Jean-Pierre Laurin v. Minister of National Revenue, [1979] CTC 2571, 79 DTC 439

Guy Tremblay [TRANSLATION]:—This case was heard at Montreal, Quebec on May 17, 1978, on common evidence with the cases of Jean-Guy Laurin (77-1288), Hubert Laurin (77-1308) and Laurent Laurin (78-63).

1. Point at Issue

It must be decided, inter alia, whether the respondent is correct in including in the appellant’s income an amount of $5,500, as part of the income of the partnership C Laurin & Fils Enrg for the 1972 taxation year. The appellant maintains that this amount is the consideration for the sale of his share in the said partnership, thus giving rise to a capital gain.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden 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 R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

3.1 On May 21,1968 the appellant entered into partnership with his father Charles and his four brothers Jacques, Jean-Guy, Hubert and Laurent, under the firm name of C Laurin & Fils Enrg, as shown by the partnership declaration registered in the judicial district of St-Hyacinthe on May 23, 1968, No 5961, a photocopy of which was filed as Exhibit A-2.

3.2 The purposes of the partnership were carpentry, construction and repair work, assembly of mobile homes, and so on, as shown by Exhibit A-2.

3.3 The evidence showed that almost all the partnership assets (lots, tools and equipment, two trucks, tractors) were contributed by the father, Charles Laurin. The appellant for his part maintained that he and his brothers each brought in assets in the form of equipment with a value of about $500 (compressor and punch). This statement was denied by Mr Charles Laurin.

3.4 The appellant stated that the business’s accounting system was more or less non-existent. The few records in existence were kept by his brother Edouard who works in a bank. All the amounts earned were deposited at the bank.

Mr Charles Laurin stated that the appellant kept the accounting records and he himself checked them.

3.5 Salaries were paid in accordance with the partners’ status (married or Single) and whether or not the partner had his proficiency card.

3.6 On November 14, 1972, the appellant and his three brothers Laurent, Jean-Guy and Hubert withdrew from the partnership of C Laurin & Fils Enrg, after signing the document filed as Exhibit A-1 which reads as follows:

Marieville, November 14, 1972.

We, the undersigned LAURENT LAURIN, JEAN-PIERRE LAURIN, JEAN-GUY LAURIN and HUBERT LAURIN, all carpenters, domiciled at Marieville in Rouville county, hereby confirm that we have transferred and assigned all our rights and interests in the partnership of LAURIN & FILS ENRG to MESSRS CHARLES LAURIN AND JACQUES LAURIN, carpenters, of Marieville, and have today been paid in full for all our rights and claims respecting the said partnership.

Signed.

3.7 The withdrawal of the four brothers came about because Mr Charles Laurin apparently decided to sell his share to someone else. Through their lawyer, they asked Mr Charles Laurin to value the partnership and return their shares to them.

The appellant stated that each brother asked for $10,000 and received $5,500.

3.8 It appears from the income and expenditure account for 1972, attached to the appellant’s tax return filed in July 1975, that the net partnership income before deduction of partners’ salaries was $52,089.76. The partners’ shares were as follows:

These amounts, derived from the partnership distribution, were included by the respondent in the income of the appellant and his brothers respectively.

3.9 The respondent included in each partner’s income an amount of $1,843.10, one-sixth of $11,058.77, which the partnership had earned and not reported. The appellant offered no evidence contesting the inclusion in the assessment of this amount of $1,843.10.

3.10 The partnership profit and loss account for 1972 attached to the appellant’s tax return was prepared by Mr Edouard Laurin.

3.11 The same partnership profit and loss account for 1972 was filed as Exhibit 1-2. Some alterations had, however, been made in Mr Charles Laurin’s writing. The changes are underlined:

The salaries totalling $30,089.06 were deducted from the total income of $52,089.76, leaving assets of $22,000.70 in the partnership. This figure was divided in four, $5,500 to each of the brothers, who stated that they regarded this as the proceeds of the sale of their share in the partnership. Mr Charles Laurin stated that he and his son Jacques wished not to draw on this net profit, in order to be able to deal with the problem of those who wished to withdraw, by paying out their shares to them.

3.12 The witnesses stated that 1972 was not only the partnership’s best year financially, but actually the only year in which a profit remained after payment of a reasonable salary to the working partners.

3.13 After the four brothers Jean-Pierre, Jean-Guy, Hubert and Laurent Laurin withdrew from the partnership, Mr Charles Laurin, by a contract notarized on January 12, 1973 and filed as Exhibit I-3, sold his personal residence and the assets used by the partnership to his other two sons, Jacques and Edouard, for $40,000 ($20,000 each). The contract provides that the $20,000 owed by Jacques was regarded as paid, in view of his previous membership in the partnership.

3.14 The notice of assessment was issued on July 2, 1976.

3.15 Following a notice of objection dated August 19, 1976, a notice of reassessment was issued on June 1, 1977, adding income of $1,843.10 as explained in paragraph 3.9.

3.16 The notice of appeal, signed on August 26,1977, was addressed first to the Department of National Revenue instead of the Tax Review Board. It was probably returned thereafter to the appellant, who eventually submitted the appeal to the Board on December 6, 1977; this was accordingly beyond the legal time limit of ninety days from August 19, 1977.

3.17 At the beginning of the hearing a written application to extend the time limit for filing the appeal was made in accordance with the Act. The respondent did not object to this request and the Board gave its decision allowing the extension and deeming the appeal filed to be valid. The parties were then able to proceed to the main issue of the case.

4. Act— Comments

4.1 The particular section relevant to this case is paragraph 96(1 )(f) of the new Act:

(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, as the case may be, shall be computed as if

(f) the amount of the 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.

4.2 Comments

It appears from the section above cited that when a member of a partnership files his tax return he must include in the computation of his income for the year his share in the net profits of the partnership for that year, whether or not there has been a cash distribution to the partners.

4.2.1 The partner’s shares

What share was each partner entitled to receive? As this is not stated in any document, Art 1848 of the Civil Code must apply:

When there is no agreement concerning the shares of the partners in the profits and losses of the partnership, they share equally.

Each partner is thus entitled to receive one-sixth of the profits.

4.2.2 Profits in 1972

What were the partnership’s profits for the year in question? Subject to the decision to be rendered in connection with the sum of $11,058.77 (see paragraphs 3.9 and 4.2.3) the net profits, according to the income and expenditure account filed as Exhibit 1-2, were $22,000. From a total sales figure of $324,312.27 there remained a balance of $52,089.76 after accounting for federal and provincial taxes, the cost of sales and current expenditures, but before deducting working partners’ salaries. However, the Board accepts Mr Charles Laurin’s evidence, confirmed by his handwritten notes on Exhibit I-2, that the salaries for that year amounted to $30,089.06. The profit that remained was thus $22,000 ($52,089.76—$30,089).

Division of the profits by six thus gives each partner $3,666.66 and not $5,500 ($22,000 + 4) exclusively to each of the four brothers who withdrew from the partnership (see paragraph 3.11).

In fact, even if the four brothers who withdrew from the partnership did receive $5,500 each representing their partnership shares, that was an event subsequent to the computation of the partners’ income for the year in question. Paragraph 96(1)(f) must be applied first, and though the sum of $22,000 did indeed remain in the partnership temporarily without being paid out to the partners, that has no effect whatever on the computation of the income of each in accordance with the Act.

The first finding is therefore that the amount of $3,666.66 has to be added to the appellant’s salary.

4.2.3 The additional income of $1,843.10

As explained in paragraph 3.9 of the facts, an unreported amount of $11,058.77 was added to the partnership income, giving rise to an addition of $1,843.10 for each of the six partners. No evidence was offered to contradict the relevant notice of assessment, and since it is therefore regarded as good and valid in fact and in law, the burden of proof falls on the appellant (paragraph 2). As he has offered no evidence the notice of assessment must therefore be maintained in this respect, even without the support of the evidence given by the respondent’s witness Mr Claude Sauvé, who explained the justification for including the amount of $11,058.77 in the partnership income (omitted sales invoices and so on). This was obviously a mistake by the accountant who drew up the income and expenditure account (R-2). The amount of $1,843.10 must therefore be included in the appellant’s income in addition to his salary and the sum of $3,666.66, as explained above.

4.2.4 The value of the partnership share

According to the evidence presented, the parties agreed that the price of the share belonging to each was $5,500, and this price was paid.

Is this price equivalent to the value of the share? It cannot be denied that there theoretically remained in the partnership an amount of $22,000 undistributed profit which had, however, been included in the income of each partner in accordance with paragraph 96(1 )(f) cited above, as explained in paragraph 4.2.2.

There was also theoretically in the partnership the amount of $11,058.77. According to the evidence presented, if the accountant had not erred in drawing up the income and expenditure account, the undistributed profits computed after payment of salaries would have amounted to $33,058.77 ($22,000 + $11,058.77).

This undistributed amount is undoubtedly a significant factor for the purpose of computing each partner’s share in the partnership, and this is before giving any consideration to the other assets. Each partner’s share is at least $5,509.76 ($33,058.77 -e- 6). The appellant received $5,500.

The Board is not required to concern itself with the question of whether the parties should have taken into account, in their agreement settling the price of the shares, the value of the assets contributed by the father alone (lots, tools and so on).

The amount of $5,500 received by the appellant for his partnership share is not in itself taxable. What is taxable is the amount of $5,509.76 ($3,666.66 + $1,843.10) deriving from the profit of $33,058.77 in 1972.

If this same profit had been made in 1971 and if tax had been paid on it, the amount of $5,500 paid in 1973 for each partnership share would not have been taxable again.

The above considerations do not lead the Board to the conclusion that the notice of assessment issued on June 1, 1977 should be upheld.

This notice shows that the appellant was assessed as follows:

The Board’s decision is that the appellant’s income should be computed thus:

5. Conclusion

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

Appeal allowed in part.