Citation: 2007TCC569
Date: 20070927
Docket: 2004-3092(IT)G
BETWEEN:
177795 CANADA INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Lamarre J.
[1] The Appellant is appealing from an
assessment made on January 22, 2004, for the taxation year ending July 31,
1992. During that period, the Appellant operated its business under the name
Sofati Ltée (Sofati). All reference to Sofati in the partial agreement on the
facts as well as in these Reasons for Judgment concerns the Appellant, as it is
the same entity.
[2] The partial
agreement on the facts produced by the parties reads as follows:
[TRANSLATION]
1. The Appellant is a corporation duly incorporated and the
addresss of its principal place of business is as follows: 1
Place Ville Marie, Suite 1812, Montréal, Quebec H3B 3M4.
2. The assessment was issued on January 22, 2004, for the
taxation year ending July 31, 1992.
3. The Appellant is a corporation which, during the taxation
year ending July 31, 1992, operated a construction business.
4. During the 1992 taxation year, the Appellant reported
business income of over $17,000,000 from a training and turnkey
construction contract abroad, namely North Africa.
5. In an assessment dated June 25, 1996, for the 1992
taxation year, the Minister of National Revenue (the “Minister”) considered
that the Appellant was not entitled to any non-capital loss from previous years
and carried forward the amount of $2,499,358 as a non-capital loss to
subsequent years.
6. On September 10, 1996, the Appellant objected to the
assessment of June 25, 1996.
7. More than seven years after the Notice of Objection was
filed, that is to say, on January 22, 2004, the Minister issued a reassessment
to increase from $2,499,358 to $7,922,562 the losses allowable for
the 1992 taxation year, that is $4,094,913 from previous taxation years
and $3,827,649 from subsequent taxation years.
8. In doing so, however, the Minister disallowed a portion
of the amount of $19,884,674 claimed as loss by the Appellant in 1988, the
disallowed portion being $16,036,040.
9. The Appellant objected to the Minister’s assessment
within the prescribed time limit. The Minister confirmed the assessment in a
decision dated May 4, 2004.
10. Preston Parkway Joint Venture
(“PPJV”) was incorporated under the Partnership Act of the State of
Texas.
11. The financial and fiscal year
of PPJV was the calendar year.
12. Prior to December 1, 1987,
the interest in PPJV was held by Louis G. Reese Inc.,
(hereinafter “Reese”) (99%), and Preston
Parkway Development Company (hereinafter “PPDC”), (1%), two American residents.
13. As of November 30, 1987, the
assets of PPJV consisted principally of real
property the cost of which was US$32,000,000 and the fair market
value (hereinafter “FMV”) was US$16,000,000.
14. As of November 30, 1987, the
real property was subject to a mortgage of US$28,000,000 held by the Bank
of New York.
15. By contract signed on December
15, 1987, Sofati Ltée and Westmount Parc Towers Inc., both Canadian
residents, purchased 99% and 1% of PPJV, respectively.
16.
The contract of
purchase for its interest in the PPJV was signed by Sofati Ltée on
December 15, 1987, retroactive to December 1, 1987.
17. Under an undated “Escrow
Indemnity Agreement” taking effect December 1, 1987, Reese and PPDC
undertook to indemnify the purchasers, that is, Sofati Ltée and Westmount Park
Towers Inc., against all claims by potential creditors listed in the agreement,
including the US$12,000,000 owed to the Bank of New York following
the auction of the real property; such indemnity ended on the first
business day after December 1, 1991, in two cases, and the first business day
after December 1, 1989, in other cases; to that end, part of purchase price of
US$390,000 was withheld to be remitted upon resolution of the claims or
on the date the indemnity ended.
18. On December 1, 1987, the Bank
of New York, which held a mortgage on the real property project developed
by PPJV, purchased it by submitting a bid of US$16,000,000; that consideration
was used to reduce the debt owed to the Bank to US$12,000,000 as it was
originally US$28,000,000 (for the present purposes, all figures have been
rounded to the nearest million).
19. The debtor (PPJV) was informed
for the first time on October 12, 1987, that the real property would be seized
and sold, if it defaulted on the mortgage payment. It was also informed at
least twenty-one days prior to the date of the seizure that the property would
be seized and sold.
20. When Sofati Ltée purchased its
interest in PPJV, it was aware that the real property would be seized by the
Bank of New York and sold at a loss.
21. As for the balance owing on the
debt to the Bank of New York, about US$12,000,000, it was paid on December
23, 1987, by PPJV to Columbia Capital Corporation to whom the
Bank of New York sold it.
22. On December 18, 1987, the Bank
of New York gave Columbia Capital Corporation
(hereinafter “CCC”), a Canadian corporation, a promissory note in the amount of
US$12,146,467.28, owed by PPJV.
23. On December 23, 1987, CCC
borrowed US$12,146,467.28 from the Bank of Montréal.
24. On December 23, 1987, CCC
loaned US$12,146,467.28 to PPDC.
25. On December 23, 1987, PPDC paid
US$12,146,467.28 to PPJV.
26. On December 23, 1987, PPJV
reimbursed US$12,146,467.28 to CCC.
27. Since the cost of the real
property for PPJV was US$32,000,000, PPJV reported a loss of US$16,000,000.
Moreover, the participants in PPJV at the end of its financial year ending
December 31, 1987, deducted their share of the US$16,000,000 in computing their
1988 income.
28. Sofati Ltée claimed 99% of the
US$16,000,000, that is CDN$19,884,674, as a loss in computing income for its
fiscal year ending July 31, 1988, and carried forward a portion of that loss,
that is CDN$16,036,040, as a deduction in computing income for its fiscal year
ending July 31, 1992.
29. Since September 1989, PPJV has
had a real property investment in Texas which generates annual profits.
[3] The Respondent
refused to carry over the loss of CDN$16,036,040 on the ground that when Sofati
purchased its share in Preston Parkway Joint Venture (PPJV), its intention was
not to carry on business with a view to profit from the activities of PPJV.
Consequently, the Respondent claims that Sofati did not become a member of a
partnership within the meaning of the Income Tax Act (ITA) and cannot
claim entitlement to the loss incurred by PPJV under section 96 of the ITA.
In other words, the Respondent submits that PPJV was not a partnership for
Canadian tax purposes when the loss related to the sale of the real property
was incurred by PPJV.
[4] Alternatively, the
Respondent submits that even if PPJV was a partnership within the meaning of
section 96 of the ITA, no loss is attributable to Sofati for its fiscal
year ending July 31, 1988 (therefore it could not be carried forward to the
fiscal year ending July 31, 1992). According to the Respondent, pursuant to
subsection 10(1) of the ITA and section 1801 of the Income Tax
Regulations (Regulations), the cost of the property for PPJV as of December
1, 1987, that is the date on which it became a partnership within the meaning
of the ITA, was the fair market value on that date, that is US$16,000,000.
Considering that the proceeds of disposition of the real property were also US$16,000,000,
no loss could be attributed to Sofati.
[5] The Appellant
challenges the two submissions made by the Respondent. On the one hand, it
submits that it became a member of PPJV, a partnership within the meaning of
the ITA, during the financial year of PPJV ending December 31, 1987, and that,
as such, it is entitled, in computing income for its fiscal year ending July
31, 1988, its portion of the loss of PPJV for its financial year ending
December 31, 1987, and to carry forward to the next years, namely July 31,
1992, the portion of that non-deducted loss in the preceding taxation years.
Moreover, the Appellant submits that the loss of PPJV is not nil but rather amounts
approximately to US$16,000,000, which represents the difference between the
cost of the real property project, US$32,000,000, and the proceeds of
disposition during the 1987 taxation year, that is approximately US$16,000,000.
Legislative provisions
[6] The relevant
legislative provisions of the ITA to which the parties made reference are as
follows:
Income Tax Act
SECTION 10: Valuation of inventory.
(1) For the purpose of computing
income from a business, the property described in an inventory shall be valued
at its cost to the taxpayer or its fair market value, whichever is lower, or in
such other manner as may be permitted by regulation.
Section 10(2)
(2) Idem. Notwithstanding
subsection 10(1), for the purpose of computing income for a taxation year from
a business, the inventory at the commencement of the year shall be valued at
the same amount as the amount at which it was valued at the end of the
preceding taxation year for the purpose of computing income for that preceding
year.
. . .
Subdivision j−Partnerships and
their members
SECTION 96: GENERAL RULES.
(1) Where a
taxpayer is a member of a partnership, the taxpayer's income, non-capital loss,
net capital loss, restricted farm loss and farm loss, if any, for a taxation
year, or the taxpayer's taxable income earned in Canada for a taxation year, as
the case may be, shall be computed as if
(a) the partnership were a separate person
resident in Canada;
(b) the taxation year of the
partnership were its fiscal period;
. . .
(g) the amount of the loss of the partnership for a taxation year
from any source or sources in a particular place were the loss of the taxpayer from that
source or from sources in that particular place, as the case may be, for the
taxation year of the taxpayer in which the partnership's taxation year ends, to
the extent of the taxpayer's share thereof.
. . .
Income Tax Regulations
Part XVIII
Inventories
. . .
VALUATION
1801.
Except as provided in section
1802, for the purpose of computing the income of a taxpayer from a business,
all the property described in all the inventories of the business may be valued
at its fair market value.
Existence of a partnership within
the meaning of the ITA
[7] The principal issue
is whether the Appellant was a member of a partnership within the meaning of
the ITA when the losses claimed were incurred by PPJV such that it could deduct
those losses from its income pursuant to section 96 of the ITA.
[8] The term
“partnership” is not defined in the ITA. In Backman v. Canada,
[2001] 1 S.C.R. 367, 2001 SCC 10, at paragraph 17, the
Supreme Court of Canada confirmed the principle that a taxpayer seeking to deduct Canadian
partnership losses under section 96 of the ITA must satisfy the definition of
partnership that exists under the relevant provincial law. Thus, the Supreme
Court of Canada pointed out that even in respect of foreign partnerships, for the purposes of
section 96 of the Act, the essential elements of a partnership that exist under
Canadian law must be present.
[9] In the case at bar,
the civil law applies. During the period in issue, articles 1830 and 1831
of the Civil Code of Lower Canada (C.C.L.C.) were in force.
[10] Articles 1830
and 1831 C.C.L.C. read as follows:
TITLE
ELEVENTH
OF
PARTNERSHIP
CHAPTER FIRST
GENERAL
PROVISIONS
Art. 1830. It is essential to
the contract of partnership that it should be for the common profit of the
partners, each of whom must contribute to it property, credit, skill, or
industry.
Art. 1831 Participation in the profits of a partnership
carries with it an obligation to contribute to the losses.
Any agreement by which one of
the partners is excluded from participation in the profits is null.
An agreement by which one
partner is exempt from liability for the losses of the partnership is null only
as to third persons.
[11] In Québec, according
to the doctrine, there are three essential elements to the formation of a partnership, in
accordance with the law applicable during the period in issue. First, it is
necessary to determine the existence of a real intention on the part of all
parties to enter into a partnership agreement. Second, each partner must make
some contribution to the formation of the partnership, whether it be monetary
or other (such as a partner’s personal qualities for instance). And finally, a
partnership cannot be formed but with a view to profit. Similarly, for a
partnership agreement to exist, there must be an agreement on the sharing of
profits among the partners. As for the sharing of losses, they are assumed to
be divided equally among the partners.
[12] In Bourboin v.
Savard [1926], 40 C.B.R. 68, Mr. Justice Rivard, of the Court of
King’s Bench (predecessor of the Quebec Court of Appeal), stated as follows at
pages 70 and 71:
A contract of partnership has three essential characteristics: (1) the
pursuit of a common purpose consisting of the realization of a profit; (2) the
constitution of a common fund through the contributions that each makes of his
property, credit, skill or industry; and (3) participation in the profits,
which entails the obligation to share in the losses, absent any agreement to
the contrary.
These three characteristics mean that there must be among both parties
the intention, juridically proved, to pursue in common, with the help of
everyone's contributions, the realization of a profit; in other words, for
there to be a partnership, it is necessary, absent an express contract, that it
be clearly apparent from the facts that both of the purported partners intend
to form a contract of partnership and not some other contract that might be
more or less analogous with the partnership. That is what the authorities have
referred to as affectio societatis comes down to.
1. C.c.,
1830; Fuzier-Herman, Rep., Vo Sociétés, No. 3; D.A. Sup. Vo Société, 134.
[13] Furthermore, in Backman,
supra, the Supreme Court of Canada stated that “. . . to ascertain the existence of a partnership the courts
must inquire into whether the objective, documentary evidence and the
surrounding facts, including what the parties actually did, are consistent with
a subjective intention to carry on business in common with a view to profit” (paragraph 25).
Moreover, “. . . a taxpayer’s overriding
intention is not determinative of whether the essential ingredient of “view to
profit” is present. It will be sufficient for a taxpayer to show that
there was an ancillary profit-making purpose” (cf. Backman, supra,
at paragraph 23).
[14] In the case at bar,
it is clear that the Appellant’s overriding intention when it acquired almost
all the interests in PPJV was to recover tax losses. In fact, by investing the
sum of US$390,000, it sought deductions in the amount of CDN$19,000,000. Indeed,
counsel for the Appellant was clear on that point. It is precisely for that
purpose that the Appellant preferred to invest in PPJV rather than to make an
offer directly to the Bank of New York (BONY) to reacquire the property
(which was the only asset of PPJV), after the Bank seized it.
[15] However, in the wake
of Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298,
the Appellant can claim to be in a partnership if it can prove that by
investing in PPJV, it had as an ancillary purpose the intent to carry on business in common, with the other members, with a view to profit.
[16] The difficulty, in
the case of bar, arises from the fact that the evidence that the intent of the
Appellant and Westmount Park Towers Inc. (WPTI) was to profit by investing in
PPJV is rather based on what happened after the American partners of PPJV,
under whose control the claimed loss incurred, withdrew from the partnership.
Indeed, the overall evidence shows that the American partners relinquished
their interests in PPJV in favour of the Appellant and its sister company WPTI
when there were no longer any assets in PPJV, and therefore, never had the
intent to carry on business in common
with a view to profit as partners of PPJV. Of course, the transfer of interests
in PPJV was effected in two steps, first through documents indicating the
transfer of 99% of the interests in PPJV belonging to Louis G. Reese
in favour of the Appellant and WPTI and then by other documents indicating the
transfer of 1% of the interests in PPJV belonging to Preston Parkway
Development Company (“PPDC”). However, all this happened concomitantly on
December 15, 1987, and retroactively to December 1, 1987, immediately prior to
the seizure of the only asset of PPJV by BONY. It is however quite clear from
the evidence that Louis G. Reese and PPDC were no longer partners in PPJV
retroactively to December 1, 1987, and that all the evidence pertaining to the
steps taken by Sofati, or its president, Michel Gaucher, on behalf of
PPJV, no longer legally involved the former American partners.
[17] That being said, the
evidence offered before me reveals the following main points.
[18] Sofati first made
its mark in major engineering contracts abroad. In 1986, Sofati began to
diversy by becoming involved in the real estate industry, first by converting
property into condominiums in Montréal with its sister company, WPTI, then in
the United
States, by
investing in both thermal power plants and real estate. Thus, Sofati was introduced
to Grubb & Ellis, a real estate brokerage company in Dallas, Texas.
[19] At the request of
Sofati, on October 8, 1987, Grubb & Ellis provided him with a study on the
the real estate market in Texas in which it was reported that it had reached a
low and that the experts recommended investing as they expected an increase in
the value of real estate in the years to come (Exhibit A‑1, Tab 31).
At the time, Sofati had a net worth of approximately CDN$70,000,000, liquid
assets of approximately CDN$10,000,000 and sales in excess of
CDN$150,000,000. In October 1987, the Sofati group met with a certain
Louis G. Reese, an American who had invested in PPJV in 1984 with an
American entity, PPDC, for the construction project of a commercial building,
the Sherry Plaza, in Dallas, Texas. The US$32,000,000 project was
financed by BONY up to US$28,000,000. When Sofati was introduced to Mr. Reese,
BONY had already informed PPJV that it intended to repossess the property
following the default on the debt payment. The building was then 95% completed
and there were many potential lessees in sight.
[20] According to
Michel Gaucher, the intention was to develop long-term projects with
Mr. Reese. It was also in his interest to form a partnership with him in
order to make a tax profit from the losses PPJV was about to incur following
the imminent foreclosure by BONY of Sherry Plaza, which was the only asset held by PPJV.
[21] Therefore, on
November 16, 1987, Sofati, through another numbered company, undertook to
acquire the interests of Mr. Reese and PPDC in PPJV, which at the time was
99% controlled by Mr. Reese. That agreement is entitled “Summary of
Proposed Acquisition of Joint Venture Interests in Preston Parkway Joint
Venture,” and reads as follows (Exhibit A‑1, Tab 48):
Summary of Proposed Acquisition
of Joint Venture Interests in
Preston Parkway Joint Venture
This will serve as a binding memorandum
of understanding between 158723 Canada Inc. (the “Purchaser”) and Louis G.
Reese Inc. and Preston Parkway Development Company (the “Vendors”) for the
Purchaser, or its nominee, to acquire either 99% or 100%, at the option of the
Purchaser, of the Joint Venture interests in the Preston Parkway Joint Venture
(the “Joint Venture”). Summaries of the facts surrounding the Joint Venture and
a summary of the steps required to complete the transaction are as follows:
Summary of Facts
1. Two
corporations, Louis G. Reese Inc. (99%) and Preston Parkway Development Company
(1%) own all of the joint venture interests in the Joint Venture. Louis G.
Reese controls both Joint Venturers.
2. The Joint
Venture is a general partnership according to Texas law.
3. The cost of the
Joint Venture property (the “Property”), to the Joint Venture, for Canadian
income tax purposes, is approximately $29 million U.S. The debt against
the property, to the Bank of New York, (the “Bank”), is approximately $26
million. $3 million of the cost of the Property was financed by equity.
4. The Joint
Venture has been in existence at all times since its original acquisition of
the Property and continues to exist. The Joint Venture will continue to exist
for such period of time as the purchasers of the Joint Venture interests
require and the Vendors will make such amendments to the Joint Venture agreement
as the Purchaser reasonably requires to ensure this.
5. The only
activity ever undertaken by the Joint Venture has been the acquisition of the
Property and the construction thereon of Sherry Plaza, which was constructed
for the purpose of resale. Louis Reese has an extensive history of speculating
in real estate and at times also acts as a real estate broker.
6. The Bank is
proposing to foreclose on the Property in either early December or early
January (foreclosures happen in Texas only on the first Tuesday of each month).
At the foreclosure, the Bank is expected to bid in for the Property at $16
million.
7. Sherry Plaza is
a small strip mall for high end retail shopping and an office building. The
project is currently 95% complete and the Bank will finance the completion. The
building is less than 10% leased at this time. If the building could be leased
at pro forma rates, it would have a projected value of $38 million U.S.
8. The Bank has
agreed to sell the deficiency amount of the debt, (the “Debt Deficiency”) as
established on foreclosure, for a nominal sum. This debt will be purchased by a
nominee of Peters & Co. Limited (“Peters”) (the “Peters Nominee”), that is
arm’s length from the current Joint Venturers. After purchasing the Debt Deficiency
from the Bank, Peters Nominee will loan the original Joint Venturers an amount
equal to the Debt Deficiency amount. The original Joint Venturers will
contribute this amount to the Joint Venture and the Joint Venture will repay
the Peters Nominee the Debt Deficiency.
Alternatively, at the option of the
Purchaser, an attempt will be made to get the Bank to lend funds to the
original partners on foreclosure, with the partners contributing such amount to
the Joint Venture and the Joint Venture repaying the Bank.
9. On foreclosure,
the Bank will grant the Joint Venture an option to reacquire the property at
any time, within the next three years, at the amount of the Bank’s outstanding
debt immediately prior to foreclosure, compounded at 10% per annum or at such
other amount as the Purchaser may agree. This option will expire on an arm’s
length sale by the Bank.
The Bank will also give the Joint Venture
reasonable access to the Property for the purposes of leasing such Property.
The Joint Venture shall bear its own expenses for this leasing program. The
Bank will retain the right to approve of all leases.
10. Immediately
after the foreclosure and the refinancing of the Deficiency Amount, the
Purchaser shall acquire the Joint Venture interests for a payment of 4¢ per $1, calculated on the difference, as
determined by a “Big 8” accounting firm, between the “costs” of the Property,
for Canadian income tax purposes, and the amount that the Property is sold for
on the foreclosure. The maximum on which such amount will be payable is $14
million U.S.
11. In addition to
the agreement between the Joint Venture and the Bank with respect to the
Property, the Purchaser may request an agreement between the Joint Venture and
Mr. Reese pursuant to which the Joint Venture has the right to participate with
Mr. Reese on future real estate transactions for a period of time. Such
agreement will be as agreed on between the parties, but this purchase of Joint
Venture interests will proceed regardless of whether such agreement can be reached.
12. Any reasonable
costs of the transaction, including a commission to Bruce Harbour at Henry
S. Miller Co., shall be borne by the Purchaser.
13. Any potential
liabilities of the Joint Venture arising before closing are the responsibility
of the Vendors and the Purchaser may require the Vendor to satisfy such
liabilities before closing.
13.5 The Vendor shall use its best effort
to obtain the cooperation of the bank, as required herein, but shall not be
held liable for any lack of such cooperation.
14. All
documentation should be completed by November 27, or such later date as the
Purchaser and Vendors may agree, with closing to occur immediately after
foreclosure and the refinancing of the Debt Deficiency. Closing is not to be
later than December 31, 1987.
15. If only 99% of
the Joint Venture interests are acquired by the Purchaser the Purchaser may
acquire such interests from such of the Vendor as it so desires.
16. This agreement
is made as of November 16, 1987, 4:30 p.m., Calgary, Alberta time.
[22] During his
testimony, Michel Gaucher stated that the purpose of the agreement was to
ensure the continuation of the “Joint Venture” which made the loan
arrangement and undertook the construction of the real property project, the
Sherry Plaza. According to him, the continuation of PPJV was ensured by that
agreement.
[23] I note that in the
agreement, the parties took the trouble to provide in paragraph 4 that
PPJV would continue to exist for the period of time required by the purchasers
and that the vendors would make the necessary amendments to the “Joint Venture
Agreement” to accommodate the purchasers. Although that clause appears to have
been inserted to ensure the continuity of the “Joint Venture,” as stated by
Mr. Gaucher, I find it hard to interpret this as expressing a common
intention to form a partnership with a view to share profits on future
projects. On the contrary, it rather suggests that the vendors wanted to
relinquish their interests in PPJV and did whatever was required to satisfy the
purchasers for the purposes of the acquisition of PPJV to their advantage. Indeed,
the real intention of the purchasers appeared in paragraph 3, as care was
taken to indicate the cost of the asset held by PPJV for Canadian income tax
purposes.
[24] What happened is
that, on November 30, 1987, the vendor partners amended the original agreement
of PPJV which provided that the sole purpose of the partnership was to purchase
and develop what then became the Sherry Plaza (Exhibit A‑1, Tab 1)
to extend its ambit to future real estate investments and the future resale of
the properties (Exhibit A‑1, Tab 2).
[25] Similarly, I note
that the purchasers intended to acquire the interests in PPJV only after the
foreclosure by BONY and the refinancing of the debt (paragraphs 10 and 14
of the agreement of November 16, 1987). However, in the “Escrow and Indemnity
Agreement” (Exhibit A‑1, Tab 8), not dated but effective
December 1, 1987—under which the purchasers undertook to pay the vendors the
sum of US$390,000 to be withheld to ensure that the purchasers were not
required to assume debt incurred by PPJV prior to December 1, 1987—it is stated
in the preambule to paragraph D, that BONY repossessed the property after the
vendors transferred their interests in PPJV to the purchasers. Moreover, the
transfer of the vendor’s interests to the purchasers took place only on
December 15, 1987, that is 15 days after BONY repossessed the property,
retroactive to December 1, 1987 (see “Assignments of Joint Venture Interest ,”
Exhibit A‑1, Tabs 4 and 6). It seems, therefore, that the
formula for the transfer of interests changed at some point, which suggests
that the purchasers were the ones who orchestrated everything, not with the
purpose of forming a partnership with the American partners with a common view
to profit, but rather to ensure the documents were in order so as to be able to
claim the coveted tax loss. Moreover, the testimony of Nancy Orr, V.P.
Finance for Sofati, indicates that, according to her, the transaction was retroactive
to December 1, 1987, to ensure “that nothing happened between the time they
close the transaction and the debt . . . with [BONY], . . . was funded”
(p. 125 shorthand notes). That does not reflect an intent to form a
partnership with Mr. Reese and PPDC, even for a very short period of time,
in PPJV, but rather to ensure that they would not be liable for the heavy debt
on which Sofati would later claim a tax loss.
[26] Furthermore,
paragraph 5 of the agreement of November 16, 1987, indicates that Mr. Reese
only invested in PPJV with the intent to build the Sherry Plaza for the sole
purpose of resale, as he had a reputation as a speculator in real estate. On
December 1, 1987, immediately prior to the repossession of the Sherry Plaza by
BONY, it granted PPJV, which was still represented by Louis G. Reese,
a non-exclusive option to purchase (“Option Agreement,” Exhibit A‑1,
Tab 9), by which PPJV could within the next three years offer to purchase
the property for the amount of the debt prior to the foreclosure
(US$28,000,000), plus all sums of money advanced by BONY for the completion of
the property and interest compounded at the rate of 10% per year. PPJV paid
US$80,000 for that option. According to Ms. Orr, it was Sofati who paid
that sum. However, that is not reported in the financial statements of PPJV for
its financial year ending December 31, 1987 (no advance by a partner is
entered, see Exhibit A‑1, Tab 29). There is however an
acknowledgement by BONY of a payment in the amount of US$55,000 by PPJV
and a US$25,000 credit, in satisfaction of the payment of US$80,000. That
acknowledgement of payment is dated December 18, 1987, and signed by Sofati on
behalf of PPJV (Exhibit A‑1, Tab 10). This therefore suggests that it
is Sofati that in fact paid that sum.
[27] It seems to me that
all this does not reflect to the intent expressed by Mr. Gaucher in his
testimony, that is to develop long-term projects with Mr. Reese. Indeed,
Mr. Reese himself did not seem interested in recovering the property he
built for resale purposes. Moreover, according to paragraph 11 of the
agreement of November 16, 1987, nothing obliged Mr. Reese to engage in
future transactions with the purchasers, as Mr. Gaucher seemed to suggest.
[28] It is however true
that on December 15, 1987, PPJV, represented by Sofati, signed a “Right of
First Opportunity Agreement” with Louis G. Reese (Exhibit A‑1,
Tab 11). In that agreement, Louis G. Reese undertook to report
on all real estate development projects in Dallas in which he would invest so
as to give PPJV the option to earn a 25% interest in such a future project, in
consideration of a contribution by PPJV of 33⅓% of the amounts to be
invested by the partners in the project. That agreement was valid for a period
of three years or less if PPJV did not express an interest after three
proposals by Louis G. Reese in which he would invest.
[29] However, after
December 1, 1987, in September 1989, PPJV only invested in one project, the
Highland Park Shopping Village in Texas, for an amount of US$175,000 (Exhibit A‑1,
Tab 30), a project in which Louis G. Reese was not at all
involved.
[30] On May 6, 1988,
PPJV, represented by Michel Gaucher, made an offer to BONY to reacquire
the Sherry Plaza for US$12,000,000. Ms. Orr conducted analyses, using a
conservative approach, which determined that an additional
US$7,500,000 had to be invested to make the project profitable. In that
offer, Mr. Gaucher offered to make a US$1,500,000 deposit, to secure a
second mortgage in the amount of US$8,500,000 and to provide a promissory note
for US$2,000,000. The US$1,500,000 was to be financed by a first mortgage in
the amount of US$4,000,000, of which the balance would be used to complete the
work. In all, US$3,500,000 was expected to be funded through the leases to
be signed (Exhibit A‑1, Tab 20). In his testimony,
Mr. Gaucher indicated that when the agreement was signed on November 16,
1987, was represented in paragraph 7 that the property could be worth
US$38,000,000 if leased according to market projections. According to him,
he viewed it as an opportunity with the possibility of making an immediate
profit. However, no market research was conducted in that respect. In any
event, the offer to purchase of May 6, 1988, which was not submitted under the
option to purchase signed on December 1, 1987, was not accepted
by BONY, which gave priority to Trammel Crow, who had advised Mr. Gaucher
on the possibilities of real estate investment in Texas, including Sherry
Plaza. Mr. Gaucher stated that he was not informed beforehand of the
parallel offer of Trammel Crow, which bought out the property from BONY for
US$14,000,000. He did not think it was even worth suing them because he did not
sign a non-competition clause with them and did not want to antagonize one of
the largest real estate firms in Texas.
[31] At the same time, in
April 1988, Sofati retained the services of Gordon Capital, a
Toronto firm specializing in “merchant banking,” to make a proposal with
Prudential Bache Securities Inc. (a merchant bank that was always looking for a
developer willing to invest), to restructure the First Republic Bank of Texas.
Sofati stated that it was willing to advance US$10,000,000 (Exhibit A‑1,
Tab 46). That proposal was made on behalf of “Michel Gaucher
Investment Group.”
[32] Michel Gaucher
explained that he did not want to associate PPJV with his proposal, following
the recent financial woes of PPJV with BONY. But, if his proposal was accepted,
he planned to invest through PPJV. In the end, the proposal did not
materialize.
[33] Subsequently, around
1989, Sofati invested in the Steinberg food chain, in the province de Quebec. According
to Mr. Gaucher, Sofati poured CDN$16,000,000 into that venture which
extended over a period of six years (until 1994). Thus, although one of the
vice-presidents of Sofati continued to explore the real estate market in Texas,
and despite the opportunity that was offered to PPJV to further invest in
Highland Park Shopping Village in 1991 (Exhibit A‑1, Tab 41), it was
not taken up and PPJV did not make any more investments after that.
[34] In the meantime,
Sofati continued to manage thermal power plants in the United States until
2000.
Analysis
[35] In Backman, supra,
at paragraphs 20 and 28, the Supreme Court of Canada made the following
observations:
20 The
existence of a valid partnership does not depend on the creation of a new
business because it is sufficient that an existing business was
continued. Partnerships may be formed where two parties agree to carry on
the existing business of one of them. It is not necessary to show that
the partners carried on a business for a long period of time. A
partnership may be formed for a single transaction. As was noted by this
Court in Continental Bank, supra, at para. 48, “[a]s long as the
parties do not create what amounts to an empty shell that does not in fact
carry on business, the fact that the partnership was created for a single
transaction is of no consequence.” Furthermore, to establish the
carrying on of a business, 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. . . .
. . .
28 In
this case, the alleged partnership held two assets: the Dallas Apartment
Complex and a one percent working interest in an Alberta oil and gas
property. We agree with the Federal Court of Appeal that the facts
in this case indicate that at the time they entered into the transactions at
issue, the Canadians did not intend to carry on business with a view to profit
in respect of the Dallas Apartment Complex. Once the Canadians acquired
their interests in the alleged partnership, the apartment complex was owned
only briefly before it was disposed of in accordance with the option granted to
the American partners and according to a pre-determined closing agenda. As was
contemplated in Continental Bank, supra, a partnership can be
formed for a brief period of time. It was also acknowledged in that case
that the parties need not hold meetings or make decisions, and that the passive
receipt of rent can constitute a business. However, in Continental Bank,
supra, the business of the partnership was
pre-existing and continued after the partnership was formed. In
this case, there was no continuity of a business, in fact, one of the first
acts of the alleged partnership was effectively to terminate the Commons’
former business of managing the apartment complex. Furthermore, there was
no evidence provided to show that the Canadians intended to make a profit
during the term of their involvement with the apartment complex. Consequently,
in the time between the entry of the Canadians and the disposition of the
Dallas Apartment Complex, the Canadians were not, judging from all the
surrounding circumstances, carrying on business in common with a view to profit
in respect of that asset..
[36] In my opinion, as in
Backman, the Appellant did not prove that it agreed with the American
partners to carry on business in common with a view to profit from the
activities of PPJV. It is true that right before the repossession of the
property by BONY, the partnership contract was amended to provide for the
possibility of investing in real property projects other than the Sherry Plaza,
and that indeed, two years later, PPJV finally invested US$175,000 in a
real property project it still has. However, considering the circumstances
surrounding the entire transaction, those facts alone do not pursuade me that
Louis G. Reese, PPDC and the Appellant had the intention to carry on
business in common with a view to profit. In my opinion, that was the key
element that had to be proven by the Appellant, which it failed to do.
[37] In Backman,
at paragraphs 41, 42 and 43, the Supreme Court of Canada made the
following observations:
41 It follows
from fundamental principles of partnership law that in order for a person to
enter and become a new partner of a valid and pre-existing partnership, that
person and the existing members of the partnership must satisfy the essential
elements of a valid partnership at the time of the entry of the new
partner. That is, they all must be carrying on business in common with a
view to profit. In this regard, we agree with the conclusion of the
Federal Court of Appeal that “the entry of new persons . . . will be considered
to constitute the creation of a new partnership, provided of course, that the
requisite components of the definition . . . are satisfied” (para. 51).
In particular, we agree with the Federal Court of Appeal’s approval of para. 3‑04
of Lindley & Banks on Partnership, supra, where the
conventional legal view is stated as follows:
The law, ignoring the
firm, looks to the partners composing it; any change amongst them destroys the
identity of the firm; what is called the property of the firm is their
property, and what are called the debts and liabilities of the firm are their
debts and their liabilities.
42 A validly
constituted partnership, therefore, is a continuing entity so long as none of
the statutory or contractual events of dissolution occurs and the composition
of that partnership remains the same. A partnership agreement may
facilitate a change in the composition of a partnership by providing that “the
partnership continues” upon the entry or withdrawal of partners, but that does
not obviate the need for persons intending to enter the partnership as
partners to meet the essential criteria of a valid partnership.
Those criteria are fundamental and cannot be avoided simply by contract
alone. This result is consistent with the view that formation of a
partnership does not depend solely on contractual arrangements but must also
satisfy the essential ingredients of a partnership described by this Court in Continental
Bank, supra.
43 Since we have already found that at the time of entering
into the transactions at issue the alleged partners did not possess the
essential ingredients of partnership as described in Continental Bank,
supra, we cannot accede to the appellant’s position on this issue.
[38] The present case
differs from Spire Freezers Ltd. v. Canada, [2001] 1 S.C.R. 391,
2001 SCC 11, where the Supreme Court of Canada found, at paragraph 24,
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.”
[39] In Spire Freezers,
as in the instant case, the series of transactions occurred on the same day.
The Supreme Court of Canada seems to have considered that there was a carrying
on of business in common between the new partners and the former partners
whereas it considered that that was not the case in Backman for the
following reasons:
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)).
[40] In this case, the
only asset of PPJV was seized immediately after the retroactive withdrawal of
the American partners. Even though the purposes of the partnership were amended
prior to their withdrawal, I am satisfied that, in view of the evidence,
neither Mr. Reese nor PPDC had an intention to carry on business in common
with a view to profit with the Appellant and WPTI. Indeed, no investment was
made with them after that. The objectives sought by the Appellant after the
withdrawal of Mr. Reese and PPDC, and the time and money invested by the
Appellant, were not to carry on the business operated by PPJV while it was
under American control. Mr. Reese and PPDC never held themselves out as
partners of the Appellant and WPTI. On the contrary, in all the documentation with
BONY, Mr. Reese clearly indicated that he and PPDC were selling their
interests to new investors.
[41] In my opinion, this
case is closer to Backman than to Spire Freezers and Continental
Bank. It also differs from Water’s Edge Village Estates (Phase II)
Ltd. v. Canada, [2003] 2 F.C. 25, 2002 FCA 291, cited by
counsel for the Appellant. At paragraph 27, Noël J. made the following
observations:
27 The subsequent finding
that the U.S. partners did not intend to carry on business in common with the
Canadian partners during this period is, in my respectful view, contrary to the
evidence. That the U.S. partners agreed to remain in that capacity in order to
insure the continued existence of the partnership (reasons, paragraph 41) is
consistent (not inconsistent) with their continued intention to carry on
business in common. Furthermore, Klink's financial statements for the period
ending 31 December 1991 reveal that the U.S. partners actually shared in the
financial results of the partnership for that period (Appeal Book, volume IV,
page 641). According to subsection 4(c) of the British Columbia Partnership
Act, R.S.B.C. 1996, c. 348, "the receipt by a person of the share of
the profits of a business is proof in the absence of evidence to the contrary
that he or she is a partner in the business". There was no evidence to the
contrary.
[42] The facts are
clearly different here.
[43] I therefore find
that the Appellant did not demonstrate that it was a member of a partnership
within the meaning of subsection 96(1) of the ITA for the purposes
of the deduction of the loss incurred by PPJV in its financial year ending
December 31, 1987. It is therefore with good reason that the Minister did not
allow it to carry forward the loss of CDN$16,036,040 to its 1992 taxation year.
[44] In view of this
finding, I will not have to rule on the quantum of the loss under section 10 of
the ITA and section 1801 of the Regulations.
[45] The appeal is
dismissed with costs, in
accordance with Tariff B of the Court, in favour of the
Respondent.
Signed at Ottawa, Canada,
this 27th day of September 2007.
“Lucie Lamarre”
Translation certified true
on this 20th day of February 2008.
François Brunet, Revisor
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