T-2422-72
John Walter Butcher (Appellant)
v.
Minister of National Revenue (Respondent)
and
T-2536-72
Grant Edward Frost (Appellant)
v.
Minister of National Revenue (Respondent)
and
T-2537-72
Ivan S. Gray (Appellant)
v.
Minister of National Revenue (Respondent)
Trial Division, Gibson J .—Toronto, October 30,
1974; Ottawa, November 8, 1974.
Income tax—Partnership dissolution—Amount paid to
retiring partner—Assessment for tax of retiring partner—
Assessment of continuing partners—Income Tax Act, s. 85F.
The three appellants and S carried on practice as char
tered accountants from 1955 until dissolution of the partner
ship in 1966, when the appellants joined in a new partner
ship and S began practice alone. From 1962 to 1966, the
four partners in their partnership accounts accounted for the
profits from their practice on an accrual basis but, individu
ally, for income tax purposes, paid income tax on the "cash
method" then permitted under section 85F of the Income
Tax Act. On dissolution, settlement was made of accounts
among the partners, including the respective shares of the
profits for the period from May 31, 1965 (the end of the last
full year of the partnership) to January 15, 1966, the date of
dissolution, when S received the sum of $37,972. The issue
on these appeals from assessment arose between the appel
lants' contention that the sum was income of S for income
tax purposes and the contention of S that it was a capital
payment to him from the continuing partners upon which
the continuing partners were required to pay income tax.
Held, allowing the appeal in part, the categorization in the
settlement of the sum of $12,484 as the share of S "in
respect to tangible assets" was supported by the evidence
that the sum represented the dollar value of S's entitlement
to the physical assets used by the partnership. The assess
ment should be upheld as to this amount. As for the balance
of $25,488, this came from the sale and purchase of the
share of S in the accounts receivable and unbilled time
(which under the "cash method" pursuant to section 85F of
the Income Tax Act were not included in computing
income). S made the sale and the continuing partners made
the purchase. Hence S should have included as income
under section 85F of the Act, the $25,488 representing the
consideration received by him as his share of such accounts
receivable and unbilled time. The appeals should be allowed
to the extent that the relevant proportionate share of that
sum should not have been added to the respective incomes
of the appellants for the respective income tax years under
appeal; the assessment should be referred back for reassess
ment accordingly.
INCOME tax appeal.
COUNSEL:
J. W. Mik for appellants.
W. J. A. Hobson for respondent.
SOLICITORS:
Blake, Cassels & Graydon, Toronto, for
appellants.
Deputy Attorney General of Canada for
respondent.
The following are the reasons for judgment
delivered in English by
GIBSON J.: These three appeals were heard on
common evidence.
The three appellants and one Roderick J.
Smith, as chartered accountants, carried on
their practice in partnership from 1955 to Janu-
ary 15, 1966 when the partnership was dis
solved. After that time, the partner Smith prac
tised alone and the other three partners, Gray,
Frost and Butcher continued to practice in part
nership in a new partnership.
From 1962 to January 15, 1966, the four
partners in their partnership accounts, account
ed for the profits earned from their practice on
an accrual basis, but individually for income tax
purposes, declared and paid income tax on the
"cash method" permitted under section 85F of
the Act at that time.
The year end of the partnership was May 31.
The partnership was dissolved by formal agree-
ment on January 15, 1966. This agreement set
tled all accounts among the partners including
the respective shares of the profits for the seven
and a half months of the partnership year after
May 31, 1965, namely, for the period May 31,
1965 to January 15, 1966.
The issue on these appeals is in respect to the
categorization for income tax purposes of what
Smith actually received on the dissolution of the
partnership on January 15, 1966. The quantum
in question is $37,972.
The three continuing partners in the new part
nership, Gray, Frost and Butcher, contend that
this said sum was income of Smith for income
tax purposes. Smith contends it represented a
capital payment to him from the continuing
partners upon which the continuing partners
were required to pay income tax.
As of January 15, 1966 (1) the allocation of
profits to Smith on an accrual basis exceeded
his allocation on a cash basis by $37,972; (2)
Smith's drawings from the partnership bank
account exceeded his share of the actual cash
received by the partnership to which he was
entitled, by $25,488; and (3) the amount to
which Smith was entitled to an allocation on
accrual basis as of January 15, 1966, exceeded
his drawings, by $12,484.
By the said contract of dissolution dated
January 15, 1966, Smith received the following
which were categorized in the said contract in
the following manner:
2..
(a) the sum of $20,000 in respect of goodwill;
(b) the sum of $12,484 in respect of tangible assets;
(c) a sum equal to $18,000 in respect of profit for the
current fiscal year less the sum of $15,810.60 being the
amount received by Smith since May 31st, 1965 by way
of drawings.
(See Exhibit 4.)
The said sum of $20,000 in respect to good
will, Smith and the continuing partners treated
as a capital receipt and a capital disbursement
and no issue arises as to it.
The said sum of $12,484 categorized as
Smith's share "in respect of tangible assets",
the appellants attempted to categorize as some
thing else, but the evidence at trial from them
does not support any other categorization. This
sum represents the dollar value of Smith's enti
tlement to the physical assets used by the part
nership to January 15, 1966, and belonging in
undivided interest to the four partners, such as
furniture and equipment. In the last balance
sheet of the company, a substantial amount is
shown as the cost of these tangible assets and
capital cost allowance has been claimed and
charged for income tax purposes.
There is no mention in the contract of dissolu
tion dated January 15, 1966 specifically of the
sum representing the difference between
$37,972 and $12,484, namely, $25,488.
That sum, $25,488, represents moneys that
Smith had drawn from the partnership bank
account as of January 15, 1966 over and above
his entitlement of the cash receipts arising from
the partnership profits. Smith had not paid
income tax on that sum as of that date.
That sum had not been received in cash by
the partnership as of January, 1966, but instead
was represented by accounts receivable and
time unbilled.
The moneys that enabled Smith to draw this
$25,488 excess over cash entitlement was
obtained by the partners borrowing from their
bank.
By the contract of dissolution dated January
15, 1966, the partners gave mutual releases to
each other and also, among other things, gave to
Smith a covenant to indemnify and save him
harmless in respect to the bank loan made by
the partnership and previously made by all the
partners, including Smith.
By the contract of dissolution, as a result the
continuing partners obtained full title to the
accounts receivable and unbilled time and
subsequently received cash for these assets, as
the accounts receivable were collected, and as
the unbilled time was billed and the bills collect
ed after billing. From these cash receipts from
these sources the bank loan was repaid.
At dissolution, the evidence was that the part
ners had not discussed among themselves, nor
had their respective solicitors (who were
employed to settle the contract of dissolution
dated January 15, 1966) whether Smith was to
pay income tax on this excess of drawings of
$25,488 over cash entitlement or whether the
continuing partners were to pay income tax on
this sum when received by way of payments on
accounts receivable even though they alone
were required to pay the bank loan which was
the source of the funds for this excess of
drawings.
As of January 15, 1966 on the execution of
the contract of dissolution, Smith was not
required to repay this said sum of $25,488
representing excess drawings over cash entitle
ment. As of that time also, the continuing part
ners were entitled to accounts receivable and to
the assets representing time unbilled. The con
tinuing partners, as stated, were required to
repay the bank loan in toto including the amount
of the bank loan which was represented by this
excess of drawings over cash entitlement by
Smith viz, $25,488.
It was suggested in alternative arguments,
that this sum of $25,488 should be categorized
for income tax purposes as a capital payment
and receipt or income payment and receipt or as
a gift.
In my view, what in effect took place in
respect to this sum of $25,488 (being excess of
drawings by Smith over cash entitlement) as of
January 15, 1966 when the contract of dissolu
tion was executed by the four partners, was a
sale and purchase of Smith's share of the
accounts receivable and unbilled time (which
under the "cash method" pursuant to section
85F of the Act were not yet included in comput
ing income). Smith made the sale and the con
tinuing partners made the purchase.
As a consequence, Smith should have includ
ed as income under section 85F(4) of the Act
the sum of $25,488 representing the consider
ation received by him in respect to his share of
such accounts receivable and unbilled time.
The appeals are therefore allowed to the
extent that the relevant proportionate share of
the sum of $25,488 should not have been added
to the respective income of the appellants for
the respective income taxation years under
appeal, and as a consequence, the assessments
for each of the years under appeal are referred
back for re-assessment, not inconsistent with
these reasons.
The appellants are entitled to costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.