Lamarre Proulx J.T.C.C.:—The appellant is appealing by way of the informal procedure from the assessments of the Minister of National Revenue (the ’’Minister") for the years 1990 and 1991.
The questions at issue are whether a partner may draw a salary from a partnership and whether the proportion in which the members of the partnership shared the profits and losses of the partnership was reasonable. The legislative provisions that are more particularly of application are subsection 24(6) of the Partnership Act of Ontario and subsection 103(1.1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").
The assumptions of fact made by the Minister to reassess the appellant are described at paragraphs 3, 4 and 5 of the reply to the notice of appeal (the "reply") and are the following:
3. In computing income for the 1990 and 1991 taxation years, the appellant deducted the following amounts as net losses from a partnership operating as Creative Skate & Dance Wear, (the "partnership"):
|Net (Loss) Income from|
|Salary to spouse||(6,880.95)||(7,340.87)|
|ADD or Ded||Adjustments|
|for tax purposes|
|- Depreciation per|
|- Depreciation claimed|
|for tax purposes||(5,596.00)||13.9.0299|
|Net Losses claimed||$(14,149,98)||7,556.42|
4 By notices of reassessment dated February 26, 1993, in respect of the assessments of the 1990 and 1991 income tax returns, the Minister disallowed,
amongst other things, in the computation of income (loss) of the partnership, the amounts claimed as salary to his spouse and, redetermined the allocation of the partnership’s net profit and losses, based on a share of 50 per cent given to each partner.
5. In so reassessing the appellant, the Minister made the following assumptions of fact:
(a) the facts admitted herein;
(b) at all material times, Judith Ellen Archbold was the appellant’s spouse (the "spouse");
(c) at all material times, the appellant and his spouse, operated through a partnership, a business named Creative Skate & Dance Wear;
(d) the appellant and his spouse were the only members of this partnership;
(e) in accordance with chapter 370, subsection 24(6) of the Partnership Act of Ontario, no partner is entitled to remuneration for acting in the business;
(f) at all material times, the appellant had a full time job with the Federal Government of Canada;
(g) the spouse’s sole source of income for the 1990 and 1991 taxation years, was her drawings from the partnership;
(h) the initial capital investment in the partnership was made with a loan taken out by the appellant and his spouse;
(i) the appellant’s contribution to the partnership was as follows:
—to find or invest additional capital when needed;
—in the evenings, the appellant would, on average take one and a half to two hours to maintain the books and records, prepare stock orders, and pay the bills;
-after his daytime job, the appellant would, from 4:00 p.m. to 5:30 p.m., work at the store in sales and stocking;
(j) the spouse’s contribution to the partnership was as follows:
—from Monday to Friday, she would be at the business location designing and sewing the merchandise, taking care of sales, picking up supplies and seeing to the overall operations of the business;
(k) the appellant and his spouse would, on Sundays and evenings, set up sales tables at skating clubs and competitions;
(l) the partnership’s bank accounts are jointly held by the appellant and his spouse and they both have signing authority on them;
(m) when the workload of the business became too heavy for the spouse, they hired a part-time sewing machine operator, on contract basis, to help meet the demand;
(n) the appellant and his spouse agreed to share income from the partnership in order to reduce or postpone tax that might otherwise have been or become payable under the Income Tax Act.
The appellant testified on his own behalf. The business began as a sewing operation at home in 1982. In 1985 the spouses wanted to expand the business and by mortgaging the family house they borrowed an amount of $20,000.
With respect to paragraph 3, the appellant said that he did not agree that the amounts of $6,880.95 and $7,340.87 were "salary to spouse". He said that it was rather a distribution of profit. The appellant filed Exhibit A-3 entitled "codicil to partnership agreement dated January 1, 1982". This codicil was signed January 1, 1985. It shows the profit sharing agreement between the spouses as members of the partnership.
(8) Profit Sharing
Profits of the partnership will be allocated as follows:
"Judy Archbold"-Ten per cent commission from gross sales plus 30 per cent of the residual profits.
"Terrance Archbold'-Seventy per cent of residual profits after "Judy" has been allocated the ten per cent commission on gross sales.
Losses of the partnership will be borne entirely by "Terrance Archbold" and in all cases "Judy Archbold" will receive ten per cent commission from gross sales.
The appellant said that the amounts shown as salary in paragraph 3 of the reply were Judy Archbold’s ten per cent commission from gross sales. He said that these gross sales are shown under the heading "income" at page 3 of the balance sheet of the business (Exhibit A-2). However, the amounts shown as salary are not what should have been ten per cent of gross sales. They would be for the year 1990, $4,880.95 and for the year 1991, $4,537.17.
Subsection 103(1.1) of the Act reads as follows:
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.
The share of the profits and of the losses which may appear reasonable for a husband who draws his income from an employment and wishes to help his wife start a family business is not reasonable within the meaning of subsection 103(1.1) of the Act. In the context of the Income Tax Act, reasonable means reasonable business wise. The appellant himself stated that he would not have entered into the same agreement if he had been directed by business reasons and dealing at arm’s length. The Minister had assessed the appellant in allocating the losses of the partnership on a ratio of 50 per cent to each member. If we take into account the investment of capital having been made entirely by the appellant this allocation appears to be more than reasonable.
With respect to the respondent’s argument that a partner may not draw a salary in accordance with subsection 24(6) of the Partnership Act, I do not believe that this subsection is to this effect where there is an agreement express to the contrary between the partners. I quote section 24 of the Partnership Act:
24. The interests of partners in the partnership property and their rights and duties in relation to the partnership shall be determined, subject to any agreement express or implied between the partners, by the following rules:
1. All the partners are entitled to share equally in the capital and profits of the business, and must contribute equally towards the losses, whether of capital or otherwise, sustained by the firm.
2. The firm must indemnify every partner in respect of payments made and personal liabilities incurred by him or her,
(a) in the ordinary and proper conduct of the business of the firm; or
(b) in or about anything necessarily done for the preservation of the business or property of the firm.
3. A partner making, for the purpose of the partnership, any actual payment or advance beyond the amount of capital that he or she has agreed to subscribe is entitled to interest at the rate of 5 per cent per annum from the date of the payment or advance.
4. A partner is not entitled, before the ascertainment of profits, to interest on the capital subscribed by the partner.
5. Every partner may take part in the management of the partnership business.
6. No partner is entitled to remuneration for acting in the partnership business.
The introductory part of section 24 of the Partnership Act makes it quite clear that there is no legal impediment for a partner to draw a salary from a partnership and therefore on this ground the appellant succeeds for the amounts of salaries precedently determined.
The respondent’s allocation of the income and losses on a ratio of 50 per cent to each member has been found to be reasonable within the meaning of subsection 103(1.1) of the Act. Therefore the assessments are referred back to the Minister for reconsideration and reassessments on the basis that, for the amounts above mentioned, the salaries of a partner may be included in the calculation of income of the partnership and that the losses must be shared on a 50 per cent ratio.
The appeals are allowed without costs.