Cyrille a Laferrière v. Minister of National Revenue, [1981] CTC 2634, 81 DTC 580

Guy Tremblay [TRANSLATION]:—This case was heard on May 27 and 28, 1980 in Montreal, Quebec.

1. Points at issue

1.1. From the notice of appeal

The question is whether the appellant, an engineer, who had been a junior partner in a firm of counsulting engineers since 1970, could in 1973 exclude from his income the sum of $96,095 received in part as the selling price to two of his partners of his rights in the partnership, namely, the part relating to work in progress.

With regard to the 1975 taxation year, the question is whether the respondent was correct in including in the appellant’s income the sum of $43,216 which was part of an amount of $89,106 in accounts receivable at the end of 1971.

1.2 From the application made under paragraph 174(3)(b)

Following the submission of an application on January 15, 1979 by the Department of National Revenue, two third parties, the two partners who bought the appellant’s share in the consulting firm, were joined to the case at bar. The common question on which the Board must render a decision is described in the application made to the Board, and reads as follows:

1. As to whether there was an agreement between the members of the partnership Desjardins, Sauriol et Associés when Mr Cyrille A Laferrière, the appellant, left on December 15, 1972, the purpose of which was to allocate to him a share of the income from the work in progress in the firm at that date, namely the sum of $96,095 such that:

(i) this sum of $96,095 should be included in computing the income of Mr Cyrille A Laferrière for the 1973 taxation year, in accordance with sections 34 and 96(1.1) of the Income Tax Act, and

(ii) this sum of $96,095 should not be included in equal shares in computing the income of the partners Jean-Claude Desjardins and Paul-Aime Sauriol, as their shares in the income from the partnership Desjardins, Sauriol et Associés for the 1973 taxation year in accordance with section 96(1 )(f) of the Income Tax Act', Act:

2. or whether there was only an agreement between Messrs Desjardins and Paul- Aime Sauriol of the first part, and Mr Cyrille A Laferrière of the second part, when the latter left on December 15, 1972, for the purpose of transferring and assigning in its entirety Mr Cyrille A Laferriere’s participation in the partnership Desjardins, Sauriol et Associés to Messrs Desjardins and Sauriol, such that:

(i) the sum of $96,095 pertaining to work in progress of the partnership Desjardins, Sauriol et Associés at December 15, 1972 should be included in half shares each in computing the income of each of the partners Jean-Claude Desjardins and Paul-Aimé Sauriol for the 1973 taxation year, as their shares in the income of the partnership for that taxation year under section 96(1 )(f) of the Income Tax Act; and

(ii) thus sum of $96,095, pertaining to work in progress of the partnership Desjardins, Sauriol et Associés at December 15, 1972, should not be included in computing the income of Mr Cyrille A Laferriere for the 1973 taxation year as his share in the income of the partnership Desjardins, Sauriol et Associés under section 96(1 )(f) of the Income Tax Act.

This is the common question which is the point now at issue before the Board.

2. Burden of proof

In a case where third parties are joined pursuant to subsection 174(3), the burden of proof in fact lies with the taxpayers concerned, namely the appellant and the third parties. The appellant was the subject of an assessment, and the third parties are presumed to be the subject of assessments. The Said assessments are presumed to be valid until evidence to the contrary is presented by the taxpayers.

3. Agreement regarding 1975

At the start of the hearing, the parties told the Board that the point raised in the notice of appeal with respect to 1975 had been resolved.

4. Facts

Regarding 1973

4.01 Between 1958 and 1970 the appellant worked as an employee for the firm of engineering consultants Desjardins, Sauriol et Associés (hereinafter referred to as “the partnership”).

4.02 On January 29, 1970 the appellant and six other engineers entered into an agreement with the two founding partners, Messrs Jean-Claude Desjardins and Paul-Aime Sauriol (the two third parties) and thereby became junior partners with 5% shares. The said agreement was filed as Exhibit A-1.

4.03 The chief clauses of the agreement that relate to the case at bar are as follows (emphasis by the Board):

Capital contribution

3. The partnership capital on February 1, 1970 was wholly owned in equal shares by Messrs Desjardins and Sauriol, and this capital is set forth in the financial statements attached hereto. No initial capital subscription is required of the junior partners.

It is agreed that accounts receivable, the amount earned on work performed but not billed and the amount earned on current contracts on February 1, 1970 shall continue to be the property of Messrs Desjardins and Sauriol.

5. The authority and the responsibility of management shall be exercised by a general meeting of all partners, and decisions shall be taken by a majority vote of the partners present at a meeting. Meetings shall be called as often as necessary at the request of at least two partners and on written or verbal notice of at least twenty-four hours.

However, any decision taken and any act performed with the authorization of two senior partners and of two junior partners jointly shall be recognized as a decision or an act of the partnership, and shall be binding on the partners as if such decision or act had been duly authorized at a meeting of the partners.

7. In general, the partners shall work for the partnership and receive their remuneration from it. For this purpose, the junior partners shall be entitled to a guaranteed annual salary of $25,000 each. The senior partners shall be entitled to an annual compensation of $50,000, not guaranteed, but to be paid in all cases before any profits are distributed to the partners in accordance with the provisions of paragraph 11 below.

Paragraph 11 was amended on December 15, 1971. It reads as follows:

Distribution of profits and remuneration

11. The net profits of the partnership, once the guaranteed salaries of junior partners and the compensation of senior partners mentioned in paragraph 7 have been deducted, shall be divided in the following proportions:

Jean-Claude Desjardins	32.5%
Paul-Aime Sauriol	32.5%
Pierre Marier	5.0%
Robert Filiatrault	5.0%
Rene Therrien	5.0%
Cyrille A Laferrière	5.0%
Liguori M Lefebvre	5.0%
Paul A Hotte	5.0%
Marcel Dubois	5.0%

14. For income tax purposes the partners undertake to report their income by the cash method, and income in accordance with this method shall be distributed among the partners in the same proportion as income by the accrued method is allocated to them.

15. Losses sustained by the partnership on accounts receivable shall be borne by the partners in the same proportion as the income derived from these accounts has been credited to them, except with regard to accounts receivable prior to February 1, 1970, which are part of the capital contribution of Messrs Desjardins and Sauriol.

17. In the event of the death, or the forced or voluntary withdrawal from business, of one of the junior partners, he (or his heirs as the case may be) shall be bound to sell Messrs Desjardins and Sauriol, and the latter shall be bound to buy, his share in the partnership at the book value on the date of the death or departure, as determined by the auditor, who shall take into account the accounts receivable, the amount earned on work performed but not billed and the amount earned on current contracts, as well as the deficit, if any, contemplated by paragraph 12, and the payment of arrears on salaries or compensation contemplated by paragraph 7. The book value shall be estimated by the auditor using a pro rata calculation of the time elapsed from the date of the last financial statements submitted to the date of the death or withdrawal.

32. For a period of five years, each partner shall remain free to withdraw from the partnership on three months’ written notice. Furthermore, a junior partner may at any time be dismissed from the partnership by a decision taken in accordance with the provisions of paragraph 5.

33. The death or withdrawal from business of a partner shall not have the effect of dissolving the partnership, which shall continue to exist for the remaining partners. When the partnership share of a junior partner is bought back by Messrs Desjardins and Sauriol, that share may be resold to a new person, and such new person then becomes a “junior partner” provided he undertakes to observe all the provisions of these agreements. The status of “junior partner” shall also automatically accrue to any new person to whom Messrs Desjardins and Sauriol may sell or give a portion of their participation in the profits of the partnership, providing however that Messrs Desjardins and Saurior shall at all times retain a 51 per cent share in the partnership. However, the admission of a junior partner shall be approved by a general meeting, in accordance with the provisions of the first paragraph of paragraph 5.

4.04 In accordance with paragraphs 5 and 32, the appellant left the partnership on November 20, 1972 as a result of certain decisions, as appears in the minutes of meetings of the partnership held on October 10, 1972 (Exhibit A-4) and November 20, 1972 (Exhibit A-5).

4.05 In accordance with paragraph 17, cited above, of agreement A-1 (para 4.03), on December 15, 1972 the appellant sold to Messrs Claude Desjardins and Paul-Aimé Sauriol his shares in the partnership. This agreement, filed as Exhibit A-2, reads as follows:

WHEREAS the seller wishes to sell and the buyers wish to buy all the rights and interests which the seller may have in the partnership ‘DESJARDINS, SAURIOL ET ASSOCIES’ and in the group of companies known as ‘GESTION DESSAU LTÉE’ and its subsidiaries;

ACCORDINGLY, the parties ageee as follows:

1. The seller sells, assigns and transfers to the buyers, who accept, all his rights and interests in the partnership DESJARDINS, SAURIOL ET ASSOCIÉS and in the group of companies known as GESTION DESSAU LTÉE and its subsidiaries, including inter alia:

(a) partnership share: Desjardins, Sauriol et Associés;

(b) fifty shares in Gestion Dessau Ltée.

2. This sale is made for a sum equal to the book value on November 20, 1972 of both the partnership share in the partnership Desjardins, Sauriol et Associés, and fifty ordinary shares of Gestion Dessau Ltée, as this shall be determined by the auditors of the partnership and of the company, Messrs Samson, Belair, Cote, Lacroix et Associés, who in determining it shall take into account the following:

(a) the financial statements to December 30, 1971 certified by Samson, Belair, Côté, Lacroix et Associés and approved by the partners of Desjardins, Sauriol et Associés and by the directors of Gestion Dessau Ltée;

(b) the financial statements to December 30, 1972 certified by Samson, Belair, Côté, Lacroix et Associés and approved by the partners of Desjardins, Sauriol et Associés and by the directors of Gestion Dessau Ltée.

In order to arrive at the sum concerned in this sale, it is agreed that for 1972 the partnership share of the seller in the partnership Desjardins, Sauriol et Associés, and the value of the shares of the seller in Gestion Dessau Ltée, shall be equivalent, in accordance with the figures of the financial statements at December 30, 1972, to the proportion pro rata of the time elapsed between January 1, 1972 and November 20, 1972.

This amount shall be spread over a period of four years, in annual, equal and consecutive instalments, without interest, the first instalment to be paid before March 1, 1973.

3. The buyers acknowledge receiving the duly endorsed certificates for transfer, representing the shares sold.

4. The parties acknowledge that in the partnership share sold by these agreements there is an untaxed accounts receivable reserve, resulting from the seller’s share in accounts receivable of the partnership Desjardins, Sauriol et Associés, and that, for the purposes of drawing from this accounts receivable

reserve for tax purposes, the seller shall be deemed to continue to be part of the partnership, so that the seller shall himself pay the taxes which may be assessed on the portion of the selling price which shall be regarded as a reimbursement of these untaxed accounts receivable.

5. The seller hereby releases the partnership Desjardins, Sauriol et Associés, and the group of companies known as “Gestion Dessau Ltée” and its subsidiaries, from any claim that he may have against them at this time.

IN WITNESS WHEREOF THE PARTIES HAVE SIGNED, at Laval, this 15th day of December, 1972.

(Signed)

CYRILLE A LAFERRIERE — seller

(Signed)

CLAUDE DESJARDINS — buyer

(Signed)

PAUL-AIMÉ SAURIOL — buyer

4.06 The amount paid for the appellant’s rights in the partnership came to $183,563, payment of which was made over a four-year period in accordance with contract A-2. The payment made for the 50 shares of Gestion Dessau Ltée was not included in the foregoing amount. It came to about $30,000 and is not relevant to the case at bar.

4.07 The amount of $183,563 was determined by the partnership auditors, the firm of accountants Samson, Belair & Associés. However, the final details of this amount were only communicated to the appellant by a letter dated March 23, 1977 (Exhibit A-6), or more accurately to his accountant Mr Raymond Poirier, CA, by André Lesage, a member of the partnership’s firm of auditors.

This amount breaks down as follows:

The difference between the amount of $185,201 and $183,563 (the total amount in fact received) is explained by the minor discrepancies between the figures determined on an accounting basis and those accepted for tax purposes. (Extract from the letter of March 23, 1977 — Exhibit A-6)

4.08 The testimony of Mr André Lesage indicated that up to this period of March 1977, there had been difficulties resulting from an error made in determining and distributing accounts receivable to December 31, 1971. These accounts were first set in early 1973 at $135,911 for each junior partner.

4.09 The adjusted cost base of the appellant’s share in the partnership had been determined for December 31, 1972. It was broken down as follows:

The figure of $172,096.00 was determined as follows, under the item “fair market value”:

Finally, under the item “Income for tax purposes”, still for the year ending December 31, 1972, it reads:

These figures were supplied by the partnership auditors to the appellant early in 1973 from financial statements (Exhibit TP-5) relating to the base income of the professional partners, the cost, determination of the ACB, income for tax purposes and so on.

4.10 The error regarding the 1971 accounts receivable in the amount of $135,911 was not detected and corrected until an audit was made by the Department of National Revenue in late 1976 and early 1977. The 1971 accounts receivable for each junior partner, including the appellant, were altered to $89,106 (Exhibit A-6).

4.11 Prior to this time, according to Mr André Lesage, CA, the figure of $232,006 (1971 accounts receivable: $135,911, plus work in progress: $96,095) was erroneously taken to be the appellant’s share, whereas it was subsequently determined in 1977, to be $183,563. The appellant’s accountant, Mr Poirier, did not wish to work on the basis of $232,006, since his client would only receive $183,563. This is the sum which he included as 1971 accounts receivable in computing 1973 and 1974 income, while at the same time taking a reserve for the same amount. He stated that he had made an error, and that he should only have included the amount of $135,911 (accounts receivable, which were themselves erroneously calculated) as 1971 accounts receivable, with a reserve in the same amount as permitted by the Act, but this does not in any way change the final result of the taxable income.

4.12 In 1972, the appellant included in his income the amount of $56,467, income received from the partnership in that year. This figure is extracted from Exhibit TP-5.

4.13 For 1972, the members of the partnership chose (Exhibit TP-1) not to include work in progress in their income, pursuant to paragraph 34(1 )(d) of the Income Tax Act. This work was to be completed in 1973.

4.14 Early in 1974, the partnership auditors supplied the appellant with partnership statements for 1973, of the same type as those filed for 1972 as Exhibit TP-5 (para. 4.09). Thestatementsfor 1973 were filed as Exhibit TP-6.

So far as the appellant is concerned, this statement only mentions the amount of $96,095 as work in progress. In the submission of the respondent, this amount should be included in the appellant’s 1973 income. The appellant did not include it: this is the subject of the assessment and of the case at bar.

4.15 With regard to paragraph 4 of Exhibit A-2, cited above (para 4.05), Mr Paul-Aimé Sauriol stated that, in his view, the expression “untaxed accounts receivable reserve” included 1972 work in progress.

According to Mr André Lesage, who is in charge of the tax section with Samson, Bélair & Associés, this expression means “1971 accounts receivable”.

4.16 It was also clearly established by Messrs Lesage and Sauriol that the partnership had served as banker for the payment of the appellant’s share, and this amount had then been transferred to the “withdrawals” account of the third parties, Messrs Sauriol and Desjardins. Their shares in the partnership thus increased by 2 /2% each. After 1973, the third parties gave a 5% share in the partnership to a new junior partner.

4.17 On April 1, 1977 the respondent issued a notice of reassessment by which he included the sum of $96,095 for 1973 that is, work in progress deducted in 1972. Following a notice of objection by the appellant, this assessment was upheld.

5. Act — case law — comments

5.1 Act

The chief sections concerned in the case at bar are section 34, subparagraphs 53(1 )(e)(i), 53(2)(c)(i), (ii) and (v), paragraph 54(b), 96(1 )(f), subsections 96(1.1), 96(1.2), and 96(1.4). They read as follows:

34. (1) In computing the income of a taxpayer for a taxation year from a business that is a profession, the following rules apply:

(a) paragraph 12(1 )(b) is not applicable;

(b) every amount that becomes receivable by him in the year in respect of property sold or services rendered in the course of the business shall be included;

(c) for the purposes of paragraph (b), an amount shall be deemed to have become receivable in respect of services rendered in the course of the business on the day that is the earliest of

(i) the day upon which the account in respect of the services was rendered

(ii) the day upon which the account in respect of those services would have been rendered had there been no undue delay in rendering the account in respect of the services, and

(iii) the day upon which the taxpayer was paid for the services; and

(d) where the taxpayer so elects in his return of income under this Part for the year, no amount shall be included in respect of work in progress at the end of the taxation year, except as otherwise provided by this section.

34. (2) Where a taxpayer has elected that paragraph (1)(d) be applicable in computing his income for a taxation year from a business that is a profession, that paragraph shall apply in computing his income from the business for all subsequent taxation years unless the taxpayer, with the concurrence of the Minister and upon such terms and conditions as are specified by the Minister, revokes his election to have the paragraph apply.

53. (1) In computing the adjusted cost base to a taxpayer of property at any time, there shall be added to the cost to him of the property such of the following amounts in respect of the property as are applicable:

(e) where the property is an interest in a partnership,

(i) an amount in respect of each fiscal period of the partnership ending after 1971 and before that time, equal to the aggregate of all amounts each of which is the taxpayer’s share (other than a share under an agreement referred to in subsection 96(1.1)) of the income of the partnership from any source for that fiscal period, computed as if this Act were read without reference to

(A) the references in section 14, paragraph 38(a) and subsection 41(1) to /2”, and

(B) paragraph 29(1 )(b) or (2)(b), paragraph (i) of this subsection, section 95, paragraph 82(1 )(b) and the provisions of the Income Tax Application Rules, 1971 relating to income from the operation of new mines.

53. (2) In computing the adjusted cost base to a taxpayer of property at any time, there shall be deducted such of the following amounts in respect of the property as are applicable:

(c) where the property is an interest in a partnership,

(i) an amount in respect of each fiscal period of the partnership ending after 1971 and before that time, equal to the aggregate of amounts each of which is the taxpayer’s share (other than a share under an agreement referred to in subsection 96(1.1)) of any loss of the partnership from any source for that fiscal period, computed as if this Act were read without reference to

(A) the references in section 14 and paragraph 38(b) to “2”, and

(B) section 31, subsection 40(2) and section 55,

(ii) an amount in respect of each fiscal period of the partnership ending after 1971 and before that time, other than a fiscal period after the fiscal period in which the taxpayer ceased to be a member of the partnership, equal to the taxpayer’s share of the aggregate of

(A) amounts that, but for paragraph 96(1 )(d), would be deductible in computing the income of the partnership for the fiscal period by virtue of the provisions of the Income Tax Application Rules, 1971 relating to exploration and development expenses,

(B) the Canadian exploration and development expenses and foreign exploration and development expenses (within the meaning assigned by subsection 66(15) ) if any, incurred by the partnership in the fiscal period,

(C) the Canadian exploration expense (within the meaning assigned by subsection 66.1(6)), if any, incurred by the partnership in the fiscal period, and

(D) the Canadian development expense (within the meaning assigned by subsection 66.2(5)), if any, incurred by the partnership in the fiscal period,

(v) any amount received by the taxpayer after 1971 and before that time as, on account or in lieu of payment of, or in satisfaction of, a distribution of his share (other than a share under an agreement referred to in subsection 96(1.1)) of the partnership profits or partnership capital.”

54. In this subdivision,

(b) “capital property” of a taxpayer means

(i) any depreciable property of the taxpayer, and

(ii) any property (other than depreciable property), any gain or loss from the disposition of which would, if the property were disposed of, be a capital gain or a capital loss, as the case may be, of the taxpayer.

96. (1) Where a taxpayer is a member of a partnership, his income, net capital loss, non-capital loss and restricted farm loss, if any, for a taxation year, or his taxable income earned in Canada for a taxation year, shall be computed as if

(f) the amount of income of the partnership for a taxation year from any source or from sources in a particular place were the income of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership’s taxation year ends, to the extent of the taxpayer’s share thereof.

96. (1.1) For the purposes of subsection (1) and sections 101 and 103,

(a) where the principal activity of a partnership is carrying on a business in Canada and the members thereof have entered into an agreement to allocate a share of the income or loss of the partnership from any source or from sources in a particular place, as the case may be, to any taxpayer who at any time ceased to be a member of

(i) the partnership, or

(ii) a partnership that at any time has ceased to exist or would, but for subsection 98(1), have ceased to exist, and either

(A) the members thereof, or

(B) the members of another partnership in which, immediately after that time, any of the members referred to in clause (A) became members

have agreed to make such an allocation

or to his spouse, estate, or heirs or to any person referred to in subsection (1.3), that taxpayer, his spouse, estate or heirs, or that person, as the case may be, shall be deemed to be a member of the partnership; and

(b) all amounts each of which is an amount equal to the share of the income or loss referred to in this subsection allocated to a taxpayer from a partnership in respect of a particular fiscal period of the partnership shall, notwithstanding any other provision of this Act, be included in computing his income for the taxation year in which that fiscal period of the partnership ends.

96. (1.2) Where in a taxation year a taxpayer who has a right to a share of the income or loss of a partnership under an agreement referred to in subsection (1.1) disposes of that right.

(a) there shall be included in computing his income for the year the proceeds of the disposition; and

(b) for greater certainty, the cost to the taxpayer of each property received by him as consideration for the disposition is the fair market value of the property at the time of the disposition.

96. (1.4) For the purposes of this Act, a right to a share of the income or loss of a partnership under an agreement referred to in subsection (1.1) shall be deemed not to be capital property.

Sections 101 and 103, referred to in subsection 96(1.1), do not apply in the case at bar. Section 101 deals with the disposition of land used in a farming business of the partnership, and section 103 with an agreement to share the income or loss of a partnership so as to reduce or postpone tax otherwise payable.

5.2 Case law

The case law cited by the parties is as follows:

1. HMQ v Samuel T Boorman, [1977] CTC 464; 77 DTC 5338;

2. I G Wahn v MNR, [1969] CTC 61; 69 DTC 5075;

3. J Sedgwick v MNR, [1963] CTC 571; 63 DTC 1378;

4. W G Briggs v MNR, [1958] CTC 11; 58 DTC 1006;

5. J E Brett v MNR, [1971] CTC 111; 71 DTC 5094;

6. William M O’Connor et al v MNR, [1943] CTC 255; 2 DTC 637.

The parties also referred to the following interpretation bulletins: IT-242 and IT-278R. The appellant referred to “The Taxation of Partnerships”, by Larry A Eddy, FCA.

5.3 Comments

5.3.1. The “untaxed accounts receivable” clause

First, the Board concludes without hesitation that the phrase “untaxed accounts receivable reserve”, contained in clause 4 of the agreement concluded on December 15, 1972, between the appellant and Messrs Desjardins and Sauriol (Exhibit A-2, see para 4.05 of the Facts), cannot include the “work in progress”, but means only “1971 accounts receivable”.

To begin with, it cannot include “work in progress”. As clause 17 of the agreement of January 29, 1970 (Exhibit A-1, see para 4.03 of the Facts) provides that the share of a departing partner will be determined by the valuation method, it establishes clearly that two of the principal factors concerned in this method are the accounts receivable and the work in progress.

How is it possible to speak in the contract of sale of the appellant’s share (Exhibit A-2) of “accounts receivable” and intend to include “work in progress” without saying so expressly?

Then, the phrase “untaxed accounts receivable reserve” can only mean 1971 accounts receivable. Clause 4 of Exhibit A-2 was only designed to adjust to the tax situation regarding the accounts receivable of professionals contained in the new Income Tax Act that came into effect January 1, 1972, and thus after agreement A-1 and before agreement A-2.

In determining the value of the appellant’s share, it was necessary to take into account the financial statements to December 30, 1971 and those to December 30, 1972, as provided in clause 2 of Exhibit A-2. The reference to untaxed accounts receivable can only be to 1971 accounts receivable because 1972 accounts receivable were, under the provisions of the new Income Tax Act, part of 1972 income. The latter accounts were dealt with by the accrual method in 1972. The accounts receivable to December 31, 1971 had been dealt with by the cash method, and so had not been taxed: thus, “untaxed accounts receivable reserve” could only mean “1971 accounts receivable”. Clause 4 of Exhibit A-2 provides that these accounts receivable are to be taxed in the appellant’s hands, because the latter shall be deemed to continue to belong to the partnership for the purposes of using up his untaxed accounts receivable reserve. Once again, this provision is merely the result of the desire to comply with the new Income Tax Act regarding 1971 accounts receivable.

Further, this presumption that the appellant continued to belong to the partnership does not apply with regard to work in progress.

5.3.2 Work in progress

Although the work in progress of professionals was also dealt with by special provision in the new Income Tax Act, the parties to agreement A-2 did not see fit to give it special treatment. The work in progress must there- fore be treated in the manner provided for in clause 17 of the partnership contract (Exhibit A-1) and in accordance with the provisions of the new Income Tax Act.

5.3.3 Clause 17 provides that in determining the value of the share of a departing partner, the accountant must take into consideration the following components:

(a) accounts receivable;

(b) the earned portion of work performed, but not billed;

(c) the earned portion of current contracts;

(d) the deficit, if any;

(e) the payment of arrears on salaries or compensation.

The Board finds that these various components are the basic components used in computing net income, that is, in the current year for components

(d) and (e), and in the following year (or years) when components (a), (b) and (c) became income, that is, were realized in accordance with the policy set out in clause 14.

5.3.4 Can these components which the agreement fixed as measurements to determine the share of a departing partner, when seen in light of the Income Tax Act, not be regarded as components of income once the selling price of the partner’s share is determined?

At first sight, it would appear that items which constitute components of income should be regarded as income. Consideration should also naturally be given to the provisions of the new Income Tax Act for professionals regarding accounts receivable and work in progress, provisions which became effective after agreement A-1 was concluded and before the conclusion of agreement A-2, as indicated above. (It should be noted that among components to be considered in computing the share of a departing partner, the amount paid by that partner when he entered the partnership was not included; the reason is clear — no amount was in fact paid. However, this component would intrinsically be not a component of income, but of invested capital.)

The cases cited by the parties appear to confirm the Board’s affirmative reply.

5.3.5 After examining the cases referred to by the parties (S T Boorman, I G Wahn, J Sedgwick and W G Briggs), the Board concludes that the payments received by the former partner are taxable in his hands to the extent that these payments result from amounts earned by that former partner, and on which no tax was paid (accounts receivable: S T Boorman and IV G Briggs; profit allocation: J Sedgwick and I G Wahn), especially if originally the departing partner paid no capital sum to purchase a share in the partnership.

5.3.6 Subsections 96(1.1), (1.2) and (1.4)

The Board is of the opinion that subsection 96(1.1), regarding partnerships, does not apply in the case at bar. As it is a taxing section, all the conditions must be applicable for it to apply. Under that section, “where . . . the members thereof have entered into an agreement . . .” with a departing partner, certain presumptions apply, specifically that “all amounts each of which is an amount equal to the share of the income . ..” must be included in the income of the departing partner.

It seems clear that, for the section to apply, all the members of the partnership must enter into an agreement with the departing partner, not merely two members as in the case at bar (even though they had majority control).

5.3.7 The precedents referred to above apply, however, even though 96(1.1) does not. The principles implicit in it are wider than subsection 96(1.1) itself. The Board does not share the view of the appellant and of Larry A Eddy in his article “The Taxation of Partnerships” that, in the absence of subsection 96(1.1), a partner who in withdrawing receives his share of the work in progress receives a capital gain. Work in progress represents an income component: if no tax has been paid on this component, in the Board’s opinion it is taxable in the hands of the recipient. If tax had been paid in 1972 on the work in progress, this item would still in theory be a component of income, but as in practice evidence would be presented that the tax had been paid, it would not be taxable again. The appellant’s share in the amount of $96,095 relating to work in progress in 1972, when he left the partnership, becomes in 1973, when he is no longer a member of it, a component which must be considered in computing his income. When he was in the partnership he paid no tax on his component. It was one of the items which was taken into account in computing the value of the appellant’s share in the partnership. The item was estimated at $96,095. It is a component of income and must be regarded as income. For the greater part of 1972, the appellant was still a member of the partnership, and all the members decided, in accordance with the Act (paragraph 34(1 )(d)), not to include work in progress in income.

5.3.8 In 1973, however, the appellant was no longer a member of the partnership. There is no provision in agreement A-2 that, for the purposes of work in progress, the appellant is deemed to remain a member of the partnership as was provided with regard to accounts receivable.

Does this mean that the amount pertaining to work in progress at the end of 1972 must be included in the appellant’s income in 1973? This is what the respondent contends, and it is the basis of the notice of reassessment for 1973 issued on April 1, 1977.

Moreover, if the appellant was deemed to continue to be a member of the partnership, whether under an agreement of subsection 96(1.1), the amount pertaining to work in progress should be included in 1973, because the evidence established that the said work had been completed in 1973.

However, the appellant is not deemed to continue to be a member of the partneship. Under what rule, then, is this component of income not taxable in 1973? — because all of it was not received in 1973? According to the evidence, the amount owed by the two senior partners, who bought back the appellant’s share, was to have been paid over a four-year period. In the opinion of the Board, because of the nature of this income component, which consisted of “1972 work in progress” (these were not 1971 accounts receivable), the Board does not see why it should not be entirely taxed in 1973. There is not basis in the Act or in the agreements for deferring the taxation to a later date.

6. Conclusion

The Board concludes that point 1 of the common question, described in paragraph 1.2, must be answered in the affirmative.

The appeal of the appellant is dismissed and the appeal of the third parties, presumed appellants, is allowed; the matter is referred back to the respondent for reassessment in accordance with the foregoing reasons for judgment.

Appeal dismissed.