27 June 2016 External T.I. 2016-0637341E5 F - Partnerships - Negative ACB -- translation

Principal Issues: 1. Whether subparagraph 53(2)(c)(v) would apply to the loans in the situation described in the letter 2. Whether the limited partner would have a gain under subsection 40(3.1) in the situation described in the letter 3. Whether subsection 40(3.13) would apply in the situation described in the letter

Position: 1. Possibly, depending of the facts. 2. Possibly, depending on the facts. 3. In general no.

Reasons: 1. Subparagraph 53(2)(c) is broad and includes "any amount received ... in lieu of payment of". 2. 53(2)(c)(v), 40(3.1), 40(3.11). 3. No contribution of capital.

XXXXXXXXXX 2016-063734

R. Gagnon

June 27, 2016

Dear Sir,

Subject: Subsections 40(3.1) and 40(3.13) of the Act

This is in response to your letter of March 15, 2016 in which you asked for our views on the application of paragraph 53(2)(c)(v) and subsections 40(3.1), 40(3.11) and 40(3.13) of the Income Tax Act (the "Act") with respect to the situation as described below.

Unless otherwise stated, all statutory references herein refer to the provisions of the Act.

Our understanding of the situation described in your letter is as follows.

Facts and assumptions

1. LP is a limited partnership governed by the provisions of the Quebec Civil Code whose fiscal period (as defined in subsection 249.1(1)) and taxation year (as defined in subsection 249(1)) ends on December 31 of each year.

2. LP is not a professional partnership as defined under subsection 40(3.111).

3. GP is a taxable Canadian corporation (within the meaning of the definition in subsection 89(1)), whose fiscal period (as defined in subsection 249.1(1)) and taxation year (as provided for in subsection 249(1)) ends on December 31 each year.

4. GP is the general partner of LP.

5. TRUST is a personal trust (within the meaning of the definition in subsection 248(1)) and an inter vivos trust (within the meaning of the definition in subsection 108(1)). Its fiscal year (as defined in subsection 249.1(1)) and its taxation year (as defined in subsection 249(1)) ends on December 31 of each year.

6. TRUST is the sole limited partner of LP. TRUST is a limited partner as defined in subsection 40(3.14). TRUST’s interest in LP is capital property (within the meaning of the definition in section 54) of TRUST. The adjusted cost base within the meaning of the definition in section 54 ("ACB") of its interest in LP at the start of year 1 was nil.

7. TRUST’s interest in LP is not an excluded interest as defined in subsection 40(3.15).

8. The Limited Partnership Agreement provides that the capital, profits and losses of LP are shared between the partners as follows: TRUST 99% and GP 1%.

9. During its taxation year 1, LP made a profit of $1,000. The income (determined under the provisions of subsection 96(1)) of LP for its taxation year 1 was also $1,000.

10. At the end of each quarter of taxation year 1, LP made a loan of money in favour of TRUST of an amount corresponding to the share of LP's profit for the quarter to which TRUST was entitled, or $247.50 (99% of $250). The total principal of the loans made by LP during taxation year 1 was $990.

11. At the beginning of the taxation year 2, TRUST made a withdrawal of its share of the LP profit for its taxation year 1, i.e. $990. TRUST’s capital withdrawal was paid by LP issuing a promissory note payable on demand to TRUST (the "Note") whose principal was $990.

12. The $990 Note and the LP loans to TRUST were immediately made subject to compensation in accordance with Articles 1672 and 1673 of the Québec Civil Code [i.e., set off].

Questions

We have formulated your inquiries under the framework of the following questions:

1. In the situation described above, does paragraph 53(2)(c)(v) have the effect of reducing the ACB of TRUST’s interest in LP, by the amount of the loans made by LP to TRUST, during taxation year 1?

2. In the situation described above, is TRUST deemed to have a gain from the disposition of its interest in LP at the end of the LP's fiscal year ending December 31 of year 1, by reason of the application of subsections 40(3.1) and 40(3.11)?

3. Is subsection 40(3.13) applicable in the situation described above?

4. Does the CRA agrees with the interpretation accorded to the concept of contribution of capital (i.e. for the purposes of subsection 40(3.13)) by the author of the doctrinal passage that was included in your letter?

Our Comments

This technical interpretation provides general comments on the provisions of the Act. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Question 1

First, the parties must demonstrate to the satisfaction of the CRA, that it is possible under Quebec civil law for a limited partnership to make loans to the limited partner and to issue this type of Note in a situation such as that described above. The provisions of the Quebec Civil Code (Article 2186 and following) on ​​partnership agreements appear to be silent in this regard. The partnership is not endowed with legal personality. In addition, there is a general principle of civil law to the effect that a person cannot make a contract with itself.

Should it not be possible for a limited partnership to make loans to the limited partner in such a situation, the amounts styled as loans in the situation described above would be treated by the CRA as amounts received in lieu of or in full or partial payment of the distribution of the taxpayer’s share of the limited partnership profits under subparagraph 53(2)(c)(v).

Moreover, in a situation such as described above, the CRA would consider all relevant information (including the partnership agreement and other documents) to determine whether the arrangement constituted a sham that was implemented to hide the true legal nature of distributions of profits or capital.

In our view, the scope of subparagraph 53(2)(c)(v) is very broad and could in theory (depending on all relevant facts, including the profit or loss of the partnership, the amount of the adjusted cost base of the interest of the limited partner, the partnership agreement, etc.) apply in respect of the loan amount (on the assumption that the loans were permitted under the civil law) in a situation such as described above. However, the question of whether subparagraph 53(2)(c)(v) would be applicable to an actual given situation can only be determined after an examination of all the relevant facts (including the partnership agreement).

It should be noted that in the application of other provisions of the Act, the Courts (see Transocean Offshore Limited 2005 DTC 5201 (FCA), Michael Holzhey 2008 DTC 2607 (TCC), Coleman E. Hall, 70 DTC 6333 (Ex.Ct.) aff’’d 71 DTC 5217 (SCC)) have given a very wide scope to the terms "on account of" and "in lieu of" (used in the English version of subparagraph 53(2)(c)(v)), which are also used in subparagraph 53(2)(c)(v).

Question 2

Subsections 40(3.1) and 40(3.11) could (depending on all relevant facts) be applicable in a situation as described above, so that the trust would have a deemed gain from the disposition of its interest. However, the question of whether subsection 40(3.1) and 40(3.11) would be applicable to an actual given situation can only be determined after an examination of all relevant facts.

Questions 3 and 4

The CRA is of the view that the profits of a limited partnership in a situation such as that described would not be considered as contributions of capital for the purposes of subsection 40(3.13).

Subsection 40(3.13) would not generally be applicable in this situation given that there is no contribution of capital.

The concept of a contribution of capital to a general partnership (SENC) or limited partnership is not limited to what is mentioned in the doctrinal passage quoted in your letter. For example, the CRA considers that the assumption by a partner of a partnership debt can constitute a form of contribution of capital.

We hope that our comments will be of assistance.

Stéphane Charette, CPA, CMA, MBA
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and
Regulatory Affairs Branch