Putting “goodwill” to work for you

Understanding the concept of “goodwill” will work to your advantage, as Greer Jacks explains in this first of a two-part series.

Indeed, understanding goodwill can put more dollars in your pocket — be it at the bargaining table during merger negotiations or when making strategic deductions from eligible capital property during the year.

Unfortunately, goodwill is a flexible concept. Black’s Law Dictionary defines it as: “A business’s reputation, patronage, and other intangible assets that are considered when appraising the business, especially for purchase; the ability to earn income in excess of the income that would be expected from the business viewed as a mere collection of assets.”

There is, however, no definition of goodwill in the Income Tax Act. We are left largely with common-law, judicial pronouncements as to its use, availability and boundaries. So what does the case law tell us?

• The Supreme Court of Canada in Gifford v. Canada, [2004] 1 S.C.R. 411 identified goodwill as an asset which can be treated as being capital in nature if it is an asset of enduring benefit that provides a lasting advantage. Vern Krishna, in his work entitled The Fundamentals of Income Tax Law, states that goodwill may result from “location, reputation, brand loyalty, competent management, good labour relations and trademarks.” In 1810, Lord Eldon in Cruttwell v. Lye, 34 E.R. 129 said that goodwill is “the probability that the old customers will resort to the old place.”

• Goodwill can exist in a regulated industry. One of the leading cases on goodwill is TransAlta Corporation v The Queen, [2012] FCA 20, which held that goodwill could exist in a regulated industry. It is instructive that the residual value method of valuing goodwill is preferred. Using this approach, the more easily valued assets are first given a fair market value, and any consideration in excess of this fair market value is assigned to goodwill. Regulatory and industry practices are relevant and important in determining the reasonableness of a goodwill valuation for income tax purposes. The test is what a reasonable businessperson would have paid for the goodwill, considering all the circumstances.

• Only businesses may take advantage of the provisions within the Act; no value can be attributed to any goodwill element in an investment property for tax purposes if that property is not used in a business.

Likewise, “personal goodwill” — which relates to the ability, skills, experience, contacts and reputation of individuals — is not transferable to the business and may have little or no commercial value under the provisions of the Income Tax Act. But, because individuals comprise businesses, it can sometimes be difficult to discern whether there is goodwill as understood in the traditional sense, or personal goodwill that resides only with the individual. The case of Les placements A & N Robitaille Inc. v. M.N.R. (1994), establishes the question that can be used to determine whether goodwill is personal: If the person withdraws from the business will any goodwill remain? If the answer is “Yes,” the next issue is apportioning goodwill between the goodwill of the business and the goodwill of the person who is exiting the business due to a sale or transfer of assets.

The concept of goodwill is evolving. Absent a definition of the term within the Act, it is a concept that is limited only by common law precedent and argumentative ingenuity. As such, it is an important concept that corporate taxpayers and advisors should understand.

Next week: Dealing with goodwill

Greer Jacks is updating jurisprudence in EverGreen Explanatory,  an online research library of assistance to tax and financial professionals in working with their clients.