Jean B Pelletier v. Minister of National Revenue, [1982] CTC 2500, 82 DTC 1498

Guy Tremblay [TRANSLATION]:-

1. Point at issue

The issue is whether the appellant was in partnership with his wife Gil- berte in the ownership of the Palm Grove Restaurant in Kapuskasing during the fiscal years 1976 (May 1, 1975 to April 30, 1976) and 1977 (May 1, 1976 to April 30, 1977). The appellant and his wife have a partnership agreement dated June 10, 1976. In fact, since their marriage in 1959, they have pooled their assets and since the purchase of the restaurant by the appellant in 1961, husband and wife have worked together, each putting in more than 12 hours a day.

The respondent included in the appellant’s income for the years at issue all net profits arising from the business, alleging that the principal reason for the signing of the partnership deed on June 10, 1976 was the reduction of tax.

2. Burden of proof

2.01 The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 Furthermore, the same judgment stipulated that the assumptions of fact on which the respondent relied to support the assessments must also be deemed to be true.

These facts alleged by the respondent are set forth in subparagraphs (a) to (c) of paragraph two of the reply to the notice of appeal. They read as follows:

2. In assessing the Appellant, the Respondent relied, inter alia, on the following assumptions of fact:

(a) that Jean B Pelletier carried on the business of a restaurant known as Palm Grove Restaurant in the town of Kapuskasing as a sole proprietor;

(b) that Gilberte Pelletier was his wife during the relevant years;

(c) that the principal reason for the agreement of June 10, 1976 between Jean B Pelletier and Gilberte Pelletier was the reduction of tax otherwise payable under the Income Tax Act. A copy of the said agreement is attached as Appendix “A”.

3. Facts

3.01 The appellant met his wife around 1956, at which time he was working as a cook in Abitibi and she was a waitress.

3.02 They were married on July 4, 1959 in the province of Quebec under the community of property regime. They then pooled their respective accumulated capital in a bank account in Lasarre. This account was opened in the husband’s name. The appellant found employment in a hotel as a cook, while his wife worked in the same place as a second cook. The money earned was deposited in the family or joint account, but always in the husband’s name.

3.03 On May 10, 1961, they decided to purchase a restaurant business (minus the building) in Kapuskasing, Ontario, known as the Palm Grove Restaurant (Exhibit A-1). The price was $13,900, $5,900 down and the balance payable at $200 a month without interest. The money for the down payment was taken from the family bank account.

The purchasing party, however, was the appellant only. In response to the question of why the appellant and his wife were not both parties to the agreement, the wife indicated that they thought that the purchase agreement had to be in the husband's name. The appellant confirmed this, saying that he did not have much education and that he thought that was how such things were done.

3.04 The appellant testified that prior to the purchase, when they discussed the possibility of buying the said business, it was clearly understood that both of them had to work in the restaurant, otherwise there was no question of going ahead with the purchase. It was then agreed that he would take sixty per cent of the profits and she would take forty per cent.

3.05 Both of them worked, he as cook and she as second cook. Subsequently, she assumed management of the staff. The restaurant was open eighteen hours a day, seven days a week, from 7 am to 1 am the following night. He worked fourteen, sometimes sixteen or eighteen, hours a day, and she not less than twelve hours a day. When she was not working (six weeks off when she had her second child in 1966; four weeks off to have her third child in 1972), it took as many as three employees to replace her. According to the appellant, if he had wished to replace his wife by only one person, it would have been necessary to pay at least $5 an hour to such a person.

3.06 Normally, the appellant looked after the purchasing and his wife looked after it when he was away. The bank account was in the husband’s name, but all income was deposited in that account. No wages were paid to either the appellant or his wife. Personal and family expenses were handled through withdrawals from the said bank account, as was the monthly $200 instalment on the debt.

3.07 In 1971, the appellant purchased the land and the building in which the business was located. His wife also signed the contract, but as a spouse and not as a party to the agreement.

in 1963, they purchased a residence across from the restaurant.

3.08 In 1974 the appellant wished to incorporate the business, but his accountant advised him instead to form a business partnership. Incorporation, according to his accountant, could come later, when earnings were higher. The company was not actually incorporated until 1979 (the appellant having 51% of the shares and his wife 49%), at which time the company purchased the business.

3.09 In 1974, at the suggestion of several individuals, the appellant obtained a dining lounge licence from the Liquor Licence Board of Ontario. The first licence was issued on June 3, 1974.

3.10 On June 10, 1976, a partnership agreement (Exhibit A-2) was concluded between the appellant (60% of net profits) and his wife (40% of net profits) (para 5). However, in the computation of net income (para 7), expenses were allocated on a fifty-fifty basis. The two parties undertook to contribute their labour, time and attention, the agreement being retroactive to May 1, 1975 (para 2).

The appellant contended that the purpose of the partnership agreement was to legalize a hitherto de facto arrangement.

3.11 On June 25, 1976, the appellant's lawyer wrote the following letter (Exhibit A-3) to the Liquor Licence Board of Ontario:

I act for Jean B Pelletier who is the owner of Palm Grove Tavern and Restaurant income tax purposes we have been asked by his accountants to prepare a

(italics by the Board)

3.12 The financial statements of the business for the fiscal years 1976 (May 1, 1975 to April 30, 1976) and 1977 (May 1, 1976 to April 30, 1977) were filed as Exhibits 1-1 and I-2. The statement of assets as at April 30, 1976 showed a balance of $65,060 for the appellant and $11,602 for his wife. As of April 30, 1977, the same financial statement showed $64,420 for the appellant and $27,049 for the wife. Withdrawals in this same year were $25,873 by the appellant and $1,375 by the wife. The net earnings in that year (1977) amounted to $42,055, with $25,233 going to the appellant and $16,822 to his wife.

3.13 Mrs Gilberte Pelletier confirmed her husband’s testimony, even though she expressed herself somewhat differently.

3.14 Mr Bryan Gagnon, a public accountant for 30 years, whose advice had led to the official formation of the partnership, testified that as a de facto partnership had existed since 1961, it was proper for the said partnership to be given legal status.

4. Act — case law — analysis

4.01 Act

The main provisions of the Income Tax Act that apply in the instant case are sections 3, 9, subsections 74(5) and 103(1). Subsections 74(5) and 103(1) read as follows:

74. (5) Where a husband and wife were partners in a business, the income of one spouse from the business for a taxation year may, in the discretion of the Minister, be deemed to belong to the other spouse.

103. (1) Where the members of a partnership have agreed to share, in a specified proportiion, 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.

4.02 Case law

Counsel for the parties referred to the following cases:

1. Peter Flicke v MNR, [1980] CTC 2538; 80 DTC 1473;

2. Dickenson v Gross, 11 TC 614;

3. Joseph Lohé v MNR, [1979] CTC 3107; 79 DTC 880;

4. Georges Marinis v MNR, [1978] CTC 2821; 78 DTC 1609;

5. Robert Porter & Sons Limited v J H Armstrong and William Wash- brough Foster, [1926] SCR 328;

6. MNR v Samuel L Shields, [1962] CTC 548; 62 DTC 1343;

7. Marx v Marx, [1964] SCR 653.

4.03 Analysis

4.03.1 From the facts adduced in evidence and described in paragraphs 3.03 to 3.08 inclusive, it appears that from 1961 to 1976, Jean Pelletier and Gilberte Pelletier took a significant number of actions that might at first glance suggest that a partnership did exist between these two individuals. In the instant case, however, the two persons involved are a husband and wife married under the community of property regime of the province of Quebec.

For a husband and wife to pool their assets and their income, even under the community of property regime, does not in itself constitute a financial partnership resulting from a partnership agreement.

A partnership agreement presupposes an expressed intention to that effect, accompanied by actions confirming that intention, especially if the two parties involved are husband and wife.

In the case at bar, according to statements made by the appellant and his wife, there was an intention to enter into a partnership contract. Did the actions of the parties confirm this intention? They spent countless hours working together and ultimately increased the capital (paras 3.05 and 3.06), which was pooled at the outset of their marriage in 1959, and thereafter, until 1961, by putting in their respective salaries (para 3.02). They used these pooled funds to buy the business in May 1961. These facts tend to support the appellant’s hypothesis. However, other facts appear to contradict it. The bank account is in the husband’s name, as is the licence issued by the Liquor Licence Board. The business purchased in 1961 and the land and building purchased in 1971 are still in the husband’s name. According to the testimony given by the appellant and his wife, it was their lack of education that led them to believe that everything should be in the husband’s name. An examination of the agreement to purchase the business in 1961 reveals, however, that the sellers of the business, Mr and Mrs George and Mary Martha Maybury, were husband and wife, and partners.

The appellant must have been aware of this fact. Could it be he thought this did not apply to him or his wife because they were married in Quebec under the community of property regime? Possibly, but there is no evidence to this effect. In any case, this evidence does not support it. On the one hand, there can be no doubt that increasing the capital of the business increases the value of the community property and that, upon the dissolution of the community (either by death or separation from bed and board and of property), one-half of the said capital becomes the property of the spouse. On the other hand, the community of property is not the partnership provided for in the Ontario statute, the Partnerships Act.

In the case at bar, it appears unlikely that the appellant foresaw separation of the profits and losses before 1976 or that he was consciously aware of such a possiblity.

The Board notes that if a husband and wife had not intended to enter into a business partnership, and intended only to live under the community of property regime, they would have acted in exactly the same manner as did the appellant and his wife.

It is possible that the appellant and his wife intended to operate as a business partnership, but no evidence was introduced to support this assertion. Once again, for two persons to work together is not in itself evidence of a business partnership, especially when the two persons are husband and wife.

If the agreement is verbal, there must be facts to confirm it: the business is owned by both parties, it is officially registered in both parties’ names, and so on. In the instant case, none of these things occurred until 1976. Even if the Board were to believe the testimony of the appellant and his wife as to their intention of running the operation as a business partnership, that is not sufficient, for such an intention must be demonstrated by actions or deeds other than those which may be attributed to a husband and wife wishing to live under a community of property regime.

In June 1976, evidence of this intention was provided when the partnership took the tangible step of drawing up a partnership agreement. In 1974, the accountant had suggested the formation of a partnership rather than the formation of a company (para 3.08). That suggestion was not acted on until 1976.

The Department of National Revenue contended that the contract itself is not valid because “the principal reason for the agreement may reasonably be considered to be the reduction . . . of the tax”, as stated in subsection 103(1) of the Income Tax Act.

The respondent’s argument is predicated mainly on the letter from counsel for the appellant to the Liquor Licence Board (para 3.11). The words are clear and there seems to be no doubt that they open the way to the presumption contained in subsection 103)1): “for income tax purposes we have been asked by his accountants to prepare a Partnership Agreement”.

The Board is of the belief that the Income Tax Act served as the occasional cause and not the efficient cause of the drafting of the partnership agreement.

In order to make their intention to carry on their business apparent to third parties, a partnership agreement was necessary. According to the accountant, it should have been done earlier. The Board agrees with this. However, it was not done earlier and, in terms of evidence, this document is all that effectively confirms the intention of operating the business as a partnership.

If the previous evidence was not sufficient to confirm the said intention, it now is, and all previous facts confirm the relevance of the said partnership agreement.

The Board is of the opinion that the Income Tax Act was the occasional cause of the drafting of the partnership agreement. The efficient cause is the de facto operation of the restaurant business as a partnership by the appellant and his spouse. The written agreement completes the evidence, but from the date of the said contract onwards.

4.03.2 The partnership agreement, however, is retroactive to May 1, 1975. It was signed on June 10, 1976, that is, after the financial statements for the 1976 taxation year (May 1, 1975 to April 30, 1976) had been completed, showing a gross business profit of $86,790 (1976) and $106,359 (1977) and a net profit of $29,006 (1976) and $42,055 (1977). A retroactivity clause in an agreement of this type is not illegal in itself as it affects the two parties. However, this retroactivity must not affect third parties.

With respect to the third party, in this instance the Department of National Revenue, can a retroactivity clause of this type be accepted? The Board thinks not.

In fact, the Income Tax Act administered by the Department specifically provides for an annual tax. After the 1976 taxation year had ended, the appellant and his spouse stipulated in a written partnership agreement (the agreement which, according to the evidence, created the partnership) that the said partnership acquired a retroactive existence to a point thirteen months in the past, that is, to May 1, 1975. The efficient cause of such retroactivity is, in my opinion, the reduction of 1976 taxes, and thus the agreement concerning this year meets the conditions of subsection 103(1) cited above.

However, this ruling on retroactivity has no bearing on the ruling concerning the value of the written partnership agreement which, it bears repeating, created the partnership on the date of its signing (or at least the Board is prepared to accept it from May 1, 1976 onwards). On the basis of the evidence, this agreement is in effect all that confirms the intention of the parties to operate the business as a partnership. All the work performed jointly from 1961 to 1976 merely demonstrates their willingness to act as husband and wife. The testimony as to the verbal agreement to operate as a partnership, rather than under a community of property regime, was not corroborated by any other evidence.

All this work done together does show, however, that the written partnership agreement ought to have been drawn up before 1976 and that the Income Tax Act, even though it is the occasional cause, is not the efficient cause of the contract taken as a whole (excepting the retroactivity).

5. Conclusion

The appeal for 1976 is dismissed. The appeal for 1977 is allowed and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed in part.