Editor’s Note: Addendum released on September 24, 2001. Original judgment has been corrected with text of addendum appended.
Spire Freezers Ltd. v. Canada, [2001] 1 S.C.R. 391, 2001 SCC 11
Spire Freezers Ltd., Patrick Gouveia, Appellants
John O’Neill, Edward Butcher,
John Dobrei and Maroje Miloslavic
v.
Her Majesty The Queen Respondent
Indexed as: Spire Freezers Ltd. v. Canada
Neutral citation: 2001 SCC 11.
File No.: 27415.
2000: November 10; 2001: March 1.
Present: McLachlin C.J. and L’Heureux‑Dubé, Gonthier, Iacobucci, Bastarache, Binnie and LeBel JJ.
on appeal from the federal court of appeal
Income tax -- Calculation of income -- Partnership -- Losses -- Original U.S. partners assigning partnership interest to Canadian assignees -- Assignees immediately selling main asset of partnership back to original partners at fair market value incurring substantial loss -- Assignees carrying on ancillary business of partnership -- Whether valid partnership established for income tax purposes -- Whether assignees entitled to deduct partnership loss.
A U.S. partnership, which was involved in the development of luxury residential condominiums and a low-rent apartment building ancillary to the main project, incurred potential losses which the appellants, through taking assignments of partnership interests, sought to acquire for use as an income tax deduction in Canada. Negotiations resulted in several transactions occurring on the same day. The corporate appellant acquired 75 percent of the partnership interest and for a brief moment was a de jure partner with a U.S. partner. The individual appellants acquired the remaining partnership interest a short time later. After the Americans left the partnership, the Canadians who had been assigned their interests sold the condominium project to them at fair market value incurring a substantial loss which was later claimed on their 1987 Canadian income tax. The Canadians also paid for the low-rent apartment building which they managed profitably for several years. Revenue Canada disallowed the losses claimed by the appellants and both the Tax Court of Canada and the Federal Court of Appeal upheld that decision.
Held: The appeal should be allowed.
The appellants are entitled to deduct the business losses. The fact that they entered into the transactions mainly to reduce their income tax liability by gaining access to the losses does not prevent a finding of partnership where, as in this case, the three essential ingredients of a valid partnership are present. First, the partnership was “carrying on business”. The partnership held the entire interest in an apartment building and the property management business that was associated with that asset was pre-existing and continued by the appellants. Although the original American partners and the corporate appellant held the property management business jointly for only a brief period of time, the duration of the carrying on of business is not determinative. A partnership may be created for a single transaction. Second, the business was carried on “in common”. The parties having entered into a valid partnership agreement setting out their rights and obligations as partners established the common purpose element and some indicia of partnership were also present during the brief period the Americans and the corporate appellant were combined. Finally, the business was carried on with a view to profit. The original partnership had been conceded to be valid and running a business with a view to a profit when the appellants were added. During the time that the corporate appellant and the Americans were partners, and up until the latter withdrew from the partnership, they continued to carry on business with a view to profit. Further, the appellants had been apprised during negotiations of the potential to make a profit from the apartment building and they clearly intended to continue that business. Since the determination of the existence of a view to a profit is not a matter of strictly quantitative analysis, the quantum of the initial loss compared to the anticipated profit does not negate the holding of partnership. The law of partnership does not require a net gain over a determined period in order to establish that an activity is with a view to profit. The parties’ intention to make a profit can be revisited on appeal in this case because the trial judge equated intention with predominant motive and did not consider whether an ancillary intention to profit existed.
Cases Cited
Applied: Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298, rev’g [1996] 3 F.C. 713; distinguished: Backman v. Canada, [2001] 1 S.C.R. 367, 2001 SCC 10; referred to: Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336.
Statutes and Regulations Cited
Income Tax Act, S.C. 1970‑71‑72, c. 63, s. 96 [am. 1984, c. 1, s. 43(1); am. 1985, c. 45, s. 48(1); am. 1987, c. 46, s. 32(1)].
APPEAL from a judgment of the Federal Court of Appeal, [1999] 4 F.C. 381, 242 N.R. 358, 99 D.T.C. 5297, [1999] 3 C.T.C. 476, 46 B.L.R. (2d) 153, [1999] F.C.J. No. 796 (QL), dismissing the appellants’ appeal from a judgment of the Tax Court of Canada, 98 D.T.C. 1287, [1998] 2 C.T.C. 2764, [1997] T.C.J. No. 1271 (QL), which found that the appellants were not entitled to deduct partnership losses under s. 96 of the Income Tax Act. Appeal allowed.
Warren J. A. Mitchell, Q.C., and John R. Owen, for the appellants.
J. S. Gill and Marilyn Vardy, for the respondent.
The judgment of the Court was delivered by
1 Iacobucci and Bastarache JJ. -- This appeal was heard with Backman v. Canada, [2001] 1 S.C.R. 367, 2001 SCC 10, released concurrently. Both appeals raise the basic question of whether a valid partnership has been established for income tax purposes.
I. Facts
2 In 1978, a partnership named the Hamilton Cove Partnership (“HCP”) was formed in California to develop a luxury residential condominium project on Santa Catalina Island off the coast of California. By late 1980, two equal partners remained, both American corporations: BCE Development Inc. (“BDI”), and its wholly owned subsidiary, Peninsula Cove Corporation (“Peninsula”).
3 In order to obtain government approvals, the partnership was required to build a low-rent apartment project known as the Tremont Apartments (“Tremont”) in Avalon on Santa Catalina Island. Tremont was owned by a corporation called the Tremont Street Apartments Corporation (“TSAC”), which was in turn fully owned by HCP.
4 By the end of 1986, the development costs of the HCP condominium project exceeded the fair market value of the project by approximately US$10 million. In the spring of 1987, several Canadian parties, of whom the appellant Spire Freezers Ltd. was the largest, were apprised of the opportunity to purchase the tax losses of the HCP project at 20 cents on the dollar.
5 After detailed negotiations, the parties came to an agreement. On November 30, 1987, the following transactions occurred:
(a) BDI and Peninsula amended their partnership agreement to keep the partnership operative regardless of the withdrawal of any of its partners.
(b) TSAC sold Tremont to HCP for approximately US$2.9 million. HCP borrowed these funds from BDI.
(c) HCP, which sold its shares of TSAC to BDI, was paid by set‑off against the loan from BDI.
(d) Peninsula sold its 50 percent interest in the partnership to the appellant Spire Freezers Ltd., and BDI sold a 25 percent interest in the partnership to the appellant Spire Freezers Ltd. For a brief instant, the de jure partners were BDI and Spire Freezers Ltd. BDI’s remaining 25 percent interest in the partnership was then sold to the Spire Group, a group made up of the individual Canadian parties other than the appellant Spire Freezers Ltd. The total purchase price was US$34,530,253.
(e) HCP immediately sold the condominium project to BDI for US$33.3 million. The sale of the condominium project at this price gave rise to an operational loss of approximately US$10.4 million.
(f) HCP changed its name to the Tremont Street Partnership.
6 In effect, Spire Freezers Ltd. and the Spire Group (together the Canadians) paid approximately US$1.2 million to acquire Tremont and the losses totaling about US$10.4 million that were incurred by the sale of the HCP project. The Canadians have managed Tremont profitably since its acquisition. In the fiscal year ending December 31, 1987, the partnership claimed a loss of US$10 million in respect of the HCP project sale and a capital loss of US$367,000 in respect of the sale of TSAC shares. Revenue Canada disallowed the losses. The appellants appealed to the Tax Court of Canada which ruled against them, as did the majority in the Federal Court of Appeal.
II. Judgments Below
1. Tax Court of Canada, 98 D.T.C. 1287
7 Rip T.C.C.J. found that the transactions in the case at bar were legally effective and were not a sham. He also found that the losses were true losses, and that the tax avoidance sections of the Income Tax Act, S.C. 1970‑71‑72, c. 63 (the “Act”), did not apply. Most of the reasons for judgment was concerned with whether the appellants were members of a partnership for the purposes of deducting losses under the Act.
8 The Tax Court judge reviewed the formal admissions of fact made by the appellants in respect of their intention to acquire a tax loss. He also noted that they were aware that the continued existence of the partnership and the ownership of the Tremont apartment building were necessary for their objective to succeed. He concluded that the appellants’ sole motivation in entering into the transactions with BDI and Peninsula was to acquire a tax loss and that the thought of the transaction being profitable was never in the minds of the appellants.
9 The Tax Court judge then applied the decision of the Federal Court of Appeal in Canada v. Continental Bank Leasing Corp., [1996] 3 F.C. 713, which has since been overturned. He held that since none of the appellants intended anything other than to obtain a tax loss, the Canadians were not partners with respect to the ownership of the HCP condominium complex and Tremont.
2. The Federal Court of Appeal, [1999] 4 F.C. 381
10 The majority of the Federal Court of Appeal (Linden J.A., Strayer J.A. concurring) affirmed the result reached in the Tax Court. The majority considered this Court’s decision in Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298. They recognized that even an ancillary purpose of profit making may form the basis of partnership. However, in the majority’s view, the Tax Court judge in this case made an unambiguous finding of fact that the Canadians, when they purported to become partners, had absolutely no intention to carry on business with a view to profit. Rather, their sole intention was to obtain a tax loss. Because the law that an ancillary profit intention is sufficient in creating a partnership was known to the Tax Court judge, and because in their view there was no persuasive evidence to demonstrate an intention to earn a profit, ancillary or otherwise, the majority held that there was no basis upon which it could reverse a finding of fact as to the intention of the parties at the time of entering into a partnership contract. Hence, the conclusion of the Tax Court judge that there was no business being carried on with a view to profit could not be challenged.
11 In his dissenting opinion, Robertson J.A. held that the reasons of the Tax Court judge should be interpreted as finding that the appellants’ predominant motive was to gain access to a tax loss. At the time of his decision, the Tax Court judge’s conclusion that a valid partnership could not be formed in such a situation was fully supported by the Federal Court of Appeal decision in Continental Bank, supra, which he quoted extensively. However, in the meantime that decision had been reversed by this Court. In Robertson J.A.’s view, it was obvious that the taxpayers’ primary intention was to acquire a substantial non-capital loss. But it is equally obvious that their secondary intention was to acquire and retain an income producing asset, Tremont, by which they could continue to carry on business in common. Hence, he concluded that this Court’s decision in Continental Bank, supra, was dispositive of the issue before the Court of Appeal and that the appellants had established a sufficient basis for a finding that a partnership existed at the material time.
III. Analysis
1. Introduction
12 In this appeal, we are asked to consider whether the appellants, Spire Freezers Ltd. and the Spire Group, are entitled to deduct the business losses they claim to have accumulated as partners in the Californian partnership HCP. The Canada Customs and Revenue Agency, on behalf of the respondent in this appeal, reassessed the appellants on the ground that they were not true partners and therefore could not claim the business losses. As already noted, this case was heard at the same time as Backman, supra, reasons in which are being released concurrently herewith, and which applied the principles enunciated by this Court in Continental Bank, supra. Like Backman, the principal issue to be decided in this appeal is: were the appellants members of a partnership at the time the losses were incurred?
13 With respect to the majority in the Federal Court of Appeal, we would allow the appeal for substantially the same reasons as expressed in the dissent of Robertson J.A. but wish to elaborate some points.
2. Were the Appellants Members of a Partnership?
14 The essential ingredients of partnerships and the proper approach to determining whether a partnership exists are discussed in Backman. We summarize those principles below.
(a) The Essential Ingredients of Partnership
15 The three essential ingredients of a valid partnership in Canada were recently described by this Court in Continental Bank, supra, at para. 22. At the time the alleged partnership is formed, the evidence must disclose that the alleged partners were (1) carrying on a business, (2) in common, (3) with a view to profit.
16 In Backman, supra, we discuss the concepts of “carrying on a business”, “business”, “in common”, and “view to profit” as applied to partnership law and as described in Continental Bank. We need not repeat that discussion here. Indeed, most of the reasoning in Backman is applicable in this case.
17 As stated in Continental Bank, and reiterated in Backman, a tax motivation will not derogate from the validity of a partnership where the essential ingredients of a partnership are otherwise present: Continental Bank, supra, at paras. 50-52; Backman, supra, at para. 22. Furthermore, as held in Backman, where a Canadian taxpayer seeks to deduct partnership losses through s. 96 of the Act, he or she must satisfy the essential elements of a partnership that exist under Canadian law. In other words, for the purposes of s. 96 of the Act, the essential elements of a partnership must be present, even in respect of foreign partnerships: Backman, supra, at para. 17.
(b) The Approach to Determining Whether a Partnership Exists
18 As explained in Backman, the determination of the existence of a partnership will depend on the true contract and intention of the parties as appearing from the whole of the facts of the case. Courts must be pragmatic in their approach to the three essential ingredients of partnership and weigh the relevant factors in the context of all the surrounding circumstances: Backman, supra, at paras. 25-26.
(c) Application to the Facts at Bar
19 The transactions at issue in this case are similar to those in Backman. As in Backman, in this case, two groups of Canadians allege that they became partners in a valid partnership through a series of transactions that involved their taking assignments of partnership interests in a pre-existing American partnership. The original American partners withdrew, leaving the resultant alleged partnership between the Canadians holding two assets. The primary asset, in this case the HCP condominium project, was held briefly and in effect sold back to the original American partners, generating a large loss for the alleged partnership. The subordinate asset, in this case the Tremont apartment building, is the vehicle through which the appellants seek to establish that there was an ancillary purpose in the transactions that rendered them members of a valid partnership, namely to carry on business in common with a view to profit.
20 However, despite the similarities between the transactions in this case and those in Backman, there are some essential differences. For example, in respect of whether there was a carrying on of business, it is notable that there is a significant difference between the subordinate assets in Backman and Spire in terms of the degree of effort required of the appellants and expended by them in management. In Backman, the subordinate asset was a one percent interest in an oil and gas property, purchased for the sum of $5,000 during the transition between American and Canadian control of the alleged partnership. The alleged partnership in Backman had no significant management control over that asset, nor did the acquisition of that asset represent a continuation of a pre-existing business of one of the putative partners. When production was shut down shortly after purchase, no other investments in oil and gas were made. Thus, in Backman, the alleged partnership was “an empty shell that does not in fact carry on business” (see Backman, supra, at para. 20). In this case, the subordinate asset held by the partnership was the entire interest in an apartment building. The property management business that was associated with that asset was pre-existing and continued by the Canadians. Tremont required a substantial management effort which the appellants provided, and from which they benefited by generating profit. As noted by Robertson J.A., “the partnership continued to hold title to a profit-generating asset, namely, the apartment building, for at least a decade after the sale of the condominium development” (para. 57 (emphasis in original)).
21 Although the original American partners and Spire Freezers Ltd. held the property management business jointly for only a brief period of time, the duration of the carrying on of business is not determinative. The fact that a partnership is created for a single transaction is of no consequence. Furthermore, it is not necessary to show that the parties held meetings, entered into new transactions, or made decisions: Continental Bank, supra, at paras. 31-33. And a business may be established even in circumstances where the sole business activity is the passive receipt of rent, as was noted by L’Heureux-Dubé J. in Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336, at para. 46. Consequently, while in Backman it could not fairly be said that the alleged partnership was carrying on business, that is not true of the appellants in this case.
22 Turning to the question of whether the business in this case was carried on “in common”, the common purpose element of a partnership was established in this case by the parties’ having entered into a valid partnership agreement setting out their respective rights and obligations as partners. Contrary to the finding of the Federal Court of Appeal in this case, some of the indicia of partnership described in Continental Bank, supra, were present during the brief period the Americans and Spire Freezers Ltd. were combined. For example, the Americans and Spire Freezers Ltd. did hold “a joint property interest in the subject‑matter of the adventure” (Backman, supra, at para. 21), that is the assets and property management business of HCP. In addition, as already noted, the business of the Tremont apartment building involved substantial efforts and management and in this sense the parties contributed “skill, knowledge or assets to a common undertaking”. All things considered, there is sufficient evidence to found a common purpose among the parties during the transition between American and Canadian control of that partnership.
23 With respect to the question of whether the business was carried on with a view to profit, it is conceded that prior to the relevant transactions, HCP was a valid and existing partnership and that it had been formed with a view to profit. It is also clear that the partnership was running a business with a view to profit when the new Canadian partners were added. The fact that the American partners withdrew from the partnership does not take away from the fact that during the time that they were partners, and up until their withdrawal from the partnership, they continued to carry on business with a view to profit. For their part, the appellants must have entered into the transactions in this case with a view to profit since they were apprised during negotiations of the potential to make a profit from the Tremont apartment building and they clearly intended to continue that business. This is in contrast to the appellant in Backman whose efforts were characterized by the trial judge as “nothing more than window dressing” and the finding by the Court of Appeal that there was no real ancillary profit-making purpose behind the appellant’s involvement in the oil and gas property.
24 The majority in the Court of Appeal rejected the contention that a valid partnership with a view to profit was formed when the new Canadian partners were admitted to the partnership based on the intention of the American partners to abandon the partnership and their possession of the Tremont asset immediately thereafter. This amounts to a conclusion that there was no carrying on of a business in common between the American and Canadian partners. However, the fact is that during the short time the American and Spire Freezers Ltd. were involved, they ran the HCP condominium project and Tremont as a business in common. The partnership subsisted and continued to carry on a business after the withdrawal of the Americans. At all relevant times, then, there were partners managing assets. At some point, all partners were associated in the management of the Tremont apartment building. In other words, at all times there was a carrying on of business in common.
25 As noted above, the duration of the partnership is not determinative. It is settled law that a partnership may be formed for a single transaction. As a general matter, internal arrangements with regard to liability between partners are not of prime importance in determining the existence of a partnership. Consequently, the liability sharing arrangement in respect of the condominium project and Tremont is not of great significance on the partnership question. Furthermore, as noted above, the fact that the appellants admitted that they principally entered into the transactions to reduce their Canadian income tax liability by gaining access to the losses does not prevent a finding of partnership.
26 The majority of the Court of Appeal also rejected the notion that there was a view to profit because the parties did not contemplate recouping the initial loss. However, the determination of the existence of a view to profit is not a matter of strictly quantitative analysis. The quantum of the initial loss compared to the anticipated profit does not negate the holding of partnership in this case. The law of partnership does not require a net gain over a determined period in order to establish that an activity is with a view to profit. For example, a partnership may incur initial losses during the start-up phase of its enterprise. That does not mean that the relationship is not one of partnership, so long as the enterprise is carried on with a view to profit in the future. Here, the transactions at issue necessarily involved a transfer of both the condominium project and Tremont. Despite the fact that a loss was incurred by the subsequent sale of the condominium project, the fact that the Canadian partners were aware of the potential for profit from the Tremont apartment building before entering the partnership and the fact that Tremont consistently turned a profit after the entry of the Canadian partners clearly establish the business was carried on with a view to profit, notwithstanding that the aggregate profits may never exceed the tax loss incurred in the year of the transactions at issue.
27 We reject the conclusion of the majority of the Federal Court of Appeal that the question of whether the parties’ intention to make a profit is a purely factual one that cannot be revisited in the instant case. The intention to make a profit cannot only be judged merely subjectively, it must also be based on objective evidence. We place little weight on the finding that the appellants’ only intent was to obtain a tax benefit. The trial judge erred with respect to this issue by failing to give proper attention to the ancillary purpose described above. As mentioned earlier, the trial judge did not have the benefit of this Court’s ruling in Continental Bank and made his findings while under the impression that the predominant motive of the taxpayer was determinative and that profit had to consist of a net gain over and above the initial loss sought to be deducted (see Rip T.C.C.J.’s reasons at pp. 1298-99).
28 In summary, although there are similarities between the transactions at issue in Backman and in this case, there are also several essential differences, including the continuity of the business of the partnership, the management effort required to sustain it, and the objective evidence of an anticipation of profit. Considering all the facts and circumstances, we believe it is clear that the formal requirements necessary for partnership are present in Spire, while in Backman they were not.
IV. Disposition
29 We would allow the appeal with costs in this Court and in the courts below, set aside the decision of the Federal Court of Appeal, and order that the appellants are entitled to deduct the loss in question under s. 96 of the Income Tax Act.
Appeal allowed with costs.
Solicitors for the appellants: Thorsteinssons, Vancouver.
Solicitor for the respondent: The Deputy Attorney General of Canada, Toronto.
Rehearing
Spire Freezers Ltd. v. Canada, [2001] 1 S.C.R. 391, 2001 SCC 11
The judgment of the Court was amended on September 24, 2001 by adding in para. 29 the words "in this Court and in the courts below" after the word "costs".