Francis M. P. McMahon v. Minister of National Revenue, [1959] CTC 166, 59 DTC 1109

THURLOW, J.:—This is an appeal against income tax assessments in respect of the appellant’s income for the years 1954 and 1955. The appeal raises the question of the liability of the appellant to pay Canadian income tax in respect of income derived by him as a partner from activities carried on in the United States by certain partnerships organized in the United States, in view of the provisions of the Convention and Protocol between Canada and the United States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion in the Case of Income Taxes and of The Canada-United States of America Tax Convention Act, 1943, S. of C. 1943-4, c. 20 (as amended by $. of C. 1950, c. 27), by which the Convention and Protocol were approved and declared to have the force of law in Canada and to prevail over any other law to the extent of any inconsistency therewith.

The facts are not in dispute. The appellant is and was at all material times a Canadian citizen resident in Canada and employed in Canada. It is not suggested that he was at any material time resident in the United States. In the years 1954 and 1955, he was a limited partner in several theatrical partnerships formed pursuant to the laws of the State of New York for the purpose, in the case of each partnership, of producing and managing a particular musical play. In each case, the partnership agreement provided for both general and limited partners, the general being the active partners, and the limited being silent partners. Under the law of the State of New York, which governed the partnerships and the relations of the partners with one another, neither of these partnerships existed as an entity separate and distinct from its members. As a result of the operations of the partnerships in producing the plays in the United States, the appellant became entitled to share in substantial profits earned in each of the years in question.

In assessing the appellant’s income for these years for the purposes of the Income Tax Act, R.S.C. 1952, c. 148, the Minister included the appellant’s share of such profits and, after computing the tax thereon, allowed a tax credit pursuant to Section 41(1) of the Income Tax Act in respect of the tax paid by the appellant to the government of the United States of America in respect of such profits. It is agreed that the assessments so made are correct if the appellant’s share in such profits is properly included in computing his income, but the appellant contends that taxation of such profits by Canada is contrary to Article I of the Convention and that, accordingly, they should not have been included in the computation of his income.

Articles I and II of the Convention are as follows:

Article I

An enterprise of one of the contracting States is not subject to taxation by the other contracting State in respect of its industrial and commercial profits except in respect of such profits allocable in accordance with the Articles of this Convention to its permanent establishment in the latter State.

No account shall be taken in determining the tax in one of the contracting States, of the mere purchase of merchandise effected therein by an enterprise of the other State.

Article II

For the purposes of this Convention, the term ‘industrial and commercial profits’’ shall not include income in the form of rentals and royalties, interest, dividends, management charges, or gains derived from the sale or exchange of capital assets.

Subject to the provisions of this Convention such items of income shall be taxed separately or together with industrial and commercial profits in accordance with the laws of the contracting States.”

The Protocol contains the following provisions which bear on the interpretation of Articles I and II:

"1. The taxes referred to in this Convention are:

(b) for Canada: the Dominion income taxes, including surtaxes, and excess-profits taxes.

3. As used in this Convention :

(b) the term ‘enterprise’ includes every form of undertaking, whether carried on by an individual, partnership, corporation or any other entity;

(c) the term ‘enterprise of one of the contracting States’ means, as the case may be, ‘United States enterprise’ or 'Canadian enterprise’ ;

(d) the term ‘United States enterprise’ means an enterprise carried on in the United States of America by an individual resident in the United States of America, or by a corporation, partnership or other entity created or organized in or under the laws of the United States of America, or of any of the States or Territories of the United States of America;

7.

(c) the term ‘dividends’, as used in this Convention, shall include all distributions of the earnings or profits of corporations.”

It will be observed that, so far as it is applicable to the facts of the present case and having regard to the provisions of the Protocol, what Article I of the Convention declares is that an enterprise carried on in the United States of America by .. . . a partnership . . . created or organized in or under the laws of the United States of America or of any of the States or Territories of the United States of America is not subject to taxation by Canada in respect of its industrial and commercial profits. In this context, the word ‘‘enterprise’’ appears to refer to the business or undertaking itself by which industrial and commercial profits are earned and, so construed, Article I would prohibit nothing but the levying of a tax on the enterprise itself. I doubt, however, that Article I is so limited, since the Convention was made with reference to certain particular tax legislation then in existence, that is to say, ‘‘the Dominion income taxes, including surtaxes, and excess-profits taxes”, the incidence of which was not upon enterprises but upon persons and corporations and, in the case of the Excess Profits Tax at that time, upon partnerships as such, as well. For this reason, I shall consider Article I as if it should also be read as declaring that a partnership created or organized in or under the laws of the United States of America or any of the States or Territories of the United States of America is not subject to taxation by Canada in respect of the industrial and commercial profits of an enterprise carried on by it in the United States of America. But I think it would be an extension of the Article not warranted by its language to read it as declaring or agreeing that no person shall be taxed by Canada in respect of his share of the industrial and commercial profits derived by a partnership so organized from an enterprise carried on in the United States. In the case of enterprises carried on in the United States by individuals alone, the protection afforded by the Article is clearly limited to individuals who are resident in the United States, and I do not think that the word ‘‘partnership’’, as used in Article 3(d) of the Protocol should be read as referring separately to each of the individual partners concerned therein, regardless of whether or not they are resident in the United States. In my opinion, the word ‘‘partnership’’ should be interpreted as referring to the partners as a group, even though the group, as such, is not a separate legal entity, rather than to the individuals themselves, to whom, if Article I were applied separately as individuals, the limitation as to residence in the United States would be applicable.

The material provisions of the Income Tax Act, pursuant to which the assessments under appeal were made, were as follows :

"2. (1) An income tax shall be paid as hereinafter required upon the taxable income for each taxation year of every person resident in Canada at any time in the year.

(3) The taxable income of a taxpayer for a taxation year is his income for the year minus the deductions permitted by Division C.

3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year from all sources inside or outside Canada and, without restricting the generality of the foregoing, includes income for the year from all

(a) businesses,

(b) property, and

(c) offices and employments.

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

6. Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year

(c) the taxpayer’s income from a partnership or syndicate for the year whether or not he has withdrawn it during the year;

139. (1) In this Act,

(ac) person’, or any word or expression descriptive of a person, includes any body corporate and politic, and the heirs, executors, administrators or other legal representatives of such person, according to the law of that part of Canada to which the context extends;”

The tax levied by Section 2(1) is a tax on persons resident in Canada. It is measured and determined by the amount of the income of such persons, computed in accordance with the provisions of the Act. The tax is not levied on enterprises or businesses as such, nor is it levied on partnerships as such.

The taxes claimed in the assessments under appeal were assessed in part by reference to profits earned in the United States of America by partnerships organized under the laws of one of the United States. Such profits, in my opinion, were profits of United States enterprises, as defined in paragraph 3(d) of the Protocol, and were not derived from the carrying on of such enterprises in Canada as contemplated by the exception to Article I of the Convention. To that extent, I think the appellant’s case for the application of Article I may be taken as made out. But the assessments were not made, nor was the tax imposed by the statute either against the businesses or enterprises so carried on by the partnerships in the United States of America or against the partnerships as such, nor were they assessed against an individual resident in the United States of America.

It is argued that to tax the partner was to tax the partnerships, since in each case the partnership was made up of the appellant and his fellow partners and had no existence apart from them. If this were true, one might expect as corollaries that all the partners would be assessable for the tax and that they would be jointly and severally liable for it. But this is obviously not the situation. The tax is not imposed on partners but on persons resident in Canada. Only the appellant has been assessed, only his shares of the profits have been brought into the computation of his income, and only he is liable for the tax so determined.

Accordingly, I am of the opinion that, as applied to the present situation, neither the provisions of the Zncome Tax Act above quoted nor the assessments under appeal are in conflict with Article I of the Convention and that that Article cannot apply so as to afford any relief to the appellant from the taxation so imposed.

The appeal, therefore, fails and it will be dismissed with costs.

Judgment accordingly.