DR S T Boorman v. Minister of National Revenue, [1976] CTC 2196, 76 DTC 1165

Delmer E Taylor:—This is an appeal from income tax assessments for the years 1970, 1971, 1972 and 1973. The matter at issue results from an interpretation placed on a partnership agreement between the appellant and his partners, which calls for division of profits in a certain manner, and therefore the responsibility for payment of appropriate income tax by the partners involved. The appellant claims in his Notice of Appeal that the partnership agreement requires that “monies received on admitting a new partner and paid to a retiring partner are to be regarded as an allocation of income”, and therefore by deduction, in either situation, taxable in the hands of the recipient, or at least not taxable in the hands of a non-recipient. The respondent assumed in reassessing the appellant that:

(a) the amount paid by the appellant to a retiring partner was not based on accounts receivable;

(b) the amount referred to in paragraph (a) above has no relation to the assets or income of the partnership subject to the provisions of paragraph

(c) hereinafter;

(c) a partner’s interest on retirement was determined by calculating the lesser of:

(i) the percentage of three prior years’ average income of the appellant;

or

(ii) initial capital contribution.

The respondent relies, inter alia, upon paragraph 12(1)(b) of the Income Tax Act, RSC 1952, c 148 as amended, and paragraph 18(1 )(b) of the Income Tax Act, SC 1970-71-72, c 63 as amended.

The appellant is a medical doctor practising his profession in Dawson Creek, British Columbia as one of several partners in the Dawson Creek Medical Clinic. The clinic has operated as a “continuing” partnership since approximately 1961 with changes from time to time in the doctors involved in the partnership, and with adjustments on occasions in the terms and conditions of the partnership arrangements. Under other circumstances, the very nature of this “continuing” partnership might be a subject of review, but in my opinion it does not enter into a determination of the question before the Board at this time. The major item of evidence submitted was Exhibit A-1, an “agreement made the 1st day of January AD 1967”, which stands as the basis for the arrangements between the partners. The Department of National Revenue has added back to the income of the appellant'for the years in question his proportionate share of the amounts paid in the same years to a retiring partner; the claim of the respondent being that these payments to the retiring partner were on account of the return of capital invested, and therefore not deductible in arriving at the net taxable income to be apportioned among the remaining partners. It is obvious that if all partners agreed on the proper interpretation of the partnership document, and if this understanding was not inconsistent with the provisions of the Income Tax Act, there would be no issue before the Board. It appears, however, that the retiring partner is content with the ruling of the Department of National Revenue since it means he has no income tax liability, while the remaining partners, at least to the extent represented by the appellant, are not satisfied with the ruling of the Department because of the income tax liability involved. In essence, the Board has been requested to interpret the partnership agreement in this respect. It was observed at the hearing that it might have been more appropriate if other interested parties, including the dissident partner, had been joined in the appeal so that all evidence might have been heard in common. Since this was not done, this decision will relate only to the matter of the appellant’s contention regarding the reassessments of the Department of National Revenue and no attempt will be made to interpret the partnership agreement or to examine the question of its legality, which was also raised at the hearing.

In the partnership document referred to as Exhibit A-1, there are two sections significant to this matter—the clause dealing with the admission of partners, and the ones dealing with the retirement of partners. These are respectively clause 33 and clauses 23, 24 and 25 and are quoted in their entirety.

33. New partners may be admitted to the partnership upon the consent in writing of not less than three-quarters (34) of the partners and upon admission shall be deemed to be full partners in the same manner as though they were parties to this agreement and they shall subscribe their names to this agreement and this agreement and any amendments hereto. shall continue to be in full force and effect and binding upon all parties. New partners shall pay to the partners of the partnership at the time of admission jointly, the sum of Ten Thousand ($10,000.00) Dollars, provided that if the new partnership shall have been employed by the partnership on a salary for a period of eighteen (18) months, the new partner shall pay to the partners the sum of Seven Thousand Five Hundred ($7,500.00) Dollars and if any partner shall have been employed by the partnership on salary for a term of two (2) years or more, the new partner shall pay the sum of Five Thousand ($5,000.00) Dollars.

23. Upon the death or retirement of any partner or partners the remaining partners shall purchase the interest of the deceased or retiring partner or partners. The interest of the deceased or retiring partner shall be paid in four (4) equal instalments, the first instalment to be paid forthwith upon the death or retirement of the partner and the remainder in three (3) equal annual instalments on the anniversary date of the death or retirement. Provided, however, that if the partners are required by the terms of this agreement to purchase the interest of more than two deceased or retiring partners at any time, the effective date of purchase shall be the date of death or retirement, but the payment of the interest of any deceased or retiring partner in excess of two shall be postponed and shall be paid consecutively according to the date of death or retirement. The first payment to be paid one (1) year following the date of the final payment to a prior deceased or retiring partner.

24. The parties hereto mutually covenant and agree that upon the death of any one or more of them, the survivor or survivors shall purchase and the estate of the deceased partner or partners shall sell, the interest of the deceased in the partnership to the survivor or survivors. There shall be no benefit of survivorship between the partners and the personal representatives of any partner who dies shall be entitled to the share of such partner. The value of the interest of the deceased partner shall be arrived at in accordance with the provisions of the next following paragraph.

25. Upon the death or retirement of any partner, his interest in the partnership shall be calculated in the following manner:—

1. His average annual income from the partnership during the preceding three (3) years or during the period that he was a member of the partnership, whichever is less, shall be reduced by twenty-five (25%) per cent.

2. One-tenth (1/10) of the amount arrived at by the preceding calculation shall be multiplied by the number of years that such deceased or retiring partner has been a member of the partnership up to a maximum of ten

(10) years.

Provided, however, that the value of the interest of a deceased or retiring partner shall not be less than the amount the deceased or retiring partner paid to become a partner.

The original intention of the partners in agreeing to these clauses remains very much in doubt, and since the appellant himself, and the retired partner who has received funds for his interest, were two of the original signing partners, there is little value to be gained in pursuing the matter in a purely academic manner. It is difficult to determine what might have been the results or what might now be the Situation if a more literal meaning of these sections had been followed. What is not in doubt, however, is precisely that which did happen, and that it provided proportionate benefits or disbenefits to all concerned. The important words in clause 33 are: “new partners shall pay to the partners of the partnership at the time of admission jointly, the sum of Ten Thousand ($10,000.00) Dollars . . . .” Evidence provided to the Board showed that no doctor had ever been admitted as a partner who had not previously been employed as a doctor by the partnership, thereby contributing in some substantial manner to the accumulation of the accounts receivable up to the date of his admission to partnership; and that in fact no doctor had ever paid in cash or property, anything on admission to the partnership. The amounts referred to in Clause 33, and which under certain other circumstances might have been regarded as contributions to capital, were in practice only a reduction of that newly admitted partner’s share in the cash receipts from the date of his admission until the reduction totalled the amount referred to in the admission clause pertaining to his case—ie $10,000, $7,500 or $5,000. He did not have these non-received amounts credited to him as income, and he did not pay income tax on them. They were credited to the income of the former partners, who paid income tax on them, and represented nothing more or less than an estimate of the unwithdrawn and often yet uncollected accounts receivable interest of the former partners, in excess of the interest of the newly-admitted partner, at the date of his admission. Specific examination of the income tax returns of the appellant together with sworn testimony from the witnesses confirmed this point. The use of the amounts involved from clause 33, ie $10,000, $7,500 or $5,000, although based on the only asset available to the partnership, its accounts receivable, nevertheless was only for convenience and simplicity in calculation and in maintaining the basics of an ongoing business.

With regard to the provision dealing with retirement from the partnership, clauses 23, 24 and 25, it can reasonably be assumed, as is the claim of the appellant, that the converse situation would obtain. The retiring partner would be accorded his interest in the accumulated accounts receivable at the date of retirement, and again for convenience and simplicity calculated according to the formula in clause 25, and paid according to clause 23. That this amount of the retiring partner’s interest may be regarded in somewhat the same light as the admission provision under clause 33, is supported by the section of clause 25 which reads as follows:

Provided, however, that the value of the interest of a deceased or retiring partner shall not be less than the amount the deceased or retiring partner paid to become partner.

Without determining a matter which is not before this Board (that is the liability for income tax of a retiring partner on the funds received after his retirement from the partnership), it can be determined that at the minimum, these payments should not be taxable income in the hands of the appellant. These amounts were received in cash by the retiring partner, and therefore differ quite markedly from the calculated amounts determined for admission under clause 33.

As a matter of clarification it should be pointed out that probably the genesis of this appeal was through the inclusion as an expense item in the Statements of Income of the partnership of certain amounts annually described as “Separation payment to retiring partners’. It was explained to the Board by the accountant responsible that this was probably not the best way of showing this amount, and the amount should have been shown on the Statement of Partners Accounts as distribution of income to the retired partners. It was apparently because of this accounting difference that the respondent added the proportionate share of this amount back to the appellant's income. The appellant had originally filed his personal income tax return correctly, by allowing in the return an adjustment for this accounting treatment.

The appeal is allowed and the matter referred back to the respondent for reassessment accordingly.

Appeal allowed.