to be personal expenses of Brett and Ouellette. An agreement made between the attorneys for Brett and Ouellette on the one hand and for the Minister of National Revenue. on the other on October 13, 1970 and filed as Exhibit A-l reads as follows :
Les parties aux présentes, par leurs procureurs soussignés, admettent ce qui suit :
A. Si quelque partie des frais légaux, payés par les contribuables ci-dessus mentionnés, est déductible aux fins du calcul du revenu desdits contribuables (dossiers Nos. B-2470 et B-2471), ce qui n’est pas admis mais expressément nié par le Ministre du Revenu National, cette partie déductible ne sera pas supérieure à $4,500.00 divisée ainsi qu’il suit:
i) Robert P. Ouellette —$2,250.00 ii) John E. Brett I LE .. .. $2,250.00 B. Les sommes de $2,250.00 pour chaque contribuable ci-dessus mentionné représentent une partie des frais légaux payés par eux à leurs procureurs, partie afférente et attribuable,
i) d’une part à la défence de Brett et Ouellette dans l’action intentée contre eux par A. Blauer (C.S. No. 537-905) ;
ii) d’autre part a l’institution de l’action intentée par Brett et Ouellette contre A. Blauer (C.S. No. 545-447)
iii) et enfin à la transaction intervenue le 28 novembre 1961.
This evidently has reference to fees paid by Brett and Ouellette to their own attorneys. The attorney for the Minister, in his written argument, explains that the $4,500 figure was reached by deducting from the $6,000 they paid to their attorneys, the sum of $1,500 which was paid in connection with their defence against the criminal charges. He argued that in view of this agreement, it is implicitly admitted that the $5,000 payable to Blauer’s solicitors would not be deductible. With respect to the $4,500, he argued that by virtue of Section 12(1) (a) of the Act, these fees would not be deductible as they were not incurred by the taxpayer for the purpose of gaining or producing income. I agree with this contention. Legal fees paid in connection with litigation by the partnership with third parties, as for instance if there had been some dispute for the payment of certain of the projects they had undertaken would be deductible, but all these fees were incurred in connection with legal disputes between Brett and Ouellette on the one hand and Blauer on the other—that is to say, between the partners themselves, and were not incurred for the purpose of gaining or producing income for the partnership. While the end result of the settlement may have been that they were able to share the fees from the Boucherville tunnel and Sherbrooke projects between themselves without them making a specific division of them with Blauer, as I have found, this does not make these legal fees and expenses made or incurred by them ‘‘for the purpose of gaining or producing income”.
In his argument, however, counsel for Brett and Ouellette was clearly referring to the $5,000 fees paid to Blauer’s attorneys in addition to the $75,000 settlement with him, and apparently does not consider that the agreement quoted has reference to these fees. In support of his contention he argues that this payment to Blauer’s lawyers was a constructive payment made on his behalf and quotes Section 16(1) of the Income Tax Act which reads as follows :
16. (1) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.
He concludes, therefore, that this $5,000 should be deducted in addition to the $75,000 as part of the settlement made to Blauer. This argument might well have been valid had I concluded that the settlement payment made to Blauer was an income payment, but since I have concluded that it was not, then this $5,000 would be merely considered as part of the capital payment made to Blauer and not deductible, even if its deduction were not precluded as a result of the agreement between the parties on October 13, 1970 with respect to the deductibility of legal fees.
The appeals of the Minister from the judments of the Tax Appeal Board are therefore allowed in the cases of Brett and Ouellette with costs in favour of appellant, except for that portion of the costs as is attributable to the joint hearing of these two cases with case No. B-2477 Aaron Blauer v. M.N.R., [1971] C.T.C. 154) of which joint costs only two-thirds shall be allowed to appellant.