1 December 1998 GST/HST Interpretation HQR0001265 - Section 127 ETA - Associated Persons -

This is further to your facsimile message of July 22, 1998 concerning the "associated" status of a limited partnership and an investment corporation within XXXXX[.] We apologize for the delay in replying.

Our understanding of the facts in this case is as follows:

•   XXXXX

•   XXXXX pursuant to the Offering Memorandum of the limited partnership and the investment corporation each consist of XXXXX of the investment corporation. A unit constitutes an equal and undivided limited partnership interest in the limited partnership. The limited partners (i.e., the investors) are registered owners of one or more units.

•   XXXXX does not own any units in the limited partnership but has a "participatory financial interest".

•   The net income or net loss of the limited partnership for a fiscal year will be determined in accordance with the cash method for income tax purposes and the accrual method for accounting purposes and will be allocated among those persons who were shown on the register as partners at the end of such fiscal year as follows:

a) the net loss for a fiscal year will be allocated to the limited partners according to each limited partner's sharing ratio;

b) until there has been distributed or set aside for distribution to the limited partners on a cumulative basis an amount equal to XXXXX of their [c]apital, the net income will be allocated to the limited partners according to each limited partner's sharing ratio;

c) for the fiscal year in which there has been distributed or set aside for distribution to the limited partners on a cumulative basis an amount equal to XXXXX of their capital, the net income for such fiscal year will be allocated as follows:

(i) an amount equal to an amount which when added to the previous distributions will be on a cumulative basis equal XXXXX of their capital will be allocated to the limited partners according to each limited partner's sharing ratio;

(ii) an amount equal to XXXXX of the balance of such net income will be allocated to the general partner; and

(iii) the remainder will be allocated to the limited partners according to each limited partner's sharing ratio;

d) for each fiscal year thereafter, the net income will be allocated XXXXX to the general partner and XXXXX to the limited partners according to each limited partner's sharing ratio.

All amounts allocated to the general partner and to the limited partners will be credited or debited, as the case may be, to their respective current accounts.

•   The investors (i.e., the limited partners) are simultaneously holding collectively XXXXX of the common shares of the investment corporation. The holders of the common shares are entitled to one vote per share at all meetings of common shareholders, to receive dividends as and when declared on the common shares by the board of directors of the corporation and, upon dissolution, liquidation or other distribution of assets of the corporation, to receive a pro rata share of all the property and assets of the corporation available for distribution to the holders of the common shares. There are no pre-emptive, redemption or surrender rights attaching to the common shares.

•   XXXXX holds the remaining XXXXX of the common shares of the investment corporation.

•   The same individual is the sole director and officer of XXXXX and the investment corporation.

•   The accountant representing the XXXXX has stated that the shareholdersinvestors have the ability to remove the sole director and officer of the investment corporation.

•   The limited partnership and the investment corporation will co-exist for approximately XXXXX before the assets are transferred from the limited partnership to the corporation.

Issue

You wish to know (1) whether XXXXX is associated with the investment corporation and (2) whether the limited partnership is associated with the investment corporation.

Comments

To determine whether one person is associated with one or more persons section 127 of the Act provides the following rules.

Under subsection 127(1) of the Act, a corporation is associated with another corporation if, by reason of subsections 256(1) to (6) of the Income Tax Act (ITA), the particular corporation is associated with the other corporation for the purposes of the ITA.

Under the ITA, the essential test which determines "association" relies on control. Subsection 256(1) of the ITA uses the phrase "controlled directly or indirectly in any manner whatever". While there is no definition of "control" in the ITA, the Courts have ruled that the word "controlled" contemplates the right of control that rests in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the board of directors or the voting power sufficient to authorize the surrender of the company's letters patent. Such control is referred to as de jure control.

In addition, corporations will also be associated in certain situations described in the ITA where another corporation, person or group of persons (the "controller") has any direct or indirect influence that, if exercised, would result in control in fact of the corporation. Such control, referred to as de facto control, is only applicable to the provisions of the ITA that refer to control, directly or indirectly in any manner whatever. Whether a person or group of persons can be said to have de facto control of a corporation, notwithstanding that they do not legally control more than 50% of its voting shares, will depend on each factual situation. Paragraphs 17-19 of IT-64R3 provides additional information on where de facto control exists.

Based on consultations with IT Rulings, it is our understanding that an argument can be made that since the same individual is the sole director and officer of XXXXX and the investment corporation, XXXXX and the investment corporation could be associated. However, this fact in itself is not decisive and other factors must be considered. In addition, based on the facts provided by the accountant, there is no evidence, i.e., direct or indirect influence, that these two corporations would be associated for purposes of the ITA. Note also that, as stated above, the shareholders have the ability to remove the sole director and officer of the investment corporation. This fact would imply that the shareholders control the investment corporation. If XXXXX and the investment corporation are not associated for purposes of the ITA, they would not be associated pursuant to subsection 127(1) of the Act.

Under subsection 127(3) of the Act, a person, i.e., a corporation, is associated with a partnership if the total of the shares of the profits of the partnership to which the person and all other persons who are associated with the person are entitled is more than half of the total profits of the partnership, or would be more than half of the total profits of the partnership if it had profits.

Note that under this subsection, a different test (profit test) is used to determine whether a person, i.e., a corporation, is associated with a partnership, as opposed to the "control" test required under the ITA.

Since the investment corporation is not entitled to more than half of the total profits of the limited partnership, it is our view that the limited partnership and the investment corporation would not be associated pursuant to subsection 127(3) of the Act.