27 May 1994 External T.I. 9408945 - TRANSFER OF PARTNERSHIP INTEREST

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:

Whether a spouse can transfer to the other spouse his/her interest in a partnership of which they are equal partners and receive a salary for his/her services in lieu?

Position TAKEN:

Technically possible but GAAR could apply to deny the tax benefit otherwise unavailable.

Reasons FOR POSITION TAKEN:

1.Interests in a partnership are transferred between spouses primarily to obtain a tax benefit by deducting losses that would otherwise become non-deductible.

2.Given the existence and purpose of various attribution rules for non-arm's length transfers, this transaction could be considered a misuse or abuse of the Act read as a whole.

					5-940894

XXXXXXXXXX			L. Roy

Attention:  XXXXXXXXXX		May 27, 1994

Dear Sir:

Subject: Transfer of partnership interest

This is in reply to your facsimile of April 9, 1994, in which you requested our opinion on whether a spouse can transfer to the other spouse his/her interest in a partnership of which they are equal partners and receive instead a salary for his/her services.

All references to statute are to the Income Tax Act S.C. 1970-71-72, c.63, as amended, consolidated to June 10, 1993 (the "Act").

The situation described in your letter appears to involve actual proposed transactions with identifiable taxpayers. Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R2, dated September 28, 1990. Where the particular transactions are completed, the enquiry should be addressed to the relevant district taxation office. In both cases, facts like the existence of a partnership, the type of farm losses carryforward by each individual along with detail of other income would be required to provide opinions on the tax implications of such transactions. Nevertheless, we offer you the following general comments which may not be applicable to the circumstances of your particular situation.

As a general rule, any transfer of ownership of property constitutes a disposition. Where the transfer is between non-arm's length parties, the property is deemed to have been disposed of at its fair market value and the transferor must report the taxable gain in his income.

However, there is an exception to this general rule where the transfer is between spouses. Provided that both taxpayers are resident of Canada at the time of the transfer, when a taxpayer transfers a capital property to his/her spouse, the property will be deemed to have been disposed of for proceeds equal to the taxpayer's adjusted cost base. Unless the taxpayer elect to opt out of the exception rule, this will apply even if the property is transferred to the spouse at its fair market value. Therefore, the taxpayer is not required to include in income in the year of disposition any capital gain that might have accrued up to the time of the transfer. However, because of the attribution rules, the net gain or loss upon disposition of the property to a third party will be attributed to the transferor.

For purposes of these comments, a partnership is a relationship between persons who carry on an activity in common. Where two taxpayers own equal interests in a partnership, the transfer of a partnership interest from one taxpayer to the other will cause the partnership to cease to exist, since the business will then be carried on by a sole proprietor.

Where a Canadian partnership ceases to exist, if, within three months of that time, one of the partners continues to carry on the partnership business as a sole proprietor and to use in the business the partnership property, subsection 98(5) of the Act will apply. Subsection 98(5) of the Act provides for, among other things, a rollover of the partnership's properties in favour of the sole proprietor and a disposition of the sole proprietor's partnership interest. The partner who continues as a sole proprietor may have to recognize a gain on the disposition of his interest if the cost amount of the properties received from the partnership exceeds the adjusted cost base of his interest. When calculating the gain resulting from the disposition of his partnership interest, the sole proprietor must add the cost of the partnership interest acquired from the other partner to his own interest.

With regard to the payment of salary to a spouse, it will be deductible only if a bona fide employer-employee relationship exists. In the absence of such a relationship, the whole amount of the so-called salary payments to the spouse will be disallowed. However, if an employer-employee relationship exists, the amount of the salary paid to a spouse will be deductible but only to the extent that it is reasonable in the circumstances. A salary paid to a spouse by a proprietor or partnership will generally be considered reasonable if:

1.the circumstances are such that a reasonable businessman would have paid the salaries; and

2.the salaries paid are commensurate with the value of the responsibilities assumed and services performed. In other words, the salaries paid have to equal the value of such services as if the services were performed by someone unrelated to either husband or wife.

Incidentally, where the primary purpose of transferring an interest in a partnership, between spouses, is to obtain a tax benefit by deducting losses of one spouse that would otherwise cease to be available, it is our view that subsection 245(2) of the Act could apply to deny the benefit of such deduction.

The foregoing comments are not rulings and in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990, are not binding on the Department.

We trust that these comments will be of assistance to you.

Yours truly,

Director
Financial Industries Division
Rulings Directorate