2006 Ruling 2006-0176351R3 - Incorporating a XXXXXXXXXX Practice

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: Where a partner of a professional XXXXXXXXXX partnership creates a professional corporation through which professional XXXXXXXXXX services are provided XXXXXXXXXX , will the corporation be carrying on a personal services business and/or earning specified partnership income?

Position: Question of fact. Generally, no, if certain conditions are met.

Reasons: Reading of relevant legislation and consistent with other rulings.

XXXXXXXXXX 2006-017635

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
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 parties. We also acknowledge the additional information provided to us through various letters, facsimiles, electronic mail transmissions and our numerous telephone conversations (XXXXXXXXXX).

DEFINITIONS

In this letter, unless otherwise expressly stated:

"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 specified Part or provision of the Act;

"Aco" means the XXXXXXXXXX;

"Affiliate" means an ex-partner of the Partnership as discussed in Paragraphs 8 and 9;

"Bco" means the XXXXXXXXXX;

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

"CCRA" means the Canada Customs and Revenue Agency;

XXXXXXXXXX;

"CRA" means the Canada Revenue Agency;

XXXXXXXXXX;

XXXXXXXXXX;

XXXXXXXXXX;

XXXXXXXXXX;

"Paragraph" refers to a numbered paragraph in this letter;

"Partner" means a partner of the Partnership;

"Partnership" means XXXXXXXXXX;

"Practice" means the professional practice of XXXXXXXXXX;

"Professional" means a XXXXXXXXXX being either a Partner or an Affiliate of the Partnership;

"Professional Corporations" means Aco and Bco, as described in Paragraphs 10-18;

"Province" means the Province of XXXXXXXXXX;

"Taxable Canadian corporation" has the meaning assigned by subsection 89(1); and

XXXXXXXXXX.

FACTS

1. The Partnership, which was formed in XXXXXXXXXX, is a XXXXXXXXXX practice consisting of approximately XXXXXXXXXX partners and is governed by a written partnership agreement (the "Partnership Agreement") entered into by all Partners. The physical and mailing address of the Partnership office is XXXXXXXXXX. The Partnership's identification number is XXXXXXXXXX . The Partnership files its annual information return with the XXXXXXXXXX Tax Services Office.

2. All Partners are XXXXXXXXXX that have their own XXXXXXXXXX practices XXXXXXXXXX. All the various XXXXXXXXXX practices of the Partners are operated through the Partnership.

3. The staff of the Partnership provides administrative support to the Partners, such as XXXXXXXXXX and paying the XXXXXXXXXX licenses and insurances. The ideology behind the Partnership was to free up the XXXXXXXXXX time for more important tasks like XXXXXXXXXX.

4. Each XXXXXXXXXX /Partner has their own expenses, which they claim against their share of the Partnership's net income (e.g., the cost of their own secretary's salary, conventions, postage).

5. The major terms of the Partnership Agreement (updated in XXXXXXXXXX) are as follows:

• the Partnership is in the business of providing professional XXXXXXXXXX services and all activities related thereto;
• an "Executive Committee", comprised of XXXXXXXXXX Partners (each having a vote), XXXXXXXXXX and the Chief Executive Officer ("CEO") of the Partnership (non-voting), is responsible for the day-to-day management of the affairs of the Partnership;
• the Executive Committee holds the power to hire employees, consultants, or advisors necessary to perform administrative services for the Partnership;
• each Partner is a full-time member of the XXXXXXXXXX. Although the Partnership Agreement (e.g., see paragraph XXXXXXXXXX of the Partnership Agreement) presently contemplates the admission of incorporated professionals as Partners, none have ever been admitted and it is intended that this clause will be deleted from the Partnership Agreement when next updated subsequent to receiving this ruling letter;
• admission of new Partners is approved by the Executive Committee and is executed by the Partner signing the Partnership Agreement;
• each Partner shall provide his or her billing information to the Partnership staff for processing and submission to the appropriate entity on the Partner's behalf;
• each Partner is required to remit to the Partnership all professional fees and earnings generated in the Province, with certain listed exceptions such as honoraria, royalties from books, earnings from patents, copyrights and trademarks, XXXXXXXXXX, etcetera;
• Partnership earnings are applied in the following manner: (1) to pay Partnership expenses, (2) to reimburse XXXXXXXXXX for the agreed administration and service fees, (3) to pay the members their revenue entitlement, and (4) to make research grants to XXXXXXXXXX;
• the individual Partner's annual net revenue entitlement from the Partnership

(i.e., their share of the Partnership's net income for income tax purposes) is calculated as a percentage of the amount of professional fees generated by that Partner for that year. The Executive Committee revises this percentage annually after considering the actual costs of the Partnership. The Partners' entitlement as a percentage of the Partner's professional revenue generated for the year was XXXXXXXXXX% and XXXXXXXXXX% for the XXXXXXXXXX and XXXXXXXXXX years respectively;

• the Partnership, on behalf of each Partner, pays the annual fees associated with membership and licensing with each of the following entities:
  • XXXXXXXXXX;
  • XXXXXXXXXX;
  • XXXXXXXXXX;
  • XXXXXXXXXX; and
  • XXXXXXXXXX.
• the Partnership pays Partners certain benefits including monthly expense allowances and if they qualify, funding for such things as maternity and disability leave;
• each Partner is required to provide and maintain their own transportation related to the practice of XXXXXXXXXX;
• partial payments (i.e., drawings), based on estimated net Partnership income for income tax purposes, are made to each Partner throughout the year. At year end, a reconciliation is performed resulting in a payment to, or recovery from, each Partner to reflect their actual share of the Partnership's net income;
• each Partner is liable for a proportionate share of the debts and obligations of the Partnership incurred while he/she is a partner;
• a Partner's entitlement to share in the net income of the Partnership terminates on the day on which the Partner dies, retires, withdraws from the Partnership, is expelled or ceases to be a Partner for any other reason;
• a Partner is deemed to have withdrawn from the Partnership when he/she ceases to be a full-time member of the XXXXXXXXXX or when he/she ceases to XXXXXXXXXX; and
• the net assets or net liabilities of the Partnership shall be divided among the Partners in proportion to their entitlement to share in the Partnership net income in the year of dissolution.

6. Other relevant facts about the Partnership are as follows:

• XXXXXXXXXX are Partners;
• each Partner provides XXXXXXXXXX services and operates his or her XXXXXXXXXX practice separate and independent from each other Partner. XXXXXXXXXX;
• there is no cost to become a Partner and no proceeds on resignation.
• although rare, it is possible that two Partners may be related to one another as siblings or spouses may co-incidentally both be XXXXXXXXXX. However, for the large majority, the Partners are not related to one another;
• each year appropriate amounts are included on T5013 slips for the amounts to be reported as Partnership income by each of the Partners;
• each Partner's XXXXXXXXXX salary is paid directly to them by XXXXXXXXXX and is reported annually on a T4 slip that is used by each Partner to report their appropriate amount of employment income. These amounts do not form part of the Partnership's income;
• during the period while a XXXXXXXXXX is a Partner, the XXXXXXXXXX is a resident of Canada;
• Partners may also be members of other partnerships formed to meet the needs of specific XXXXXXXXXX groups and these groups may include other XXXXXXXXXX who are not members of the Partnership. XXXXXXXXXX; and
• the Partnership has access to XXXXXXXXXX chartered bank accounts. XXXXXXXXXX of the accounts are in the Partnership's name. Signing authority is with the CEO and the senior Partner of the Partnership. The XXXXXXXXXX account is in the name of XXXXXXXXXX. Cheques and cash receipts are deposited to this account for the credit of the Partnership. Through an affiliation agreement with XXXXXXXXXX, the Partnership not only uses office facilities and XXXXXXXXXX staff, but the Partnership has access to a XXXXXXXXXX bank account from which it can access short-term working capital loans on an as-requested, as-required basis. In exchange, the Partnership pays XXXXXXXXXX certain service and administrative fees to allow XXXXXXXXXX to recover its operating costs incurred for the benefit of the Partnership and to provide funds to XXXXXXXXXX.

7. To the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling

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

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

c) is under objection by the taxpayer(s) or a related person,

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

e) is the subject of a ruling previously issued by Revenue Canada, the CCRA or the CRA.

PROPOSED TRANSACTIONS

8. The Partnership Agreement will be modified such that a Partner, wishing to provide his/her professional XXXXXXXXXX services through a professional XXXXXXXXXX corporation, will, upon incorporation, resign and cease to be a Partner and shall become an Affiliate of the Partnership.

9. Upon ceasing to be a Partner and becoming an Affiliate, a Professional would not be providing services to the Partnership and would not be entitled to any financial participation in Partnership income. They would also lose other benefits previously provided by the Partnership, including the right to vote at Partnership meetings, the right to serve on the Executive Committee, monthly expense allowances and funding for such things as maternity and disability leave.

10. XXXXXXXXXX will incorporate the Professional Corporations through which they will operate their respective Practices. As noted in Paragraph 8, upon such incorporation XXXXXXXXXX will cease to be Partners and will become Affiliates.

11. Aco will be controlled by XXXXXXXXXX, who will be the legal and beneficial owner of all of the voting shares of Aco. XXXXXXXXXX spouse will subscribe for XXXXXXXXXX non-voting shares of Aco. XXXXXXXXXX will be Aco's sole officer and director and will provide professional XXXXXXXXXX services XXXXXXXXXX on behalf of Aco, pursuant to the terms of a written employment contract between XXXXXXXXXX and Aco. In addition to detailing XXXXXXXXXX compensation, the contract will also set out XXXXXXXXXX duties and responsibilities and will contain a clause to the effect that all Practice revenue earned by XXXXXXXXXX will be income of Aco. For greater certainty, Aco's sole business will be providing XXXXXXXXXX services through XXXXXXXXXX and those services will only be provided directly to individuals who are Aco's XXXXXXXXXX .

12. Bco will be controlled by XXXXXXXXXX, who will be the legal and beneficial owner of all of the voting shares of Bco. XXXXXXXXXX spouse will subscribe for XXXXXXXXXX non-voting shares of Bco. XXXXXXXXXX will be Bco's sole officer and director and will provide professional XXXXXXXXXX services XXXXXXXXXX on behalf of Bco pursuant to the terms of a written employment contract between XXXXXXXXXX and Bco. In addition to detailing XXXXXXXXXX compensation, the contract will also set out XXXXXXXXXX duties and responsibilities and will contain a clause to the effect that all Practice revenue earned by XXXXXXXXXX will be income of Bco. For greater certainty, Bco's sole business will be providing XXXXXXXXXX services through XXXXXXXXXX and those services will only be provided directly to individuals who are Bco's XXXXXXXXXX.

13. The Professional Corporations

(i) will be taxable Canadian corporations and Canadian controlled private corporations.

(ii) will not be restricted from competing with the business of the Partnership; and

(iii) will operate in accordance with the rules and regulations set out by XXXXXXXXXX and with the XXXXXXXXXX concerning permitted shareholders.

14. Other Partners may also incorporate their professional XXXXXXXXXX practices by setting up professional XXXXXXXXXX corporations (the "other XXXXXXXXXX") on a similar basis as is described in this letter for the Professional Corporations. However, in this letter we are only ruling on the Professional Corporations.

15. All persons legally or beneficially owning shares of a particular Professional Corporation will be residents of Canada and will not be a legal or beneficial shareholder of another Professional Corporation or other XXXXXXXXXX.

16. None of the Professional Corporations or the other XXXXXXXXXX will be related persons with the exception of any Professional Corporations or other XXXXXXXXXX that may be set up coincidentally by individuals who are spouses or siblings.

17. Each Professional Corporation will enter into a separate written administrative services and agency contract with the Partnership. Pursuant to the terms of the contract, the Partnership will be entitled to a fee from the Professional Corporation in return for providing administrative support services to that Professional Corporation. The Partnership will also act as an agent of the Professional Corporation in the following capacities:

? to prepare and submit the necessary documentation regarding billings of professional fees to the appropriate entity (e.g., XXXXXXXXXX, workers' compensation commission, etc.);
? to collect professional revenue;
? to remit payments to the appropriate entities on account of professional fees and licences, liability and malpractice insurance as well as fees and donations to XXXXXXXXXX as dictated by each Professional Corporation; and
? to deposit the remaining funds, after deduction of the agreed service fee, to the Professional Corporation's bank account for the Professional Corporation's use absolutely.

18. The Partnership and each Professional Corporation, on a case-by-case basis, will negotiate the service fee for these administrative services provided by the Partnership. The amount charged will be equal in amount to the fair market value of the services being provided. The fee will be renegotiated on an annual basis (or as mutually agreed by the parties) to allow for adjustments reflecting changes in costs associated with the provision of these services by the Partnership.

19. Regardless of the existence of a Professional Corporation or other XXXXXXXXXX, each Affiliate will continue to carry out their XXXXXXXXXX duties with XXXXXXXXXX in accordance with their employment arrangement with XXXXXXXXXX.

PURPOSES OF THE PROPOSED TRANSACTIONS

20. The primary purpose of the proposed transactions is to allow existing and future partners to earn professional income from their XXXXXXXXXX practice through their professional corporation without forcing the entire Partnership to forgo the benefits of the efficiencies that the partnership provides and without causing termination of the business agreements entered into by the Partnership with other entities including XXXXXXXXXX.

21. The proposed transactions will:

? allow a Partner to benefit from the legislative amendments which permit XXXXXXXXXX in the Province to render professional services through a professional XXXXXXXXXX corporation;
? provide a Partner with an increased level of control over their participation in their Practice through individual management of personal practice preferences and expenses;
? permit a Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Partnership;
? provide the Partner with more control over his/her own estate and financial planning;
? enhance the Partnership's ability to retain current and recruit additional professionals; and
? permit a Partner to achieve the above objectives while satisfying XXXXXXXXXX requirements concerning XXXXXXXXXX being members or Affiliates of the Partnership.

22. None of the reasons for the separate existence of the Professional Corporations is to reduce the amount of taxes that would otherwise be payable under the Act or to increase the amount of any investment tax credit under section 127.1.

RULINGS

Provided that

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes 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. Provided that XXXXXXXXXX supplying their respective professional XXXXXXXXXX services XXXXXXXXXX on behalf of Aco or Bco, as the case may and as described in Paragraph 11 and 12, would not, but for the existence of the particular Professional Corporation, be an officer or employee of the XXXXXXXXXX in respect of those professional XXXXXXXXXX services, then each Professional Corporation will not be considered to be carrying on a "personal services business" as defined by subsection 125(7).

B. Provided the Professional Corporations are not members of any partnership in a particular year, the income earned by the Professional Corporations in that year will not be "specified partnership income" as defined by subsection 125(7).

C. The proposed transactions described in this letter will not, in and of themselves, cause subsections 56(2), 56(4) or 246(1) to apply so as to include an amount of the Professional Corporations' Practice income in computing the income of XXXXXXXXXX.

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

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5, issued by the CRA on May 17, 2002, and are binding provided the proposed transactions are entered into on or XXXXXXXXXX. These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly that the CRA has agreed to or accepted the reasonableness, fair market value, or proper tax treatment of any fees or expenditures referred to in this letter.

OPINION

The application of subsection 256(2.1) is determined on a year-to-year basis. We are therefore unable to rule that this provision will never apply to the Professional Corporations. In general, where a business that was previously carried on in a partnership is subsequently carried on by former partners' newly incorporated professional corporations and no longer in partnership for reasons other than income tax, this fact, in and of itself, would generally not cause subsection 256(2.1) to be applicable. The reasons for the separate existence of two or more professional corporations involve a question of fact that can only be determined on a case-by-case basis. However, based on the facts, the proposed transactions and the purposes of the proposed transactions described herein, it is our view that the incorporation of the Professional Corporations to provide professional XXXXXXXXXX services XXXXXXXXXX will not, in and of itself, cause subsection 256(2.1) to be applicable to the Professional Corporations.

In accordance with paragraph 22 of Information Circular 70-6R5, the above comments are only an expression of opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on the CRA.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch