Jacques Y Paquin v. Minister of National Revenue, [1974] CTC 2181, 74 DTC 1142

The Assistant Chairman:—This is an appeal against an income tax assessment for the 1971 taxation year.

In his original declaration of income, the appellant deducted the sum of $19,030 which, according to the accountants for the Cheverny 1971 Film Fund (hereafter referred to as “Cheverny”), represented his portion of the capital cost allowance for films acquired by Cheverny, in which the appellant had become a partner. Subsequently, in. an amended declaration, the appellant reduced his claim for this allowance to the amount of his taxable income, that is $8,171.96. Does this amount constitute a portion of the capital cost allowance and is the appellant therefore entitled to claim it as a deduction?

The appellant is a doctor with the Canadian Armed Forces. To put his finances in order and plan his estate, he invested a sum of $5,000 in the purchase of cinematographic films on the advice of the Société d’Analyse et de Planning Financiers Inc in trust (“Société d’Analyse”).

According to the notice of appeal, the appellant had been led to believe that this investment would entitle him to a reduction of $19,000 in his taxes. The Société d’Analyse had in fact published an advertisement claiming a substantial reduction in the taxes of business and professional people (exhibit R-1).

On December 17, 1971, Cheverny, a limited partnership, was established under the Act amending the Alberta Companies Act, RSA 1955, c 53. Within this company, Amenico Films Ltd (“Amenico”), which was the manager, was the only majority shareholder and 54 other persons were shareholders or limited partners, including the appellant who had invested $5,000. The stated purpose of Cheverny was to acquire and possess films and to invest in these films (exhibit R-3).

On January 21, 1973 Cheverny, represented by Amenico, concluded a management contract with the Société d’Analyse by which the latter was to “administer, direct and control” Cheverny’s property (exhibit R-6).

On December 9, 1971, a contract was signed between Euro-lnter- national Films (“Euro”) and Titan Productions Incorporated (“Titan”), (exhibit R-2), for the purchase by Titan of exclusive rights to the distribution, showing, use, projection and so forth in a certain area of the film Nell Anno Del Signore.

The purchaser paid $950,000 for these rights, $120,000 of which was paid within seven days following the signing of the contract, with the balance of $830,000 to be paid at the purchaser’s discretion. In default of payment, the purchaser would restore the rights to the seller, upon notice in writing, and be absolved of all obligation. The contract and the purchaser’s rights were valid in perpetuity (exhibit R-2).

On December 22, 1971 Titan in turn sold all its rights to the film Nell Anno Del Signore to Cheverny by means of a contract for the sum of $950,000. A payment of $120,000 was made. within seven days following the signing of the contract and Cheverny was not legally obligated to repay the balance of $830,000, which bore no interest (exhibit R-3).

The same rights to other films, including Commandos, Cobra and Temps de Loup, were acquired by Cheverny on payment of an initial instalment of $605,000 towards the total purchase price of $3,821,000, while avoiding any obligation with regard to the remaining $3,216,000. The contract and the rights of the purchaser were also valid in perpetuity.

In my view, the Board is here confronted with a well-organized scheme which enabled the participants to make unjustified claims to tax deductions on income from other sources, by means of an abuse of the capital cost depreciation system.

The appellant appears to have been seduced by advertising based on the prodigious investment of sums providing a very large capital cost allowance, which resulted in a substantial reduction in his income and also enabled him to recover the amount of his investment. The advertisement (exhibit R-1) reads as follows:

Tour de la Bourse

800 Place Victoria, suite 3704

Montreal 115, Quebec

Tel: (514) 861-0491

134 West 58th Street

New York, NY 10019

Tel: (212) Plaza 7-6681

Reduce Your Taxes by Several Thousand Dollars a Year

In 1969, 1970 and 1971, our experts helped hundreds of business and professional people to reduce their taxes substantially. This is your chance to take advantage of the same opportunity.

Find out more right away, with no obligation.

(signed) Robert Bastien

Robert BASTIEN, economist, MBA Executive Vice-President

SAPF

Expert in tax reduction. ”

Although it was purely hypothetical for the appellant, these advertising tactics impressed him sufficiently for him to commit himself to investing $5,000 in order to receive a capital cost allowance of $19,030.

The scheme can be summarized as follows:

1. Organize a limited partnership. The partners will not be obliged to assume the company’s debts beyond the limit of their investment.

The manager will be “a limited company”.

2. Purchase one or more films at an excessive price. This will be partially paid for with the partners’ investments. Taking advantage of a no-recourse clause, the company will not be required to pay the balance.

3. Permit each partner a capital cost allowance equal to sixty per cent of his portion of the films’ total purchase price.

4. Allow the partners to deduct this depreciation from their income from other sources.

5. Promote the films for the benefit of the contributors to enable them to recover the principal and interest on their loans from the receipts from the showing of the films.

In his original declaration, the appellant had calculated his capital cost allowance, for which he claimed $19,030, on his portion of the total purchase price of the rights to the films, that is $3,821,000. This was based on the sixty per cent permitted under class 18 of Schedule B to the Income Tax Regulations. In his amended declaration, this allowance was reduced to the amount of his taxable income for the 1971 taxation year, which was $8,171.96.

Since the matter in question is capital cost allowance, paragraph 11(1)(a) of the Income Tax Act is applicable here. The paragraph reads as follows:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation.

The real purchase price of the films to the Cheverny partners must therefore be established. Was it $3,821,000 or $605,000, and on which of these two amounts should the appellant calculate the percentage of his allowance, if he is entitled to one?

Within the meaning of the section cited, the cost to the partners may not include, because of the no-recourse clause in the contract, the sums which they are not legally obligated to pay. There is no evidence to indicate that the balance of the purchase price of the films ($3,816,000) was paid at any time by Cheverny. The terms of the contract make it quite. apparent that Cheverny was not obligated to do so. The cost to the partners was therefore $605,000 and not $3,821,000. If, on the basis of his investment of $5,000, the appellant had been entitled to deduct a capital cost allowance, this should have been calculated under paragraph 11 (1)(a) of the Act as a proportion of “his part of the capital cost of the films to the taxpayer", which the evidence has established as a maximum of $5,000.

Nevertheless, for reasons which will be explained, the appellant may not claim a capital cost allowance. The facts and the law do not justify his claim.

In his reply to the notice of appeal, the respondent alleges, among other things, that Cheverny, without becoming the owner of the films, had only purchased the distribution rights described above. Consequently, neither Cheverny nor the appellant could claim the capital cost allowance of 60 per cent permitted for class 18 under Schedule B to the Regulations.

An interesting point concerns the nature of the films designated under class 18. I feel that it would be mistaken to interpret the word “film” simply as a material thing. Films, in principle, are merely a medium, as are books, offering literary, scientific, artistic and other

works to the public. In my view, there are two elements to a film: the physical films themselves and their contents. The work of the authors contained in these films thus assumes primary importance here, since it was the rights to the contents of these films that were sold in such a way as to make Cheverny the true owner, notwithstanding the prohibition on reproduction in Quebec.

I‘ am of the opinion that the rights acquired by Cheverny to the contents. of the films in question are in accordance with the requirements of class 18 of Schedule B to the Regulations, in other words, that they constitute Cheverny’s property rights in the films.

The facts in this appeal nevertheless present an insurmountable problem in the application of this tax recovery formula. A partnership as such cannot be regarded as a taxpayer, and its income is the total of the incomes of the partners, which is determined in proportion to their contribution to and interest in the partnership. The Act, however, does not state that the partners may claim a portion of the partnership’s expenses proportionate with their interest. Even though a partnership is not deemed to have legal status, its affairs are managed and conducted like those of a single owner. Once the results of its operations for a year have been established, each partner may claim his portion of the net profit or bear his share of any loss. The result of the partnership’s operations must, however, be determined before the profits can be distributed or the losses claimed.

In the case of Mr I v MNR, 2 Tax ABC 107; 50 DTC 256, it was held that expenditures made by a partnership in order to produce income were deductible, but only from the income of the partnership. In E A Brunetta v MNR, [1969] Tax ABC 820; 69 DTC 594, it was held that the expenses of a partnership should be deducted from its income before the profits were distributed among the partners.

There is nothing in the Income Tax Act that allows a partner to deduct from his income from sources other than the partnership a portion of the capital cost allowance to which the partnership is entitled in the conduct of its affairs. A deduction for these expenses, relative to the operations of the partnership, must be recorded in the partnership’s books and, I feel, should be calculated in its profit and loss accounts.

If, after the capital cost allowance and other operational expenses have been deducted, a partnership still registers a profit at the conclusion of its operations, which can be distributed among the partners on a pro rata basis, the partners obviously cannot claim a second capital cost for allowance for the same property. If the operations of the partnership result in a loss, the partners are entitled to a déduction. This is not, however, a deduction under the heading of a capital cost allowance under. paragraph 11(1)(a), but a deduction for a business loss pursuant to paragraph 27(1 )(e) of the Act.

Although under the circumstances it is no more than an obiter dictum, I am nevertheless of the opinion that if Cheverny, as a result of the expenditure of the capital cost allowance: had suffered a substantial loss, the partners could then have deducted their portion of this business loss, on a basis proportional with their interests, from their income from other sources. However, this company is a limited partnership, the claim for operating losses may never exceed the amount of money invested by each of its partners.

Nowhere in this appeal is it stated that Cheverny, in which the appellant is a partner, claimed a capital cost allowance for the films acquired. Whether or not it made such a claim, I am convinced that the appellant, as a partner, may not substitute himself for Cheverny and deduct from his income from other sources an expense which belongs to Cheverny alone, and which should appear in Cheverny’s operating accounts.

There is no evidence that Cheverny suffered a loss for the taxation year under appeal, which probably would have allowed the appellant to recover an amount of tax proportionate to his investment. In default of such evidence, the burden of which rests with the appellant, the Board must dismiss the appeal as unfounded in fact and in law.

The appeal is dismissed.

Appeal dismissed.