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Citation: 2004TCC308
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Date: 20040422
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Dockets: 2002-2897(IT)I
2002-2530(IT)I
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BETWEEN:
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MICHEL OUELLET,
J. BRYAN ARBIC,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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[OFFICIAL ENGLISH TRANSLATION]
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REASONS FOR JUDGMENT
Lamarre Proulx, J.
[1] These appeals were heard on common evidence. The taxation year in dispute is 1992. The issues are the following:
(1) Is there actually a partnership, and if so, is it carrying on a business?
(2) If so, are the appellants limited partners of the partnership, within the meaning of subsection 96(2.4) of the Income Tax Act (the Act), at some point in 1992?
(3) If the answers to issue number 1 are affirmative, are the appellants partners who, on a regular, continuous and substantial basis throughout the year in question during which the business of the partnership is ordinarily carried on, are not actively engaged in the activities of the partnership business or carrying on a similar business as that carried on by the partnership during the year in question within the meaning of the definition of "specified member" in subsection 248(1) of the Act?
(4) If the answers to issue number 1 are affirmative, did the project presented by the partnership as a scientific research and experimental development project constitute systematic investigation or search carried out in a field of science or technology by means of experiment or analysis for the advancement of science within the meaning of subsection 2900(1) of the Income Tax Regulations (the Regulations) and if so, what are the amounts of expenditures qualifying for the investment tax credit?
[2] The appellant Michel Ouellet, in his 1992 tax return, claimed a business loss in the amount of $6,701 and an investment tax credit of $1,675 in relation to his investment in the general partnership "D-Drive enr." (hereinafter the Partnership).
[3] The initial assessment, dated May 20, 1993, accepted these claims. On March 15, 1996, a reassessment was carried out in relation to the year 1992 disallowing the deduction of $6,701 and the investment tax credit of $1,675. A notice of objection was filed on June 11, 1996. On April 22, 2002, the Minister of National Revenue (the Minister) confirmed the reassessment.
[4] The appellant J. Bryan Arbic, in his tax return for the year 1992, claimed a business loss in the amount of $13,401 and an investment tax credit in the amount of $3,350. The initial assessment, dated July 26, 1993, accepted these claims. They were disallowed by a reassessment dated March 15, 1996. The notice of objection had been filed late. On July 19, 1996, an extension of time in which to file a notice of objection was granted. The reassessment was confirmed on March 25, 2002.
[5] In reassessing this appellant, the Minister relied on the facts described in paragraph 7 of the Reply to the Notice of Appeal, as follows:
[Translation]
(a) The Partnership was registered on September 2, 1992, at the office of the prothonotary;
(b) The Partnership reportedly collected $127,000 from 10 so-called partners;
(c) According to form T5003, the appellant invested $10,000 in the Partnership;
(d) The financial statements filed by the Partnership presented the following information:
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BALANCE SHEET
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Assets
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Cash
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964
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Debtors
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15,051
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Liabilities
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Creditors
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15,551
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Net Assets
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Investments
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127,000
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Net loss
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126,536
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STATEMENT OF RESULTS
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Sales
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0
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Research and development costs
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124,460
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Professional fees
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1,770
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Registration fees
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200
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Financial charges
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106
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Net loss
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126,536
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(e) Certain documents show that the purported partners borrowed money from Bryan Arbic in an amount corresponding to 50% of their investment;
(f) Certain documents show that a research contract was granted by the Partnership to "Les conseillers et distributeurs Consuform inc." (hereinafter "Consuform");
(g) Bryan Arbic was the president and shareholder of Consuform;
(h) Certain documents indicate that Consuform purchased the investment shares of the alleged partners for an amount equivalent to the amount borrowed (50%). This was planned from the commencement of the Partnership;
(i) Consuform never issued any cheque to the purported partners for the purchase of their interest. The shares were acquired through the discharge of the purported loans made by Mr. Arbic to the purported partners;
(j) Consuform indicates in its financial statements for the period ending December 31, 1993, an item entitled "other asset" in the amount of $63,500;
(k) The audit performed by the Minister shows that the money circulated in the following way:
Partner
(50% of the amount
claimed invested)
Bryan Arbic
50%
(l) The appellant's so-called investment was in fact only a financial set-up by which it was provided, on the one hand, that a portion of the so-called investment (50%) would be loaned to the partners and, on the other hand, that the interests acquired by the partners under this financial set-up would be sold for an amount equivalent to the amount loaned;
(m) The project presented by the Partnership was audited by a scientific advisor and it was his view that the project did not meet the eligibility criteria;
(n) There is nothing to demonstrate that the Partnership performed any research and development, or operated any business whatsoever.
[6] Except with respect to the $20,000 invested in the partnership by Mr. Arbic, appearing in paragraph 6(c) of the Reply to the Notice of Appeal concerning him, the other facts referred to in this paragraph 6 of the Reply are identical to those in the Reply concerning the appellant Ouellet.
[7] At the outset of the hearing, in the course of his preliminary remarks, the respondent's counsel informed the Court of the respondent's position. The first submission is based on the absence of a partnership, within the meaning of the Civil Code of Québec and as interpreted by the cases. In such circumstances, the appellants, it is argued, are not entitled to either a business losses deduction or an investment credit.
[8] According to the respondent's counsel, there is no partnership because this partnership existed only on paper. It lacked some of the conditions essential to the existence of a partnership. These essential conditions are that there be a contribution by the partners, an intention to associate, an intention to work together on an equal footing, the affectio societatis, the search for a profit and the sharing of the profits or losses.
[9] A second submission is that there is no business. Under section 37 of the Act, a deduction for scientific research and experimental development expenditures can be claimed only by a corporation that carries on a business. But no business was being carried on, the respondent says.
[10] A third submission is that the two appellants were limited partners. Limited partners are not entitled to the deduction for loss in relation to scientific research or to the investment tax credit.
[11] A fourth submission is that, assuming there is a partnership that exists and that this partnership carries on a business and that the appellants are not limited partners, they are passive members included in the definition of specified member. If they are passive members, the appellants are entitled to the loss deduction but not to the investment tax credit. However, the losses must be in relation to expenditures incurred in the circumstances set out in subsection 2900(1) of the Regulations. Among other conditions, these must be expenditures on scientific research and experimental development.
[12] Mr. Arbic introduced himself as being a financial planner. He admitted paragraphs 7(a) to 7(k) of the Reply, with the exception of the reference: "This was planned from the commencement of the Partnership" in paragraph 7(h). He denied paragraph 7(l) and paragraph 7(n).
[13] Concerning the statement in paragraph 7(h) that Consuform purchased the interest of the alleged partners for an amount equivalent to the amount borrowed, 50 percent, and that this was planned from the commencement of the partnership, Mr. Arbic says he does not know whether this was a plan since the commencement of the partnership but that it definitely was the way in which it developed.
[14] Concerning the statement in paragraph 7(l) that it was provided in advance that 50 percent of the investment would be loaned to the partners and that, on the other hand, the interest acquired by the partners would be sold for an amount equivalent to the sum loaned, Mr. Arbic says no, it was not provided in advance and that if the project had succeeded there would have been no need to redeem. The redemption was made to protect his friends in the project.
[15] He testified that the expert's report had not been conveyed to him with the documents pursuant to his request for access to information. However, he had been informed in 1995 that the project did not qualify.
[16] Mr. Arbic says that in 1992 he is not sure he was the sole shareholder of Consuform. It is possible that a Mr. Loignon was still one of the shareholders.
[17] The declaration of partnership in the office of the prothonotary, corporate names, of the Superior Court, concerning D-Drive Society (Reg'd) was filed as exhibit R-1. This document is signed August 31, 1992. The date of commencement of business indicated thereon is the same. The Partnership's address is 455 St-Antoine West, Suite 508. It is the same address as one of the two signatories, Michel Hallé. The other signatory is Bryan Arbic.
[18] An amended declaration of the Partnership, signed on September 2, 1992 by the eight other partners joining the Partnership, was filed as exhibit R-2.
[19] The Partnership's business plan, dated August 31, 1992, was filed as exhibit R-3. It was provided at page 7 of the document that the Partnership would grant the research contract to Consuform Inc. Mr. Arbic says that he is the one who made this decision, which was made before August 1992. The head office and principal place of business of Consuform Inc. are at the same address as Mr. Arbic's residence. He says that he also has his office there.
[20] At page 11 of the business plan (exhibit R-3), there is a table of tax considerations for a contribution of $10,000. The tax saving for a partner who invested $10,000 is indicated in the amount of $7,795, and for a "Designated Partner", $5,010. Note 3 of the document explains the calculation in relation to the "designated partner", as follows:
(3) In the case where the Partner is considered for tax purposes as a Designated Partner, he could not claim either the federal provincial Tax Credits. However, the federal tax deduction would be higher by not being reduced by the provincial Tax Credit.
[21] The business plan (exhibit R-3) had been sent to Revenue Canada in order to obtain a tax shelter number, which was obtained.
[22] Exhibit R-4 is Mr. Arbic's "Contribution Form" in the amount of $20,000 and is dated September 2, 1992.
[23] The service contract between the Partnership and Consuform was filed as exhibit R-6. The cost is limited to $124,460, the total of the amounts invested.
[24] The Partnership's minute book was filed as exhibit R-7. The address of the place of business is changed to 115, 8ième Avenue, Laval, Quebec, the address of Mr. Hallé's residence.
[25] Mr Arbic says that when the partners invested in D-Drive, each signed a cheque for half the amount invested in the name of the Partnership. Mr. Arbic loaned the other half to the partnership for the partner, who signed a term note. This note or these notes were filed as exhibit R-9.
[26] The formulation of these notes is identical for all the investors. There is no note for the appellant Arbic. In the case of the appellant Ouellet, this note read as follows:
Billet à terme / Term Note
Taux/Rate = 6%/annum montant/amount $ 5000 $
I, the undersigned, hereby secure my loan from Bryan Arbic by ceding all my intellectual or other proprietary rights of my Interests in "D-DRIVE SOCIETY REG'D" if the said loan is not repaid by 30 June 1993.
Je, soussigné, donne en garantie pour le prêt consenti par Bryan Arbic tous les droits de propriété, intellectuels ou autres, de mon intérêt dans la Société D-DRIVE Enr. advenant le défaut de remboursement du dit prêt le 30 juin 1993.
date (signature)
(signé/signed)
Nom/Name M. Ouellet Tél: ( )
Adresse/address
[27] As of June 30, 1993, no one had repaid the loan, because, according to Mr. Arbic, as of June 30, 1993, "[Translation] we knew that the project had not succeeded," although they had hoped that the project would succeed.
[28] Each partner signed some identical purchase options in favour of Consuform Inc. These purchase options were filed as exhibit R-10.
[29] The purchase option read as follows in the case of the appellant Ouellet:
PURCHASE OPTION
The OPTIONOR, MICHEL OUELLET hereby grants to Consuform Inc., the OPTIONEE, an irrevocable option to purchase all rights, titles and interest in the research and development program in which the OPTIONOR has participated as a Partner of the D-DRIVE SOCIETY REG'D, (the "Interests"), for the exact sum of cinq mille ($5000).
The purchase of the Interests includes the research reports, the developed technology and the conceived product prototypes, particularly all intellectual proprietary rights of the Partnership Interest. The option may be exercised by the OPTIONEE on or after the 15th of July 1993.
(signature)
Consuform Inc. (OPTIONEE)
by Mr. Bryan Arbic, President
I, the undersigned, declare this purchase option to be satisfactory and hereby accept such option. I confirm having received a duly signed copy of this option.
date (signature)
Partner (OPTIONOR)
[30] One such option was also completed for Mr. Arbic.
[31] Mr. Arbic confirms that the Partnership had no income in 1992 or in 1993 and had no clients. The Partnership was dissolved on December 31, 1993.
[32] Consuform received invoices in the approximate amounts of $20,000 from Mr. Arbic (exhibit R-13), $10,000 from Mr. Hallé (exhibit R-14), $3,000 from Mr. Ronald Loignon (exhibit R-15) and $16,000 from Mr. Michel Ouellet (exhibit R-16). Of the $63,000 actually invested by the partners (since of the total of $127,000, one half came from loans made by Mr. Arbic to the partners), almost all was paid to Messrs Arbic, Hallé, Loignon and Ouellet.
[33] Michel Ouellet is an engineer. The appellant admitted paragraphs 7(a) to 7(f). In regard to the statement in paragraph 7(g), he says he does not know whether Mr. Arbic was the president and shareholder of Consuform.
[34] In the beginning, he simply wanted to invest $5,000. Mr. Arbic mentioned to him that he could invest $10,000. It had been explained to him that if he invested $10,000, he could claim a loss and an investment tax credit. He made his investment on December 22, 1992 according to his own bank documents filed as exhibit R-18. He invested $5,000 and borrowed the other $5,000 from Mr. Arbic.
[35] In response to a question from the respondent's counsel, he says he did not meet all the participants in the Partnership. The connections he had with the other investors were through Mr. Arbic who served basically as a phone booth among everyone.
[36] The witness relates that he had previously worked on a volunteer basis for Consuform, perhaps in 1991. He has worked full time at Hydro-Québec since 1987. He worked for other companies in the evening or on weekends. Notwithstanding, he was the one who handled the project development plan for Consuform.
[37] He was surprised to see that Mr. Frasson, who is the Minister's expert witness, had consulted only Appendix C or the business plan. It is true that there were no other documents but he wished that Mr. Frasson had spoken to him as an expert on high technology.
[38] Mr. Arbic handled the administrative side, and he handled the technical part.
[39] Exhibit R-16 is an invoice presented by Michel Ouellet to Consuform Inc. dated December 22, 1992, a date that was corrected in handwriting to indicate December 1, 1992, and in the amount of $11,128, and another dated December 31, 1992, which was changed in handwriting to December 29, 1992, in the amount of $5,564. The work described consisted largely of meetings with certain persons.
Minister's witnesses
[40] Georges Darsaklis is an auditor for Revenue Canada. The Partnership was audited in 1994. He filed a folder of documents as exhibit R-22. He cites as an example an investor for whom I will indicate only the initials, S.M. This investor has invested $10,000. At tab 1 of exhibit R-22, we see a cheque made out by S.M., dated November 6, 1992, in the amount of $5,000, to the order of D-Drive Society Reg'd. On the same date, according to exhibit R-9, he signs a term note for the loan granted by Bryan Arbic. According to exhibit R-10, the purchase option given by S.M. is dated November 6, 1992. It is in the amount of $5,000. The three documents were made on the same day.
[41] As an auditor, he concluded that a partnership is an association of persons who want to do business for the purposes of earning income. In circumstances where a member of a partnership, on the same day that he becomes a member, abandons all of the rights that he has in the partnership, the auditor does not see how that person can earn income from that partnership. The redemption is made at $5,000, but it is the totality of the shares that is redeemed. Consuform Inc. is going to pay $5,000 for all the shares, which, technically speaking, are worth $10,000.
[42] The auditor filed a financing table for the Partnership as exhibit R-23. In the case of a $20,000 amount that was presumably invested, the investor writes a cheque for $10,000 to the D-Drive partnership. The Partnership writes a $10,000 cheque for Consuform. Consuform writes a cheque for $10,000 drawn in favour of Mr. Arbic. On the same day, Mr. Arbic redeposits the cheque in the Partnership, which results in an entry of $20,000 on the books.
[43] The auditor filed a table based on entries in the books of the Partnership and Consuform as exhibit R-24. This document shows the entries for amounts invested and withdrawals as loans. It also shows that Mr. Arbic himself contributed only $10,000 to the Partnership.
[44] Serge Huppé, the team leader in quality assurance and review at the Appeals Branch in Ottawa, testified. He filed a folder of documents as exhibit R-27. He was involved in the research and scientific development cases in the fall of 1993. The investors had begun to receive their notices of reassessment. They had filed notices of objection while at the same time taking political measures by sending letters to their MPs and the Minister of National Revenue, the Minister of Finance and the Prime Minister of Canada. As an appeals officer at headquarters, it was his role to prepare draft replies for the various MPs who had received letters from their constituents.
[45] A taxpayers association was formed by the various investors. The executive committee of this association, and its lawyer, had requested a meeting with the Minister. The Minister delegated the Deputy Minister of National Revenue to this meeting, which was held on March 15, 1995. Also participating were the Assistant Deputy Minister, Appeals, the Assistant Deputy Minister, Policy and Legislation, and the witness's supervisor. The federal tax authorities set up a working group and a task force, composed of Revenue Canada officials, to clarify the issues for them and propose some acceptable solutions.
[46] There were about 176 partnerships and close to 8,000 investors.
[47] On June 30, 1995, a proposed settlement was offered to the investors in the scientific research tax shelters. The settlement offered the investors a loss of a current nature on the disposition of the investment in their partnership. Some interest amounts, other than a promoter's, might be cancelled. However, the investor would agree that he was not entitled to any business loss or investment tax credit on the partnership. For example, a person who had invested $10,000 in 1992 and disposed of his shares in 1993 for $5,000 would be entitled to a business loss of $5,000 as a deduction for 1993, and interest amounts were cancelled. The partnership had to have a tax shelter number and it had to have been a redemption of the interest in the partnership in a year subsequent to the year of investment.
[48] At tab 1 of exhibit R-27 there is a form letter dated November 23, 1995 that was sent to taxpayers who had invested in some partnerships used as scientific research tax shelters, and who had not yet accepted the settlement proposed on June 30, 1995. This letter proposed the same settlement.
[49] At tab 3 of exhibit R-27, there is a document showing that this letter was sent to Mr. Arbic on November 23, 1995, and at tab 4, to Mr. Michel Ouellet.
[50] Mr. Huppé explained that the appellants were considered limited partners because the risk associated with their investment was limited.
[51] The risk was limited in the sense that a partner could lose only one half of the investment. The redemption offer as well was a benefit since the Partnership no longer had any assets when the research contract was awarded.
[52] They could have been considered sleeping partners. They were not participating actively in the activities of the partnership business in a regular, continuous and substantial way. Their role was limited to having agreed that a document was signed to entrust the research to a research and development corporation.
[53] Mr. Huppé explained that a limited partner is not entitled to any business loss or tax credit. The specified member who is not a partner (in other words the sleeping partner) is entitled to the business loss but not the investment tax credit. He referred to the document included at tab 1 of exhibit R-27, "[Translation] General Partnerships Used as SR & ED Tax Shelters. Questions and Answers".
[54] The witness said that 85 percent of the people accepted the settlement. The interest was cancelled to the date of the assessment implementing the settlement. For the Partnership, there were ten partners. Seven accepted the settlement.
[55] In August 1996, 600 taxpayers, instead of accepting the settlement, filed a notice of appeal in the Court. In March 1997, one case was selected with the co-operation of counsel for these appellants. It involved facts similar to those in dispute. The judgment was handed down on March 12, 2001. The appellants' counsel withdrew from the case in the fall of 2001. This case is referred to as McKeown v. Canada, [2001] T.C.J. No 236.
[56] Claude Frasson is a professor of computer science at the Faculty of Arts and Sciences of the University of Montréal. Among his various occupations, he is the director of the Héron research laboratory in that faculty and director of a research group involving seven universities and composed of 75 researchers.
[57] An expert whose services are retained by the Minister is instructed to review the documentation pertaining to the research that is submitted by the taxpayer. The latter has a duty to supply the documents in support of this research. In conducting his evaluation, Mr. Frasson examined the business plan and a document entitled "Research Report D-Drive Society Reg'D, 31 December 1992". This two-page document was filed as exhibit R-28 and shows that the items of uncertainty were the same as those that had existed initially. The document states that it was not possible to resolve these issues owing to a lack of financial resources. However, there was no description at the beginning of the basic assumptions and methods pertaining to the research, or the establishment of an adequate budget. In fact, there was no report of data resulting from any research. There was no basic hypothesis, no result, no demonstration of interim statements showing that some work had in fact been done; in short, no scientific documentation. The expert's report was filed as exhibit R-29.
Submissions
[58] Counsel for the respondent refers, first, to section 96 of the Act, which sets out the general rules governing the tax treatment of partnership income. Under this section, a partnership's income is first computed as if the partnership was a person. Then the income or losses are distributed in proportion to the shares of the partners. In regard to a taxpayer's loss, reference must be made to paragraph 96(1)(g) of the Act.
[59] Counsel argues that for section 96 to apply, however, there must initially be a partnership and this partnership must carry on a business.
[60] Counsel points out that for the purposes of deductions for scientific research and experimental development under section 37 of the Act, the partnership must be carrying on a business and the research must have some relationship to the business of the partnership.
[61] He refers to article 1830 of the Civil Code of Lower Canada, which was in force in 1992:
Art. 1830. It is essential to the contract of partnership that it should be for the common profit of the partners, each of whom must contribute to it property, credit, skill, or industry.
[62] He cites a decision of the Court of King's Bench, Bourboin v. Savard, [1926] B.R. 68, per Mr. Justice Rivard, at pages 70 and 71:
[Translation]
A contract of partnership has three essential characteristics: (1) the pursuit of a common purpose consisting of the realization of a profit; (2) the constitution of a common fund through the contributions that each makes of his property, credit, skill or industry; and (3) participation in the profits, which entails the obligation to share in the losses, absent any agreement to the contrary.
These three characteristics mean that there must be among both parties the intention, juridically proved, to pursue in common, with the help of everyone's contributions, the realization of a profit; in other words, for there to be a partnership, it is necessary, absent an express contract, that it be clearly apparent from the facts that both of the purported partners intend to form a contract of partnership and not some other contract that might be more or less analogous with the partnership. That is what the authorities have referred to as affectio societatis comes down to.
[63] Counsel for the respondent also referred to the decision of the Supreme Court of Canada in Backman v. Canada, [2001] 1 S.C.R. 367, at the following passages:
14 As noted at the outset, the resolution of this appeal turns on the application of principles of the law of partnership. The principal issue is whether the appellant was a member of a valid partnership such that he could deduct partnership losses from his income pursuant to s. 96 of the Act....
25 As adopted in Continental Bank, supra, at para. 23, and stated in Lindley & Banks on Partnership, supra, at p. 73: "in determining the existence of a partnership . . . regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case". In other words, to ascertain the existence of a partnership the courts must inquire into whether the objective, documentary evidence and the surrounding facts, including what the parties actually did, are consistent with a subjective intention to carry on business in common with a view to profit.
[64] Counsel argues that the McKeown case, supra, is similar to the case at bar in that there was a partnership that had been created that assigned a research project to a corporation, and that the money invested in the partnership was going into a research contract. He referred in particular to paragraphs 389, 390, 392, 393 and 395:
[389] It is not disputed that the way the parties themselves characterize an agreement is not decisive. What must be determined is whether the parties to the agreement in this case actually behaved as if a partnership existed.
[390] The Court must therefore review the evidence to ascertain whether the parties really intended to form a partnership.
...
[392] Moreover, although they received millions of dollars from investors, the groups in question and their members, by and large, did not really care about the progress of the work or the results achieved. The members of the groups did not have any control, even in a general way, over the progress of the research work done by Omzar Technologies Inc. The members, including the appellant, did not participate in making any decisions relating to the groups' activities. They were not involved in the various stages of the research work. The investors merely followed Omzar Technologies Inc.'s instructions. The groups as such were totally inactive.
[393] On the evidence, I conclude that the investors in question were merely seeking substantial tax benefits and never demonstrated any intention of working together to undertake scientific research and experimental development activities. In short, they had no intention of forming a genuine partnership.
...
[395] In the case at bar, no steps or requests whatsoever were taken or made to ensure that the project would be profitable. I cannot find anything suggesting that the groups in question could have been profitable. No market research survey had been done. No marketing plan had been developed. Moreover, the structure put in place was set up solely for tax purposes, as shown by the "participation program" that was established only to create the illusion that the government's criteria were being met.
[65] Counsel for the respondent submits that, as in the analysis of the facts by Garon C.J.T.C.C. in the above case, the analysis of the facts in this case points to the conclusion that the parties had no subjective intention of forming a partnership. They never manifested any intention of working together in the pursuit of scientific research and experimental development activities. The investors in question were seeking only tax benefits. There was no other action. Counsel submits, therefore, that there was no partnership.
[66] In the event that there was a partnership, counsel attacks the other relevant considerations. He argues that the investor, through the term note, was entitled to a benefit as described in subparagraph 96(2.2)(d)(iv). So the investor's at-risk amount was non-existent.
[67] He notes that the appellant, Bryan Arbic, had not signed the term note. For him, it was only the "Purchase Option" that could be exercised. Counsel says the appellant Arbic is a limited partner, since he knows in advance that his liability for losses will be limited.
[68] He explains that a limited partner is not entitled to any loss in relation to the scientific research and experimental development expenditures, through the operation of paragraph 96(1)(g), since the amount deducted by the Partnership by virtue of section 37 is expenditures of this nature.
[69] The specified member (which includes the limited partner under the definition appearing in subsection 248(1) of the Act) is not entitled to the investment tax credit under subsection 127(8) of the Act. This, through the operation of the definition of "investment tax credit of partnership" and "investment tax credit". Assuming that there was actually some scientific research and experimental development, if the partner is a specified partner, in order to compute the investment tax credit to which the partner might be entitled, qualified expenditures claimed under section 37 should not be taken into account.
[70] Respondent's counsel Ms. Boutin argues that not only were the appellants limited partners, they were also sleeping partners. There is no evidence that the appellants were participating in any activity or business of the Partnership in an ongoing way. There is no indication of business in terms of the Partnership. Awarding a certain research contract to Consuform does not make the appellants active in terms of the Partnership.
[71] Furthermore, she submits, it is notable that both appellants did some work for Consuform, but they did it in the exercise of their personal undertakings. It was in that capacity that the appellants billed Consuform and it was in that capacity that they were paid.
[72] Moreover, the work had to have been characterized as scientific research and experimental development within the meaning of section 2900 of the Regulations. The expert clearly demonstrated that this work did not meet the criteria of the Act.
[73] The appellant Arbic, for his part, argues that he was active in the partnership. He maintains that D-Drive still exists and that it still has some value. He argues that the options were never exercised. So there is still some value in D-Drive. He refers to the decision of the Supreme Court of Canada in Stewart v. Canada, [2002] 2 S.C.R. 645 and submits that this decision set aside the notion of reasonable expectation of profit when there is no personal interest. He refers as well to the decision of the Supreme Court of Canada in Singleton v. Canada, [2001] 2 S.C.R. 1046. He argues that the loans, as made by Consuform to the investors, were in compliance with the Act since they were separate transactions.
[74] Mr. Arbic also suggests that the expert witness, or expert, should have come to meet with him in 1992 and guide him in regard to his project.
[75] Mr. Ouellet, for his part, adds that there were many meetings concerning the Partnership.
Analysis and conclusion
[76] Although the Minister's witness stated that the appellant Arbic was assessed as a limited partner, the reasons given in the confirmation of the assessment appear in tab 11 of exhibit R-27:
We have considered your objection for the year shown above, pursuant to subsection 165(3) of the "Income Tax Act".
As a result, we hereby confirm that the assessment has been made in accordance with the provisions of the "Income Tax Act" on the basis that:
The amount claimed for a business loss has been disallowed as a deduction in the calculation of your income pursuant to paragraph 18(1)(a) and subsection 37(1) of the Income Tax Act. This amount does not constitute a loss resulting from a business operating with a reasonable expectation of profit.
It has not been shown that the investment tax credit were deductible pursuant to section 127 of the Income Tax Act.
[77] I had some difficulty understanding, during the hearing, why the appellant Bryan Arbic was referring to the decision of the Supreme Court in Stewart, supra, since there was no mention of a reasonable expectation of profit in the arguments of law in the Reply to the Notice of Appeal. I think it is conducive to the effective conduct of a hearing that the Court be informed of these various points.
[78] I understand that the Stewart decision was delivered on May 23, 2002, and that the Reply was signed on August 22, 2002. Although, when the reasons for a reply are other than those of the assessment, this may have some effect on the burden of proof, in this case I think the proof has in any case been made by the respondent. It should be noted in this regard that the appellants filed no documentation.
[79] The appellant Arbic, in his written preliminary notes, displayed some indignation because the respondent's counsel had informed him of the limitation period on the filing of an expert witness's report. He made no request to call an expert witness at the hearing. I could have considered that request. In any event, the Minister's expert had considered the two existing documents pertaining to the planned research.
[80] The same appellant also objected to the lengthy period of time that had elapsed between the year in question and the year in which his appeal was heard. The evidence disclosed that the appellants were reassessed within the normal assessment period. In my decision, dated October 3, 2003, on a preliminary motion in Normand Lassonde v. The Queen, [2003] T.C.J. No. 560 (QL), I found that there was no reason to set aside the assessment because of the time elapsed between the taxation year in question and the year in which the appeal of that assessment was heard. This decision is now on appeal before the Federal Court of Appeal. For the purposes of the present appeal, I hold to that decision. Nor do I see here any reasons in fact or in law for setting aside this assessment.
[81] As to the decision of the Supreme Court of Canada in the Singleton case, there is really no need to determine its application, given the conclusions I will reach. However, I will say that in Singleton the issue was whether the borrowed money had been borrowed for business reasons or for personal reasons, through distinct transactions. In the case at bar, the issue is whether the partners actually borrowed one half of the amount invested, given that there was no enforceable obligation to repay the loan.
[82] In my opinion, the evidence has disclosed that the facts considered by the Minister were accurate. Moreover, it is my opinion, based on my analysis of the facts, the applicable law and the court decisions, that the submissions by the respondent's counsel are correctly based and I adopt them as my own.
[83] Was there the formation of a genuine partnership? In my opinion, the same observations made by Garon C.J.T.C.C. in McKeown, supra, can also be made in this case. I see no manifestation of any intention to work together on the part of the investors, including the appellants. There was no discussion on how to manage the Partnership and what its activities would be. The members of the Partnership were simply investors who conducted themselves as such and in no way participated in the life of the Partnership. The appellants Arbic and Ouellet, especially Mr. Arbic, had decided everything in advance. Although Mr. Arbic denied this fact, the evidence clearly disclosed that everything had been decided in advance and that this was an investment plan for purposes of tax savings taking the form of a partnership, but a partnership that was not in the nature of a partnership.
[84] Basing myself on the Backman decision, supra, I find that the documentary evidence and the circumstances of the case, including the actions of the parties, are incompatible with the subjective intention to carry on a business in common for the purpose of realizing a profit.
[85] Let us look, nevertheless, at the statutory provisions pertaining to the concepts of limited partners. Paragraphs 96(1)(a) and (g) of the Act read as follows:
96(1) General Rules ¾ 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;
...
(g) the amount, if any, by which
(i) the loss of the partnership for a taxation year from any source or sources in a particular place,
exceeds
(ii) in the case of a specified member (within the meaning of the definition "specified member" in subsection 248(1) if that definition were read without reference to paragraph (b) thereof) of the partnership in the year, the amount, if any, deducted by the partnership by virtue of section 37 in calculating its income for the taxation year from that source or sources in the particular place, as the case may be, and
(iii) in any other case, nil
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.
[86] The definition of "specified partner" appears in subsection 248(1) of the Act:
"specified member" of a partnership in a fiscal period or taxation year of the partnership, as the case may be, means
(a) any member of the partnership who is a limited partner (within the meaning assigned by subsection 96(2.4)) of the partnership at any time in the period or year, and
(b) any member of the partnership, other than a member who is
(i) actively engaged in those activities of the partnership business that are other than the financing of the partnership business, or
(ii) carrying on a similar business as that carried on by the partnership in its taxation year, otherwise than as a member of a partnership,
on a regular, continuous and substantial basis throughout that part of the period or year during which the business of the partnership is ordinarily carried on and during which the member is a member of the partnership;
[87] Paragraph 96(1)(g)(ii) does not apply to the sleeping partner but it does apply to the limited partner. In this case, the effect of the two provisions is that a limited partner cannot deduct the amounts deducted by the partnership in relation to expenditures on scientific research and experimental development.
[88] If the Partnership was a genuine partnership, were the appellants limited partners?
[89] This notion is defined in subsection 96(2.4) of the Act:
Limited partner. For the purposes of this section and sections 111 and 127, a taxpayer who is a member of a partnership at a particular time is a limited partner of that partnership at that time if the taxpayer's partnership interest is not an exempt interest at that time (within the meaning assigned by subsection (2.5)) and if, at that time or within three years after that time,
(a) by operation of any law which governs the partnership arrangement, the liability of the taxpayer in the taxpayer's capacity as a member of the partnership, is limited;
(b) the taxpayer or a person with whom the taxpayer does not deal at arm's length is entitled to receive an amount or obtain a benefit that would be described in paragraph (2.2)(d) if it were read without reference to subparagraphs (ii) and (vi) thereof;
(c) one of the reasons for the existence of the taxpayer who owns the interest
(i) may reasonably be considered to be to limit the liability of any other person with respect to that interest, and
(ii) may not reasonably be considered to be to permit any person who has an interest in the taxpayer to carry on that person's business (other than an investment business) in the most effective manner; or
(d) there is an agreement or other arrangement for the disposition of an interest in the partnership and one of the main reasons for the agreement or arrangement may reasonably be considered to be to attempt to avoid the application of this subsection to the taxpayer.
[90] Counsel proposed that the appellants were partners under paragraph 96(2.4(b) of the above definition, incorporating paragraph 96(2.2)(d), which reads as follows:
At-risk amount. For the purposes of this section and sections 111 and 127, the at-risk amount of a taxpayer, in respect of a partnership of which he is a limited partner, at any particular time is the amount, if any, by which the aggregate of
...
(d) where the taxpayer or a person with whom the taxpayer does not deal at arm's length is entitled, either immediately or in the future and either absolutely or contingently, to receive or obtain any amount or benefit, whether by way of reimbursement, compensation, revenue guarantee or proceeds of disposition or in any other form or manner whatever, granted or to be granted for the purpose of reducing the impact, in whole or in part, of any loss that the taxpayer may sustain by reason of being a member of the partnership or by reason of holding or disposing of an interest in the partnership, the amount or benefit, as the case may be, that the taxpayer or the person is or will be so entitled to receive or obtain, except to the extent that the amount or benefit is included under subparagraph 66.1(6)(b)(ix), 66.2(5)(b)(xi) or 66.4(5)(b)(viii) in respect of the taxpayer or the entitlement arises
(i) by virtue of a contract of insurance with an insurance corporation dealing at arm's length with each member of the partnership under which the taxpayer is insured against any claim arising as a result of a liability incurred in the ordinary course of carrying on the partnership business,
(ii) by virtue of a prescribed revenue guarantee in respect of a prescribed film production,
(iii) as a consequence of the death of the taxpayer,
(iv) by virtue of an agreement under which the taxpayer may dispose of the partnership interest for an amount not exceeding its fair market value, determined without reference to the agreement, at the time of the disposition,
(v) by virtue of a revenue guarantee or other agreement in respect of which gross revenue is earned by the partnership except to the extent that the revenue guarantee or other agreement may reasonably be considered to ensure that the taxpayer or person will receive a return of a portion of the taxpayer's investment,
(vi) in respect of an amount not included in the at-risk amount of the taxpayer determined without reference to this paragraph, or
(vii) by reason of an excluded obligation (as defined in subsection 6202.1(5) of the Income Tax Regulations) in relation to a share issued to the partnership by a corporation,
and, for the purposes of this subsection, where the amount or benefit to which the taxpayer is at any time entitled is provided
(e) by way of an agreement or other arrangement under which the taxpayer has a right, either absolutely or contingently (otherwise than as a consequence of the death of the taxpayer), to acquire other property in exchange for all or any part of the partnership interest, for greater certainty the amount or benefit to which the taxpayer is entitled under the agreement or arrangement shall be not less than the fair market value of that other property at that time, or
(f) by way of a guarantee, security or similar indemnity or covenant in respect of any loan or other obligation of the taxpayer, by the partnership or a person or partnership with whom the partnership does not deal at arm's length, for greater certainty the amount or benefit to which the taxpayer is entitled under the guarantee or indemnity at any particular time shall not be less than the aggregate of the unpaid amount of the loan or obligation at that time and all other amounts outstanding in respect of the loan or obligation at that time.
[91] I think that in fact, through the operation of the term notes and the options to purchase, the partners committed nothing more than their individual contributions. They were limited partners, therefore. Insofar as the at-risk amount is concerned, again, on the basis of the term notes and the options to purchase, it became non-existent.
[92] As mentioned previously, the limited partner is not entitled to any loss in relation to the expenditures on scientific research and experimental development under paragraph 96(1)(g). Nor is he entitled to the investment tax credit under subsection 127(8) of the Act.
[93] In any case, to be entitled to the deductions of expenditures on scientific research and experimental development, these expenditures must be qualified. I am persuaded by the testimony of the expert witness that these expenditures were not, as they were inconsistent with the requirements of section 2900 of the Regulations.
[94] The appeals are dismissed because the Partnership was not a genuine partnership within the meaning of the law applicable to partnerships; if a genuine partnership had been involved, on the facts the appellants were specified members (a notion that includes the limited partner and the sleeping partner); and even if the appellants had been partners in the full sense of the word, the expenditures purportedly incurred for purposes of scientific research and experimental development were not qualified expenditures.
Signed at Ottawa, Canada, the 22nd day of April, 2004.
Lamarre Proulx J.
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