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Citation: 2003TCC343
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Date: 20030626
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Docket: 1999-4257(IT)I
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BETWEEN:
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LINDA SPENCER,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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AND BETWEEN:
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Docket: 2001-891(IT)I
ROBERT J. SPENCER,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
O'Connor, J.T.C.C.
[1] The Appellants commenced operating
an embroidery business in 1988 in partnership. The partners,
being husband and wife, were not dealing with each other at
arms' length. At commencement the share of each partner was
established at 50 per cent and that continued in 1988, 1989
and 1990. In 1991 the partnership changed to an 85-15 split and
in 1992 it changed to a 90-10 split, in each case in favour of
Robert. The 90-10 split continued through the 1993, 1994 and 1995
years.
[2] The partnership had certain losses
in 1993, 1994 and 1995. The parties have agreed that the total
net losses, exclusive of certain amounts of additional interest,
to be discussed later, were $20,049 in 1993, $25,744 in 1994 and
$20,395 in 1995. The figure $20,049 in 1993 does not emerge from
the pleadings nor the evidence. It is explained in a letter of
the Department of Justice to this Court with a copy to the agent
for the Appellants. It reads in part as follows:
...
(a) the deduction of
legal expenses should be allowed in the amount of $4,877.52;
(b) this deduction
of legal expenses should be used to calculate the loss of the
partnership operating as Personal Designs for the 1993 taxation
year, therefore, the loss for the 1993 taxation year of the
partnership would be $20,049.52; ...
[3] The Minister of National Revenue
("Minister") contends that the 85-15 and 90-10 splits
are unreasonable and that what is reasonable, based upon the
input of the respective partners was 50-50. The Minister refers
to subsections 103(1) and 103(1.1) of the Income Tax Act
("Act") which read as follows:
103: Agreement to share income, etc., so as to reduce or
postpone tax otherwise payable.
(1) Where the members of a partnership have
agreed to share, in a specified proportion, any income or loss of
the partnership from any source or from sources in a particular
place, as the case may be, or any other amount in respect of any
activity of the partnership that is relevant to the computation
of the income or taxable income of any of the members thereof,
and the principal reason for the agreement may reasonably be
considered to be the reduction or postponement of the tax that
might otherwise have been or become payable under this Act, the
share of each member of the partnership in the income or loss, as
the case may be, or in that other amount, is the amount that is
reasonable having regard to all the circumstances including the
proportions in which the members have agreed to share profits and
losses of the partnership from other sources or from sources in
other places.
(1.1) Agreement to share income, etc., in unreasonable
proportions. Where two or more members of a partnership who
are not dealing with each other at arm's length agree to
share any income or loss of the partnership or any other amount
in respect of any activity of the partnership that is relevant to
the computation of the income or taxable income of those members
and the share of any such member of that income, loss or other
amount is not reasonable in the circumstances having regard to
the capital invested in or work performed for the partnership by
the members thereof or such other factors as may be relevant,
that share shall, notwithstanding any agreement, be deemed to be
the amount that is reasonable in the circumstances.
[4] The main issue therefore in these
appeals is the allocation of the partnership losses.
[5] With respect to the split between
the partners the following is noted.
1. Linda had no income in
1993, 1994 and 1995 (only certain losses) whereas Robert had the
following employment incomes, namely, $51,135 in 1993, $55,610 in
1994 and $91,496 in 1995.
2. As a result of claiming
90 per cent of the partnership losses Robert became entitled to
income tax refunds of $15,029 in 1993, $17,471 in 1994 and
$28,376 in 1995. The foregoing facts do not by themselves mean
that the Appellants were engaged in tax planning so as to
allocate as much as possible of the losses to Robert but they are
to be considered in the overall picture, when one attempts to
ascertain what is a reasonable allocation.
3. Robert had a full-time
job, with Casco Inc. working sometimes 36 hours a week and
sometimes longer and in 1995 he worked 1000 hours of overtime.
This reduced the amount of time he could devote to the
partnership.
4. Linda developed skills
in embroidery and although her time for partnership activities
was limited by the fact she had to care for a nephew with
Attention Deficit Disorder she still had some time for the
partnership business.
5. Linda alone appears as
one of the creditors in the list of creditors prepared by
Deloitte & Touche (Exhibit R-11) in respect of one of the
partnership's bankrupt debtors, Vortex Apparel.
6. Other invoices
(Exhibits R-12 and R-13) and loan documentation (Exhibit R-14)
were addressed to Linda.
7. Linda was heavily
involved with income tax and accounting matters of the
partnership. She also took some sales, orders and placed stock
orders.
8. Although Robert
supplied the financing totalling approximately $200,000, Linda
was a guarantor of several loans to the partnership.
[6] Based on the foregoing it is
relatively clear that Linda contributed to the partnership much
more than 10 per cent. The various Exhibits, in particular R-12
to R-14 and the evidence indicate that Linda was more active in
the business than the Appellants maintain.
[7] It is true that the majority if
not all of the financing, totalling approximately $200,000 for
the business, was provided by Robert and that he exercised
greater management in the business than Linda. However, it must
not be forgotten that the business began to turn a profit in 1996
and that from and after the year 1996 the business was operated
as a sole proprietorship of Linda. Admittedly, Linda in the years
in question, could not spend as much time in the activities of
the business but she definitely did contribute and turning a
profit in 1996 and subsequent years, when Linda ran the business
alone, suggests that she must have contributed more than 10 per
cent in 1993, 1994 and 1995.
[8] On balance therefore I find that
Linda contributed considerably more than 10 per cent to the
operations of the business in the years in question and
consequently I am of the opinion that the reasonable
apportionment for the years 1993, 1994 and 1995 is 25 per cent
for Linda and 75 per cent for Robert.
[9] I have been influenced in coming
to the foregoing conclusion by the decision of this court in
Leung v. Canada, [1997] T.C.J. No. 792 and Zalesky v.
Canada, [2000] T.C.J. No. 457. In Leung the Court, on
the issue of reasonable allocation pointed out that the onus is
on the taxpayer to prove the reassessment wrong and in
Zalesky, a reasonable allocation between husband and wife
in circumstances not unlike those in these appeals was held to be
75-25 not 100 per cent for the husband as was claimed.
[10] Another issue in these appeals is that
the Appellants, although not claimed on their respective returns,
seek to add the following to the interest amounts already
claimed, namely $9,074 in 1993 which when added to the interest
claimed on the 1993 return of $12,226 would make a total of
$21,300; $8,043 in 1994 which when added to the interest claimed
on the 1994 return in the year of $13,900 would make a total of
$21,943; $13,927 in 1995 which when added to the interest claimed
on the 1995 return in the year of $7,200 would make a total of
$21,127.
[11] At a point in time when the partnership
was audited, which occurred prior to the decision of the Supreme
Court of Canada in Stewart v. Her Majesty the Queen,
[2002] S.C.J. No. 46, ("Stewart")there was a
possibility that the Minister would deny the Appellants'
losses in their entirety on the grounds there was no reasonable
expectation of profit. It is possible that this is the reason the
Appellants only claimed the reduced amounts of interest on their
returns for the three years in question. The Appellants wish to
increase their losses by adding the additional amounts of
interest. Counsel for the Respondent points out that the
Appellants knew of the total amounts of interest, deliberately
did not claim those amounts, that the reassessment was based on
the amounts of interest claimed in the returns, that the
Appellants only raised these additional amounts in 2001,
notwithstanding that the audit had been completed in 1996 and
notwithstanding that Revenue Canada by letter of July 23, 1997
required the Appellants, under threat of a summary conviction and
fines, to file documents pertaining to 1993, 1994 and 1995
(Exhibit R-4) to which letter the Appellants did not respond.
That letter was followed by a further letter of October 17, 1992
(Exhibit R-5), to which there was also no response.
[12] Counsel for the Respondent in argument
submitted, in part, as follows:
MR AITKEN: Your Honour, the
Crown's position on this comes down to the simple matter of
Returns being filed by the taxpayer. Revenue Canada, relying on
those Returns, to its detriment, and the Tax Court, the Crown,
finding itself today in the face of new evidence some ten years
after the fact.
As we have discussed in cross-examination, these amounts were
identified, your honour. These are not interest expenses that
came from another source or they were another creditor that was
unknown. These were existing creditors. The taxpayer chose to
claim certain amounts of those expenses, which were not the full
amounts.
Returns were filed and they were certified. If I'm not
mistaken the evidence has established that Mr. Fehr was in fact
advising the taxpayers prior to the 1993 year. So the taxpayers
had the benefit of an accountant.
In those Returns amounts were claimed in respect of, for example,
the Bank of Montreal loan, a loan through the Bank of Nova Scotia
for a mortgage, the LEAD loan. Those seem to be the three ones
that we focus on.
...
The information with respect to those loans was readily
ascertainable and, your honour, as a matter of fact as we've
established, the amounts were known. ...
We have not seen an explanation of the difference. It has not
been offered, any explanation as to where these amounts come
from. What they are attributable to. No piece of evidence
establishing that they were even paid has been offered.
What we have are - - before you - - are unsubstantiated
allegations of any amount being paid and deducted without proof
of their being incurred and evidence as to their purpose.
With all this information available the parties waited until 2001
to send information. At the earliest 2001, to the Justice lawyer.
That being said, a requirement to produce books and records was
issued on July 23rd, 1997 and a follow-up letter with proposed
adjustments was sent on October 2nd, 1997.
To my mind, your honour, those would be the flags. That would be
the time to dig back in the records to find out if it's in
your child's binder. Take a look through the basement
to see if there's anything you've missed. Especially if
it's $9,000 in one year, $8,000 in the second and $14,000 in
a year. Those are significant amounts, your honour.
And as a result of all the foregoing, I submit to you that this
is a clear case where estoppel by representation should be
applied to exclude this evidence.
...
Reasonable expectation of profit was an issue that has been
conceded in terms of there being a business at the appeals level.
It was conceded. Had there been an additional 9,000, 8,000 and
$14,000 in expenses for interest, perhaps that decision would
have been different, for Revenue Canada, leaving aside the
possible success of a re-op argument today, of course, in light
of Stewart. However, that being said, the position would have
been different.
In my opinion the position of Counsel for the Respondent is
correct and the Appellants are estopped from claiming the
additional amounts of interest in each year. Looked at from
another point of view, the issue of additional amounts of
interest is not properly before this Court.
[13] Consequently the appeals are allowed to
the extent of and in accordance with these reasons. There shall
be no costs.
Signed
at Ottawa, Canada this 26th day of June 2003.
J.T.C.C.
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