October 07, 2011

Sherway Centre Limited (Appellant) v. Her Majesty the Queen (Respondent)

2001 DTC 5158
Supreme Court of Canada
March 1, 2001

(Court File No. 27415.)

Deductions — Partnership losses — In computing its income for 1987, a California partnership (of which corporate taxpayer and individual taxpayers were partners) deducting its losses on a condominium project, and on its sale of shares of a California corporation owning a subsidized rental project — Whether taxpayers carrying on business in common with a view to profit, and hence partners of the California partnership, thereby entitling them to deduct their proportionate share of the partnership said losses — Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1, as amended, ss. 67, 96 and 245(1).

In 1978, a partnership (“HCP”) was formed in California to develop a luxury residential condominium project. By late 1980, two equal partners remained (“BDI” and “Peninsula”). A low-rental apartment project known as “Tremont” was owned by a corporation (“TSAC”) which was in turn fully owned by HCP. By the end of 1986, the development costs of the HCP condominium project had exceeded the fair market value thereof by approximately US $10 million. At this point, the resident Canadian taxpayers were informed of the opportunity to purchase HCB’s tax losses at 20 cents on the dollar. Accordingly, on November 30, 1987, a series of transactions took place. TSAC sold Tremont to HCP for approximately US $2.9 million. To do this HCP borrowed the funds from BDI, and by way of set off, sold its shares of TSAC to BDI. Peninsula sold its 50 per cent interest in HCP to the Canadian corporate taxpayer (Spire Freezers). BDI sold a 25 per cent interest in HCP to Spire Freezers; and it sold the remaining 25 per cent interest therein to the other (Canadian) individual taxpayers. HCP sold its condominium project forthwith to BDI, resulting in an operational loss of approximately $US 10.4 million. In effect, Spire Freezers and the individual taxpayers paid some US $1.2 million to acquire Tremont and the losses totalling about US $10.4 million. The Canadians, however, managed Tremont profitably after its acquisition. For its fiscal year ending December 31, 1987, HCP reported 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 the TSAC shares. On reassessment, the Minister disallowed the deduction by the Canadian taxpayers, for 1987, of their proportionate share of HCP’s said losses. Both the Tax Court of Canada (98 DTC 1287), and the Federal Court of Appeal (99 DTC 5297) dismissed the taxpayers’ appeals. Rip, T.C.C.J. of the Tax Court had found that the transactions in issue were legally effective, and were not a sham. In his view, moreover, the losses in issue were true losses, and the tax avoidance section of the Act did not apply. However, he did find that the taxpayers’ sole motivation in entering into the transactions was to acquire a tax loss, so that the thought of the transaction being profitable was never in their minds. As a result, he concluded that the taxpayers were not partners with respect to the ownership of the HCP condominium complex and Tremont. The Federal Court of Appeal (Robertson, J.A. dissenting) recognized (after considering the decision of the Supreme Court in Continental Bank Leasing Corporation v. The Queen) that even an ancillary purpose of profit making may form the basis for a partnership. However, in the majority’s view, the Tax Court Judge had made an unambiguous finding of fact that the Canadians had absolutely no intention to carry on business with a view to profit, their sole intention having been to obtain a tax loss. The majority went on to find that there was no basis upon which to reverse this finding of fact. Robertson, J.A.’s dissent, on the other hand, was predicated on his finding that the taxpayers’ secondary intention was to acquire and retain an income-producing asset, Tremont, by which they could continue to carry on business in common with a view to profit. The taxpayers appealed to the Supreme Court of Canada.

Held: The taxpayers’ appeals were allowed for substantially the same reasons as those expressed in Robertson, J.A.’s dissent. The three essential ingredients for a partnership set out by the Supreme Court in the Continental Bank case (i.e., (1) carrying on a business, (2) in common, (3) with a view to profit) were present in the case at bar. A tax motivation will not derogate from the validity of a partnership where the essential ingredients of a partnership are otherwise present (as was the situation here). Indeed, the Tax Court Judge had erred by failing to give proper attention to the ancillary business purpose underlying the taxpayers’ partnership in the case at bar. Furthermore, in determining the existence of a partnership, courts must be pragmatic, and the result will depend on the true contract as well as on the intention of the parties, looking at all the facts. In the case at bar, Tremont required a substantial management effort which the taxpayers provided, and from which they benefited by generating profit. This was in contrast to the situation in Backman v. The Queen, 2001 DTC (SCC), where there was no real ancillary profit-making purpose behind the taxpayers’ continuing involvement in the one per cent interest being held by their alleged partnership in an oil and gas property (which had been purchased for only $5,000). In light of all of the foregoing, the taxpayers were entitled to the loss deductions sought. The decision of the Federal Court of Appeal was set aside, and the Minister was ordered to reassess accordingly.