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Citation: 2007TCC517
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Date: 20070904
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Docket: 2006-862(IT)I
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BETWEEN:
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JAMES MAZURKEWICH,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent,
AND
Docket: 2006-876(IT)I
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BETWEEN:
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JEFFREY K. ALMEN,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Bowman,
C.J.
[1] These appeals from assessments made under
the Income Tax Act for the 2001 and 2002 taxation years were heard
together. The issue that is common to the appeals for both appellants is the
allocation of partnership losses.
[2] Mr. Mazurkewich’s
appeals raise a separate issue having to do with moving expenses. In 2000, he
moved from British Columbia to Saskatoon to start a new business in partnership with
Mr. Almen and their respective spouses. The Crown does not dispute that
the expenses claimed were in fact incurred and were proper moving expenses
within the meaning of section 62 of the Income Tax Act but contends
that:
(a) they cannot be
deducted in 2001 because the appellant had nil income; and
(b) they
can be deducted in 2002 only to the extent of $547 because that is all the income
that the appellant earned at the new work location.
Section
62(1) reads as follows:
62. (1) Moving Expenses – There may
be deducted in computing a taxpayer’s income for a taxation year amounts paid
by the taxpayer as or on account of moving expenses incurred in respect of an
eligible relocation, to the extent that
(a) they were not
paid on the taxpayer’s behalf in respect of, in the courseof or because of, the
taxpayer’s office or employment.
(b) they were not
deductible because of this section in computing the taxpayer’s income for the
preceding taxation year;
(c) the total of
those amounts does not exceed
(i) in any case
described in subparagraph (a)(i) of the definition “eligible relocation”
in subsection 248(1), the taxpayer’s income for the year from the taxpayer’s
employment at a new work location or from carrying on the business at the new
work location, as the case may be, and
(ii) in any case
described in subparagraph (a)(ii) of the definition “eligible relocation” in
subsection 248(1), the total of amounts included in computing the taxpayer’s
income for the year because of paragraphs 56(1)(n) and (o); and
(d) all
reimbursements and allowances received by the taxpayer in respect of those
expenses are included in computing the taxpayer’s income.
I agree with Crown counsel on both
points. Therefore, the appeal of Mr. Mazurkewich for 2001 should be
quashed because it is from a nil assessment. (Okalta Oils Ltd. v. M.N.R.,
55 DTC 1176 (S.C.C.)). A recent and useful discussion of the rule is found in the
decision of the Federal Court of Appeal in Interior Savings Credit Union v.
R., [2007] 4 C.T.C. 55.
[3] Moreover, the
appeal for 2002 is allowed to permit $547 of the moving expenses to be
deducted. The remainder of the moving expenses can be carried forward to
subsequent years and deducted in those years to the extent that the appellant,
Mr. Mazurkewich, has income from the new work location. See Moodie v. R.,
[2004] 4 C.T.C. 2329.
[4] I turn now to the
somewhat larger issue that is involved in both Mr. Mazurkewich’s appeal
for 2002 and Mr. Almen’s appeals for 2001 and 2002. It requires a
consideration of the question of the payment or notional payment for services
rendered to a partnership by a partner. I was surprised to find that the matter
is somewhat more complex than I had believed.
[5] By a partnership
agreement made as of March 28, 2000, the appellants and their respective
wives (Elizabeth Almen and Diane Mazurkewich) formed a partnership under the
name of Pruden’s Point Resort. Paragraph 1.03 provided:
“Partnership”
Interest” means the proportionate interest of any particular Partner in the
Partnership at any particular time, the initial proportionate interest being as
prescribed by Schedule “A” attached to this Agreement.
Paragraph 2.04 provided:
The
net profits, if any, of the Partnership which the Partners determine to
distribute shall be allocated and distributed to each Partner in proportion to
their respective Partnership Interest existing as of the date of distribution.
Any losses sustained or incurred by the Partnership shall be borne by the
Partners in proportion to their respective Partnership Interest existing as of
the date the loss is incurred.
[6] Schedule A was not
attached but the appellants and Diane Mazurkewich agreed that the four
partners had equal interests of 25%. The two wives worked at the resort and I
accept that they worked hard and that they did everything that was necessary to
make the operation viable including bookkeeping, cleaning and cooking. Their
husbands, the appellants, worked at jobs away from the resort and contributed
financially to the partnership. It is obvious that the contribution of all four
partners to the operation, whether it was in the form of labour or of money,
was essential to the success and viability of the enterprise.
[7] In the years under
appeal, 2001 and 2002, the business of the partnership sustained a loss. In
2001, the loss was shown in the statement of business activities filed with the
appellants’ returns as $55,859.61 and for 2002, $44,613.84. This was calculated
as follows:
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2001
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2002
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Sales $150,149.02
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$173,454.68
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Cost of goods sold $
68,464.75
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$ 60,596.29
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Expenses $137,543.00
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$157,672.23
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Loss ($
55,859)
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($ 44,613.84)
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[8] This is the loss of
the partnership under subsection 96(1) of the Income Tax Act and
each partner’s share of the loss should be 25% thereof or $13,964.75 in 2001
and $11,153.46 in 2002. The accountant for the appellants, who also acted as
their agent in the appeals, adjusted the loss as follows:
Net Loss from Operations 2001 $(55,860.00)
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Distribution
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Jeff
Almen
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Elizabeth
Almen
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Jim
Mazurkewich
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Diane
Mazurkewich
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Total
__________
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Partnership Wages
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$ (7,840.00)
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$(21,280.00)
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$ -
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$ (29,120.00)
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(58,240.00)
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Net Distribution
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_(28,525.00)
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(28,525.00)
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(28,525.00)
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(28,525.00)
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(114,100.00)
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Net Loss from
Operations
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$(20,685.00)
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(7,245.00)
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$ (28,525.00)
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$ 595.00
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$(55,860.00)
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Partner Adjustments
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$
(6,720.00)
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$ 6,720.00
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$ (14,560.00)
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$ 14,560.00
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$ -_____
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Net Loss from Operations 2002 $
(44,613.84)
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Distribution
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Jeff
Almen
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Elizabeth
Almen
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Jim
Mazurkewich
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Diane
Mazurkewich
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Total
__________
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Partnership Work
Credit
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$ -
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$(29,120.00)
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$ -
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$ (29,120.00)
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$(58,240.00)
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Net Distribution
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_(25,713.46)
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(25,713.46)
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(25,713.46)
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(25,713.46)
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(102,853.84)
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Net Loss from
Operations
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$(25,713.46)
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$ 3,406.54)
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$ (25,713.46)
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$ 3,406.54
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$(44,613.84)
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Partner Adjustments
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$ (14,560.00)
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$ 14,560.00
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$ (14,560.00)
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$ 14,560.00
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$ -_____
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[9] If one takes 2001
as an example and looks at the bottom line (net loss from operations), it will
be apparent that the net loss that is being distributed is correct ($55,860.00)
but it is not allocated in accordance with the 25% interest of each partner. A
far bigger percentage is being allocated to the husbands, a small portion to
Elizabeth Almen and a small amount of income to Diane Mazurkewich. The
justification advanced for this is that the wives, who admittedly devoted a
great deal more labour to the partnership business than the appellants, should
get some recognition for the time and work they did.
[10] The fact of the
matter is that the attribution of “partnership wages” to them is purely
notional. Nothing was paid to them and they did not declare these notional
wages in their income tax returns. All that happened was that the loss was
increased from $55,860.00 to $114,100.00 by the additional notional wages. In
the result the partnership loss was allocated among the four equal partners on
a 37%, 12%, 51% and 0% basis.
[11] Mr. Grandfield
argued the appellants’ position with great conviction and sincerity. The
question of the deductibility of salaries or wages paid to a partner by a
partnership appears to be more controversial than I had thought.
[12] Interpretation
Bulletin IT‑138R (now cancelled) was relied upon by the appellants’
agent. It previously said:
Salaries
10. Salaries paid by a
partnership to its members do not constitute a business expense, but are a
method of distributing partnership income among members. The income of a
partnership in a taxation year may be less than the salaries which the
partnership agreement requires to be paid to the partners. In this event, the
excess of the salaries over such income appears as a deduction in the partners’
capital accounts. Such a reduction of the capital of each partner is allowed as
a deduction in determining the allocation to him of the income or loss of the
partnership.
11. For example,
suppose that A and B are members of AB partnership. Under
the partnership agreement, A is to receive an annual salary of $2,500,
after which A and B divide the income or loss equally. The income
of the partnership before deduction of the $2,500 salary paid to A is
$1,000. The loss after the salary is deducted is $1,500 and $750 is charged to
each of the capital accounts. In such a case, A’s income is $1,750
($2,500 - $750) and B’s loss is $750. Thus A’s income of $1,750
minus B’s loss of $750 equals the income of the partnership.
[13] Without commenting
on whether the view expressed in IT-138R is defensible or not, it does not, in
any event, support the appellants’ position for several reasons:
(a) nothing was in
fact paid to the appellants’ spouses;
(b) it results in an
allocation and loss that is not in accordance with the partnership agreement;
(c) the wages notionally
attributable to the spouses were not brought into their income.
[14] Generally I should
have thought it open to question whether salary or wages paid by a partnership to
a partner could be deducted as a business expense of the partnership. This view
is consistent with that expressed by Hamlyn J. in Crestglen Investments
Ltd. v. M.N.R., [1993]
2 C.T.C. 3210 at paragraph 23:
Moreover, a
partnership is not a distinct legal entity apart from the partners. A partner
cannot be both the employer and the employed in the same partnership business.
The tax treatment of a partners partnership income is the same whether it is
partnership distribution or monies allocated for partnership management
services. Thus a partner cannot be an employee of a partnership2 that is capable of entering into a contract
of employment with the partnership and as a consequence an incorporated
employee could not become an employee of a partnership that the incorporated
employee was a partner.
[15] The question of the
tax treatment of salary or wages paid by a partnership to a partner has however
yet to be definitively determined. I mentioned the Crestglen case above,
in which Hamlyn J. followed Re Thorne and N.B. Workmen’s Comp. Bd. (1962),
48 M.P.R. 756, 33 D.L.R. (2d) 167 (aff’d without written reasons,
S.C.R. 1962 S.C.R. viii), which he referred to in a footnote.
[16] Nonetheless, there
is certainly strong support for the opposite point of view. In Archbold v.
The Queen, [1995] 1 C.T.C. 2872, Lamarre Proulx J. held that where an
express agreement among partners permitted it, a partnership could pay a salary
to one of its partners and such amount was a deductible expense. This view was
shared by the eminent legal scholar and writer, the late
Dr. Wolfe D. Goodman, Q.C., in an article published in Goodman
on Estate Planning (2003) Volume XII, No. 1, page 931.
[17] Mr. Grandfield’s
preparation was thorough and the material that he gave me was very helpful in
assisting me to understand the complexity of the problem. The question is
discussed in Understanding the Taxation of Partnerships, 5th Edition
(2006) at paragraphs 234-238 and in Death of a Taxpayer, 8th
Edition (2005) at pages 148-149. The administrative practice of the Canada
Revenue Agency (“CRA”) on this question seems to be going through an
evolutionary process. The most recent pronouncement by the CRA is found in
Technical News No. 30 of May 21, 2004. Sooner or later the matter
will need to be fully argued, possibly with the benefit of expert accounting
advice.
[18] I do not think that
any useful purpose would be served by my coming down on either side of this
debate without further argument. It is not necessary for my decision here since
nothing was in fact paid to the wives.
[19] The appeal of
James Mazurkewich for 2001 is quashed and the appeal for 2002 is allowed
to permit Mr. Mazurkewich to deduct $547 as a moving expense.
[20] The appeals of
Jeffrey Almen for 2001 and 2002 are dismissed.
Signed at Ottawa, Canada, this 4th day of September 2007.
Bowman, C.J.
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