Manji v. R., [1999] 3 CTC 2220, 99 DTC 885

Sarchuk T.C.J.:

This is an appeal by Aziz Jaffer B. Manji (the Appellant) from an assessment of tax with respect to his 1988 taxation year by virtue of which he was obliged to include in computing income for that year taxable capital gains of $225,000 and $124,883, respectively, on the transfer of his interest in two properties.

Facts [1]

In 1986, the Appellant entered into a Joint Venture with Zaar Property Corp. (Zaar) [2] known as Holbrook Manor Project (the Joint Venture). Holbrook Manor Holdings Ltd. (Holbrook Manor) was a bare trustee which held revenue producing property and certain investments in limited partnership units for the beneficial interest only of the joint venturers.

The Sunnybrook Property

On or about February 5, 1988, Equitable Capital Corp. (Equitable) acting for itself as to an undivided two-thirds interest and acting in trust for Holbrook Manor as to an undivided one-third interest, entered into an agreement to purchase a retail plaza located at 660 Eglinton Avenue East, Toronto, Ontario (the Sunnybrook property) for the purchase price of $14,900,000. The closing of the Sunnybrook property transaction was scheduled for March 31, 1988 (the closing date). [3]

On February 18, 1988, Holbrook Manor made its initial investment by paying the amount of $140,000 to Equitable, in trust, to purchase an equity interest in the Sunnybrook property. These funds were to be held in trust by Equitable and utilized only when the transaction was completed. [4]

On March 16, 1988, the Holbrook Associates Limited Partnership (Holbrook Associates LP) was created, with Holbrook Manor being the general partner. The limited partners were to be made up of a number of other investors. [5] On the same date, the Sunnybrook Limited Partnership (Sunnybrook LP) was created to own the Sunnybrook property. [6] According to Manji, it was intended that Holbrook Associates LP would be one of the partners in the Sunnybrook LP.

On March 17, 1988, Equitable and Holbrook Manor entered into an agreement with Sunnybrook LP to transfer their beneficial interest in the Sunnybrook property on the closing date for a purchase price equal to the fair market value of the property which was agreed to be $16,000,000. / [7] This acquisition agreement provided, inter alia, that Sunnybrook LP would satisfy the purchase price as follows:

(i) the assumption of $10,000,000 of indebtedness owing in respect of mortgages;

(ii) a cash payment in the amount of $4,395,000;

(iii) by way of an allocation to the capital account of Equitable and Holbrook Manor in respect of the interest acquired by them in the Sunnybrook LP; [8] and

(iv) three Units in the Sunnybrook LP to be acquired by Equitable and Holbrook Manor.

The parties also acknowledged, inter alia,that Holbrook Manor reserved the right to assign its interest in Sunnybrook LP to Holbrook Associates LP. According to the Appellant, this assignment did take place and Holbrook Associates LP became a limited partner in Sunnybrook LP.

With respect to this transaction, the Appellant testified that shortly before the scheduled closing date, three of the proposed Holbrook Associates LP limited partners (the Proposed Partners) had not yet advanced the funds required for the purchase of their respective limited partnership units. The amounts of their respective intended investments were: Shams Ramji (in trust) - $107,000; 738518 Ontario Ltd. (Dr. Zul and Almas Verjee) - $160,500; and Azad Karim (in trust) - $107,000. The total of the funds to be invested by the Proposed Partners was $374,500 (the Unadvanced Funds).

On March 25, 1988, Holbrook Manor made its “second investment” into the Holbrook Associates LP by paying the amount of $409,500 in trust to the law firm of Robins Appleby (the solicitors retained by the investors to complete the transaction). According to Manji, this $409,500 investment had two components. First, the amount of $35,000 was to be used to make a capital contribution from Holbrook Associates LP to the Sunnybrook LP to be used by the Sunnybrook LP towards initial working capital requirements. The second component, totalling $374,500, was an additional investment deposit made by Holbrook Manor to the Holbrook Associates LP to ensure sufficient funds were available on the closing date to allow the transaction to close pending the investment of the Unadvanced Funds. [9]

The Appellant also testified that the Unadvanced Funds were invested into the Holbrook Associates LP by the Proposed Partners on or very shortly before March 31, 1988, the closing date of the Sunnybrook Property transaction. [10] In turn, on March 31, 1988, the closing date of the Sunnybrook Property transaction, Holbrook Manor received the sum of $374,500 from Robbins, Appleby (the solicitors for the Sunnybrook LP) which was deposited into its bank account. In the Holbrook Manor Project - Joint Venture financial statements for year end December 31, 1988, the payment of $374,500 was treated as a credit in respect of the Joint Venture’s investment in Holbrook Associates LP. [11]

According to the Appellant, as of March 31, 1988, the amount of the capital investment made by Holbrook Manor into the Holbrook LP was $175,000, being made up of:

(a) the initial deposit in the amount of $140,000;

(b) plus the capital contribution towards initial working capital in the amount of $35,000.

(c) plus the additional investment deposit in the amount of $374,500;

and

(d) less the refund of the additional investment deposit in the amount of $374,500.

He further testified that the $374,500 payment made to Holbrook Manor did not form part of the consideration it received for the transfer of its one-third interest in the Sunny brook Property.

90 Eglinton Avenue East

In April or May, 1988, Equitable and the Holbrook Associates LP decided to cause the Sunnybrook LP to sell the Sunnybrook Property. In or about May 16, 1988, Equitable entered into an agreement to purchase a commercial office building at 90 Eglinton Avenue East, Toronto (the Eglinton property) for the purchase price of $40,500,000 (reduced by letter agreement dated June 30, 1988 to $40,300,000) (the Eglinton purchase agreement). [12]

On May 20, 1988, Sunnybrook LP entered into an agreement to sell the Sunnybrook property for $17,000,000. Shortly thereafter, Amin Jivraj, one of the limited partners in Holbrook Associates LP who had paid a subscription price of $160,500 for a 7.5% interest, entered into an agreement with Holbrook Manor to sell his partnership interest to it for the amount of $178,620. This agreement raised Holbrook Manor’s interest in Holbrook Associates LP from 25% to 32.5%.

On or about June 30, 1988, Holbrook Manor made an investment towards the purchase of the Eglinton property by paying the amount of $500,000 to Equitable which funds were used by it to pay one-half of the required deposit. The amount of $500,000 was sourced from Holbrook Manor. [13] The Appellant alleges that at the time the cheque was drawn, Holbrook Manor was acting as general partner for Holbrook Associates LP. On August 12, 1988, the 90 Eglinton Limited Partnership (the 90 Eglinton LP) was created. [14]

On August 10, 1988, Equitable assigned and transferred a one-half interest in the Eglinton purchase agreement to Holbrook Manor in consideration of Holbrook Manor’s having previously paid one-half of the deposit ($500,000) required pursuant to the Eglinton purchase agreement and assuming the obligations and liabilities pursuant to the terms of the 90 Eglinton purchase agreement. [15]

On August 12, 1988, all of the partners in the 90 Eglinton LP entered into an agreement defining the rights, obligations and liabilities of the general partner and the limited partner (the Limited Partnership Agreement). [16] On that same date, Equitable and Holbrook Manor entered into an Assignment and Transfer Agreement with the 90 Eglinton LP to transfer all of its right, title and interest in and to the Eglinton purchase agreement to the 90 Eglinton LP on the closing date for a purchase price of $2,350,000, to be paid as follows:

(i) by the 90 Eglinton LP issuing to each of Equitable and Holbrook Manor a non-interest bearing promissory note in the amount of $500,000 payable upon closing and conveyance of the real property to the partnership; [17]

(ii) by 90 Eglinton LP issuing four Class “B” limited partnership Units of 90 Eglinton LP to each of Equitable and Holbrook Manor; and

(iii) by crediting each of Equitable and Holbrook Manor with $168,750 towards their capital account for each such Class “B” limited partnership Unit (i.e. $675,000 to each capital account). [18]

The limited partnership agreement also provided that the Class “B” limited partners, namely Equitable and Holbrook Manor, would have the right, exercisable at any time on or after the closing date to withdraw capital from their respective capital accounts of 90 Eglinton LP. [19]

On August 15, 1988, the sale of the Sunnybrook property by Sun- nybrook LP closed. The net cash proceeds received by Sunnybrook LP from this sale were $3,432,000. The Holbrook Associates LP share of these proceeds was $1,077,417. This amount was invested into 90 Eglinton LP together with a further $800,583 secured by a loan from Equitable for a total investment of $1,878,000. As Holbrook Manor owned a 32.5% interest in Holbrook Associates LP, its investment in 90 Eglinton LP was 32.5% of the total investment or $610,350. [20]

On September 1, 1988, the purchase of the 90 Eglinton property closed. On September 8, 1988, Holbrook Manor received a total cash payment of $1,175,000 from 90 Eglinton LP. The amount of $1,150,000 was deposited to the account of Holbrook Manor, which represented the $1,175,000 payment net of legal expenses.

In the Holbrook Manor Project — Joint Venture financial statement for year ending December 31, 1988, $500,000 of the foregoing payment was recorded as an offset to the deposit of $500,000 paid by Holbrook Manor to the project vendors (which had been secured by a promissory note) and the balance of the payment in the amount of $650,000 was treated as a credit in respect of the withdrawal of capital in the investment of Holbrook Associates LP. The Appellant alleges that it had been previously agreed that both of these payments were to be directed by Holbrook Associates LP entirely to the benefit of Holbrook Manor. The remaining $25,000 reflected a holdback with respect to closing costs.

The financial statements of 90 Eglinton LP for the period ending December 31, 1988 disclose that the limited partnership had paid out $675,000, the amount credited to the capital account of Holbrook Manor in respect of the four Class “B” Units issued to it. This payment was characterized as a withdrawal of capital in respect of Holbrook Associates LP. [21]

On January 30, 1989, Equitable, acting for itself and in trust for Holbrook Manor, filed an election pursuant to subsection 97(2) of the Income Tax Act electing the acquisition cost to the Sunnybrook LP of the Sun- nybrook Property to be not greater than the adjusted cost base to Equitable and Holbrook Manor. The fair market value of the property disposed of was reported as $16,000,001; the total adjusted cost base was $14,925,372 which was also the agreed amount. The fair market value of the consideration received was $16,000,001. Holbrook Manor’s share of the gain and the transfer according to the amounts reported in the Sunnybrook election was $358,219 (one-third of $l,074,630). [22]

On December 22, 1989, Holbrook Manor made an election pursuant to subsection 97(2) of the Income Tax Act that the acquisition cost to the 90 Eglinton LP of Holbrook Manor’s one-half interest in the Eglinton purchase agreement to be no greater than the adjusted cost base to Holbrook Manor of its interest in the Eglinton purchase agreement in the amount of $500,000 and not Holbrook’s share of the purchase price paid by 90 Eglinton LP to Holbrook which was $1,175,000 (90 Eglinton election). The fair market value of the property disposed of was reported as $1,175,000; the adjusted cost base was $500,000 which was also the agreed amount. The fair market value of the consideration received was $1,175,000. [23]

Conclusion — The Sunnybrook property

With respect to the Sunnybrook transaction the Respondent contends that the payment of the $374,500 was part of the proceeds (cash consideration received by the Holbrook Manor (as trustee for the Joint Venture) on the transfer of its interest in the Sunnybrook property to the Sunnybrook LP) and therefore, is subject to tax. More specifically, the consideration which Holbrook Manor received for the transfer of its one-third interest in the Sunnybrook property was a partnership interest and $374,500 which, the Respondent alleges, it received immediately following the transfer of its interest in the Sunnybrook property to Sunnybrook LP.

I am satisfied that the Respondent’s position is not supportable on the facts. On the other hand, the evidence does support the position advanced by the Appellant that the $374,500 received by Holbrook Manor represented nothing more than a refund to it of its advance to Holbrook Associ- ates LP on behalf of the Proposed Partners. This advance was made by Holbrook Manor to ensure that sufficient funds were available on the closing of the Sunnybrook property. The filing for Holbrook LP under the Ontario Securities Commission, Schedule A which lists all of the partners, confirms that the Proposed Partners did indeed invest their funds and become partners. [24] Evidence was also adduced from Alaudin Jamal (Jamal), who was the accountant for the Appellant, Holbrook Manor and Holbrook Associates Limited Partnership, and was responsible for preparing the year-end financial statements. His understanding of the $374,500 advanced to Holbrook Associates LP was that it represented a short-term loan from Holbrook Manor to the Proposed Partners. Once the money was received from them, this amount was considered an excess and a refund was made payable to Holbrook Manor. He testified that his subsequent accounting treatment of the $374,500 was consistent with it being a short-term loan. The cheque in that amount would not have shown up in the Sunnybrook LP financial statements because the payment was made by Holbrook Manor and not Holbrook Associates LP. Furthermore, as the payment was from Holbrook Manor, the $374,500 would also not show up in Holbrook Associates LP’s financial statements. It also did not show up in Holbrook Manor’s year end statements as the $374,500 was both paid and refunded within that period. Jamal’s testimony is consistent with that of the Appellant with respect to the source of these funds and the nature of the payments and refunds.

One further factor supports the Appellant’s position. The $374,500 could not be a withdrawal of capital as the Sunnybrook LP agreement expressly prohibited the withdrawal of capital on the closing date. In the same vein, if Holbrook Manor withdrew that amount upon closing, Equitable would have made a matching withdrawal of $749,000 (2 x $374,500), as was the case in the 90 Eglinton transaction. For the foregoing reasons, I have concluded that the Appellant’s position that there is a clear flow of funds supported by documentary evidence is correct.

Accordingly, with respect to this issue, the appeal is allowed.

Appellant’s Position — 90 Eglinton Avenue East

With respect to this transaction, the Appellant takes the position that the Minister erred in assuming that the payment of $675,000 constituted consideration paid in respect of the rollover transaction. More particularly, the Appellant’s position is that the partners of Holbrook Associates LP had agreed that Holbrook Manor would be entitled to the amount of any withdrawal of capital that Holbrook Associates LP would make pursuant to the syndication in light of Holbrook Manor having provided the funds for the $500,000 deposit.

Counsel for the Appellant made reference to Haro Pacific Enterprises Ltd. v. R.^ [25] and suggested that it was authority for the proposition “that it is only where a taxpayer has made no cash contribution to a partnership that a capital withdrawal will be deemed to be consideration for the transfer of property to a partnership pursuant to a subsection 97(2) rollover transaction. He submitted that:

The case law only requires a withdrawal of capital to form part of the consideration paid in respect of a rollover in very limited circumstances. Specifically, where one partner transfers property only to a partnership and receives a payment in return shortly after the transfer equal to one-half of a simultaneous cash contribution made by another partner, the true commercial and practical nature of the transaction requires that the payment form part of the consideration for the transfer of the property to the partnership.

Counsel for the Appellant argued that “the Holbrook Associates LP withdrew $675,000 from its capital account of the 90 Eglinton LP which payment was directed by it entirely to the benefit of Holbrook Manor”. On this basis, since Holbrook Manor owned a 32.5% interest in the Holbrook Associates LP, the amount of Holbrook Manor’s cash investment in the 90 Eglinton LP was 32.5% of the $1,878,000 invested in the 90 Eglinton LP by the Holbrook Associates LP or $610,350. According to Counsel, this was the real cash being invested by Holbrook Manor, and thus, the withdrawal of capital should only be deemed to be consideration for a “roll-in gain” to the extent that the draw exhausts the taxpayer’s previous cash contributions. Accordingly, given the true commercial nature of the transaction, the $675,000 should be reduced by $610,350 to result in Holbrook Manor’s receiving $64,500 as consideration for its transfer of its interest in the 90 Eglinton property to the 90 Eglinton LP.

Counsel for the Appellant further submitted that in the event the Court were to find that Holbrook Manor entered into the 90 Eglinton rollover agreement with the 90 Eglinton LP on its own behalf (i.e. as trustee for the Joint Venture) Holbrook Manor as a limited partner of 90 Eglinton LP made a capital withdrawal of $675,000 from its capital account of 90 Eglin- ton LP. Again, Holbrook Manor, by virtue of its 32.5% interest in the Holbrook Associates LP contributed $610,350 to the 90 Eglinton LP. Thus, the same result occurs, i.e. that Holbrook Manor receives $64,500 as consideration for its transfer of its property interest in the 90 Eglinton property to the 90 Eglinton LP being a $675,000 capital withdrawal less the $610,350 cash investment.

Respondent’s Position

With respect to the 90 Eglinton transaction, the Respondent maintains that the payment of $675,000 was part of the proceeds received by the Joint Venture on the transfer of its interest in the 90 Eglinton property to the 90 Eglinton LP and therefore is subject to tax. In the alternative, if the amount was not received as proceeds on the transfer, paragraph 85(1)(b) of the Act operates to deem the agreed amount to be the fair market value of the consideration received by the Joint Venture which was $1,175,000 less the Adjusted Cost Base of $500,000. Therefore, the capital gain was $675,000.

It is the Respondent’s position that the evidence does not support a finding that at all relevant times Holbrook Manor was acting solely as general partner for Holbrook Associates LP. Counsel for the Respondent argued that there was an obligation on the part of the 90 Eglinton LP to pay $675,000 to each of Equitable and Holbrook Manor when so requested by the respective parties after the date of closing. Counsel further argued that all Class “B” Unit holders of the 90 Eglinton LP were entitled to withdraw a total of $675,000 at their discretion and that this amount was received as consideration for the rollover and was not a withdrawal of capital.

Conclusion

The issue to be determined is whether the $675,000, or part of it, received by Holbrook Manor from the 90 Eglinton LP was the consideration for the transfer of its interest in the 90 Eglinton property.

The Appellant’s basic premise is that although Holbrook Manor initially acted as a bare trustee for the Joint Venturers when it was made the general partner of Holbrook Associates LP it participated in the subsequent transactions solely in its capacity as a general partner. While there was some evidence from the Appellant to that effect (generally by way of affirmation of leading questions by his Counsel), it was not supported by any other testimony or by any relevant documents Furthermore, it is an admitted fact that Holbrook Manor was a bare trustee for the beneficial interest only of the Joint Venturers, one of whom was the Appellant and that throughout, Holbrook Manor acted as bare trustee for the Joint Venturers. [26]

The Appellant argued that on June 30, 1988, the Holbrook Associates LP made an investment towards the purchase of the 90 Eglinton property by paying the amount of $500,000 to Equitable and that these funds were sourced from Holbrook Manor. The fact is that on May 16th, Equitable entered into an agreement to purchase 90 Eglinton Avenue East. Shortly thereafter, Holbrook Manor acquired a one-half interest in the agreement of purchase and sale of the 90 Eglinton property which was then transferred to 90 Eglinton LP. The $500,000 payment came from Holbrook Manor’s account, was paid directly to Equitable and was subsequently the subject of an assignment and transfer agreement between Equitable and Holbrook Manor. [27] The fair market value of the transfer price paid by 90 Eglinton LP was $2,350,000 of which Holbrook Manor was entitled to one-half, namely, $1,175,000. This amount was satisfied by way of a promissory note in the amount of $500,000 and a credit to Holbrook Manor’s capital account in 90 Eglinton LP in the amount of $675,000. The documents related to these transactions clearly establish that Holbrook Manor and Equitable were the agreement vendors and the Class “B” limited partners and there is nothing therein or in the limited partnership agreement [28] to support the Appellant’s contention that Holbrook Manor did so as the general partner of Holbrook Associates LP.

For its part, Holbrook Associates LP invested a total of $2,553,000 in 90 Eglinton LP. This investment consisted of 12 Class “A” Units with a value of $1,878,000 and the four Class “B” Units having a value of $675,000. The Class “A” Units were paid for with the proceeds from the Sunnybrook property sale in the amount of $1,077,417 and a loan from Equitable in the amount of $800,583. Holbrook Manor as general partner of Holbrook Associates LP had a 32.5% interest in Holbrook Associates LP’s $1,878,000 investment in 90 Eglinton LP (i.e. the 12 Class “A” Units) which interest amounted to $610,350.

Furthermore, the rollover agreement [29] specifically provided that Holbrook Manor would be a Class “B” Limited partner with a deemed capital contribution of $675,000. Although the ultimate $675,000 withdrawal of capital was credited against Holbrook Associates LP’s interest in 90 Eglin- ton LP, the fact is that the $675,000 (minus $25,000 for legal fees) was paid directly to Holbrook Manor. The suggestion by the Appellant that this payment was made in this fashion simply because Holbrook Associates LP did not maintain a current bank account was neither convincing nor determinative of the relationship between the parties.

Pursuant to the 90 Eglinton property rollover agreement, Holbrook Manor was entitled to withdraw $675,000 from the 90 Eglinton LP. That amount was the exact amount credited to Holbrook Manor’s Class “B” Unit capital account on the execution of the rollover agreement. The 90 Eglinton LP paid the sum of $1,150,000 to Holbrook Manor approximately 27 days after the rollover agreement was executed. This consisted of the promissory note in the amount of $500,000 and a capital withdrawal of $675,000 (less $25,000 paid for legal fees). The only logical conclusion is that this amount was paid in consideration for the transfer of the 90 Eglinton property. The onus is on the Appellant to demonstrate otherwise and in my view, this has not been done. The Appellant’s submission that there was a verbal agreement among the partners of Holbrook Associates LP that Holbrook Manor would be entitled to the amount of any withdrawal of capital made pursuant to the syndication because Holbrook Manor had provided the $500,000 deposit is unconvincing and is not supported by any of the relevant documents or by testimony from any of the other partners in Holbrook Associates LP. The transactions in which the parties were engaged were governed by complex and sophisticated partnership agreements drafted by their respective Counsel. It is difficult to accept Counsel’s submission that the partners of Holbrook Associates LP simply failed to put this purported agreement into writing.

In Vantem Holdings Ltd. v. [30] a similar question was considered by Bell T.C.C.J. In concluding, he observed that:

The form of the entire transaction does not conceal its substance. I find that the amounts paid or credited to the Appellant in reduction of its “capital account” were, in reality, proceeds of disposition of the assets transferred by it to the Partnership....

This comment applies equally in the present appeal.

The appeal with respect to the 90 Eglinton property rollover is dismissed. Each party shall bear their own costs.

Appeal allowed in part.

Appendix “A”

Admitted Facts

1. In 1986, the Appellant entered into a joint venture with Zaar Property Crop. (“Zaar”). The Appellant and Zaar will hereinafter sometimes be referred to collectively as the “Joint Ventures”.

2. At all material times, Zaar was controlled by Mr. N.E. Kanji.

3. The joint venture between the Appellant and Zaar was known as Holbrook Manor Project — Joint Venture (the “Joint Venture”)

5. Holbrook Holdings Ltd. (“Holbrook Manor”) was a bare trustee which held a revenue producing and certain investments in limited partnership units for the beneficial interest only of the Joint Venturers.

6. Holbrook Manor acted throughout as a bare trustee for the Joint Venturers.

7. On or about February 5, 1988, Equitable Capital Corp (“Equitable”) acting for itself as to an undivided two-thirds interest and acting in trust for Holbrook Manor as to an undivided one-third interest, entered into an agreement to purchase a retail plaza located at 660 Eglinton Avenue East, Toronto, Ontario (the “Sunnybrook Property”) for the purchase price for $14,900,00.

8. The closing of the Sunnybrook Property transaction was scheduled for March 31, 1998.

11. On or about March 16, 1998, the Holbrook Associates Limited Partnership (the “Holbrook Associates LP”) was created, with Holbrook Manor being the general partner, with the limited partners to be made up of a number of others investors.

12. On or about March 16, 1998, Sunnybrook Limited Partnership (the “Sunnybrook LP”) was created to own the Sunnybrook Property.

23. On or about May 16, 1988, Equitable Capital Corp. (“Equitable”) entered into an agreement to purchase a commercial office building at 90 Eglinton Avenue East, Toronto, Ontario (the “Eglinton Prop- erty”) for the purchase price of $40,500,000 (the “Eglinton Purchase Agreement”).

24. On or about May 20, 1998 the Sunnybrook LP entered into an agreement to sell the Sunnybrook Property for $17,000,000.

25. Shortly thereafter, one of the limited partners in the Holbrook Associates LP, Amin Jivraj in trust, who had paid a subscription price of $160,500 for a 7.5% interest, entered into an agreement with Holbrook Manor to sell his partnership interest to Holbrook Manor for the amount of $178,620. This agreement raised Holbrook Manor’s interest in the Holbrook Associates LP from 25% to 32.5%.

26. By letter agreement dated June 30, 1988, the purchase price of the Eglinton Property was reduced to $40,300,000.

30. On or about August 12, 1988, all of the partners in the 90 Eglinton LP entered into an agreement (the “90 Eglinton LP Agreement”).

33. On or about August 15, 1988, the sale of the Sunnybrook Property by the Sunnybrook LP closed.

38. On or about September 1, 1988, the purchase of the Eglinton Property closed.