The Chairman (judgment delivered from the Bench: November 23, 1972):—James Wright Simpson (No 71-1279) has appealed against a reassessment of the Minister of National Revenue for the taxation year 1968. The case also involves Julian Evans (No 71-1277) and Arthur Ivor Morris (No 71-1278). It is agreed by the parties that the evidence is the same in each case and that the decision in the Simpson case will also be the decision in the Evans and the Morris cases. A brief outline of the facts will clearly indicate why this is so.
The three appellants, who were chartered accountants, had been associated with a firm of accountants known as Riddell, Stead, Graham and Hutchison since in or about the year 1964. According to Exhibit R-1, a memorandum of agreement and articles of partnership were executed between the appellants and Riddell, Stead, Graham and Hutchison (hereinafter sometimes referred to as “Riddell Stead”), whereby the appellants were to be the operating partners in a management consultant business. This partnership agreement, filed as R-1 and dated February 1, 1967, supersedes and cancels a previous agreement of June 1, 1964.
The evidence of Mr James Simpson was the main evidence adduced on behalf of the appellants per se. He testified that the agreement
(R-1) was entered into, as I have said, for the purpose of conducting a management consultant practice in various muncipalities in Canada, although primarily, if not entirely, in Montreal, Toronto and Vancouver. Under this new agreement (R-1) the partners were to be the same as under the previous agreement with the exception of two partners named Collins and Hunter who were, if I may use the term, “paid off”. They ceased to be active partners under the new arrangement, had no say in the partnership affairs, and no share in the losses or profits thereof, although presumably they did continue for a while to take part in the day-to-day business.
According to the document filed as Exhibit A-1, the partnership also operated in the United States through a company known as Stevenson, Jordan and Harrison, which throughout this hearing has been referred to as “Jordan”, and the partnership—and when I say “partnership” I mean the partners under the arrangement set forth in Exhibit R-1—held an 85% interest in the aforesaid company. There were other partnerships (or, I suppose, companies is the proper designation in the legal sense), namely, Samson, Belair, Simpson and Riddell Inc (known as “Samson Belair’), in which the partnership held 50% of the shares and Samson, Bélair, Coté and Lacroix, a firm of chartered accountants, held the other 50%; Unica Research Co Ltd, which was 81% controlled by the partnership; and Simpson, Riddell, Stevenson (International) Ltd, in which the partnership held 85% of the shares. However, for the purposes of this case, only “Samson Bélair” and “Jordan” have really been dealt with at any length in the evidence and are the two associations that are the nub of the problem before the Board today.
The problem is a very difficult one, and arriving at a solution and reaching a conclusion in this matter is one of the most difficult tasks I have had to face in this past year. I am therefore greatly indebted to both counsel for the very efficient, clear and concise manner in which they have presented their arguments to me and the manner in which they have brought out the evidence. This is one of the few cases in which all of the large number of witnesses called have been eminently qualified to give professional opinions on various aspects of the case. At times—a circumstance which merely confirmed my assessment of the difficult aspects of this case—emotions have run high, and both counsel have been anything but backward in asserting and supporting their clients’ best interests throughout.
The problem arises as a result of difficulties that developed between the appellants and “Riddell Stead” in the spring of 1968. At that time the business had been proceeding and difficulties, so far as financial aspects were concerned, had arisen, and “Riddell Stead” through a Mr Kent, one of the witnesses called, arranged a meeting with the appellants. The appellants had been carrying on, or, as the term indicates, “operating” the business as the operating partners and had been submitting statements to “Riddell Stead” every four weeks for the purpose of showing to “Riddell Stead” the progress of the partnership and to allow “Riddell Stead” to protect their interest, or at least to keep track of how it was progressing. Exhibit R-1 indicates, in paragraph 4 of page 5, that profits and losses were to be shared as follows: Simpson, 40%; Evans and Morris 25% each; and “Riddell Stead” 10%.
In March of 1968 Mr Ledanyi, who had been scrutinizing these 4-weekly reports from the operating partners, presumably at the request of his superiors in “Riddell Stead”, according to his evidence hurriedly prepared a document which was filed as the balance sheet of the partnership as of January 31, 1968. This is filed as Exhibit A-2, together with the minutes of a meeting of the partners on March 19, 1968. The financial statement as of January 31, 1968 was prepared about March 27, 1968. This statement shows, in the notes thereon which Mr Ledanyi acknowledged to be his, that no provision was made for doubtful and uncollectable accounts in order to arrive at a combined loss for the year. Mr Ledanyi then submitted that statement to “Riddell Stead” and, as a result, a series of meetings took place between the operating partners and “Riddell Stead” which culminated in the execution of Exhibit R-2, a document which, in the result, ended the association of the appellants with the partnership of R-1.
When the final statement for the year 1968 was presented, some 13 months later, to the appellants, it showed that they had made a profit on the business, whereas they had anticipated and calculated a substantial loss on their account as of January 31, 1968. The statement was not delivered until March of 1969, and of course it was necessary for the appellants to file their individual tax returns in April. They therefore had very little time in which to prepare and file their tax returns. Appellant’s Exhibit A-3, dated April 2, 1968, from “Riddell Stead”, signed by Mr Kent and sent to all three appellants, indicated that their net drawings or charges to their accounts were required to be paid back to the firm, the total sum amounting to approximately $100,000. These statements of account were preceded by a letter (Exhibit A-11) from a Mr Griffiths to the appellants, which I read as being an offer to the appellants to purchase the interest of “Riddell Stead” in the partnership described in Exhibit R-1.
Much evidence has been led to show that, as of the end of January 1968, a loss of a substantial amount with respect to “Jordan” should have been either included in a reserve for doubtful accounts or written off. At that time there was a debt of some $200,000 owing to the partnership by way of demand loans and current accounts. Nothing was indicated in Exhibit A-2 to show this amount to be owing other than an account receivable from associated companies. There was also a figure of $26,000 for “Samson élair’, which company, the evidence indicates, had a contract with the Quebec Government to perform certain services for the Castonguay Commission but had been told that they had exceeded their mandate. Some difficulty, or at least some doubt, had therefore arisen, certainly in the minds of Simpson and the other appellants, as to whether or not the payment of any further sums would be forthcoming. According to the appellants, this also should have been taken into consideration, either by way of a reserve for doubtful accounts or as a write-off. Evidence indicates that accountants’ treatment of write-offs is different from their treatment of reserves for doubtful accounts, but the distinction is not sufficiently great to affect the outcome of this appeal, for I am satisfied that either approach would result in a loss to the appellants in this instance.
A Mr George Simpson, who is not related to the appellant Simpson but who is a chartered accountant, as were all the other witnesses, gave evidence as an independent witness that, early in April of 1969, the appellant Simpson came to him with a request that he (George Simpson) prepare the personal income tax return of the appellant James Simpson for the 1968 taxation year. I think one can almost take judicial notice of how busy accountants are with such requests ait that time of the year, and l am certain that Mr George Simpson undertook the task at that point in time only because it was for a fellow member of the profession. The appellant Simpson showed Exhibit R-4 to his accountant George Simpson, but this did not provide all the information that the latter felt was necessary. However (using Mr Kent’s letter, which had indicated to them—and by “them” I mean the appellants—that a loss was evident, they projected a figure and the results are shown in Exhibit R-3. The differences, of course, are tremendous. In Exhibit R-4 the appellants are shown to have made a profit, whereas in R-3, by projecting the losses, the profit is wiped out and a loss for the year of some $187,719 is shown. If this figure is accepted, then, of course, there would be no taxable income for the fiscal year for these appellants.
I have indicated to the appellants’ counsel in the course of the argument, and I am satisfied from the questions that I put to the witnesses, that I should consider, and have considered, Mr Ledanyi and Mr Kent to be something less than active participants in this appeal but certainly also something less than independent witnesses. As one trained in the law and not in accountancy, to me, as a layman with respect to accountancy matters or the interpretation of financial statements but perhaps as one with some slight knowledge of how to read such documents, it would seem that if, as a practitioner, I were presented with such a document as appellant’s Exhibit 2 by a client, it would be obvious to me that I would require a great deal more information, particularly with respect to the “Jordan” account, before I would accept the accounts as being entirely collectable. It may well be that investigation would show that it was a safe account and that it would probably be collected in the normal course of events, but in any case such an investigation would seem to be called for before preparing a statement.
In answer to a hypothetical question, Mr Ledanyi reluctantly conceded this point. He is a trained accountant. All the other witnesses called were also trained accountants. Mr George Simpson, and a Monsieur Gagne who was also called as an independent witness on behalf of the appellants, indicated that either a reserve or a write-off should have been provided for in that 1968 statement (Exhibit A-2). I therefore have no hesitation in coming to the conclusion that the said Exhibit A-2, the financial statement for the year ended January 31, 1968, did not show a true picture, according to sound accounting principles and practice, of the partnership’s financial position as of that date.
However, having said that, I now come to the most difficult aspect of this case, and that is, whether or not it makes any difference to the outcome of the appeals in the face of the respondent’s Exhibits R-1 and R-2. It is urged upon me in a most persuasive manner by counsel for the appellants that the events of the spring of 1968, beginning with the Ledanyi statement and ending with the signing of the document filed as Exhibit R-2, must be looked at as having all transpired after the end of the fiscal year for which the tax, if any, was to be assessed. In other words, the mutual releases, and I use the term in the broad sense, that were included in Exhibit R-2, do not affect, for income tax purposes, the amount of the tax that. was payable, or not payable, by the partnership for its fiscal year ended January 31, 1968. In other words, the appellants’ basis of argument is, as I understand it, and it was clearly put, that, as individuals, partners cannot deal in tax losses as incorporated companies sometimes can; that either the partnership did or it did not suffer a loss in 1968, and their counsel cites many cases, relying particularly on Sura v MNR, [1962] CTC 1; 62 DTC 1005, not because it is analogous in any way to the factual situation that exists here but as to the principle that the individual is the person who is taxed, that is, the person who earns the income.
Also cited was the case of Hogan v MNR, 15 Tax ABC 1; 56 DTC 183, for the principle that it is the taxpayer who shall decide when a debt is to be considered bad. In other words, in a complete fiscal year where there have been losses, and where, as in this case, there is a partnership, the losses belong to the partners just as, if there had been profits, the profits would be assessed as income of the partners whether or not they were withdrawn in the fiscal year.
Counsel also goes on to say that, since good accounting practice demands that the accounts reflect preparation in accordance with sound accounting principles, therefore the appellants in question should be able to deduct the loss notwithstanding the eventual disposition of their interest in the partnership as effected through respondent’s Exhibit R-2.
Counsel for the respondent, of course, holds—or urges upon me to hold (which he did at the opening of the case in the form of a motion)— that the appellants cannot succeed, since, on the basis of Exhibits R-1 and R-2 alone, they have disposed of their interests in the partnership and the partnership has continued on without their participation. This, therefore, then brings me to the agreement in question, namely, the said Exhibits R-1 and R-2, as well as other exhibits that are to be read in conjunction with them. Certain markings which have been made on the exhibits in blue ink were made by myself, and have no significance whatsoever with regard to the contents of the agreement other than to draw certain phrases to my attention in the course of rendering this decision.
If I look first at paragraphs A, B and C of Exhibit R-2, this section lends itself to the interpretation, in my view, that it is really a concession by “Riddell Stead” to the appellants in this case. If one reads paragraph 20 of Exhibit R-1, which of course predates Exhibit R-2, R-1 being, as I have said, effective as of February 1, 1967, and R-2 having been dated May 18, 1968, the second subparagraph thereof indicates that:
upon resignation the amounts due to or from the resigning partners will be determined as shown in the partnership accounts, exclusive of capital gains, as of the effective date of resignation. Any sums due to or from a resigning partner are payable forthwith.
In my view, and on the evidence of Mr James Simpson, one of the appellants, the appellants had more to lose if they insisted on strict compliance with the provisions of the aforementioned paragraphs of Exhibit R-1, or at least that inference can be drawn by me from James Simpson’s evidence. If it was apparent to me, and if it was apparent to the other independent witnesses, that a reserve or a write-off should have been included in Ledanyi’s statement (Exhibit A-2), surely it should have been obvious to the appellants themselves, who were trained in this field and who would seem to have been in the position to make a similar assessment of the situation. As operating partners for the fiscal year ending January 31, 1968 they were aware of all the facets of the operation of this partnership, or, at least, they should have been. They had been preparing monthly statements and forwarding them to “Riddell Stead” as I have said previously.
When one looks at the letter from Mr Kent (Exhibit A-5) to the appellants, it is open to the interpretation that, by the signing of the document R-2, it was not possible for “Riddell Stead” to make any further concessions, in the light of what has been revealed by the proportionate share of losses of the partnership that devolves, in accordance with Kent’s calculations, on the individuals. It was this letter of June 27, 1968 that was allegedly the basis for the 1968 returns filed by the appellants, but to me it indicates that, in allowing the three appellants to dispose of their interests in the partnership in the manner in which they did, that is, via Exhibit R-2, “Riddell Stead” had gone as far as it was prepared to go with respect to these individuals. That the partnership was to continue is unquestioned and, in my view, unquestionable in the light of the provisions of Article 23 of Exhibit R-1, which I have underlined and which read, beginning at the third line:
Upon the death, removal, retirement or resignation of a partner for whatever cause, the partnership shall continue amongst the remaining or surviving partners, and each and every partner, by the fact of his admission as a partner, renounces any right he may have under the law to dissolve the partnership at will.
Mr James Simpson has said in the witness-box that the partners were told they would have to come up with approximately $100,000 to repay the drawings of the three appellants and meet the demand of the bank, or else, as Mr Simpson put it, “Kent was prepared to allow the chips to fall where they may”. Simpson says that they were unable to comply. They asked for time to see if they could introduce new capital into the business, presumably to replace that of ‘‘Riddell Stead”, and this might explain the letter from Mr Griffiths. In any event, it was clear from Mr Simpson’s testimony that he and his fellow appellants were not in a position to meet the demand for repayment at that time, and so I infer from those facts that the appellants willingly, and perhaps gladly, agreed to abandon their interest in the partnership in exchange for the cessation of demands by “Riddell Stead” for the repayment of their drawings.
I can find, therefore, that ample consideration existed in the minds of the appellants at the time of the signing of Exhibit R-2 that this was a means of disposing of their interest in a continuing partnership without having to put up any of their own funds. These parties, as has been pointed out, were not dealing at arm’s length. I assume and infer from the evidence that ail the facts surrounding the two agreements were fully within the knowledge of the parties. They were represented by counsel and I am satisfied that at the time they were well advised, under all the circumstances, to execute the document of May 18, 1968 as they did. I further find as a fact that they are, in my view, bound by that decision, and that there is therefore no error in law or in fact in the assessments of the Minister in this instance.
In the event that the case should go further, and for the assistance of any other tribunal that might hear the case, I may say that I base my decision solely on the evidence of the appellant Simpson as to the appellants’ position in the spring of 1968 and on the fact that the documents were signed in good faith, and in my view the documents are the determining factor in this transaction. If I am wrong in so holding, it is my belief that the appellants would be entitled to succeed, as I have said, because I am satisfied that under sound accounting principles a loss would have resulted if a reserve or a write-off had been applied at the appropriate time.
However, as I again repeat, with full knowledge of the contents of Lecanyi’s statement, they entered into this agreement by which I now find them to be bound. Therefore, in the end result, the appeals are dismissed.
Appeals dismissed.