Laxton v. The Queen, 89 DTC 5327, [1989] 2 CTC 85 (FCA)

Stone, J.A. (Pratte and Desjardins, JJ.A., concurring): —This appeal from a judgment of the Trial Division raises an issue as to whether the receipt by the appellant of a $229,000 interest-free loan required him, in computing his income for the 1981 and 1982 taxation years, to include an amount pursuant to either paragraphs 3(a) or 245(2)(a) of the Income Tax Act, R.S.C. 1952, c. 148 as amended ("the Act"), or both as the trial judge held.

In preparing his income tax returns for the years in question, the appellant did not include any amount in respect of the interest-free loan. His taxable income for the 1981 and 1982 taxation years was revised by way of reassessments as a result of which there were added as “management fees" the amounts of $34,457.94 and $37,279.17 respectively. This impacted upon the availability of his revised non-capital loss, so much so that if the first amount had not been included in 1981 taxation income, the loss available for deduction in 1982 would have been greater by a sum equivalent thereto. In his appeal from the reassessments, the appellant asked that the Trial Division refer the reassessments back to the Minister for reconsideration and reassessment on the basis that the amounts in question be excluded from his 1981 and 1982 taxable income and that there be allowed in 1982, as an additional non-capital loss deduction, the sum of $34,357.94. The parties agreed at trial, and the trial judge so found, that these amounts were overstated in the reassessments, the correct figures being $34,206.88 in 1981 and $37,116.88 in 1982.

As the trial judge has set out the facts which gave rise to the present dispute, [1] I am relieved of the need to do more than briefly summarize them. The appellant, a Vancouver lawyer, was a party to a tri-partite agreement made August 29, 1979. Though it carried no particular label, the agreement was referred to in the pleadings and evidence and by the trial judge as a "joint venture agreement”. The other parties to the agreement were a four- member firm of chartered accountants and the regional council of a trade union, and all of the parties were cumulatively described as "the Developers".

The agreement had as its purpose the development of a commercial office building in Vancouver to be known as the "Evergreen Building”. Title to the lands was to be acquired by Evergreen Building Limited acting as a bare trustee for facilitating the acquisition, construction and operation of the building. The parties each agreed to acquire, through the instrumentality of the company, an undivided interest in the lands and premises "as co-owners and as tenants-in-common" (Article 2.1), and also agreed that each "shall be a co-owner upon the terms and conditions set forth in this Agreement" (Article 15.4). Any right to ownership of the property and assets was agreed to be "a sole individual right, not a joint, collective or partnership right" (Article 15.9). They agreed as well that the appellant's proportionate interest in the lands and premises would be 36.66 per cent and that of the others 31.67 per cent each (Article 3.1). All questions affecting the lands and premises and their development were to be determined by a vote of developers holding more than 60 per cent interest in total in the lands and premises on the basis of one vote for each one per cent of lands and premises owned (Article 16.1). The parties expressly agreed that the agreement was "not intended to create nor shall it be construed to have created any partnership or agency whatsoever" or that the lands and premises were to be considered as "partnership property" notwithstanding the division of profits and losses according to proportionate shares (Article 15.1), and that none of them “shall be deemed to be the partner, agent or legal representative of the others" (Article 15.2). Each of the parties was bound to be "proportionately responsible for all bank loans and mortgage loans to be obtained by and for the purpose of the said lands and premises and the development thereof" and to “be responsible and liable for payments of his Proportionate Share of all monies owing or that may be owing on such bank or mortgage loans” (Article 15.6). The liability of each party for such payments was to be adjusted in the case of any variance in a proportionate interest so as to reflect the revised interest (Article 15.7). In point of fact, during 1982 the appellant's proportionate interest increased from 36.66 per cent to 45 per cent and then to 50 per cent of total ownership.

At the very heart of the dispute are certain provisions found in Articles 3, 7 and 8 of the agreement, which should be recited in their entirety. After first defining the proportionate interest of each of the parties, Article 3.1 went on to provide:

The Developers further agree that should the said lands and premises be sold, the profit, if any, shall be allocated as to John Laxton, the first $450,000, and the balance, if any, to the Developers in accordance with their respective Proportions. The $450,000 paid to John Laxton or such part thereof as is necessary shall be used first to repay any loans made by the Developers to John Laxton.

Article 7.1, 7.2, 8.1 and 8.2 of the agreement read:

7.1 It is agreed that John Laxton shall be responsible for management of development up to and until the completion of construction and for that purpose be shall devote such time and skill to the development as is necessary to have the construction completed expeditiously.

7.2 It is further agreed that John Laxton will be advanced as an interest free loan, the following amounts on the following terms:

(a) advances will be made in monthly instalments of $10,000.00 each, commencing April 1,1979 and on the first day of each month thereafter up to and including June, 1980;

(b) the said advances are to be derived solely from mortgage funds and the provisions of Article 9.3 herein may not be used to generate sufficient monies to make such advances;

(c) In the event of a cash shortfall, one-half of the amounts advanced pursuant to subclause (a) hereof shall be repaid by John Laxton.

8.1 Following completion of construction the Developers will contract for the long-term management of the lands and premises.

8.2 Commencing April 30, 1981, John Laxton shall oversee the general management of the lands and premises on behalf of the Developers for which John Laxton shall be paid a monthly fee computed on an annual basis as follows:

(a) $450,000.00 minus such interest free loans made to John Laxton pursuant to Article 7.2 hereof, together with any other interest free loans made to John Laxton, multiplied by an amount equivalent to the prime rate charged by the Bank of Montreal, Main Branch, Vancouver, British Columbia, to its most favoured commercial customers.

(b) If at any time the Developers have insufficient monies to make the payment pursuant to paragraph (a) hereof, John Laxton may lend to the Developers sufficient monies to make such payment, which loan shall bear interest equivalent to the prime rate charged by the Bank of Montreal, Main Branch, Vancouver, British Columbia, to its most favoured customers and shall be compounded semi-annually.

In rejecting the appeal against the reassessments, the trial judge considered that the benefit of the interest-free loan was taxable income in the hands of the appellant either as being an "amount" under paragraph 3(a) and the definition of that word in subsection 248(1) [2] , or a "benefit" within paragraph 245(2)(a) [3] of the Act. After analyzing and rejecting several arguments of the appellant at trial (and renewed before this Court), she summed up her reasons for dismissing the appeal at page 9 of her reasons for judgment:

Where an agreement explicitly provides that a taxpayer's remuneration for services is to take the form of an interest free loan, the taxpayer should be required to recognize that remuneration in some form in his taxable income. This is particularly so where there are acknowledged borrowing costs being paid by another in order to obtain the funds being loaned to the taxpayer. It is difficult to understand why the value of the benefit received by the taxpayer should not be equated to the amount of the borrowing costs, or in this case, by reference to the calculation as provided for in article 8 of the joint venture agreement.

She also rejected the appellant's contention that the amounts or benefits in question were not taxable in 1981 or 1982 in any event because the instalments of interest-free loan had been advanced in 1979 and 1980, when she wrote at page 11 of her reasons for judgment:

But I do not think that applies in a case such as the present where the benefit conferred by the interest free loan is seen as component of the compensation being paid for management services which is calculated and invoiced on a monthly basis over several years. The benefit occurs on a continuing basis, as long as the loan remains outstanding.

I accept, as the appellant contends, that the Act contains no specific provision [4] creating tax liability in respect of the "benefits" the appellant is alleged to have received in 1981 and 1982. He argues from this that neither paragraph 3(a) nor 245(2)(a) should be construed as reaching the reassessed amounts. In any event he says that the portion of these amounts attributable to his own proportionate interest in the joint venture should be excluded.

The appellant begins with the general submission that his economic position was not enhanced over and above that which would have been the

(a) determine the aggregate of amounts each of which is the taxpayer's income for the year (other than a taxable capital gain from the disposition of a property) from a source inside or outside Canada, including, without restricting the generality of the foregoing, his income for the year from each office, employment, business and property;

248. (1) In this Act,

"amount" means money, rights or things expressed in terms of the amount of money or the value in terms of money of the right or thing . . .

case had he been charged interest on the loan at prevailing commercial rates and been paid a larger management fee. The economic reality of the transaction, he says, was that the right to a management fee and the use of the interest-free loan were merely a set-off of one against the other that resulted in no additional income to him, and therefore gave rise to no "amount" or "benefit" within either paragraph 3(a) or 245(2)(a). The trial judge rejected this argument. She expressed the view at page 8 of her reasons for judgment that the appellant had “received economic advantage in the form of cash compensation plus an interest free loan”. She also considered (at page 3) that Articles 7 and 8 in effect provided for a management fee "to be calculated by reference to the interest payable on $450,000 as that might fluctuate from time to time”, the cash component of which "was to vary depending upon whether or not the plaintiff had been advanced a total amount of $450,000 as an interest free loan, or some lesser amount".

The appellant contends that while it is proper to read Articles 7.1 and 7.2 together, they should not be read in conjunction with Article 8.2 which is entirely independent of the first two. This latter Article, he claims, specifies exactly the form the management fee would take and its method of calculation. It was a payment of interest that had nothing whatever to do with Article 7. I am unable to accept this submission. The payment to be made pursuant to Article 8.2 was as a fee to "oversee the general management of the lands and premises". Although it was to be calculated by reference to the difference between the amount of interest-free loan advanced ($229,000) and the lull sum of $450,000 as multiplied by a factor based upon the prevailing bank prime lending rate, the resulting payment was a cash percentage of that difference and not merely interest thereon. I think the judge was correct in treating it as such and that, in the total context of Articles 7 and 8, it represented remuneration or consideration for services performed by the appellant. That this seems also to have been the understanding of the appellant himself is apparent from his testimony given at trial. When asked upon examination-in-chief why in pursuance of Article 8.2 the figure of $450,000 "was to be reduced . . . if there had been interest free loans made to you?", he gave the following as the intent of the agreement: ”. . . I should not get any more than the $450,000 so that if I had received part of it by way of an interest free loan then that . . . amount should be considered for the payment of the management fee". [5] As the trial judge found, the interest -free loan advanced pursuant to Article 7.2 was linked to and was in reality part of the overall management fee arrangement in favour of the appellant. Article 8.2 recognized that as the appellant had already the use of a $229,000 loan free of interest, the $450,000 figure should be reduced accordingly, resulting in a smaller fee payable pursuant to that Article.

If this be the correct view, then the case does not raise the wider question of whether interest forgone by a lender is liable to taxation as an "amount" or as a "benefit" under paragraphs 3(a) or 245(2)(a) of the Act. It is concerned only with whether the arrangement in issue attracted tax under either of those paragraphs because it involved the receipt by the appellant of an interest-free loan as consideration or remuneration for services rendered.

Turning then to the taxing provisions relied upon, I am satisfied that the learned trial judge was correct in holding that there were here "amounts" that were taxable in 1981 and 1982 under paragraph 3(a) of the Act. The fact that the appellant received the interest-free loan as compensation for the services he rendered means that the amounts constituted the "taxpayer's income . . . from a source inside . . . Canada” within the meaning of paragraph 3(a) of the Act. That being so, I need not consider the possible application of paragraph 245(2)(a). I do not accept the appellant's submission that, because by the terms of the agreement the full sum of $450,000 would become repayable in certain circumstances upon resale of the Evergreen Building, this conclusion is not open to the Court. While Article 3.1 plainly provides for the conditional repayment of loans made by the developers to the appellant, the latter continued to receive this form of reward for services while the loan remained outstanding, and particularly throughout 1981 and 1982.

Two questions remain to be considered. The first is whether the appellant is right in contending that the amounts, if taxable at all, are not taxable in 1981 and 1982 but only in 1979 and 1980 during which years the interest-free loan instalments were advanced. As I agree with the trial judge's reasoning on the point (already recited), I simply wish to adopt it as my own. Though the advances were undoubtedly made in 1979 and 1980, the fact remains that the benefit thereby enjoyed was a continuing one which most certainly ran throughout the years 1981 and 1982 as well.

The final question is said to emerge out of the nature of the relationship that existed between the appellant and his fellow developers at the time of the loan instalments. The parties to the agreement spoke of "the continuance of the “joint venture" (Article 15.12), the "best interests of the joint venture" and of the "entire joint venture" (Article 16.3). The relationship, described in the evidence and pleadings and accepted by the trial judge as one of joint venture", was declared by the agreement not to be one of "partnership". Thus in Articles 15.1 and 15.2 we find the following:

15.1 This Agreement is not intended to create nor shall it be construed to have created any partnership or agency whatsoever. Nothing herein shall deem the said lands and premises to be considered partnership property notwithstanding that the profits and losses to be derived therefrom or incurred therein may be divisible among the developers in accordance with their proportionate interest.

15.2 None of the Developers shall be deemed to be a partner, agent or legal representative of the others of them whether for the purposes of this Agreement or otherwise. No Developer shall have any authority or power to act for or to undertake any obligation of responsibility on behalf of any of the other Developers except as herein may be expressly provided.

The parties also agreed (Article 2.1) that they were "co-owners and . . . tenants-in-common" and also that they would “develop, own and manage same on terms and subject to the conditions of this Agreement". It is on the basis of this declaration and of these provisions that the appellant submits that any benefit enjoyed by him by reason of the interest-free loan must be reduced by the extent of his own proportionate interest including his responsibility under Article 15.6 to repay only his own share of mortgage funds out of whose surplus the interest-free loan was taken. There could thus be no benefit to him in respect of that interest, but only such as was conferred on him by his fellow joint venturers in paying management fees to the extent of their combined interests. This argument was rejected by the trial judge.

The appellant says that the trial judge arrived at the wrong conclusion because she treated the joint venture as having legal existence separate from that of its members, which it does not. He points to page 4 of her reasons where she spoke in terms of the mortgage funds having been "provided to the venture group" and of the "venture" having paid bank interest on that financing, and to page 6 where she said that the mortgage loan had been made "by the joint venture". She also found significant that the cost of the borrowed mortgage funds were carried into the unaudited financial statement of the joint venture and, thus, into the appellant’s own personal income tax returns to the extent of his proportionate share of that cost. Her conclusion, as expressed at pages 9-10, was that the whole of the benefit derived from the interest-free loan was paid to the appellant by the joint venture. She said:

With respect to the plaintiff's third argument, I accept counsel for the defendant's position that this is not a case of "self-dealing" where the taxpayer “borrower” and the taxpayer “income recipient” are one. The joint venture, through the vehicle of Evergreen Building Limited (as bare trustee), is interposed. Even though the taxpayer may, as a practical matter, be ultimately liable (along with the other joint venturers) for the total amount of the joint venture's debt, this does not mean that he has paid the cost of borrowing. The cost of borrowing was borne by the joint venture. The fact that the plaintiff pays one-third of that (subsequently increased to 45-50%) does not mean that he can ignore for the purposes of his income calculation, remuneration paid to him by the joint venture in the form of an interest free loan. . . The fact that the taxpayer may himself be liable (as a member of the joint venture) for part of the borrowing costs is an independent matter and indeed, in this case, his tax returns were prepared on that basis. The cost of borrowing by the joint venture was accounted for as an expense of the joint venture and the plaintiff's proportion of that expense was carried into his income tax return under the joint venture account. It seems to me that to allow a one-third reduction of the income attributable to this interest free loan would be to allow that deduction twice over.

It seems to me that this conclusion is available if, as a matter of law, the joint venture had separate legal existence or, at very least, is to be so regarded for income tax purposes. Now, that it had no such existence is manifest. The group composing the joint venture came together on a purely voluntary basis. The property belonged to them in undivided shares and they shared profits and losses in the manner provided in their agreement. The business venture they formed could of itself neither hold any property nor incur any costs.

This is not to say that the results of group operations or activities could never be ascertained for tax purposes at the joint venture level. That clearly would be the case if the joint venture were to be regarded as a "partnership" to which the provisions of section 96 of the Act applied. [6] Here, though the respondent conceded that a "joint venture" had been formed, it is nowhere suggested in the pleadings that the joint venture constituted a "partnership" within the meaning of that section or, if it did, that the result would be different. [7] Under that section the results of each year's operation of a partnership must to be determined at the "partnership" level as if it "were a separate person resident in Canada" and having its own fiscal period. The trial judge did not treat the joint venture for tax purposes as falling under section 96 and, indeed, made no express mention of that section. She noted that the mortgage funds had been borrowed by the joint venture, that the joint venture had expensed the cost of the borrowing in its own accounts and had made the interest-free loan to the appellant. So viewed, the case was not, in her opinion, one of "self-dealing" by a taxpayer using borrowed money for his own purposes.

I accept that the factors singled out by the trial judge may well argue against the sought after reduction in the amounts added by the reassessments, but these factors must surely be weighed in overall context with others that are also present. As already noted, it was conceded and the trial judge so found that the grouping of interests here involved was that of “joint venture". That a “joint venture" per se may differ from a “partnership” has been recognised by Canadian Courts, [8] and that neither is a legal entity is

(d) each income or loss of the partnership for a taxation year were computed as if this Act were read without reference to subsections 59(1.1) and

(1.2) and 66(12.1) and paragraphs 59(3.1)(a) and 66(12.2)(a), (12.3)(a) and 12.5(a) and as if no deduction were permitted by subsection 65(1), section 66, 66.1, 66.2 or 66.4 or the Income Tax Application Rules, 1971 in respect of this paragraph;

(e) each gain of the partnership from the disposition of land used in a farming business of the partnership were computed as if this Act were read without reference to paragraph 53(1)(i);

(f) the amount of the income of the partnership for a taxation year from any source or from sources in a particular place were the income of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership's taxation year ends, to the extent of the taxpayer's share thereof; and

(g) the amount of the loss of the partnership for a taxation year from any source or from sources in a particular place were the loss of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership's taxation year ends, to the extent of the taxpayer's share thereof.

also plain. A joint venture cannot contract in its own right; only its members may do so. Obligations cannot be incurred by it, but only by its members. It may neither sue nor be sued in a separate capacity. A lender must look for redress not to the joint venture but to its members. The existence of unaudited accounts drawn up to reflect the group operations does not of itself clothe the joint venture with separate legal existence, and the correctness for tax purposes of the appellant filing personal tax returns on the basis of the net results to him of operations at a given point in time is not a question we are required to pass upon in these proceedings.

I must respectfully differ with the trial judge on this final aspect of the appeal only. Given that the joint venture was a voluntary grouping having no separate legal existence apart from its members, the mortgage funds were borrowed by such members in proportion to their respective interests and, subject to the terms of the loan agreement and of any loan guarantees, each of them were liable to make repayment accordingly. It follows too that moneys advanced to the appellant from surplus mortgage funds were in fact advanced according to the proportionate interests that each venturer held in those funds. The results are that the appellant did in law incur the cost of borrowing mortgage funds in proportion to his interest, and did in law use some of the funds for his own purposes. Obviously, he could not lend to himself [9] , but his fellow participants in the venture could lend to him and so they did to the extent of their combined interests. I have already concluded that the benefits conferred by them in advancing their proportionate shares of the interest-free loan are subject to taxation in his hands pursuant to paragraph 3(a) of the Act.

In the result, I would allow the appeal, set aside the judgment of the Trial Division and refer back the assessments of the appellant's income tax for the years 1981 and 1982 to the Minister of National Revenue for reconsideration and reassessment on the basis that the taxable benefits received by the appellant as a result of having had, during those years, the enjoyment of an interest-free loan of $229,000 are, for the 1981 taxation year, an amount of $34,206.88 less the appellant’s share of the costs of the loan for that year and, for the 1982 taxation year, an amount of $37,116.88 less the appellant's share of the costs of the loan for that year. I would grant the appellant his costs both here and below.

Appeal allowed.