2001 Ruling 2000-0062843 - LIMITED PARTNERSHIP; REORG; CAPITAL GAINS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues
1. Whether Partnership can be purified before 85(2) transfer

2. Whether 40(3.13) will apply to deny basis bump.

3. Whether 110.6(14(f) applies

4. Whether paragraph provisions of para (c) in definition QSBCS in 110.6(1) are satisfied.

Position:

1. Yes, provided non-resident partners do not intend participate in the business in the future

2. No.

3. No.

4. Yes.

Reasons:

1. No restriction in 85(2) and non-residents will not benefit from 85(2) transfer rules
2. 40(3.16)(d)
3. 110.6(14)(f)(ii)(A)
4. Although for a brief time General Partner will be the sole owner of Newco share and the Limited Partnership assets will not yet have been transferred to Newco, paragraph (c) use test is with respect to the time when Individual Limited Partner (who is disposing of a share) and Limited Partnership, not the General Partner (who cannot benefit from QSBCS deduction in 110.6), owned the share

XXXXXXXXXX 2000-006284

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

RE: XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling. We also acknowledge your subsequent correspondence and telephone calls.

To the best of your knowledge and that of the taxpayers involved in this ruling request, none of the issues contained herein is:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of one or any of the taxpayers or a related person;

(iii) under objection by one or any of the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "Adjusted Cost Base ("ACB") of a Partnership Interest" has the meaning assigned in section 54 and as modified by paragraphs 53(1)(e) and 53(2)(c) of the Act;

(c) "Canadian Partnership" has the meaning assigned in subsection 102(1) of the Act;

(d) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7) of the Act;

(e) "CCRA" means the Canada Customs and Revenue Agency;

(f) "Company Act" means the XXXXXXXXXX;

(g) "General Partner" of the Limited Partnership is XXXXXXXXXX. General Partner is related to the Principal;

(h) "General Partnership Unit" means the interest of General Partner in the Limited Partnership;

(i) XXXXXXXXXX;

(j) Individual" has the meaning assigned in subsection 248(1) of the Act;

(k) "Individual Limited Partner" means any Limited Partner who is an individual. None of the Individual Limited Partners are related to the General Partner or will be related to PurchaseCo;

(l) "Limited Partners" mean the Taxpayers, other than General Partner;

(m) "Limited Partnership" means the existing Limited Partnership, known as XXXXXXXXXX. This partnership name is registered pursuant to the laws of the Province;

(n) "Limited Partnership Agreement" means XXXXXXXXXX;

(o) "Limited Partnership Assets" means assets of the Limited Partnership that are described in subsection 85(2) of the Act, including inventory, land, building, and furniture and fixtures, and does not include "Limited Partnership Other Assets";

(p) "Limited Partnership Other Assets" means assets of the Limited Partnership, other than Limited Partnership Assets, and including cash and investments, receivables, prepaids, property taxes paid in advance and deferred financing fees;

(q) "Limited Partnership Unit" means an interest of a Limited Partner in the Limited Partnership. There are XXXXXXXXXX Limited Partnership Units;

(r) "Newco" means a new company to be incorporated pursuant to the laws of the Province. Newco will be a CCPC and a TCC;

(s) "Partner(s)" means one or more Limited Partners or the General Partner or a combination of the two;

(t) "Principal" is XXXXXXXXXX, an individual resident in Canada;

(u) "Province" means the Province of XXXXXXXXXX;

(v) "PurchaseCo" means a CCPC that will be incorporated under the Company Act. All the issued shares of the capital stock of PurchaseCo will be directly or indirectly owned by the Principal or persons related to the Principal. PurchaseCo will be related to the General Partner;

(w) "Qualified Small Business Corporation Share" ("QSBCS") has the meaning assigned by subsection 110.6(1) of the Act;

(x) "Related Limited Partner" means XXXXXXXXXX, a Limited Partner related to General Partner and PurchaseCo;

(y) "Related persons" has the meaning assigned in subsection 251(2) of the Act;

(z) "Small Business Corporation" ("SBC") has the meaning assigned by subsection 248(1) of the Act;

(aa) "Specified Investment Business" ("SIB") has the meaning assigned by subsection 125(7) of the Act;

(bb) "Specified Member" of a partnership has the meaning assigned by subsection 248(1) of the Act;

(cc) "Taxable Canadian Corporation" ("TCC") has the meaning assigned by subsection 89(1) of the Act; and

(dd) "Taxpayers" means individuals and corporations listed in Appendix A, all of whom have an interest in Limited Partnership.

Our understanding of the relevant facts, proposed transactions and purposes of the proposed transactions is as follows:

FACTS

1. The Limited Partnership is a partnership of, XXXXXXXXXX Limited Partners and one General Partner. As detailed in Annex A, the Taxpayers are composed of corporations and individuals. Attached Annex B details Partners who are Related Persons. Limited Partnership is a Canadian Partnership and will remain so until it is wound-up.

During the year XXXXXXXXXX , Related Limited Partner has purchased XXXXXXXXXX Limited Partnership Units from Limited Partners. It is anticipated that additional Limited Partnership Units will be purchased from unrelated Limited Partners by PurchaseCo up to the commencement date of the proposed transactions.

2. The Limited Partnership was formed in XXXXXXXXXX . Initial Limited Partner contributions for XXXXXXXXXX units totaled $XXXXXXXXXX. Since this time, the aggregate of accumulated losses for income tax purposes sustained by the Limited Partnership and the cash distributions provided to its Limited Partners and General Partner is in excess of the initial capital contributions of $XXXXXXXXXX. As at XXXXXXXXXX, a typical Limited Partner who has held his or her interest since the initial subscription would have a negative ACB of $XXXXXXXXXX per Limited Partnership unit and the General Partner has a negative ACB of $XXXXXXXXXX.

3. Limited Partnership has carried on an active business of XXXXXXXXXX. Limited Partnership employs substantially more than five full-time employees XXXXXXXXXX. In addition to the basic services that relate to XXXXXXXXXX as described in paragraph 5 of Interpretation Bulletin IT-434R, Limited Partnership provides, inter alia, extra services such as XXXXXXXXXX.

4. General Partner is not a Specified Member of Limited Partnership.

5. The only changes to the debt structure of Limited Partnership since the XXXXXXXXXX has been the periodic renegotiation and renewal of its long-term debt obligations with various lenders. Throughout the period beginning XXXXXXXXXX and ending immediately before the winding-up of Limited Partnership there has not been and will not be any substantial increase in the indebtedness of Limited Partnership. The long-term debt outstanding as of XXXXXXXXXX and the amount that was outstanding as of XXXXXXXXXX is $XXXXXXXXXX.

6. At the XXXXXXXXXX meeting of the Limited Partnership, a Resolution was passed to undertake this series of transactions being proposed herein subject to the receipt of a favourable Advance Income Tax Ruling. Of a total of XXXXXXXXXX issued and outstanding Limited Partnership units, XXXXXXXXXX voted in favour of these transactions. At the time of the vote, Limited Partners that are related to General Partner owned XXXXXXXXXX Limited Partnership Units. Accordingly, removing the related party votes in favour of the transactions, XXXXXXXXXX voted in favour of the transactions. Limited Partners that are related to General Partner currently own XXXXXXXXXX Limited Partnership Units.

At the same meeting, consensus was achieved on the consideration that the Limited Partners will receive for the disposition of their Limited Partnership Units. Prior to this meeting, the value of a Limited Partnership Unit was determined using a liquidation approach. XXXXXXXXXX The results of these calculations has determined that the fair market value of a Limited Partnership Unit immediately before the transfer of assets to Newco described in paragraph 17 below and the contribution of capital described in paragraph 10 below will be $XXXXXXXXXX.

7. In XXXXXXXXXX non-resident Limited Partners (listed in Appendix C), who are not related to the Principal or the General Partner sold their Limited Partnership Units to a company related to the General Partner for a mutually agreed upon selling price. These Limited Partnership Units were purchased from these non-resident Limited Partners to facilitate the Proposed Transactions described below.

8. All Limited Partners hold their Limited Partnership Units as capital property.

9. The most recent audited financial statements for the Limited Partnership are for the year ended XXXXXXXXXX.

PROPOSED TRANSACTIONS

10. XXXXXXXXXX of the Limited Partnership Agreement will be amended to allow a capital contribution by the Partners without the issuance of additional Limited Partnership Units.

XXXXXXXXXX of the Limited Partnership Agreement will also be amended to allow for the allocation of the proceeds of disposition (shares of Newco) and any gain or loss on the transfers described in paragraph 17 below to take into consideration the contribution of capital by the Partners contemplated in paragraph 13 below.

11. PurchaseCo will loan to the General Partner and Individual Limited Partners who so choose (a "Debtor"), on a non-interest bearing basis, an amount of cash approximately equal to their negative ACBs. The aggregate negative ACB of the Limited Partners and General Partner is approximately $XXXXXXXXXX. These loans from PurchaseCo to Individual Limited Partners will be evidenced by demand promissory notes where recourse to PurchaseCo on default by a Debtor is limited to that Debtor's Limited Partnership Units or the shares of Newco that the Debtor will receive on the winding-up of the Limited Partnership.

Related Limited Partner will not receive a loan from PurchaseCo as the ACB of its Limited Partnership Unit is not expected to be negative at the time when the proposed transactions are completed. Related Limited Partner will not make any capital contributions to Limited Partnership.

12. All Individual Limited Partners are individuals who have owned their Limited Partnership Units continuously from a time that is prior to XXXXXXXXXX.

13. The General Partner and Individual Limited Partners who so choose to receive loans described in paragraph 11 above, will each contribute a sufficient amount of cash into the Limited Partnership so that their negative ACBs of their Limited Partnership Units or General Partnership Unit each become nil. The General Partner will contribute further capital sufficient to bring the capital deficiency of the Limited Partnership to a positive position. All of the amounts of capital received by the Limited Partnership from the Limited Partners and the General Partner will be used to repay debt obligations of the Limited Partnership.

14. Limited Partnership shall seek approval from certain secured creditors to transfer all of the assets and liabilities from the Limited Partnership to Newco.

15. Newco will be incorporated under the laws of the Province, being authorized to issue XXXXXXXXXX common or ordinary shares without nominal or par value and XXXXXXXXXX preferred shares having a redemption value of XXXXXXXXXX each, of which one (1) common share shall be issued to the General Partner for XXXXXXXXXX.

16. The transactions described in paragraphs 17, 18 and 19 below will be completed on the same day and in the order set out below.

17. Limited Partnership will transfer all of the Limited Partnership Assets to Newco in return for preferred shares of Newco and an assumption by Newco of certain liabilities of the Limited Partnership in an amount equal to the aggregate of the cost amounts to the Limited Partnership of the Limited Partnership Assets to the Limited Partnership. Newco and General Partner (acting on behalf of the Limited Partnership and the Partners) will jointly elect pursuant to subsection 85(2) of the Act in prescribed form and within the time determined under subsection 85(6) of the Act with respect to the transfer of the Limited Partnership Assets. The agreed amounts for each Limited Partnership Asset (or group or class of Limited Partnership Assets) in respect of such election will not be less than the least of the amounts specified in subparagraphs 85(l)(c.l)(i) and (ii) and will not exceed the respective fair market value of each Asset (or group or class of Assets), nor will they be less than the amounts permitted by paragraph 85(l)(b) of the Act (the "agreed amounts"). The value of the preferred shares of Newco will be equal to the difference between the fair market value of the Limited Partnership Assets and the liabilities assumed by Newco.

At the same time, Limited Partnership will also transfer the Limited Partnership Other Assets to Newco. Consideration received by the Limited Partnership for the Limited Partnership Other Assets will be the assumption by Newco of liabilities of the Limited Partnership, the amount of which will be equal Limited Partnership's tax cost of the Limited Partnership Other Assets.

The transfers by Limited Partnership of the Limited Partnership Assets and the Limited Partnership Other Assets will together be a transfer of all or substantially all of the assets used in the business carried on by Limited Partnership.

18. Limited Partnership will distribute preferred shares in Newco to all of the Limited Partners in settlement of the disposition of their Limited Partnership Units. Limited Partnership will distribute preferred shares in Newco to General Partner in settlement of the disposition of its General Partnership Unit.

19. Limited Partnership will be wound up such that the conditions in paragraphs 85(3)(a) to (c) of the Act are satisfied.

20. Related Limited Partner will transfer its preferred shares in Newco to PurchaseCo in exchange for shares of PurchaseCo under subsection 85(1) of the Act.

21. General Partner will transfer its one common share and its preferred shares in Newco to PurchaseCo in exchange for shares of PurchaseCo under subsection 85(1) of the Act.

22. PurchaseCo will purchase the Newco shares directly from Individual Limited Partners who wish to sell their shares. Should certain Individual Limited Partners not wish to sell their shares in Newco, Newco will redeem these shares at their redemption amount. All Individual Limited Partners deal at arm's length with Purchase Co.

23. The cash proceeds actually received by each Individual Limited Partner will be reduced by the amount of the promissory note payable by that Individual Limited Partner to PurchaseCo.

24. All or substantially all of the assets of Newco from the time of the transaction described in paragraph 17 to the time when the Individual Limited Partners sell their preferred shares of Newco to PurchaseCo will be used by Newco in its active business XXXXXXXXXX. The principal purpose of Newco will not be to derive income from property. Newco will carry on the business that Limited Partnership carried on, as described in paragraph 3 above.

25. The non-residents who sold their Limited Partnership Units, as described in paragraph 7 of the Facts above, do not intend to acquire, at any time either directly or indirectly, an interest in Newco, PurchaseCo, or the new corporation described in paragraph 26 below.

OTHER INFORMATION

26. During the year XXXXXXXXXX, Newco, PurchaseCo and General Partner will amalgamate.

PURPOSE OF THE PROPOSED TRANSACTIONS

27.The purpose of the proposed transactions is to restructure the affairs of the Partners, without creating adverse tax consequences, which will create a corporate entity to XXXXXXXXXX while:

• Providing a vehicle through which a Partner can utilize his/her capital gains exemption on disposition of Qualified Small Business Corporation shares which is currently available to other Canadian shareholders of entities similar to Newco;
• Allowing for the purchase of the XXXXXXXXXX business by an entity related to the General Partner;
• Eliminating unlimited liability inherent in XXXXXXXXXX through a limited partnership for the General Partner;
• Providing increased business efficiency through the utilization of a smaller management team thereby enabling Newco to be more responsive to any business environment changes;
• Winding-up the Limited Partnership on a tax-deferred basis.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as set forth below:

A. By virtue of subsections 40(3.1) and (3.15) and paragraph (3.16)(d), subsection 40(3.13) of the Act will not apply.

B. An amount paid by a Partner to the Limited Partnership (as described in paragraph 13) will be added to the ACB of that Partner's Limited Partnership Unit pursuant to subparagraph 53(1)(e)(iv) of the Act.

C. Section 54.2 of the Act will apply on the disposition by Limited Partnership of the Limited Partnership Assets to Newco (as described in paragraph 17) to deem the shares of Newco to be capital property of the Limited Partnership.

D. Provided Newco carries on the business as described in paragraph 24 above, Newco will not be a SIB.

E. Paragraph 110.6(14)(f) will not apply to the preferred shares of Newco issued to the Limited Partnership by virtue of the exception in subparagraph (ii) of that paragraph.

F. Provided that when the shares of Newco are disposed of by Individual Limited Partners (as described in paragraph 22 above) Newco continues to be a CCPC and all or substantially all of the fair market value of Newco's assets at that time continue to be attributable to assets that are used principally in its active business of XXXXXXXXXX and are carried on primarily in Canada by Newco, Newco will be a SBC at that time.

G. The disposition by an Individual Limited Partner of his or her share in Newco immediately after receiving that share from Limited Partnership will not, in and of itself, preclude the Newco shares from being "capital property" of the Individual Limited Partner.

H. Provided that a share of Newco that was disposed of by an Individual Limited Partner is capital property of that Individual Limited Partner,

(a) paragraph 110.6(14)(f) will not apply by virtue of the exception in clause (ii)(A) therein;

(b) paragraph 110.6(14)(d) will apply to deem Limited Partnership to be related to an Individual Limited Partner, provided the Individual Limited Partner was a member of Limited Partnership throughout the time when Limited Partnership owns the shares of Newco;

(c) throughout the XXXXXXXXXX immediately preceding the disposition (described in paragraph 22 above) of a share of Newco by Individual Limited Partner that share of Newco will not have been owned by anyone other than Individual Limited Partner or Limited Partnership, within the meaning of paragraph (b) of the definition of QSBCS;

(d) provided that Newco carries on business as described in paragraphs 3 and 24 above during the period that commences, at the latest, immediately before the Individual Limited Partner acquires the share, the share of Newco will be a share of a corporation throughout that part of the XXXXXXXXXX immediately preceding the disposition (described in paragraph 22 above) of a share of Newco by Individual Limited Partner while that share was owned by the Individual Limited Partner of Limited Partnership, more than 50% of the fair market value of the assets of which was attributable to assets described in subparagraph (c)(i) of the definition of QSBCS;

(e) the share will be a "QSCBS" at the time of that disposition; and

(f) provided that a Individual Limited Partner was resident in Canada throughout a taxation year, subsection 110.6(2.1) of the Act will apply in computing the taxable income for the taxation year of the Individual Limited Partner to allow the Individual Limited Partner to deduct an amount not exceeding the least of the amounts in (a), (b), (c), and (d) of subsection 110.6(2.1).

I. Subsection 84.1(1) of the Act will not apply to the transfer by Individual Limited Partners to PurchaseCo as described in paragraph 22 above.

J. Provided that the Limited Partnership winds up its affairs within 60 days from the date of the transfer of the Limited Partnership Assets (described in paragraph 17 above) and immediately before the winding-up there was no Partnership property other than money or property received from Newco as consideration for the disposition, the provisions of paragraphs 85(3)(d) to (h) of the Act will apply.

K. Paragraph 85(1)(e.2) of the Act will not apply to deem a benefit to be conferred on a related person on the transfer, described in paragraph 17 above of the Limited Partnership Assets to Newco under subsection 85(2) of the Act.

L. Provided that no former non-resident Limited Partner referred to in paragraph 7 above directly or indirectly becomes a shareholder of PurchaseCo or the new corporation described in paragraph 26 above, subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given.

CAVEAT

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R4 issued by the CCRA on January 29, 2001, and are binding provided the proposed transactions are completed on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that CCRA has agreed to or accepted:

(i) the determination of FMV or ACB of any property referred to in this letter;

(ii) the GST implications of any of the proposed transactions; and

(iii) any other tax consequences arising from the facts or proposed transactions described herein, other than those specifically confirmed in the rulings given.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

XXXXXXXXXX