Date:
20070117
Dockets: A-612-05
A-613-05
Citation: 2007
FCA 53
CORAM: LÉTOURNEAU
J.A.
EVANS
J.A.
MALONE
J.A.
BETWEEN:
A-612-05
XCO INVESTMENTS LTD.
Appellant
and
HER MAJESTY THE QUEEN
Respondent
A-613-05
WEST TOPAZ PROPERTY LTD.
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT OF THE
COURT
(Delivered from the Bench at Vancouver,
British Columbia, on January 17, 2007)
LÉTOURNEAU J.A.
[1]
These
are appeals from a decision of Chief Justice Bowman (Chief Justice) of the Tax
Court of Canada (Tax Court) rendered on November 14, 2005. The Chief Justice
allowed the appellants’ appeal in part. He reduced the income attributed by the
Minister of National Revenue to the appellants by $557,556.
Issues on appeal
[2]
These
appeals raise three issues:
a)
whether the Chief Justice erred in applying the specific tax avoidance
provision found in subsection 103(1) of the Income Tax Act (Act) to
reallocate income initially attributed by the appellants to Woodwards Store
Limited (Woodwards), the newly admitted third member of their Partnership;
b)
whether the Chief Justice erred in determining that the reasonable
amount to allocate to Woodwards pursuant to subsection 103(1) of the Act was
$557,556; and
c)
if the Chief Justice was mistaken in applying subsection 103(1) to the
Partnership’s allocations of income, whether the general anti-avoidance rule
(GAAR) in section 245 of the Act can apply so as to reallocate income among the
partners.
[3]
These
three issues, as we shall see, encompass the five points in issue stated by the
appellants in their memorandum of facts and law.
The facts underlying the
Tax Court decision
[4]
The
appeals in the Tax Court were heard together and were from assessments for the
appellants’ 1993 and 1994 taxations years.
[5]
This
case centres on a partnership called The West Topaz Real Estate Partnership
(the Partnership) created on 6 December 1986. The original partners were Bosa
Brothers Construction Ltd. (BBCL) and XCO Investments Ltd. (XCO), who held a
99% interest and 1% interest respectively in the partnership. This division of
interest reflected the initial capital contributions to the partnership of $99
and $1 respectively. Both partners were wholly owned subsidiaries of Astron
Realty Group Inc., a corporation controlled by Natale Bossa (XCO Investments
Ltd. v. The Queen, 2005 TCC 655, par. 5-6 [XCO TCC]). When the Partnership
was established in 1986, the partnership agreement established that for both
income tax and accounting purposes, the income allocated to the partners would
be in accordance with their proportionate interests (Partnership Agreement,
Article VII, cited in XCO TCC, ibid, par. 7).
[6]
In
December 1986, the same month that the Partnership was established, two
properties were transferred to the Partnership: the Topaz Apartments and the
Westhill Apartments. The latter property was transferred by BBCL. BBCL also
transferred its partnership interest to the appellant, West Topaz Property Ltd.
(West Topaz), a newly incorporated and wholly owned subsidiary of Astron Realty
Group, Inc. (XCO TCC, supra, note 2, par. 8, 6). As the Chief Justice put it,
The result was that from
1986 to 1992 the Partnership consisted of West Topaz as to 99% and XCO as to
1%. The Partnership owned the two apartment properties, Topaz Apartments and
Westhill Apartments. West Topaz acted as trustee for the Partnership (ibid,
par. 9).
[7]
In
1992, a series of transactions occurred that gave rise to the present appeals.
They are outlined in detail at paragraph 11 of the Chief Justice’s reasons. In
short, three things occurred in anticipation of the sale of the Westhill
Apartments by the Partnership:
a)
Woodwards, a public retail company with substantial accumulated
non-capital losses, entered into the Partnership with respect only to the
Westhill Apartments. It was given a right to participate in 80% of the
operating income and net cash flow of the Westhill Apartments. In exchange, it
contributed cash equal to the 80% of the estimated net equity of the Westhill
Apartments, less outstanding mortgages, and less a 6.5% discount to reflect the
fact that the tax base of the property was less than its current value. The
estimated fair market value of the Westhill Apartments was $10,800,000. The
total mortgages on the property were $8,500,000 (discussed below). Subtracting
the 6.5% discount and mortgages, Woodwards actually contributed $1,260,000.
b)
Before Woodwards entered the Partnership, there were two mortgages on
the property, totalling $3,500,000. On 13 March 1992, Natale Bossa set up a
series of payments to place a $5,000,000 mortgage on the property, facilitating
Woodwards’ entry into the Partnership. The series of payments involved a
circular transfer of money from Bosa Development Corporation, through:
i) Natale
Bossa as a bonus;
ii) to
Bancorp, a corporation controlled by Natale Bossa, as a shareholder loan;
iii) to
the Partnership as a mortgage advance; and
iv) back
to Bosa Development Corporation as a mortgage receivable.
c)
On 19 March 1992, the original partnership agreement was substantially
amended to reflect Woodwards participation in 80% of the Westhill Apartments,
with West Topaz holding a 19.8% interest and XCO holding a 0.2% interest in
that property. The partners agreed to share in the distribution of the proceeds
of the sale in proportion to their interests. Woodwards was entitled to
withdraw from the Partnership within 180 days, but, once Westhill Apartments
was sold, it could not withdraw until the after the subsequent fiscal year-end
of the Partnership. The definition of majority partner was revised to mean West
Topaz rather than the holder of a majority interest (ibid, par. 11).
[8]
On
20 March 1992, 420688 BC Ltd., an arm’s length company, purchased the Westhill
Apartments for $10,850,000.
[9]
On
25 March 1992, Woodwards entered into an escrow agreement with the Partnership
and Owen Bird, Barristers and Solicitors, whereby it was agreed that Woodwards’
$1,260,000 capital contribution to the Partnership would be held in trust by
Owen Bird. As is made clear by a reference in the escrow agreement, some time
prior to 25 March 1992, Woodwards prepared and delivered its notice of
withdrawal from the Partnership: see appeal book, vol. 1, page 311, paragraph
4. The Chief Justice cited the following facts from the appellants’
submissions:
The sale of the Westhill
Apartments closed on July 8, 1992, with the receipt of sale proceeds of
$10,090,467, not including an initial deposit of $750,000 that was paid
earlier. The proceeds were disbursed as follows:
$1,715,736 to CMHC;
$1,860,952 to the
National Trust Company;
$5,000,000 to Bancorp in
payment of the unregistered mortgage;
$2,917 for legal fees;
and
$1,510,862 was disbursed
to the Appellant;
On July 13, 1992, the
Appellant received the initial deposit of $750,000;
On July 13, 1992, Owen
Bird was instructed to release to the Partnership the $1,260,000 that was being
held in escrow, plus accrued interest of $25,200. A cheque was made payable to
the Appellant and deposited to its Royal Bank account; and
On May 15, 1993,
Woodwards transferred its interest in the Partnership to the Appellant for
$1.00 and other good and valuable consideration;
For the April 30, 1992
fiscal year-end of the Partnership Woodwards was allocated operating income for
accounting purposes of $11,563 out of a total of $292,066. For tax purposes the
allocation of operating income to Woodwards was $118,405 out of $292,066;
On May 4, 1992,
Woodwards received a letter advising them that their distributable share of
operating income for March 1992 was $8,827. A cheque for that amount was
included with the letter;
A summary of the
distribution of net sale proceeds dated July 13, 1992, shows net proceeds of
$2,260,862 ($1,510,862 + $750,000). Woodwards 80% share of the proceeds was
calculated to be $1,808,689.86. The Appellant accordingly sent Woodwards a
cheque for that amount on July 13, 1992. The proceeds would have been
$7,260,862 if not for the $5,000,000 Bancorp mortgage;
For the April 30, 1993
year-end of the Partnership, Woodwards was allocated partnership income of
$5,748,931 consisting of $5,725,794 related to the gain on the sale of the
Westhill Aparments and $23,137 related to operating income. This income was
sheltered using Woodwards' non-capital losses; and
For the April 30, 1994
year-end of the Partnership, the residual amount of $6,652,877 in Woodwards'
capital account was reallocated to the remaining partners. The Appellant was
allocated 99% and XCO was allocated 1%; (ibid).
[10]
In
response to this allocation of income, the respondent expressed its view that
Woodwards was not a true partner in the Partnership, and reallocated all of the
income attributed to Woodwards back to the two appellants in proportion to
their 99% and 1% respective interests (ibid, par. 12). The appellants
appealed this reallocation to the Tax Court.
Whether
the Chief Justice erred in applying the anti-avoidance provision contained in
subsection 103(1) of the Act
[11]
Subsection
103(1) of the Act reads:
|
103. (1) Where the members of a partnership
have agreed to share, in a specified proportion, any income or loss of the
partnership from any source or from sources in a particular place, as the
case may be, or any other amount in respect of any activity of the
partnership that is relevant to the computation of the income or taxable
income of any of the members thereof, and the principal reason for the
agreement may reasonably be considered to be the reduction or postponement of
the tax that might otherwise have been or become payable under this Act, the
share of each member of the partnership in the income or loss, as the
case may be, or in that other amount, is the amount that is reasonable
having regard to all the circumstances including the proportions in which the
members have agreed to share profits and losses of the partnership from other
sources or from sources in other places.
|
103. (1) Lorsque les associés d'une société de
personnes sont convenus de partager en proportions déterminées tout revenu ou
perte de la société de personnes provenant d'une source donnée ou de
sources situées dans un endroit déterminé ou tout autre montant qui se
rapporte à une activité quelconque de la société de personnes et qui doit
entrer en ligne de compte dans le calcul du revenu ou du revenu imposable de
tout associé de cette société de personnes et lorsqu'il est raisonnable de
considérer que cette convention a pour objet principal de réduire les impôts
ou de différer le paiement des impôts qui auraient pu être ou devenir
payables par ailleurs en vertu de la présente loi, la part du revenu ou de la
perte, selon le cas, ou de l'autre montant, revenant à chaque associé
de la société de personnes est le montant qui est raisonnable, compte tenu
des circonstances, y compris les proportions dans lesquelles les associés
sont convenus de partager les profits et les pertes de la société de
personnes provenant d'autres sources ou de sources situées à d'autres
endroits.
|
(Emphasis added)
[12]
There
is now no dispute that a valid Partnership existed between Woodwards and the
appellants. The Chief Justice was satisfied that the legal relations created by
the partnership agreement were not shams and were genuine and legally
effective: see paragraphs 14 and 15 of his decision.
[13]
That
said, he properly found, in our view, that the bringing of Woodwards into the
Partnership was principally tax motivated at least from the appellants’
perspective. Counsel for the appellants at the hearing before us conceded as
much. For an outlay of something over one half million dollars, the appellants
were expecting to save taxes of over $2,000,000: see paragraph 31 of his
decision. He was “unable to identify any other commercial or non-tax purpose”: ibidem.
[14]
The
appellants submit that subsection 103(1) does not apply in the present instance
as there was profit trading, not loss trading. They rely upon the decision of
the Tax Court of Canada in Loyens v. Her Majesty the Queen, 2003 TCC 214
where, at paragraph 110, the judge wrote:
From my reading, I do
not see how the Respondent can glean any remarks that support the proposition
that profit sharing is prohibited… Clearly OSFC Holdings Ltd. prohibits
loss trading. However, I would not extend the principles enunciated in OSFC
Holdings Ltd. with respect to loss trading to conclude that profit trading
is interchangeable with loss trading.
[15]
The
Loyens case raised a section 245 (GARR) analysis as to whether there had
been an abuse of the provisions of the Act as a whole. Subsection 103(1)
addresses a different problem and provides a different test. The subsection
applies when there is a sharing of income (or loss) of the Partnership, which
is the case in the present instance.
[16]
Having
found that subsection 103(1) applies because there is a sharing of income and
the principal reason for the agreement with Woodwards was the reduction of tax
otherwise payable, this brings us to the second question to be answered, i.e.
whether the allocation of income to the partners was unreasonable.
[17]
The
Chief Justice found that an allocation to Woodwards of 80% of the income from
the Westhill Apartments was unreasonable in view of the fact that Woodwards’
contribution was both ephemeral and for all practical purposes risk-free: see
paragraphs 33 and 34 of his decision. These are findings on questions of fact
or mixed fact and law and therefore can only be disturbed on appeal if the
appellants satisfy us that the judge made a palpable and overriding error.
[18]
In
our view, there was sufficient evidence to support his conclusions. Mr.
Lazzari, an accountant responsible primarily for tax matters for Bosa
Development Corporation, testified that having Woodwards as a partner was never
contemplated to be a long term arrangement: see transcript of proceedings, vol.
1, pages 90, 93 and 214. Indeed, there was no community of business interest
between Woodwards, which was a public retail company, and the Partnership
operating a rental business. The sale of Westhill Apartments was imminent and
it was not contemplated that Woodwards would remain a partner beyond the fiscal
year in which the sale occurred.
[19]
As
for the fact that Woodwards’ contribution to the Partnership was practically
risk-free, the evidence before the Chief Justice revealed that the Partnership
agreement, when it was amended, specifically limited Woodwards’ liability to
debts or obligations relating solely to Westhill Apartments.
[20]
In
addition, under an escrow agreement, Woodwards’ capital contribution was
safeguarded until it agreed to release the funds or until it received its
initial distribution from the sale of the Westhill Apartments. In fact, this is
what occurred: Woodwards’ capital contribution to the Partnership was not
released from the escrow agreement until after Woodwards received its payout
from the sale of the Westhill Apartments: see appeal book, page 342, the letter
of the appellants to Owen, Bird acknowledging payment of the initial
distribution to Woodwards and requesting the release of Woodwards’ capital
contribution pursuant to the escrow agreement. On the basis of that evidence,
the Chief Justice was entitled to draw a conclusion that, in fact, Woodwards’
contribution was “for all purposes risk-free”.
[21]
The
appellants contend that the Chief Justice failed to take into account the fact
that the provision regarding the allocation of income and loss for tax and
accounting purposes among members of the Partnership was made more than five
years before Woodwards joined the Partnership. It was, they submit, a rational,
reasonable and normal formula for the allocation of income under the Act. They
argue that “a court should not substitute its view as to what is reasonable in
the circumstances by second guessing the business judgment of a taxpayer”: see
paragraphs 16 to 18 of their Memorandum of Fact and Law. They cite, in support
of their position, this excerpt from Martin J. in Signum Communications Inc.
v. The Queen, 88 DTC 6427, at page 6430, a decision later affirmed by this
Court, 91 DTC 5360:
… where there is a
rational, reasonable and normal formula employed in the allocation of the
losses, as there was in this case where they were allocated in proportion to
the capital contributed, there are no grounds on which the Minister can invoke
the provisions of section 103.
[22]
A
reading of the reasons provided by the Chief Justice shows that he did not fail
to take into account the Partnership’s provision regarding the allocation of
income among the members of the Partnership. It is clear under subsection
103(1) of the Act that the proportions in which the members have agreed to
share profits and losses is only one of the circumstances to be looked at. The
subsection required him to look at all the circumstances in determining
whether the amount allocated is reasonable. This is what the Chief Justice did.
[23]
In
our view, the Chief Justice was right to conclude that, having regard to all
the circumstances, the allocation of 80% of the income to Woodwards was
unreasonable.
[24]
Though
the Partnership was valid, there was no real basis upon which to distribute
profits to Woodwards. The participation of Woodwards as a partner was always
intended to be short-term. Its capital contribution was hardly necessary or
useful to the Partnership. It offered nothing in the way of expertise to the
Partnership. In effect, it contributed nothing other than its losses. Though
the effect of the transaction in this case was to transfer profit to a loss
company (rather than to transfer loss to a profitable company), the appellants
were able, through the participation of Woodwards, to take advantage of Woodwards’
accumulated losses for less than it would have cost them in taxes had the
Partnership’s income been allocated to them directly.
[25]
In
our view, this case was an appropriate case in which to apply subsection
103(1). We are of the view that the Chief Justice did not err in this respect.
Whether
the Chief Justice erred in determining that the reasonable amount to allocate
to Woodwards pursuant to subsection 103(1) of the Act was $557,556
[26]
The
Chief Justice was of the view that the true economic reality of the arrangement
between Woodwards and the appellants was an important ingredient in determining
what would be a reasonable allocation of income in the present case: see
paragraph 35 of his decision. Keeping that in mind, he concluded that a
reasonable treatment of the arrangement under section 103 of the Act would be
to treat Woodwards’ share of the income as the amount it actually received,
i.e. $557,556.
[27]
We
cannot say that his decision in this respect is unreasonable. The $557,556 that
Woodwards took out of the Partnership was money that the appellants never
benefited from and they should not be taxed on this income. The other income
allocated to Woodwards for tax purposes was not reasonably allocated and is
properly viewed as taxable in the hands of the appellants.
Whether
the general anti-avoidance rule (GAAR) in section 245 of the Act can apply so
as to reallocate income among partners
[28]
We
do not need to answer this question in view of the conclusions that we have
reached with respect to section 103 of the Act.
Conclusion
[29]
For
these reasons, the appeals will be dismissed with one set of costs, plus
disbursements in each file.
“Gilles Létoureau”
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