Kenneth W. Mahon v. Minister of National Revenue, 91 DTC 878, [1991] 1 CTC 2543 (TCC)

Margeson, T.CJ.:—This appeal arose as a result of the Minister’s disallowance in the year 1981 of a reported loss of $20,448 as the appellant's share of the loss of North Vancouver Centre Developers, Limited Partnership, of which the appellant argues he was a partner for the taxation year ending December 31, 1981.

In the pleadings reference is made also to the reported gain of the taxpayer in 1982 and the Minister argued that there was no gain since he was not a partner. However, it was agreed at the outset that I would not deal with the 1982 taxation year as in effect it would be to increase the assessment and so the appeal with respect to 1982 is dismissed.

The appellant argued that he was a partner in the North Vancouver Centre Developers, Limited Partnership, hereinafter referred to as partnership" and as such was entitled to deduct from his income in the year 1981 his share of the loss.

The Minister's position is that the appellant was not a partner during the year 1981 and therefore cannot claim any loss.

The Minister relies upon the provisions of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), namely: sections 3, 4 and 9; subsection 96(1); paragraph 18(1)(a) as they read for the year 1981 as well as sections 2, 3, 51, 64, 65, 70, 71 and 75 of the Partnership Act, R.S.B.C. 1979,

c. 312.

The sole question for determination by me is whether or not the appellant was a "partner" under the Income Tax Act on December 31,1981 as to enable him to be advantaged by the provisions of section 96 of the Income Tax Act.

Mr. K.W. Mahon gave evidence before me. He is a chartered accountant and in 1981 reviewed the private offering memorandum of the partnership including a letter from the accountants settin out certain tax implications of the partners which also included a schedule of limited partners contributions; projected financial information; mortgage financing information; pro forma balance sheet; projected development and financing costs; projected partner ship income allowable to the limited partners; projected cash flow for the dental development part of the project and notes on the assumptions used for the financial and tax information.

He considered the basic purpose of the project which was to construct the residential portion of the development consisting of 56 units. Each limited partner would receive his pro rata share of the net rents.

On December 28, 1981, he subscribed to the subscription agreement for 1054 units in the Limited Partnership representing the Strata Lot described as 1103 and paid the sum of $6,587.50 to Adera Realty Corporation Trust Account as an agent for the partnership. He also executed a note for $79,050. He also gave evidence that he paid a further amount of $19,762.50 on January 27,1982 and another payment of $15,810 On March 10, 1982.

His position was that he had no control over the General Partners, but did say that the concrete high rise was done and through March 1982 the general contractor was proceeding in a normal manner. By May 1982 he first heard of difficulties regarding the liens against the property and that the lenders would not advance further funds until these were cleared up. He and other limited partners realized they had a considerable financial exposure that they had not contemplated when they became involved, they wanted to know how to get out of it and they retained legal counsel for such purposes.

With the help of their solicitors they were able to impress upon the general partners that since they had not complied with all aspects of the agreement that the limited partners may have been legally exposed to further liability than they should have been, and a negotiated settlement was reached with the general partners to allow Mr. Mahon and others to get out.

By way of a letter sent to Adera Realty Corporation and North Vancouver Centre, Limited Partnership, on June 23, 1982 Mr. Mahon released the partners in consideration of the return of the funds that he had paid and in accordance with section 75 of the Partnership Act of British Columbia. Exact contents of the letter are as follows:

June 23, 1982

Adera Realty Corp., and North Vancouver Centre Limited Partnership c/o 701-900 West Hastings Street Vancouver, BC.

Dear Sirs:

Re: North Vancouver Centre Limited Partnership

I have not received notice of acceptance of my subscription as required by Paragraph 4 of the form of subscription. I also understand that the partnership certificate has not been amended in accordance with Section 65 of the Partnership Act to reflect my admission as a limited partner. I also understand that by reason of the filing of various liens against the title to development, it will not be possible for title to the strata lots to be conveyed nor for the financing to be perfected as provided in the Offering Memorandum.

I am therefore entitled to the return of the funds and promissory note which I delivered with the form of subscription; and I hereby demand the repayment of the funds and the delivery of the note forthwith.

Pursuant to Section 75 of the Partnership Act, I hereby renounce my interest in the profits and other compensation by way of income from the business of the partnership.

In consideration of the return of the said funds and promissory note to me, I hereby release the four general partners from any liability to me in connection with the partnership.

Yours very truly,

Kenneth W. Mahon

On June 24, 1982, his money was refunded to him.

The appellant gave evidence that the arrangement was not a sham and that as of December 31, 1981, he believed he was a partner in association with others with a view to earning a profit until 1982 when he got his money back.

In cross-examination he admitted that when he found out he was not on the certificate as a Limited Partner, he did nothing about getting his name on as he wanted out at that point. He agreed that the partnership was earlier referred to as Dentco Operations Building. He did not look at earlier financial statements but he said he must have been familiar with them because they were the basis for the deduction claimed in 1981. He did not know when the partnership got the property but assumed that it had good title to it.

He admitted that he did not pay his capital contribution to the partnership name itself but paid it to what he considered to be their agent, and he felt it was legitimate.

He agreed that on the financial statements the contribution from he and the other limited partners was still set up as a receivable but he felt that with his cash and promissory note contributions he had complied with the agreement that he had signed.

He was referred to the increase in appraisal of the property but said he did not know about it but felt that the project was a viable one, and whether or not it needed more equity to be viable as the Minister suggested was another issue as he said.

According to him there was no specific clause in the agreement allowing him to extricate himself from it. He admitted that on November 18,1982 the project went into receivership and that one of his accounting partners became receiver manager. Further, he admitted to owning shares in Adera Realty through Adera Construction who was the 50 per cent shareholder of Adera Realty. He also owned shares in Adera Financial Realty.

The cross-examination further disclosed that according to the financial statements Adera Financial Corporation Ltd. had a mortgage against the partnership property for $850,000 at prime plus six per cent plus $150,000 bonus. The partners were all dentists he said. He admits he did not receive a unit certificate from the partnership. Further, he says that it turned out to be a financial disaster for the general partners and for the limited partners but not for him. However, in redirect he said that when he signed the subscriber's agreement he had no reason to believe it would fail.

Appellant's Position

The appellant argues that the only issue before me is whether or not the taxpayer was a partner of the partnership on December 31, 1981. He says there is no definition of partner under the Income Tax Act but the Partnership Act of British Columbia defines the term "partnership" under section 2. He further refers to the Interpretation Bulletin No. IT-90 which generally says the same thing.

The appellant says that in order to be a partner the agreement need not be in writing. One need only to have a relationship between persons carrying on business with a view to profit. There was an elaborate partnership agreement. There is evidence of the partnership. They refer to themselves as partners, it sets out the purposes and powers of the partnership, it refers to profits and how the property is to be divided among the limited partners. The document sets out the requirements for a limited partner and Mr. Mahon did all he had to do under section 3 of the subscription agreement and immediately was accepted as a partner by the agent on behalf of the general partners who signed the acceptance the same day as Mr. Mahon signed the agreement.

The appellant says that money was paid to the general partners’ agent Adera Realty Corporation and a note was also given and all the requirements of the subscription agreement were met as per section 3 and 6 of the agreement. He says that by December 31, 1981, he had met all the requirements of the agreement and he was bound by the agreement and the general partners were bound to him. He refers to article 10, paragraph 10.1 of the partnership agreement and directs us to that as the authority for one limited partner having power of attorney for all the others. He says the appellant made a further contribution on January 27, 1982 by cash and a further one on March 10, 1982 and he obviously felt that it was a going concern with the ability to earn a profit, and he continued to be a partner after December 31, 1981 and according to the documents, the partnership was still going as late as December 14, 1987 as a change of registered office was filed with the Registrar of Companies for British Columbia shown by Exhibit R-3.

The appellant argues that when the partners discovered the problems, they took all steps to protect themselves. They felt that the general partners had breached the agreement and there would be further breaches and there was nothing wrong with that and because they acted after December 31, 1981, as they did and even their actions on June 23, in sending the letter under section 75 of the Partnership Act did not change that, which was after the fact for this case having the important date as December 31, 1981.

The appellant says that the financing was arranged for the limited partners, each strata lot was assigned to each Limited Partner so he could mortgage his unit whenever the title was conveyed to the Limited Partner, which could not be done until the building was completed and the plan deposited in the Registry and the lot surveyed. This could not have been done by June 30, 1982 because Mr. Mahon was not on the agreement at that point. This did not mean that he was not a partner on December 31, 1981. When the limited partners found that the project was not going ahead, that the general partners could not deliver the strata lot and the whole project was about to collapse they took action to protect themselves.

It is pointed out by the appellant that they could have acted otherwise to protect themselves such as suing for damages, they could have taken action to have the certificate completed as was required to comply with the limited partnership requirements of the Partnership Act but they were going in another direction at that point as they wanted out not in and they looked around to see how they could get out. This, they argued, did not affect their status as partners on December 31, 1981. Even if the terms of the statute and the agreement had not been complied with to make them limited partners on December 31, 1981 so as to give them the benefit of the statute as limited partners, they were still partners under the Income Tax Act.

The appellant further argues that under the agreement he had only to pay $26,350 by December 31 and he had paid $85,637.50 including the promissory note and by January he had paid up all of his agreed-upon capital contributions of $105,400 which was not due until February 28,1982 and the balance under the agreement was not due till June 30, 1982 and by that time he was out of the agreement. He says he had nothing else to do under the agreement.

Further, he says there is no evidence to support a sham or conspiracy agreement among all the limited partners to get a tax reduction as suggested by the Minister.

The appellant refers to the case of M.N.R. v. Shields, [1962] C.T.C. 548; 62 D.T.C. 1343 and distinguishes it from the present case because he says there was an estoppel in that case where the taxpayer had filed statutory declarations saying that he was the sole proprietor of the business under the Partnership Registration Act and then made an agreement with his son, who was 16 years of age and attending school, purporting it to be a partnership agreement for income tax purposes.

The Court held it to be a mere simulate agreement and that the parties never acted on it and it did not govern their transactions, and there was no intention so to do.

The appellant further distinguishes Slingsby Manufacturing Co. v. Geller (1907), 6 W.L.R. 223 (Man. C.A.) by arguing that it merely stands for the proposition that there is no limited liability until the party complies with the Act and that does not affect the situation in the case at bar.

Respondent's Position

The position of the Minister is that there was a subscription agreement and signatures but it was voidable, conditional, and has no effect for tax purposes. He says it is not the same situation as in Shields, supra, but (obviously from his argument) is implying that the parties got together and put up the so-called agreement in such a way that if the project did not work out that they would get out of it and save taxes.

He says that in this case the sole effect of the partnership is that Mr. Mahon gets a tax deduction. He implies from Shields, supra, that that is not sufficient for income tax purposes to establish a partnership by the mere production of a partnership deed. It must be shown that the parties thereto acted on it and that it governed their transactions in the business being carried on.

The Minister argues further that the evidence shows that the parties did not act on the agreement and that they did not govern their transactions in the business being carried on for the following reasons:

(1) Under the agreement the appellant did not pay in the proper amount but only part of it and it was not paid to the partnership as required. It was paid to Aidera in trust and was recorded in the financial statements of the partnership as a receivable.

(2) He says that the agreement required the general partners to put the names of the new limited partners in the Registrar maintained by the general partners and to deliver the unit certificate to the subscriber. This was not done he says.

(3) Title to the strata lot was not transferred in accordance with the agreement.

(4) The return of capital was not done in accordance with the agreement which required that all debts be paid relative to the rental development activities or there remained sufficient assets to pay them.

(5) Mr. Clow, the person who signed as agent for the general partners may not have had authority to do so and it was not clarified by the appellant.

The Minister argues that the partnership is a creation of statute, there is none at common law. I presume he is referring to a partnership with limited liability (see Lindley on Partnership, 7th ed., page 229). He then refers to various sections of the Partnership Act, supra, to point up the fact that if you do not comply strictly with the statute you are not a partner. Again, I presume he is referring to a Limited Partner.

He says the appellant should have known that these sections have to be complied with and if you enter into a partnership for proper purposes that you would see that they were done. His position is that the appellant is now free of the liability as a general partner by virtue of his letter of June 23, but he is now caught up by the Income Tax Act as he is not a partner thereunder. He argues that if there is no liability by Mr. Mahon how can there be a loss. He refers to Slingsby, supra, and by inference I suppose he is suggesting that Mr. Mahon was a creditor and not a partner as that was the other scenario suggested in that case.

He argues that the partnership agreement here was treated as voidable by all parties. The general partners let the limited partners out for no reason and readily agreed to return the money so Mr. Mahon could get the loss. If section 75 of the Partnership Act shows anything, it shows that he was not a general partner, a limited partner or any partner and was not liable for any loss after he sent the letter of June 23, 1982.

Analysis and Decision

As indicated earlier, the sole issue to be determined here is whether or not the appellant was a partner under the Income Tax Act on December 31, 1981 when he claimed his share of the partnership loss of $20,448. Section 96 of the Income Tax Act does not define partnerships and as pointed out in Interpretation Bulletin IT-90, even the position of the Minister is that reference should be made to the provincial law. In this case the applicable law is the Partnership Act of British Columbia, R.S.B.C. 1979, c. 312.

Section 2 of the Act defines partnership. "(1) Partnership is a relation which subsists between persons carrying on business in common with a view of profit".

Section 3 sets out rules for determining whether a partnership does or does not exist. The list is not intended to be exclusive or exhaustive because the section says". . . regard shall be had to the following rules”. This section must surely be looked at in light of the more general section 2 and therefore the various rules are offered as guide posts only. We must look to the facts in each case, and as pointed out in M.N.R. v. Shields, supra, the mere presence of an agreement does not conclude the matter and it must be shown that the parties acted on it, and that it governed their transactions in the business carried on. Corollarily speaking I would think that the mere absence of an agreement would not prevent the finding of the existence of a partnership.

In the case at bar we must look to the state of facts as they existed on December 31, 1981. Was there a partnership in existence of which Mr. Mahon was a member? Further, it is not necessary to find a limited partnership or that Mr. Mahon was a limited partner and entitled to the protection of the provisions of the Partnership Act as to liability but only that he was a" partner".

The facts before me warranted by the evidence of the appellant and in many respects substantiated by the documentary evidence, satisfy me that as of December 31, 1981, there was an executed, elaborate partnership agreement in existence in fact in which Mr. Mahon was described as a partner, which is some evidence of a partnership. Further, they refer to themselves as partners, it sets out the purpose of the partnership, how profits are to be divided among the partners, it refers to the partnership property, it sets out the requirements of limited partners, it establishes a schedule for the remittance to the partnership of the capital of the members, conveyance to the limited partners of the units of property, how the assets might be dealt with by the general partners, how profit and loss is to be dealt with and in specific terms governs the relationship between the general partners and the limited partners, so called.

The document was signed by the appellant and accepted by the agent for the general partners, so designated by the signature of the agent on the document.

In furtherance of the agreement and in compliance with the terms of the agreement, Mr. Mahon says he paid moneys to the agent for the partnership and complied with those terms of the subscription agreement and considered himself to be a partner, and obviously believed himself to be a limited partner at that point, bound by all the terms of the agreement and that the general partners were bound also. He believed he had legal rights and obligations under the agreement and was entitled to share in the profits of the partnership.

The Minister says he did not comply with the terms of the agreement by not paying in the proper amount of money as required. But even if he did not, why would that change the document from an agreement to a non-agreement? Just because some of the terms of the agreement were not complied with that would not void the agreement although it might very well give rise to legal rights vis-a-vis the parties. In any event, I am satisfied that the appellant by December 31, 1981 had paid in all amounts required to be paid under the agreement. The agreement did not call for cash to be paid and when you add up the cash contributions and the promissory note contributions, I am satisfied he complied.

The Minister further argues that the moneys were not paid to the partnership but to Aidera in trust and therefore the agreement was not complied with. I see no merit to this argument no more than to suggest that in a property transaction that a deposit paid to a real estate agent under a purchase and sale agreement was not paid to a real estate agent on behalf of the purchaser under the terms of the agreement. The appellant stated it was so paid and there was no evidence, only innuendo, that the money was really to be held by the agent for the benefit of the appellant in the event that something went wrong with the project. I accept the evidence of the taxpayer that the funds were paid in trust for the partnership and even though the funds were referred to in the financial statements as an account receivable, that did not change their character from what the appellant testified they were to something else.

The Minister says that the title to the strata lot was not conveyed to the taxpayer in accordance with the agreement and therefore there was no agreement in effect on December 31, 1981. The logical conclusion to be drawn from that argument would be that the agreement was not a binding agreement until all the terms of it were complied with. That would surely only be so if the various terms were prerequisites to the formation of the agreement and they were clearly not so.

It is obvious that the property could not be conveyed until after the plan and survey were done and the balance of the money to be paid under the agreement was not until June 30. Does that mean that there could be no partnership agreement with Mr. Mahon until June 30, 1982? Surely not!

The Minister argues that the return of capital was not done in accordance with the agreement and therefore there was no agreement, but that was not done until June 24,1982 and we have to decide whether there was an agreement in effect on December 31, 1981.

The Minister interprets the Partnership Act so as to require a strict compliance with it so as to create a partnership. As earlier pointed out, the Partnership Act only generally tries to define partnership and surely you can be a partner at common law even though you may not have satisfied all the requirements of the Partnership Act so as to enable you to take advantage of its limited liability aspects. I cannot escape the conclusion that the Minister is confusing the requirements of a "limited partner", a creature of statute, with a partner, who can be defined with reference to the general provisions of the Partnership Act and the common law.

The Minister argues that the appellant would have seen that all the requirements of the general partners were complied with if he seriously considered himself to be a partner. But surely that begs again the fact that these duties were only imposed upon the general partner after the completion of the agreement and does not operate retroactively so as to make void on December 31, 1981 an agreement otherwise valid.

Again, he argues that since the appellant is free of the agreement as a result of his letter of June 23, 1982 and his liability as a partner that that letter operates retroactively to December 31, 1981 and the appellant is caught by the Income Tax Act so that he is not a partner thereunder.

He argues that once the letter was sent he no longer had any liability as a partner, a general partner or as a limited partner by virtue of section 75 of the Act. I do not have to decide whether this is a correct interpretation of section 75 or not because again that happened after June 23, 1982 and cannot have any effect on whether or not he was a partner on December 31, 1981.

I take it from the respondent's argument before me that the letter of June 23, 1982 was evidence that the appellant really did not believe he was a partner in 1981, but surely that only goes to the question of credibility of the taxpayer as being contradictory to the evidence given before me and to be weighed by me with all the other evidence in deciding whether or not he was a partner in 1981.

However, I view the actions of the taxpayer in June 1982 as nothing more than an attempt by him to get out of the partnership in any way that he could including any arguments he or his counsel might have made since the general partners had not complied with all of their requirements to make him a limited partner, that he might be exposed to unlimited liability and might have a course of action against them and was able to convince the general partners to let him out on a very favourable basis. Again, those actions taken in 1982 do not affect the position of the appellant at the relevant time for this appeal.

The respondent also indicated that the appellant suffered no loss in 1981 since he got all his money back in 1982, so as to suggest an unjust result for him. But I see no provision in the Income Tax Act to disentitle him to the loss claimed in 1981 if he were a partner.

The respondent urged me to consider the trial decision in Slingsby, supra, which decided that because the parties intended to establish a limited or special partnership and failed to do so, there was no general partnership because there was a lack of intention to bind the partners personally. However, the Appeal Court held otherwise and said that the only part that failed was the attempt to limit Rosenthol’s liability, that there was no requirement to find a power to bind the co-partners in order to establish a general partnership. The Appeal Court there looked at more than the declaration and found that a partnership was verbally agreed to apart from the declaration which failed. A fortiori, here, there is satisfactory evidence to establish a general partnership apart from the written agreement.

The case of M.N.R. v. Shields, supra, does not assist the respondent because try as he might, the respondent was unable to extract any evidence from the appellant that the agreement here was a mere simulate one, and not a reality.

In the result I am satisfied that the appellant was a partner in the "partnership" on December 31, 1981, and that he was entitled to a capital loss of $20,448 for that year, the appeal in that regard is allowed with costs and the matter referred back to the respondent for reassessment based upon that finding.

The appeal with respect to the 1982 taxation year is dismissed.

Appeal allowed in part.