See Also
Wolf Electric Tools Ltd. v. Wilson (1968), 45 TC 326 (Ch.D.)
Upon being advised by its Indian distributor ("Ralli") that the taxpayer (which carried on business as a mechanical and electrical engineer) risked having the import of its tools into India being banned by the Indian government, the taxpayer and Ralli incorporated an Indian joint-venture company ("Ralliwolf") to manufacture in India selected lines of the taxpayer's tools for distribution in India, and 45% of the shares of Ralliworth were issued to the taxpayer in consideration for the transfer by the taxpayer to Ralliworth of plant and equipment, and various drawings, designs and other know-how, and for the taxpayer's covenant to "keep out" of India for 10 years.
This arrangement was characterized by Pennycuick J. as a transfer of the goodwill of the taxpayer's Indian business quoad the selected lines, coupled with an obligation to supply confidential information, and the taxpayer accordingly received all the shares of Ralliwolf on capital account, notwithstanding that there had only been a partial disposition of an asset (namely, goodwill).
Doughty v. Commissioner of Taxes, [1927] AC 327 (PC)
On the incorporation of a partnership, the excess of the nominal value of the shares issued over the net book value of the assets transferred was assigned, in part, to goodwill, and the balance was applied to write-up the book value of the inventory. In finding that this transaction did not give rise to a taxable profit on the transfer of the inventory, Lord Phillimore applied the principle (at p. 331) that:
"Income tax being a tax upon income, it is well established that the sale of a whole concern which can be shown to be a sale at a profit as compared with the price given for the business, or at which it stands in the books, does not give rise to a profit taxable to income tax."
Commentary
As goodwill generally or always is an eligible capital property rather than a capital property, its disposition generally should give rise to an eligible capital amount rather than a capital gain. However, essentially the same principles that apply elsewhere in determining whether a disposition has occurred on capital account or income account (which for the most part are discussed in this site under the s. 9 heading) also apply in this context.
Consistently with the principle that the purchase (or sale) of all or substantially all the assets of a business occurs on capital account except to the extent that the assets in question are stock-in-trade ([pin type="node_head" href="523-Southam"]Southam[/pin]), the sale of goodwill as part of the sale of a business has been found to occur on capital account (Doughty).
Although it has been variously defined (see [pin type="node_head" href="140-Demco"]Demco[/pin], [pin type="node_head" href="140-Pepsi"]Pepsi-Cola[/pin], [pin type="node_head" href="140-Robitaille"]Robitaille[/pin]), goodwill can be regarded as being the value of a busines or business operation that cannot be attributed to specific assets (see [pin type="node_head" href="737-Transalta"]Transalta[/pin]). It may follow from this that goodwill is an asset that can only be transferred through the transfer of the business or operation. In Wolf Electric, there was found to be a transfer of goodwill notwithstanding that the taxpayer had only transferred parts of its business in respect of selected product lines.
For a discussion of more recent Canadian decisions, see "[pin type="subtopic" href="140-cumulative-eligible-capital"]Cumulative Eligible Capital[/pin]."