Date: 20090210
Docket: A-69-08
A-70-08
Citation: 2009 FCA 33
CORAM: NADON
J.A.
SHARLOW
J.A.
PELLETIER
J.A.
BETWEEN:
A-69-08
SYLVANO TESAINER
Appellant
and
HER MAJESTY THE QUEEN
Respondent
A-70-08
MARY LYNNE TESAINER
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
SHARLOW J.A.
[1]
This
is an appeal of a judgment of Justice McArthur of the Tax Court of Canada
dismissing the appeals of Silvano Tesainer and Mary Lynne Tesainer from
assessments made under the Income Tax Act, R.S.C. 1985, c. 1 (5th
supp.), for 1992, 1993 and 1995. The issue in the income tax appeals was
whether an amount received by Mr. Tesainer and Ms. Tesainer in settlement of a
legal action resulted in a taxable capital gain. Justice McArthur concluded
that it did. The issue in this appeal is whether that conclusion is correct in
law.
[2]
Fenix
Development Limited Partnership (“Fenix”) was a limited partnership. The
general partner was Fenix Developments G.P. Inc. There were 93 limited
partners. In 1988, Mr. Tesainer and Ms. Tesainer purchased limited partnership
units of Fenix in a private placement described in an offering memorandum dated
August 16, 1988. Mr. Tesainer and Ms. Tesainer together incurred a cost of $100,000
for their limited partnership units.
[3]
It
is undisputed that the limited partnership units acquired by Mr. Tesainer and
Ms. Tesainer comprised an “interest in a partnership” as that term is used in
section 53 of the Income Tax Act. It is also undisputed that for the
purposes of this case, nothing turns on the fact that Fenix was a limited partnership
rather than a general partnership.
[4]
The
intended business of Fenix was the development and operation of commercial real
estate. When the offering memorandum for limited partnership units was issued
in 1989, Fenix had commenced the process of acquiring property on which it
intended to build a project called Meadowpines. Meadowpines was never completed
because in 1989, the promoters of Fenix ran into difficulties with the Ontario
Securities Commission which led to the loss of the Meadowpines property and the
failure of the business. After 1991, Fenix ceased to be active in the business
for which it was formed. In 1995, a special resolution was made to dissolve
Fenix. The parties agree that for income tax purposes, Fenix was regarded as
having ceased to exist in 1995.
[5]
It
was asserted by Mr. Tesainer and Ms. Tesainer, and not questioned by the Crown,
that all of the capital of Fenix was lost when its business failed, leaving
substantial unsatisfied creditor claims. The record contains little financial
information about Fenix, but for the purposes of this appeal I have assumed
that all of the partnership capital was lost before 1992.
[6]
In
1992, an action was commenced against the lawyers who had been retained to
advise Fenix on matters of securities law in relation to the private placement
and the offering memorandum. There were 75 named plaintiffs. One was Fenix
(named as “Fenix Developments G.P. Inc., on behalf of Fenix Development Limited
Partnership”). The other 74 were individuals, including Mr. Tesainer and Ms.
Tesainer. All of the plaintiffs were represented by the same counsel.
[7]
The
individual plaintiffs, including Mr. Tesainer and Ms. Tesainer, were holders of
limited units of Fenix. As indicated above, only 74 of the 83 limited partners
were individual plaintiffs but all of the partners of Fenix were represented in the
lawsuit through Fenix, which was also a plaintiff.
[8]
The
claims against the lawyers are summarized in paragraph 1 of the statement of
claim, which reads as follows:
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1. The plaintiffs claim
as follows:
(i)
the
individual plaintiffs claim the amount of their investment, being the total
of $3,261,000, in accordance with Schedule “A” attached hereto [Schedule “A”
lists the individual plaintiffs and the amount invested by each of them to acquire
limited partnership units; Mr. Tesainer and Ms. Tesainer are shown as having
invested $100,000];
(ii)
the
plaintiff Fenix Developments G.P. Inc., on behalf of Fenix Developments
Limited Partnerships, claims:
(a) in the alternative
to the claim in sub-paragraph (i), damages in the amount of $3,261,000; and
(b) in any event,
damages in the amount of $3,500,000 in respect of liabilities incurred in
connection with the Meadowpines Project as more particularly described below;
and
(i)
all
of the plaintiffs claim:
(a) lost profits in
the amount of $4,135,000;
(b) punitive damages
in the amount of $5,000,000;
(c) pre and
post-judgment interest in accordance with the Courts of Justice Act; and
(d) their costs on a
solicitor and client basis.
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[9]
It
is alleged in the statement of claim that the lawyers were negligent and in
breach of their legal obligations to Fenix and to prospective and actual
investors (i.e., the individual plaintiffs) when they gave erroneous legal
advice, when they failed to advise Fenix and the individual plaintiffs on a
timely basis when they knew or ought to have known that the legal advice they
gave was wrong, and when they dealt with the Ontario Securities Commission in a
manner that put their own interests in conflict with their duty to Fenix and
the individual plaintiffs.
[10]
It
is also alleged in the statement of claim that, but for the negligence and
other wrongful conduct of the lawyers, the private placement would not have
closed when it did, there would have been no breach of the securities laws and no
trouble with the Ontario Securities Commission, the business of Fenix would not
have failed but would have succeeded and resulted in profits that would have
been shared by the individual plaintiffs, Fenix would not have lost its capital,
and the individual plaintiffs would not have lost the value of their investments
in Fenix.
[11]
The
Crown did not dispute that the allegations in the statement of claim, if true,
would have established for the individual plaintiffs a cause of action against
the lawyers that was independent of the cause of action of Fenix against the
lawyers. Therefore, for the purposes of this appeal I will assume that independent
causes of action could have been made out on the same factual foundation.
[12]
The
action was settled in 1995. The terms of the settlement agreement are
confidential. It is sufficient for the purposes of this appeal to say that all
of the claims were settled by the payment of a sum of money in trust for the
individual plaintiffs. That amount, net of a deduction for legal fees, was
divided among the individual plaintiffs in proportion to the amount they had
paid to acquire their limited partnership units. Mr. Tesainer and Ms. Tesainer
received a total of $98,300 of the settlement payment.
[13]
Mr.
Tesainer and Ms. Tesainer took the position, when filing their income tax
returns, that the settlement payment was not taxable as income or as a capital
gain. However, they were reassessed on the basis that the settlement payment should
be treated for income tax purposes as though it were a distribution of capital
by Fenix. On that basis, by the combined operation of subparagraph 53(2)(c)(v)
and paragraph 98(1)(c) of the Income Tax Act, the payment gave
rise to a taxable capital gain taxable in the hands of Mr. Tesainer and Ms. Tesainer.
[14]
Pursuant
to subparagraph 53(2)(c)(v) of the Income Tax Act, a distribution
of partnership capital is treated for income tax purposes as a reduction in the
adjusted cost base of the partnership interest in relation to which it is made.
If the resulting adjusted cost base of the partnership interest is a positive
amount, the only tax consequence of the distribution is to increase the capital
gain (or reduce the capital loss) that may arise in future if, for example, there
is a sale or other disposition of the partnership interest. However if, as in
this case, the capital distribution reduces the adjusted cost base of the
partnership interest to a negative amount, paragraph 98(1)(c) of the Income
Tax Act requires the negative amount to be treated for income tax purposes
as a gain on the disposition of the partnership interest.
[15]
The
payment in issue in this case was not a distribution of partnership capital.
There was no change in the corpus of the partnership capital of Fenix, or the
relative interests of the limited partners of Fenix (see Stursberg v. M.N.R.
(1993), 155 N.R. 366, [1993] 2 C.T.C. 76, 93 D.T.C. 5271 (F.C.A.). It was a payment made by the
lawyers to the individual plaintiffs, and not to Fenix. Although it was paid in
settlement of all of the claims of Fenix and the individual plaintiffs against the
lawyers, there is no suggestion and no evidence that any part of the settlement
was paid to or for the benefit of Fenix. There is no basis for concluding that
an amount was owed to Fenix and paid to the individual plaintiffs at the
direction or with the concurrence of Fenix.
[16]
Although
the payment was not actually a distribution of partnership capital, the Crown
argues that it should be treated as such for income tax purposes because it is
intended to replace a distribution of partnership capital. This is a reference
to the surrogatum principle discussed in Tsiaprailis v. Canada,
[2005] 1 S.C.R. 113. Justice McArthur accepted that argument because, as he
explained at paragraph 17 of his reasons:
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[…]
(i) it replaced the Appellants’ capital investment […]; (ii) the Appellants’
lawsuit was for the amount of their investment; (iii) they claimed the return
of their $100,000 and received $98,300; (iv) the documentary evidence clearly
points to it being a return of capital; and (v) the partnership agreement was
in reality at an end in 1991.
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[17]
In my
view, the Crown’s argument is based on a misunderstanding of the surrogatum
principle, and Justice McArthur erred in law in accepting it. The settlement
payment in this case cannot be said to have replaced a distribution of
partnership capital because, as a matter of law, it did not and could not have
discharged any claim of the individual plaintiffs against Fenix, much less a
claim for a distribution of partnership capital.
[18]
The
claim of the individual plaintiffs against the lawyers, as described in
paragraph 1(i) of the statement of claim, is quantified by reference to the
amounts they invested in Fenix. However, it does not follow that the settlement
payments must be characterized as a return of the invested amount, or an amount
paid in substitution for that amount. The transaction that occurred in this
case did not and could not serve the legal or practical function of a distribution
of partnership capital.
[19]
The
validity of that conclusion is demonstrated by considering what would have
happened if the action against the lawyers had been settled by the payment of
an amount to Fenix. In that event, Fenix might have determined that it should
make a capital distribution to the limited partners, but no such distribution
could have been made without first settling any outstanding claims of the
creditors of Fenix, and then the distribution of any remaining amount would
necessarily have been shared among all of the limited partners in accordance
with the distribution rights (except to the extent those rights were waived). That
is not what happened in this case. What happened was that each individual
plaintiff received an amount in settlement of his or her personal claim for damages.
[20]
For these
reasons, I would allow this appeal with costs in this Court and in the Tax
Court of Canada. I would set aside the judgment of the Tax Court and allow the
income tax appeals of Mr. Tesainer and Ms. Tesainer, and refer this matter
back to the Minister for reassessment on the basis that subparagraph 53(2)(c)(v)
does not apply to the settlement payments.
“K.
Sharlow”
“I
agree.
M. Nadon J.A.”
“I
agree.
J.D. Denis Pelletier J.A.”
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