Date: 20000321
Docket: 98-1642-IT-G
BETWEEN:
BARRY R. CARD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Beaubier, J.T.C.C.
[1] This appeal pursuant to the General Procedure was heard at
London, Ontario on March 14, 2000. The Appellant called John
VanderHoeven, C.A.; Paul Knill, a lawyer; Fausto Boniferro, a
lawyer; and the Appellant also testified. Paragraphs 12 to 15 of
the Reply read:
12. The Minister of National Revenue (the
"Minister") assessed the Appellant for the 1995 year by
Notice of Assessment dated July 3, 1997 to increase the
Appellant's reported Net Professional Income by $197,576.00
and to increase the Appellant's reported Interest Income by
$9,054.
13. In so Assessing the Appellant, the Minister relied on,
inter alia, the following assumptions:
a) The Appellant reported Net Professional Income for the 1995
taxation year in the amount of $88,217.23 and Interest Income in
the amount of $20.00;
b) the Appellant's Net Professional Income for the 1995
taxation year is in the amount of $285,792.98 and his Interest
Income is in the amount of $9,074, as per the calculations in
schedule A;
c) the Appellant is a lawyer who was a partner with the law
firm Siskind, Cromarty, Ivey & Dowler (hereinafter the
"Partnership");
d) The relations between the Appellant and other law firm
partners were governed by a Partnership Agreement dated February
1, 1994 (hereinafter the "Partnership Agreement");
e) The fiscal period of the Partnership ended January 31,
1995;
f) The Appellant withdrew from the Partnership effective
January 31, 1995;
g) At all relevant times, the partnership had elected not to
include in income work in progress pursuant to sections 34 and 96
of the Act;
h) For the fiscal period ending on January 31, 1995, the
Partnership allocated the net earnings according to the
Partnership Agreement;
i) In computing the net earnings for each partner, the
Partnership allocated to the Appellant an amount of $273,296.00
for the fiscal period ending January 31, 1995;
j) The Appellant had no rights with respect to the income to
be produced by the work in progress in subsequent fiscal periods;
and
k) The Minister properly calculated the interest.
B. ISSUES TO BE DECIDED
14. The issue is whether the Minister properly assessed the
Appellant by increasing the reported Net Professional Income by
$197,576.00 and by increasing the reported Interest Income by
$9,054.
C. STATUTORY PROVISIONS RELIED ON
15. He relies on sections 3, 9, 34, 34.2, 96 and 249.1 on
subsections 12(1) and 248(1) of the Income Tax Act, R.S.C.
1985, c. 1 (5th Suppl), as amended (the
"Act") and section 229 of the Income Tax
Regulations, Consolidated Regulations of Canada, c. 945, as
amended.
[2] All assumptions except 13(b) and (i) are correct. (b) is
in dispute. Instead of "net earnings", (i) should read
"income for tax purposes" whereupon it would be
correct.
[3] The following paragraphs of the Partnership Agreement
titled "with effect from February 1, 1994", (Exhibit
R-1, Tab 6), are important:
1.03 DETERMINATION OF OWNERSHIP INTERESTS
The assets (other than real estate) of the firm shall be owned
and the liabilities of the firm shall be shared by the partners
from time to time in accordance with their respective capital
accounts. Each partner shall maintain a capital account in the
firm in accordance with the provisions of section 2.06. For the
purposes of this agreement, the term "capital account
percentage" shall mean with respect to each partner the
percentage which such partner's capital account is to the
total of capital accounts of all partners in the firm.
Ownership interest in the firm's real estate and other
terms of the partners agreement governing real estate owned by
the firm are set out in Schedule A.
...
2.04 ACCRUAL ACCOUNTING SYSTEM AND WIP
The accounts of the firm shall be maintained on a full accrual
system according to generally accepted account principles. All
lawyers and those employees who are designated by the Managing
Partner must docket their time to the client files on which they
work. The firm shall maintain records of the time dockets and the
value of time based upon billing rates assigned by the Managing
Partner. Docketed time which has not been billed or written off
is referred to as "Work in Progress"
("WIP").
2.05 NET LOSS
If expenses exceed the revenues of the firm, then resulting in
a net loss, such net loss shall be borne by the partners in
accordance with their capital account percentages and such net
loss will be charged against each partner's capital
account.
2.06 CAPITAL ACCOUNTS
Each partner shall maintain a capital account in the firm at a
monetary level to be determined by the Compensation Committee,
with reference to the permanent capital needs of the firm
established from time to time of the partnership, in accordance
with the following guidelines:
(i) levels of capital shall be equated to percentages of net
income;
(ii) a minimum capital account of $75,000 and a maximum
capital account of $200,000 is established;
(iii) a capital account must be created in the amount of
$25,000 by each partner on his/her admission to the partnership
with a further sum of $25,000 being contributed at the end of the
second year following admission to the partnership and as to the
remaining $25,000 at the end of the third year following
admission to the partnership and thereafter shall be maintained
in accordance with this section 2.06;
(iv) partners whose capital account is required by the
Compensation Committee because of the application of subsection
(i) hereof to be increased shall be allowed a minimum of three
and maximum of five years to increase such capital account;
(v) partners whose capital accounts are being reduced because
of the application of subsection (i) hereof will receive a return
of capital over a three to five year period;
(vi) with the exception of the initial capital payment of new
partners, partners may increase capital accounts either by way of
cash infusion or by way of drawing less from the firm than their
percentage of net income. In the case of partners who borrow
funds from the bankers to create or increase their capital
account, the firm will provide to the banker of letter of comfort
(but not a guarantee), with respect to each such partner;
(vii) interest shall be paid on partners' capital accounts
at the same rate at which the firm pays interest to its banker.
Interest shall be calculated on the amount of the capital
accounts determined at the commencement of each fiscal year and
shall be payable quarter-yearly in arrears. In addition, monthly
statements reflecting billings, cash collected and time docketed
will be prepared,
...
2.09 NON-CASH ASSETS
Any introduction or withdrawal of any assets, other than cash,
by a partner will be on terms and conditions determined by the
partners in the firm, having full regard to the income tax
implications of such transactions.
...
5.02 RETIREMENT, DEATH, PERMANENT DISABILITY AND REMOVAL
OF PARTNERS
A partner shall cease to be a partner of the firm:
(i) on the date of the death of such partner;
(ii) on the date when the firm determines that such partner is
unable to perform his or her duties as partner because of his or
her long term disability, as defined in the policy of insurance
insuring the majority of partners of the firm; or
(iii) on the expiry of the period specified in a written
notice of termination given to the firm by a partner provided
such notice specified a date not less than three months following
the date on which it is given and provided such notice is
effective on the expiry of fiscal quarter-year; or
(iv) upon the date a partner is deemed to retire pursuant to
Section 5.06 or the date such partner is removed from the
partnership pursuant to section 5.07;
(each of the foregoing dates being referred to as
"termination date")
5.03 PAYMENTS TO DEPARTING PARTNERS
...
(b) WITHDRAWAL
Where a partner ceases to be a partner pursuant to subsections
(iii) and (iv) of Section 5.02, he/she shall be paid by the
partnership the amount of his/her capital account determined, in
each case on the termination date, in three equal instalments,
the first f such instalments to be made on the first anniversary
date of the termination date and the second and third instalments
to be made on the second and third anniversary dates of the
termination date respectively.
In the case of payments made pursuant to 5.03(a) and (b),
interest at the rate paid by the firm to its bankers calculated
from the termination date shall be paid on the unpaid balance of
such partner's capital account quarter-yearly on each fiscal
quarter year of the firm until the capital account is paid in
full.
The amount of the capital account of such departing partner
shall, irrespective of the date on which such termination takes
place, be determined with reference to the capital account of
such partner at the commencement of the fiscal year in which
he/she leaves the firm adjusted as follows:
(i) by increasing the capital account by the amount of net
income allocated to such departing partner by the Compensation
Committee for the period ending on the termination date in
question, which allocation the Compensation Committee shall
determine in its discretion, acting reasonably, having regard to
the principles established pursuant to Section 2.02 as applied to
the net income of the firm earned to the termination date.
Notwithstanding the foregoing the Compensation Committee shall,
if the determination date is other than a fiscal year end, be
entitled to make such estimates as it shall deem appropriate in
arriving at the allocation of net income. In the event that the
departing partner shall disagree with the amount of net income
allocated to him or her by the Compensation Committee, the
allocation so made shall, at the request of the departing
partner, be reviewed by the firm's accountants who shall for
such purpose act as experts and whose review and determination of
income of the departing partners shall be final and binding upon
the firm and the departing partner. The costs of such review
shall be borne by the firm and the departing partner equally.
(ii) by reducing the capital account by all drawings made to
such partner up to and including the termination date.
...
5.05 LIMITATION ON PAYMENTS
In any fiscal year, the firm shall not make payments of
capital exceeding 4.5% of the net income of the firm for the
preceding fiscal year (the "payment limit"), to
partners who have ceased to be partners pursuant to section 5.02,
to partners who have elected under section 5.04 and to partners
who are on medical leave or disability pursuant to section 5.01.
Should payments to such persons exceed the payment limit,
payments to all such persons shall abate proportionally so that
the total amount paid in the fiscal year is limited to the
payment limit. The years over which such payments are to be made
shall be extended accordingly until the amount payable under this
agreement is paid in full.
...
5.08 REMOVAL OF MATERIAL
A retiring partner who remains in practice in the Province of
Ontario is entitled to receive from the firm any files, wills,
documents, minute books, seals or other material to which a
client is entitled, upon delivering to the firm a signed
direction by the client so entitled, and upon payment to the firm
of any outstanding accounts for fees or disbursements rendered to
such client.
Except with respect to "fee on completion files", as
established by written retainer, at the time that any uncompleted
file is delivered from the firm to a retiring partner, the firm
shall require that it be interim billed and paid. With respect to
"fee on completion files", the retiring partner and the
Managing Partner or his or her designate shall agree upon the
value in dollars of the work in progress for that file and
disbursements which are due to the firm. The retiring partner
agrees that upon completing the said file, he or she will deliver
to the firm the agreed upon amount for the work, and
disbursements that has been done or incurred on the file by the
firm prior to its delivery to the retiring partner.
...
[4] The major issue in this appeal is work in progress
("WIP") which is defined in paragraph 2.04 as
"Docketed time which has not been billed or written
off". It is also referred to in paragraph 5.08, the value in
dollars of which is agreed to be "due to the firm".
[5] The Appellant retired from the law firm (to join another
law firm in London) at the expiry of its fiscal year, January 31,
1995. In about May a partners' meeting reviewed alternative
schedules submitted by their accountants, KPMG (Mr.
VanderHoeven). They then voted that the Appellant would not be
allocated any work in progress for that year end, but at the same
time allocated $357,750 of work in progress to one partner who
never docketed time. The allocations were done based on
partnership points and on the basis that, in essence, the
Appellant was no longer a partner and had no points.
[6] In particular, Mr. Boniferro pointed out that the
allocation did not affect the Appellant's capital account or
his net earnings allocation as determined by the Compensation
Committee under Article II of the Partnership Agreement. It did
affect his income (loss) for tax purposes as set out in Exhibit
R-1, Tab 8. Once a partner withdrew, his existing work in
progress was crystallized, whereas the continuing partners had
the following risks:
(1) That the firm would have to pay out the withdrawing
partner, based on his fixed WIP.
(2) That existing work in progress might never be paid.
(3) That there would be a cost to collect existing work in
progress.
By contrast the withdrawing Appellant remained liable for
guarantees of the firm debts from which he had not been released.
At the conclusion of Mr. Boniferro's testimony, the following
exchange occurred:
Q. As far as Exhibit A-2 – and this is my last question
– would you agree that if the partnership had considered it
fair to adjust the incomes of all partners on the basis of the
WIP being shared in accordance with the partnership, that the
resulting schedule would be the one that appears as alternative
A?
A. Yes, that's my understanding.
[7] The alternatives respecting Mr. Card as entered in
evidence are as follows:
|
|
Allocated by the Partnership
|
Adopted by Mr. Card
|
KPMG's Schedule A
|
|
|
|
|
|
|
Net earnings allocated
|
$137,920
|
$137,920
|
$137,920
|
|
Building depreciation adjustment
|
(16,720)
|
(16,702)
|
(16,720)
|
|
Net earnings per financial statements
|
121,218
|
121,218
|
121,218
|
|
Add 1994 work in progress
|
125,351
|
125,331
|
125,351
|
|
Deduct 1995 work in progress
|
0
|
172,629
|
172,356
|
|
Add 1994 unbilled disbursements
|
19,411
|
19,411
|
19,411
|
|
Deduct 1995 unbilled disbursements
|
0
|
35,822
|
35,765
|
|
Add non-deductible meals and entertainment
|
1,349
|
1,349
|
1,349
|
|
Add depreciation
|
9,631
|
9,631
|
9,631
|
|
Deduct CCA
|
3,664
|
3,664
|
3,664
|
|
Income (loss) for tax purposes
|
273,296
|
64,845
|
65,175
|
As can be seen, the differences are in the portions
underlined. All relate to the 1995 WIP. The remarkable thing is
that Mr. Card did not have access to KPMG's figures until
this hearing.
[8] Subsection 96(1) of the Income Tax Act describes a
partner's income from a partnership as, in essence, the
partner's share thereof. It reads, in part:
96.(1) Where a taxpayer is a member of a partnership, the
taxpayer's income, non-capital loss, net capital loss,
restricted farm loss and farm loss, if any, for a taxation year,
or the taxpayer's taxable income earned in Canada for a
taxation year, as the case may be, shall be computed as if
(a) the partnership were a separate person resident in
Canada;
(b) the taxation year of the partnership were its
fiscal period;
(c) each partnership activity (including the ownership
of property) were carried on by the partnership as a separate
person, and a computation were made of the amount of
(i) each taxable capital gain and allowable capital loss of
the partnership from the disposition of property, and
(ii) each income and loss of the partnership from each other
source or from sources in a particular place,
for each taxation year of the partnership;
(d) each income or loss of the partnership for a
taxation year were computed as if this Act were read without
reference to paragraphs 12(1)(z.5) and 20(1)(v.1),
section 34.1 and subsections 66.1(1), 66.2(1) and 66.4(1) and as
if no deduction were permitted under any of section 29 of the
Income Tax Application Rules, subsections 34.2(4) and
65(1) and sections 66, 66.1, 66.2 and 66.4;
...
Thereupon subsection 96(1.1) reads:
96(1.1) For the purposes of subsection (1) and sections 34.1,
34.2, 101, 103 and 249.1,
(a) where the principal activity of a partnership is
carrying on a business in Canada and its members have entered
into an agreement to allocate a share of the income or loss of
the partnership from any source or from sources in a particular
place, as the case may be, to any taxpayer who at any time ceased
to be a member of
(i) the partnership, or
(ii) a partnership that at any time has ceased to exist or
would, but for subsection 98(1), have ceased to exist, and
either
(A) the members of that partnership, or
(B) the members of another partnership in which, immediately
after that time, any of the members referred to in clause (A)
became members
have agreed to make such an allocation
or to the taxpayer's spouse, estate or heirs or to any
person referred to in subsection (1.3), the taxpayer, spouse,
estate, heirs or person, as the case may be, shall be deemed to
be a member of the partnership; and
(b) all amounts each of which is an amount equal to the
share of the income or loss referred to in this subsection
allocated to a taxpayer from a partnership in respect of a
particular fiscal period of the partnership shall,
notwithstanding any other provision of this Act, be included in
computing the taxpayer's income for the taxation year in
which that fiscal period of the partnership ends.
[9] In this case, the remaining partners themselves voted the
WIP allocation of which the Appellant complains at the May 1995
meeting.
[10] Section 34 of the Income Tax Act reads:
34. In computing the income of a taxpayer for a taxation year
from a business that is the professional practice of an
accountant, dentist, lawyer, medical doctor, veterinarian or
chiropractor, the following rules apply:
(a) where the taxpayer so elects in the taxpayer's
return of income under this Part for the year, there shall not be
included any amount in respect of work in progress at the end of
the year; and
(b) where the taxpayer has made an election under this
section, paragraph (a) shall apply in computing the
taxpayer's income from the business for all subsequent
taxation years unless the taxpayer, with the concurrence of the
Minister and on such terms and conditions as are specified by the
Minister, revokes the election to have that paragraph apply.
[11] The law partnership performed the allocation in its
discretion. There is no evidence that the allocation was
fraudulent. At the conclusion of his testimony, Mr. Boniferro
admitted that if the partners had allocated WIP according, in
essence, to the partnership points it would have worked out,
approximately, to what the Appellant proposes. In exact amount,
it would be that described in Exhibit A-2, Schedule A. The fact
that the partners did not do this may be a question for
arbitration according to the Partnership Agreement or for another
court. However, on the evidence, Sections 96 and 34 were complied
with by the partnership and the allocation was made by the
partnership as assessed. The remaining partners filed according
to that allocation and the firm statement with that allocation
was delivered to the Appellant who adopted and filed a different
statement which did not accord with the partnership's
allocation. The Income Tax Act requires that the
partnership's allocation is the one which must be assessed
upon. That was done. Therefore that assessment is confirmed.
[12] There is no evidence that the interest amounts which the
Appellant disputed were improperly assessed. Therefore that
assessment is confirmed.
[13] The appeal is dismissed.
[14] The Respondent is awarded party and party costs.
Signed at Ottawa, Canada this 21st day of March 2000.
"D.W. Beaubier"
J.T.C.C.
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