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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