Mihelakos v. R., 97 DTC 1450, [1997] 3 C.T.C. 2975 (TCC)

Hamlyn T.C.J.:

• (a) including in taxable income the amount of $40,000 as the Appellant's portion of a taxable capital gain of a partnership; and

• (b) allowing a net capital loss of $19,237 on the disposition of an interest in a partnership.

Facts

2 Prior to March 10, 1988, the Appellant carried on business in Halifax in equal partnership with Charles (Kyriakos) Doumakis (“Mr. Doumakis”) under the name Armdale Market (the “partnership”). Included in the assets of the partnership were two properties: 55 St. Margaret's Bay Road which was rented by the partnership as a commercial property; and 59 St. Margaret's Bay Road which was partly rented and in which the partnership carried on its business.

3 The Appellant and Mr. Doumakis experienced a falling out and continuing dissension between the two of them led to a communication break down and the termination of their business relationship. Mr. Doumakis, communicating through Mr. Alan Stern, Q.C., the partnership's solicitor, offered to purchase the Appellant's interest in the partnership for $300,000, out of which the Appellant would pay his half share of the outstanding mortgage on the partnership's properties.

4 The solicitor prepared two agreements of purchase and sale between the Appellant and Mr. Doumakis, both dated March 4, 1988. The first provided for the Appellant to sell his half interest in the real property to Mr. Doumakis for $175,000. The second provided for the Appellant to sell his half interest in the other business assets, including goodwill, to Mr. Doumakis for $125,000. The closing date was set down for March 8, 1988.

5 The Appellant signed a deed conveying his interest in the real property and a bill of sale conveying the business's fixtures and equipment. No other signatures were on these documents at the time the Appellant signed them, and the Appellant stated that he did not realize that the conveyances were being made in favour of what purported to be a partnership consisting of Mr. Doumakis and his two sons, James and Chris Doumakis. Nor did the Appellant realize that the grantors of the assets were purported to be both he and Mr. Doumakis.

6 The Appellant said he understood that he was selling his partnership interest to Mr. Doumakis, subject to an obligation to discharge one-half of the existing mortgage on the real property.

7 A few days after signing the deeds, the Appellant received, through his solicitor, the agreed payment from Mr. Doumakis. Out of this $300,000, the Appellant's solicitor paid out half of the outstanding mortgage on the real properties in the amount of $43,785.48.

Issue

• (a) a sale by the Appellant of his interest in the Armdale Market partnership;

• (b) a sale by the partnership of its assets; or

• (c) a distribution by the partnership of its assets to its partners, including the Appellant.

Appellant's Position

9 The Appellant submits that the documentation prepared for signature by the Appellant and Mr. Doumakis was inconsistent and did not reflect their intention. It was the Appellant's understanding he was selling his partnership interest to Mr. Doumakis.

10 The Appellant further submits that since the documentation was inconsistent as to the parties' intention, it becomes necessary to look at the circumstances surrounding the transactions to determine their true substance. The Appellant did not agree to the sale by the partnership of its assets to another partnership, but to the sale of his partnership interest.

Respondent's Position

11 The Respondent submits that on March 10, 1988 the partnership disposed of its land, equipment, inventory, and goodwill for proceeds of disposition deemed to be $600,000 pursuant to subsection 98(2) of the Income Tax Act (the “Act”). The partnership realized a taxable capital gain in the amount of $80,000 on this disposition; one-half of this amount ($40,000) was properly included in the Appellant's income pursuant to subparagraph 96(1)(c)(i) of the Act. The documents themselves show a sale of assets; warranty deeds were executed to transfer the properties and a bill of sale was executed to transfer the inventory and equipment.

12 The Respondent also submits that on March 10, 1988 the partnership ceased to exist and that the Appellant suffered a net capital loss of $19,237 pursuant to subsection 98(3) of the Act.

Analysis

13 In a climate of unhappy differences, Mr. Doumakis transmitted an offer through the solicitor to buy out his partner, the Appellant, for the price of $300,000. After a short period of deliberation, the Appellant accepted the offer. In consideration for the $300,000, the Appellant was to transfer everything he owned in the partnership to Mr. Doumakis[FN1: <p>At least that is how the Appellant understood the offer initially. The Appellant testified that, when he executed the documents, he saw that he was transferring his interest to Mr. Doumakis and his two sons. However, this made no difference to him.</p>] and to pay out his share of mortgage on the real estate properties of the partnership.

14 Some of the confusion as to the characterization of the transaction is understandable. No thought was given to the characterization of the transaction by the Appellant or Mr. Doumakis. Both witnesses indicated that at that time they had implicit faith in their solicitor to look after the legal technicalities. It is to be noted that the solicitor, in one of the reporting letters to the Appellant, did not accept any responsibility for the tax consequences of the transaction. What was the thought process behind the draftsmanship of the documentation is not known; the solicitor was not called as a witness. Further, it is to be noted that the Appellant has had only a minimal formal education and was not comfortable in English, let alone technical legal language and, as such, did not read the documents prepared for signature save that he determined the amount to be paid to him. It is of note that originally he thought he was selling to his partner but found out at the closing of the transaction he was selling his interest to his partner's sons. As stated, this made no difference to him.

15 The documents themselves mire the transaction in ambiguity. The document entitled Agreement of Purchase and Sale of Assets (exhibit A-1, Tab 1) appears to be structured as a sale of specific partnership assets. However, what was being sold was all the Appellant owned in the business. This included equipment, goodwill, the business name, and inventory. Moreover, the Appellant covenanted to use his best efforts to preserve for the purchaser the goodwill of suppliers, customers and others having business relations with the purchaser.[FN2: <p>The business was defined as “the business, owned and operated by the Vendor and Purchaser as Partners, known as the Armdale Market at Halifax, Nova Scotia.”</p>]

16 The Agreement of Purchase and Sale of the real property (exhibit A-1, Tab 2) described the subject of the sale as “the1/2interest of James Mihelakos in the property.”

17 The Bill of Sale (exhibit A-1, Tab 3) states that the Appellant and Mr. Doumakis sold “[a]ll fixtures and equipment at Armdale Market” to Mr. Doumakis and his two sons.

18 Mr. Stern's reporting letter to the Appellant (exhibit A-1, Tab 5) described the transaction as the “Sale - 55 and 59 St. Margaret's Bay Road and Armdale Market (the business) Doumakis/Mihelakos to Doumakis”.

19 The letter signed by the Appellant and delivered to the Registrar of Joint Stock Companies (exhibit A-1, Tab 9) dated March 10, 1988 reads as follows:

Re: Armdale Market

This is to advise that as of March 10, 1988, I ceased to be a partner in the above-noted partnership, and I hereby confirm that Kyriakos Doumakis, James Doumakis and Chris Doumakis are now the only members of said partnership.

20 From the above evidence, it is clear that more is needed to determine the true character of the transaction, i.e., whether the sale was that of an interest in the partnership, a sale of the assets of the partnership or a distribution of assets to the partners.

21 Evidence of a subjective intention cannot be used to correct documents which clearly point in a particular direction.[FN3: <p><em>Friedberg v. R.</em>(1991), 92 D.T.C. 6031 (Fed. C.A.)at page 6032.</p>] However, when documents are ambiguous or do not explain the whole transaction, the Court may look to other evidence as to what the parties intended.[FN4: <p><em>Brodeur v. Minister of National Revenue</em>(1987), 87 D.T.C. 351 (T.C.C.)at pages 353-54 .</p>]

22 From the documents, I conclude the transaction was structured in part as an asset sale. One explanation offered by counsel about the ambiguity of the transaction flows from conflicting legal theories as to the legal nature of a partnership, i.e., the entity theory versus the aggregate theory.[FN5: <p>Appellant's counsel referred the Court to Cy M. Fien, “Causes and Effects of the Dissolution and Winding Up of a Partnership,”<em>Report of Proceedings of the Thirty-Third Tax Conference</em>, (Toronto, Canadian Tax Foundation, 1982) at page 497.</p>] Whatever the reason, one cannot characterize the transaction as either the sale of assets or the sale of a partnership interest on the basis of the documents alone.

23 At trial, the uncontroverted evidence of the two former partners was that they believed that the Appellant was selling and the purchaser was buying the Appellant's entire interest in the partnership.

24 The real estate properties located at 55 and 59 St. Margaret's Bay Road, the fixtures and equipment located there, and the other assets of the business constituted partnership property. I find that it was the clear intention and agreement of the Appellant and Mr. Doumakis to treat the assets as partnership property, notwithstanding the terminology used in some of the documentation effecting the transfer of those assets.[FN6: <p>R.C. I'Anson Banks,<em>Lindley and Banks on Partnership</em>, 17th ed., (London, Sweet &amp; Maxwell, 1995) at page 504;<em>Partnership Act</em>of Nova Scotia, R.S.N.S. 1989, c. 334, ss. 22, 23(1) and 24.</p>]

25 The partnership did not dispose of its assets. In those documents which indicate that assets were sold, it is the Appellant who appears to be transferring those assets. However, since the assets were the property of the Armdale Market partnership, the Appellant was not entitled to dispose of those assets. It is my conclusion that what the Appellant transferred was his interest in the partnership and subsection 98(2) of the Act does not apply.[FN7: <p>See<em>D &amp; B Oilfield Contracting Ltd. v. Minister of National Revenue</em>(1989), 89 D.T.C. 425 (T.C.C.).</p>] The partnership did not “cease to exist” when the Appellant transferred his partnership interest, therefore subsection 98(3) has no application.

Conclusion

26 From the evidence, by way of the transaction, the members of the partnership changed but the partnership continued with the new partners acquiring the interest of the Appellant. Thus, I conclude what the Appellant disposed of was his capital interest in the partnership. The proper characterization of the transaction and of the net amounts received by the Appellant after deducting the amounts for the mortgage debt on the real properties of the partnership represents the proceeds of disposition of the capital interest in the partnership.

Decision

27 The appeal is allowed and the assessment is referred back to the Minister for reconsideration and reassessment on the basis that on March 10, 1988, the Appellant disposed of his partnership interest and that partnership interest was capital property.

28 The Appellant is entitled to his costs.