Docket: A-38-16
Citation:
2017 FCA 107
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CORAM:
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PELLETIER J.A.
WEBB J.A.
DE MONTIGNY J.A.
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BETWEEN:
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HER MAJESTY THE
QUEEN
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Appellant
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And
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JEFFREY N.
GREEN,
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YVES POTVIN,
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JONATHAN
RUBENSTEIN
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and IAN DIXON
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Respondents
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REASONS
FOR JUDGMENT
WEBB J.A.
[1]
This appeal raises the question of how the at-risk
rules that limit the availability of losses incurred by a limited partnership
apply when the partner of a limited partnership is another limited partnership.
The Crown had brought a motion for determination, under Rule 58(1)(a) of
the Tax Court of Canada Rules (General Procedure), SOR/90-688a, of the
following questions:
(a) In a two-tiered partnership structure,
where the top-tier partnership has no at risk amount in respect of the
lower-tier partnership at the end of a particular fiscal period, do business
losses incurred by the lower-tier partnership in the particular fiscal period
retain their character as business losses of the top-tier partnership, thus
available to be allocated to the partners of the top-tier partnership as
business losses (which would then be subject to the application of the at-risk
rules in the hands of the partners of the top-tier partnership)?
(b) If the answer to question (a) above is
no, does a limited partnership loss that the top-tier partnership has in the
lower-tier partnership flow through to the partners of the top-tier partnership
such that they have a limited partnership loss?
[2]
The Tax Court Judge answered the first question
in the affirmative and therefore, he did not answer the second question (2016
TCC 10).
[3]
The Crown has appealed from the Order of the Tax
Court Judge and for the reasons that follow I would dismiss the appeal.
I.
Background
[4]
A partnership, in the common law jurisdictions,
is the relationship that subsists between persons carrying on a business in
common with a view to profit (Backman v. Her Majesty the Queen, 2001 SCC
10, [2001] 1 S.C.R. 367 at para. 18; section 2 of the Partnerships Act,
R.S.O. 1990, c. P.5; section 2 of the Partnership Act, R.S.B.C. 1996, c.
348).
[5]
Since a partnership is a relationship, a
partnership is not a person at law. This is reflected in the Income Tax Act,
R.S.C. 1985, c.1 (5th Supp.) (ITA) as a partnership does not pay tax but rather
it allocates its income to its partners on a source by source basis (section 96
of the ITA).
[6]
Any doubt about whether a partnership, which is
not a person, would be recognized as a partner of another partnership for the
purposes of the ITA has been removed as a result of the provision of subsection
102(2) of the ITA:
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(2) In this
subdivision, a reference to a person or a taxpayer who is a member of a
particular partnership shall include a reference to another partnership that
is a member of the particular partnership.
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(2) Pour
l’application de la présente sous-section, la mention d’une personne ou d’un
contribuable qui est un associé d’une société de personnes vaut également
mention d’une société de personnes qui fait partie de la société de
personnes.
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[7]
In this case, throughout the years 1996 to 2009,
the respondents were limited partners in Monarch Entertainment 1994 Master
Limited Partnership (MLP). MLP was, during this time, a limited partner in 31
different limited partnerships (the PSLPs). Each PSLP incurred business losses
for the fiscal years from 1996 to 2009 which were allocated mostly to MLP and
then mostly by MLP to its limited partners (including the respondents). The
at-risk amount for 1996 to 2008, for the purposes of the ITA, of each of the
respondents in MLP was nil and for MLP in each of each of the PSLPs was also
nil. The respondents added the losses allocated to them by MLP over these years
to their limited partnership losses.
[8]
In 2009, as a result of a capital gain that was
allocated by MLP to its limited partners, the at-risk amount of the respondents
in MLP was increased and each respondent then claimed a portion of the accumulated
limited partnership losses in respect of MLP.
II.
Decision of the Tax Court
[9]
The Tax Court Judge acknowledged that the
provisions of the ITA are to be interpreted based on a textual, contextual and
purposive analysis (paragraph 25 of the reasons and paragraph 10 of Canada
Trustco Mortgage Co. v. Her Majesty The Queen, 2005 SCC 54, [2005] 2 S.C.R.
601). The Tax Court Judge concluded that the answer to the first question was
yes – the business losses incurred by the lower-tiered limited partnership (the
PSLPs) did retain their character as business losses in the top-tier limited
partnership (MLP) and could be allocated by the top-tier limited partnership
(MLP) to its partners as business losses.
III.
Issue
[10]
The issue in this appeal is whether the Tax
Court Judge was correct in determining that business losses could be flowed
through from one limited partnership to another limited partnership and then to
the partners of that second limited partnership retaining their character as
business losses throughout.
IV.
Standard of Review
[11]
The only issue in this appeal raises a question
of law and therefore the standard of review is correctness (Housen v.
Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235).
V.
Analysis
[12]
As noted above, partnerships (including limited
partnerships) are not persons and, except as provided in subsection 102(2) of
the ITA, are not taxpayers for the purposes of the ITA. Subsection 102(2) of
the ITA only applies for the purposes of Subdivision j of Division B of Part I
(sections 96 to 103 inclusive). Since partnerships are not persons and are not
liable to pay taxes under the ITA, the partners of the partnership are the
persons who will report the income of the partnership (in proportion to their
interest in the partnership and allocated to them on a source by source basis)
and will be liable for any taxes payable on such income, unless the partner is
another partnership.
[13]
The provision which allocates the income of a
partnership to its partners is section 96 of the ITA, which is set out in the
appendix. This section provides that a partner’s income is to be computed as if
the partnership were a separate person. Paragraphs 96(1)(f) and (g)
of the ITA provide that the source of income earned or loss incurred by the
partnership is maintained by allocating to each partner their share of income or
loss from each source of income or loss. The source of income is important for
the purposes of the ITA. As noted by the Supreme Court of Canada in Stewart
v. Her Majesty the Queen, 2002 SCC 46, [2002] 2 S.C.R. 645, at paragraph 5,
“[i]t is undisputed that the concept of a ‘source of
income’ is fundamental to the Canadian tax system…”.
[14]
If a taxpayer is a member of a limited
partnership, that partner’s ability to use their share of any losses realized
by that limited partnership is restricted as a result of the provisions of
subsection 96(2.1) of the ITA. Generally, the amount of the loss that may be
claimed is limited to the amount by which the at-risk amount of that partner in
that limited partnership exceeds the total of the amounts set out in paragraphs
96(2.1)(b)(ii), (iii) and (iv) of the ITA. Since the adjustments as set
out in paragraphs (b)(ii), (iii) and (iv) are not relevant in this
appeal, for ease of reference the restriction on claiming losses incurred by a
limited partnership will be described as the amount by which the losses exceed
the at-risk amount.
[15]
In this case the Crown focused on the
consequences under subsection 96(2.1) of the ITA that arise when the losses
exceed the at-risk amount. Paragraphs (c), (d) and (e) of subsection 96(2.1) of
the ITA provide that the amount by which the taxpayer’s share of the losses of
a limited partnership exceeds that partner’s at-risk amount in that limited
partnership:
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shall
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est à la fois :
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(c) not be deducted
in computing the taxpayer’s income for the year,
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c) non
déductible dans le calcul de son revenu pour l’année;
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(d) not be
included in computing the taxpayer’s non-capital loss for the year, and
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d) exclu du
calcul de sa perte autre qu’une perte en capital pour l’année;
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(e) be deemed to
be the taxpayer’s limited partnership loss in respect of the partnership for
the year.
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e) réputé être
la perte comme commanditaire subie par le contribuable dans la société de
personnes pour l’année.
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[16]
The Crown’s argument is that since subsection
96(2.1) of the ITA applies to a taxpayer who is a member of a limited
partnership and since MLP in this case will be a taxpayer for the purposes of
subsection 96(2.1) of the ITA, this provision will apply to MLP as a member of
the lower-tier limited partnerships (the PSLPs). As a result, each year that
the lower-tier limited partnerships (PSLPs) incurred losses, such losses would
be deemed to be the limited partnership losses of the top-tier limited
partnership (MLP). As such, according to the Crown, these losses would no
longer be business losses to MLP and would be effectively trapped in MLP as the
provision which would allow a partner to claim such losses in the future (if
the limited partnership later had income), is paragraph 111(1)(e) of the ITA.
Paragraph 111(1)(e) of the ITA is not in subdivision j of Division B of Part I
and only applies to taxpayers as determined for the purposes of section 111.
Since MLP is not a taxpayer for the purposes of section 111, MLP could not use the
limited partnership losses in the future. The allocation of limited partnership
losses by a partnership to its partners is not contemplated in section 96 of
the ITA.
[17]
As noted by the Tax Court Judge, the provisions
of the ITA are to be interpreted based on a textual, contextual and purposive
analysis (Canada Trustco, at para. 10). In this case, in my view, the
text of the provision should not be read in isolation. Rather the context and
purpose are important in interpreting the words that are used.
[18]
Since a partnership does not pay tax, the
purpose of section 96 of the ITA is not to determine the income of a
partnership for the purposes of determining the amount of tax payable by that
partnership. The purpose of section 96 is to ensure that any income or loss
realized by the partnership is allocated to its partners and that the source of
that income or loss is maintained to allow the members of that partnership to
identify the source of income or loss for the purposes of section 3 of the ITA.
[19]
The opening words of section 96 of the ITA state
that:
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96 (1) Where a
taxpayer is a member of a partnership, the taxpayer’s income, non-capital
loss, net capital loss, restricted farm loss and farm loss, if any, for a
taxation year, or the taxpayer’s taxable income earned in Canada for a
taxation year, as the case may be, shall be computed as if …
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96 (1) Lorsqu’un contribuable est un associé d’une société de
personnes, son revenu, le montant de sa perte autre qu’une perte en capital,
de sa perte en capital nette, de sa perte agricole restreinte et de sa perte
agricole, pour une année d’imposition, ou son revenu imposable gagné au
Canada pour une année d’imposition, selon le cas, est calculé comme si
…:
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(emphasis added)
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(je souligne)
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[20]
The words “as the case
may be” indicate that it is recognized that not all of the matters
listed (income, non-capital loss, etc.) will necessarily be applicable to all
members of a partnership. In particular, the general rule for determining
income is in section 3 of the ITA. This provision commences with the words “The income of a taxpayer for a taxation year …”.
Since a partnership is not a taxpayer for the purposes of section 3, this
determination or computation of income does not apply to a partnership.
[21]
Similarly, non-capital losses are defined in
subsection 111(8) of the ITA. The opening words of this definition are “‘non-capital loss’ of a taxpayer for a taxation year means
…”. Since a partnership is not a taxpayer for the purposes of section
111, this definition would not apply to a partnership and, therefore a
partnership, that is a member of another partnership, would not have a
non-capital loss as defined in subsection 111(8) and would not compute a
non-capital loss.
[22]
When the instructions in computing income and
non-capital loss contained in paragraphs 96(2.1)(c) and (d) of
the ITA are read in context, in my view, they again are only intended to apply
to taxpayers who are required to compute these amounts under sections 3 and
111, respectively. Since partnerships are not taxpayers for the purposes of
sections 3 and 111, these sections do not apply to partnerships.
[23]
It should also be noted that generally the ITA
provides that limited partnership losses will be deductible in the future if
the at-risk amount of the partner in the limited partnership increases.
However, the provision allowing the future deduction is paragraph 111(1)(e)
of the ITA which does not apply to partnerships since this deduction is only
available “for the purpose of computing the taxable
income of a taxpayer for a taxation year …”. It does not seem to me that
Parliament would have intended to apply the restriction on limited partnership
losses to partnerships (MLP) as members of another limited partnership (PSLP) but
deny such partnerships (MLP) the benefit of the deduction in the future if the limited
partnership (PSLP) should earn income resulting in an increase in the at-risk
amount of that partnership (MLP) in the limited partnership (PSLP). Therefore,
in my view, paragraph 96(2.1)(e) of the ITA would also not apply to a
partnership that is a member of a limited partnership.
[24]
The position of the Crown would require a
partnership (MLP) that is a member of another partnership (PSLP) to compute
income which would result in a blending of income and losses from various sources
into a single amount – the income or loss of the top-tier partnership (MLP) for
a particular year. Assume, for example, that the lower tier partnership (PSLP#1)
has the following sources of income for a particular year:
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Source
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Income (Loss)
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Business A
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$1,500
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Business B
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($800)
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Property
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$1,000
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[25]
In determining income as provided in section 3,
the income from each source is aggregated (paragraph 3(a)) and the loss
from each source is totaled and deducted from the aggregate income amount
(paragraph 3(d)). Therefore the income of the top tier partnership (MLP)
would be:
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Income from Business
A:
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$1,500
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Income from Property:
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$1,000
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Paragraph 3(a)
amount:
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$2,500
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Loss from Business B:
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($800)
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Income:
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$1,700
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[26]
The top-tier partnership (MLP) would have income
of $1,700 from the lower-tier partnership (PSLP #1) and this amount would be aggregated
with the income amounts from all of the other partnerships of which the
top-tier partnership (MLP) was a member. For simplicity, it will be assumed
that in this example there is only one partnership of which MLP is a member.
[27]
The problem with this interpretation is the
application of section 96 to the top-tier partnership (MLP). How does this
partnership (MLP) allocate the $1,700 in income to its partners? What is the
source of the income of $1,700? The source of income would be lost as MLP would
have combined together all of its sources of income and losses into a single
amount. This would make it impossible for each member of MLP to determine that
member’s source of income or loss for the purposes of section 3 as a source of
income from a particular business or property.
[28]
In the above example, the lower-tier partnership
earned income. Subsection 96(2.1) of the ITA only applies if a taxpayer is a
member of a limited partnership and only if the losses of the limited partnership
exceed the at-risk amount of the taxpayer in respect of that partnership.
However, since subsections 96(1) and (2.1) of the ITA both refer to the
computation of income, it does not seem to me that Parliament would have
intended that the computation of income would only apply to a partnership that
is a member of another limited partnership if that other limited partnership
has a net loss in excess of the at-risk amount of the member in respect of the
limited partnership. Either Parliament would have intended that the computation
of income would be done for all partnerships who are members of other
partnerships or not at all for partnerships that are members of other
partnerships.
[29]
Since the computation of income for a
partnership that is a member of another partnership will cause problems when
that top-tier partnership attempts to allocate its income on a source by source
basis to its partners, in my view, Parliament did not intend for a partnership
that is a member of another partnership to compute income. Rather, Parliament
intended for the sources of income (or loss) to be kept separate and retain
their identity as income (or loss) from a particular source as they are
allocated from one partnership to another partnership and then to the partners
of that second partnership (and so on as the case may be). This would mean that
losses from a business incurred by a particular PSLP would still be losses from
a business in MLP and then allocated by MLP to its partners as losses from that
business.
[30]
There is also another problem with the Crown’s
interpretation of section 96 of the ITA. Assume that PSLP#1 has a loss of
$1,000 in year 1 and a profit of $1,000 in year 2. One would expect that after
these two years the ultimate partners would not pay any tax since PSLP#1 only
broke even. However, if the Crown is correct that the loss incurred in year 1
is a limited partnership loss of MLP and cannot be allocated to its partners,
MLP would not be able, in year 2, to use the limited partnership loss of $1,000
because MLP is not a taxpayer for the purposes of section 111. Therefore, the
ultimate partners would presumably pay tax on the income of $1,000 without
having the benefit of being able to deduct the loss incurred in year 1. If the
income of $1,000 earned in year 2 is not included in the income of the partners
of MLP because it does not have a source, this would cause even more problems
if PSLP#1 were to continue to make a profit. In my view this could not have
been the intended result and supports the interpretation adopted by the Tax
Court Judge.
[31]
The Crown argued that if the losses incurred by
a particular partnership (PSLP) retain their character as business losses when
flowed through another partnership (MLP), there could be a possibility that
losses incurred by one limited partnership could be claimed against income from
another limited partnership. The Crown also submitted that the at-risk rules
could be avoided entirely if the top-tier partnership (MLP) were a general
partnership. However, in my view, these concerns do not outweigh the concerns
that arise based on the Crown’s interpretation. Parliament could amend the ITA,
if it should choose to do so, and, depending on the particular facts of another
situation, the Canada Revenue Agency could seek to apply the general
anti-avoidance rule in section 245 of the ITA. Whether this rule would apply in
any particular situation can only be determined based on an application of the
law to the particular facts.
[32]
As a result, I would dismiss the appeal, with
costs.
“Wyman W. Webb”
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“I agree
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J.D. Denis Pelletier J.A.”
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“I agree
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Yves de
Montigny J.A.”
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