Date: 20030424
Docket: A-208-02
A-311-02
Citation: 2003 FCA 192
SEXTON J.A.
PELLETIER J.A.
BETWEEN:
PETER BROWN
Appellant
and
HER MAJESTY THE QUEEN
Respondent
Heard at Toronto, Ontario, on March 3, 2003.
Judgment delivered at Ottawa, Ontario, on April 24, 2003.
REASONS FOR JUDGMENT BY: ROTHSTEIN J.A.
CONCURRED IN BY: SEXTON J.A.
PELLETIER J.A.
Date: 20030424
Docket: A-208-02
A-311-02
Citation: 2003 FCA 192
SEXTON J.A.
PELLETIER J.A.
BETWEEN:
PETER BROWN
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
[1] The appeal and cross-appeal in Court file A-208-02 are from a judgment of Rip J. of the Tax Court of March 13, 2002, in which he allowed, in part, the appellant's appeal in respect of the re-assessments of his 1993, 1994, 1995, and 1996 taxation years. The appeal and cross-appeal in Court file A-311-02 are from an order of Rip J. of April 22, 2002, in which he awarded costs to the respondent but excluded costs in respect of two expert witnesses.
FACTS
Facts pertaining to the issues of arm's length and valuation
[2] On October 1, 1993, the CEG Partnership, which had been a limited partnership, was reconstituted as a general partnership. The general partnership was established on the basis that it would raise from partners, capital with which it would acquire software programs for video games from American Softworks Corporation (ASC). By agreement made as of October 1, 1993, the CEG Partnership agreed to acquire, on a date to be agreed upon, but not later than December 31, 1993, the software programs from ASC (the Software Agreement). By December 31, 1993, 28 partners, including the appellant, had agreed to acquire 825 units of the CEG Partnership at US$10,000 per unit, for a total of US$8,250,000. The appellant acquired 80 units on December 31, 1993.
[3] The CEG Partnership purchased the software programs from ASC for US$8,170,000 on December 31, 1993. It paid this amount partly in cash and partly by way of a promissory note for US$4,950,000 due December 31, 2003, with interest at 6% per annum (Acquisition Note).
[4] The partners paid for their units in CEG Partnership by way of a cash payment over 6 months of US$4,000 per unit and by way of assuming a proportionate share of the Acquisition Note on the basis of US$6,000 per unit.
Facts pertaining to application of the At-Risk Rules
[5] By a Partnership Amending Agreement made as of December 31, 1995, between the managing partner, CEG Corporation, and every other general partner of the CEG Partnership, including the appellant, the general partners became entitled to retract their partnership units. Under the retraction right, any general partner could require the managing partner to redeem all of the partner's units on December 31, 2003, for US$8,000 per unit. In addition, provided the common stock of ASC was listed on a stock exchange at December 31, 2003, a partner who exercised a retraction right would be entitled, on December 31, 2003, to a proportionate share of ASC common stock that had been issued to the CEG Partnership.
[6] By Amending Agreement No. 3 made as of December 31, 1995, to the Software Agreement, ASC agreed with the CEG Partnership, among other things, to provide financial assistance to the CEG Partnership that may be necessary to enable the Partnership to meet its obligations in respect of the retraction right. ASC further agreed to issue to the CEG Partnership the amount of common stock, if listed on December 31, 2003, referred to in the Partnership Amending Agreement.
Deductions Claimed by the Appellant
[7] For the purposes of the appeal and cross-appeal, the appellant deducted from his income in 1993 and 1994 business losses, including capital cost allowance, based on the acquisition cost of the software programs and expenses incurred by the Partnership after taking into account revenue. In 1996, he had a loss carry forward arising from his losses as a partner in the CEG Partnership.
[8] The Minister re-assessed the appellant, disallowing the deductions claimed.
JUDGMENT OF THE TAX COURT
[9] On appeal to the Tax Court, the Tax Court Judge found:
a) pursuant to subsection 251(1) of the Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1, the appellant and the vendor ASC did not deal with each other at arm's length and, therefore, paragraph 69(1)(a) of the Act applied;
b) by virtue of paragraph 69(1)(a), the appellant was deemed to have acquired his proportionate share of the software programs from ASC for fair market value. Fair market value was determined by the Tax Court Judge to be CAD$4,128,000 as compared to the acquisition cost of US$8,170,000;
c) by virtue of subsection 96(2.4) of the Act, the appellant was a deemed limited partner in the CEG Partnership;
d) as a deemed limited partner, the appellant's only amount at risk was the US$4,000 per unit cash component of the purchase price of the units; the amount of the assumed Acquisition Note of US$6,000 per unit was not at risk;
e) the appellant was entitled to take into account in calculating his income or loss from the CEG Partnership, capital cost allowance based on fair market value of CAD$4,128,000 as the fair market value was less than the amount the appellant had at risk; and
f) the appellant was entitled to deduct interest expenses in 1994 and 1995 in respect of interest paid to ASC on that portion of the Acquisition Note assumed by the appellant.
ALLEGED ERRORS
[10] The appellant says the Tax Court Judge erred:
a) in finding that the appellant and ASC did not deal at arm's length;
b) in finding the fair market value of the software programs to be less than the purchase price of US$8,170,000; and
c) in finding that the amount the appellant had at risk was US$4,000 per unit and not his full contribution to the CEG Partnership of US$10,000 per unit.
[11] For purposes of its cross-appeal, the Minister says the Tax Court Judge erred by finding that only the US$6,000 per unit represented by the assumption of the Acquisition Note was not at risk. He says the Tax Court Judge should have also found that the appellant's US$4,000 per unit cash payment was not at risk. As a result, the Minister says the appellant should not be entitled to any deduction in respect of losses of the CEG Partnership because none of his partnership contribution was at risk.
[12] Both the appellant and respondent appeal the disposition of costs made by the Tax Court Judge.
ANALYSIS
Did the CEG Partnership and ASC deal with each other at arm's length at the relevant time?
[13] The parties agree that the relevant time for determination of the arm's length question was December 31, 1993. They also agreed, at the hearing of the appeal, that CEG Corporation, the managing partner of the CEG Partnership, and another partner were in a non-arm's length relationship with the vendor ASC. However, the appellant says it was an error of law for the Tax Court Judge to find that, just because the vendor and managing partner, and another partner, were not dealing with each other at arm's length, that all the partners, and in particular the appellant, were also not dealing with ASC at arm's length.
[14] Paragraph 69(1)(a) of the Income Tax Act provides that when 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 fair market value at the time of acquisition, the taxpayer will be deemed to have acquired it at fair market value. Paragraph 69(1)(a) provides:
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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; |
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; |
Paragraph 69(1)(a) is an anti-avoidance rule. It is structured to discourage non-arm's length parties from dealing with each other at prices other than fair market value.
[15] It is a question of fact whether unrelated persons deal with each other at arm's length. Paragraph 251(1)(c) provides:
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251. (1) For the purposes of this Act, ... c) ... it is a question of fact whether persons not related to each other are at a particular time dealing with each other at arm's length. |
251. (1) Pour l'application de la présente loi: ... c) ... la question de savoir si des personnes non liées entre elles n'ont aucun lien de dépendance à un moment donné est une question de fait. |
[16] Parties are not considered to be dealing with each other at arm's length if one person dictates the terms of the bargain on both sides of the transaction. (See Minister of National Revenue v. Merritt Estate, [1969] 2 Ex. C.R. 51, citing Locke J. in Canada (Minister of National Revenue) v. Sheldon's Engineering Ltd., [1955] S.C.R. 637.)
[17] On October 1, 1993, the two partners of the CEG Partnership were Garth Turner and CEG Corporation. Mr. Turner was the sole director and shareholder of CEG Corporation. He was also counsel for ASC. At the hearing, the appellant conceded that as of October 1, 1993, ASC and the CEG Partnership were not dealing with each other at arm's length.
[18] However, the appellant says that although the Software Agreement says it was made as of October 1, 1993, it really was not finalized until all twenty-eight persons who became partners agreed to subscribe for partnership units on December 31, 1993. In agreeing to subscribe for partnership units, each partner was exercising independent judgment and was not under the control of anyone who was, or had been, acting on behalf of the vendor ASC.
[19] First of all, under paragraph 96(1)(a) of the Income Tax Act, when a taxpayer is a member of a partnership, the taxpayer's income or loss is to be computed as if the partnership was a separate person. Paragraph 96(1)(a) provides:
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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; |
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; |
[20] Under subsection 96(1), a partnership is treated as if it is a taxpayer and its income and loss is computed as if it is a separate person. The income and loss computed will then be allocated to each partner according to the partner's proportionate interest in the partnership. Any matter relevant to the computation of partnership loss, including the effect of any acquisition or disposition of property, must be determined as if the partnership is a separate person. Where the acquisition of property is relevant, the question is whether the vendor and the partnership were dealing with each other at arm's length. In the case where a partnership is one of the parties, the question is whether the directing mind of the partnership is the same as the directing mind of the other party to the transaction. The question is not whether an individual who decided to become a member of the partnership that was acquiring property made his decision to enter the partnership independently.
[21] The appellant relied on Chutka v. The Queen, [2001] D.T.C. 5093, to argue that he should be considered to have made his own decision based on his own economic interest and that there was no person or group of persons deciding to enter into the Software Agreement on the part of the partnership. The result of the appellant's approach is that the computation of his loss from the partnership should be determined at the partner level and not as if the partnership was the taxpayer. He says that, as he was dealing with ASC at arm's length, subsection 69(1)(a) would not be applicable.
[22] This Court had occasion to deal with the Chutka decision in Deptuck v. The Queen, 2003 FCA 177. In Deptuck, the Court found that there is no obstacle to the application of subsection 69(1) to a partnership and that the arm's length rule, one that is fundamental to the computation of income, applies to a partnership. At paragraph 13, Noël J.A. stated:
However, it seems clear that when regard is had to subsection 96(1), the arm's length rule, which operates at the income computation stage, must be applied to the partnership rather than the partners. Subsection 96(1) envisages a single computation of income at the partnership level which requires in turn that partnership property be held at a uniform cost ...
[23] Once a factual determination is made that the partnership and a vendor were not dealing at arm's length, then the consequences of that determination apply to all the partners, even if, on the facts, some of them were at arm's length from the vendor and others were not. Whether or not the partnership was at arm's length from the vendor is a question to be decided on the basis of the relationship of the directing minds of each at the time the transaction was structured. Once that determination is made, it applies to all the partners, even those, like the appellant, who subsequently join the partnership. The facts that determine the arm's length question do not change simply because new persons subscribe for partnership units.
[24] Even accepting the appellant's interpretation that the binding effect of the Software Agreement was subject to a sufficient number of partnership units being subscribed for, I do not think that changes the fact that the terms of the agreement were agreed to when ASC and the CEG Partnership were not dealing with each other at arm's length. While the subscribing partners may have done independent due diligence to satisfy themselves that they should subscribe for units in the CEG Partnership, the evidence is that they were accepting the Software Agreement as it had been negotiated when the CEG Partnership and ASC were not dealing with each other at arm's length. In these circumstances, the appellant entered the CEG Partnership after the Partnership was already a party to a non-arm's length transaction.
[25] The Tax Court Judge relied on a number of other facts to support his arm's length conclusion but it is not necessary to deal with them.
[26] There is no evidence that the appellant had any influence on the transaction that had already been negotiated between ASC and the CEG Partnership when they were not dealing with each other at arm's length. As a result, the conclusion of the Tax Court Judge that the appellant and ASC did not deal with each other at arm's length should not be disturbed.
Valuation
[27] The Tax Court Judge conducted a thorough analysis of valuation of the software programs. He accepted the discounted cash flow method of valuation. He made some adjustments to the assumptions made by expert witnesses. Finally, he concluded that the fair market value of the software programs on December 31, 1993, was CAD$4,128,000 rather than the purchase price of US$8,170,000 paid by the CEG Partnership.
[28] The appellant says that the fair market valuation task in this case was "highly complex and virtually impossible". The appellant then advances a number of reasons why the Tax Court Judge should have rejected certain evidence and argues that, had the Judge done so, he would have concluded that the fair market value approximated the purchase price.
[29] From a review of the reasons of the Tax Court Judge, it is apparent that he tackled the difficult task of estimating fair market value in a diligent and thorough manner. It is not suggested he did not understand the evidence. In his reasons, the Tax Court Judge explained his valuation analysis at some length. After a series of conference calls and input from both parties, he wrote Directions and Reasons for Directions in which, among other things, he determined the fair market value of the software programs.
[30] The question of valuation is a matter of the assessment of expert and other evidence and, barring palpable and overriding error, is not to be interfered with by this Court. The appellant argues that a lower standard of deference is applicable to the assessment of expert evidence by a trial judge. However, since Housen v. Nikolaisen, 2002 SCC 33, that is no longer the case. Findings of fact and factual inferences drawn by a trial judge, whether from expert or other evidence, are to be reviewed on a palpable and overriding error standard. The appellant has not shown palpable and overriding error on the part of the Tax Court Judge in respect of the valuation issue.
[31] The appellant also expresses some dissatisfaction with the procedure adopted in a December 18, 2001, conference call necessitated by the requirement, after the Tax Court Judge's Reasons were issued on November 15, 2001, for the Tax Court Judge to determine the fair market value of the software programs. The appellant, however, does not say that he was denied procedural fairness and there is no indication in the record that he was denied the opportunity to participate in the conference call. Indeed, the appellant subsequently made submissions relative to the matters discussed in the conference call. I see no reviewable error in respect of the procedure adopted by the Tax Court Judge.
Conclusion in Respect of Arm's Length and Valuation Issues
[32] The appellant agrees that, should this Court not accede to his position on the arm's length and valuation issues, the appeal would have to be dismissed. Because I have found that this Court should not interfere with the findings of the Tax Court Judge on these issues, it is not necessary to consider other arguments raised by the appellant.
[33] In respect of the arm's length and valuation issues, the appeal should be dismissed.
CROSS-APPEAL
Findings of the Tax Court Judge and Position of the Parties in Respect of the Appellant's Amount at Risk
[34] The Tax Court Judge found that the portion of the appellant's cost of partnership units represented by his assumption of his proportionate share of the Acquisition Note, based on US$6,000 per unit, was not at risk. However, he found that the US$4,000 per unit already paid by the appellant was at risk. The Minister says the entire amount of the appellant's contribution to the CEG Partnership, i.e. US$10,000 per unit, was not at risk.
[35] He says that the Partnership Amending Agreement dated December 31, 1995, provided for the retraction of the appellant's partnership units for US$8,000 per unit. Amending Agreement 3 provided for financial support by ASC to the CEG Partnership to honour the exercise of the retraction right by partners. Further, Amending Agreement 3 provided that the partners would receive stock of ASC when issued, which the Minister says was worth US$2,000 per unit. As a result, the Minister says the entire amount of US$10,000 per unit contributed to the CEG Partnership by the appellant was not at risk. Therefore, the appellant should be entitled to no deductions in relation to the losses of the CEG Partnership.
[36] The appellant says the Tax Court Judge erred in deeming him a limited partner. He further says that even if he was properly deemed to be a limited partner, the Partnership Amending Agreement and Amending Agreement 3 would not affect his at-risk amount for 1993 or 1994 as the Partnership Amending Agreement and Amending Agreement 3 did not come into existence until December 31, 1995.
The At-Risk Rules Relevant to This Case
[37] Broadly speaking, the At-Risk Rules of the Income Tax Act restrict limited partners' losses from a limited partnership, for income tax purposes, to their capital at risk. For purposes of this case, a general partner is deemed to be a limited partner for purposes of the At-Risk Rules if the general partner is entitled to receive a benefit that, in whole or in part, reduces the impact of any losses because the partner is a member of the partnership.
[38] To determine if the At-Risk Rules apply to the appellant, it must first be determined whether, although he is a general partner in the CEG Partnership, he is deemed to be a limited partner pursuant to paragraph 96(2.4)(b). If so, then paragraph 96(2.2)(d) is applied to determine the taxpayer's at-risk amount.
[39] For the appellant's 1993 taxation year, paragraph 96(2.4)(b) provided in relevant part:
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(2.4) For the purposes of this section ... a taxpayer who is a member of a partnership at a particular time is a limited partner of that partnership at that time ... if, at that time or within three years after that time, ... (b) the taxpayer ... is entitled to receive an amount or obtain a benefit that would be described in paragraph (2.2)(d) ... |
(2.4) Pour l'application du présent article ... le contribuable qui est, à un moment donné, un associé d'une société de personnes est commanditaire de cette société de personnes ... si, à ce moment ou dans les trois ans suivants: ... b) soit le contribual ... a le droit de recevoir un montant ou avantage visé à l'alinéa (2.2)d) ...
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[40] For the appellant's fiscal year ending after November 1994 and subsequent taxation years, paragraph 96(2.4)(b) provided in relevant part:
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(2.4) For the purposes of this section ... a taxpayer who is a member of a partnership at a particular time is a limited partner of the partnership at that time ... if, at that time or within 3 years after that time, ... (b) the member ... is entitled, either immediately or in the future and either absolutely or contingently, to receive an amount or to obtain a benefit that would be described in paragraph 96(2.2)(d) ... |
(2.4) Pour l'application du présent article ..., le contribuable qui est, à un moment donné, un associé d'une société de personnes est commanditaire de cette société de personnes si ... à ce moment ou dans les trois ans suivants: ... b) soit l'associé ... a le droit, immédiat ou futur et absolu ou conditionnel, de recevoir un montant ou un avantage qui serait visé à l'alinéa (2.2)d), ...
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[41] For the appellant's 1993 taxation year, paragraph 96(2.2)(d) provided in relevant part:
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(d) where the taxpayer ... is entitled, either immediately or in the future, and either absolutely or contingently, to receive or obtain any amount or benefit, whether by way of reimbursement, compensation, revenue guarantee or proceeds of disposition or in any other form or manner whatever, granted or to be granted for the purpose of reducing the impact, in whole or in part, of any loss that the taxpayer may sustain by virtue of the taxpayer's being a member of the partnership ... |
d) le montant ou l'avantage que le contribuable ... a le droit immédiat ou futur, absolu ou conditionnel, de recevoir - sous forme de remboursement, compensation, garantie de recettes, produit de disposition ou autre - et qui est accordé en vue de supprimer ou réduire l'effet d'une perte dont le contribuable serait tenu en tant qu'associé de la société de personnes ... |
[42] After November 1994, and the subsequent taxation years, paragraph 96(2.2)(d) provided in relevant part:
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(2.2)(d) any amount or benefit that the taxpayer ... is entitled, either immediately or in the future and either absolutely or contingently, to receive or to obtain, whether by way of reimbursement, compensation, revenue guarantee, proceeds of disposition, loan or any other form of indebtedness or in any other form or manner whatever, granted or to be granted for the purpose of reducing the impact, in whole or in part, of any loss that the taxpayer may sustain because the taxpayer is a member of the partnership ...
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(2.2)(d) le montant ou l'avantage que le contribuable ... a le droit, immédiat ou futur et absolu ou conditionnel, de recevoir - sous forme de remboursement, de compensation, de garantie de recettes, de produit de disposition, de prêt ou autre forme de dette ou sous toute autre forme - et qui est accordé en vue de supprimer ou de réduire l'effet d'une perte que le contribuable peut subir en tant qu'associé de la société de personnes ... |
[43] As will be subsequently explained, both 1993 and 1994 versions of paragraph 96(2.4)(b) and paragraph 96(2.2)(d) lead to the same result.
[44] Dealing first with the question of whether the appellant was properly deemed to be a limited partner, subsection 96(2.4) refers to the taxpayer being a member of a partnership "at a particular time" and "at that time". The time referred to is any time during a taxation year in which the losses the taxpayer seeks to deduct are restricted by subsection 96(2.1). For purposes of this case, the time is any time within the appellant's taxation years 1993 and 1994. If the appellant was a limited partner on December 31, 1993, or in 1994, his allowable partnership losses, for income tax purposes, may not exceed his at-risk amount in respect of the CEG Partnership in those years. Subsection 96(2.1) provides in relevant part:
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(2.1) Notwithstanding subsection (1), where a taxpayer is, at any time in a taxation year, a limited partner of a partnership, the amount, if any, by which (a) the total of all amounts each of which is the taxpayer's share of the amount of any loss of the partnership, determined in accordance with subsection (1), for a fiscal period of the partnership ending in the taxation year from a business (other than a farming business) or from property exceeds (b) the amount, if any, by which (i) the taxpayer's at-risk amount in respect of the partnership at the end of the fiscal period exceeds the total of ... shall (c) not be deducted in computing the taxpayer's income for the year, (d) not be included in computing the taxpayer's non-capital loss for the year, and (e) be deemed to be the taxpayer's limited partnership loss in respect of the partnership for the year.
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(2.1) Malgré le paragraphe (1), dans le cas où un contribuable est commanditaire d'une société de personnes au cours d'une année d'imposition, l'excédent éventuel: a) du total des montants dont chacun représente la part, dont il est tenu, d'une perte de la société de personnes résultant d'une entreprise - à l'exclusion d'une entreprise agricole - ou d'un bien, calculée conformément au paragraphe (1), pour un exercice de la société de personnes se terminant au cours de l'année, sur: b) l'excédent éventuel: (i) de la fraction à risques de l'intérêt du contribuable dans la société de personnes à la fin de l'exercice, sur le total des montants suivants: ... est à la fois: c) non déductible dans le calcul de son revenu pour l'année; d) exclu du calcul de sa perte autre qu'une perte en capital pour l'année; e) réputé être la perte comme commanditaire subie par le contribuable dans la société de personnes pour l'année. |
Are the December 31, 1995, Agreements relevant to the question of whether the appellant is a deemed limited partner?
[45] The appellant says that subsection 96(2.4) should not be found to have retroactive effect. Rather, he says subsection 96(2.4) should be interpreted to tie the deemed limited partner status to the occurrence of the event that created the status. Under this interpretation, he says the question is whether it was known on December 31, 1993, that he would be entitled to obtain benefits under the Partnership Amending Agreement and Amending Agreement 3 within the 3 year window contemplated by subsection 96(2.4), i.e. by December 31, 1996. Because these agreements did not come into existence until December 31, 1995, he says that it was not known that he would be entitled to obtain benefits under them and that, therefore, he should not have been deemed to be a limited partner for the taxation years 1993 and 1994.
[46] The appellant acknowledges that there is another interpretation to the words "within 3 years" in subsection 96(2.4); namely, that if a taxpayer becomes entitled to receive a benefit within 3 years of the year in which he seeks to deduct partnership losses, he will be deemed to be a limited partner in the taxation year he seeks to deduct the losses. That was the interpretation of the Tax Court Judge and the Minister. However, the appellant says the interpretation that favours him is the preferable one.
[47] I am unable to accept the appellant's preferred interpretation of subsection 96(2.4). The words "at a particular time" in this case refer to any time in 1993 including December 31, 1993, and any time in 1994, as these are the years when the appellant sought to deduct partnership losses. The Partnership Amending Agreement and Amending Agreement 3, both came into existence on December 31, 1995. This was "within 3 years after that time" in relation to the years in which the appellant sought to deduct partnership losses, namely 1993 and 1994.
[48] There are two difficulties with the appellant's preferred interpretation. The first is that it requires that the words "at a particular time" and "at that time" in subsection 96(2.4) mean the time when the appellant became a partner in the CEG Partnership. However, in subsection 96(2.4), the words "at a particular time" and "at that time" refer to the taxation year in which the taxpayer seeks to deduct partnership losses.
[49] The second is that the appellant's interpretation ignores that there are two different times referred to in paragraph 96(2.4)(b); one being the time when the entitlement to the benefit arises and the other being the time when the benefit is obtained. The appellant's interpretation merges the two times even though they are contemplated to be distinct under the provision.
[50] Paragraph 96(2.4)(b), in its 1993 version, incorporating the words of paragraph 96(2.2)(d) in brackets, reads:
... within three years after that time, ...
(b) the taxpayer ... is entitled to ... obtain a benefit ... (either immediately or in the future ...)
These words mean that the entitlement to the benefit must arise within 3 years after "that time", i.e. within 3 years after December 31, 1993 or December 31, 1994. However, the obtaining of the benefit may be at any time in the future. Reading the words in the way the appellant wishes would restrict the words "in the future" to a 3 year period. Such a limitation is not expressed or implied in the words of paragraph 96(2.4)(b).
[51] The same difficulty arises in the 1994 version of paragraph 96(2.4)(b). The amendment makes it explicit that the entitlement to the benefit must arise within 3 years of the year when the taxpayer wishes to deduct his partnership losses, although the obtaining of the benefit may occur at any time in the future.
... within 3 years after that time, ...
(b) the member ... is entitled, either immediately or in the future ... to obtain a benefit ...
[52] Under both the 1993 and 1994 versions of paragraph 96(2.4)(b), the 3 year window is the 3 years after the taxation year in which the taxpayer seeks to deduct partnership losses. If the taxpayer becomes entitled to obtain the benefit within the 3 years after the taxpayer seeks to deduct partnership losses, the taxpayer will be deemed a limited partner, regardless of whether the benefit itself is obtained immediately or at any time in the future.
[53] On the correct interpretation of paragraph 96(2.4)(b), the December 31, 1995, Partnership Amending Agreement and Amending Agreement 3 came into existence within the 3 year period after the appellant sought to deduct his partnership losses, i.e. December 31, 1993, and December 31, 1994. It is, accordingly, relevant to the determination of the appellant's at-risk amount in the CEG Partnership.
The Effect of the Agreements
[54] What, then, was the effect of the Partnership Amending Agreement and Amending Agreement 3 on the appellant's at-risk amount in respect of his contribution to the CEG Partnership? Paragraph 5(b) of Amending Agreement 3 provided that ASC would provide financial assistance to the CEG Partnership as necessary to enable the partnership to meet its obligations in respect of the retraction right granted to the partners by the Partnership Amending Agreement. The retraction right gave the appellant the right, in exchange for his partnership units, to obtain from the Partnership US$8,000 per unit.
[55] In addition, by paragraph 5(c) of Amending Agreement 3, ASC, in support of the retraction right, agreed to issue to the CEG Partnership common stock of ASC representing the balance of the retraction price which, in turn, would be allocated to the partners exercising their retraction right in amounts proportionate to their units in the Partnership.
[56] Section 5 of Amending Agreement 3 provides:
5. Supporting Retraction of Units
(a) ASC acknowledges that the Partnership is contemporaneously providing the partners of the Partnership (the "Partners") a retraction right, as defined under section 5.12 of the Partnership Agreement, as amended and is effective as of December 31, 1995, a copy of which is attached hereto as Schedule A (the "Retraction Right") for $8,000 U.S. per Unit plus, if paragraph (c) below applies, common stock in the capital of ASC.
(b) ASC hereby agrees that in consideration of the amendment hereunder, ASC will provide such financial assistance to the Partnership that may be necessary to enable the Partnership to meet the obligations in respect of the Retraction Rights and as continuing security for its obligations to the Partnership under this paragraph (b), ASC shall pledge the Acquisition Notes of the Partners which are currently pledged to ASC. Such pledge shall be released to ASC by December 31, 2003 for those Partners whose Units are not retracted.
(c) In addition, in support of the Retraction Right, ASC agrees to issue, in accordance with all applicable securities laws, for a nominal cash amount, to the Partnership, common stock of ASC representing the balance of the retraction price up to 1/4 of 1% (in the aggregate on a fully diluted basis) of the closing reported publicly traded common stock value of ASC on December 31, 2003 (the exact number of which will be in accordance with the formula provided thereunder). Such common stock will be used as part of the proceeds payable to the Partners under the Retraction Right, provided that if the common stock of ASC is not listed on any stock exchange for public trading on December 31, 2003, this paragraph ©) shall not apply.
[57] The Tax Court Judge indicated in his Reasons that the appellant's at-risk amount was nil. However, he subsequently issued an Addendum to his Reasons in which he indicated that he did not intend that the at-risk amount of the cash component of the cost of the partnership units, namely US$4,000 per unit, was to be nil, i.e. that the cash component was at risk. In other words, he only found that US$6,000 per unit represented by the assumption of the Acquisition Note was not at risk. Since his finding of fair market value for the software programs was only two percent less than the cash contributions to the Partnership, which he found to be at risk, the appellant was entitled to deduct losses based on the calculation of the fair market value of the software programs.
[58] From a consideration of the Partnership Amending Agreement and Amending Agreement 3 dated December 31, 1995, it is difficult to see why the entire cash component of the cost of the partnership units was at risk. If the retraction right is taken into account, the US$8,000 per unit available to the partners has the effect of reducing the at-risk portion of their US$10,000 per unit contribution to the Partnership to US$2,000. The right to retract for US$8,000 per unit is an entitlement to obtain a benefit for the purpose of reducing the impact of losses the appellant may sustain by reason of being a member of the CEG Partnership. The financial assistance provided by ASC, pursuant to Amending Agreement 3, is security that the retraction right will be honoured. It follows that the US$8,000 per unit is applicable to reduce the appellant's at-risk amount to US$2,000 per unit.
[59] With respect to the remaining US$2,000 per unit, the Minister argued that, pursuant to paragraph 5(c), the entitlement to ASC shares by the Partnership constituted proceeds payable to the CEG partners under their retraction rights. Therefore, the entitlement was a benefit described in paragraph 96(2.2)(d) and the entitlement to the shares should be treated as accounting for the balance of US$2,000 per unit so that the appellant's at-risk amount should be considered to be nil.
[60] There is no doubt the shares were intended to be in addition to the US$8,000 per unit entitlement. There is a suggestion in the evidence of W.J. Kosovitch, the Chief Financial Officer of ASC, that he believed the shares being offered to the Partnership would have a maximum value of US$2,000 per unit. However, this is weak evidence of value. There certainly was not any way to know what the market capitalization of ASC would be on December 31, 2003, when the shares, if they were issued at all, were to be made available to the CEG Partnership.
[61] I acknowledge that the Minister assumed the appellant's amount at risk in the Partnership was nil and that, implicitly, that meant that the Minister was assuming a value of US$2,000 per unit for the shares. However, the evidence that was adduced as to the value of the shares causes me to infer that the value is simply not ascertainable. I am of the opinion that the evidence adduced on this issue demonstrates that the share benefit is simply too vague to ascribe a value to it. While paragraph 96(2.2)(d) is worded broadly, it seems to me that, where, according to the evidence, the amount of the benefit referred to is not ascertained or ascertainable, paragraph 96(2.2)(d) cannot apply. Based on the evidence led on this issue, I am satisfied that the Minister's assumed value of the share benefit is displaced because the value is not ascertainable.
[62] I acknowledge that in making this finding, I am weighing the evidence that was before the Tax Court Judge. However, he did not address this issue. In these circumstances, it is open to this Court to do so. See Gronnerud (Litigation Guardians of) v. Gronnerud Estate, 2002 SCC 38 at paragraph 33.
[63] I conclude that, having regard to the entitlement of the appellant to US$8,000 per unit under the retraction right granted to him by the CEG Partnership and the financial assistance provided by ASC in support of the retraction right, the appellant's amount at risk was US$2,000 per unit.
INTEREST
[64] Rip J. allowed the appellant's deductions for interest expenses in 1994 and 1995 in respect of interest paid to ASC, on that portion of the Acquisition Note assumed by the appellant. The Minister did not cross-appeal in respect of the appellant's 1995 taxation year and, therefore, the interest deduction in 1995 is not an issue in this appeal.
[65] In respect of 1994, the Minister does ask that his assessment be reinstated. The assessment denied the appellant's interest deduction in 1994. In the Reasons of Rip J., there is no substantive discussion of interest and it does not appear that the subject of interest was seriously in issue before him. In this Court, the Minister made no substantive submissions on the interest issue, either in his factum or in oral argument.
[66] Without any submissions by the Minster as to why Rip J. erred (if he did), in allowing the appellant's 1994 interest deduction, I am not prepared to assume error. Therefore, in respect of the appellant's 1994 interest deduction, I would dismiss the Minister's appeal.
COSTS IN THE TAX COURT
[67] Both the appellant and the respondent appeal the Tax Court Judge's disposition with respect to costs. The Tax Court Judge awarded costs to the respondent but excluded certain expert witness costs.
[68] The appellant says he was substantially successful in the Tax Court and that the Tax Court Judge should have awarded costs to him and not to the Minister. The Minister says the Tax Court Judge should not have denied the Minister the expert witness costs he refused to award.
[69] It is trite law that costs are within the discretion of the Tax Court Judge and barring a finding that such discretion was not exercised in accordance with law, the Court will not interfere with the award.
[70] With respect to the appellant's argument that he was substantially successful in the Tax Court, the Tax Court Judge took a different view. He considered the Minister substantially successful because the appellant's claimed deductions were, according to his finding, cut roughly in half. He dealt with this point expressly in his reasons for his costs order. Although uncommon, it was within his discretion to find as he did.
[71] Be that as it may, by reason of this Court allowing, in part, the Minister's cross-appeal and further reducing the appellant's at-risk amount from that determined by the Tax Court Judge, the net result of the proceedings is much more favourable to the Minister. There is no basis for interfering with the costs award of the Tax Court Judge in favour of the Minister.
[72] The appellant complains that he should not have to pay for certain costs associated with the trial being heard in different locations. However, it appears it was pursuant to the appellant's request that the trial be conducted wherever the Court was available that gave rise to these costs the appellant now asks that he be relieved of. I would not accede to that request.
[73] As to the Minister's cross-appeal relative to costs associated with two experts, the Tax Court Judge dealt expressly with the issues in his Costs Reasons. He found that there were significant deficiencies in the reports of the two experts. For this reason, he found that the appellant should not have to pay for these reports.
[74] The Minister says the correct legal test is whether the expenses are reasonably necessary to advance a party's position. I do not quarrel with the legal test. However, when the costs of expert witnesses are at issue and the reports are found to be significantly deficient, it is for the trial judge to determine to what extent he will impose costs for the experts on the losing party.
[75] I acknowledge that the Tax Court Judge appears to have taken a rather narrow view with respect to the costs of the two experts. However, I am not satisfied he took into account irrelevant considerations or failed to take into account relevant ones.
[76] For these reasons, I would not disturb the disposition of costs by the Tax Court Judge.
CONCLUSION
[77] I would dismiss the appeal with costs. I would allow the cross-appeal with costs, but only to reduce the appellant's at-risk amount to US$2,000 per unit. In all other respects, I would dismiss the cross-appeal. The matter should be remitted to the Minister of National Revenue to re-assess in accordance with these reasons.
[78] The figures used throughout these reasons are, almost exclusively, in U.S. dollars. As it is preferable that the figures in the judgment be in Canadian dollars and because there may be consequential adjustments to the appellant's tax loss carry-forward, the parties shall, within 21 days of the date of these reasons, submit a form of judgment in Canadian dollars and including consequential adjustments if necessary. If counsel are unable to agree, each shall file a form of preferred judgment, together with submissions not exceeding 3 pages, double-spaced, and not more than 30 lines per page, explaining why there is disagreement with the form proposed by opposing counsel.
[79] Counsel for the Minister shall also submit a lump sum for fees and disbursements for the appeal, preferably with agreement from counsel for the appellant. If the parties are unable to agree as to costs, each shall make submissions not exceeding two pages, double-spaced, and not exceeding 30 lines per page, justifying the proposal for costs being made.
"Marshall Rothstein"
J.A.
"I agree
J. Edgar Sexton J.A."
"I agree
J.D. Denis Pelletier J.A."
FEDERAL COURT OF APPEAL
NAMES OF COUNSEL AND SOLICITORS OF RECORD
DOCKET: A-208-02, A-311-02
STYLE OF CAUSE: PETER BROWN v. HER MAJESTY THE QUEEN
PLACE OF HEARING: TORONTO, ONTARIO
DATE OF HEARING: MARCH 3, 2003
REASONS FOR JUDGMENT: ROTHSTEIN J.A.
CONCURRED IN BY: SEXTON J.A.
PELLETIER J.A.
DATED: April 24, 2003
APPEARANCES:
Mr. Craig C. Sturrock FOR THE APPELLANT
Mr. David Davies FOR THE APPELLANT
Mr. D.D. Graham Reynolds, Q.C. FOR THE RESPONDENT
Ms. Lisa Macdonell FOR THE RESPONDENT
SOLICITORS OF RECORD:
Thorsteinssons
Tax Lawyers
Vancouver, B.C. FOR THE APPELLANT
Mr. Morris Rosenberg
Deputy Attorney General of Canada FOR THE RESPONDENT