Docket: 2010-1639(IT)I
BETWEEN:
MONIQUE PAAJANEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on common evidence with Tapio
Paajanen
(2010-1638(IT)I) on June 8, 2011 at Sudbury, Ontario
By: The Honourable Justice Judith Woods
Appearances:
|
Agent for the
Appellant:
|
Robert D. Topp
|
|
Counsel for the
Respondent:
|
Ashleigh Akalehiywot
|
____________________________________________________________________
JUDGMENT
The appeal with respect to an
assessment made under the Income Tax Act for the 2004 taxation year is
dismissed.
The appeal with respect to an assessment made under the Act
for the 2005 taxation year is allowed, and the assessment is referred back to
the Minister of National Revenue for reconsideration and reassessment on basis that the income of the appellant from a partnership
was $2,888.
The
appellant is entitled to her costs, if any.
Signed at Toronto, Ontario this 21st day of June 2011.
“J. M. Woods”
Citation: 2011 TCC 310
Date: 20110621
Dockets: 2010-1638(IT)I
2010-1639(IT)I
BETWEEN:
TAPIO PAAJANEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent;
AND BETWEEN:
MONIQUE PAAJANEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Woods J.
[1]
These are appeals by Monique
Paajanen and her husband, Tapio Paajanen, in respect of assessments made under
the Income Tax Act for the 2004 and 2005 taxation years.
[2]
There is only one issue
to be determined and that is the amount of Mrs. Paajanen’s income from a
business that she operated in partnership with her sister, Danielle Audet.
[3]
The respondent submits
that the sisters did not share income on a reasonable basis in the relevant
taxation years, and that Mrs. Paajanen’s share of the income should be
increased pursuant to subsection 103(1.1) of the Act. For the 2004
taxation year, it is submitted that Mrs. Paajanen’s share should be increased
from $754 (6.5 percent) to $5,803 (50 percent). For the 2005 taxation year, it
is submitted that her share should be increased from $2,888 (15 percent) to
$9,627 (50 percent).
[4]
The issue is relevant not
only for Mrs. Paajanen but also for her husband because his entitlement to a
personal credit under paragraph 118(1)(a) of the Act is affected
by the amount of his wife’s income.
[5]
The respondent raised a
preliminary objection regarding the appeal for Mrs. Paajanen’s 2004 taxation
year. It was submitted that this appeal should be quashed because it dealt with
a nil assessment. Mrs. Paajanen’s counsel did not object to this as long as it
did not affect Mr. Paajanen’s appeal for the 2004 taxation year. After some
discussion, counsel for the respondent agreed with this position.
[6]
The factual findings
below are based on the evidence presented at the hearing and the pleadings. In
this regard, many of the facts set out in the notice of appeal were not
challenged at the hearing and I have accepted them.
Factual
background
[7]
In 1996, Mrs. Paajanen
and her sister, Mrs. Audet, decided to commence a retail business in partnership.
The nature of the business is evident from its name, the Barnyard Birder Nature
Shop.
[8]
The circumstances which
led to the formation of the partnership are sympathetic. Mrs. Audet’s husband
had died in 1995 and she was left with very few financial resources and two
young children to raise. Mrs. Paajanen wished to help her sister with a
potential source of income by building a business in partnership.
[9]
It appears that the
business did not earn a significant profit in its early years.
[10]
The following chart
summarizes the income allocated to each of the partners as well as I can
determine from the notice of appeal. I would also note that most of the income
shown as being allocated to Mrs. Audet (Partner 2) prior to the taxation years
at issue was accounted for as wages but I do not think that this is material.
|
Year
|
Total
Income
|
Allocation
Partner 1
|
Allocation
Partner 2
|
|
1999
|
$11,178
|
$4,339
|
$6,839
|
|
2000
|
5,574
|
459
|
5,114
|
|
2001
|
4,855
|
427
|
4,427
|
|
2002
|
4,090
|
45
|
4,045
|
|
2003
|
2,722
|
361
|
2,361
|
|
2004
|
11,606
|
754
|
10,852
|
|
2005
|
19,253
|
2,888
|
16,365
|
[11]
The notice of appeal
also indicated that partner drawings always exceeded income until 2005 and that
the allocations to partners generally reflected cash distributions.
[12]
In most years, the vast
majority of the income was received by Mrs. Audet. I accept the evidence of
Mrs. Paajanen that she agreed to this because her sister was in difficult
financial circumstances. Mrs. Paajanen agreed to limit her own cash withdrawals
in order that the business would be viable in the long run.
[13]
The income allocated to
Mrs. Paajanen in the 2004 and 2005 taxation years represented 6.5 percent and
15 percent, respectively, of the total partnership income.
[14]
As I understand it, the
business has become quite successful and the partners now share income equally.
[15]
There is no written
partnership agreement. The income allocations represent an oral agreement
between the partners.
Analysis
[16]
Subsection 103(1.1) of
the Act requires that a partner’s share of income be adjusted if the
partner has agreed to share income with a non-arm’s length person on a basis
that is not reasonable. The provision reads:
103(1.1) Where two or more members of a
partnership who are not dealing with each other at arm’s length agree to share
any income or loss of the partnership or any other amount in respect of any
activity of the partnership that is relevant to the computation of the income
or taxable income of those members and the share of any such member of that
income, loss or other amount is not reasonable in the circumstances having
regard to the capital invested in or work performed for the partnership by the
members thereof or such other factors as may be relevant, that share shall,
notwithstanding any agreement, be deemed to be the amount that is reasonable in
the circumstances.
[17]
It is submitted by the
respondent that the allocations agreed to by the partners, 6.5 and 15 percent, are
not reasonable given that the sisters’ contributions to the partnership were
relatively equal. It is a submitted that a 50-50 income allocation is more
reasonable.
[18]
As mentioned above,
this would result in an increase in income from $754 to $5,803 in the 2004
taxation year and from $2,888 to $9,627 in the 2005 taxation year.
[19]
Counsel for the
respondent referred in support to decisions of this Court which have suggested
that allocations between non-arm’s length partners should be based only on business-related
criteria such as work performed and capital invested: Fillion v The Queen,
2004 DTC 2667; Zalesky v The Queen, [2000] 4 CTC 2126; Spencer v The
Queen, [2003] 4 CTC 2679; Archbold v The Queen, [1995] CTC 2872,
para 9.
[20]
A business approach to
allocations makes sense in the cases above because they all involved close
family members representing one economic unit, such as a spouse or children,
and tax planning appeared to be a key factor in the allocations.
[21]
However, it would be
wrong in my view to state as a general principle that allocations between
non-arm’s length partners must always be based solely on business-related
criteria.
[22]
First, I would note that
subsection 103(1.1) is not drafted in such a narrow manner. Although it
specifically mentions business-related criteria, it goes on to include any
“relevant” factor. This suggests that Parliament did not want to limit the
types of factors that should be taken into account.
[23]
Second, in considering
whether an allocation agreed to by partners is reasonable, it should be borne
in mind that subsection 103(1.1) is an anti-avoidance provision. Terms such as
“reasonable” and “such other factors as may be relevant” should be interpreted
with this purpose in mind. A few years ago, I took a similar approach in
interpreting subsection 55(2), another anti-avoidance provision, in 729658
Alberta Ltd. v The Queen, 2004 DTC 2909.
[24]
In this case, the
agreement between Mrs. Paajanen and Mrs. Audet to share income unequally was not
at all motivated by tax considerations. There was a modest tax saving to Mr.
Paajanen with respect to personal credits, about $1,000 per year. It does not
make sense that this factor influenced the partners’ agreement to share income
unequally. I accept the evidence of Mrs. Paajanen and her accountant that the
allocations had nothing to do with tax.
[25]
In this particular
case, it is reasonable in my view for the partners to agree to share income
based on the actual cash distributions to each partner. The appeals will be
allowed, except for Mrs. Paajanen’s appeal for the 2004 taxation year.
[26]
The appellants shall be
entitled to their costs, if any.
Signed at Toronto,
Ontario this 21st day of June 2011.
“J. M. Woods”
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