Spire Freezers Ltd. v. Canada, [2001] 1 S.C.R. 391, 2001 SCC
11
Spire Freezers Ltd., Patrick Gouveia, Appellants
John O’Neill, Edward Butcher,
John Dobrei and Maroje Miloslavic
v.
Her Majesty The Queen Respondent
Indexed as: Spire Freezers Ltd. v. Canada
Neutral citation: 2001 SCC 11.
File No.: 27415.
2000: November 10; 2001: March 1.
Present: McLachlin C.J. and L’Heureux‑Dubé,
Gonthier, Iacobucci, Bastarache, Binnie and LeBel JJ.
on appeal from the federal court of appeal
Income tax -- Calculation of income -- Partnership
-- Losses -- Original U.S. partners assigning partnership interest to Canadian
assignees -- Assignees immediately selling main asset of partnership back to
original partners at fair market value incurring substantial loss -- Assignees
carrying on ancillary business of partnership -- Whether valid partnership
established for income tax purposes -- Whether assignees entitled to deduct
partnership loss.
A U.S. partnership, which was involved in the
development of luxury residential condominiums and a low-rent apartment
building ancillary to the main project, incurred potential losses which the
appellants, through taking assignments of partnership interests, sought to
acquire for use as an income tax deduction in Canada. Negotiations resulted in
several transactions occurring on the same day. The corporate appellant
acquired 75 percent of the partnership interest and for a brief moment was a de
jure partner with a U.S. partner. The individual appellants acquired the
remaining partnership interest a short time later. After the Americans left
the partnership, the Canadians who had been assigned their interests sold the
condominium project to them at fair market value incurring a substantial loss
which was later claimed on their 1987 Canadian income tax. The Canadians also
paid for the low-rent apartment building which they managed profitably for
several years. Revenue Canada disallowed the losses claimed by the appellants
and both the Tax Court of Canada and the Federal Court of Appeal upheld that
decision.
Held: The appeal
should be allowed.
The appellants are entitled to deduct the business
losses. The fact that they entered into the transactions mainly to reduce
their income tax liability by gaining access to the losses does not prevent a
finding of partnership where, as in this case, the three essential ingredients
of a valid partnership are present. First, the partnership was “carrying on
business”. The partnership held the entire interest in an apartment building
and the property management business that was associated with that asset was
pre-existing and continued by the appellants. Although the original American
partners and the corporate appellant held the property management business
jointly for only a brief period of time, the duration of the carrying on of
business is not determinative. A partnership may be created for a single
transaction. Second, the business was carried on “in common”. The parties
having entered into a valid partnership agreement setting out their rights and
obligations as partners established the common purpose element and some indicia
of partnership were also present during the brief period the Americans and the
corporate appellant were combined. Finally, the business was carried on with
a view to profit. The original partnership had been conceded to be valid and
running a business with a view to a profit when the appellants were added.
During the time that the corporate appellant and the Americans were partners,
and up until the latter withdrew from the partnership, they continued to carry
on business with a view to profit. Further, the appellants had been
apprised during negotiations of the potential to make a profit from the
apartment building and they clearly intended to continue that business. Since the determination of the existence of a view to a profit is
not a matter of strictly quantitative analysis, the quantum of the initial loss
compared to the anticipated profit does not negate the holding of partnership.
The law of partnership does not require a net gain over a determined period in
order to establish that an activity is with a view to profit. The parties’
intention to make a profit can be revisited on appeal in this case because the
trial judge equated intention with predominant motive and did not consider
whether an ancillary intention to profit existed.
Cases Cited
Applied: Continental
Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298, rev’g [1996] 3 F.C. 713;
distinguished: Backman v. Canada, [2001] 1 S.C.R. 367, 2001 SCC 10;
referred to: Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336.
Statutes and Regulations Cited
Income Tax Act, S.C. 1970‑71‑72, c. 63, s. 96 [am. 1984, c. 1, s.
43(1); am. 1985, c. 45, s. 48(1); am. 1987, c. 46, s. 32(1)].
APPEAL from a judgment of the Federal Court of Appeal,
[1999] 4 F.C. 381, 242 N.R. 358, 99 D.T.C. 5297, [1999] 3 C.T.C. 476, 46 B.L.R.
(2d) 153, [1999] F.C.J. No. 796 (QL), dismissing the appellants’ appeal from a
judgment of the Tax Court of Canada, 98 D.T.C. 1287, [1998] 2 C.T.C. 2764,
[1997] T.C.J. No. 1271 (QL), which found that the appellants were not entitled
to deduct partnership losses under s. 96 of the Income Tax Act. Appeal
allowed.
Warren J. A. Mitchell, Q.C.,
and John R. Owen, for the appellants.
J. S. Gill and Marilyn
Vardy, for the respondent.
The judgment of the Court was delivered by
1
Iacobucci and Bastarache JJ.
-- This appeal was heard with Backman v. Canada, [2001] 1 S.C.R. 367,
2001 SCC 10, released concurrently. Both appeals raise the basic question of
whether a valid partnership has been established for income tax purposes.
I. Facts
2
In 1978, a partnership named the Hamilton Cove Partnership (“HCP”) was
formed in California to develop a luxury residential condominium project on
Santa Catalina Island off the coast of California. By late 1980, two equal
partners remained, both American corporations: BCE Development Inc. (“BDI”),
and its wholly owned subsidiary, Peninsula Cove Corporation (“Peninsula”).
3
In order to obtain government approvals, the partnership was required to
build a low-rent apartment project known as the Tremont Apartments (“Tremont”)
in Avalon on Santa Catalina Island. Tremont was owned by a corporation called
the Tremont Street Apartments Corporation (“TSAC”), which was in turn fully
owned by HCP.
4
By the end of 1986, the development costs of the HCP condominium project
exceeded the fair market value of the project by approximately US$10 million.
In the spring of 1987, several Canadian parties, of whom the appellant Spire
Freezers Ltd. was the largest, were apprised of the opportunity to purchase the
tax losses of the HCP project at 20 cents on the dollar.
5
After detailed negotiations, the parties came to an agreement. On
November 30, 1987, the following transactions occurred:
(a)
BDI and Peninsula amended their partnership agreement to keep the
partnership operative regardless of the withdrawal of any of its partners.
(b)
TSAC sold Tremont to HCP for approximately US$2.9 million. HCP borrowed
these funds from BDI.
(c)
HCP, which sold its shares of TSAC to BDI, was paid by set‑off
against the loan from BDI.
(d)
Peninsula sold its 50 percent interest in the partnership to the
appellant Spire Freezers Ltd., and BDI sold a 25 percent interest in the
partnership to the appellant Spire Freezers Ltd. For a brief instant, the de
jure partners were BDI and Spire Freezers Ltd. BDI’s remaining 25 percent
interest in the partnership was then sold to the Spire Group, a group made up
of the individual Canadian parties other than the appellant Spire Freezers Ltd.
The total purchase price was US$34,530,253.
(e)
HCP immediately sold the condominium project to BDI for US$33.3 million.
The sale of the condominium project at this price gave rise to an operational
loss of approximately US$10.4 million.
(f)
HCP changed its name to the Tremont Street Partnership.
6
In effect, Spire Freezers Ltd. and the Spire Group (together the
Canadians) paid approximately US$1.2 million to acquire Tremont and the losses
totaling about US$10.4 million that were incurred by the sale of the HCP
project. The Canadians have managed Tremont profitably since its acquisition.
In the fiscal year ending December 31, 1987, the partnership claimed a loss of
US$10 million in respect of the HCP project sale and a capital loss of
US$367,000 in respect of the sale of TSAC shares. Revenue Canada disallowed the
losses. The appellants appealed to the Tax Court of Canada which ruled against
them, as did the majority in the Federal Court of Appeal.
II. Judgments
Below
1. Tax
Court of Canada, 98 D.T.C. 1287
7
Rip T.C.C.J. found that the transactions in the case at bar were legally
effective and were not a sham. He also found that the losses were true losses,
and that the tax avoidance sections of the Income Tax Act, S.C. 1970‑71‑72,
c. 63 (the “Act”), did not apply. Most of the reasons for judgment was
concerned with whether the appellants were members of a partnership for the
purposes of deducting losses under the Act.
8
The Tax Court judge reviewed the formal admissions of fact made by the
appellants in respect of their intention to acquire a tax loss. He also noted
that they were aware that the continued existence of the partnership and the
ownership of the Tremont apartment building were necessary for their objective
to succeed. He concluded that the appellants’ sole motivation in entering into
the transactions with BDI and Peninsula was to acquire a tax loss and that the
thought of the transaction being profitable was never in the minds of the
appellants.
9
The Tax Court judge then applied the decision of the Federal Court of
Appeal in Canada v. Continental Bank Leasing Corp., [1996] 3 F.C. 713,
which has since been overturned. He held that since none of the appellants
intended anything other than to obtain a tax loss, the Canadians were not
partners with respect to the ownership of the HCP condominium complex and
Tremont.
2. The Federal Court of Appeal, [1999]
4 F.C. 381
10
The majority of the Federal Court of Appeal (Linden J.A., Strayer J.A.
concurring) affirmed the result reached in the Tax Court. The majority
considered this Court’s decision in Continental Bank Leasing Corp. v. Canada,
[1998] 2 S.C.R. 298. They recognized that even an ancillary purpose of profit
making may form the basis of partnership. However, in the majority’s view, the
Tax Court judge in this case made an unambiguous finding of fact that the
Canadians, when they purported to become partners, had absolutely no intention
to carry on business with a view to profit. Rather, their sole intention was
to obtain a tax loss. Because the law that an ancillary profit intention is
sufficient in creating a partnership was known to the Tax Court judge, and
because in their view there was no persuasive evidence to demonstrate an
intention to earn a profit, ancillary or otherwise, the majority held that
there was no basis upon which it could reverse a finding of fact as to the
intention of the parties at the time of entering into a partnership contract.
Hence, the conclusion of the Tax Court judge that there was no business being carried
on with a view to profit could not be challenged.
11
In his dissenting opinion, Robertson J.A. held that the reasons of the
Tax Court judge should be interpreted as finding that the appellants’
predominant motive was to gain access to a tax loss. At the time of his
decision, the Tax Court judge’s conclusion that a valid partnership could not
be formed in such a situation was fully supported by the Federal Court of
Appeal decision in Continental Bank, supra, which he quoted
extensively. However, in the meantime that decision had been reversed by this
Court. In Robertson J.A.’s view, it was obvious that the taxpayers’ primary
intention was to acquire a substantial non-capital loss. But it is equally
obvious that their secondary intention was to acquire and retain an income
producing asset, Tremont, by which they could continue to carry on business in
common. Hence, he concluded that this Court’s decision in Continental Bank,
supra, was dispositive of the issue before the Court of Appeal and that the
appellants had established a sufficient basis for a finding that a partnership
existed at the material time.
III. Analysis
1.
Introduction
12
In this appeal, we are asked to consider whether the appellants, Spire
Freezers Ltd. and the Spire Group, are entitled to deduct the business losses
they claim to have accumulated as partners in the Californian partnership HCP.
The Canada Customs and Revenue Agency, on behalf of the respondent in this
appeal, reassessed the appellants on the ground that they were not true
partners and therefore could not claim the business losses. As already noted,
this case was heard at the same time as Backman, supra, reasons
in which are being released concurrently herewith, and which applied the
principles enunciated by this Court in Continental Bank, supra.
Like Backman, the principal issue to be decided in this appeal is: were
the appellants members of a partnership at the time the losses were incurred?
13
With respect to the majority in the Federal Court of Appeal, we would
allow the appeal for substantially the same reasons as expressed in the dissent
of Robertson J.A. but wish to elaborate some points.
2.
Were the Appellants Members of a Partnership?
14
The essential ingredients of partnerships and the proper approach to
determining whether a partnership exists are discussed in Backman. We
summarize those principles below.
(a) The Essential Ingredients of Partnership
15
The three essential ingredients of a valid partnership in Canada were
recently described by this Court in Continental Bank, supra, at
para. 22. At the time the alleged partnership is formed, the evidence must
disclose that the alleged partners were (1) carrying on a business, (2) in
common, (3) with a view to profit.
16
In Backman, supra, we discuss the concepts of “carrying on
a business”, “business”, “in common”, and “view to profit” as applied to
partnership law and as described in Continental Bank. We need not
repeat that discussion here. Indeed, most of the reasoning in Backman
is applicable in this case.
17
As stated in Continental Bank, and reiterated in Backman,
a tax motivation will not derogate from the validity of a partnership where the
essential ingredients of a partnership are otherwise present: Continental
Bank, supra, at paras. 50-52; Backman, supra, at para.
22. Furthermore, as held in Backman, where a Canadian taxpayer seeks to
deduct partnership losses through s. 96 of the Act, he
or she must satisfy the essential elements of a partnership that exist under
Canadian law. In other words, for the purposes of s. 96 of the Act, the
essential elements of a partnership must be present, even in respect of foreign
partnerships: Backman, supra, at para. 17.
(b) The Approach to Determining Whether a
Partnership Exists
18
As explained in Backman, the determination of the existence of a
partnership will depend on the true contract and intention of the parties as
appearing from the whole of the facts of the case. Courts must be pragmatic in
their approach to the three essential ingredients of partnership and weigh the
relevant factors in the context of all the surrounding circumstances: Backman,
supra, at paras. 25-26.
(c) Application to the Facts at Bar
19
The transactions at issue in this case are similar to those in Backman.
As in Backman, in this case, two groups of Canadians allege that they
became partners in a valid partnership through a series of transactions that
involved their taking assignments of partnership interests in a pre-existing
American partnership. The original American partners withdrew, leaving the
resultant alleged partnership between the Canadians holding two assets. The
primary asset, in this case the HCP condominium project, was held briefly and
in effect sold back to the original American partners, generating a large loss
for the alleged partnership. The subordinate asset, in this case the Tremont
apartment building, is the vehicle through which the appellants seek to
establish that there was an ancillary purpose in the transactions that rendered
them members of a valid partnership, namely to carry on business in common with
a view to profit.
20
However, despite the similarities between the transactions in this case
and those in Backman, there are some essential differences. For
example, in respect of whether there was a carrying on of business, it is
notable that there is a significant difference between the subordinate assets
in Backman and Spire in terms of the degree of effort required of
the appellants and expended by them in management. In Backman, the
subordinate asset was a one percent interest in an oil and gas property,
purchased for the sum of $5,000 during the transition between American and
Canadian control of the alleged partnership. The alleged partnership in Backman
had no significant management control over that asset, nor did the acquisition
of that asset represent a continuation of a pre-existing business of one of the
putative partners. When production was shut down shortly after purchase, no
other investments in oil and gas were made. Thus, in Backman, the
alleged partnership was “an empty shell that does not in fact carry on business”
(see Backman, supra, at para. 20). In this case, the subordinate
asset held by the partnership was the entire interest in an apartment
building. The property management business that was associated with that asset
was pre-existing and continued by the Canadians. Tremont required a
substantial management effort which the appellants provided, and from which
they benefited by generating profit. As noted by Robertson J.A., “the
partnership continued to hold title to a profit-generating asset, namely,
the apartment building, for at least a decade after the sale of the condominium
development” (para. 57 (emphasis in original)).
21
Although the original American partners and Spire Freezers Ltd. held the
property management business jointly for only a brief period of time, the
duration of the carrying on of business is not determinative. The fact that a
partnership is created for a single transaction is of no consequence.
Furthermore, it is not necessary to show that the parties held meetings,
entered into new transactions, or made decisions: Continental Bank,
supra, at paras. 31-33. And a business may be established even in
circumstances where the sole business activity is the passive receipt of rent,
as was noted by L’Heureux-Dubé J. in Hickman Motors Ltd. v. Canada,
[1997] 2 S.C.R. 336, at para. 46. Consequently, while in Backman it
could not fairly be said that the alleged partnership was carrying on business,
that is not true of the appellants in this case.
22
Turning to the question of whether the business in this case was carried
on “in common”, the common purpose element of a partnership was established in
this case by the parties’ having entered into a valid partnership agreement
setting out their respective rights and obligations as partners. Contrary to
the finding of the Federal Court of Appeal in this case, some of the indicia
of partnership described in Continental Bank, supra, were present
during the brief period the Americans and Spire Freezers Ltd. were combined.
For example, the Americans and Spire Freezers Ltd. did hold “a joint property
interest in the subject‑matter of the adventure” (Backman, supra,
at para. 21), that is the assets and property management business of HCP. In
addition, as already noted, the business of the Tremont apartment building
involved substantial efforts and management and in this sense the parties
contributed “skill, knowledge or assets to a common undertaking”. All things
considered, there is sufficient evidence to found a common purpose among the
parties during the transition between American and Canadian control of that
partnership.
23
With respect to the question of whether the business was carried
on with a view to profit, it is conceded that prior to the relevant transactions,
HCP was a valid and existing partnership and that it had been formed with a
view to profit. It is also clear that the partnership was running a business
with a view to profit when the new Canadian partners were added. The fact that
the American partners withdrew from the partnership does not take away from the
fact that during the time that they were partners, and up until their
withdrawal from the partnership, they continued to carry on business with a
view to profit. For their part, the appellants must have entered into the
transactions in this case with a view to profit since they were apprised during
negotiations of the potential to make a profit from the Tremont apartment
building and they clearly intended to continue that business. This is in contrast to the appellant in Backman whose efforts
were characterized by the trial judge as “nothing more than window dressing”
and the finding by the Court of Appeal that there was no real ancillary
profit-making purpose behind the appellant’s involvement in the oil and gas
property.
24
The majority in the Court of Appeal rejected the contention that a valid
partnership with a view to profit was formed when the new Canadian partners
were admitted to the partnership based on the intention of the American
partners to abandon the partnership and their possession of the Tremont asset
immediately thereafter. This amounts to a conclusion that there was no
carrying on of a business in common between the American and Canadian
partners. However, the fact is that during the short time the American and
Spire Freezers Ltd. were involved, they ran the HCP condominium project and
Tremont as a business in common. The partnership subsisted and continued to
carry on a business after the withdrawal of the Americans. At all relevant
times, then, there were partners managing assets. At some point, all partners
were associated in the management of the Tremont apartment building. In other
words, at all times there was a carrying on of business in common.
25
As noted above, the duration of the partnership is not determinative.
It is settled law that a partnership may be formed for a single transaction.
As a general matter, internal arrangements with regard to liability between
partners are not of prime importance in determining the existence of a
partnership. Consequently, the liability sharing arrangement in respect of the
condominium project and Tremont is not of great significance on the partnership
question. Furthermore, as noted above, the fact that the appellants admitted
that they principally entered into the transactions to reduce their Canadian
income tax liability by gaining access to the losses does not prevent a finding
of partnership.
26
The majority of the Court of Appeal also rejected the notion that there
was a view to profit because the parties did not contemplate recouping the
initial loss. However, the determination of the existence of a view to profit
is not a matter of strictly quantitative analysis. The quantum of the initial
loss compared to the anticipated profit does not negate the holding of
partnership in this case. The law of partnership does not require a net gain
over a determined period in order to establish that an activity is with a view
to profit. For example, a partnership may incur initial losses during the
start-up phase of its enterprise. That does not mean that the relationship is
not one of partnership, so long as the enterprise is carried on with a view to
profit in the future. Here, the transactions at issue necessarily involved a
transfer of both the condominium project and Tremont. Despite the fact that a
loss was incurred by the subsequent sale of the condominium project, the fact
that the Canadian partners were aware of the potential for profit from the
Tremont apartment building before entering the partnership and the fact that
Tremont consistently turned a profit after the entry of the Canadian partners
clearly establish the business was carried on with a view to profit,
notwithstanding that the aggregate profits may never exceed the tax loss
incurred in the year of the transactions at issue.
27
We reject the conclusion of the majority of the Federal Court of
Appeal that the question of whether the parties’ intention to make a profit is
a purely factual one that cannot be revisited in the instant case. The
intention to make a profit cannot only be judged merely subjectively, it must
also be based on objective evidence. We place little weight on the finding
that the appellants’ only intent was to obtain a tax benefit. The trial judge
erred with respect to this issue by failing to give proper attention to the
ancillary purpose described above. As mentioned earlier, the trial judge did
not have the benefit of this Court’s ruling in Continental Bank and made
his findings while under the impression that the predominant motive of the
taxpayer was determinative and that profit had to consist of a net gain over
and above the initial loss sought to be deducted (see Rip T.C.C.J.’s reasons at
pp. 1298-99).
28
In summary, although there are similarities between the transactions at
issue in Backman and in this case, there are also several essential
differences, including the continuity of the business of the partnership, the
management effort required to sustain it, and the objective evidence of an
anticipation of profit. Considering all the facts and circumstances, we believe
it is clear that the formal requirements necessary for partnership are present
in Spire, while in Backman they were not.
IV. Disposition
29
We would allow the appeal with costs, set aside the decision of the
Federal Court of Appeal, and order that the appellants are entitled to deduct
the loss in question under s. 96 of the Income Tax Act.
Appeal allowed with costs.
Solicitors for the appellants: Thorsteinssons, Vancouver.
Solicitor for the respondent: The Deputy Attorney General
of Canada, Toronto.
Email this Content