Income Tax Technical News, No. 30, 21 May 2004

Although there is no impediment to the creation of partnership interests that carry different entitlements to share in the income or other attributes of the partnership, the sharing of these tax attributes is subject to section 103.

As noted earlier, loss consolidation transactions must be legally effective. ...However, we would not feel comfortable providing a ruling on a loss consolidation transaction that contemplates dollar amounts and time frames that are blatantly artificial. Thus, in order to be provided with a ruling, we must be able to satisfy ourselves that the transactions are plausible, and the quickest way for us to obtain such assurance is through a commitment letter. ...

While we have not reached the point where we would state that CRB Logging is no longer good law, we have provided rulings on some upstream shareholding situations. The key criteria to be met in such situations is the existence of other assets in the parent company that can generate sufficient income to pay the dividends on the preferred shares held by the subsidiary.

The Agency "would not feel comfortable providing a ruling on a loss consolidation transaction that contemplates dollar amounts and time frames that are blatantly artificial".

Although, as a general rule the inclusion/deduction mechanism provided under ss.12(1)(a), 12(1)(e) and 20(1)(m) should apply to amounts received in a year by a taxpayer in the course of a business in respect of services not rendered or goods not delivered before the end of the year or that otherwise may be regarded as not having been earned in the year, in some circumstances a full inclusion (without reserve) under s. 9(1) may be more appropriate, for example, where the taxpayer has substantially performed all its obligations, or where the taxpayer would be allowed to retain the prepayment even if it did not perform.

The GE Capital case is consistent with the views of the Agency that at common law a rescission of a debt obligation will be implied when the parties have effected such an alteration of its terms as to substitute a new obligation in its place which is inconsistent with it to an extent that goes to the very root of it; and the Agency has ruled that there was no new obligation coming into existence when the terms of an existing obligation were changed to defer the payment of interest payments until maturity, to amend the security interests of the debt holders, and to change the conversion ratio.

Under the scheme of the Act it is acceptable to transfer deductions within an affiliated group of corporations. The Agency will not feel comfortable providing a ruling on a loss consolidation transaction "that contemplates dollar amounts and time frames that are blatantly artificial". Respecting CRB Logging, the Agency has "provided rulings on some upstream shareholding situations. The key criteria to be met in such situations is the existence of other assets in the parent company that can generate sufficient income to pay the dividends on the preferred shares held by the subsidiary".

Partner cannot be a partnership employee and cannot receive “salary”

The CCRA continues to stand by its assertion that a “salary” paid to a partner is not deductible in computing the income of the partnership. In our view, the earning of income from employment by a member of a partnership would be inconsistent with the legal relationships that define a partnership (i.e., two or more persons carrying on business in common with a view to profit). That is, a partner is a participant in the business of the partnership and not an employee. …

Each member of a partnership carries on business as both a principal and an agent of the other members of the partnership. Accordingly, an agreement between the members of the partnership to employ a particular partner would be an attempt by the particular partner to enter into a contract of employment with him or herself. Such an agreement would, at law, be a nullity. The Tax Court of Canada considered this issue in Crestglen Investments Limited [f.n. 9: Crestglen Investments Limited v. MNR, 93 DTC 462; [1993] 2 CTC 3210 (TCC). It is important to note that the prohibition against entering into a contract with oneself may be overridden by statute. For example, section 60 of the Partnership Act (Alberta), section 60 of the Partnership Act (Saskatchewan) and section 13 of the Limited Partnership Act (Nova Scotia) authorize a limited partner to loan money to and transact other business with the limited partnership. See also paragraph 12(2)(b) of the Limited Partnership Act (Ontario) which authorizes a limited partner to act as a contractor for the limited partnership.] and reached the same conclusion:

The tax treatment of a partner's partnership income is the same whether it is a partnership distribution or monies allocated for partnership management services. Thus a partner cannot be an employee of a partnership that is capable of entering into a contract of employment with the partnership...

Treatment as partnership draws of amounts received by a partner in the course of the partnership business

A provision in the partnership acts of the common law provinces prohibits a partner from receiving remuneration for acting in the course of the partnership business, subject to any agreement between the partners. Accordingly, these statutes do not prohibit the members of a partnership from agreeing to remunerate one or more members of that partnership based on, among other things, hours billed or revenues generated.

Although the payment of remuneration to a partner acting in the course of the partnership business is not strictly prohibited, it does not necessarily follow that such remuneration would be a deductible expense of the partnership. There are at least two reasons why a deduction would be inappropriate.

First, if a deduction were available, the partner would have two sources of income from carrying on one business:

1) the remuneration (which would not be income from carrying on the partnership business since it would be an expense of the partnership); and

2) the partner's share of the income or loss from the partnership.

Second, to allow a deduction in computing the income from the partnership business would be to allow the recipient partner a deduction for an amount paid to him or herself.

Thus, in our view, any remuneration paid to a partner for work performed in the course of the partnership business is properly treated as a distribution of income or a draw against capital and would not be deductible in computing partnership income.

Treatment as s. 9 income of amounts received in the course of a separate business

There are some circumstances in which we would allow a partnership to deduct an amount paid to a partner. For example, we would be prepared to allow a deduction in computing the income of a partnership for fees paid to a partner if the fees are paid in consideration for services provided to the partnership by the partner acting other than in his or her capacity as a partner (i.e., the services are not related to the ownership of the partnership interest). That is, the services are provided by the partner in the course of carrying on a business separate from the business carried on by the partnership. Accordingly, the problem of deriving two sources of income from one business does not arise since the amount paid to the partner is included in that partner's income from the separate business. In addition, in the circumstances where a partner is providing services to the partnership other than in the capacity as a partner, we would be willing to accept that the agreement under which the services are provided does not offend the rule against contracting with oneself. However, to avoid uncertainty as to the deductibility of these payments, we would encourage taxpayers not to enter into service contracts directly with the partnership but to enter into these contracts through a separate entity.

Although there is no impediment to the creation of partnership interests that carry different entitlements to share in the income or other attributes of the partnership, the sharing of these tax attributes is subject to section 103.