Date: 19991116
Docket: A-689-95
ROBERTSON J.A.
NOËL J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
PINOT HOLDINGS LTD.
(FORMERLY CAPOZZI ENTERPRISES LTD.)
Respondent
ORDER
The appeal is allowed with costs here and below, the decision of the Tax Court Judge is set aside and the appeal to the Tax Court of Canada is dismissed.
"Robert Décary"
J.A.
Date: 19991116
Docket: A-689-95
CORAM: DÉCARY J.A.
ROBERTSON J.A.
NOËL J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
PINOT HOLDINGS LTD.
(FORMERLY CAPOZZI ENTERPRISES LTD.)
Respondent
Heard at Vancouver, British Columbia, Friday, October 29, 1999
Judgment rendered at Ottawa, Ontario, Tuesday, November 16, 1999
REASONS FOR JUDGMENT BY: NOËL J.A.
| CONCURRED IN BY: DÉCARY J.A. |
ROBERTSON J.A.
Date: 19991116
Docket: A-689-95
CORAM: DÉCARY J.A.
ROBERTSON J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
PINOT HOLDINGS LTD.
(FORMERLY CAPOZZI ENTERPRISES LTD.)
Respondent
REASONS FOR JUDGMENT
NOËL J.A.
This is an appeal by Her Majesty from a decision of the Tax Court of Canada allowing in part the respondent"s appeal from a reassessment issued by the Minister of National Revenue with respect to its 1987 taxation year.1
The sole issue before the Tax Court was whether the respondent upon transferring property to a partnership ("the Capri Assets") and upon the appropriate elections being filed was entitled to the tax deferral provided for by ss. 97(2) of the Income Tax Act ("the Act"). Having regard to the elected amounts, no tax or recapture was exigible as a result of this transfer to the extent that no consideration had been received by the respondent beyond "an interest in the partnership".
In filing its tax return for the 1987 taxation year, the respondent relying on ss. 97(2) took the position that no tax or recapture was exigible. The Minister disagreed and issued a reassessment on the basis that consideration in the amount of 13.5M had been received by the respondent beyond its partnership interest. On appeal, the Tax Court held that monetary consideration in the amount of 6.750M rather than 13.5M had been received thereby allowing the appeal to the extent of 50%.
The Facts
The Tax Court Judge in his reasons identified the relevant facts as follows:
| 1. The Appellant, Pinot Holdings Ltd., formerly Capozzi Enterprises Ltd., is a company formed under the laws of the Province of British Columbia. |
| 2. The Appellant was the owner of certain real estate assets including a hotel and shopping centre and other real estate, all in Kelowna, British Columbia (the "Capri Assets"). |
| 3. The Appellant was indebted to the Bank of Montreal under three mortgages on the Capri Assets totalling $13,500,000, was in default thereunder and desperately needing new financing. |
| 4. On November 8, 1986 the Appellant and Mannai Investment Corporation Ltd. signed a letter of intent to create a partnership between two new corporations to be formed by them and to have the Appellant transfer the Capri Assets to the partnership for $13,500,000. |
| 5. The letter of intent also set out that the new corporation formed by Mannai Investment Corporation Ltd. was to loan the partnership $5,000,000 interest free, and that the partnership would borrow an additional $10,000,000 from a financial institution, such $10,000,000 loan to be secured by a mortgage on the Capri Assets. The letter of intent provided further that the total of $15,000,000 would be applied as follows: the partnership would acquire the Capri Assets from the Appellant for $13,500,000 and would spend the remaining $1,500,000 on renovations to the Capri Assets. |
| 6. Prior to January 30, 1987 a company known as 312894 B.C. Ltd. ("312894") was incorporated and acquired all the shares of the Appellant; and Mannai Investment Corporation Ltd. incorporated a company known as Mannai Properties Inc. ("Mannai"). |
| 7. On January 30, 1987 Mannai, the Appellant and 312894 entered into a partnership agreement under the laws of British Columbia for the purposes of owning and operating the Capri Assets. |
| 8. On January 30, 1987 the partnership entered into an Agreement of Purchase and Sale to purchase the Capri Assets from the Appellant for $13,500,000 with a closing date of February 25, 1987. |
| 9. Under this Agreement of Purchase and Sale the partnership agreed to pay the purchase price of $13,500,000 to Salloum Doak, Barristers & Solicitors, in trust, to be disbursed to the Bank of Montreal, the Appellant's creditor prior to the partnership, when clear title to the Capri Assets was registered in the name of the partnership. |
| 10. On January 30, 1987 the partnership entered into a loan agreement with Mannai to borrow $5,000,000 to be disbursed to the partnership on a date to be mutually agreed upon by the partnership and Mannai. |
| 11. On February 10, 1987 the partnership entered into an agreement with the Hongkong Bank of Canada to borrow $10,000,000 secured by, inter alia, a mortgage against the Capri Assets. |
| 12. On February 26, 1987 the Hongkong Bank of Canada mortgage was registered against the Capri Assets and the proceeds of that loan plus $3,500,000 of the Mannai loan for a total of $13,500,000 was advanced to Salloum Doak, in trust in accordance with the Agreement of Purchase and Sale. |
| 13. On February 27, 1987 Salloum Doak disbursed the $13,500,000 to the Bank of Montreal in full payment of the mortgages then held by that bank on the Capri Assets. |
| 14. The Appellant and the other members of the partnership jointly elected on Form T-2059, filed pursuant to subsection 97(2) of the Income Tax Act ("Act") in respect of the transfer of the Capri Assets to the partnership. The amounts elected in respect of each depreciable asset was equal to the undepreciated capital cost thereof to the Appellant and the amount elected in respect of each non-depreciable capital property was equal to the adjusted cost base thereof to the Appellant. Pursuant to the loan agreement with Mannai (paragraph 10 above) on or about February 25, 1987, Mannai loaned $5,000,000 to the partnership. $3,500,000 of this loan was advanced as set forth above in paragraph 12. |
| 15. Pursuant to the partnership agreement the interests of the partners in the partnership were as follows: the Appellant, 5%; Appellant's parent, 312894, 45%; and Mannai, 50%. |
| 16. The Minister issued a Notice of Reassessment dated August 29, 1991 in respect of the Appellant's taxation year ending December 31, 1987 reassessing the Appellant for federal tax of $1,374,221.20, a late filing penalty of $329,428.11, provincial tax and penalty of $563,591.25, and arrears interest of $1,271,315.73. The Minister increased the Appellant's income for 1987 by including recapture of capital cost allowance of $3,716,895 and by increasing the Appellant's taxable capital gain by $977,435, both in respect of the transfer by the Appellant of the Capri Assets to the partnership. In making the reassessment, the Minister disregarded the elected amounts shown on Form T-2059 filed on behalf of the members of the partnership in respect of the transfer of the Capri Assets and reassessed the Appellant on the basis that the Appellant had aggregate proceeds of disposition in respect of the Capri Assets of $13,500,000.2 (emphasis added) |
Legislative Provisions
The basic rule under the Act is that property transferred to a partnership by a member of the partnership is deemed to have been acquired by the partnership and disposed of by the partner for proceeds equal to its fair market value:
| 97(1) Where at any time after 1971 a partnership has acquired property from a taxpayer who was, immediately after that time, a member of the partnership, the partnership shall be deemed to have acquired the property at an amount equal to its fair market value at that time and the taxpayer shall be deemed to have disposed of the property for proceeds equal to that fair market value.
|
97(1) Lorsque, à une date quelconque après 1971, une société a acquis des biens d'un contribuable qui, immédiatement après cette date, faisait partie de la société, cette dernière est réputée les avoir acquis à un prix égal à leur juste valeur marchande à cette date et le contribuable est réputé en avoir disposé et en avoir tiré un produit égal à cette juste valeur marchande.
|
However, the Act provides that property may also be transferred to a partnership on a tax deferred basis by reference to the corporate "rollover" provisions provided for under s. 85 of the Act:
| 97(2) Notwithstanding any other provisions of this Act, ... where at any time after November 12, 1981 a taxpayer has disposed of any capital property ... to a partnership that immediately after that time was a Canadian partnership of which the taxpayer was a member, if the taxpayer and all the other members of the partnership have jointly so elected in prescribed form and within the time referred to in subsection 96(4), the following rules apply:
| (a) the provisions of paragraphs 85(1)(a) to (f) apply to the disposition as if |
| (i) the reference therein to 'corporation's cost' were read as a reference to "partnership"s cost", |
| (ii) the references therein to 'other than any shares of the capital stock of the corporation or a right to receive any such shares' and to 'other than shares of the capital stock of the corporation or a right to receive any such shares' were read as references to 'other than an interest in the partnership', |
| (iii) the references therein to 'shareholder of the corporation' were read as references to 'member of the partnership', |
| (iv) the references therein to 'the corporation' were read as references to 'all the other members of the partnership', and |
| (v) the references therein to 'to the corporation' were read as references 'to the partnership';" |
|
97(2) Nonobstant les autres dispositions de la présente loi, [...] lorsque, à une date quelconque après le 12 novembre 1981, un contribuable a disposé d'un de ses biens en immobilisation [...] en faveur d'une société qui, immédiatement après cette date, était une société canadienne dont le contribuable était membre, et que le contribuable et tous les autres membres de la société ont fait conjointement un choix à cet égard selon le formulaire prescrit et dans le délai mentionné au paragraphe 96(4), les règles suivantes s'appliquent:
| (a) les alinéas 85(1)(a) à (f) s'appliquent à la disposition comme si un renvoi à |
| (i) "pour la corporation" était interprété comme étant un renvoi à "pour la société", |
| (ii) "autre que toutes actions du capital-actions de la corporation ou un droit d'en recevoir" était interprété comme étant un renvoi à "autre qu'une participation dans la société", |
| (iii) "actionnaire de la corporation" était interprété comme étant un renvoi à "membre de la société", |
| (iv) "la corporation" était interprétée comme étant un renvoi à "tous les autres membres de la société", et |
| (v) "à la corporation" était interprété comme étant un renvoi à "à la société"; |
|
After making the directed changes, the relevant paragraphs in ss. 85(1) provide in effect as follows:
| (a) the amount that the taxpayer and all the other members of the partnership have agreed on in their election in respect of the property shall be deemed to be the taxpayer's proceeds of disposition of the property and the partnership's cost of the property;
(b) subject to (c), where the amount that the taxpayer and the other members of the partnership have agreed on in their election in respect of the property is less than the fair market value, at the time of the disposition, of the consideration therefor (other than an interest in the partnership) received by the taxpayer, the amount so agreed on shall, irrespective of the amount actually so agreed on by them, be deemed to be an amount equal to that fair market value; ...
|
(a) la somme convenue sur laquelle le contribuable et tous les autres membres de la société ont fait conjointement un choix à cet égard est réputée être, pour le contribuable, le produit de disposition et, pour la société, le coût du bien;
(b) sous réserve de l'alinéa (c), lorsque la somme convenue entre le contribuable et tous les autres membres de la société, dans leur option, relativement au bien, est inférieure à la juste valeur marchande, à la date de la disposition, de la contrepartie de la disposition (autre qu'une participation dans la société), reçue par le contribuable la somme ainsi convenue est, quel qu'en soit le montant effectivement convenu entre eux, réputée être une somme égale à cette juste valeur marchande; [...]
|
Decision of the Tax Court
The Tax Court Judge refused to disregard the agreement of purchase and sale under which the Capri Assets were transferred to the partnership. The respondent had urged the Tax Court Judge to ignore this agreement alleging that it had been forced upon the parties by the Hong Kong Bank of Canada. The Tax Court Judge stated in this regard:
| Although I agree that labelling a document "Agreement of Purchase and Sale" does not necessarily make it so, I observe that another document entitled "Fee Agreement" apparently signed January 30, 1987 and only by the partnership and Mannai contains a "whereas" which reads as follows: |
| the parties hereto entered into a Partnership Agreement on the 30th day of January 1987, being the effective date of the Partnership, which may from time to time be postponed until registration of the purchase of the Partnership assets. |
| Again, in my view, these Agreements, by themselves, do not determine the issue but they cannot be totally ignored in attempting to ascertain the substance of the transaction.3 (emphasis in the original) |
The Tax Court Judge then analysed the transaction in context. He stated:
| In my opinion one must examine the entire picture before and after the entering into the partnership agreement and the advancement of funds. Before the partnership agreement and the new loans from Mannai and the Hongkong Bank of Canada, which were made to the partnership, the Appellant was the sole debtor to the Bank of Montreal in an amount of $13,500,000 and the sole owner of the Capri Assets. After the partnership agreement and the new loans and the advance of funds to the Bank of Montreal, the Appellant was no longer indebted to the Bank of Montreal and was no longer the sole owner of the Capri Assets, but through the partnership the Appellant and its parent owned together 50% of the Capri Assets and Mannai also owned 50%.4 (emphasis added) |
He went on to conclude that the respondent had in effect received in addition to a partnership interest $6,750,000 rather than 13.5M:
| Because of the foregoing, I have concluded that for its transfer of the Capri Assets to the partnership the Appellant did receive something in addition to a simple |
| interest in the partnership. The partnership, in effect, advanced $13,500,000 to the Appellant which the Appellant used to pay its indebtedness to the Bank of Montreal. Consequently, in my opinion, subsection 97(1) is applicable and subsection 97(2) is not applicable because the Appellant received more than an interest in the partnership with the result that the rollover provisions of paragraphs 85(1)(a) to (f) are not available. In my further opinion, however, since the Appellant and its parent were liable for 50% of the new loans there was a refinancing to that extent. Consequently, what the Appellant received as consideration for the transfer of the Capri Assets in addition to an interest in the partnership was 50% of $13,500,000, i.e., $6,750,000 and that this latter figure, rather than the $13,500,000 used by the Minister, is the figure which represents the proceeds of disposition of the Capri Assets.5 (emphasis added) |
The Minister was ordered to reassess the respondent accordingly and the present appeal ensued.
Preliminary Concession
Both the appellant and respondent agree that the Tax Court Judge erred in holding that ss. 97(1) was the applicable provision. The respondent and its partners filed an election under ss. 97(2) with the result that this is the provision which governs. Under ss. 97(2), the cost of property transferred to the partnership and the proceeds to the transferor are deemed to be equal to the agreed amount. This presumption applies unless the transferor receives consideration having a fair market value higher than the agreed amount in which case the cost to the partnership and the proceeds to the transferor are deemed to be equal to the value of the consideration actually received by the transferor. The issue in this appeal therefore turns on the extent of the consideration received by the respondent upon the transfer of the Capri Assets to the partnership.
Position of the Parties
The appellant points out that based on the evidence and indeed according to the Tax Court"s own finding, the respondent received 13.5M. upon the transfer of the Capri Assets to the partnership. According to the appellant, it was not open to the Tax Court Judge to reduce this consideration because part thereof could be viewed as having been received by the respondent in the course of a refinancing operation.
The respondent contends that the finding by the Tax Court Judge that there was a 50% refinancing of the Capri Assets and that as a result the consideration to the respondent under the agreement of purchase and sale was 6.750M rather than 13.5M is a mixed conclusion of fact and law which should not be overturned lightly.6 If anything, the respondent contends that the refinancing was not partial but total and that on a proper analysis, the Tax Court Judge should have disregarded the agreement of purchase and sale altogether and held that it received no consideration other than a partnership interest.7
Analysis and Decision
There is no doubt that the Tax Court Judge was correct in holding that the transaction took place in the course of a refinancing operation. There is also no doubt, however, that in the course of this operation, the totality of the respondent"s ownership interest in the Capri Assets were transferred to the partnership under the terms of the agreement of purchase and sale. The Tax Court Judge recognized so much, but he reduced the consideration paid under the agreement by 50% because on his view of the matter, the respondent remained liable for 50% of the new loans. The narrow issue raised by this appeal is whether the consideration paid pursuant to the agreement of purchase and sale can be reduced for purposes of ss. 97(2) based on the reasoning advanced by the Tax Court Judge.
The Tax Court Judge expressly excluded the application of ss. 97(2) and disposed of the matter by reference to ss. 97(1). Having regard to the prescriptions of ss. 97(1), it would appear that he was of the view that only half of the value of the Capri Assets could be considered as having been received by the respondent from the partnership (and presumably paid by it) because the respondent retained a 50% interest in the Capri Assets through its partnership interest (and that of its parent) and remained liable for half of the loans.
I need not opine on the correctness of this view although it does seem to ignore the separate existence of the partnership for income computation purposes and in particular paragraph 96(1)(c) which requires that taxable income be computed on the basis that:
| (c) each partnership activity (including the ownership of property) were carried on by the partnership as a separate person, and a computation were made of the amount of
| (i) each taxable capital gain and allowable capital loss of the partnership from the disposition of property, and |
| (ii) each income and loss of the partnership from each other source or from sources in a particular place, |
| for each taxation year of the partnership; |
|
c) chaque activité de la société (y compris une activité relative à la propriété de biens) était exercée par celle-ci en tant que personne distincte, et comme si était établi le montant
| (i) de chaque gain en capital imposable et de chaque perte en capital déductible de la société, découlant de la disposition de biens, et |
| (ii) de chaque revenu et perte de la société afférents à chacune des autres sources ou à des sources situées dans un endroit donné, |
| pour chaque année d"imposition de la société; |
|
(emphasis added)
It is unquestionable in this instance that the intention of the partners was that the whole of the Capri Assets be transferred to the partnership:
| It is for the partners to determine by agreement amongst themselves what shall be the property of the firm (and the quantum of their beneficial interests therein inter se) and what shall be the separate property of one or more of them ...8 (emphasis added) |
Since the whole of the Capri Assets were transferred to the partnership,9 it follows in my view that the whole of their value must also be considered as having been paid by the partnership and received by the respondent for purposes of ss. 97(1). This is so even though, according to the Tax Court Judge"s view of the matter, the respondent retained a 50% ownership interest in these assets and remained liable for 50% of the new loans.
Although the Tax Court Judge decided the matter under ss. 97(1), it can be seen from his reasons that he would have found that only 50% of the amount paid by the partnership for the Capri Assets could be viewed as "consideration" under ss. 97(2) if he had directed his mind to this provision.
I stress that the Tax Court Judge"s decision is not premised on the existence of a sham or on a finding that the partners somehow disguised the true nature of their transaction. He states in his summary of the relevant facts that the respondent transferred the totality of its interest in the Capri Assets to the partnership and received 13.5M as payment.10 The Tax Court Judge also finds that this amount upon being paid was remitted to the Bank of Montreal in order to retire the respondent"s outstanding mortgage and that this allowed for a clean title in the Capri Assets to be registered in the name of the partnership.11 There is therefore no doubt, based on the Tax Court Judge"s own findings, that the amount of 13.5M was paid to the respondent by the partnership as payment for the Capri Assets and that the transaction was genuine in all respects.
Nevertheless, the Tax Court Judge saw fit to ignore half of the consideration based on his view that, at the end of the day, the Capri Assets were refinanced to the extent of 50%. In this regard, the respondent contends that the Tax Court Judge was entitled to look through the partnership and hold in effect that part of the consideration which it received retained its character as loan proceeds.12 In support of this contention, the respondent reminds the Court that a partnership has no separate existence in law and that consequently a loan to the partnership can be looked upon as a loan to the partners.13
This is no doubt so according to the common law and provincial statutes governing partnerships generally, but the suggestion that for tax purposes amounts disbursed by a partnership from borrowed funds in the discharge of an obligation owed to one of its partners retain their character as loan proceeds is, in my view, wholly without foundation. While a partnership is not in law a separate person, paragraph 96(1)(c) which I alluded too earlier, requires that a partnership compute its income as though it was a separate person. It necessarily follows that the legal character of amounts paid by a partnership to a partner is a function of the obligation being discharged irrespective of how the payment is funded.14 This is so with respect to any payment relevant to the computation of the amounts contemplated by paragraph 96(1)(c).15
In my view, it was not open to the Tax Court Judge in this instance to look beyond the transaction as it was understood by the respondent and its partners and modify it in light of his perception of the economic substance of the transaction.16 When the parties to a contract come to an agreement and there is no question that the agreement accurately reflects their bargain, there is no basis for disregarding the agreement. Just as the Tax Court Judge could not ignore the agreement of purchase and sale because it reflected what actually took place between the parties, it was not open to him to alter the consideration agreed to and paid under this agreement by reference to his perception of the "substance" of the transaction. In this regard, the statement of Lord Wright in the course of his analysis of the contractual relationship binding the Duke of Westminster to his servants remains eminently good law:
| And what the legal effect is as between the covenantor and the covenantee must determine for revenue purposes the character of the payments actually made... And once it is admitted that the deed is a genuine document, there is in my opinion no room for the phrase "in substance." Or, more correctly, the true nature of the legal obligation and nothing else is "the substance."17 |
I would therefore allow the appeal with costs here and below, set aside the decision of the Tax Court Judge and dismiss the appeal to the Tax Court of Canada.
"Marc Noël"
J.A.
"I agree.
Robert Décary J.A."
"I agree.
Joseph T. Robertson J.A."
__________________
1The decision is now reported at 96 D.T.C. 1277.
2Ibid at 1278.
3Supra note 1 at 1281.
4Ibid at 1282.
5Ibid.
6[1976] 2 S.C.R. 802">Stein Estate et al. v. The Ship "Kathy K" et al., [1976] 2 S.C.R. 802 and Joseph R. Dundas v. The Queen, [1995] 1 C.T.C. 184 (F.C.A.) are cited in this regard.
7This assertion is made by the respondent on the basis that under the loan agreement it was jointly and severely liable for the new loans and as such remained liable to repay the totality of the refinanced debt and not only half of it as the Trial Judge seems to have assumed in the course of his reasoning. (See paragraphs 26 to 39 of the respondent"s memorandum of fact and law.) The appellant on its part points out that the Tax Court Judge in holding that there was a 50% refinancing ignored the separate corporate existence of the respondent and its parent and that on a proper analysis, he should have held that there was a 5% refinancing. (See paragraphs 48 to 51 of the appellant"s memorandum of fact and law.)
8Lindley on the Law of Partnership, 15th ed. (London: Sweet & Maxwell, 1984) at p. 496.
9The Tax Court Judge so finds in his summary of the relevant facts. See point 9 quoted under paragraph 4 of these reasons.
10See points 8 and 9 of the Tax Court Judge"s summary of relevant facts quoted under paragraph 4 of these reasons.
11See paragraphs 9, 12 and 13 of the Tax Court Judge"s summary of relevant facts quoted under paragraph 4 of these reasons.
12It is well established that the advancement of borrowed funds by a lender to a borrower cannot constitute "consideration" for tax purposes. See for instance Dunkelman v. M.N.R., 59 D.T.C. 1242, Kenneth B.S. Robertson Ltd. v. M.N.R., 2 D.T.C. 655, Dominion Taxi Cab Association v. M.N.R., 54 D.T.C. 1020, M.N.R. v. Atlantic Engine Rebuilders Limited, 67 D.T.C. 5155 and The Queen v. Imperial General Properties, 85 D.T.C. 5045.
13Norco Development Ltd. v. The Queen, 85 D.T.C. 5213 and Wildenburg Holdings Limited v. Minister of Revenue, 98 D.T.C. 6462 are cited in support of this proposition.
14One need only think of rents paid by a partnership out of borrowed funds to one of the partners for space occupied by the partnership. It is unquestionable that for tax purposes, these payments retain their character as "rent" despite being funded by borrowings.
15This would encompass the computation of capital gains, capital losses, non-capital losses as well as the recapture of excessive amortization on depreciable property which is part and parcel of the computation of income.
16See the recent decision of the Supreme Court in Shell Canada Ltd. v. Canada, [1999] S.C.J. 30, and in particular paras. 38-42 thereof.
17Inland Revenue Commissioners v. Westminster (Duke), [1935] A.C. 1 at pp. 30-31.
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