Date: 20001222
Docket: A-267-98
CORAM: LINDEN J.A.
ISAAC J.A.
CAMPBELL J.
BETWEEN:
BRUCE CHUTKA
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
GUNNAR KJELSTRUP MADSEN
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
MARY ANN MADSEN
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
STEPHEN FUNK
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
LARRY J. LEE
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
KEN GRUNENBERG
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
ROSE HEINEKEY
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
WALLACE T. OPPAL
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
Heard at Vancouver, British Columbia, on Wednesday, December 6, 2000
JUDGMENT delivered at Ottawa, Ontario, on Friday, December 22, 2000
REASONS FOR JUDGMENT BY: LINDEN J.A.
CONCURRED IN BY: ISAAC J.A.
CAMPBELL J.
Date: 20001222
Docket: A-267-98
CORAM: LINDEN J.A.
ISAAC J.A.
CAMPBELL J.
BETWEEN:
BRUCE CHUTKA
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
GUNNAR KJELSTRUP MADSEN
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
MARY ANN MADSEN
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
STEPHEN FUNK
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
LARRY J. LEE
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
KEN GRUNENBERG
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
ROSE HEINEKEY
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
WALLACE T. OPPAL
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
LINDEN J.A.
These are appeals from a decision of the Tax Court of Canada dated March 23, 1998 dismissing eight appeals from reassessments under the Income Tax Act1 rejecting claims for deductions of capital cost allowance in respect of the 1982, 1983 and 1984 taxation years. The appeals were consolidated as one proceeding under Court file number A-267-98 by Order of Mr. Justice Stone on May 11th, 1999. The appellants were at all relevant times partners in a limited partnership named Inter-Teck Oil Limited Partnership ("ITOLP"). They seek to deduct from their income the losses pertaining to the purchase of units in the capital of ITOLP.
Facts
ITOLP came into being as part of a larger scheme to fund the purchase and operation of machinery used to process sewage waste into marketable products, including oil. A brief description of this scheme is useful for contextual purposes. On February 22, 1979, International Resource Recovery Inc. ("IRRI") was incorporated under the laws of British Columbia. At all relevant times its sole shareholder and president was Jagroop S. Gill. IRRI was in the businessof converting organic material at sewage treatment plants managed by the Greater Vancouver Sewerage and Drainage District into marketable material. One of the assets of IRRI was equipment designed and created by Mr. Gill to transform sewage waste into marketable products.
On November 9, 1982, Inter-Teck Management Ltd. ("ITML") was incorporated under the laws of British Columbia. Again, its sole shareholder and director was at all relevant times Mr. Gill. On November 10, 1982, a certificate made under section 51 of the B.C. Partnership Act2 was filed with the Registrar of Companies. The certificate evidenced a limited partnership agreement that was entered into between ITML as the "General Partner" and Mr. Gill as the "Founding Partner", leading to the birth of ITOLP. The purpose of ITOLP was to "fund[...] the purchase and operation of machinery to be used to process sewage waste into marketable end products including oil". The partnership agreement was signed by Mr. Gill on behalf of ITML as general partner and by him on his own behalf as founding partner.
By a series of agreements entered into between IRRI and ITOLP -- also on November 10, 1982 -- it was arranged that the ITOLP would carry out the processing of sewage on premises subleased to it by IRRI and with processing equipment sold to it by IRRI. ITML undertook to manage ITOLP's project of converting the sewage waste into marketable products. IRRI was also contracted to maintain and provide technological advice and research to ITOLP in respect of the processing equipment.
Of interest in this appeal is the purchase and sale of the processing equipment which took place at a stated price of $6,850,000.00 payable over a period from December1, 1982 to November 30, 1992. The transaction was made by conditional sales contract signed by Mr. Gill on behalf of the vendor IRRI and on behalf of the purchaser and ITOLP's general partner, ITML. Capital cost allowance was claimed on the basis that the equipment was included in Class 29 of Schedule II of the Income Tax Regulations. Accordingly, 25% of the equipment's capital cost was claimed in 1982 ($1,712,500.00), 50% in 1983 ($3,425,000.00) and 25% in 1984 ($1,712,500.00). These claims gave rise to alleged losses per unit in ITOLP of $6,402.30 in 1982, $6,358.54 in 1983 and $6,275.12 in 1984.
However, the Minister of National Revenue did not share the appellants' opinion as to the appropriate capital cost of the processing equipment. The Minister found that the sale of the equipment was not made at arm's length. Consequently, section 69(1)(a) of the Act applied to deem ITOLP to have acquired the equipment at its fair market value. On this approach, the Minister reassessed the capital cost allowance deductions on the basis of the equipment's fair market value which, in the Minister's view, was $422,000.00. The losses per unit in ITOLP were therefore reduced to $262.00 in 1982, $494.00 in 1983 and $685.00 in 1984.
The Tax Court Decision
The appellants appealed the reassessments to the Tax Court, and on March 20, 1998, those appeals were dismissed.The Tax Court Judge was satisfied that this Court's decision in Sidhu v. Canada (M.N.R.)3disposed of the appeals. In that decision, the Court upheld a decision of the Tax Court that the non-arm's length provisions of the Act applied to an employment relationship between a partnership and one of its employees for the purposes of determining insurable employment under the Unemployment Insurance Act. Even though the employee was not related to the individual partner who hired her, the contract of employment bound all of the partners by virtue of section 7 of the B.C. Partnerships Act, including the employee's son-in-law. Accordingly, the contract was tainted by the familial relationship and could not be taken as having been made at arm's length pursuant to paragraph 251(2)(a) of the Act. Applying that decision to the facts before him, the Tax Court Judge reasoned as follows:
| While I am prepared to accept that a partnership is not a legal entity it does not, in my view, follow that a contract entered into between a partnership as one party and a corporation or individual as the other party cannot be a non-arm's length transaction as described in [section 251 of the Act]. The act of the General Partner ITML in signing the agreement to purchase the processing equipment for $6.850M bound itself contractually and it also obligated Mr. Gill, the Limited Partner. Together they constituted the partnership.4 |
The Tax Court Judge similarly rejected the appellants' contention that, since the calculation of capital cost allowance and tax in general are to be made at the partnership level as though the partnership were "a separate person",5 then the non-arm's length provisions of the Act cannot apply because, on the one hand, paragraph 69(1)(a) only applies to acquirers that are "taxpayers" and, on the other hand, subsection 251(2)'s concept of "relatedness" only applies to individuals and corporations. In rejecting this argument, the Tax Court Judge, relying on ITOLP's membership as reflected in the certificate filed with the Registrar of Companies on November 10, 1982, concluded:
| Paragraph 96(1)(a) is not a statutory declaration that for the purposes of the Act a partnership is not a taxpayer... It deals with "a taxpayer who is a member of a partnership". That includes an individual or corporation. The income or loss of taxpayer partners is to be computed at the partnership level as if the partnership were a separate person. Income and losses are then allocated to the partners. The basic approach to the proper interpretation of paragraph 69(1)(a) in the context of these appeals is the same as that just utilized in respect of the arm's length provisions of the Act. Again when the sale and purchase agreement was entered into on November 10, 1982 there were only two partners in [the Partnership]. ITML was the General Partner and Mr. Gill the Limited Partner. Together they constituted the Limited Partnership. When ITML entered into the agreement it not only bound itself contractually to IRRI, but it also bound the Limited Partner, Mr. Gill, in the same way. Both IRRI and Mr. Gill are persons and taxpayers.6 |
Accordingly, the Tax Court Judge decided that the non-arm's length provisions properly applied to deem the purchase price of the equipment to be its fair market value, namely $422,000.00. Since no significant evidence was tendered before the Tax Court to rebut the fair market value of the equipment as assessed by the Minister, the reassessments were accepted and the appeals dismissed.
The Legislative Provisions
The following legislative provisions are relevant to the present appeals:
| Income Tax Act 69. (1) Except as expressly otherwise provided in this Act, (a) where a taxpayer has acquired anything from a person with whom the taxpayer was not dealing at arm's length at an amount in excess of the fair market value thereof at the time the taxpayer so acquired it, the taxpayer shall be deemed to have acquired it at that fair market value; 96. (1) Where a taxpayer is a member of a partnership, the taxpayer's income, non-capital loss, net capital loss, restricted farm loss and farm loss, if any, for a taxation year, or the taxpayer's taxable income earned in Canada for a taxation year, as the case may be, shall be computed as if (a) the partnership were a separate person resident in Canada; (b) the taxation year of the partnership were its fiscal period; (c) each partnership activity (including the ownership of property) were carried on by the partnership as a separate person, and a computation were made of the amount of (i) each taxable capital gain and allowable capital loss of the partnership from the disposition of property, and (ii) each income and loss of the partnership from each other source or from sources in a particular place, for each taxation year of the partnership; 248. (1) In this Act, "person", or any word or expression descriptive of a person, includes any corporation, and any entity exempt, because of subsection 149(1), from tax under Part I on all or part of the entity's taxable income and the heirs, executors, administrators or other legal representatives of such a person, according to the law of that part of Canada to which the context extends; |
69. (1) Sauf disposition contraire expresse de la présente loi: a) le contribuable qui a acquis un bien auprès d'une personne avec laquelle il avait un lien de dépendance pour une somme supérieure à la juste valeur marchande de ce bien au moment de son acquisition est réputé l'avoir acquis pour une somme égale à cette juste valeur marchande; 96. (1) Lorsqu'un contribuable est un associé d'une société de personnes, son revenu, le montant de sa perte autre qu'une perte en capital, de sa perte en capital nette, de sa perte agricole restreinte et de sa perte agricole, pour une année d'imposition, ou son revenu imposable gagné au Canada pour une année d'imposition, selon le cas, est calculé comme si: a) la société de personnes était une personne distincte résidant au Canada; b) l'année d'imposition de la société de personnes correspondait à son exercice; c) chaque activité de la société de personnes (y compris une activité relative à la propriété de biens) était exercée par celle-ci en tant que personne distincte, et comme si était établi le montant: (i) de chaque gain en capital imposable et de chaque perte en capital déductible de la société de personnes, découlant de la disposition de biens, (ii) de chaque revenu et perte de la société de personnes afférents à chacune des autres sources ou à des sources situées dans un endroit donné, pour chaque année d'imposition de la société de personnes; 248. (1) Les définitions qui suivent s'appliquent à la présente loi. « _personne_ » Sont comprises parmi les personnes tant les sociétés que les entités exonérées de l'impôt prévu à la partie I sur tout ou partie de leur revenu imposable par l'effet du paragraphe 149(1), ainsi que les héritiers, exécuteurs testamentaires, administrateurs ou autres représentants légaux d'une personne, selon la loi de la partie du Canada visée par le contexte. La notion est visée dans des formulations générales, impersonnelles ou comportant des pronoms ou adjectifs indéfinis. |
| "taxpayer" includes any person whether or not liable to pay tax; |
« _contribuables_ » Sont comprises parmi les contribuables toutes les personnes, même si elles ne sont pas tenues de payer l'impôt. |
| 251. (1) For the purposes of this Act, (a) related persons shall be deemed not to deal with each other at arm's length; (2) For the purpose of this Act, "related persons", or persons related to each other, are ... (c) any two corporations (i) if they are controlled by the same person or group of persons, |
251. (1) Pour l'application de la présente loi: a) des personnes liées sont réputées avoir entre elles un lien de dépendance; (2) Pour l'application de la présente loi, sont des "personnes liées" ou des personnes liées entre elles: ... c) deux sociétés: (i) si elles sont contrôlées par la même personne ou le même groupe de personnes, |
| Income Tax Regulations 1102.(1a) Where the taxpayer is a member of a partnership, the classes of property described in this Part and in Schedule II shall be deemed not to include any property that is an interest of the taxpayer in depreciable property that is partnership property of the partnership. |
1102.(1a) Lorsqu'un contribuable est associé d'une société de personnes, les catégories de biens définies dans la présente partie et dans l'annexe II seront réputées ne comprendre aucun bien constituant une participation du contribuable dans un bien amortissable d'une société de personnes appartenant à la société de personnes. |
B.C. Partnership Act
7. Every partner is an agent of the firm and his other partners for the purpose of the business of the partnership. The acts of every partner who does any act for carrying on in the usual way business of the kind carried on by the firm of which he is a member bind the firm and his partners, unless the partner so acting has in fact no authority to act for the firm in the particular matter, and the person with whom he is dealing either knows that he has no authority, or does not know or believe him to be a partner.
The Parties' Submissions
The appellants argue that ITOLP's status under the Act makes it an ineligible target of paragraph 69(1)(a)'s fair market value deeming provision. The appellants start from the premise that paragraphs 96(1)(a) and (c) require that a partnership be treated like a "separate person" and that each "partnership activity (including the ownership of property)" be considered as if it were "carried on by the partnership as a separate person" for the purposes of calculating income tax. Buttressing this special recognition of the partnership as an entity separate from its members is section 1102(1a) of the Income Tax Regulations7 which requires that capital cost allowance be calculated as though "partnership property" were acquired by the partnership rather than the partners. Since the processing equipment was purchased "on account" of ITOLP, it must be taken as "partnership property" within the meaning of subsection 23(1) of the B.C. Partnership Act, and it must be treated for income tax purposes as having been acquired by ITOLP as an entity separate from the individual partners.
In the appellants' view, it follows from the foregoing that, contrary to the approach adopted by the Tax Court Judge, the non-arm's length provisions of the Act must as a matter of income tax law be applied at the partnership level as if ITOLP, not Mr. Gill or ITML, acquired the processing equipment. As it happens, the relevant non-arm's length provisions of the Act do not appear to contemplate partnerships. For example, in the appellants' estimation ITOLP cannot be a "related person" pursuant to section 251 because the term "person" encompasses corporations but not partnerships. Even though section 96 requires that ITOLP be considered as a "separate person" for income tax purposes, this concept of personhood is artificial and limited. A partnership itself is not a person nor is it deemed to be a person. The appellants note that where the legislator has specially deemed partnerships to be persons in other provisions of the Act, no similar deeming treatment applies with respect to the non-arm's length provisions under review. Even if ITOLP were to be considered a person, the appellants point out that paragraph 69(1)(a) only applies to acquirers that are "taxpayers". But, it is finally contended, ITOLP is not a "taxpayer" within the meaning of the Act. Again, partnerships have exceptionally been deemed to be taxpayers but not in the instant case. Accordingly, the $6,850,000 purchase price for the processing equipment must stand and be applied for the purposes of calculating the capital cost allowance available for each unit in the Partnership.
In the alternative, the appellants argue that the purchase and sale of the processing equipment was conducted at arm's length and the purchase price was fair. According to the appellants, ITML as general partner had no incentive to inflate the purchase price of the equipment because it could not participate in the tax losses of ITOLP. Even though Mr. Gill was also a limited partner, he occupied this position purely to get the partnership started, not to participate in its profits or tax losses. In the appellants' submission, this view is supported by the fact that Mr. Gill ultimately gave up his partnership unit in 1983 pursuant to the limited partnership agreement. In terms of the ITOLP's control, only 12 of the 274 limited partnership units were held by persons related to Mr. Gill, and the limited partners actually controlled the general partner by way of provisions allowing for the latter's replacement upon the occurrence of certain events. In any event, the appellants argue that the purchase price was fair because it was the opinion of one investor, Mr. James P. Turner, that the sewage conversion equipment could not be reproduced at less than $10,000,000. While conceding that no expert evidence was adduced on this point, the appellants argue that the large investments by the many limited partners and their ratification of the agreement attest to the fact that the equipment was sold for its fair market value.
The respondent's arguments, though less dramatic, are more succinctly put. Crown Counsel characterizes the purchase and sale of the processing equipment as having been made between IRRI (a company solely owned by Mr. Gill) and two taxpayers, namely ITML (the company Mr. Gill owned and the sole general partner in ITOLP) and Mr. Gill (the sole limited partner in ITOLP). Under long-established rules of partnership law, the two taxpayers gained undivided ownership of the equipment due to their status as partners. To say, as the appellants do, that paragraph 69(1)(a) does not apply to Mr. Gill and ITML because they did not acquire anything runs contrary to these established partnership principles. Such principles have been affirmed by this Court in Sidhu, supra,8 and were properly applied by the Tax Court Judge in piercing the `partnership veil' to examine the relationship between IRRI, ITML and Mr. Gill. Doing so clearly reveals that the parties to the purchase and sale were not dealing with each other at am's length. Rather they were "related persons" within meaning of subparagraphs 251(2)(b)(i) and 251(2)(c)(i) of the Act.
The respondent further argues that the Court should not entertain the appellant's submissions as to the equipment's fair market value because the Minister's assumption as to the equipment's true value was never disputed at trial. Specifically, no expert testimony was brought to rebut the Minister's assumption, and the Tax Court Judge accepted, as a finding of fact, the fair market value assumed by the Minister. This finding should not be disturbed as the Tax Court Judge was entitled to make it.
Analysis
The central issue in these appeals is the extent to which subsection 96(1) of the Act and subsection 1102(1a) of the Income Tax Regulations affect, and indeed supercede, the characterization of transactions involving partnerships at private law. The appellants urge the Court to accept the position that income tax law treats partnerships as limited purpose "separate persons" in that they are persons for the purposes of transacting separately from their members but not for the purposes of attracting the non-arm's length transaction rules of the Act. Despite the enthusiastic advocacy of appellants' counsel, I am not persuaded that this view can prevail.
A partnership's lack of separate legal personality is what distinguishes it from an individual or corporation. The Act maintains this lack of legal personality, and does not generally treat partnerships as taxpayers. Instead, it is the individual partners who pay tax on the basis of their particular share of the income or losses of the partnership. In order for this `flow through' of tax consequences to take place, subsection 96(1) of the Act requires that the income or losses of the partnership be computed as if the partnership were a "separate person" and each "partnership activity ... were carried on by the partnership as a separate person..."9As a part of this conceptual separation, expenditures to acquire depreciable property are capitalized at the partnership level, and capital cost allowance is only deductible at that stage. Section 1102(1a) protects the integrity of calculating capital cost allowance at the partnership level by ensuring that depreciable assets owned by a partner in his or her personal capacity are not intermingled with assets of the same class owned by the partnership.10In my view, the foregoing `regime' implies nothing more than a notional construct for calculating a taxpayer's tax liability. It is a purely administrative convenience necessary to sustain the Act's view of the partnership as a conduit or vehicle for taxpayers.
In this way, the fiction of a partnership as an entity separate from the partners is temporary and does not extend to colour the true legal nature of transactions at the time they are entered into by a partnership. The characterization of legal relationships is generally left to established principles of partnership law. This approach was most recently affirmed by this Court in Adams v. Canada (appeal by Robinson)11where Roberston J.A. made the following observations:
| [para11] It is well accepted that at common law a partnership does not constitute a distinct legal person such that it is separate from its members. Indeed, it is the lack of a separate legal personality and limited liability that distinguishes a partnership from a corporation. In this regard, the Income Tax Act recognizes the lack of legal personality of a partnership by not treating "it" as a taxpayer. Admittedly, a partnership must file an annual information return setting out the income of the partnership, but it is the individual partners who are liable to pay tax on the partnership's income. For taxation purposes the partnership is treated as a "separate person resident in Canada" solely for the purpose of calculating income at the partnership level. In this way each partner's share of the income may be allocated accordingly: see paragraph 96(1)(a). |
| [para12] Accepting that a partnership does not constitute a distinct legal entity, neither at common law nor for tax purposes, then in strict legal theory the true tenants under a lease entered into by a partnership are the individual partners existing as of the date of the lease. Title to land, whether it be freehold or leasehold, cannot vest in a non-entity such as a partnership: see A.B. Oosterhoff, W.B. Rayner, Anger and Honsberger Law of Real Property, vol. 2 (Toronto: Canada Law Book, 1985) at 1256. In the present case each of the eighteen doctors in the Partnership must be deemed to have been a tenant under the lease agreement of May 21, 1985. |
Similarly, ownership of the processing equipment could not, and did not, vest in ITOLP. Rather, the acquisition of the processing equipment took place between IRRI and ITML on behalf of ITOLP. Both IRRI and ITML were "persons" and "taxpayers" within the meaning of the Act and were controlled at all material times by Mr. Gill who was also the limited partner in ITOLP at the time of the transaction. This state of affairs is clear from the certificate filed pursuant to section 51 of the Partnership Act on November 10, 1982, upon which the Tax Court Judge was entitled to rely in arriving at his decision. Whether or not subsequent subscribers to ITOLP `ratified' the purchase of the processing equipment does nothing to alter the proper characterization of the transaction.
Accordingly, paragraph 69(1)(a) was properly invoked by the Minister to deem the purchase price to be the fair market value of the processing equipment by virtue of the parties being "related persons" within the meaning of section 251. In the absence of expert evidence to rebut the Minister's assessment of the equipment's fair market value, the deemed acquisition price of $422,000.00 must stand and the capital cost allowance deducted accordingly.
Disposition
The appeals are dismissed with one set of costs. A copy of these Reasons shall be placed in the file of each Appellant, namely, files A-267-98, A-268-98, A-269-98, A-270-98, A-271-98, A-272-98, A-273-98 and A-274-98.
"A.M. Linden"
J.A.
"I agree
Julius A. Isaac J.A."
"I agree
Douglas Campbell J."
__________________1 R.S.C. 1985, c. 1 (5th Supp.), as amended [hereinafter the Act].
2 R.S.B.C. 1979, c. 312 [hereinafter the Partnership Act ].
3 (1997) 208 N.R. 398 [hereinafter Sidhu].
4 Tax Court Judgment, Appeal Book, p. 57 at paragraph 11.
5 Paragraph 96(1)(a) & Regulation 1102(1a).
6 Tax Court Judgment, Appeal Book, p. 57 at paragraph 14.
7 C.R.C. 1977, c. 945 (as amended).
8 Though in a different context.
9 See B.J. Arnold et al., Materials on Canadian Income Tax , 11th ed. (Scarborough, Ont.: Carswell, 1996) at ch. 8; P.W. Hogg & J.E. Magee, Principles of Canadian Income Tax Law, 2nd ed. (Scarborough, Ont.: Carswell, 1997) at ch. 20.
10 P. McQuillan & J.P. Thomas, Understanding the Taxation of Partnerships , 4th ed. (North York, Ont.: CCH, 1999) at ¶ 214.