2005 Ruling 2005-0130131R3 - Partner Creating Professional Corporation

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.

Principal Issues: When a partner of a partnership (while remaining a partner) creates a professional corporation through which professional services will be provided to the partnership, will the professional corporation be eligible for the small business deduction?

Position: Yes.

Reasons: Legislation.

XXXXXXXXXX 									2005-013013

XXXXXXXXXX, 2005

Dear XXXXXXXXXX

Re: XXXXXXXXXX
Business Number XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above noted partnership. We acknowledge receipt of the additional information in XXXXXXXXXX.

We understand that, to the best of your knowledge, none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayer or a related person,

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person,

(iii) is under objection or appeal by the taxpayer or a related person,

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

(v) is the subject of a ruling previously issued by the Canada Revenue Agency.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supplement), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

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

DEFINITIONS

(a) "CRA" is the Canada Revenue Agency;

(b) "Province" is the Province of XXXXXXXXXX;

(c) "Partnership" is a reference to the existing partnership of "XXXXXXXXXX", which was formed pursuant to the laws of the Province;

(d) "Partner" is a reference to each of, or any of, the partners of the Partnership and, collectively, they are referred to as the "Partners";

(e) "Contracting Company" means each of the XXXXXXXXXX professional corporations that will be incorporated, as permitted pursuant to the laws of the Province for the benefit of an existing Partner of the Partnership and that will be engaged by the Partnership to provide Professional Services as independent contractors and, collectively, they are referred to as the "Contracting Companies";

(f) "Practice" means the provision of XXXXXXXXXX services currently provided by the Partnership;

(g) "Professional Services" means XXXXXXXXXX services;

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

(i) "Personal services business" has the meaning assigned by subsection 125(7) of the Act;

(j) "Related persons" has the meaning assigned by subsection 251(2) of the Act;

(k) "Specified partnership income" has the meaning assigned by subsection 125(7) of the Act;

(l) "Taxable Canadian corporation" ("TCC") has the meaning assigned by subsection 89(1) of the Act.

FACTS

1. The Practice is currently carried on by the Partnership. The Partners are the only partners of the Partnership. The Partnership has been carrying on business since XXXXXXXXXX, under the current partnership agreement (the "Partnership Agreement"). However, it had been carrying on business under predecessor partnership agreements for many years prior to XXXXXXXXXX. The Partners, approximately XXXXXXXXXX in total, provide Professional Services to the Partnership. All the Partners are individuals; none of the Partners are Related persons with the exception of XXXXXXXXXX sets of spouses who are Partners.

2. The Partnership's identification number is XXXXXXXXXX. The Partnership files its information returns with the XXXXXXXXXX Taxation Center and deals with the XXXXXXXXXX Tax Services Office.

3. There are a number of self-employed XXXXXXXXXX ("Associates") who provide Professional Services to the Partnership. This arrangement is governed by an associate agreement (the "Associate Agreement"). The Associates are not Partners of the Partnership; each Associate is paid a percentage of his or her gross production.

4. In the past, the Partners provided their Professional Services through the Partnership.

5. The Partnership operates the Practice on a "fee for service" basis or on a contract basis. Remuneration for Professional Services provided to XXXXXXXXXX of the Partnership is paid by XXXXXXXXXX

6. The Partnership is bound by the Partnership Agreement, the terms of which include the following:

a) The net profits and losses of the Partnership shall be divided and borne by the Partners as may be agreed upon from time to time;

b) Each Partner's share of the profits of the Partnership is based on a formula that takes into account the Partner's ratio of gross production to total Partners' production; this ratio is applied to the Partnership's net income before the deduction of direct remuneration, allocation of office sharing allowance and high production allowances; from that amount, a deduction is made from each Partner for direct remuneration, i.e., wages and payments to Associates;

c) Capital accounts will be maintained for each Partner;

d) Upon the death or retirement of a Partner (for whatever reason) the deceased or retiring Partner is entitled to the Partner's capital account together with the Partner's undrawn profits in the Partnership.

7. The Partnership Agreement provides for the creation of an "Executive Committee" of the Partners. The Executive Committee consists of XXXXXXXXXX Partners. This committee shall, subject to the Partnership Agreement, manage and supervise the affairs of the Partnership. The formula for the determination of profits and losses, shall be proposed by the Executive Committee of the Partnership and approved by the Partners of the Partnership, and subject to an annual review thereof, such method as so determined shall continue in force and effect until varied by special resolution that must be approved by at least XXXXXXXXXX% of the Partners (paragraph XXXXXXXXXX of the Partnership Agreement).

8. The Partnership Agreement provides that when a Partner dies or retires (for whatever reason) the deceased or retiring Partner shall be entitled to their capital account at the date of such death or retirement but shall not be entitled to any goodwill of the Partnership.

PROPOSED TRANSACTIONS

9. Partners will be permitted to provide Professional Services through Contracting Companies engaged by the Partnership to provide the Professional Services as independent contractors. Each Contracting Company will employ an individual licensed to practice XXXXXXXXXX in XXXXXXXXXX. None of the Contracting Companies will be Related persons with the exception of the Contracting Companies that may be set up by individuals who are spouses.

10. Each Contracting Company will be required to enter into a written contract for service (the "Contract") with the Partnership. The Contract will provide that the amount of the fee for the Professional Services provided by the Contracting Company to the Partnership will be negotiated on a case-by-case basis and will vary with the number and type of Professional Services to be provided by the Contracting Company. The amount of the fee will be equal to the fair market value for the Professional Services provided by the Contracting Company to the Partnership. The contract shall be for a fixed period of XXXXXXXXXX months. The contract may be renewed each year and either party upon one-month notice may also terminate it.

11. So long as the Contracting Company fully discharges its responsibilities under the agreement with the Partnership, the Contracting Company will not be restricted from providing services to other persons or otherwise prohibited from competing with the Partnership.

12. All payments from XXXXXXXXXX received by the Partnership in respect of services provided by the Contracting Companies will be for the benefit of the Partnership.

13. The Partnership will supply certain supplies, personnel, facilities and equipment that are required to provide Professional Services to the XXXXXXXXXX of the Partnership. A Contracting Company will be responsible for the following expenses:

a. professional membership fees and insurance;
b. continuing education;
c. transportation;
d. communication;
e. maintaining the professional standards set by the Partnership or by the XXXXXXXXXX; and
f. expenditures on personal practice preferences of the Contracting Company.

14. The sole officer and director of each Contracting Companies will be an employee of that Contracting Company and will provide Professional Services for the benefit of the Contracting Company pursuant to the terms of the Contract with the Partnership. The employment relationship will be evidenced by a written employment agreement.

15. A Partner who provides services for the benefit of his/her Contracting Company will be entitled to receive a salary from his/her Contracting Company for such services provided.

16. In some cases the Partner would cease to be a party to and bound by the Partnership Agreement, and therefore cease to be a Partner. In other cases the Partner would remain a Partner, but that Partner's allocation of income from the Partnership would be reduced to exclude the amounts paid to their Contracting Company pursuant to the Contract. The Partner's gross production as required for the income allocation formula will include the production of Associates and/or Contracting Companies of which the services will be engaged to provide XXXXXXXXXX services to the XXXXXXXXXX of the Partnership.

PURPOSE OF THE PROPOSED TRANSACTIONS

17. The purpose of the proposed transaction will be to allow a Partner to provide his or her Professional Services through a Contracting Company to the Partnership with the following advantages:

a. To allow a Partner to benefit from the amendment by the Province which permits XXXXXXXXXX to render professional services through a corporation.

b. Provide a Partner with an increased level of control over their participation in the Practice through individual management of personal practice preferences.

c. Permit a Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Practice.

d. Provide a Partner with more control over his/her own estate and financial planning.

e. To enhance the Partnership's ability to retain current and recruit additional XXXXXXXXXX.

RULINGS

Provided that:

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) the proposed transactions are completed in the manner described above; and

(c) there are no other transactions which may be relevant to the rulings requested;

our rulings are as follows:

A. The business activities of the Contracting Companies will not be considered a personal services business, as defined in subsection 125(7) of the Act.

B. Any income derived from charges to the Partnership by the Contracting Companies as described above will be income from an active business within the meaning of "active business carried on by a corporation" as defined in subsection 125(7) of the Act and will not fall within the meaning of "specified partnership income" as defined in subsection 125(7) of the Act.

C. Subject to sections 18 and 67 of the Act, the fees payable by the Partnership to the Contracting Companies as described in the proposed transactions will be deductible by all the Partners in their respective calculations of their share of the Partnership income for purposes of the Act.

D. Subsections 56(2), 56(4) and 246(1) of the Act will not apply to cause the income received by the Contracting Companies to be taxed as income of any Partner as a result of the execution and implementation of the proposed transactions.

E. Sharing of income between the Partners of the Partnership will not be subject to adjustment pursuant to subsection 103(1) of the Act solely as a result of the proposed transactions.

F. Implementation of the proposed transactions, in and by themselves, will not result in the application of the provisions of subsection 245(2) of the Act to re-determine the tax consequences confirmed in the rulings given above.

COMMENTS

We are unable to rule that subsection 256(2.1) of the Act will never apply to the Contracting Companies since the application of that subsection must be determined on a year-to-year basis and the reasons for the separate existence of the Contracting Companies could change over time.

In general, where a function of a professional partnership that was previously carried on by the partnership is subsequently carried on by a partner's professional corporation for bona fide reasons other than for income tax reasons, this fact, in and by itself, would generally not cause us to consider that subsection 256(2.1) of the Act would be applicable. The determination of the particular reasons for the separate existence of two or more corporations or the reasons for a change in a partnership function would remain a question of fact that could only be determined on a case by case basis.

However, based on our understanding of the facts, proposed transactions and purposes of the proposed transactions described in this letter, nothing has come to our attention that would, in and of itself, cause us to consider that subsection 256(2.1) of the Act would be applicable to the incorporation of the Contracting Companies, for the purpose of providing services to the Partnership, as described in paragraph 10 above.

CAVEAT

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transactions are implemented on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.

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

(i) the fair market value of the services referred to in this letter;
(ii) the accuracy of any amounts referred to in this letter; or
(iii) the GST implications of any of the proposed transactions.

Yours truly,

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