Date: 20000721
Docket: 1999-4046-IT-I
BETWEEN:
WILLARD ZALESKY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments for the appellant's 1995 and 1996 taxation years. The issue is the allocation of losses from a Watkins distributorship carried on by the appellant and his wife, Tammi. The business consisted of the sale of personal and household products.
[2] It is admitted that the distributorship is a business and that the appellant and his wife are partners. The question is what portion of the losses should be allocated to each partner. The respondent says the split should be 50:50. The appellant says it should be 75:25 in his favour.
[3] In filing his returns for 1995 and 1996 the appellant claimed a business loss from the distributorship of $14,439.02 and $13,207.76 and allocated 100% to himself.
[4] The Minister of National Revenue adjusted the losses for 1995 and 1996 to $2,358 and $3,599 respectively, and allocated 50% to the appellant and 50% to the appellant's wife Tammi.
[5] The appellant's representative, who is an accountant, made the allocation in 1995 and 1996. He admits that the appellant's claim of 100% in those two years was a touch on the aggressive side. The downward adjustment of the partnership losses is not challenged. The allocation, however, is.
[6] Subsections 103(1) and 103(1.1) of the Income Tax Act read as follows.
103(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 postponements 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) Where two or more members of a partnership who are not dealing with each 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.
[7] Subsection 103(1) is not strictly speaking relevant. The respondent relies on subsection 103(1.1).
[8] The Minister acted upon the following assumptions:
(a) The business losses reported by the Appellant were from a Watkins distributorship (the "Business") engaged in the sale of personal and household products;
(b) The Business was started in or about 1990 when Tammi, the Appellant's wife was laid off from her employment with Loblaws;
(c) Since 1990, Tammi had no income and was involved actively in the daily operations of the business on almost a full-time basis;
(d) The Appellant was at all relevant times a full-time employee with Canada Post and assisted his wife when required as time permitted;
(e) The capital introduced into the Business was not significant and consisted mainly of a personal computer purchased in 1993 and included in the Capital Cost Allowance schedules in 1995 at a cost of $3,011 plus a personal vehicle purchased several years ago and shown in the Capital Cost Allowance schedules in 1993 at a cost of $1,071;
(f) The Business was operated from the Zaleskys' residence;
(g) For the purposes of the Goods and Services Tax, the Business was registered under the names of the Appellant and his wife;
(h) The Business was assigned a dealer account by Watkins Incorporated and that dealer account (account #38509) had the names of both the Appellant and his wife;
(i) The public were able to purchase Watkins products only by going through a dealer; Customers who ordered directly over the phone using the Business as a dealer had to have an access code that was linked to the dealer account of the Zaleskys;
(j) The voice mail message of the Business answering machine stated, in Tammi's voice, "You have reached Tammi and Willard, your Watkin's representatives";
(k) The Business recruited distributors, sponsored them and supported their continuing active involvement in the group;
(l) The group to which the Business sponsors and the Business belonged was known as "Group Tammi and Willard Zalesky" and this name was used in the promotional material issued by the sponsors;
(m) In the years under appeal, the Appellant and his wife were both determined as Directors by Watkins Incorporated and this determination was based on the sales volume and the number of down-line sales representatives;
(n) In the years under appeal, the Business revenue included two bonus cheques received each month from Watkins's Incorporated based on personal sales and group sales;
(o) In reporting the losses from the Business, the Appellant allocated the losses as follows:
1990 and 1991: Appellant nil
Tammi 100%
1992 : Appellant 50%
Tammi 50%
1993 to 1996 : Appellant 100%
Tammi nil
1997 : Appellant no loss or profit reported
Tammi no loss or profit reported
(p) The Business was carried on as a partnership by the Appellant and his wife;
(q) The principal reason for the arrangement for allocating to the Appellant all losses from the Business in the years under appeal may reasonably be considered to be the reduction of the tax that might otherwise have been or become payable by the Appellant;
(r) The allocation of 100% of the losses from the Business to the Appellant is unreasonable in the circumstances.
(s) The Appellant has failed to establish the basis for a reasonable sharing of losses from the Business;
(t) The allocation of 50% of the losses from the Business to the Appellant was deemed to be reasonable in the circumstances.
[9] By and large the facts relied on by the Minister of National Revenue are right. Mr. Zalesky had a full time job as a letter carrier for Canada Post. He usually got home some time after 1:00 p.m. Mrs. Zalesky had more time to devote to the business, but she was in bad health, suffering from severe and prolonged migraines. She was not physically able to do much of the work. Both spouses worked in promotion and went to parties and fund-raising activities at which Watkins products were sold.
[10] I find as a fact that the time the two spouses devoted to the business was roughly equal.
[11] I completely agree with the respondent that a 100% allocation to the appellant is unreasonable.
[12] However the 75% now suggested by the appellant's representative, Mr. Decosse, strikes me as more reasonable than the 50% urged by the respondent. What tips the scales in favour of the 75:25 split is the fact that the husband has throughout the entire period funded the losses out of his salary. This in my view is a factor that must be taken into account. Subsection 103(1.1) refers specifically to capital invested and of course underwriting the losses by contributions out of his salary is an investment of capital.
[13] One might of course be inclined to question the appropriateness of the practice of adjusting the yearly allocation of profits and losses between partners depending on where they will achieve the best tax advantage. In the absence of any agreement to the contrary there is of course a presumption that the partners share equally (Partnerships Act, R.S.O. 1990, c. P.5, section 24; Lindley & Banks on Partnership, 16th Edition, page 461). However subsection 103(1.1) requires that the allocation be adjusted for tax purposes in light of the circumstances. This obviously does not affect the rights of the partners inter se but for the purposes of the Income Tax Act the adjustment under subsection 103(1.1) is in my view appropriate in this case. I would expect of course that having established 75:25 as a proper split the partners would maintain that allocation when and if the business becomes profitable.
[14] The appeals are allowed and the assessments for 1995 and 1996 are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the partnership losses should be allocated between the appellant and his spouse on the basis of 75:25.
[15] The appellant is entitled to his costs, if any.
Signed at Ottawa, Canada, this 21st day of July 2000.
"D.G.H. Bowman"
A.C.J.