January 27, 2012

XCO Investments Ltd. and West Topaz Property Ltd. v. Her Majesty the Queen

2005 DTC 1731
Neutral Citation: 2005 TCC 655
Tax Court of Canada
Date: November 14, 2005

Court File Nos. 2002-2024(IT)G and 2002-2036(IT)G (General Procedure)

Allocations of partnership income — General anti-avoidance rule (“GAAR”) — Whether, under subsection 103(1) of the Act, or under the GAAR, Minister justified in reallocating to corporate taxpayers all of partnership income that had previously been allocated to their third corporate partner — Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1, ss. 85(1), 97(2), 103(1), 245(1), 245(2), 245(3), 245(4), 245(5).

Facts: From 1986 to 1992, the corporate taxpayers, “West Topaz” and “XCO”, held a 99% and a 1% interest, respectively, in a partnership. Woodwards Stores Limited (“Woodwards”) was a public retailing company with significant accumulated non-capital losses. On March 19, 1992, the partnership agreement was amended to give Woodwards, West Topaz, and XCO interests of 80%, 19.8% and .2%, respectively, in the partnership, as consideration for Woodwards’ capital contribution to the partnership of $1,260,000. On July 8, 1992, the partnership sold one of its two properties (the Westhill Apartments) in an arm’s length transaction to a numbered corporation. On May 15, 1993, Woodwards transferred its interest in the partnership to the taxpayers for $1 and other consideration, after giving notice to the partnership at some time before March 25, 1992 of its intention to withdraw from the partnership. For the partnership’s April 30, 1994 year end, the residual amount in Woodwards’ capital account with the partnership was reallocated to the taxpayers. In assessing the taxpayers for 1993 and 1994, the Minister reallocated to the taxpayers all of the partnership income that had been allocated to Woodwards for the partnership’s April 30 year ends during which it had been a partner of the partnership. In the Minister’s view, the allocation of the partnership’s income to Woodwards while it was a partner was either unreasonable, contrary to subsection 103(1) of the Act, or it was unacceptable under the GAAR as part of a series of avoidance transactions designed to enable the taxpayers to avoid tax on what would have been their share of the partnership income, had it not been allocated to Woodwards and absorbed by Woodwards’ losses. The taxpayers appealed to the Tax Court of Canada.

Held: The taxpayers’ appeals were allowed in part. The legal relationships created by the documentation affecting the partnership were not shams, but were genuine and legally effective. The Minister was correct in not pressing his initial argument that there was no valid partnership among Woodwards, West Topaz, and XCO. However, there was no commercial or non-tax purpose for the transactions bringing Woodwards into the partnership. Woodwards’ contribution to the partnership was “ephemeral” and “risk free”, for all practical purposes. Allocating to it 80% of the partnership income from the Westhill Apartments sale, therefore, was unreasonable in light of the provisions in subsection 103(1) of the Act. However, Woodwards did actually receive $557,556 as a profit from participating in the partnership, taking into account its capital contribution of $1,260,000 to the partnership, and the disbursement to it of 80% of the partnership’s proceeds from the Westhill Apartments sale. It was reasonable, under subsection 103(1), to reduce, by $557,556, the amounts of partnership income reallocated by the Minister from Woodwards to the taxpayers in the assessments for 1993 and 1994. It was also appropriate for the Minister to have relied first on subsection 103(1) of the Act, and to have resorted to the GAAR provisions as a second alternative, since the GAAR is “a provision of last resort” (see Canada Trustco Mortgage Company v. The Queen (S.C.C.)). The Minister was ordered to reassess accordingly.