Hollinger v. M.N.R., 73 D.T.C. 5003, [1972] C.T.C. 592 (FCTD)

The Associate Chief Justice:—This is an appeal from an assessment made with respect to the appellant’s 1966 taxation year whereby a certain deduction made from her tax in that year pursuant to paragraph (b) of subsection (1) of section 33* [1] of the Income Tax Act and section 6 of the Established Programs (Interim Arrangements) Act, SC 1964-65, c 54, was disallowed by the respondent.

Appellant, although married to a Montreal doctor and residing in the Province of Quebec, claims that she was, in 1966, and continues to be, a non-active partner in a commercial undertaking in Hackensack, New Jersey, USA, carrying on business under the name of Galler—7 Up Bottling Co.

The above partnership was created under the laws of the State of New Jersey by agreement dated December 30, 1963, which agreement, she says, is governed by the laws of the said State as to form and effect.

Under the terms of the partnership agreement and the laws of the State of New Jersey, income, according to the appellant, derived by her is not business income but passive income derived from the capital invested in the partnership.

In her 1966 taxation year, appellant received income of $64,785.67 from her interest in the above-mentioned partnership.

Appellant says that she computed her tax payable to Canada in the manner provided by the Income Tax Act and, in particular, deducted from her tax otherwise payable the amount of approximately $12,217.32 pursuant to subsection (1) of section 33 of the Income Tax Act and section 6 of the Established Programs (Interim Arrangements) Act.

In addition to paying tax to the United States, appellant was assessed tax by the Province of Quebec on her income from all sources pursuant to section 4 of the Provincial Income Tax Act.

The respondent, as we have seen, reassessed appellant and disallowed the deduction made by appellant from tax otherwise payable.

The position taken by the appellant is that she is entitled to the deductions from the tax otherwise payable which is permitted by subsection 33(1) of the Income Tax Act and section 6 of the Established Programs (Interim Arrangements) Act because at all material times and in particular on December 31, 1966 she was a resident of the Province of Quebec and had no income for the year from a business with a permanent establishment outside such province.

She submits that failure to allow the deduction permitted by section 33 of the Income Tax Act will result in triple taxation on her investment income from the partnership and that such a finding would be unreasonable and would not bring about a result which conforms to the apparent scheme of the Income Tax Act and the Regulations made thereunder.

The respondent, on the other hand, does not admit that the appellant was an inactive partner in Galler—7 Up Bottling Co and says that in any event the distinction is irrelevant under the income Tax Act. The appellant, he says, has deducted not $12,217.32 but $24,063.66 from her basic tax as abatement for provincial taxes, although she was, he says, only entitled to a credit in the amount of $8,289.15 pursuant to paragraph (b) of subsection (1) of section 33 of the Income Tax Act (supra) as it stood at the time and subsection (2) of section 2601* [2] of the Regulations and section 6 of the Established Programs (Interim Arrangements) Act.

The respondent admits that the appellant was assessed tax by the Province of Quebec but adds that the liability of the appellant pursuant to the federal Income Tax Act is not affected by any assessment made pursuant to the laws of the Province of Quebec and that, therefore, this matter is irrelevant.

The parties produced an agreed statement of facts which is reproduced hereunder:

1. During the 1966 taxation year, appellant was a resident of the Province of Quebec.

2. Appellant was, in 1966, and continues to have a partnership interest in a commercial undertaking in Hackensack, New Jersey, U.S.A., which carries on business under the name of Galler—7 Up Bottling Co. (hereinafter referred to as “Bottling”).

3. Bottling was created under the laws of the State of New Jersey by Agreement dated December 30, 1963 (hereinafter referred to as the “Agreement”).

4. During the 1966 taxation year the appellant received total! income of $98,745.87 which consisted of

(a) income from foreign property in the amount of $33,960.20, dividends and interest and

(b) income derived from her partnership interest in Bottling in the amount of $64,785.67.

5. During the 1966 taxation year the appellant’s total income originated from the United States of America and was fully taxable under the Income Tax Act and under the Quebec Provincial Income Tax Act.

6. The income described in paragraph 4(a) above in the amount of $33,960.20 was income earned in the Province of Quebec during the 1966 taxation year.

7. In computing the deduction for provincial taxes under section 33 of the Income Tax Act (the “Act”) in respect of 1966, the appropriate percentage figure in respect of the appellant as a resident of the Province of Quebec is 47% of the basic tax.

8. For purposes of computing the federal deduction for provincial taxes, appellant has deducted 47% of the basic tax as defined in section 33 of the Act, namely $24,063.66, which deduction had the effect of reducing to nil her federal tax payable.

9. In arriving at the computation of appellant’s federal abatement for provincial taxes, the respondent has deducted an amount that bears the same relation to 47% of the basic tax that appellant’s income described in paragraph 4(a) ($33,960.20) bears to her total income for the taxation year ($98,745.87), namely the sum of $8,289.15, which deduction had the effect of establishing at the sum of $12,217.32 her federal tax payable.

10. All moneys referred to in this agreed statement of facts are calculated in Canadian funds.

The problem involved herein, in so far as this appellant is concerned, is applicable also to future years.

The issue, which is one of law, expressed in simple words, is whether the income received by the appellant from her interest in the New Jersey partnership should be characterized as income from property or income from the carrying on of a business. If such income is to be considered as income from property, then of course the appellant is entitled to the deduction abatement for provincial taxes permitted by section 33 of the Income Tax Act reproduced supra which here would be $25,278 or 47% X $53,784 (ie, the basic tax, $49,937, obtained by applying $45,070 on the first $90,000 and 65% on the remaining $7,487.47). If this income, as contended by the respondent, is to be considered as income from a business, then the appellant would be entitled to an abatement of $8,289.15 only, obtained by taking

$33,960.00 (appellant’s investment income), [plus]

51,199.27 (basic tax on the total income of $98,745.87

incorrectly calculated)

and subsection 2601(1) of the Regulations provides that

(1) Where an individual resided in a particular province on the last day of a taxation year and had no income for the year from a business with a permanent establishment outside the province, his income earned in the taxation year in the province is his income for the year.

This, of course, means that the income of an individual residing in a province for a given year, is the aggregate of his income no matter where earned as long as it is not earned from a business with a permanent establishment outside the province. It is, therefore, in so far as [it is] income earned from investments or property deemed to be earned in the province even if such income comes from outside the province or country.

I should also add, however, that subsection 2601(2) provides that

(2) Where an individual resided in a particular province on the last day of a taxation year and had income for the year from a business with a permanent establishment outside the province, his income earned in the taxation year in the province is the amount, if any, by which

(a) his income for the year

exceeds

(b) the aggregate of his income for the year from carrying on business earned in each other province and each country other than Canada determined as hereinafter set forth in this Part.

The principal effects of the above regulations are that

(1) all of an individual’s non-business income is deemed to be earned in whichever province he resides in on the last day of the taxation year and

(2) business income whether of a corporation or an individual is allocated to the provinces (or other places) in which the business has “permanent establishments”.

If subsection 2601(1) applies here, then the appellant’s deduction of $25,278 is correct (47% X $53,784). If, on the other hand, subsection 2601(2) applies, then, of course, the respondent’s deduction of $8,584.56* [3] is the proper one.

The above subsection 2601(2) appears to clearly state that if a resident in a province has income for the year from a business outside the province, then his income earned in the province is the amount by which his income for the year exceeds the aggregate of his income for the year from carrying on business earned in each other province or country. If this section were to apply to the present appellant, as suggested by the respondent, she would be paying a tax of close to $70,000 (or $69,860.03) as hereinafter set down instead of an amount of $55,057.12 according to the appellant or $51,067.27 if she was living in the Province of Ontario, as hereunder set down:

According to the calculations of the appellant, the latter should pay a tax of $55,057.12 on a taxable income of $97,487.47:

She would, according to the respondent, on a taxable income of $97,487.47 pay a tax of $69,860.03:

Counsel for the appellant says that the latter is not trying to avoid or lessen her tax liabilities on the income she has received. The only reason that the amount of federal tax payable works out to “nil”, if her calculation thereof is accepted, is due to the specific arrangements which the federal government has made with respect to

(a) provincial income taxes and cost sharing arrangements for certain programs sponsored by or paid for by the provinces, and

(b) foreign taxes paid by Canadian residents.

In so far as the provincial income taxes and cost sharing arrangements are concerned, the intent of the federal legislation is to permit the provinces to raise the funds for such purposes by means of provincial taxation, coupled with a partial withdrawal by the federal government from taxation of amounts which are subject to provincial taxation. The purpose of relating the deduction to “income earned in the province” is, according to the appellant, to ensure that the deduction from federal tax is given only in respect of income which has borne the appropriate provincial tax.

The matter of the specific arrangements which the federal government has made with respect to foreign taxes paid by Canadian residents represents the policy of the Canadian federal government relating to taxes paid on income earned outside Canada and this deduction is equal, in general, to the lesser of the foreign tax paid on the income or the portion of Canadian tax otherwise payable applicable to the foreign income.

In the case of the appellant, if the deduction for provincial taxes is calculated as submitted by the appellant, the effect of the foreign tax deduction is, of course, to reduce the federal tax payable to nil, although, as indicated above, the overall taxes payable by her are still higher than they would be in other jurisdictions in Canada.

The question, of course, is how can the appellant in the face of subsection 2601(2) of the Regulations (which, as already mentioned, states that the income earned in the taxation year in the province by an individual resident in a province, who earns income from a business, with a permanent establishment outside the province, is the amount by which his income for the year exceeds the aggregate of his income for the year from carrying on business earned outside the province or country) contend that she is entitled to compute the deduction for provincial taxes under section 33 of the Act based on a. figure which includes the income from her partnership interest in Galler—7 Up Bottling Co.

She can only do so if she establishes that such income must be considered as “income earned in a province” within the meaning of the Act and the above Regulations bearing in mind that income from property, even if such property is outside the province, is deemed to be income earned in the province.

The position taken by the appellant is that the income received by her from the partnership in so far as she is concerned, is income from property. William A Kaufmann, attorney-at-law of the city of Hoboken, NJ, USA was heard on behalf of the appellant for the purpose of, inter alia, expressing an opinion on the law of New Jersey in respect of whether, assuming certain facts (which are not contested here) “does the income of the appellant in 1966 from the partnership constitute business income or investment income from property”.

He was of the view that under New Jersey law the income received by the appellant in 1966 from the partnership did not constitute business income but rather inactive investment income from property.

He then stated that

(a) the present partnership of Galler—7 Up Bottling Co is a continuation of the partnership formed in 1942 by the late Charles Galler and his wife Ruth;

(b) the operations of the old partnership were in effect continued under the new partnership and in the same manner they had been conducted since 1945, namely under the management of Ruth Galler;

(c) the appellant’s interest in the partnership consisted of 15% inherited from her father’s estate and 5% given to her by her mother from the interest acquired by the mother from one of the daughters’;

(d) the appellant’s income from the partnership was not under the laws of New Jersey, income derived from the carrying on of a business by her;

(e) the appellant’s income from the partnership arose from the use of her capital by the partnership;

(f) the return of benefits under the partnership agreement is similar to a dividend paid to shareholders or bank or mortgage interest;

(g) the appellant’s income is essentially passive investment income;

(h) the appellant herself had no role in the partnership other than the investment of capital.

From the agreement, it is also apparent that the appellant is an inactive partner. It expressly states that the mother shall be the manager in full charge of the partnership affairs for which she receives a weekly salary of $400 deducted as an expense of the business partnership. Mr Kaufmann suggested that the return of benefits under the agreement is similar to a dividend paid to stockholders and it would seem that if the appellant held shares in a company formed to operate the business instead of an interest in the partnership, and received dividends from her shares she would be able to calculate her tax liability on the full amount received which might conceivably be the same amount as that received from her share of the partnership operations.

The question, therefore, is whether the benefits received by the appellant under the agreement simply represent a return on capital irrespective of whether such return is based on risk capital or use of capital and should be considered as being essentially and factually passive investment income or whether such benefits must be considered as business income as the source of such income flows from a business operation.

Counsel for the appellant submitted that there are two possible approaches to characterizing appellant’s income from her interest in the partnership. One is, he says, to apply the laws of the State of New Jersey which is where the partnership agreement was executed, the other is to apply the Canadian law. I have no intention of determining whether the foreign law applies here or not as I can see no relevant difference between the New Jersey law or the Quebec or Canadian law of partnership which would be relevant to the matters dealt with in this appeal. I shall, therefore, be content to consider the law as it stands in this country.

Counsel for the appellant points out that paragraph 6(1 )(c)* [4] of the Income Tax Act is couched in such terms that it brings into the tax net the income of the taxpayer and not that of the partnership or that the words used by the draftsman require the inclusion of the taxpayer’s income from a partnership and does not require inclusion of the income of the partnership.

I must say that, although this is so, it appears to me that there is a very good reason for the above requirement in that it is only that part of the share of the partnership that belongs to the taxpayer that must be included in the taxpayer’s income and not the shares of all the partners or of the partnership generally. I therefore fail to see how this can be of any assistance to the appellant. Counsel for the appellant further says that the question of whether income is from a business or property is one that must be resolved on the facts of each particular case and no simple criterion is determinative. The criteria which may, he says, be drawn from the authorities and which may serve as indicia are:

(1) whether the income was the result of efforts made or time and labour devoted by the taxpayer;

(2) whether there was a trading character to the income;

(3) can the income be fairly described as income from a business within the meaning of that term as used in the Act; and, finally, (4) the nature and extent of services rendered or activities performed.

I believe that most of those criteria are what may be termed subjective ones, ie, which deal or apply to the person receiving the income rather than to the objective question of the source of the income which, in my view, is always the overriding consideration which must determine the matter. The source here is clearly a business source. If income from property has any meaning at all, it can only mean the production of revenue from the use of such property which produces income without the active and extensive business-like intervention of its owner or someone on his behalf. I have in mind, for instance, property such as bonds or debentures or shares or real property which do not require the exertion of much activity or energy in order to produce the revenue. There is no question that the appellant has entered into a partnership here with her mother and sister and this partnership is clearly operating a business from which she receives her share of the profits. A partnership, and this applies to the civil law as well as to the common law, is essentially a contractual relationship between two or more persons. The contract is usually in writing but need not be so. There must be a business carried on and, of course, this is what we have here. Each partner usually contributes either property, skill or labour but this is not essential and a partner may be a passive one who, such as here, merely supplies capital. There must be some arrangement for division of profits and usually an arrangement for the sharing of losses, although this also is not essential. The Partnership Act in the common law provinces defines partnership as “the relationship that subsists between persons carrying on business in common with a view to profit”. Article 1830 of the Quebec Civil Code says that

1830. It is essential to the contract of partnership that it should be for the common profit of the partners, each of whom must contribute to its propery, credit, skill or industry.

It is possible that, in some cases, the holding of property in joint tenancy, tenancy in common or other form of joint ownership, may not in itself create a partnership. However, when there is a clear business operation conducted and a receipt of a share of profits such as here, there can, in my view, be no question that the amounts received by the appellant are income from a business and not from property.

I am afraid that although it does appear that the appellant is paying a large amount of taxes on the income she receives, I cannot see how I can hold that she was wrongly assessed in the light of subsection 2601(2) of the Income Tax Regulations and the requirements of its subparagraphs which are all met here and which are namely that:

(1) the appellant resided in a province on the last day of taxation year,

(2) she received income from a business, and

(3) that business had a permanent establishment outside the province, in the State of New Jersey.

The appeal is therefore dismissed with costs.