Does the formation of a partnership with only Canadian partners in order to meet the requirement of a "Canadian partnership" under subsection 97(2) followed by the admission of a non-resident as a partner soon after (e.g. the next day) jeopardize the rollover?
CRA indicated that the issues in a denied ruling request, entailing the transfer of a non-Canadian business into a partnership which a non-resident became a member, could be illustrated as follows: Corp A is a taxable Canadian corporation, which transfers the business, represented by depreciable property with a capital cost and FMV of $100,000 and a UCC of $50,000, on a s. 97(2) rollover basis to a newly-formed partnership between it and its wholly-owned Canadian subsidiary (holding 1 of the 100 initial units) in consideration for a $50,000 promissory note and 50,000 units. The next day, the non-resident becomes a partner by contributing $50,000 for 50,000 partnership units (49.95%), thereby diluting Corp A's interest to 50.04%, with the promissory note then being repaid. CRA stated:
As part of the series of transactions, there is a dilution on a percentage basis in favour of a non-resident but without any Canadian tax recognition of the latent income gain. The new anti-avoidance rules under subsections 100(1.4) and (1.5) do not yield taxation to Corp A on the admission of the non-resident as a partner because there is no dilution of its partnership interest on a fair market value basis (i.e. the FMV of Corp A's partnership interest is still $50,099). If instead there had been a direct disposition by Corp A to the non-resident of part (49.95%) of its partnership interest, amended subsection 100(1) would have resulted in a fully taxable gain to Corp A of $24,975, which amount is also equivalent to 49.95% of the latent recapture in the depreciable property of $50,000.
The CRA will challenge such an arrangement by applying the GAAR. In our view, the determination of a misuse or abuse of the Act must be made having regard to the 2012 amendments to subsection 100(1) that extend its application to acquisitions by non-residents and the addition of the anti-avoidance dilution provisions contained in new subsections 100(1.4) and (1.5).
See 2014 CTF Conference