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T-1043-73
James W. Simpson (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Addy J.—Montreal, May 4, 5 and 6, June 15 and 16; Ottawa, September 2, 1976.
Income tax—Alleged profits or losses incurred by taxpayer pertaining to operation of partnership—Partnership subsisted from February 1967, to May 1968—Final statement of part nership published in March 1969 and plaintiff taxed accord- ingly—Agreement dissolving partnership does not authorize financial report prepared contrary to normal accounting prin- ciples—Agreement res inter alios acta in so far as defendant concerned—Plaintiff not bound by decision affecting report after dissolution of partnership Income Tax Act, R.S.C. 1952, c. 148, s. 85D as amended by S.C. 1953-54, c. 57, s. 24.
Plaintiff and two colleagues (whose appeals will be subject to the same decision as the one in this case) formed a partnership with a firm of accountants by memorandum of agreement dated February 1, 1967. In March 1968, a draft balance sheet and statement of the partnership as of January 31, 1968, the end of the partnership's fiscal period, was very unfavourable and the plaintiff and his two colleagues withdrew from the partnership by memorandum of agreement dated May 18, 1968, in which all parties gave general releases concerning monies owing and obligations to account. A final statement for 1968 was presented in March 1969, and showed a profit on which the plaintiff was taxed. It made no provision for bad debts, but defendant claims that plaintiff is estopped from objecting to this unusual accounting procedure because he had granted for consideration a general release of any obligation to account and because the decision to defer the reserve for bad debts to, or write them off in, a later year was that of the partnership still existing.
Held, the appeal is allowed and the matter is referred back for re-assessment.
(1) The memorandum of agreement by which the plaintiff withdrew from the partnership merely refers to accounting between the parties and does not refer to accounting for taxation purposes. Even if it did, it would be unenforceable as being contrary to public policy (see Canadian General Electric Co. v. M.N.R. [1962] S.C.R. 3).
(2) The agreement is res inter alios acta and the Minister of National Revenue is not a party to it or referred to as a person having a right to enforce it.
(3) The election to postpone the write-off of the partnership debts was made after the plaintiff withdrew from it. There was, in effect, no subsisting partnership and the use of its name for business purposes was its use by the firm that was the only
remaining member of the partnership. In other words, the memorandum of agreement was between the plaintiff and that firm only.
(4) Section 85D of the Income Tax Act does not apply since the agreement of May 18, 1968 did not constitute a sale of a business as contemplated in that section.
Canadian General Electric Company v. M.N.R. [1962] S.C.R. 3, applied.
APPEAL. COUNSEL:
Mitchell Klein for plaintiff.
Brian Schneiderman for defendant.
SOLICITORS:
Phillips & Vineberg, Montreal, for plaintiff.
McMaster, Meighen & Associates, Montreal, for defendant.
The following are the reasons for judgment rendered in English by
ADDY J.: The plaintiff is appealing a decision of the Tax Review Board which upheld a decision of the defendant in re-assessing him for the taxation year 1968.
The identical facts also applied to the cases of one Julian Evans and one Arthur Ivor Morris who had instituted the same appeals with identical results and it was agreed by all concerned that the decision on this present case would constitute deci sions in the appeals of the other two taxpayers.
The plaintiff and the other two above-referred to taxpayers, all chartered accountants, had been associated in partnership with a firm of account ants known as Riddell, Stead, Graham & Hut- chinson (hereinafter referred to as "Riddell Stead") the partnership being known as Simpson, Riddell, Stead & Partners (hereinafter referred to as "The Partnership").
The case concerns the alleged profits or losses incurred by the taxpayer during 1968 pertaining to the operation of the aforesaid Partnership which was dissolved by agreement of the partners on the 18th of May 1968, following some serious disa greements and misunderstandings between them.
The Partnership was originally formed on the 1st day of February 1967 in order to conduct a management consultant business. Under the agree ment the profits and losses were to be shared as follows: the plaintiff 40%, Evans and Morris 25% each and Riddell Stead the remaining 10%. There were two other persons, described as partners, who were not active or operating partners, whose income was limited and who could not share in the general profits. They had nothing to say in the operation of the Partnership and their interest and participation do not in any way affect the issues before me.
The Partnership conducted its management con sultant business directly and through other firms of accountants and business managers in various places in Canada and in the United States of America. It operated in the U.S.A. through a management consultant company known as Ste- venson, Jordan & Harrison Management Consult ants Inc. (hereinafter referred to as "Jordan"). It possessed a 74% interest in Jordan, this interest in turn was held by means of a holding company known as Simpson, Riddell, Stevenson Internation al Limited (hereinafter referred to as "S.R.S. International"), 85% of the shares of this holding company being owned by the Partnership. There also existed in Montreal another management con sultant company, namely, Samson, Belair, Simp- son, Riddell Inc. (hereinafter referred to as "Sam- son Belair") which was owned 50% by the Partnership and 50% by a firm of accountants known as Samson, Belair, Côté & Lacroix (herein- after referred to as "Côté Lacroix"). The Partner ship also held 81% control of another management consultant firm in Montreal known as Unica Research Company Limited (hereinafter referred to as "Unica"). The plaintiff and the aforesaid Morris and Evans had been operating the Partner ship and submitting progress statements every four weeks.
One Ladanyi who, on behalf of Riddell Stead, had been examining the statements in March 1968, filed a draft balance sheet and statement of the Partnership as of the 31st of January, 1968, being the end of the Partnership's fiscal period. As
a result of this statement, which was very unfa vourable, several meetings were held which, as stated previously, eventually led to the plaintiff, Morris and Evans all withdrawing from the Part nership. A letter had been addressed to the plain tiff and sent by one Kent on behalf of Riddell Stead dated the 2nd of April 1968. It was filed at trial as Exhibit P-3 and stated that the combined operations of the Partnership and its affiliated and associated companies had resulted in a loss for the year ending the 31st of January 1968 and that, as a result, all drawings by partners made in anticipa tion of profits had been in excess of entitlement and were immediately repayable to the Partner ship. It stated that the books revealed that the net drawings of the plaintiff for the period amounting to some $31,125.51 had to be repaid within two days, in default of which he would be deemed to have committed a breach of the Partnership con tract and would be removed as a partner pursuant to the articles of agreement.
The final statement for 1968 was only presented about one year later, that is, in March 1969. This statement, contrary to the previous indications that a substantial loss would occur, showed a profit on the Partnership business for the period in question. The plaintiff was therefore taxed accordingly by the defendant.
The issue between the parties concerns consider able sums of money owing the Partnership from its associated and affiliated firms at the time in ques tion and the financial liquidity or at least the prospective ability to pay of some of those busi nesses at the time. Specifically, the issue is wheth er, for the period in question according to good accounting principles, a large amount if not all of these accounts receivable from affiliated firms should have either been written off or included in a special reserve for bad debts or whether, on the contrary, it was proper accounting in the circum stances to treat them at that time as ordinary accounts receivable which would be paid in the ordinary course of business. It is worthy to note here and counsel for both parties agreed that, for the purpose of this case, it matters not whether the questionable accounts receivable were written off or merely made the subject of a reserve for bad debts, since the profit or loss position of the Part-
nership for the period in question would be the same in either case.
As to whether they should or should not be dealt with as bad debts and reserved or written off, apparently equally qualified experts were called and came to diametrically opposed conclusions. Each expert was equally emphatic and categorical and stated that he was absolutely certain of his conclusion although fully cognizant of the reason ing and of the conclusions of those sharing a completely opposite view. Such blatantly contra dictory views are not of much assistance to the Court and since there appears to be no lack of knowledge or expertise on either side one can only speculate as to either the sincerity or the interest of the experts from one or the other or both sides. The question requires a positive or negative answer and one therefore is left to a large extent to an examination of the facts and to the application to those facts of common sense, illuminated or obscured as the case may be, by the general princi ples so confidently propounded and categorically interpreted by the experts.
The balance sheet of the Partnership for the year ending the 31st of January 1968 relied upon by the Defendant's expert and on which the plain tiff was taxed (Exhibit P-17) shows a profit of $36,089 after an allowance of doubtful accounts of some $7,997, while that prepared and upheld by the plaintiff's expert shows a loss of $187,719 for the same period after an allowance of doubtful accounts in the amount of some $231,805. There is therefore a difference in result of some $223,808 as to the operations for the period in question, a not inconsiderable amount if one considers that if no reserve of any kind were taken for doubtful accounts the income would only amount to some $42,000 in any event.
A second point made by the defence was that even if the failure to make any provision for bad debts was against generally accepted accounting principles, the plaintiff could not now object to whatever losses which did incur being included in a reserve for bad debts or being written off in subse-
quent years rather than in the year of dissolution, by reason of the fact that, in the memorandum of agreement of the 18th of May 1968 by which the plaintiff withdrew from the Partnership, he grant ed a general release to the Partnership and to the remaining partner and more particularly a release from any obligation to account and, in return, received a release of the monies apparently over drawn by him and was relieved from any obliga tion of repaying them to the Partnership. A further argument of the defence was that, in any event, whether and when any reserve for bad debts was to be taken was up to the taxpayer, that the Partner ship had decided to defer the reserve or write off to a later year and that the Partnership, at the time of that decision, consisted of Riddell Stead.
As to the actual value of the questionable accounts, several important pieces of evidence were tendered at trial. Exhibit P-11 produced at trial was a letter dated the 29th of March 1968 prepared by a senior officer of the Partnership. The Partnership was at that time offering to sell to the plaintiff for the sum of $250,000 cash, assets totalling approximately $452,000. These assets consisted of the Partnership's shares of Jordan and S.R.S. International plus training material valued at $37,669 plus an assignment of the Partnership advances made to S.R.S. International in the amount of $17,558 and those made to Jordan in the amount of $352,822. The shares of Jordan were later sold for $45,000 in November 1968. Exhibit P-11 therefore clearly establishes that in March 1968 the Partnership was ready to sell at a loss of some $202,000.
In the summer of 1968, the firm of Dunwoody and Company made a firm offer to purchase the shares of Jordan and buy for $100,000 the inter- company account, which stood at approximately $389,000. This would have represented a discount or a loss of some $289,000. This offer was accept ed by the Partnership. The purchase was subse quently called off by the purchaser as the offer was conditional upon three key employees of
Jordan remaining with the company after the pur chase and it became evident that if the sale went through, these employees would not be willing to remain. This again clearly illustrates the value placed on the Jordan account at that time by Riddell Stead. The account was in fact subse quently written off at the end of 1968 in the amount of $269,000 and the ultimate loss eventu ally turned out to be $168,000.
It appears clear to me that, from every stand point, Jordan was actually insolvent in January of 1968, and had very little prospect from its own resources of being in a position to pay the balance of $206,094 owing in its current account as of the 31st of January 1968 as shown on Exhibit P-6. In so far as the Partnership itself is concerned, the statement at the end of 1968 produced as Exhibit 22 showed a loss for the year of $287,505 and bad debts of some $181,000.
Samson Belair had been performing services for the Castonguay Commission and had been billing the Commission on a continuing basis. According to the witness Kent, whose evidence on this point I accept, Samson Belair's operations were really conducted generally as an agent of the Partner ship. In 1968, serious differences arose as to the amounts being charged for the services rendered the Commission and the latter, subsequently, not only denied liability for an amount of some $96,488, for which it had been billed, but actually claimed that it had overpaid for the services already rendered and claimed further that, even if the amount overpaid were returned, Samson Belair was legally obliged in addition to complete its work and report to the Commission without any further compensation whatsoever. A reserve for this account as a bad debt was actually made as of the 31st of January 1969. Although some consider able time later the amount was actually paid by the Castonguay Commission, there is no evidence to contradict that led by the plaintiff to the effect that at the time the statement for the period ending the 31st of January 1968 was actually prepared, namely in March 1969, the claim against the Castonguay Commission was appar ently on a very shaky foundation and no evidence whatsoever was led as to the effect that at that time there was really any expectation of it being paid. What factual evidence does exist seems to
point clearly to the conclusion that, at the relevant time when the statement was prepared, the Part nership could expect to lose one half of this total amount, in accordance with its interest in Samson Belair.
In addition, Exhibit P-10 shows a deficit or loss as of the end of the period of $12,546. The losses or profits of the Partnership were to be calculated on the combined operations of the associated com panies and firms which, of course, include Samson Belair.
The letter produced as Exhibit 3, to which I referred previously and in which the representative of Riddell Stead in the Partnership claimed that a very substantial loss had occurred in the Partner ship operations during the period in question, is quite relevant, in my view, when considering the manner in which the amounts owing by Jordan and by Samson Belair to the Partnership at that time, should be treated.
As it is much more in conformity with the factual evidence before me, I accept the evidence of the expert Bessener called on behalf of the plaintiff rather than that of the expert of the defendant, to the effect that, according to good accounting practice, if not written off then a reserve for bad debts should have been created for receivables due the Partnership from Samson Belair in the amount of $54,517 (being one half of the above-mentioned figures of $96,488 (Exhibit P-19) and $12,546) and for those due from Jordan in the amount of $168,460, this latter amount being the amount actually written off as of November 1968, when the shares of Jordan were sold by the Partnership, rather than the amount of $206,094 owing as of the 31st of January 1968, shown on Exhibit P-6.
My conclusion on this first issue necessarily leads to a consideration of the second issue raised, namely, whether the memorandum of agreement of the 18th of May 1968 constitutes in any event a bar to the plaintiff's right to object to the losses having been claimed subsequently by Riddell Stead as the sole remaining member of the Part nership rather than as of the 31st of January 1968.
Paragraph 4 of article 6 of the original Partner ship agreement provided that the plaintiff would be entitled to 40% of the profits and be responsible
for 40% of the losses of the Partnership. The memorandum of the 18th of May 1968 provided that the remaining partner, Riddell Stead, and the Partnership release the plaintiff from all accounts, actions, suits, claims, proceedings and demands which they might have against the plaintiff in respect of any losses of the Partnership for the period up to the date of the plaintiff's resignation or in respect of any drawings made by the plaintiff in excess of •the capital contributed by him or standing to his credit or in excess of any other credits owing to him. It also provided that no demand for an accounting would be made by any of the parties and nullified a provision in the original Partnership agreement to the effect that a resigning partner would have to repay sums due by him to the Partnership. Finally, the plaintiff released the Partnership and Riddell Stead from all monies, accounts, actions, claims, etc., which he might at any time have or have had against them.
In so far as the substance of the agreement is concerned, it merely refers to an accounting as between the parties and there is no mention what soever of taxes, of taxation or of any accounting for taxation purposes. It is clear in my view that the agreement does not, in any way, purport to authorize Riddell Stead or anybody else to submit a financial report prepared contrary to normal accounting principles, covering the operation of the Partnership for the year ending January 1968 which would be binding on the plaintiff. Further more, if it did, I feel that any such provision would be unenforceable at law as being contrary to public policy since all accounting for taxation purposes must be in accordance with proper accepted accounting principles (refer Canadian General Electric Company v. M.N.R. 1 ).
In the second place the agreement is res inter alios acta in so far as the defendant is concerned: the Minister of National Revenue is not a party to the agreement nor is he referred to as a person having any particular right to enforce any provi sion of the agreement. It follows that, since there is no privity of contract between the parties, any
1 [1962] S.C.R. 3 per Martland J. at page 12.
covenant or undertaking of the plaintiff is not enforceable by and cannot be relied upon by the defendant from a contractual standpoint, nor can the defendant claim contractual estoppel against the plaintiff by reason of that contract. It does not even indirectly purport to express any intention on the part of the plaintiff to allow the accounts to be prepared by Riddell Stead in such a way as to defer a loss to a later year. Furthermore, any such intention was denied by the plaintiff and no evi dence was led by the defendant to contradict that testimony.
For the above reasons I fail to see how the agreement of the 18th of May 1968, or the settle ment between the parties based on it, can be of any avail to the defendant or how they can be invoked by the defendant as a bar to the plaintiff's claim.
This brings me to the final issue as to whether the plaintiff was bound in any event by the election made by the Partnership to postpone the write-off of these debts until a later date.
The election was actually made some consider able time after the 18th of May 1968. The three operating partners, that is, the plaintiff, Evans and Morris had all withdrawn from the Partnership on the last-mentioned date and had executed identical contracts. The other two individuals who were not operating partners, if they were partners at all, had withdrawn from their role in May 1968 and were paid out of salary account as were ordinary employees. Had they not withdrawn, I would have been prepared to hold that they never at any time were partners in a legal sense since they contribut ed no capital, were not responsible in any way for losses and had no say in the management. Although described as partners in the original agreement, they were nothing more than employees whose income was guaranteed up to a fixed amount on a first share of the profits.
From the 18th of May, the only remaining partner in the original Partnership was the firm of Riddell Stead described in the aforesaid agreement
as "the remaining partner." Counsel for the defendant argued that, as the firm of Riddell Stead was itself a partnership, the Partnership from which the plaintiff and the others resigned on the 18th of May 1968 continued to exist at law and was formed by the partners who constituted the firm of Riddell Stead. I cannot subscribe to this argument: neither the rights, duties, remuner ations nor the financial responsibilities of the person constituting the firm of Riddell Stead could, from the 18th of May 1968, be determined, governed or fixed in any way by the original agreement of the 1st of February 1967 under which the Partnership from which the plaintiff resigned was constituted. These rights, duties, remunerations and financial responsibilities could only, from the 18th of May 1968, be determined in accordance with the Partnership agreement of the firm of Riddell Stead itself, in which the plaintiff never had any interest whatsoever. I therefore find that from the 18th of May 1968, the agreement of the 1st of February 1967 was at end since all of the parties except one had been released from it and the Partnership was in fact and at law dis solved. What existed from that date was the firm of Riddell Stead who continued to do business under the name and style of Simpson, Riddell, Stead & Partners, which was in effect the name and style of a partnership which had ceased to exist.
It appears clear therefore that, although the memorandum of agreement of the 18th of May 1968 purports to be made between three parties, namely, Riddell Stead as the remaining partner, the Partnership itself and finally the plaintiff, the agreement, in my view, is one between two parties, namely, Riddell Stead and the plaintiff since Rid- dell Stead was the sole remaining partner and Simpson, Riddell, Stead & Partners did not exist any longer as a partnership since the resignation of the 18th of May 1968 but existed merely as a firm name under which Riddell Stead continued to do business.
I might add incidentally that section 85D of the Income Tax Act 2 has no application by reason of the fact, among other reasons, that the agreement of the 18th of May 1968 did not constitute a sale
2 S.C. 1953-54, c. 57, s. 24.
of a business as contemplated in that section.
It follows that from that date the plaintiff could not be bound in so far as the defendant is con cerned by any election made by the firm of Riddell Stead as to how, when and how much of the outstanding debts were to be written off. As be tween the parties to this action this issue can only be determined by applying the test of good accounting practice under the circumstances.
Since I have held that good accounting practice would have required that the following debts either be written off or made the subject of a reserve for bad debts as of the end of January 1968, namely, Samson Belair: $54,517, Jordan: $168,460, the matter will be referred back to the Minister for re-assessment accordingly. The plaintiff will be entitled to his costs except for those of the adjourned hearing of June 15 and 16, 1976, which at trial I granted to the defendant in any event of the cause. There will be judgment accordingly.
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