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:
1. Since a partnership is not a person resident in Canada, can a valid section 16.1 election be entered into by a partnership which is the lessor?
2. Would the answer differ if one of the partners was a tax-exempt entity?
3. Would a valid election be cancelled if subsequently a tax-exempt entity becomes a partner?
PositionS:
1. Yes, on behalf of the individual partners if the conditions are met, such as each of the partners being resident of Canada, not being tax exempt, etc.
2. The partnership would not be able to enter into a valid election.
3. Not necessarily.
Reasons:
1. The lessee would, in law, be entering into a lease with all of the partners, as a group. As long as each of the partners met the requirements in 16.1 a valid election could be entered into with the lessee.
2. The tax-exempt would not meet the requirements of 16.1 and would preclude the lessee from entering into a valid election with the partners as a group.
3. We have not had considered this issue previously. In the absence of specific legislation similar to 16.1(1)(i) of the Act, our preliminary view is that this fact would not, in and of itself, result in the cancellation of the section 16.1 election. However, consideration will be given to whether GAAR would be applied in abusive situations.
Tax Executives Institute Liaison Meeting
December 7, 1999
Question 29: Section 16.1-- Partnerships and Tax-Exempt Entities
Increasingly, active operating businesses are being carried on in Canada through publicly traded limited partnerships. Moreover, tax-exempt entities such as pension and mutual funds frequently invest in such partnerships. In many cases the general partner is unable to determine whether the limited partners are tax exempt because the interests are either unregistered or held at a stock brokerage in "street name." For valid reasons, the businesses in these limited partnerships may lease equipment to others and, hence, the lessees may request that the lessor make a joint election under section 16.1 Act.
One requirement for a valid election under section 16.1 is that the lessor be "a person resident in Canada." The preamble to section 16.1 was recently amended to provide that the lessor must be "...a person resident in Canada other than a person whose taxable income is exempt from tax under this Part...." The Explanatory Notes to the legislation imply that the amendment was enacted to counter certain transactions where tax-exempt entities were able to significantly reduce their financing costs but at a considerable cost to the fisc. Specifically, the Department of Finance was concerned with transactions where equipment that would otherwise have been used directly by a tax-exempt entity in the course of providing services is instead leased to a taxable entity that provides the services on behalf of the tax-exempt entity. The lease revenues are then used by the tax-exempt to finance the asset purchase.
1. Assuming all partners in a partnership are taxable entities, can a section 16.1 election be made with a limited partnership as the lessor? In two separate technical interpretations (see 9112095 and 9708635), the Income Tax Rulings & Interpretations Directorate of Revenue Canada opined that a partnership can be a party to a section 16.1 election as either a lessee or a lessor. While there is a strong legal basis for the position that a partnership can be lessee in a section 16.1 election, the case is less clear that a limited partnership can be a lessor. Briefly, under par 96(1)(a) of the Act, where a taxpayer is a member of a partnership, income is computed as though the partnership were a separate person resident in Canada. Since section 16.1 is relevant in computing the partnership-lessee's income, it follows that the partnership should be considered "a person resident in Canada" for purposes of section 16.1. This rationale seemingly does not track as well for a partnership acting as a lessor under a section 16.1 election. Technical interpretation 9708635, however, properly confirms that a partnership can be a lessor in a section 16.1 election, but the interpretation omits the explanation for its position. Will Revenue Canada please confirm that a valid section 16.1 election can be made with a partnership as the lessor and explain the basis for its position?
2. Assuming the answer to Question 1 is yes, would the recent amendment regarding tax-exempt lessors preclude a publicly-traded limited partnership, which may from time to time have unit holders that are tax-exempt entities, from being a lessor in a section 16.1 election? In responding to the question, assume that the ownership interest of such tax-exempt entities ranges from 20 to 50 percent of the partnership.
3. If a partnership whose tax-exempt partners own in excess of some threshold percentage of the partnership cannot be a lessor in a section 16.1 election, what would Revenue Canada's position be if at the time of making the election the partnership has no tax-exempt partners but at a subsequent time during the lease term a tax-exempt entity acquires an interest in the partnership?
Responses
1. In order for section 16.1 of the Income Tax Act (the "Act") to apply, one of the requirements is that the lessee must lease tangible property from "a person resident in Canada...". A partnership is not a person, unless the Act specifically deems it to be so (e.g., see paragraph 33.1(2)(a) and subsection 66(16) of the Act). This is so notwithstanding that section 96 of the Act provides that the income of a member of a partnership is computed as if the partnership were a separate person resident in Canada. However, in response to Q.28 at the 1990 Round Table, Revenue Canada stated
...it is the Department's practice, relying on the provisions of subsection 96(1), to consider a partnership to be a person when the computation of income at the partnership level under Division B of Part I is involved...
Section 16.1 of the Act involves the computation of the lessee's income, not that of the lessor/partnership. This coupled with that fact that there is no provision deeming a partnership to be a person for purposes of section 16.1, leads us to conclude that a lessor/partnership cannot meet the requirement of section 16.1 that the lessor be a person resident in Canada.
However, with reference to the reality that a partnership is merely the relationship that subsists between persons carrying on business in common with a view to profit, it is our view that under the lease, the lessee would be contracting with each of the members of the partnership. This being the case, the lessee could enter into a valid section 16.1 election, as long as each of the partners of the partnership was a person resident in Canada (subject to the exclusions that follow in that provision concerning tax exempts and non-residents and assuming all the other requirements of the provision are met). It is our view that this is the reasoning for the closing words in opinion 9708635 referred to above. Those words are "In our opinion, joint elections may be made pursuant to subsection 16.1 of the Act by a lessee and a partnership as lessor, where the election would otherwise be valid."
2. As alluded to in our response to question 1 the election can be made by a partnership only where the election would otherwise be valid, i.e. all of the conditions are met by the members of the partnership. Since the lessee is entering into a lease with all of the partners of the partnership, each of those partners must be persons resident in Canada other than a person whose taxable income is exempt from tax under Part I. In our view, even if there is one tax-exempt partner in the partnership this would preclude the lessee from entering into a valid section 16.1 election with the members of the partnership.
3. If the other requirements are met, a valid section 16.1 election can be made between a lessee and a non-resident person/lessor who holds the lease in the course of carrying on a business through a permanent establishment in Canada, any income from which is subject to Part I tax. Where there is a change of facts subsequent to entering into the lease, paragraph 16.1(1)(i) of the Act applies to cancel a prior election under subsection 16.1(1) of the Act. This would be so where the lessor ceases to be resident and does not hold the property in connection with a business carried on through a permanent establishment in Canada, the income from which is subject to tax in Canada. There is no similar provision in the law where a tax-exempt entity acquires an interest in the partnership after the lease and section 16.1 election is entered into. We have not had the opportunity to consider this issue previously, and in the absence of specific legislation similar to 16.1(1)(i) of the Act, it would be our view that this fact would not, in and of itself, result in the cancellation of the section 16.1 election. However, consideration will be given to whether GAAR would be applied in situations where the facts indicate that (i) a particular tax-exempt's acquisition of an interest in the lessor/partnership was deferred until after the partnership had entered into an otherwise valid 16.1 election with the lessee and (ii) the reason for this deferred acquisition was to attempt to insure that the tax-exempt would not preclude the partnership from entering into this election.
Allan Nelson
992958
November 24, 1999
1
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