Howatt v. MNR, 89 DTC 215, [1989] 1 CTC 2325 (TCC)

Brule, T.C.J.:—This is an appeal from a reassessment of income tax in respect of the appellant's 1979 taxation year in which the Minister claimed that the appellant had received earnings from a partnership with his two brothers, and further did not make a replacement property election pursuant to subsection 44(1) of the Income Tax Act.

Facts

The appellant was born and raised on a family farm in Ontario. Through circumstances he took over the operation of the family farm. Subsequently his two younger brothers became involved in the farm with the appellant in a partnership known as "Howatt Bros.” A dispute amongst the brothers ensued and Ivan Howatt, the appellant, was asked to leave. This was late in December 1978. A meeting at a lawyer's office took place wherein the appellant asked what he was to receive as his share. No answer was given at the time.

The younger brothers had moved away from the farm leaving the appellant to look after 300 cattle. The brothers had dismissed the hired help but the appellant kept on one person whom he paid himself. The brothers, in January 1979, froze the appellant out of the banking operations, took it upon themselves to sell a load of cattle and obtained the proceeds. No active family business was carried on and the appellant stayed on the property until a monetary settlement was reached. The brothers did not pay him during this guardianship period and he received no payments which could be termed partnership income.

An accountant filed the appellant's tax return for 1978 and indicated there was no need to file anything for 1979 respecting the partnership as no income was received from this, and effectively the partnership had been terminated as of December 31, 1978.

Subsequently an audit of the brothers was conducted by Revenue Canada and the appellant's accountant, based on this, filed a tax return for the appellant for 1979 to the end of March in that year when the brothers claimed the partnership ended. This was done without the appellant's knowledge or permission and he did not know of such a filing until June 1983. At the time of filing Mr. W.J. McEachren, the accountant, included a protest but felt as a result of the audit he was obliged to file the return respecting the first three months of 1979.

When he was finally paid by his brothers the appellant moved to Alberta where he purchased a farm property. According to the evidence Mr. McEachren was instructed to report that the appellant had acquired a replacement property but such was not corroborated, and no election as required by section 44 of the Income Tax Act was filed.

Appellant's Position

It was agreed that all indications from the evidence showed that the partnership ended on December 31, 1978. The appellant accepted this but wanted his share of the partnership before moving out. The other two brothers had left the farm and were otherwise gainfully employed outside any partnership. The only reason the appellant stayed, apart from receiving his share, was to protect the animals and if he had done otherwise he might have been liable for neglecting their welfare.

The brothers froze the appellant out of the bank account operated by the partnership without his knowledge, sold cattle without his knowledge, and refused to carry on business. All of this indicated the partnership ceased when the brothers left the farm and, unfortunately for the appellant, took over all the assets. Both brothers wanted the appellant out as of the end of December but he remained until he was paid which he felt was reasonable under the circumstances. Protecting the well-being of the cattle was thought to be helpful in receiving payment for his share of the partnership.

Reference was made to section 26 of the Partnership Act of Ontario which reads:

26.(1) Where no fixed term is agreed upon for the duration of the partnership, any partner may determine the partnership at any time on giving notice of his intention so to do to all the other partners.

This is so where no written partnership is in existence, as was the case here. The partnership was determined, subject to price, at the meeting with the lawyer late in December 1978.

An argument was put forth that a liberal interpretation should be given to the provisions of section 44 of the Income Tax Act. Here the appellant bought a new farm property and so reported in subsequent tax returns. He also was assured by Mr. McEachren that this would be reported to obtain the benefit provided by the section.

Minister's Position

As to the rollover provided by subsection 44(1) it is clear that there must be some form of election noted. This was not done either by the appellant in his 1980 tax return or by Mr. McEachren and therefore should not be allowed.

With respect to the income situation and the existence of the partnership during the first three months of 1979, the Court was directed to section 42 of the Ontario Partnership Act.

Subsection 42(1) reads as follows:

42.(1) Where any member of a firm dies or otherwise ceases to be a partner and the surviving or continuing partners carry on the business of the firm with its capital or assets without any final settlement of accounts as between the firm and the outgoing partner or his estate, then, in the absence of an agreement to the contrary, the outgoing partner or his estate is entitled, at the option of himself or his representatives, to such share of the profits made since the dissolution as the court finds to be attributable to the use of his share of the partnership assets, or to interest at the rate of 5 per cent per annum on the amount of his share of the partnership assets.

Final settlement did not come until late in March 1979 when the appellant was paid, and therefore he should be liable to a share of the partnership income as set out in the tax return filed for herein by Mr. McEachren.

When the appellant stayed on the farm and continued working it was indicative that he was carrying on the partnership business. Reference was made to the case of Stephen R. Dacen v. M.N.R., [1979] C.T.C. 2868; 79 D.T.C. 732.

While the facts in the Dacen case are substantially different it stands for the proposition that on allocation of profit to an ex-partner is valid without his concurrence.

Counsel referred the Court to subsection 98(1) of the Income Tax Act which reads in part

98(1) For the purposes of this Act, where, but for this subsection, at any time after 1971 a partnership would be regarded as having ceased to exist, the following rules apply:

(a) until such time as all of the partnership property and any property substituted therefor has been distributed to the persons entitled by law to receive it, the partnership shall be deemed not to have ceased to exist, and each person who was a partner shall be deemed not to have ceased to be a partner,

(b) the right of each such person to share in such property shall be deemed to be an interest in the partnership.

Reference was also made to subsections 96(1.1) and 96(1.4) and counsel indicated these provisions applied as there were assets being disposed after December 31, 1978, especially the 300 cattle.

In conclusion it was stated that no evidence of negotiations including a date of dissolution of the partnership was submitted to the Court and as a result it was not effectively dissolved as of the end of 1978.

Analysis

In so far as the provisions of subsection 44(1) having application while it may have been the intention of the appellant to have such apply and even though he may have instructed his accountant Mr. McEachren to so do the fact remains that no election was made as required. It is not sufficient to override the election by acquiring similar property which would otherwise qualify for the election if no election is made. While there is no form provided the presence of an intention to elect must be included in the proper tax return. In Theo Toebast and Rita Toebast v. M.N.R., [1983] C.T.C. 2089; 83 D.T.C. 55 the Court held that apart from the timing of the purchase of replacement property there was the legal requirement to fulfil, namely an election to be made as provided.

Here, unfortunately, no election was made, and regardless of who was charged with this the appellant must bear the consequences and hence this aspect of the appeal is dismissed.

Turning now to the date of dissolution of the partnership, one finds some conflict. The appellant was certain in his mind that the date was the end of the then fiscal period, namely December 31, 1978. His accountant acquiesced to the audit of the brothers and showed in a tax return for three months of 1979 that the appellant did in fact have income and realized a capital gain. The authority for filing this return without consulting the appellant never existed, and it appears that such was filed somewhat unwillingly.

The Minister relied on the provisions of section 42 of the Ontario Partnership Act, subsection 98(1) of the Income Tax Act and the Dacen case, supra. Reference was made to subsections 96(1.1) and 96(1.4) but these have no application as they are predicated on an agreement being in existence and there was no agreement in this case.

For the provision in the Ontario Partnership Act to apply there must be a carrying on of business by the other partners. Also in the Dacen case, supra, the remaining partners continued to operate. But do we have this situation here?

From all the evidence it would seem that no partnership existed after 1978. The appellant believed it was terminated when the brothers told him that they wanted him out and was only awaiting payment of his share. The other brothers took matters into their hands, selling cattle, without replacement stock, collecting moneys, but not carrying on any obvious business. There was no evidence that the appellant was to receive anything by way of income from the partnership, only getting a capital payment for his share, the amount of which was to be determined as of the end of December 31, 1978. Naturally, it took time to arrive at a valuation and this was not completed until mid-March of 1979.

With reference to the provisions of section 98 of the Income Tax Act, supra, there is a contemplation that the partnership should continue to exist until all partnership property has been distributed. Here there was no thought of doing this, nor was a price fixed based on all partnership assets and their realization. Not until after the audit was a figure arrived at which indicated a share for the appellant. By that time he had been paid out. As early as the meeting in the lawyer's office late in December the appellant wanted to know how much he would be paid, thus at least realizing that the partnership was terminated even though there was no actual notice. Valuations were prepared but these had to be made as of the end of the period in 1978. No other information was available, nor from evidence was any considered in arriving at a final valuation.

It was not based on distribution of partnership property or any substituted property which led to the settlement. So much animosity existed that the appellant was happy to accept a low figure for his share and to get out. It was not until after the audit by Revenue Canada that the other brothers attempted to fix the appellant with a share of income for 1979. The appellant did not receive any of the money supposedly allocated to him.

The result therefore is that the partnership was determined and dissolved as Of December 31, 1978. The appellant is not responsible for any income attributed to him in 1979. The provisions of subsection 44(1) are not permitted.

The appeal is allowed and the matter referred back to the Minister for reconsideration and reassessment on the basis that the appellant had no income in 1979 from the supposed partnership with his brothers in that year and in all other respects the appeal is dismissed.

Appeal allowed in part.