Citation: 2010TCC406
Date: 20101006
Docket: 2008-1251(IT)G
BETWEEN:
STEPHEN STOW,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
AMENDED REASONS FOR JUDGMENT
Sheridan, J.
[1] This appeal originally involved several
issues spanning the Appellant’s 1999 to 2006 taxation years. At the hearing,
however, counsel advised that the only issues remaining for the Court’s
consideration were the Appellant’s entitlement to a deduction of approximately
$6 million as his share of a loss in the Seaview Trading Partnership and to certain
childcare expenses in 2003. It was agreed by the parties that the Appellant’s
entitlement to a childcare expense deduction would follow the Court’s
disposition of the partnership issue. Accordingly, the appeal proceeded on
agreed facts and read-in portions from examinations for discovery in respect of
the partnership issue only.
[2] The Statement of Agreed Facts (Partial) reads as follows:
The parties
admit the following facts only for the purposes of these appeals and any
further appeals respecting them. The parties also agree to the authenticity of
the attached documents listed on Schedule “A” hereto and consent to their
admission into evidence only for the purposes of these appeals and any further
appeals respecting them. Either party may adduce other evidence relevant to
these appeals and not inconsistent with the facts in this statement and
attached documents.
1. Seaview Venture Sdn. BHD (“Venture”) and Ethical Equity
Sdn. Bhd. (“Ethical”) are Malaysian corporations owned by the Appellant’s
spouse (the “Spouse”).
2. On the advise of a Malaysian resident, David Crichton-Watt
(“Watt”), a friend of the Appellant and the Spouse, the Spouse decided in 2003
that Venture and Ethical would enter into a general partnership under the name
of Seaview Trading Partnership (Bermuda) (the “Partnership”) [FOOTNOTE 1: The
term “Partnership” is used in this Statement of Agreed Facts (Partial) for
convenience only, as an abbreviation of the Seaview Trading Partnership
(Bermuda), and is not an admission by the Respondent that the endeavour meets
or met the legal definition of a partnership, which will otherwise be
determined by the pleadings and the evidence.] to carry on the business of
acquiring and trading in commodities, options, forward contracts, futures
contracts and other derivative financial instruments.
3. The Spouse was not involved in any trading activities and
had no experience or expertise in trading.
4. At all material times, Watt was manager and a director of
Venture.
5. At all material times, Hue See Leng, a business associate
of Watt, was manager and director of Ethical.
6. A written partnership agreement was not executed and
registered in Bermuda until October 3, 2003 (the “Partnership Agreement”). See Tab
1 of the Joint Book.
7. Prior to December 18, 2003, Venture and Ethical had
contributed total capital of approximately $ 8.5 CDN to the Partnership. See
Tab 4 and 5 of the Joint Book.
8. Venture and Ethical owned 80% and 20% interests in the
Partnership, respectively.
9. The Partnership had a fiscal year end of December 31.
10. The Partnership Agreement stipulated that profits and losses
were to be allocated to those persons who were partners at the end of each
fiscal year of the Partnership in proportion to their capital accounts.
11. On December 18, 2003, approximately two weeks prior to the
Partnership’s fiscal year end, the Appellant purchased Venture’s 80% share of
the Partnership for $1,063,664 CDN. See Tabs 13 and 14 of the Joint Book.
12. At the time the Appellant acquired Venture’s interest in the
Partnership, the Partnership’s net book value was approximately $957,714, such
that the net book value of the interest that the Appellant acquired from Venture
was approximately $766,171. See Tab 3 of the Joint Book.
13. The Appellant executed the following documents as part of
his acquisition of Venture’s share of the Partnership: Partnership Interest
Transfer Agreement, Assignment of Partnership Interest and Agreement to be
Bound. See Tabs 7, 8 and 9 of the Joint Book.
14. At the time the Appellant acquired Venture’s share of the
Partnership it was known that the Partnership had unrealized losses in the
amount of $7,547,810 (the “Loss”) relevant to the 2003 fiscal period. See Tabs
4 and 5 of the Joint Book.
15. The Loss was the result of currency trades taking place
between October 10, 2003 and December 8, 2003 all with December 19, 2003 as the
specified settlement date. See a copy of the trade tickets at Tab 2 of the
Joint Book.
16. No fresh trades were initiated by the Partnership between
December 8, 2003 and December 31, 2003.
17. On December 31, 2003 the Loss was allocated 80% to the
Appellant and 20% to Ethical.
18. In 2003, the Appellant reported a loss from the Partnership
in the amount of $6,038,248.
19. Alistair MacDonald of Triathlon Ltd., and an individual
resident in Bermuda was at all material times manager of the Partnership.
20. The Partnership retained the services of Vancouver broker
Victor Adair, of Refco Futures (Canada) Ltd. to execute trades on its behalf.
21. On March 26, 2004, Ethical’s 20% interest in the Partnership
was purchased by Zen Capital & Mergers Ltd., (“Zen”) a corporation resident
in Canada related to the Appellant, with the result that the Partnership became
a “Canadian partnership” as defined in the Income Tax Act at that time.
22. Zen is wholly owned by the Appellant.
23. The Spouse executed the Agreement to be Bound and Assignment
of Partnership Interest effecting Zen’s acquisition in her capacity as director
of Zen. See Tabs 10 and 11 of the Joint Book.
24. The Appellant executed the Partnership Interest Transfer
Agreement on behalf of Zen. See Tab 12 of the Joint Book.
25. The Partnership incurred net trading losses in the amounts
of $131,996, $28,659, $2,070.31 and $1,740 in the 2004, 2005, 2006 and 2007
taxation years. See Tabs 29, 30, 31 and 32 of the Joint Book.
[3] The Minister’s assumptions in respect of
the partnership issue are set out at paragraph 1.9 of the Reply to the Notice
of Appeal. While most of them have been incorporated either expressly or by
implication into the Statement of Agreed Facts (Partial), the following assumed
facts remain in dispute:
1.9.128 the principle (sic) reason that
Venture and Ethical agreed to the allocation of losses was to reduce or
postpone the Appellant’s liability for tax in Canada by the application of
losses of the Seaview Trading Partnership losses to his income reported in
Canada;
…
1.9.133 the Appellant’s purchase of Venture’s share
of the Seaview Trading Partnership had no viable commercial purpose and lacked
all credible commercial motivation except for the purpose of utilizing losses;
1.9.134 the original Seaview Trading Partnership
ceased to exist immediately before December 18, 2003 and a new partnership
began on that date;
1.9.135 any losses of the Seaview Trading
Partnership are attributable to Venture and Ethical and not to the Appellant or
Zen;
…
1.9.142 the Appellant incurred nil partnership
losses in his 2003 taxation year and not $6,038,248, as claimed;
…
1.9.146 the Appellant paid a premium of $301,912
over and above the value of 80% of the net book value of the Seaview Trading
Partnership;
1.9.147 as it had only come into existence in 2003
and had earned no income, the Seaview Trading Partnership was not worth any
more than the net book value;
[4] The Appellant’s position is that the sole
issue is “one of continuity of partnership”, whether, upon the Appellant’s acquisition
of Venture’s 80% interest, the Seaview Trading Partnership continued as the
“same partnership”. Subject to the concerns raised under
“Preliminary Matter”, below, the Appellant maintains that the Minister was not
justified in making a reallocation under section 103 of his share of the
partnership loss.
[5] The Respondent’s primary position is that
the Appellant is not entitled to any partnership loss deduction because no
valid partnership came into existence upon his acquisition of Venture’s interest
in the Seaview Trading Partnership on December 18, 2003. Alternatively, the
Minister argues that even if there was a valid partnership, section 103 of the Income
Tax Act applies to reduce the Appellant’s share of partnership losses from
the $6 million claimed to “nil”.
Preliminary Matter –
Appellant’s Position
[6] At the commencement of the hearing, counsel
for the Appellant advised the Court that it ought not to entertain any submissions
from the Respondent other than those related to the “continuity” of the partnership
issue as neither the “validity” of the partnership nor the application of
section 103 had been properly pleaded. Counsel contended that both were
inconsistent with the Minister’s admissions, assumptions and/or answers on
examination for discovery.
[7] In respect of his concerns with the
validity of the partnership issue, counsel for the Appellant referred first to
the facts assumed by the Minister, in particular, in paragraph 1.9.134 of
the Reply:
1.9.134 the original Seaview Trading Partnership
ceased to exist immediately before December 18, 2003 and a new partnership
began on that date;
[8] This assumption had been put to the
Respondent’s nominee, Mr. Brian Ellis, the Canada Revenue Agency auditor
assigned to the Appellant’s file, on examination for discovery:
…
Q …
I wonder if you could go to paragraph 134, which if I
understand it is the nub of the respondent’s position. If I understand it
correctly, really the debate we’re having on the partnership revolves around
the partnership before and after this December 18th date. Do I understand the respondent’s position is that the
transfer of the Seaview Venture partnership interest from Seaview Venture to
Mr. Stow caused the partnership to cease to exist; is that right? To
terminate?
A And a new partnership to be formed.
Q Okay. Then a new partnership is formed with Stow and Ethical –
A As a Canadian partnership.
Q -- going forward. And that carried on –
that second partnership carried on until Zen comes into the picture?
A Yes.
Q And then we commence – you have a third
partnership?
A We didn’t make that determination.
Q That’s fine. Thank you. I understand that
now.
[9] Counsel for the Appellant also referred the
Court to paragraph 1.2 of the Reply in which the Respondent admitted of the
following allegations in the Notice of Appeal:
41. In the 2003 taxation year the Appellant
acquired an 80% partnership interest and became a general partner in the
Seaview Trading Partnership (Bermuda) (the “Seaview Partnership”), a general
partnership registered in Bermuda and carrying on a derivative trading business
in Canada.
42. In the 2003 taxation year, the Seaview
Partnership held its inventory of derivative instruments in Canada, including contracts for the future
sale of currencies with major financial institutions as counterparties such as
the Royal Bank of Canada and
the Bank of Montreal.
43. In the fiscal year ending December 31,
2003, the Seaview Partnership realized a business loss of $7,547,810 from the
disposition of Canadian inventory of derivative instruments.
44. the Appellant was allocated 80% of the
Seaview Partnership loss (being $6,038,248) pursuant to section 96 of the Act.
[10] Read as a piece, counsel argued, the effect
of the Respondent’s admissions, assumptions and answers on examination for
discovery is that the Minister has pleaded and admitted that there was a
partnership both before and after December 18, 2003. Thus, the only issue before
the Court is whether:
… the “Partnership continued as the same partnership. In the
Appellant’s submission, the law on continuity of partnerships set out above is
a complete answer to the basis of the assessment raised by the Respondent and
is sufficient to decide this case.
[11] In respect of the Respondent’s alternative
argument under section 103, counsel for the Appellant submitted that the
Respondent ought not to be permitted to make what was, essentially, an
unpleaded alternative argument. Apart from a bare reference to section 103 in
the “Statutory Provisions Relied On” section, he contended, the Reply was in
all other respects devoted exclusively to the “continuity of the partnership”
issue.
Preliminary Matter
- Respondent’s Position
[12] The Respondent’s position is that the
Minister’s pleadings put the validity of the partnership formed on December 18,
2003 squarely in issue. According to counsel for the Respondent, the Minister’s
arguments can be linked directly to the assumed fact at paragraph 1.9.133 of
the Reply to the Notice of Appeal:
1.9.133 the Appellant’s purchase of Venture’s share of the Seaview
Trading Partnership had no viable commercial purpose and lacked all credible
commercial motivation except for the purposes of utilizing losses;
[13] Counsel submitted that the law is well
established that whenever a new partner joins an existing partnership, the
existence of the three prerequisites of partnership must be reaffirmed: that there is 1) a business; 2) carried
on in common; 3) with a view to profit. She argued that “the fact articulated …
at paragraph 1.9.133 of the Reply go [sic] directly to the intent to
profit issue that is the third ingredient of the partnership test”, the salient fact being that there was no
“ancillary profit making purpose” and thus, no view to profit at the time of
the Appellant’s acquisition of Venture’s interest on December 18, 2003.
[14] In respect of assumption 1.9.134, counsel
for the Respondent submitted that the statement that “a new partnership began” could not be taken as an admission of the
existence of a valid partnership at law because the Minister cannot plead
conclusions of law as assumptions of fact. The use of the word “partnership” in the
Reply was merely intended as a kind of short-hand reference for the
relationship that came into existence between Ethical and the Appellant when he
acquired Venture’s shares on December 18, 2003.
[15] As for section 103, counsel for the
Respondent argued that the inclusion of section 103 and subsection 152(9) as
“statutory provisions relied on”, together with the assumed fact at paragraph
1.9.128 combined to put the applicability of that provision in issue. Paragraph
1.9.128 reads as follows:
1.9.128 the principle (sic) reason that
Venture and Ethical agreed to the allocation of losses was to reduce or
postpone the Appellant’s liability for tax in Canada by the application of the
losses of the Seaview Trading Partnership losses to his income reported in Canada.
Preliminary Matter
Analysis
[16] But for the Appellant’s own characterization of the
matter in dispute, I would have had some sympathy for counsel’s submission that
there is little in the Reply that speaks directly to the validity of the partnership
and even less, to the view to profit. Section 96, the lynch pin of the
partnership rules under the Act, is not even listed among the statutory
provisions relied upon in the Reply. The only provision listed pertaining to
partnership is section 103. Section 103 is an anti-avoidance provision which,
under certain circumstances, permits the Minister to allocate to a taxpayer
partner a loss share amount different from that claimed. Interestingly, under
section 103, the validity of the partnership is not in question; its focus is
on the reasonableness of the share of a partnership loss claimed by a
particular member of that partnership. Thus, given the general vagueness of the
Minister’s framing of the issue as simply “whether the Appellant is entitled to
deduct a loss from the Seaview Trading Partnership”, one might be
forgiven for concluding that section 103 had formed the basis of the Minister’s
assessment, especially given the use of language evocative of that provision
elsewhere in the Reply.
[17] Given the above, I find untenable the
Appellant’s contention that the Respondent ought to be precluded from making
submissions on section 103.
[18] As for the matter of the “validity of the
partnership”, I agree with counsel for the Appellant’s submissions that the Respondent’s
pleadings and answers on discovery could have been more clearly stated.
[19] It seems that by the time of the hearing,
the Respondent had formed a similar view: why else the sudden bulking up of the
Reply’s barebones statement of the issue in the Respondent’s Points of
Argument? At paragraph 2.1.5 of the Reply, the issue is simply stated as “whether
the Appellant is entitled to deduct a loss from the Seaview Trading
Partnership”; under Section 1 of the Points of Argument, however, a far
more detailed description appears:
1. The issues to be determined
are:
a. whether the Appellant was a member of a valid
partnership;
b. if not, then he is not entitled to the
$6,038,248 partnership loss claimed in 2003;
c. if there is a valid partnership, then the
issue is whether the circumstances of this case justify reallocation by the
Minister pursuant to section 103.
2.
The Respondent says according to the law, a new
entity was formed on December 18, 2003. That entity does not meet the test of
what is a partnership at law due to the presence of the Appellant’s tax
motivations and the lack of any ancillary business motivation.
3.
As the new entity is not a valid partnership,
the Appellant is not entitled to the $6,038,248 losses from the Partnership as
claimed in his 2003 taxation year.
4.
If the Respondent is wrong, and this Honourable
Court finds that the new entity was a valid partnership at law, then the
Respondent submits that section 103 applies to limit the Appellant’s losses to
$nil.
[20] Having said all that, I am unpersuaded by
the Appellant’s argument regarding the “continuity” of the partnership before
and after December 18, 2003. Whether expressed as such or as the “validity” of
the partnership as of that date, it seems to me that the same test applies. The
jurisprudence is clear that the question is not whether the partnership as
configured upon the arrival of a new partner is the “same partnership” as the
originally configured partnership but rather, whether upon the acquisition of
an interest in that partnership by a new member, the three prerequisites for a
valid partnership exist in respect of the newly configured partnership. As stated
in Backman:
42 A validly constituted partnership … 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 the
partnership … 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.
[Emphasis added.]
[21] Thus, even to prove the “continuity” of the
partnership, the Appellant must still show that upon becoming a member of the
Seaview Trading Partnership, there was 1) a business; 2) carried on in common;
3) with a view to profit. As the Respondent has conceded the first two
criteria, the Appellant need prove only the third element, that as of December
18, 2003, the Seaview Trading Partnership had a “view to profit”.
[22] Before turning to
the substantive issues, one final comment on the state of the Respondent’s
pleadings and answers on examination for discovery: while the Minister’s lack of precision does not justify
restricting the Respondent’s submissions in the manner requested by the
Appellant, nor is it without other consequences. I am mindful of the fact that the
partnership issue before the Court was but one in a reassessment involving many
other facets of the Appellant’s operations, all of which had to be addressed in
the Reply. Complexity, however, does not relieve the Minister of his duty to
express clearly the basis for each aspect of the assessment; as Sharlow, J.A.
put it in R. v. Anchor Pointe Energy
Ltd.:
Fairness
requires that the facts pleaded as assumptions be complete, precise, accurate
and honestly and truthfully stated so that the taxpayer knows exactly the case
and the burden that he or she has to meet.
In the present case, the lack of specificity in the
Respondent’s pleadings, particularly the assumptions, lessened the evidentiary
burden which the Appellant might otherwise have faced. I was unmoved by counsel
for the Respondent’s argument that a negative inference ought to be drawn from
the Appellant’s having relied solely on the Statement of Agreed Facts (Partial)
and the read-ins from the examination for discovery rather than calling
additional witnesses such as his spouse, legal advisors, accountant or broker
to testify to a partnership business plan. While the evidence presented by both
parties left me with the feeling that I had not heard the whole story, I found
the Appellant’s evidence, on balance, sufficient to rebut the Minister’s
assumptions and more persuasive of his position than the contentions advanced
by the Respondent.
Substantive Issues
1. Validity
of Partnership – View to Profit
Appellant’s Position
[23] The Appellant’s position is that the
Seaview Trading Partnership continued before and after the Appellant’s
acquisition of Venture’s interest on December 18, 2003. As a member of a valid
partnership, under section 96 the Appellant was entitled to an 80% share
of any partnership losses as of its December 31, 2003 year end.
Respondent’s
Position
[24] The Respondent’s position is that no valid
partnership came into existence upon the Appellant’s entry into the Seaview
Trading Partnership on December 18, 2003 because there was no view to profit. The
assumption underpinning the Respondent’s position is that “the Appellant’s
purchase of Venture’s share of the Seaview Trading Partnership had no viable
commercial purpose and lacked all credible commercial motivation except for the
purpose of utilizing losses”.
[25] Counsel for the Respondent submitted that
the Appellant’s only intention in acquiring Venture’s interest in the Seaview
Trading Partnership was to access its losses for use in the affiliated family
businesses. While acknowledging that being motivated to enter a partnership for
tax planning purposes does not, in itself, preclude the existence of a valid
partnership,
counsel argued that the Appellant must nonetheless prove a co-existing
“ancillary profit-making purpose”. According to the Respondent, there is no
evidence to support such a finding.
Substantive Analysis
[26] For the reasons set out below, I am
satisfied that a valid partnership came into existence upon his acquisition of
Venture’s interest in the Seaview Trading Partnership on December 18, 2003.
[27] The Seaview Trading Partnership had three
iterations: the partnership originally created on April 1, 2003 by Venture and
Ethical (the “Original Partnership”); the partnership under appeal, created on
December 18, 2003 upon the Appellant’s acquisition of Venture’s 80% share (the
“Appeal Partnership”); and a subsequent partnership created on March 26, 2004
upon Zen’s acquisition of Ethical’s 20% share (the “Subsequent Partnership”).
For the sake of clarity, these defined terms will be used hereafter in the
Reasons.
[28] In Backman and its companion case, Spire
Freezers, the Supreme Court of Canada held that that “upon the entry of a
new partner, the criteria of a valid partnership must be reaffirmed in order
for the partnership to continue in its new form”. In determining the existence of a valid
partnership, the Court 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.
Courts must be pragmatic in their approach to the
three essential ingredients of partnership. Whether a partnership has been
established in a particular case will depend on an analysis and weighing of the
relevant factors in the context of all the surrounding circumstances. That the
alleged partnership must be considered in the totality of the circumstances
prevents the mechanical application of a checklist or a test with more
precisely defined parameters.
[29] The Respondent does not dispute that the
Original Partnership between Venture and Ethical was valid. Nor does the Crown take
issue with the validity of any of the partnership documents: the original
partnership agreement between Venture and Ethical dated October 3, 2003 (“Original Partnership Agreement”) and the
Appeal Partnership agreements i.e., the Partnership Interest Transfer Agreement, the Assignment Of Partnership Interest, and the Agreement To Be Bound all dated December 18, 2003.
[30] Each of these documents contains fairly
standard clauses. Paragraph 2.1 of the Original Partnership Agreement provides
the basic “continuity of partnership” clause mentioned in Backman:
The Partnership shall commence on the date hereof and shall continue
until terminated by the Partners in accordance with this Agreement. The
Partnership formed hereby is a general partnership and the Partners hereby agree
to carry on business with each other and to share amongst them any profits
arising therefrom in accordance with this Agreement. The event of a person or
persons becoming or ceasing to be Partners shall not dissolve the Partnership.
[31] Similarly, paragraph 3 of the Agreement to
be Bound between the Appellant and Venture and Ethical expressly provides that
“Notwithstanding [Venture’s] departure from the Partnership and the admission
of [the Appellant] to the Partnership, the Partnership continues intact over
the transition”. These documents also adopt the business
purpose of the partnership stated in the Original Partnership Agreement of
carrying on trading activities as further described in paragraph 2 of the
Statement of Agreed Facts (Partial).
[32] There being on the face of it “objective,
documentary evidence” of the Appeal Partnership’s view to profit, it remains
for the Appellant to show that the surrounding facts are consistent with a
subjective intention to do the same. The Backman decision requires the
Court to take a pragmatic approach to that analysis and consider, among other
things, “what the parties actually did”.
[33] In Spire Freezers, the Supreme Court
of Canada looked at the following facts to hold there was a valid partnership;
in so doing, the Court contrasted its findings with those in Backman
where the opposite conclusion was reached:
… The alleged partnership in Backman had no significant
management control over [the subordinate asset, a one per cent interest in an
oil and gas property] 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 …. the alleged partnership was “an empty shell that
does not in fact carry on business”… In [Spire Freezers] 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 [partners]. [The business] required a substantial
management effort which the [partners] provided, and from which they benefited
by generating a 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”.
[34] The divergent results in Backman and
Spire Freezers, notwithstanding their quite similar facts and having
been decided by the same trial judge, illustrate dramatically the fact-driven
nature of the inquiry into the existence of a valid partnership. In my view,
the present case falls on the Spire Freezers side of the ledger.
[35] The Seaview Trading Partnership’s only
asset was its currency trading business. That same asset was used to carry on
the same business before and after December 18, 2003 and continued until 2007.
In Water’s Edge, the Federal Court of Appeal overturned
the findings of the Tax Court judge to hold a valid partnership existed even
though the partners (unabashedly motivated by tax planning) paid $320,000 to
acquire interests in a partnership whose only asset was an obsolete computer
valued at $7,000, the lease of which was to expire within days of the
acquisition.
[36] Here, there was no change in the conduct of
what, prior to the Appellant’s acquisition of Venture’s partnership interest,
the Minister assumed had been a valid commercial enterprise. Indeed, in his
assumptions, the Minister virtually adopted the description of the business
activities in both the Original Partnership Agreement and the subsequent Assignment of
Partnership Interest executed by the Appellant upon his entry into the Appeal
Partnership with the remaining original partner, Ethical.
[37] The Appellant was a lawyer and an
experienced currency trader in his own right; concurrent with his membership in
the Appeal Partnership, he was also engaged in that business activity in his
personal capacity. While it is true that the Appellant and
Ethical delegated the day-to-day operations of the Appeal Partnership to other
qualified individuals, the Supreme Court of Canada held in Continental Bank
that “[t]he fact that the management of the Partnership was given to the
Managing Partner does not mandate a conclusion that the business was not
carried on in common” and by analogy, is not fatal to a finding
of a view to profit. Furthermore, the Respondent’s reliance on Spire
Freezers for the proposition to the effect that evidence of management
efforts is necessary for a view to profit is misplaced; that aspect of the
Court’s findings had to do with whether there was “a business”, a question that is not in dispute in the
present matter.
[38] Here, the Seaview Trading Partnership,
throughout its iterations as the Original Partnership, the Appeal Partnership
and the Subsequent Partnership, continued in the same business activities with
the same manager and broker until sometime in 2007. If recent history is any
indication, the derivative trading business is not without a certain amount of
risk. In any case, although the partnership’s efforts ultimately resulted in a
net loss, that was not through lack of activity, as suggested by counsel for
the Respondent in her submissions; indeed, there were trades totalling some
$40 million over the lifetime of the Seaview Trading Partnership. It is against
this larger background that the $6-million loss must be considered.
[39] Counsel for the Respondent was also
troubled by the fact that the Appellant was aware of the Original Partnership’s
currency trading losses prior to his acquisition of Venture’s interest; that
the purchase occurred just one day before their crystallization; and that the
Appellant had been a member of the Appeal Partnership for only two weeks before
its December 31, 2003 year end.
[40] I do not find these submissions persuasive.
In OSFC Holdings Ltd. v. R.,
the Federal Court of Appeal held that under the section 96 partnership rules,
“[i]rrespective of when a partner enters the partnership in a taxation year of
the partnership, provided he is a partner at the end of the taxation year, the
loss of the partnership from any source for its taxation year is the loss of
the partner. Thus, the validity of the partnership
does not hinge on the length of a partner’s tenure as a member. Examples of
valid short-term partnership appear throughout the jurisprudence; most notably,
Spire Freezers, in which there was a valid partnership even though its
existence lasted, literally, “a brief instant”.
[41] Counsel for the Respondent made several
other submissions regarding the Minister’s position that the Appellant had no
view to profit and acquired Venture’s interest in the Original Partnership only
to utilize its losses. First, there was the matter of the purchase price of
Venture’s interest in the Original Partnership. The Minister assumed at
paragraph 1.9.146 of the Reply that:
1.9.146 the Appellant paid a premium of $301,912
over and above the value of 80% of the net book value of the Seaview Trading
Partnership;
[42] Counsel submitted that there was no
evidence of a business plan or that the Appellant had engaged in any “hard
bargaining” to acquire Venture’s interest. In paying $1,063,664 for Venture’s partnership share when it
had a net book value of $766,171, the Appellant paid a “premium” of
approximately $300,000 to access a loss worth seven times the purchase price.
There cannot be, counsel argued, “[a] remarkable discrepancy” between the
amount paid to become a member of the partnership and hence enjoy the loss, and
the amount of the loss claimed …”.
Counsel likened the Appellant’s situation to those of the taxpayers in Makuz
v. Canada and Witkin v. Canada in which it was held that there was no
view to profit.
[43] The jurisprudence is clear that for the
establishment of an “ancillary profit‑making purpose”, the evidentiary
threshold is a low one - in the present case, all the more so given
the imprecision of the Minister’s assumptions. It must also be kept in mind
that the intention to operate with a view to profit is a subjective one. I am
not at all persuaded by the submissions of counsel for the Respondent that the
Appellant’s answers on examination for discovery lead inexorably to the
conclusion that his sole intention was to access tax losses. While admitting his
plan to use the losses in the family businesses, the Appellant also stated:
118 Q What was the basis for your decision to get
involved?
A Well, the basis was on advice from the family,
the family lawyers. It all came from here, which was that if there was a loss
in one of the family assets, which I might be able to utilize in my own
personal situation, and there was a business that I would want to continue, I
think that’s reflected in the pricing that I paid.”
[44] Even counsel for the Respondent could go no
farther in her submissions than to say it was “not clear” from the above
response that the Appellant was motivated entirely by tax planning. The
Appellant does not dispute that in deciding to acquire Venture’s interest in
the Original Partnership, he relied on the family’s legal advisors, in
particular, Mr. Watt, who was himself involved in currency trading. There is nothing inherently wrong with
the Appellant’s having relied on their advice. His answer also indicates that
in taking such counsel, the Appellant had considered, at least to some extent,
the partnership’s business viability and its purchase price. The jurisprudence
shows a partnership may exist even where new partners have acquired losses well
in excess of the amount paid for their partnership interests: see Water’s
Edge, mentioned above, and Spire Freezers in which the new partners
paid US $1.2 million to acquire about US $10.4 million in losses. In OSFC,
Rothstein, J.A. (as he then was) noted, in the context section 245, that:
… the primary purpose of a transaction will be determined on the
facts of each case. In particular, a comparison of the amount of the estimated
tax benefit to the estimated business earnings may not be determinative,
especially where the estimates of each are close. Further, the nature of the
business aspect of the transaction must be carefully considered. The business
purpose being primary cannot be ruled out simply because the tax benefit is
significant.
[45] This approach is equally useful in the
determination of a view to profit. I have no reason to doubt the Appellant’s
evidence on examination for discovery that he and his wife relied on the advice
of their respective advisors as to the “fair” value of Venture’s partnership
interest. When considered from a Backman pragmatic perspective, the
Appellant’s explanation that it is more difficult to evaluate precisely the
value of a partnership interest in a group of family-controlled enterprises
than, for example, publicly traded stock is not unreasonable.
[46] As for the Respondent’s reliance on Makuz
and Witkin, in my view, both decisions are readily distinguishable.
Unlike the present matter, they involved a complex set of transactions geared only
to produce a tax benefit for a multitude of putative partners. Though decided
by different judges, the same facts were present in each case. To get a flavour of the nature of the scheme,
regard may be had to the summary of former Chief Justice Bowman in Makuz at
paragraphs 27 to 29:
I have traced the complex series of transactions
beginning with the creation of CA, the construction of the Claridge with the
large losses and 79 unsold units through to the final transactions whereby MSI
transferred 5.4% of the units some time after March 31, 1988. It is important
to determine just what the appellants were getting when they paid an aggregate
of approximately US $37,220 for each 1% partnership interest of CH1.
Considering that the transactions were all
pre-orchestrated, the appellants were buying on March 28, 1988 into a
partnership which in two days would be stripped of all of its assets and be
left with nothing but a promise by MSI to convey 5.4% of the Claridge units to
it if, as and when it acquired them.
The appellants were getting the prospect of a large tax
write-off in respect of a loss that it was certain had already occurred plus a
chance, a possibility, or a hope of getting a 5.4% interest in 79 unsold
condominiums. We know what the losses were worth if they could successfully be
used by the appellants – the tax value of a write-off of over $40,000,000. What
was an uncertain chance of getting 5.4% of 79 unsold condominium units worth?
The promotional material says that the unsold 79 units had a fair market value
(“fmv”) of about US $23,000,000. Without deciding whether the figure is
correct, 5.4% of $23,000,000 is $1,242,000.
[47] It was against this backdrop that the Court
expressly rejected the taxpayers’ “testimony about their subjective intentions”
to find that there was only an “illusory” prospect of profit. In Witkin, the
Federal Court of Appeal adopted Beaubier, J.’s findings that the taxpayer’s
“plan was that the operation of [the partnership] would be carried on in the
same losing manner as before” and that “there was only a mere possibility of a
return of capital and that possibility was remote”. The Court also found that the taxpayer, a
sophisticated businessman, “chose not to use or review projections given to
him”.
[48] There is no such evidence in the present
matter. The Appellant’s acquisition of Venture’s interest was not a complex
transaction: both before and after the Appellant’s acquisition of Venture’s
interest, the same business continued using the same asset managed by the same
administrator and broker. While no formal business plan was in evidence, its
production is not a prerequisite to a finding of a view to profit, particularly
in view of the Respondent’s ambiguous pleadings. There is no obligation on a
partner to adduce evidence as to exactly how or in what amount partnership
losses are going to be recouped.
[49] The Respondent’s argument also addressed the
partnership documents which, according to counsel, expressly “anticipated that
issues might arise with respect to the price he paid”. Counsel pointed, in particular, to
clauses 2.2 and 2.5 of the Partnership Interest Transfer Agreement. She noted
that the same clauses were used in the Partnership Interest Transfer Agreement
governing Zen’s acquisition of Ethical’s partnership interest in March 2004, evidence of a pattern of behaviour
inconsistent with an ancillary profit-making purpose.
[50] I do not find this argument at all persuasive.
These clauses must be read in context. They are essentially standard form terms
used to signal the parties’ intention that the purchase price be equal to the
fair market value of the partnership interest; furthermore, they provide a
formula for a price adjustment, up or down, should it later be
determined that it was not equal to that amount. There is nothing out of the
ordinary in the inclusion of such a provision in a document of this kind.
[51] In all the circumstances, I am satisfied
that Ethical and the Appellant had a view to profit when he acquired Venture’s
80% interest on December 18, 2003 and that a valid partnership came into
existence on that date.
2. Applicability
of Section 103
[52] Given that the Appeal Partnership was a
valid one, the next issue is whether the Minister was justified in allocating
to the Appellant a share of the Appeal Partnership loss equal to ‘nil’ under
section 103 of the Act.
Legislation
[53] Section 103 must be read in the context of
subsection 96(1), the general provision governing the treatment of partnership
losses. Subsections 103(1) provides that:
103(1) Where the members of a partnership have agreed
to share, in a specified proportion, any income or loss of the partnership
from any source or from sources in a particular place, as the case may be, 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 any of
the members thereof, and the principal reason for the agreement may
reasonably be considered to be the reduction or postponement of the tax that
might otherwise have been or become payable under this Act, the share
of each member of the partnership in the income or loss, as the case may
be, or in that other amount, is the amount that is reasonable having
regard to all the circumstances including the proportions in which
the members have agreed to share profits and losses of the partnership from
other sources or from sources in other places. [Emphasis added.]
[54] Subsection 103(1.1) uses similar language
but employs different triggering and reasonableness criteria:
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. [Emphasis added.]
Respondent’s Position
[55] The Minister submits that either of
subsection 103(1) or subsection 103(1.1) “would operate to reallocate the $6
million loss claimed by [the Appellant] to nil”. Counsel for the Respondent submitted
further that whether under subsection 103(1) or subsection 103(1.1), “… the
test is really the same. You have to look at all of the circumstances to
determine whether the amount allocated is reasonable”.
[56] According to counsel for the Respondent,
the Minister’s assessment under section 103 was premised on the following
assumption of fact:
1.9.128 the principle (sic) reason that Venture
and Ethical agreed to the allocation of losses was to reduce or postpone
the Appellant’s liability for tax in Canada by application of the losses of the
Seaview Trading Partnership losses to his income reported in Canada; [Emphasis
added.]
[57] Referring, as it does, to an agreement
between Venture and Ethical, the members of the Original Partnership (rather
than the Appellant and Ethical, the members of the Appeal Partnership), the
Minister’s assumption would appear, at first blush, to be barking up the wrong
tree. But, as I understand the submissions of counsel for the Respondent, to
conclude thusly is to take too narrow a view:
… there is nothing in [subsection 103(1)] that says the analysis
begins and ends with the partnership agreements. The reference to an agreement
to share is not bound to what is stipulated in the partnership agreements,
because if it was, it is unlikely that there would ever be any assessments
under section 103.
…
And [counsel for the Appellant] is right, Venture is
no longer a member of the partnership and has not, to my understanding,
retained any residual rights. I understand the purpose and the effect of the
partnership agreements between Venture and the Appellant to convey to the
Appellant all of the rights that Venture would have had under the partnership
agreement. I don’t think there is anything that remained with Venture. It is
certainly not our position.
…
The fact that only one party in the allocation
arrangement has a principal tax motivation is not a bar to the application of
section 103. So the Crown doesn’t have to show any intention in respect of
Ethical. And what is relevant is not the intention at the time the partnership
agreement is drafted, but rather the purposes for which the agreement is being
used.
Now, let’s not forget that Ethical was owned by [the
Appellant’s] spouse, Venture was owned by [the Appellant’s] spouse,
Thorsteinssons was representing the partnership and Thorsteinssons was
representing the family. So this is all one – this is all under the umbrella of
one plan. It’s a common intention, it’s a common agreement that Venture must
have agreed that these losses would be attributed to [the Appellant] and not
[his spouse]. Maybe she couldn’t use the losses. We know how much she earned,
we know what her line 150 income was in 2003, and just for your reference that
is found on the first page of [the Appellant’s] return for 2003 behind Tab 28
[of the Joint Book of Documents]. She earned net income on $51,792. Of course
we don’t know how that amount was arrived at. But maybe she couldn’t use the
losses and maybe [the Appellant] could. Otherwise, why would the losses have
been transferred to [the Appellant]?
So where it comes down to the agreement for sharing
the profit and losses, that’s the agreement that section 103 is looking at. It
is not the partnership agreement. It is not some document. It’s what was the
agreement between these parties? Well, judge them by what they did.
[58] For ease of reference, the different iterations
of the Seaview Trading Partnership between 2003 and 2007 and their respective memberships
are reiterated below:
Original Partnership: Venture and Ethical
(April 1- December 17, 2003);
Appeal Partnership: the Appellant and Ethical
(December 18, 2003 – March 26, 2004;
Subsequent Partnership: the Appellant and Zen
(March 26, 2004 – 2007).
[59] Rooted as it is in
the assumed agreement to share between Venture and Ethical, the Respondent’s
contention that subsection 103(1) applies to the Appellant’s circumstances
requires evidence to show that the Appellant’s spouse, as the directing mind of
Venture and Ethical, caused the two companies, possibly as early as April 1,
2003 when the Original Partnership was created or as late as October 3, 2003
when the Original Partnership Agreement was executed and registered in Bermuda, to agree to Venture’s specified proportion
of 80% of its profits or losses to give effect to a subsistent “common
agreement” between her, Venture, Ethical and the Appellant which anticipated
the Appellant’s acquisition on December 18, 2003 of Venture’s share of what
would by then be the Appeal Partnership’s $6-million loss (which even as of the
later date of October 3, 2003, did not yet exist) all of the derivative
trading losses occurred between October 10, 2003 and December 8, 2003 all for the principal reason of reducing
or postponing the tax that would be otherwise payable by the Appellant.
[60] As mentioned at the outset, the section 103
assessment was only part of a much larger examination of the Appellant’s
affairs which, perhaps, influenced the Minister’s overall conclusions. But this
appeal must be decided on the evidence presented to justify the Minister’s
application of section 103. That requires more than asking the Court to look at
the final result and impute bad intentions to the steps leading to it. It must
be remembered that the Minister made no allegations of sham and did not invoke
section 245. The one assumption relied upon by the Minister in respect of the
section 103 assessment, paragraph 1.9.128, makes no reference to the Appellant
having been a party to the assumed agreement between Venture and Ethical or to
their agreement having underpinned the specified proportions agreed to. Certainly,
no assumptions were made regarding the multi-party arrangement propounded by
counsel for the Respondent in her submissions. There is no positive proof of
its existence and, in my view, little justification for its inference. Like the
Respondent’s musings as to whether the Appellant’s spouse could have used
Venture’s losses, it strikes me as largely a matter of speculation.
[61] What the evidence does show is that the
partnership documents governing the relationship between the Appellant and
Ethical (and even, with Venture) provided that the Appellant and Ethical agreed
to share the Appeal Partnership’s losses, if any, in specified proportions of 80%
and 20%, respectively. Assumptions consistent with this conclusion are subsumed
in the Statement of Agreed Facts (Partial) and have to do with the valid
transfer of Venture’s 80% share under the Original Partnership to the Appellant
as a member of what then became the Appeal Partnership. While in certain
circumstances the kind of agreement contemplated by section 103 might include
more than the formal partnership documents, in the present case, I am not
convinced there is any reason to look beyond the partnership documents, all of
which are accepted by the Minister as validly constituted and from which it is
clear that the proportions for sharing partnership profits and losses
originally agreed to were consistently maintained throughout the history of the
Seaview Trading Partnership.
[62] In XCO Investments Ltd. v. Canada, the Federal Court of Appeal described the
two-step procedure in the operation of subsection 103(1) as follows:
Having found that subsection 103(1) applies because there is a
sharing of income and the principal reason for the agreement [between
the appellant and the new partner] was the reduction of tax otherwise payable,
this brings us to the second question to be answered, i.e. whether the
allocation of income to the partners was reasonable.
[63] As there was an
agreement to share in specified proportions between the Appellant and Ethical, the second prong of the first criterion
requires consideration of whether the principal reason for that agreement “may
reasonably be considered” to have been “to reduce or postpone the tax”
otherwise paid or payable. It is notable that unlike in subsection 103(1.1),
there are no listed criteria for determining the reasonability of that
consideration; under subsection 103(1), it is only after the triggering factors
have been met that regard may be had to “all the circumstances including the
proportions in which the members have agreed to share” partnership losses.
[64] Here, the Appellant admits to having been
motivated, in part, to acquire Venture’s partnership interest by the prospect
of gaining access to partnership losses. That is not the same, however, as admitting
to having had, as his principal reason for having agreed with Ethical to share
in 80-20 proportions, “the reduction or postponement of the tax that might
otherwise have been or become payable under the Act” as required under
subsection 103(1). Where is the evidence of such a motivation to be found?
[65] The facts of the present matter are a far
cry from those in XCO Investments Ltd. and the subsequent subsection
103(1) decision, Penn West Petroleum Ltd. v. The Queen. First of all, there was no issue in those
cases as to the identification of the proper parties to the impugned agreement.
Both decisions involved the complex fact situations typical of clever schemes to
produce a tax benefit. In both cases, the agreements between the existing
partners and the new partners skewed dramatically the originally agreed-to
allocations to achieve a specific tax benefit for at least one of the parties
under the partners’ agreement to share. Further, in each case, the new
partner’s involvement was expressly intended to be temporary, lasting only a few
days and leading the former Chief Justice to describe as “ephemeral” the new
partners’ participation in their respective partnerships.
[66] In
XCO, Bowman, C.J. summarized the agreement as follows:
29 In
cash terms Woodwards [the new partner] paid $1,260,000 and received cash of
$8,827 plus $1,808,689.86. The difference of $548,689.98 between $1,808,689.86
and $1,260,000 is very close to $561,600 which is 80% of $702,000, the 6.5%
discount from the assumed fair market value of $10,800,000 of the Westhill
Apartments. In the result Woodwards made a profit of $548,689 and received
$8,867 in operating profits for a total of $557,556.
30 This
was the actual cash that it cost the appellants [the existing partner] to
obtain Woodwards' participation. For that they saved or would have saved, if
the plan had worked, the tax on $5,867,336 ($118,405 + $5,748,931). I have not
worked out the actual tax savings to the appellants. I suppose I could try but
I would probably get it wrong. Suffice it to say that it would probably be well
over two million dollars, several multiples of their actual cash outlay.
31 What,
then, was the predominant purpose of this transaction? From the appellants'
point of view it was obviously to save tax. For an outlay of something over one
half million dollars they were expecting to save taxes of over $2,000,000. The
motivation is obvious. I have been unable to identify any other commercial or
non-tax purpose.
32 From
Woodwards' point of view there was no tax motivation at all. It involved a pure
business proposition. It had no tax to pay and none to save. For its participation
in the scheme it received a profit of about $550,000.2
33 Woodwards'
contribution was both ephemeral and for all practical purposes risk free. It is
therefore unreasonable for it to be allocated 80% of the income from the
Westhill Apartments. That is exactly what subsection 103(1) is there for.
[67] After making a thorough analysis of the
transactions underpinning the allocations, the Court concluded that the Minister’s
application of subsection 103(1) was justified. The Federal Court of Appeal upheld the trial judge’s decision to allocate
to the existing partner the $557,556 value of the profit actually received by
the new partner, Woodwards.
[68] In the subsequent case of Penn West
Petroleum, Bowman, C.J. upheld the Minister’s allocation under subsection
103(1) of the proceeds of the disposition of partnership property in accordance
with their respective partnership interests on the basis that:
[48] … the principal reason for the arrangement between the
Appellant and Phillips in the form in which it was configured … was the
reduction of the appellant’s tax that would otherwise have been payable. There
was no reason for the arrangement other than to make the lower price that
Phillips was prepared to pay fiscally palatable to the Appellant. The
Minister’s reallocation of the proceeds of disposition of the resource property
to the partners in accordance with their interest in the partnership is
reasonable whereas it is highly unreasonable to make somebody a 5.27% partner
for 25 days (January 30, 1995 to February 24, 1995), pay it 5.27% of the other
income and yet allocate to that partner … (100%), of the deemed proceeds of disposition
of assets distributed to that partner.
[69] I agree with counsel for the Appellant that
no such “offending factors” are present in this appeal. Ethical and
the Appellant claimed a share of the loss in existence at the 2003 partnership
year end that conformed precisely with each partner’s percentage interest under
the Appeal Partnership agreements which, in turn, conformed to the shares
originally agreed to under the Original Partnership Agreement. No amendments or
other agreements were made geared at securing a tailor-made tax benefit for the
Appellant or putting him in a more advantageous position than the remaining
partner, Ethical, or than the exiting partner, Venture, had been in prior to
its departure. Finally, unlike the new partners in XCO and Penn West
Petroleum, the Appellant remained a member of the Appeal Partnership and
the Subsequent Partnership for four years, actively carrying on the same
business as had been by the Original Partnership. Such a level of participation
lacks the “ephemeral” quality that proved the undoing of the taxpayers in XCO
and Penn West Petroleum.
[70] In all the circumstances, it may not
reasonably be considered that the principal reason for the agreement between
the Appellant and Ethical to share partnership losses in 80-20 proportions was
the reduction or postponement of tax. The second prong of the first of the triggering
criteria of subsection 103(1) not having been satisfied, the Minister was not
justified in applying that provision to allocate a ‘nil’ amount as the
Appellant’s share of the Appeal Partnership’s losses. If I am in error in so
concluding, for many of the same reasons, I am not convinced, having regard to
the relevant criteria in subsection 103(1), that the Appellant’s 80% share was
“not reasonable”; accordingly, the Minister was not justified in applying
subsection 103(1).
[71] Turning, then, to subsection 103(1.1), that
provision applies “where two or more members of a partnership who are not
dealing with each other at arm’s length agree to share any” loss 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 loss
“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”. Once these conditions have been found to exist,
then “that share shall, notwithstanding any agreement, be deemed to be the
amount that is reasonable in the circumstances”. Unlike subsection 103(1),
subsection 103(1.1) makes no reference to agreeing to share in “specified
proportions”.
[72] There being no dispute that Ethical and the
Appellant were not at arm’s length and having found that the Appeal Partnership
documents constitute the only agreement between the Appellant and Ethical to
share partnership losses, the triggering criteria of subsection 103(1.1) are
satisfied. The next question is to determine whether the Appellant’s 80% share
was “not reasonable” having regard to the “capital invested in” or “work
performed for” the Appeal Partnership by the Appellant and Ethical or “such
other factors as may be relevant”.
[73] Looking first at the “capital invested”
criterion, counsel for the Respondent argued that the difference in value
between Venture’s capital investment of $6.8 million in the Original
Partnership and the $1.1 million purchase price paid by the Appellant to
acquire Venture’s interest in what then became the Appeal Partnership is
significant since, notwithstanding that disparity in their respective
acquisition prices, both Venture and the Appellant would have had access to a
$7.5 million loss. In these circumstances, counsel for the Respondent argued,
while it might have been reasonable for Venture to have claimed an 80% share of
that loss as a member of the Original Partnership, it was not reasonable in the
circumstance for the Appellant to have claimed the same amount as a member of
the Appeal Partnership.
[74] Yet again, the Respondent’s argument blurs
the distinction between the membership of the Original Partnership and of the
Appeal Partnership. As I read subsection 103(1.1), the salient fact in
determining whether the share of any one of the non-arm’s length partners who
has agreed to share is reasonable is the proportion “that share” bears to the
capital invested/work performed by “the members” in that partnership. A typical
situation would be where one partner has contributed all of the capital or does
the bulk of the work and yet the partnership agreement provides for an equal division
of the profits and losses. Depending on the circumstances, the share claimed by
the partner making the lesser contribution may be unreasonable and a different
amount allocated under subsection 103(1.1). By way of example, counsel for the
Appellant referred the Court to the Informal Procedure decision of Spencer
v. The Queen in which husband and wife partners agreed
to share profits and losses in equal shares. After finding certain facts as to
their actual participation in the partnership business, the Court applied
subsection 103(1.1) to deem their respective shares to be 75/25, respectively,
rather than the agreed-to 50/50 split.
[75] Following that
approach, how is Venture’s
capital contribution to the Original Partnership relevant to the subsection
103(1.1) analysis? As I read that provision, the relevant comparator vis-à-vis
the Appellant is the only other member of the Appeal Partnership, Ethical. Though
he invested less than the former partner Venture, when the Appellant acquired
his interest, the partnership’s financial situation had changed; the amount he
paid to acquire Venture’s interest was not disproportionate to Ethical’s equity
in the partnership at that time. The Appellant’s capital was at risk. He paid
$1.1 million for an interest in the Appeal Partnership with an assumed and
agreed net book value of $766,000,
found not to be unreasonable in the context of a family-run group of businesses.
On these facts, just because the Appellant acquired a partnership interest for
significantly less than the partnership losses to which he gained access does not
in itself justify a deemed allocation under section 103. Even if Venture’s
capital contribution to the Original Partnership is considered as a “relevant” “other
factor”, it is not sufficient to disturb the preponderance of evidence
supporting the conclusion that the Appellant’s 80% share was not unreasonable.
[76] The second of the named criteria under
subsection 103(1.1) is the “work performed by” any of the non-arm’s length
partners relative to the work performed by the members of the partnership.
Here, it is an agreed fact that the partnership (in all three iterations)
employed a manager and a broker to handle its operations. Thus, as between Ethical
and the Appellant (or, even following the logic of the Respondent’s argument,
Venture), neither partner outstripped the other in terms of work done; both
relied entirely on the partnership’s employees to carry out the work of the
partnership. As mentioned above, Continental Bank makes clear that a
valid partnership may exist even where its management is given to a managing
partner; thus, the fact that the day-to-day operations of the Appeal
Partnership were delegated to qualified employees is not sufficient in itself
to bring the Appellant within the ambit of subsection 103(1.1).
[77] Counsel for the Respondent also referred to
the Appellant’s having known about the loss prior to his acquisition of
Venture’s interest and his not having been a member of the Original Partnership
under the tenure of which the $6-million loss was accumulated.
[78] Assuming these are “relevant” “other
factors”, I am not persuaded that these facts render unreasonable the
Appellant’s 80% share. First of all, if the jurisprudence is any indication, it
is hardly out of the ordinary for an in-coming partner to have been aware of
accumulated partnership losses prior to joining the partnership; there is
nothing in the case law to suggest that it is enough in itself to trigger the
application of subsection 103(1.1). To the extent that such knowledge implies
the Appellant was motivated by a potential tax benefit, that is not one of the
named criteria under subsection 103(1.1) and in any event, his tax motivations
in acquiring Venture’s interest were found above to have been properly balanced
with an ancillary profit-making motive and not to have influenced the
allocation of their share proportions. Finally, as also noted above, the allocation
of partnership losses depends on who is a member of a validly constituted
partnership at the end of the partnership’s fiscal year, not when such losses
might have been accumulated. There is no question that the Appellant and
Ethical were members of the validly constituted Appeal Partnership at the end
of 2003. For the reasons set out above, the evidence is not there to justify
the application of subsection 103(1.1) to the Appellant’s situation.
[79] All in all, I agree with counsel for the
Appellant that section 103 has no application to the present case and that the
effect of the Minister’s interpretation of these provisions is to “… reallocate
partnership loss from the December 31st partners, Ethical and [the
Appellant], back to the pre-December 18th partners, Ethical and
Venture, even though Venture had ceased to be a partner as of [December 18,
2003]”. Nothing in subsection 103(1) or
subsection 103(1.1) permits the allocation of a partnership loss to a former
partner. To hold otherwise would be contrary to subsection 96(1) to which, as
counsel for the Appellant noted, there is a proposed amendment that would
permit the kind of allocation argued for by the Respondent in the present
matter.
[80] For the reasons set out above, the appeal of
the 2003 taxation year is allowed, with costs, and the reassessment is referred
back to the Minister of National Revenue for reconsideration and reassessment on
the basis:
1. that the
Appellant is entitled to a partnership loss, as claimed, in the 2003 taxation
year on the basis that he was a member of a valid partnership that came into
existence on December 18, 2003 and further, that the Minister of National
Revenue was not justified in making an allocation of a partnership loss under
section 103; and
2. that the Appellant is entitled to a
childcare deduction of $16,000; and
3. with respect to the 2003 taxation year,
the Appellant did not earn business income of $754,787 from the disposition of
share of 360networks.
This Amended Judgment and Amended Reasons
for Judgment are issued in substitution for the Judgment and Reasons for
Judgment dated August 3, 2010.
Signed at Ottawa, Canada, this 6th day of October,
2010.
“G. A. Sheridan”
Email this Content