Docherty v. The Queen

Docherty v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2003-12-18
Neutral citation
2003 TCC 754
File numbers
1999-3141(IT)G
Judges and Taxing Officers
Campbell J. Miller
Subjects
Income Tax Act
Decision Content
Docket: 1999-3141(IT)G
BETWEEN:
WILLIAM DOCHERTY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard together with the appeals of Ronald J. Hakem (1999-3168(IT)G)
on October 7, 8 and 9, 2003, at Windsor, Ontario
By: The Honourable Justice Campbell J. Miller
Appearances:
Counsel for the Appellant:
Arthur M. Barat, Q.C. and Avril Farlam
Counsel for the Respondent:
Richard Gobeil and Ronald MacPhee
____________________________________________________________________
JUDGMENT
Whereas at the commencement of the hearing, counsel for the Appellant informed the Court that the Appellant was withdrawing his appeals for the 1992, 1994 and 1995 taxation years because they were from nil assessments.
The appeals from assessments of tax made under the Income Tax Act for the 1992, 1993, 1994 and 1995 taxation years are dismissed, with costs.
Signed at Ottawa, Canada, this 18th day of December, 2003.
"Campbell J. Miller"
Miller J.
Docket: 1999-3168(IT)G
BETWEEN:
RONALD HAKEM,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeals heard together with the appeal of William Docherty (1999-3141(IT)G)
on October 7, 8 and 9, 2003, at Windsor, Ontario
By: The Honourable Justice Campbell J. Miller
Appearances:
Counsel for the Appellant:
Arthur M. Barat, Q.C. and Avril Farlam
Counsel for the Respondent:
Richard Gobeil and Ronald MacPhee
____________________________________________________________________
JUDGMENT
The appeals from assessments of tax made under the Income Tax Act for the 1990, 1991, 1992, 1993, 1994, 1995 and 1996 taxation years are dismissed, with costs.
Signed at Ottawa, Canada, this 18th day of December, 2003.
"Campbell J. Miller"
Miller J.
Citation: 2003TCC754
Date: 20031218
Docket: 1999-3141(IT)G
BETWEEN:
WILLIAM DOCHERTY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 1999-3168(IT)G
AND BETWEEN:
RONALD J. HAKEM,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1] The Appellant, Mr. Docherty, has for 48 years been in the property development business in the City of Windsor, primarily through the auspices of R.C. Pruefer Co. Limited (Pruefer), a company controlled by him. Pruefer was responsible for the development of the Windsor City Centre project in the late 1970s and early 1980s. In 1990, it successfully bid on the development of the City of Windsor Multi-Use Facility Project. The organization of such a project was through a partnership. Mr. Docherty and Mr. Hakem, the second Appellant, whose appeals were heard on common evidence, were partners in the Windsor Multi-Use Facility Project Partnership (the "Partnership"). From 1990 to 1995, the Partnership recorded expenses in connection with the project being fees billed by Pruefer in excess of $11 million (the "Expenses"). The project has yet to be developed. The substance of this case is the partner's ability to deduct such expenses; in Mr. Hakem's case, from 1990 to 1996; and in Mr. Docherty's case for 1993 only, as it was conceded by Mr. Docherty that no appeal was available against the nil assessments of 1992, 1994 and 1995.
[2] The issues in these appeals are:
(a) Were Mr. Docherty and Mr. Hakem limited partners in the Partnership in the years at issue, and, therefore, subject to the at-risk rules set out in section 96 of the Income Tax Act (the Act) limiting the deductibility of losses?
(b) Were the Expenses reasonable?
(c) Were the Expenses contingent and, therefore, not deductible in accordance with paragraph 18(1)(e) of the Act?
(d) Were the Expenses incurred for the purposes of gaining or producing income and, therefore, deductible in accordance with paragraph 18(1)(a) of the Act?
[3] I find that Mr. Docherty and Mr. Hakem were limited partners for the pertinent years. While that conclusion is a complete answer in dismissing the Appellants' appeals, in the event I am wrong in that conclusion, I will comment upon the reasonableness of the Expenses. It will be unnecessary to address the other issues.
Facts
[4] I will first review the facts surrounding the Partnership arrangements and then turn to the circumstances of the Windsor Multi-Use Facility Project.
Partnership arrangement
[5] By agreement dated June 14, 1989, [1] Pruefer entered into a Partnership Agreement with Mr. Docherty, to carry on business under the name of the Windsor Multi-Use Facility. According to the Agreement, the Partnership was to be converted to a limited partnership sometime in the future. On the same day, the Partnership entered into an agreement with Pruefer pursuant to which Pruefer was to develop, negotiate and represent all things necessary to enable the Partnership to develop a multi-purpose facility in the City of Windsor. This Agreement stated that the management fees were to be calculated as follows:
As at the fiscal year end of the partnership, the partners will review the performance of R.C. Pruefer Co. Limited and determine a reasonable management fee for the above noted services based on R.C. Pruefer's performance.
[6] A document entitled "Founders Limited Partnership", dated December 4, 1990, was issued by Mr. Docherty to attract investors for the multi-use facility undertaking. Investors were offered the opportunity to buy an investment unit for $400,000 with $100,000 cash down and the balance to be paid in $15,000 instalments over a number of years, according to the terms as set out in the limited partnership agreement.
[7] On December 3, 1990, a Limited Partnership Agreement[2] was entered into between Mr. Docherty, as the Initial Limited Partner and Windsor Multi-Use Facility General Partner Inc. ("General Partner"), all the shares of which were owned by Mr. Docherty. The Agreement stated that the Partnership was constituted as a limited partnership pursuant to the Limited Partnerships Act (Ontario) to carry on business under the name Windsor Multi-Use Facility. The Partnership was to issue units to investors for the purpose of raising capital of the Partnership to be invested in the business of the Windsor Multi-Use Facility. The business of the Partnership was defined to be the development and operation of the multi-use facility. Mr. Docherty was issued an initial limited partnership unit which was redeemable at any time for one dollar.
[8] The sale of the Partnership units was to be through an Offering Memorandum. The funds realized through the sale of units were to be used to repay costs incurred to date in the development of the multi-use facility and to further the development of the Facility. The Agreement authorized the issuance of up to 15 units. At all relevant times, Mr. Docherty was director, president and secretary of the General Partner.
[9] On December 4, 1990, in a Confidential Private Placement Offering Memorandum,[3] the Limited Partnership of December 3, 1990 was stated to be formed for the purpose of taking on an assignment of the rights of Pruefer under its proposal with the City of Windsor for a multi-use facility, earning income from the operation thereof and maintaining limited liability. A minimum of eight and a maximum number of 15 limited partnership units were to be sold for $400,000 each. The limited partnership units were payable as follows: (i) an initial deposit of $100,000 upon subscription; (ii) the balance of $300,000 payable by execution of a subscription balance note with $15,000 payments on December 31, 1991 and on December 31 of each year to and including December 31, 2000; and the final $150,000 payable in $15,000 (plus interest) payments paid out of the partners' shares of net income for each fiscal year; if their shares of net income was less than $15,000, the shortfall would accumulate and payment would be deferred until the next fiscal year.
[10] The Offering Memorandum provided that the aggregate subscription proceeds were to be used to pay: $855,000 for costs for site investigations, marketing surveys, feasibility studies, and representations to the City of Windsor; $312,000 for professional fees and $175,000 for a management fee to Pruefer for a total amount of $1,342,000. The Offering Memorandum also provided that the Limited Partnership would enter into a management agreement with Pruefer for the management of the Facility throughout the term of the sublease. The Partnership was to review and determine the acceptability of the fee charged by Pruefer. Mr. Menzies, Pruefer's accountant, indicated that he inserted this requirement as he saw 'lawsuit' written all over, as he put it, and wanted to ensure that the partners had a say.
[11] On December 13, 1990, and December 18, 1990, Michael Ziter and Ronald Hakem, respectively, each acquired one limited partnership unit. They each paid the initial cash contribution of $100,000. Mr. Hakem testified that he invested out of a sense of civic pride, as well as what he perceived to be a reasonable rate of return and an opportunity to take advantage of a tax shelter in the early stages. He believed the projections were achievable. He also indicated there were no freebies in the deal for investors, no free tickets, no guarantees or warranties.
[12] The Limited Partnership Agreement of December 3, 1990, was amended as of December 28, 1990. The Agreement now provided for "General Partners" Class A, B and C. Mr. Docherty offered little explanation for the change, indicating only that it was done in consultation with Mr. Menzies, who drafted the amended agreement. Mr. Hakem stated that the change was made upon advice from his lawyer and tax accountant. He recognized the risk of liability in becoming a general partner, but felt he could rely on Mr. Docherty's track record. Under this amending agreement, initial cash contributions of $100,000 remained the same for a Class B or C unit holder. However, the balance of the subscription price was now to be payable together with interest out of the unit holders share of net income for each year when net income had been calculated by the General Partner. Mr. Menzies explained the general partner units were identical, and only distinguished by letter to know in which year units were acquired; that is, a different class for each different year. An identical provision was inserted for each of the Class A, B and C, General Partners as follows:[4]
7.1 Rights, Power and Authority
The General Partners Class A shall have only the rights expressly stated in this Agreement to affect the Partnership's structure and its affairs. The General Partners Class A shall have no right, power or authority to act for or on behalf of the Partnership or to bind the Partnership and, except for the exercise of the voting and approval rights expressly granted to the General Partners Class A under this Agreement, shall not interfere or take part in the conduct or control of the Partnership's business. The General Partners Class A shall be personally liable and bound by any debt, liability or obligation of the Partnership. The General Partners Class A may advance or lend money to the Partnership or transact other business with the Partnership. The rights and liabilities of the General Partner Class A transacting business with the Partnership shall be as provided in the Partnership Act (Ontario).
[13] The Amending Agreement of December 28, 1990, also contained a new provision with respect to the cash required to finance the operations of the Windsor Multi-Use Facility. Specifically, to the extent that the cash required was not available out of revenues, cash contributions were to be raised from the General Partners Classes A, B and C except for the first 15 years where Pruefer would advance on behalf of the General Partners Classes B and C the amounts they would otherwise be obligated to make. Pruefer would only be entitled to recover the amounts out of any monies to which the General Partners Classes A and B would otherwise be entitled from the business operations without interest. After the 15 years, Pruefer's right to recover any amounts advanced would expire. Given the significance of this provision it is worthwhile repeating it in its entirety:[5]
3.13 Cash Required
The cash required to finance the operations of the Windsor Multi-Use Facility to the extent that it is not available out of revenues shall be raised by cash contributions from the General Partners Class A, General Partners Class B and General Partners Class C in proportion to their respective interests as General Partners Class A, General Partners Class B and General Partners Class C except during the period expiring fifteen (15) years from the date of closing, R.C. Pruefer Co. Limited shall advance on behalf of the General Partners Class B and General Partners Class C the cash contributions which the General Partners Class B and General Partners Class C would otherwise be obligated to make and R.C. Pruefer Co. Limited thereafter be entitled to recover the amounts out of any monies to which the General Partners Class B and General Partner Class C would otherwise be entitled from the business operations without interest. After the said fifteen (15) year period R.C. Pruefer's right to recover any amounts advanced by it on behalf of the General Partners Class B and General Partners Class C shall expire and thereafter the General Partners Class B and General Partners Class C shall be liable to pay for their share of all cash deficiencies, R.C. Pruefer Co. Limited shall no longer have any right to recover the amounts previously advanced from the General Partners Class B and General Partners Class C. Subject to the aforesaid, each General Partner Class B's and General Partners Class C's share of any deficiency shall be due and payable thirty (30) days after demand therefore by the manager acting as agent for all Partners.
Mr. Menzies explained this was inserted to ensure the Partners were liable for operational losses.
[14] A further provision was inserted requiring that the General Partner could be removed, if in default, by a special resolution of the Partnership but only if all amounts owing by the Partnership to the former General Partner had been paid in full.
[15] By Agreement dated December 28, 1990, Mr. Hakem disposed of the limited partnership unit acquired by him on December 18, 1990, in consideration of the issuance to him of a Class B unit with the same capital value as the limited partnership unit. Mr. Ziter did likewise. Mr. Docherty retained his initial limited partnership unit. The Partnership records were somewhat confusing as to Mr. Hakem's unit holdings, at one point indicating that he held three units. Mr. Hakem, however, was adamant that he ultimately only held one and one-half units; the unit acquired in December 1990, and a one-half interest in a unit the following year.
[16] The Partnership Agreement of late December 1990 was further amended November 28, 1991 again signed solely by Mr. Docherty on behalf of all parties. Mr. Docherty could not recall the reason for this amendment. Paragraph 3.13 was amended to do away with the expiration of the General Partners Class B and Class C obligation to cover operational losses after 15 years. In its stead the provision now provided that the General Partners would remain liable. The amended portion read as follows:[6]
... After the said fifteen (15) year period, the General Partners Class B and General Partners Class C shall be liable to pay for their share of all accumulated net losses and each General Partner Class B's and General Partners Class C's share of any subsequent net loss shall be due and payable one hundred and twenty (120) days after demand by the General Partner acting as agent for all Partners and R.C. Pruefer Co. Limited shall have the right to recover all amounts advanced, prior to and subsequent to the said fifteen (15) year period, from the General Partners Class B and General Partners Class C pursuant to 3.7 above from the business operations with simple interest at prime charged by the Main Branch of the Canadian Imperial Bank of Commerce.
[17] In 1991, four and a quarter more units were sold in the Partnership. The Ronald Hakem Trust, in which Mr. Hakem was a 50 per cent beneficiary, acquired one unit. The Michael Ziter Trust, in which Michael Ziter was a 50 per cent beneficiary, also acquired one unit. All the units acquired in 1991 were registered as Class C units. The face value of the units totalled $1.7 million. The cash contributed in respect thereto in 1991 was $170,000.
[18] On October 1, 1992, the Limited Partnership Agreement was further amended and restated, though no signed copy was produced at trial. It provided:
(i) Pruefer was now named as a party to the Agreement together with the General Partner, Mr. Docherty as the initial limited party, any existing limited partners and those partners holding Classes B and C units. Pruefer was to be issued a Class A Partnership interest in consideration of certain capital contributions;
(ii) the parties agreed to carry on a limited partnership, the business of the Partnership being the development and operation of the Multi-Use Facility;
(iii) the funds realized through the sale of the units were to be used to repay costs incurred in the development of the Facility and to further the development of the Facility;
(iv) net losses of the Partnership were to be determined by the General Partner and allocated to each partner on the basis of his contributions provided that in the first fiscal year in which a Class C unit has been issued, for the purpose of allocating the loss, the capital contribution of such a partner was to be multiplied by a factor of 2.7 - that is the loss otherwise to be allocated would be increased by a factor of 2.7;
(v) the Agreement also contained the same provision relating to the cash requirements of the Class B and Class C unit holders to finance the operations of the Facility and the liability of Pruefer in respect thereto as was in the December 28, 1990 version of the Partnership Agreement; that is, the Classes B and C unit holders' obligation in that regard expires after 15 years; and
(v) the Classes B and C unit holders were not to interfere or take part in the conduct or control of the Partnership's business.
[19] An Offering Memorandum was also issued on October 1, 1992. The Memorandum provided for a maximum of five limited partnership units and also for a maximum aggregate of 20 Classes A, B and C Partnership units for a subscription price of $400,000 for each limited partnership unit and for each Class C unit, with payment terms almost identical to those set out in paragraph 9 hereof for limited partnership units. The price per unit for each Class A and B Partnership unit was to now be determined by the General Partner and was to be payable in accordance with the terms of a subscription balance note. The note provided that the amount determined by the General Partner and set out in the note, together with interest thereon, was to be paid out of the partner's share of net income. If the partner's share of net income was less than the amount determined by the General Partner plus accrued interest, then payment would be deferred until the next fiscal year and so on from time to time for each fiscal year.
[20] The Offering Memorandum of October 1992 also provided that the aggregate subscription proceeds were to be used to pay the administration and development costs incurred by the Partnership for site investigations, marketing surveys, feasibility studies, and representations to the City of Windsor and the Province of Ontario, professional fees and management fees incurred to date and to further the purposes of the Partnership. It also provided that the Limited Partnership would enter into a management agreement with Pruefer for the management of the Facility throughout the term of the sublease. The Offering Memorandum highlighted that pursuant to a Lease Agreement with the City, Pruefer had been granted until January 31, 1993 to satisfy the City of Windsor with respect to the raising of the necessary financing for the project.
[21] In 1992, the financial statements of the Partnership disclosed that 13 more Class C units were sold, with a total face value of $5,200,000. Cash contributions in the year were approximately $1,750,000.
[22] In summary, the history of the Class B and Class C units acquired in the Partnership is as follows:
Tax Year
1990
1991
1992
1995
No. of Units Acquired
2
4.25
13.25
Cumulative total
2
6.25
19.5
19.5
Subscription price (cumulative total)
800,000
2,500,000
7,700,000
7,7000,00
Cash Paid
(cumulative total)
200,000
370,000
2,329,000
2,600,00 (approx.)
Amount outstanding
600,000
2,130,000
5,371,000
5,772,112 (including interest)
[23] Mr. Hakem paid the following to the Partnership:[7]
Year
Cash Paid
Loss Claimed
1990
100,000
250,000
1991
65,000
215,000
1992
22,500
138,885
1993
22,500
135,724
1994
22,500
92,249
1995
5,625
62,461
$238,125
$894,319
[24] Mr. Docherty paid the following to the Partnership:
Year
Amount Paid
Loss Claimed
1992
80,000
203,513
1993
74,457
1994
49,200
1995
12,000
33,313
1996
24,000
116,000
354,179
[25] On February 6, 1996, the Limited Partnership Agreement was further amended by replacing paragraph 3.13 with the following provision:[8]
e) Paragraph 3.13 of the Limited Partnership Agreement is amended by deleting the same and substituting the following:
"Cash Required"
The cash required to finance the operations of the Partnership to the extent that it is not available out of revenues shall be raised by cash contributions from the General Partners Class A, General Partners Class B and General Partners Class C in proportion to their respective interests as General Partners Class A, General Partners Class B and General Partners Class C except during the period expiring fifteen (15) years from the date of closing, R.C. Pruefer Co. Limited shall advance on behalf of the General Partners Class B and General Partners Class B and General Partners Class C would otherwise be obligated to make and R.C. Pruefer thereafter be entitled to recover the amounts of such advances out of any monies to which the General Partners Class B and General partner Class C would otherwise be entitled from the business operations without interest.
[26] I shall now turn to the activities in which the Partnership and more specifically, Mr. Docherty, through the auspices of Pruefer, were engaged in developing the Multi-Use Facility Project.
Development of the Multi-Use Facility Project
[27] Mr. Docherty controls Pruefer. In 1979, Pruefer successfully bid on a project in Windsor known as the City Centre Project. This project consisted of the riverfront development of three hotels, a commercial podium and a nine-floor parking garage. The project extended back three blocks from the riverfront. Bridges connected the hotels to the parking. Mr. Docherty was able to attract The Hilton as one of the hotels.
[28] In the late 1980s, Mr. Docherty was approached by the City of Windsor City Manager for assistance in acquiring downtown property for further redevelopment, specifically the development of a multi-use facility. Pruefer was able to acquire the land and pass it on to the City. The City acquired the bulk of the land for redevelopment by expropriation at a cost of approximately $8 million. The City sought proposals for the Multi-Use Facility Project in late 1989. Pruefer submitted a proposal hoping to tie in with the existing City Centre Project.
[29] The City ultimately decided to pursue that proposal with Pruefer. During the 1990s, serious negotiations were ongoing between Pruefer and Windsor to develop a mutually agreeable proposal. On November 20, 1990, City Council enacted a Resolution approving the Pruefer proposal. In the fall of 1990, Mr. Docherty had submitted a draft Memorandum of Agreement in Principle to the City which was approved on December 21, 1990. The Agreement covered the following:
i. Pruefer would construct the Multi-Use Facility with no cost to the City and would obtain a 30-year lease on the building with a rent of $1.00 per year;
ii. the City would be required to go to the Ontario legislature for a special Private Act to provide a land tax exemption for the property as well as permission for the less than market value rent proposal;
iii. after 30 years the ownership of the Multiplex would revert back to the city but in the interim a trust fund would be created to ensure the proper maintenance of the complex;
iv. Pruefer would be able to encumber its leasehold interest up to $25 million with the added right to encumber chattels and equipment up to $2.5 million;
v. a ticket surcharge for facility events would fund ongoing upkeep of the facility (the "enhancement fund"); and
vi. Agreements with the City, including a commercial ground lease, were to follow. The implementation of the Memorandum and its major components was to be in 3 phases, namely (a) the Conditions Precedent Phase, (b) the Construction Phase, and (c) the Lease Phase.
[30] Over the next two years, Pruefer proceeded to obtain the necessary legislative amendment from the Ontario government. Pruefer also conducted its own market surveys and feasibility studies to determine the economic viability of the project. Cash flow and revenue projections were based on the venue accommodating hockey, boxing, concerts, bingos, conventions and trade shows, estimating annual revenues of approximately $59.5 million with net profit of $6.5 million. Critical to the success of the project was the ability to lease property at a nominal amount, to exempt the property from certain municipal taxes and to maintain an enhancement fund from revenues of the project to keep the facility in constant repair. Mr. Docherty's efforts through Pruefer accomplished all of these objectives.
[31] By 1992, Mr. Docherty realized the project required greater economic strength, and he hatched the idea of including a casino in the project. The casino was to be owned and operated by the Province of Ontario. On March 24, 1992, City Council passed Resolution 282/92, which endorsed the concept of a casino and supported Pruefer's petition to the Province of Ontario to secure approval for the location of a casino in the City of Windsor on the Multi-Use site.
[32] Mr. Docherty spoke to Bitove, an organization which provided food services to the SkyDome in Toronto and obtained a commitment of financial support from them. Mr. Hawkins, who was with Bitove at the time, testified that the project had appeal, that the projections he saw from Mr. Docherty were conservative, and that the nominal rent and tax abatement were critical to the viability of the project. He acknowledged that the tax and rent concession might be valued at approximately $20 million. Discussions between Mr. Docherty and Bitove culminated in a Memorandum of Understanding dated December 16, 1992 setting out the arrangements by which Bitove would lease and operate the premises. This Memorandum of Understanding constituted a form of agreement of cooperation. As the facility did not proceed, there was no further involvement by Bitove.
[33] Mr. Docherty had a study done by academics endorsing the casino project, which appears to have satisfied the City of the merits. A casino committee was established with some high profile respectable community members from labour, business, university and the City. The Government of Ontario did approve downtown Windsor as the site of a pilot casino plan in October 1992, though not specifically the Multi-Use site proposed by Pruefer. The City then proceeded to rescind Resolution 282/92 in October 1992.
[34] On September 21, 1992, Pruefer and the City of Windsor entered a "Ground Lease Agreement"[9] in which certain conditions precedent were to be met prior to January 31, 1993, failing which the lease would be void ab initio. Two of the conditions were:[10]
(i) The Landlord shall have validly and finally passed a by-law or by-laws pursuant to the City of Windsor Act, 1991, S.O. 1991, chap. Pr28
(a) authorizing the entering into of the lease of the Site herein at less than fair market value as contemplated by Section 1(a) of said Act;
(b) exempting the Site from all taxes for municipal or school purposes as contemplated by Section 1(b) of said Act; and
(c) authorizing establishment of the Enhancement Fund as contemplated by Section 2 of said Act;
(ii) The Tenant shall have provided full disclosure to the Landlord of the firm financing commitments and arrangements procured by the Tenant relative to the construction of the Facility and associated improvement of the Site, and all such financing commitments and arrangements with respect to the Project shall have been approved by the Landlord, which approval may be withheld by the Landlord in its absolute and unfettered discretion;
[35] Mr. Docherty assisted the City in finalizing the use of the existing Art Gallery as a temporary site for a casino from June 1994 for a four-year period. In July 1993, the City of Windsor granted an extension to Pruefer to meet the conditions set out in the 30-year lease. The extension was until 30 days after cessation of use of the Art Gallery as an interim casino. The Gallery was used for over four years as a casino. The City later rescinded this extension on August 3, 1993, shortly after the commencement of a lawsuit in which Pruefer and the Partnership brought action against the City of Windsor for specific performance of the lease or, in the alternative, damages of $100 million. Pruefer and the Partnership ultimately were not successful with this lawsuit, judgment being rendered in January 1996.
[36] As well as securing the nominal rent, the tax exemption and the go-ahead for a Windsor casino, Mr. Docherty was also active in assisting the City of Windsor obtain all the necessary real estate for the Project. This involved acting as intermediary for the City in acquiring the McLean property as well as some Holiday Inn property. He also attempted to obtain certain Canadian Tire property though that property deal never concluded.
[37] Apart from pursuing the lawsuit from 1993 to 1996, there was little evidence of other activity in connection with the Multi-Use Facility Project until 1997. Minutes of a Partnership meeting dated April 7, 1994, indicated an interest in pursuing positions in other projects adjacent to the multi-use site though no other evidence was presented suggesting this was pursued further.
[38] In late 1996 or early 1997, Mr. Docherty was in contact with JEBB Corporation (JEBB), an organization seeking to become an integral part of the Western Super Anchor proposal. This was the name given to the successor to the multi-use facility proposal. Mr. Docherty provided JEBB with significant assistance in the form of their previous proposal on the multi-use facility, including the basic proposal documents, projections, development of the lease and hotel development. Mr. Docherty also introduced JEBB to Pruefer's former architects, Rosetti Associates. A comparison of the original Windsor Multi-Use Facility proposal put forth by Mr. Docherty's group, and the JEBB proposal ultimately submitted in February 1998 shows some similarities. JEBB indicated in a letter to Mr. Docherty on October 6, 1997, that:[11]
... in consideration of your group's assistance, JEBB will make available to your group a small percentage of the equity investment in the project. The specific terms have not yet been reached. We would expect that the equity investment of your group to be in the range of 5%, ...
Mr. David Batten, from JEBB, testified that he understood the Partnership would receive a five per cent equity interest if the project proceeded. Mr. Batten also highlighted the importance of the low rent and tax-exempt status for the project. To date the JEBB proposal has not proceeded.
[39] On January 9, 1997, a Partnership meeting was held during which it was resolved that the Multi-Use site be re-conveyed to the City of Windsor.
[40] The fees billed by Pruefer to the Partnership from 1990 to 1995 inclusive are summarized as follows:[12]
EXPENSE
1990
1991
1992
1993
1994
1995
Multi-Use Facility Commencement
855,000
1,500,000
1,600,000
1,053,713
661,693
785,120
Professional fees
312,000
650,000
270,000
16,464
Casino Commencement
1,875,305
810,000
522,172
Management fees
175,000
________
_________
________
________
_______
Total fees
1,342,000
1,500,000
4,125,312
2,133,826
1,183,865
801,584
Owing to Pruefer at Year End
1,142,000
2,472,000
5,247,989
7,365,958
7,158,663
8,239,633
[41] Mr. Docherty described commencement costs as hard items such as those reflected in a 1990 Pruefer invoice identifying site investigation, market surveys, feasibility studies, management meetings, meetings with Windsor Utilities, lease negotiations and preparation of revenue statements. These expenses were incurred primarily in-house at Pruefer; there was no evidence of these expenses being incurred by anyone other than Pruefer. In an internal summary of the 1990 expenses, the $855,000 commencement costs for 1990 were simply described as general overhead. On a December 7, 1990, invoice, the fee of $175,000, which Mr. Docherty referred to as a management fee, was called administrative overhead costs and further outlined financing inquiries, meetings with architects, employees, surveyors and booking agents, preparing bid, visits to other arenas and primary negotiations with the Province of Ontario. On the accountants' internal summary of expenses this $175,000 was referred to as "markup".
[42] The 1991 fee of $1.5 million was invoiced by Pruefer to the Partnership simply as management fees, as was the 1992 invoice, though the parties agreed this was broken down into commencement costs, professional fees and casino commencement costs as set forth above.
[43] Mr. Docherty explained that the appropriate fees were determined by himself and his accountant, Mr. Alexander Menzies, once per year, primarily based on time spent on a project. Mr. Menzies described this more as a matter of Mr. Docherty setting the fee, and then Mr. Menzies determining from an accountant perspective whether the fee was plausible.
[44] This requires further explanation, and I will use the 1993 fee of $2,133,826 as an example. For 1993, Mr. Menzies went over an internal working paper, which illustrated the process he used in determining reasonableness. It was clear that Mr. Docherty told him he wished to bill $1.8 million. To be consistent with prior years, Mr. Menzies simply apportioned the $1.8 million amongst Multi-Use commencement costs (40 per cent - $720,000), casino commencement costs (45 per cent - $810,000) and professional marketing costs (15 per cent - $270,000). To justify the $1.8 million, Mr. Menzies started by determining all of Pruefer's real costs for the calendar year. As Pruefer worked on a March 31 year-end, this required some pro-rating from one year to the next. Mr. Menzies relied on three major heads of expenses in Pruefer: apartment managers, general and administrative, and interest. Pruefer did carry on some other ongoing business such as property management for 1993. Mr. Menzies arrived at a total of expenses for Pruefer of $1.277 million. He then allocated that amount amongst Pruefer various activities, alloting a 46 per cent share to the Multi-Use Project. This allotment appears to have been done on a time spent basis. The 46 per cent of Pruefer's $1.277 million costs attributable to Multi-Use was $581,000. Then, the final step was to markup that $581,000 to reflect what Mr. Menzies believed, based on a course taken some years earlier, would be a reasonable profit margin of 50 to 60 per cent. To be clear, this meant that if a 50 per cent profit margin was sought, the cost would be doubled. In 1993, to achieve the $1.8 million fee desired by Mr. Docherty, the $581,000 was marked up by a factor of 3 to 1 (i.e. tripled), a profit margin of approximately 68 per cent. In reviewing the 1993 unaudited financial statements for the Partnership, the $810,000 casino commencement cost and the $270,000 professional and marketing costs appear on the statement, but the $720,000 multiple use commencement costs is shown as $1,053,713. Mr. Menzies could not account for the additional $333,713. He confirmed that he would have gone though a similar process for the other years in issue in establishing the appropriate fee. With respect to the 1994 fees, Mr. Menzies indicated they would have related primarily to the lawsuit.
[45] Mr. Docherty testified that in the years in question all of his time was spent on the Multi-Use Facility Project. He also indicated that in the later years of the project, he received input from a couple of other Pruefer employees in the determination, with Mr. Menzies, of an appropriate fee. The annual fee was to be approved by the Partnership, though the December 31, 1990 approval was contained in minutes of a meeting in which only Mr. Docherty was present, acting on behalf of the General Partner, the Limited Partners and the holders of Class A and Class B general partner units. Indeed, all minutes tendered as evidence up to September 1991 were signed solely by Mr. Docherty.
[46] While there was no documented evidence of specific Partnership approval of Expenses for 1992, 1993, 1994 and 1995, Mr. Hakem testified that the partners would review and approve financial statements, which contained Pruefer's fee, as it was indeed the only Partnership expense. Minutes of the meeting of the Partnership of April 7, 1994, signed by Mr. Docherty as chairman, evidence the approval of the 1992 and 1993 financial statements. Unsigned minutes of a February 7, 1996, Partnership meeting indicate approval of the 1995 financial statements.
[47] From its perspective, Pruefer reported the amounts billed by it to the Partnership in its own financial statements for the relevant period but also:
- as a Class A partner in the Partnership, had losses allocated to it from the Partnership (occasioned by its own billings to the Partnership) in 1990 and 1991 (approximately $791,100 and $410,000 respectively);
- claimed doubtful or bad debts ($1,220,000 and $3,839,941) with respect to its billings to the Partnership for its 1992 and 1993 taxation years yet continued to bill substantial amounts in subsequent years;
- reflected in its GST recordings, a write-off of its billings to the Partnership for 1992 and 1993; and
- made negative adjustments in its accounts with respect to subsequent billings to the Partnership.
[48] In a Notice of Objection dated June 1996, filed by Pruefer concerning a GST assessment in regards to the Windsor Multi-Use Facility, Pruefer stated:
In respect of each of the projects the taxpayer has made a taxable supply for consideration to a person with whom the taxpayer was dealing at arm's length and in each case the taxpayer has determined that the indebtedness of that party was not collectible and was a bad debt.
[49] Pruefer made no efforts to collect from the Partnership or the Partners any debt outstanding. Mr. Hakem did confirm that he considered the debt to Pruefer still outstanding. Mr. Docherty suggested he would have talked to the partners but they must not have had the money to pay Pruefer.
Analysis
(a) Were Mr. Docherty and Mr. Hakem limited partners in the Partnership in the years at issue and, therefore, subject to the at-risk rule set out in section 96 of the Act, limiting the deductibility of losses?
[50] The relevant legislation is as follows:
96(2.1) Notwithstanding subsection (1), where a taxpayer is, at any time in a taxation year, a limited partner o