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SUPREME COURT OF NEW ZEALAND

NATHAN & CO LTD v INLAND REVENUE COMMISSIONER (NZ)

Hardie Boys, J

12 August, 4 September 1970 - Auckland

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Hardie Boys, J    In May 1966 it became known to the directors of the objector company in these proceedings that the firm of A J Entrican, Sims & Co Ltd was likely to be willing to entertain an offer for its grocery and fancy goods business, in which respects it was in competition with the objector company in Auckland, although the latter had commercial interests of a very much wider ranging kind. After some preliminary discussions the directors of L D Nathan & Co Ltd submitted to the directors of A J Entrican, Sims & Co Ltd an offer: "For your wholesale grocery, tobacco, confectionery and fancy goods business carried on at Customs Street East, Auckland, including all stock in trade, import licences and goodwill, and all motor vehicles, but excluding plant fittings and debtors, and for your retail grocery businesses at Wellsford and Pukekohe including all stock and plant and the land and buildings of both shops, but excluding book debts."

   There followed in the course of four pages certain "fixed figures" and other "expected figures" which were to be the subject of a stock taking; amongst the "fixed figures" was an item of £11,750 described as follows:-

   

"(iii) Goodwill: This item includes all import licences and a complete list of the names and addresses of your bona fide retail and institutional customers, together with your co-operation in the preparation and distribution of a full circular on your letterhead to these customers. For this part of your business we offer £11,750. We have based our goodwill figure on the value of the company's current import licences which for the 1965-66 year amounted to £18,936, as under present-day conditions general trade with a customer invariably depends on what 'short' or imported lines we are able to make available. It is expected that you will use your best endeavours in the transfer of any Agencies held."

   The offer was accepted on 20 May 1966 and carried fully to completion. But the Court is concerned only with this item of £11,750, and in respect of it counsel are in agreement that £8750 relates to the value of the import licences referred to and £3000 relates to the value of the list of customers. There were no agencies transferred.

   The evidence shows that licences to the value of £6606 in fancy lines and £12,330 in grocery lines, making the total of £18,936 referred to above, were currently held by Entrican, Sims & Co Ltd in May 1966, but were due to expire (as all licences do) on the following 31 July. The Customs Department consented to the transfer of all the licences to LD Nathan & Co Ltd, a consent which is not usually given except to enable the transferee to service the requirements of the customers of the transferor. With the annual review of licences which takes place and the changes in categories which occur today, so the Court is informed, only 42½ per cent of the original licences remain, a factor which is needed to be borne in mind in assessing the permanency of the thing transferred. Mr G H Browne, at the time of the transaction the chief accountant, but now the secretary of L D Nathan & Co Ltd, explained to the Court that at the time of the transaction the Government had announced its intention to remove import licences at as early a date as possible and, whilst this did not happen, in many of the categories affected by this particular transaction there were numerous changes of goods within the categories. The illustration which struck me most vividly was the example pointed out where £7116 was held as a licence for the importation of fish, but when it came to renewal, only sardines were eventually permitted to be imported under that category, whereas formerly it included all kinds of fish, be it salmon, anchovies or other kinds, with the result that, if the importer had imported no sardines under that particular licence in the previous year, he could get none in the subsequent year.

   The objector company set this item of £11,750 up in its books under the style "Provision for Write Off A J Entrican, Sims & Co Ltd import licences", writing off £5500 in its annual accounts for the year ended 31 July 1966 and the balance (with some adjustments and dollar conversion) in the year ended 31 July 1967-a sum of $10,990.78.

   In accordance with the contemplated arrangements, circulars were prepared to be sent to the former customers of Entrican, Sims & Co Ltd, but only after the list had been carefully scanned, for some people who were already the objector's customers would have been on Entrican, Sims & Co list. The total list of customers contained 1055 names, but there were 680 of these who were of a kind whom L D Nathan & Co Ltd either already dealt with or did not desire to commence dealings with and they were simply notified that Entrican, Sims & Co Ltd would no longer be taking their orders. That left 375 who between them got one of two special letters inviting them to trade with Nathans either on credit or on a cash basis. Mr B S Cole, the general manager and a director of L D Nathan & Co Ltd, has assessed that the company now has 216 customers who commenced their dealings through the list supplied by Entrican, Sims & Co Ltd

   I accept it from the evidence that, in relation to the total turnover of L D Nathan & Co Ltd, the increased turnover from customers acquired from Entrican, Sims & Co Ltd was relatively insignificant and in terms of licences the new licences represented 5.9 per cent. But the desirable things achieved by the transaction were the opportunity to purchase lines in short supply-goods with a "scarcity value"-available only under the acquired licences and the opportunity to expand the number of customers by acquiring the lists of the vendor's customers. As Browne said in evidence: "The opportunity to purchase imported goods was dependent on these licences, without the imported goods to service the customers, the customers' list would have been of smaller value. One really goes hand in hand with the other, if we want to service more customers we must have more imported goods supplied, and for this reason we regarded purchase of import licences as being a very material part of this transaction."

   Having written off in the course of two successive fiscal years the two sums of £5500 and $10,990.78, the objector claimed the sums as a deduction from tax for the respective years involved. The Commissioner, however, considered that the objector was not entitled to claim the deductions and, after amended assessments and objections had been lodged, a formal disallowance of objection was entered and the Commissioner was required to state this case now before the Court. The question is posed this way:-

   "8. The objector contends:

   (a) that the deduction of the amounts referred to in para. 4 hereof in respect of the write-off of 'Entrican's Licences' in accordance with s 111 of the Land and Income Tax Act 1954 is not precluded by s 112(a) of the Land and Income Tax Act 1954 or any other provision of that Act,

   (b) that the Commissioner incorrectly included the said amounts in the objector's assessments.

   "9. THE Commissioner contends that the deduction of the amounts referred to in para 4 hereof in respect of the write-off of 'Entrican's Licences' is precluded by s 112(a) of the Land and Income Tax Act 1954.

   

"10. THE questions for the determination of this Honourable Court are whether the Commissioner acted correctly in making the assessments referred to in para 5 hereof, and if not then in what respects should such assessments be amended."

   Section 111 and the relevant portion of s 112(a) are set out hereunder:-

   "111. Expenditure or loss incurred in production of assessable income.-In calculating the assessable income of any taxpayer, any expenditure or loss to the extent to which it-

   (a) is incurred in gaining or producing the assessable income for any income year; or

   (b) is necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income for any income year-

   may, except as otherwise provided in this Act, be deducted from the total income derived by the taxpayer in the income year in which the expenditure or loss is incurred.

   

"112. Certain deductions not permitted.-Notwithstanding anything to the contrary in section 111 of this Act, in calculating the assessable income derived by any person from any source, no deduction shall, except as expressly provided in this Act, be made in respect of any of the following sums or matters:

 

(a) investment, expenditure, loss, or withdrawal of capital money used or intended to be used as capital; money used in the improvement of premises occupied; interest which might have been made on any such capital or money if laid out at interest."

   The matter falls to be determined in two distinct parts, the answer to which will not necessarily be the same, namely, the acquiring for £3000 of the list of customers and the acquiring for £8750 of the import licences. Whilst they are grouped together under the one title of goodwill in the letter, which eventually constituted the bargain between the two parties, they are not necessarily payments for goodwill at all, and one of the first difficulties is to determine whether the objector company is to be held to its choice of language. Mr Bridger, for the Crown, endeavoured unsuccessfully to have Browne agree that his company had taken over Entrican, Sims & Co Ltd's grocery and fancy goods business "as a going concern", but Browne very properly would not have it so, for no part of the latter's city premises was being taken over and it was clear that the Wellsford and Pukekohe shops were to be closed and sold.

   Such few of the many cases at which I have looked as mention goodwill in the context of the problem now before the Court seem uniformly to associate the good name that is being transferred with the locality value of what is being sold and bought. If truly any part of what was paid was for goodwill in the ordinary acceptance of that term, that would on authority be properly treated as a capital payment and not be deducted as an income deduction; per Lord Pearce in BPAustralia Ltd v Federal Commissioner of Taxation, [1965] 3 All ER 209; [1966] AC 224, at p 262, line F: "Where a trader buys out a rival in order to secure his goodwill or to suppress it and so provide or maintain a clear field for his own enterprise over a substantial period, there is a definite prima facie pointer towards a capital payment."

   In Strick v Regent Oil Co Ltd, [1965] 3 All ER 174; [1966] AC 295, at p 329, lines E-F, Lord Morris of Borth-y-Gest; quoted with approval from the judgment of Starke, J, in Hallstroms Property Ltd v Federal Commissioner of Taxation (1946), 3 AITR 436; 72 CLR 634, at p 647: "In his judgment in that case Starke, J, while emphasizing that none of the so-called definitions or tests or any other definitions or tests suggested by the cases are decisive, pointed out that an asset or advantage need not have a tangible existence and expressed the view that expenditure to acquire the goodwill of a business or to acquire restrictive covenants against competition in business may be of a capital nature. In agreement with what was said by Starke, J, I consider that no different result is reached according as to whether an asset or advantage is of a tangible or of an intangible nature." In Sun Newspapers Ltd v Federal Commissioner of Taxation (1938), 1 AITR 403, at p 408; 61 CLR 337, at p 356, Latham, CJ, said: "The goodwill of a business is an asset of the business, and is plainly a capital asset. It is radically different from assets which are turned over and bought and sold in the course of trading operations." He goes on on the same page: "As a direct consequence of the agreement, the publication of the World ceased immediately, and immunity from a threatened competition within a large area was also obtained for a period of three years. Such a transaction must, in my opinion, be regarded as a transaction which added to the goodwill of the enterprise. In substance it amounted to the addition of a capital asset, immaterial in character but substantial in value and significance, to the general equipment of the business enterprise of the appellant companies."

   In the view I have formed the determination of this matter does not depend upon describing that which Nathans acquired as goodwill. Suffice it that by the payment which they made they acquired certain rights, the exploitation of which could add to their profits. The use of the new licences would enable them, for the licensing period still current, to import goods which were in short supply and might not be available to other importers, thus giving them a scarcity value and making them attractive both to their old customers and to those taken over from Entrican, Sims & Co Ltd who had been accustomed to getting the same lines of goods through that firm. Their holding of the licences gave them if not a priority at least a standing of some value in applications for the next year's licences in the same categories. A certain element of monopoly value is thereby created, and, whilst it cannot be said that the licences are in any sense permanent, for as long as the licences lasted in the same form as that in which they were taken over, it would be unlikely that L D Nathan & Co Ltd would lose their opportunity to share pro rata with others holding the like licences in the importation of those particular types of goods.

   In the case of the list of customers, what was obtained was much less tangible. It was simply an opportunity of making contact with a new group of customers to invite those whose names appeared on the list to do business with a new shareholder, what has been described as "the opportunity to serve the claimed-to-be customers of a former competitor and keep them if it could", Robert Dixon Co Ltd v Minister of National Revenue (Can) (1962), 29 Tax ABC 131, at p 134. It is to be remembered that both L D Nathan & Co Ltd and Entrican, Sims & Co sold only to the retail trade, and retailers must make it part of their own business to keep in touch with and to know their best sources of supply

   In almost every one of the cases which I have examined (and at all levels of judicial utterance) emphasis is laid upon the fact that there is no clear rule or guide-line that can be followed Indeed, Lord Upjohn in Strick v Regent Oil Ltd, supra, quoted the observations of Lord Greene, MR, in Inland Revenue Commissioners v British Salmson Aero Engines Ltd, [1938] 3 All ER 283, at p 289; [1938] 2 KB 482, at p 498, where he said: "There have been many cases which fall on the borderline. Indeed, in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons." Lord Upjohn's comment is ([1965] 3 All ER, at p 199; [1966] AC at p 345): "Somewhat cynical, but true. It is a question of facts and degree and above all judicial common sense in all the circumstances of the case and, while no one regrets it more than I, I do not believe it is possible to lay down any principle when dealing with trading contracts, which would be of any guidance alike to Crown and subject in future cases."

   Thus heartened by the belief that I am just as likely to be wrong as right, I look for the criteria which seem to have been the determining factors in the leading cases in deciding whether a particular payment was deductible for income tax purposes as revenue or whether it was capital. The industry of counsel has supplied me with a host of cases, including photostat copies of determinations of Queen's Counsel in Canada who sit on Tax Appeal Board cases, but I propose in the course of this judgment to refer, as far as possible, only to cases of high authority, for all the others claim to derive their own authority from them.

   Sooner or later almost every one of them quotes in whole or in part or paraphrases the words of Cave, LC, in Atherton v British Insulated and Helsby Cables Ltd, [1926] AC 205, at p 213: "But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital." But even this, as Lord Pearce pointed out in the BP Case, supra, at [1966] p 264, whilst useful as an expression of general principles on prima facie indications, "provides no analogy" to many cases. Lord Reid in Strick v Regent Oil Ltd, supra, stressed that it is essential to have in mind the facts with which Viscount Cave was dealing-that is, a pension fund set up for staff members and intended to endure for the whole life of the company without addition for the purpose. Lord Cave's phrase "once and for all" has been the subject of many later judicial pronouncements and their effect is summarized by Lord Reid in Strick v Regent Oil Ltd, supra, ([1965] 3 All ER at p 181; [1966] AC at pp 316-7): "Ever since the Vallambrosa Rubber Co Ltd v Farmer ((1910), 5 TC 519) in 1910 recurrence as against a payment once and for all has been accepted as one of the criteria in a question of capital or income. I would regard a payment which has to be made every three years to retain an advantage as a recurrent payment, whereas for practical purposes I would not think that the fact that another payment will have to be made after 20 years if the situation does not change in that time would prevent the first payment from being regarded as made once and for all."

   Lord Reid had earlier said ([1965] 3 All ER at p 180; [1966] AC at p 314(ibid)): "When one is dealing with tangible assets it is generally not very difficult to reach a decision. Things which the trader uses in his business to produce what he has to sell are part of his fixed capital and their cost is a capital outlay although their useful life may be short, as in Hinton (Inspector of Taxes) v Maden and Ireland Ltd ([1950] 3 All ER 356 HL). Things which he turns over in the course of his trade are circulating capital and their cost is a revenue expense."

   English judgments of high authority make liberal use of the judgments of Dixon, J, in the High Court of Australia in Sun Newspapers Ltd v Federal Commissioner of Taxation, supra, and in Hallstroms Property Ltd v Federal Commissioner of Taxation, supra. In the former case he said at p 359(and for comparison I list capital on the left and revenue on the right):-

   

"The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between

the business entity, structure, or organization set up or established for the earning of profit,
and the	process by which such an organization operates to obtain regular returns by means of regular outlay,

 

the difference between outlay and returns representing profit or loss."

   In the latter case Dixon, J, had made a comparison, which Lord Morris of Borth-y-Gest in the Regent Oil Case, supra, at p 328, adopted, having said that the process of description as opposed to that of definition may sometimes be aided by noting contrasts. "Dixon, J, distinguished-

between the acquisition of the means of production
	and the use of them;
between establishing or extending a business organization
	and carrying on the business:
between the implements employed in work
	and the regular performance of the work in which they are employed:
between the enterprise itself
	and the sustained effort of those engaged in it."

   Lord Morris then takes from the South African decision in New State Areas Ltd v Inland Revenue Commissioner (SA), [1946] AD 610, at p 621, a contrast between expenditure forming:

   

"part of the costs of improving or adding to the income-earning plant or machinery
	and part of the cost of performing the income-earning operations."

   In Commissioner of Taxes v Nchanga Consolidated Copper Mines Ltd, [1964] 1 All ER 208; [1964] AC 948, Lord Radcliffe stated that Courts have stressed the importance of observing a demarcation between

   

"the cost of creating, acquiring or enlarging the permanent (which does not mean perpetual) structure of which the income is to be the produce or fruit
	and the cost of earning that income itself or performing the income-earning operations."

   In Robert Addie & Sons Collieries Ltd v Inland Revenue Commissioners, [1924] SC 231; 8 TC 671, the Lord President (Clyde) posed the question:

	"Is the expenditure part of the company's working expenses; is it expenditure laid out as part of the process of profit earning?
Or on the other hand, is it a capital outlay; is it expenditure necessary for the acquisition of property or of rights of a permanent character, the possession of which is a condition of carrying on its trade at all?"

   Lord Pearce in the BP Case, supra, [1966] AC, at p 264, after referring to the difficulties of making a distinction in borderline cases, said that: "conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer: 'depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured employed or exhausted in the process': per Dixon, J, in Hallstroms Pty Ltd v Federal Commissioner of Taxation."

   I ask myself the same question: what was this expenditure calculated to effect? Possibly the answer is; an increase in turnover with reduced competition, the increase occurring at the intake (so to speak) through the licences and at the outlet through the customers greedy for the new goods acquired. That is not very different from what Lord Pearce referred to in the BP Case, at p 265, where he said that the real object of the petrol company was "not the tie, but the orders which would flow from the tie". If that were all there were to it, one could find, as was held in the BP Case, that the payment was of a revenue nature, money paid to obtain the ties to satisfy the appetite of retailers having become part of the regular conduct of the business and, as one of the current necessities of the trade, not taxable for income tax purposes. But here there is no tie; by Government grant a right to trade in named goods is vested in one person and if one is lucky it may become transferred into one's own name-for a price. I cannot see, however, that this expenditure is other than fixed capital rather than circulating capital evidenced by the fact that 4 years later, despite changes in the categories and the goods needing to be licensed, 42½ per cent still remains out of what was originally paid for. To that extent it is enduring. Lord Pearce defined the distinction at p 265 as being: "Fixed capital is prima facie that on which you look to get a return by your trading operations. Circulating capital is that which comes back in your trading operations."

   Nor is there shown to be a recurrent need for Nathans to repeat the process with another willing vendor; it might well do so and accept the opportunity if it arose, but, if it dealt in a lump sum with a different vendor, it would not make the payment in 1966 to Entrican, Sims & Co any the less a payment once and for all.

   It is the lack of "enduring benefit or advantage" within Viscount Cave's phrase that seems to me to make the difference between what was paid for the licences and what was paid for the list of customers. Reference has already been made to the fact that four years afterwards it is assessed that 42½ per cent of the benefit and advantage of the original licences remains and I have, no doubt, that there remains some residual advantage from parts of the lost 57½ per cent, for all that Browne said he had always looked on the licences as "very impermanent, very transitory". But the evidence relating to the list of customers not only showed that only 375 out of 1055 were useful and only 216 of them remain with Nathans, but also that they appear to be mostly dairies which change hands every year or so.

   So long as Nathans hold the licences and their terms remain substantially unvaried, they have the right to import specified goods up to a specified value. But the customers of Entricans were not in any instance tied to them and cannot be forced to deal with another firm. The licence gives Nathans a right to trade, the list only an opportunity to canvass for business. The one endures for the purchaser's profit-making purposes for so long as the licensing system attaches to that class of goods; the other exist at the whim of the customer and the profit derived from the outlay will depend on the imponderable factor of the length of time the customer's trade will continue.

   It could, of course, be argued that nothing can ever obliterate the retailer-customer relationship once it is established, whilst the licensing system could vanish overnight as a matter of Government policy; but, applying the dictum of Dixon, J, already quoted from Hallstroms' Case, supra, from a practical and business-like point of view rather than upon the juristic classification of legal rights, the business man would, in my view, far sooner say, "I have such and such licences" than "I have such and such customers" (always provided his licences were for goods in public demand). The passage already quoted from Browne's evidence (ante) seems to bear this out, although he spoke of the two elements going hand in hand.

   So viewed, the more important element is the quantity and class of licences held.

   Having come to that conclusion, I have turned back to pp 816-7 of the judgment and metaphorically speaking have put a glove on each hand, the left marked "capital" and the right marked "revenue"; using the suggestion of Lord Morris of Borth-y-Gest in the Regent Oil Case, supra, at p 329, that the process of description as opposed to that of definition may sometimes be aided by noting contrasts, I have brought down left or right hand according as the particular criterion set out seemed applicable at all to this case; in doing so, I dealt separately with the value of the import licences and then separately again with the value of the list of customers.

   Dealing first with the £8750 paid for the import licences, "capital" holds a convincing lead on points over "revenue". As referee virtually in my own contest, I named the score as capital 8, revenue or non-applicable 2. The second bout, with the £3000 for customer lists favoured revenue, but was less conclusive and there were "rounds", so to speak, which gave the advantage to neither, and as to which I have preferred not to use Lord Greene's suggestion of spinning a coin. So I tried again with less strict tests and came up with a score of 7 to 2 in favour of "revenue". This did not surprise me; for it accorded with the view which had been cumulatively forming in my mind as each of the relevant criteria which goes into the scales on a total consideration was noted. Nor was I surprised to find differing results for the licences as compared with the customer lists.

   Accordingly I answer question 10 as follows:-

   

   

"The Commissioner acted, in part, incorrectly in making the assessments referred to in para. 5 of the case stated and the same should be amended by deleting the sum of £3000 ($6000)-part of the sums of £5500 and $10,990.78 added back as 'write off of Entricans licences.' "

   As no point has been taken as to the write off taking place over successive years, I add as part of the answer to question 10: "The sum of £1500 should be deducted from assessable income for the year ended 31 July 1966 and the sum of $3000 should be deducted from assessable income for the year ended 31 July 1967."

   As each party has been successful in part, there will be no order as to costs.