The Assistant Chairman:—Although this appeal relates to an assessment of income tax for the 1971 taxation year, the dispute, in actuality, relates to a claimed expense in the 1969 taxation year and a further expense in the 1970 taxation year of the appellant. Because of the loss-carry-forward provisions of the Income Tax Act, RSC’ 1952, c 148, there was no assessment of tax for either of those years from which it could appeal, but in 1971 the appellant was assessed by the Minister of National Revenue for a greater quantum of tax in that year than the appellant expected. The appellant had carried forward from 1969 and 1970 what .it thought was its loss position and applied those amounts against its income for the 1971 taxation year. The Minister’s opinion was different from that of the appellant’s as he did not agree that the expenses claimed by the appellant, which will be detailed more fully hereinafter, were expenses and consequently, insofar as he was concerned, there was no loss to carry forward to 1971.
The appellant, at the time the claims involved in this appeal arose, was a subsidiary of a corporation which was incorporated under the laws of Germany. The name of the appellant’s parent was Bopparder Maschinenbaugesellschaft MBH—BOMAG (hereinafter called “Bomag Germany’’). In April 1969 Bomag Germany caused another company to be incorporated pursuant to the laws of the Province of Ontario, whose name was Com-Pakall Construction Equipment Limited (hereinafter called “Com-Pakall”). By agreement dated April 29, 1969, Com- Pakall entered into an agreement with companies, namely, Pakall Limited, Pakall Manufacturing Limited and Pakall Compaction Equipment Limited to acquire their assets and equipment. By further agreement dated the 30th day of April 1969, Com-Pakall made with Pakall Compaction Equipment Limited (hereinafter called “Pakall”) a sales and consulting agreement. Several matters were agreed to in the agreement. The most relevant paragraphs are as follows: (In this agreement the “Company referred to is Com-Pakall.)
1. The Company hereby retains Pakall as a consultant to advise the Company in the manufacture of compaction equipment and to assist in the sale of the product throughout North America for a period commencing on May 1, 1969 and ended and fully to be completed on April 30, 1970.
2. PAKALL shall be: paid and the Company hereby agrees to pay Pakall the sum of $10,000 to be paid in 12 equal instalments of $833.33 on the first day of each and every calendar month throughout the term of this Agreement.
3. PAKALL shall make Long available during ordinary business hours to advise the Company regarding the manufacture and sale of the products of the Company throughout the North American market and Long shall be employed by Pakall.
4. PAKALL is hereby retained to act as a sales agent for the product of the Company upon the following terms:
(a) Pakall shall have no defined territory within North America but shall have the right to sell the product of the Company to anyone in North America but not on an exclusive basis and shall not be able to sell to the ultimate user in a territory in which the Company may now or in the future have an exclusive dealer, in which case the sale shall be made by Pakall through the dealer and the commission hereinafter mentioned shall be at the sale price to the dealer and not to the ultimate user;
(b) It is agreed that in the case of the five machines listed by type and serial number in Schedule “A” annexed hereto and the first five machines manufactured by the Company, or any person, firm, corporation, partnership, company or other legal entity on behalf of the Company, that special conditions with regard to commission only shall apply. A commission of $2,000 shall be paid to Pakall when each of the said machines is sold by the Company. If however any one of the said machines is sold by Pakall for less than $30,000 the commission payable to Pakall for such machine shall abate dollar for dollar as the sale price shall reduce so that if the sale price were $29,000 the commission Pakall would receive would be $1,000, if $28,500 the commission Pakall would receive would be $500 and if $28,000 there would be no commission at all, no sale shall however be made without the Company’s consent. Provided always however that if Pakall shall obtain the consent of the Company to such sale, commission shall be in such amount as the parties shall agree upon. Subject to the terms of this clause, the commission payable to Pakall shall be paid proportionately to it as payment is made for the machine. If any one of the said 10 machines is repossessed, the balance of commission still outstanding on the sale under which the said machine was originally sold and repossessed shall be paid to Pakall when the machine is disposed of and such commission shall be
paid to Pakall proportionately as payment is made for the machine when disposed of after being repossessed and so on from time to time until Pakall shall have received the full commission it would have received if the machine had not been repossessed. If any dispute shall arise over the amount due to Pakall for commission such dispute shall be determined by such firm of chartered accountants mutually agreed upon by Pakall and the Company and the fee of which shall be paid equally by Pakall and the Company.
(c) In all cases other than as set out in the foregoing subclause Pakall shall be paid a commission of 4% on all sales effected by Pakall which commission shall be calculated on the sale price which the purchaser shall agree to pay, fob the manufacturing facilities of the Company and for reasons of clarity only, this shall not be deemed to include any retail sales tax payable by the purchaser, interest or carrying charges payable by a purchaser in order to finance a purchase or freight charges.
The said commission shall be payable by the Company when the Company receives payment from the purchaser in any manner whatsoever; for example, if a down payment of $5,000 is received, 4% of that amount would be paid to Pakall on account of its commission and if a further payment of $2,000 is received, 4% of that amount would be paid to Pakall on account of its commission and if the sale price is secured by any conditional sale contract, chattel mortgage, promissory note or any like contract or security and such contract or security is sold the 4% of the value of such contract or security would immediately be paid to Pakall as commission, or calculated on the amount actually received by the Company; if Long approves the sale of such security.
(e) Pakall shall always employ and make available the services of Long and Pakall shall not, from May 1, 1969, until December 31, 1969, be employed directly or indirectly by another but shall devote its whole time and attention to the affairs of the Company and. shall act dilligently as a salesman and shall not accept any remuneration or honorarium from another during such period.
From January 1, 1970 until April 30, 1970 Pakall shall as as consultant to the Company and make itself available to the Company at such reasonable times and for such reasonable periods as the Company shall reasonably require,
There are other paragraphs to the agreement of that date, but they really have slight significance to this appeal. The transaction took place in accordance with the said agreement and reasonably shortly thereafter Com-Pakall started to carry on the business which, in effect, had previously been carried on by Pakall. It should be mentioned that the “Long” referred to in the sales and consulting agreement was the person who was, if not the sole shareholder of each of the corporations in the sale agreement, the controlling shareholder.
After Com-Pakall started to operate the business, it found that Long was interfering with production in that, in the course of production, he was stopping the operation to make changes rather than going through the engineering department. He was, in the words of Walter Kuettner (hereinafter called “Kuettner”) who was the general manager and secretary of Com-Pakall as well as Bomag (Canada) Limited (hereinafter called “the appellant”), always interfering with production and the relationship between the men was deteriorating. He discussed the matter with Long and advised him to stop working on production and spend his time and efforts concentrating on the sale of Com- Pakall’s products. Shortly thereafter Long let it be known that he could not work on a full-time basis. In addition, shortly after Com- Pakall started business, it found that its suppliers would not deal with it on a regular basis because of the history they had had with Pakall. It found that it was forced to pay for goods in advance and then had to wait 3 or 4 months to get them. When it acquired the business, it obviously, in the opinion of Kuettner, did not acquire any goodwill. In that respect Com-Pakall decided to get out of the Com-Pakall name. It should be mentioned that at this time the issued share capital of Com-Pakall was owned 80 per cent by Bomag Germany, 10 per cent by Kuettner and 10 per cent by either Long or Pakall. Those obstacles being considered, a decision was made by Bomag Germany that another company should be incorporated under a different name and it should take over the business operations carried on by Com-Pakall. To this end the appellant was incorporated in July of 1969 pursuant to the laws of the Province of Ontario. At all material times to this appeal the shares of the appellant were owned 90% by Bomag Germany and 10% by Kuettner. The inventory of Com-Pakall was, shortly after incorporation, transferred to the appellant if no tax was involved as a result. of the transfer. The employees of Com-Pakall for the next month or so remained with Com-Pakall and Com-Pakall invoiced the appellant to reimburse it for the services provided including the making of the machinery. Com-Pakall sent out invoices for equipment it leased in the period of August to September 1969. On or about October 1, 1969, the appellant sent to all distributors with which it was familiar, a notice that it had taken over the operations of Com-Pakall as of October 1, 1969. Com-Pakall retained ownership of the buildings and some equipment which the appellant rented from it. They carried on business in this fashion between each other until Com-Pakall had made a profit against which it could write off its prior losses. After that, Com-Pakall was wound up and Kuettner was of the.belief this happened around 1972. The relationship with Long continued to deteriorate and Kuettner approached Long to see on what basis the sales and consulting agreement could be terminated. Ultimately, by document captioned “Release” and dated the blank day of November 1969, Long and the companies mentioned in the sales agreement, namely, Pakall Limited, Pakall Manufacturing Limited and Pakall Compaction Equipment Limited, gave the release to certain persons. The release agreement contains the following recital clause:
AND WHEREAS John H Long, Pakall Limited, Pakall Manufacturing Limited and Pakall Compaction Equipment Limited wish no longer to be associated with or to be employed by Com-Pakall and wish to give up their rights under the said recited Agreements;
WITNESSETH that in consideration of the sum of $20,000 now paid to John H Long, Pakall Limited, Pakall Manufacturing Limited and Pakall Compaction Equipment Limited, the receipt whereof is by each of them hereby acknowledged, and in consideration of these presents, Long and Pakall Limited, Pakall Manufacturing Limited and Pakall Compaction Equipment Limited do hereby remise, release and forever discharge Karl Heinz Schwamborn and Com-Pakall Construction Equipment Limited and each of them, their respective heirs, executors, administrators, successors and assigns, of and from all manner of actions, causes of action, suits, debts, claims and demands whatsoever which the said John H Long, Pakall Limited, Pakall Manufacturing Limited and Pakall Compaction Equipment Limited ever had, now have or which their respective heirs, executors, administrators, successors or assigns, or any of them, hereafter can, shall or may have for or by reason of any cause, matter or thing whatseover (sic) existing up to the present time and arising out of the said recited Agreements or otherwise.
An agreement was entered into between Com-Pakall and the appellant dated February 2, 1970 (Exhibit A-6) as follows:
WHEREAS Com-Pakall has a line of credit with the Canadian Imperial Bank of Commerce which it has allowed Bomag to use;
AND WHEREAS Com-Pakall has paid John Long $20,000 in lieu of commission, terminated its contract with him and allowed Bomag to sell certain of Com-Pakall’s products.
WITNESSETH that the parties agree as follows:
1. Any monies borrowed by Com-Pakall and used by Bomag shall be repaid by Bomag to the Canadian Imperial Bank of Commerce and Bomag shall be responsible for any interest due on such monies.
2. Bomag and Com-Pakall acknowledge that: Bomag has advanced money to pay John Long the amount of $20,000 in lieu of commission and to terminate his contract and accordingly Bomag has obtained the advantage of selling the compaction equipment formerly sold by John Long and Com- Pakall.
3. This Agreement confirms the verbal arrangement made between the parties and the course of conduct of the parties with regard to the matters mentioned herein.
Kuettner stated that, insofar as he was aware, the only payment to Pakall from the appellant was for the inventory of Pakall’s goods. He believes that there was no goodwill. On cross-examination Kuettner agreed that the sales and consulting agreement which Pakall had with Com-Pakall was not an exclusive agreement in either respect. He also agreed that the sales and consulting agreement was never assigned by Com-Pakall to the appellant. He also agreed that in the release agreement from Long et al to Com-Pakall, no mention was made of the appellant. In explanation of that fact, it was pointed out that the original agreement was between Com-Pakall and Pakall, not the appellant. The obligation under the release was just assumed by the appellant and the only evidence that Pakall and Long et a/ accepted the appellant as a new debtor consists solely of the fact that the cheque in payment of the amount referred to in the release was negotiated as drawn. As to the actual payment of the $20,000, the payer was Com-Pakall and the payee could have either been Long or ‘Pakall. According to Kuettner, the appellant did reimburse Com- Pakall for the cost as it was getting the business—it should assume the expenses. It was presumably set up as a payable by the appellant to Com-Pakall in November 1969. As to the payment by the appellant to Pakall, it could have been in cash, possibly put through as part of another transaction, or paid by journal entry to offset amounts which the appellant owed Com-Pakall. The audited financial statements of the appellant for the 1970 fiscal year ending on November 30 contained several notes. Note 6 which was referred to by counsel for the respondent reads as follows:
Loan Payable (bank, via) Associated Company: This loan was made by the bank to Com-Pakall Construction Equipment Limited and lent in turn to Bomag (Canada) Limited. Although the loan is due to an associated company, it should be regarded as a bank loan, for the purpose of liquidity.
Mr Kuettner agreed that the proper interpretation from that note would be that, to the accountants, the appellant had loaned the money, but really the appellant had paid the $20,000 to Long et a/. Kuettner agreed that the money advanced (the $20,000) did not collect interest. He also confirmed that the appellant is still selling goods which Com- Pakall had manufactured and is doing it without any new agreement.
We now turn to the other expense claimed by the appellant in the 1970: taxation year which the Minister, by his assessment in 1971, disallowed in the computation of the loss it could carry forward. The appellant, as stated by Kuettner, was incorporated solely for one purpose, namely, to acquire the assets and business undertaking carried on by Com-Pakall. Sales were not too good. If I recall the evidence correctly as a matter of fact, there had been no sales by the time the sales and consultation agreement was nullified. Kuettner, the appellant and Bornag Germany knew that Bomag Germany, by document dated January 30, 1967, had granted to a company, Wett- laufer Equipment Limited (hereinafter called “Wettlaufer”), a sales and distributorship agreement of its property throughout Canada. Kuettner stated that, insofar as he knew, no fee was paid by Wettlaufer to Bomag Germany for this franchise. It was presumed that Wettlaufer was making money selling Bomag Germany’s equipment. Kuettner apparently consulted Bomag Germany and its officials. as to the position of the appellant and apparently the suggestion was made that the losses of the appellant would be minimized if it could take over the franchise which had been given to Wettlaufer more or less immediately. Apparently Kuettner was authorized to approach Wettlaufer on this basis. Of course it was expected that the appellant would take over after the expiration of the franchise agreement. It would appear that the franchise agreement would expire on December 31, 1970. Paragraph 15 of the agreement reads as follows:
This agreement shall remain in force until December 31, 1970. Thereafter it will run and operate as an agreement which may be terminated by either party on 6 months’ notice.
Presumably any time after incorporation of the appellant, Bomag Germany could have given notice that the agreement would expire on December 31, 1970. The Board was advised that sometime, possibly in 1967, Wettlaufer became the wholly-owned subsidiary of Charterhouse Canada Limited (hereinafter called “Chartérhouse”). Kuettner approached the officers of Wettlaufer or Charterhouse for the purpose of discussing the termination of the agreement at the end of December 1969 rather than its regular expiry date of the end of December 1970. In due course an agreement was reached. The agreement was expressed in a formal document dated June 27, 1969 between Charterhouse and Bomag Germany. The main paragraph of that agreement is as follows:
2. Bomag shall pay to Charterhouse on the 1st day of each and every month in 1970 the sum of $9000 (Canadian funds) by cash or certified cheque payable at Toronto, Canada; provided that Bomag may at its option in lieu of the aforesaid monthly payments pay to Charterhouse on. January 1, 1970 the sum of $103,680 (Canadian funds) by cash or certified cheque payable at Toronto, Canada.
(The Bomag mentioned in this quote is Bomag Germany in these Reasons.)
It should be noted that the appellant’s name is nowhere mentioned in that agreement. The appellant took over the Bomag Germany stock which Charterhouse had on hand at the end of 1969 and, in due course, employed some of the employees of Charterhouse. The appellant paid the sums required to be paid by paragraph 2 of the agreement of June 27, 1969. Each month Charterhouse invoiced the appellant for the payment required in that paragraph, and each month the appellant paid the amount. In the opinion of Kuettner, net earnings generated to the appellant exceeded $108,000 which it paid pursuant to paragraph 2 to Charterhouse. In addition to that, if the contract had not been cancelled and then assumed by the appellant, the appellant clearly would have lost money. In 1970, as far as corporate bodies were concerned, there was no doubt that the appellant would be paying the money due to Charterhouse pursuant to the agreement. An agreement dated February 2, 1970, was signed by Bomag Germany and the appellant with respect to the Charterhouse franchise. That agreement (Exhibit A-9) reads as follows:
WHEREAS Bomag Germany entered into an Agreement with Charterhouse Canada Limited dated June 27, 1969 and the shareholders of Bomag Germany thereafter caused Bomag Canada to be created for the purpos
(sic) of selling the products contemplated by the Charterhouse Agreement, WITNESSETH that the parties agree as follows:
1. This Agreement confirms the verbal arrangements and course of conduct of the parties following the incorporation of Bomag Canada.
2. Bomag Canada shall have the right to all of the benefits contained in the Charterhouse Agreement and shall assume the responsibilities thereunder.
3. All payments under the Agreement shall accordingly be paid by Bomag Canada to Charterhouse for the franchise rights which Bomag Canada enjoys.
It was not usual that Bomag Germany would issue franchise agreements. In 1971 such an agreement was issued. The reason for this was that an American company acquired control of Bomag Germany in late 1970 and, apparently because of some requirements, the agreement had to be entered into. Such an agreement was entered into by the appellant with Bomag Germany. There is no sum mentioned in that franchise. Mr Kuettner confirmed that the franchise agreement between Wettlaufer and Bomag Germany was an arm’s-length transaction and it was not. assigned to the appellant. Insofar as the amount which was paid to Charterhouse to reduce the term from 3 years to 2 years is concerned, the negotiations were what one could call typical negotiations. Charterhouse wanted more than $108,000 and Bomag Germany wanted to pay less. The final figure was the result of negotiations. As Kuettner put it—in the eyes of the appellant, it received the benefit from the release and it should pay the price. Actually, as he also stated, Bomag Germany paid nothing for that release—the appellant paid all. On cross-examination of Keuttner, reference was once again made to the appellant’s financial statements for its 1970 fiscal year previously referred to, and in this instance reference was made to Note 12. Note 12 reads as follows:
Settlement of Franchise Agreement: The parent company, Bopparder Maschinenbaugesellschaft GmbH was party to an agreement with Wettlaufer Equipment Limited dated January 30, 1967 for the agency of Bomag Equipment in Canada. This agreement was assigned. by Wettlaufer to: Charterhouse Canada Limited. The agreement was to terminate on December 31, 1970. In order to terminate the agreement on December 31, 1969 Bopparder Maschinenbaugesellschaft entered into an agreement with Charterhouse dated June 27, 1969, under which $108,000 were due to the latter. This obligation was assumed and discharged by Bomag (Canada) Ltd.
Mr Kuettner said that, as far as he was concerned, the obligation was always the appellant’s and it was not assumed by it, but he cannot recall objecting to the auditor’s use of the word “assumed” in the last line although he may have. There was however, as he reiterated, no agreement giving the appellant the right to sell Bomag Germany’s products in lieu of Wettlaufer (Charterhouse) in 1970, but it did sell and it is still selling them.
With respect to the payment of the $20,000, counsel for the appellant submitted that that expense was a current business. expense and Clearly within the ambit of paragraph 12(1 )(a) of the Income Tax Act before tax reform. His submission continued that the appellant clearly was in business by October 1, 1969. The contract was an onerous contract and, if not entirely, substantially all payments pursuant to it would be on account of sales commission and consulting fees, and as such were normal business expenses. If the contract had run its normal course, the payments required to be paid pursuant to it would clearly have been a deductible expense and consequently, his submission was that the commutation of them would still be an expense. In this respect, appellant’s counsel referred to several cases including Avco of Canada Limited v MNR, 16 Tax ABC 144; 56 DTC 551, especially the portion of the reasons on pages 147 and 553 respectively which indicated that in that case no capital asset or new advantage for the enduring benefit of the appellant was deemed to have been obtained and the payment was held to be deductible. Reference was also made by him to Johnston Testers Ltd v MNR, [1965] CTC 116; 65 DTC 5148. This was a payment made by the appellant to obtain the release of an obligation to pay royalties for the use of certain patents. In the circumstances of the case the Exchequer Court held the payment to be deductible.
Counsel for the Crown in the instant case contended that the. expense was not an expense within the meaning of paragraph 12(1)(a) of the Act as, first of all, there had been no assignment of the obligation by Com-Pakall to the appellant and the payment, in effect, if it were paid by the appellant—and he contended it was not—was a gratuitous payment. The appellant had no obligation to pay commis- siens or consulting fee pursuant to an agreement to which it was not a party, which agreement had not been assigned to it. He contended that: the documentary evidence, especially the auditors notes which were quite current with the events or at least not 8 years later, reflects much more accurately what happened in 1969 than did the evidence at the hearing. That evidence indicated that the money was loaned to the appellant by Com-Pakall on an interest-free basis so it could pay its obligation. Exhibit A-6 indicated that the appellant advanced the money to Com-Pakall. Counsel for the Minister also pointed out that it really was not solely a commutation of commissions because of the circumstances of the case—a commission could be something other than the $20,000. In addition to that, there was a consulting fee and other obligations from which Com-Pakall was released by the release. Insofar as the cases of Johnston Testers Ltd and Avco of Canada Limited were concerned, counsel pointed out that the payment by those taxpayers was to the person with whom they had the relationship, not to a person who was In effect a stranger to them.
Insofar as the expense of $108,000 is concerned, counsel for the appellant contended that the payment was to acquire the right to sell Bomag Germany’s goods on an exclusive basis. He also contended that this expenditure was clearly an expenditure falling within the ambit of paragraph 12(1 )(a) of the Act before tax reform but, if it were held not to be so, then it was a capital expenditure within the meaning of paragraph 12(1)(b) of the Act and, as such since it was a franchise for a limited period, capital cost allowance could be claimed on it pursuant to the provisions of Class 14 of Schedule B to the Income Tax Regulations. In the circumstances, since it was for one year only, the effect is that, if the appellant’s counsel is correct, the whole amount is deductible in 1970. Counsel for the Minister did not contend that, were it held that the appellant acquired a franchise from Charterhouse, that franchise was not for a limited period: Counsel for the appellant contended that, after December 31, 1969, Charterhouse no longer had a- franchise from Bomag Germany and the appellant was selling Bomag Germany’s goods and consequently it is obvious that the appellant now had the business which Charterhouse formerly had. Therefore, if it received the benefit, it should have the responsibility for making the payment. Counsel pointed to Exhibit A-9, being the agreement between Bomag Germany and the appellant, which indicated that Bomag had all the rights which had been contained in the Charterhouse agreement. His final remark was that the final documents with respect to the transaction did not reflect the substance of the transaction.
Counsel for the Minister took the position that the agreement terminating the franchise of Charterhouse prematurely was an agreement between Bomag Germany and Charterhouse and not only was thé appellant not a party to this agreement, but the appellant was not even mentioned in the agreement. The appellant just paid the financial obligations to its parent and there was no assignment of the franchise formerly held by Charterhouse to the appellant. Counsel also made reference to: Exhibit A-9 and the wording of it. (It is to be understood, according to counsel for the appellant, that as at December 31, 1969, the Charterhouse franchise had been cancelled by Bomag Germany.) He then commented—What do some of the clauses in that agreement mean? He stated Clause 2 meant the appellant “shall have the right to all of the benefits contained in the Charterhouse Agreement and shall assume the responsibilities thereunder.’’ The Charterhouse agreement at this time, namely February 2, 1970, did not exist. If the agreement did not exist, how can the appellant receive any benefits that were contained in it. Also he pointed out Clause 3 which reads: ‘‘All payments under the Agreement shall accordingly be paid by Bomag Canada to Charterhouse for the franchise rights which Bomag Canada enjoys.’’ Stress was made of the present tense of the word “enjoy”. He contended that without this agreement the appellant already had the franchise rights which he contends it received, as did Charterhouse or Wettleufer, gratuitously.
I am of the opinion that neither payment was a payment within the ambit of paragraph 12(1)(a) of the Income Tax Act. The appellant did not have any obligation to Mr Long or Pakall pursuant to the agreement between Com-Pakall and Pakall. If the appellant made the payment, the payment was made gratuitously and, in any event, the obligations under the agreement between Pakall and Com-Pakall had never been transferred to the appellant. Likewise the appellant made a gratuitous payment to Charterhouse. The agreement cancelling the franchise was between the appellant’s parent and Charterhouse. There was no assignment or purchase of any franchise from Charterhouse to the appellant. Consequently, the payment once again is a gratuitous payment and, as such, is neither deductible pursuant to the provisions of paragraph 12(1)(a) of the Income Tax Act, nor is it capital which is subject to capital cost allowance within paragraph 12(1)(b) or paragraph 11 (1)(a).
The appeal is dismissed.
Appeal dismissed.