The tax impact of selling a book of business has been settled by Supreme Court of Canada.

A purchase and sale agreement between two former Midland Walwyn employees for a client list has been ruled to be a purchase that was created to give an enduring benefit to the purchasing broker, says the SCC. Therefore his purchase was made to build his capital, and prevents him from deducting either the purchase-price, or the interest paid on the money he borrowed to make the purchase, from his income.

Both were payments “on account of capital,” says the country’s top court, and neither can be deducted under the Income Tax Act. The Income Tax Act permits commissioned salespeople to deduct non-capital expenses incurred to earn employment income, but capital expenses other than automobiles or airplanes are not deductible.

The case began in 1995 when Thomas Gifford, a broker and former employee of Midland Walwyn, borrowed $100,000 to purchase the list of retiring broker, Scott Bentley. Midland Walwyn was concerned about keeping the clients at the firm and the branch manager facilitated the agreement.

Gifford made a claim on his tax return for a deduction of depreciation of goodwill and interest and insurance expense. It was disallowed.

Gifford subsequently took his case to the Tax Court of Canada, changing his stance to argue that the payment to Bentley was a “current marketing expense” made for the purposes of obtaining clients. As an employee he should be able to deduct the payment and the interest on the borrowed money, he argued.

The Tax Court judge agreed with Gifford, finding that this payment did not result in the acquisition of an enduring asset because “clients are fleeting, volatile and evanescent.” Both the FCA and SCC disagreed with that assessment.

The SCC says that Gifford was purchasing the goodwill that Bentley “developed over years of dealing with his clients … The appellant was interested in Bentley’s relationship with his clients and not just the names on the list … If the appellant only wanted access to the names of the client he theoretically would not have needed to involve Bentley at all and could have dealt directly with Midland Walwyn … The goodwill and the agreement not to compete amounted to a capital asset to Mr. Gifford.”

This view resulted in the SCC taking a different view on the characterization of the interest paid by Gifford. The court decided that “it is not necessary to determine whether the payment is a capital expenditure but to determine whether the payment is being made ‘on account of capital.’ This distinction in terms is particularly important in relation to interest payments, because loan proceeds are seldom retained in the form they are received, unlike other capital assets.”

“This distinction … does not require an examination of what those loan proceeds are spent on.” Therefore, writes Major, if the loan adds to the financial capital then the payment of interest on that loan will be considered to be a payment “on account of capital.”

Furthermore, the court decided that “the fact that the transaction occurred between two employees instead of two businesses does not, by itself, change the characterization of the transaction.”