2001 Ruling 2000-0061203 - INCORPORATE PARTNERSHIP

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: whether incorporation of partnership as professional corporation is a personal services business

Position: no - if Principal carrying out services through a Contracting Company does not provide services to Newco in his/her capacity as an employee or officer of Newco

Reasons: same as 2000-0034813 and E 9915403

XXXXXXXXXX 			2000-006120

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

RE: XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling and your letter dated XXXXXXXXXX.

To the best of your knowledge and that of the taxpayers involved in this ruling request, none of the issues contained herein is:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of one or any of the taxpayers or a related person;

(iii) under objection by one or any of the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "Canadian-controlled private corporation" ("CCPC') has the meaning assigned by subsection 125(7) of the Act;

(c) "CCRA" means the Canada Customs and Revenue Agency;

(d) "College" means the XXXXXXXXXX;

(e) "Contracting Companies" mean the companies, yet to be incorporated for the benefit of individual Principals, which will carry on the XXXXXXXXXX and which will enter into contractual relations with Newco for the provision of professional services. Contracting Companies are described under the heading "Proposed Transactions" below;

(f) "Contracting Professionals" mean the Professionals who choose to enter into contractual relations with Newco for the provision of professional services in the Practice as independent contractors, as described under the heading "Proposed Transactions;

(g) XXXXXXXXXX;

(h) "Newco" means a new company to be incorporated pursuant to the laws of the Province;

(i) "Partnership" means the existing partnership of XXXXXXXXXX a registered partnership name pursuant to the laws of the Province;

(j) "Practice" means the professional practice of XXXXXXXXXX at various locations within the Province currently carried on by the Partnership, conducting research to further the science of XXXXXXXXXX;

(k) "Principal" means each individual who is a partner of the Partnership as of the date hereof;

(l) "Professional" means each individual XXXXXXXXXX who currently provides professional services to the Partnership as required in the Practice, whether in his or her capacity as a partner of the Partnership (being the Principals), an employee of the Partnership, or an independent contractor;

(m) "Professional Employee" means a Professional who chooses to enter into an employment relationship with Newco for the provision of employment services;

(n) "Province" means the Province of XXXXXXXXXX;

(o) "Taxable Canadian corporation" ("TCC") has the meaning assigned by subsection 89(1) of the Act;

(p) "Taxpayers" means those individuals listed in Appendix A; and

(q) "University" means the XXXXXXXXXX.

Our understanding of the relevant facts, proposed transactions and purposes of the proposed transactions is as follows:

FACTS

1. The Partnership is a partnership of XXXXXXXXXX.The Taxpayers applying for this Ruling are all of the Principals.

2. The Principals have provided XXXXXXXXXX.

3. The Partnership is governed by a written partnership agreement that was signed in XXXXXXXXXX and amending agreements signed in XXXXXXXXXX. (The partnership agreement and the two amending agreements are collectively referred to herein as the "Partnership Agreement".) The major terms of the Partnership Agreement are as follows:

(a) Partners are either "partners", "non-equity partners" or "part time partners". There are currently XXXXXXXXXX partners and XXXXXXXXXX non-equity partners or part time partners;

(b) Partners share in profits of the Partnership allocated in accordance with their respective interests;

(c) Non-equity partners are entitled to allocations of net income and net losses from the Partnership based on the percentage that their workload is of a full-time workload, less XXXXXXXXXX%;

(d) Part-time partners are entitled to allocations of net income and net losses from the Partnership based on the percentage that their workload is of a lull-time workload, less XXXXXXXXXX%;

(e) If a partner withdraws from the Partnership within XXXXXXXXXX years of joining the Partnership, or, where a partner withdraws and begins practice within the boundaries of the XXXXXXXXXX, unless otherwise agreed by a majority, they are entitled to receive only XXXXXXXXXX% of their capital account interest;

(f) The Partnership may also engage XXXXXXXXXX. These staff XXXXXXXXXX are not members of the Partnership and are paid an agreed monthly amount; and

(g) Principals are entitled to full income support from the Partnership while disabled for up to a XXXXXXXXXX period.

4. The most recent annual financial statements for the Partnership are for the year ended XXXXXXXXXX.

5. XXXXXXXXXX.

6. XXXXXXXXXX.

7. XXXXXXXXXX.

8. The Partnership provides XXXXXXXXXX services at XXXXXXXXXX locations in XXXXXXXXXX provide equipment used in these facilities. Revenue from XXXXXXXXXX accounts for approximately XXXXXXXXXX% of the revenue of the Partnership.

9. All of the Principals are residents of Canada. None of the Principals is "related" to another Principal within the meaning of paragraph 251(2)(a) of the Act.

PROPOSED TRANSACTIONS

10. Newco will be incorporated under the laws of the Province, and will be authorized to issue an unlimited number of common shares without nominal or par value. Newco will be a CCPC and a TCC.

11. XXXXXXXXXX.

12. XXXXXXXXXX, the Partnership will transfer all of its assets (the "Assets") to Newco in return for XXXXXXXXXX common shares of Newco and a demand non-interest bearing promissory note (the "Note") in an amount equal to the aggregate of the cost amounts of all such Assets to the Partnership. Newco and each Partner will jointly elect pursuant to subsection 85(2) of the Act in prescribed form and with the time determined under subsection 85(6) of the Act with respect to the transfer of the Assets. The agreed amounts for each Asset (or group or class of Assets) in respect of such election will not be less than the least of the amounts specified in subparagraphs 85(l)(c.l)(i) and (ii) and will not exceed the respective fair market value of each Asset (or group or class of Assets), nor will they be less than the amounts permitted by paragraph 85(l)(b) of the Act (the "agreed amounts").

13. The Partnership will wind up its affairs on the day immediately following the transfer of all of its Assets to Newco. Immediately before this wind up, the Partnership will have no assets other than the said XXXXXXXXXX common shares of Newco and the Note. Each Principal shall receive, in full satisfaction of their respective interests in the Partnership, one (1) common share of Newco and a XXXXXXXXXX interest in the Note.

14. For administrative convenience and in accordance with Interpretation Bulletin IT-378R - Winding Up of a Partnership:

(a) the common shares of Newco issued on the acquisition of the Partnership property shall be issued directly in the names of the Principals, so that each Principal shall have one (1) common share of Newco issued in his or her name; and

(b) once the cost amounts of the Partnership property are determined, a promissory note in the amount of XXXXXXXXXX of the aggregate of the cost amounts of the Assets shall be issued by Newco directly to each Principal.

The intent is that the common shares and the promissory note will beneficially belong to the Partnership and not to the Partners themselves at the time of issue.

15. The shareholders of Newco will elect directors from among themselves. It is expected that each shareholder will be a director. The directors shall elect the officers, and it is expected that the president of Newco will be the individual who is currently the managing partner of the Partnership.

16. Newco and each of its shareholders (being all the Principals) shall enter into a Shareholders' Agreement which shall provide, among other things that:

(a) The business of Newco shall be the Practice;

(b) Newco will conduct the Practice by contracting with independent contractors to provide the required services, and may also employ XXXXXXXXXX and others;

(c) Each shareholder of Newco can be a member of the board of directors, should he or she so desire;

(d) The net profits of Newco available for distribution (in the discretion of the directors) shall be distributed annually by way of dividends on the outstanding shares from time to time; and

(e) Newco may, upon approval XXXXXXXXXX of the shareholders, purchase any shares held by any shareholder, and such shareholder shall sell such shares, for fair market value.

17. Newco will carry on the Practice by providing the professional services through:

(a) individuals XXXXXXXXXX in the Province employed by Newco to provide such services;

(b) individuals XXXXXXXXXX in the Province engaged by Newco as independent contractors to perform such services on behalf of Newco (Contracting Professionals); and/or

(c) companies engaged by Newco as independent contractors to provide the services of individuals XXXXXXXXXX in the Province to provide such services on behalf of Newco (Contracting Companies).

18. XXXXXXXXXX. Each Principal will have the option of providing professional services to Newco in respect of the Practice by entering into an employment arrangement with Newco, entering into a contract for services with Newco (as an independent contractor), or forming a new company to enter into a contract for services with Newco (as an independent contractor). Other Professionals may practice with Newco upon such terms as the respective Professional and Newco may agree.

19. Although it is not anticipated, some of the Professionals (including some Principals) have the option of electing to enter into an employment relationship with Newco (as contemplated in paragraph 17(a) above) pursuant to a written employment agreement. The employment agreement will provide, among other things that:

(a) The employee shall perform such duties as Newco may direct from time to time in respect of the Practice;

(b) The term of employment shall be from year to year, and may be terminated by either party by XXXXXXXXXX days notice;

(c) The amount of annual salary will be negotiated from year to year in respect of each employee and will be paid monthly, subject to the usual source deductions;

(d) Newco shall pay all expenses related to the employee's service, including professional membership fees and XXXXXXXXXX insurance costs;

(e) Newco shall supply all supplies, instruments and equipment as required in the performance of the employee's duties;

(f) The employee shall be entitled to compassionate leave and up to XXXXXXXXXX months disability leave with pay;

(g) The employee shall be entitled to XXXXXXXXXX days leave with pay to attend conventions and continuing professional education as approved by Newco; and

(h) The employee shall be entitled to XXXXXXXXXX calendar weeks vacation each calendar year.

20. Professionals may, as contemplated in paragraph 17(b) above, enter into a contractual relationship with Newco, whereby the Professional, as an independent contractor, agrees to provide certain professional services to Newco that are required in the Practice on a per diem fee basis. The amount of the per diem fee will be negotiated on a case by case basis and will vary with the level and type of professional services to be provided (i.e. XXXXXXXXXX service, research, teaching). This arrangement will be evidenced by a written contract, which provides, among other things that:

(a) The Contracting Professional and Newco agree to practice XXXXXXXXXX in association, whereby the Contracting Professional shall provide certain professional services required by Newco in the Practice;

(b) The contract shall be for a fixed period, but may be terminated by either party upon XXXXXXXXXX days notice;

(c) The obligation of the Contracting Professional shall be set out in a negotiated practice profile, expressed as the number of work days per year the Contracting Professional provides each of the following professional services, with a per diem rate for each type of service:

(i) XXXXXXXXXX;

(ii) XXXXXXXXXX;

(iii) Research;

(iv) Teaching;

(v) Administration; and

(vi) Other.

(d) The per diem rates will be established for each type of services, and will take into account such factors as experience, difficulty, risk to the practitioner, and the requirement to work outside of normal hours;

(e) The Contracting Professional shall be compensated for each type of service based upon the established per diem rate, to be paid by Newco to the Contracting Professional on the last day of each month, provided the Contracting Professional's level of services is substantially complete (as defined by the agreement) in keeping with the set practice profile;

(f) All payments from third parties in respect of services provided by a Contracting Professional for the benefit of Newco in the Practice shall be made directly to Newco;

(g) Newco shall supply certain supplies, instruments, facilities, and equipment required in the provision of professional services by the Contracting Professional, but the Contracting Professional shall be responsible for all expenses incurred by him or her in respect of the following:

(i) Professional membership fees and insurance;

(ii) Continuing professional education;

(iii) Transportation;

(iv) Communication;

(v) Maintaining the professional standards set by XXXXXXXXXX from time to time; and

(vi) Expenditures on personal practice preferences of the Contracting Professional.

21. The particulars of the Contracting Professional's practice profile, the per diem compensation rate for services and the definition of "substantial completion" will be negotiated on an individual basis each year of the term of the arrangement.

22. The Contracting Professional will not be restricted from providing professional services to other persons or otherwise prohibited from competing with Newco, except that for a period of XXXXXXXXXX years following the termination of association with Newco, the Contracting Professional shall be prohibited from providing services to XXXXXXXXXX to which services were provided by the Contracting Professional on behalf of Newco.

23. Some Professionals will incorporate companies to provide professional services to Newco (as contemplated by paragraph 17(c) above) upon the same basis as with Contracting Professionals, mutatis mutandis, which arrangement between Newco and each Contracting Company will be evidenced in writing.

24. Each Contracting Company will be controlled by the respective Professional, who will be the legal and beneficial owner of the majority of issued shares and all of the issued voting shares, and the sole officer and director of that Contracting Company. The voting common shares of each Contracting Company will be beneficially owned by the respective Professional and, in some cases non-voting common shares will be owned by his or her family members. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada.

25. A legal or beneficial shareholder of a Contracting Company will not be a legal or beneficial shareholder of another Contracting Company.

26. Each Contracting Company shall obtain a permit XXXXXXXXXX prior to entering into a contract with Newco to provide professional services.

27. The respective Professional will be an employee of the Contracting Company and will provide professional services for the benefit of the Contracting Company pursuant to the terms of its contract with Newco. The relationship will be evidenced by an Employment Agreement in writing.

28. Each Contracting Professional and/or Contracting Company will be responsible for, and bear the risk of, loss of income for long term disability (i.e. disability beyond XXXXXXXXXX months) and will make their own arrangements in this regard. Each Professional employee will receive income for a period of time during any disability. The amount paid to them would be determined on the basis of their salary.

29. As the change from partner to Contracting Professional or Contracting Company will entail a significant increase in certain types of business risk, as a transitional provision, Principals will be offered the option to elect either self-employment (either directly as a Contracting Professional or through a corporation as a Contracting Company) or an employment arrangement as a Professional Employee. This will allow each Principal the ability to independently manage risks relating to the transition; they can elect either to enter into a self-employment arrangement with more risks and a higher compensation or to become an employee with fewer risks but reduced compensation.

30. Professionals who are not currently Principals will not have the same transitional provision; the decision about what contractual arrangements are offered will depend on the needs of Newco as determined by its board. Similarly, XXXXXXXXXX wishing to provide services in the future may be offered a limited range of options depending on the needs of Newco at the time.

31. There will not be any contractual relations between or among any of Newco and the Contracting Companies other than the arrangements described above.

32. No Professional will be an employee, officer, director or shareholder (whether legally or beneficially) of more than one (1) Contracting Company.

33. Related persons of a Professional (within the meaning of subsection 251(2) of the Act), shall be shareholders, if at all, of only the Contracting Company controlled by the particular Professional.

34. Each Professional deals at arm's length with each other Professional.

35. Newco shall estimate its annual revenues and endeavor to contract with the Contracting Professionals and the Contracting Companies in such a manner that will result in an annual profit to Newco. To the extent Newco's taxable income for any particular taxation year exceeds XXXXXXXXXX the excess will likely be distributed (in the absolute discretion of the directors) as bonuses to the directors of Newco.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to restructure the professional practices of the Principals, without adverse tax consequences, so that they meet their professional obligations in respect of the Practice while:

• Eliminating joint and several liability inherent in providing professional services through a partnership;
• Providing each Principal with the opportunity to participate in the practice as a Contracting Professional or through a Contracting Company and, as such, having increased control over his or her individual level of participation in the Practice;
• Providing each Principal with a better congruence between efforts put into the Practice and the financial return received from his or her respective professional practice;
• Providing a vehicle through which an individual Principal may, if he or she so desires, provide professional services external to the Practice;
• Providing increased business efficiency for each Principal through individual management of personal practice preferences and expenses;
• Permitting each Principal to have control over expenditures reflecting personal practice preferences, where such expenditures may not be in the interest of all participants in the Practice;
• Providing more flexibility for estate planning on the part of each individual Principal;
• Facilitating ease of entry to the Practice by other professionals and exit from the Practice by the Principals.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as set forth below:

A. Subsection 85(2) of the Act will apply to the transfer of the Assets by the Partnership to Newco (described in paragraph 3 of the Facts) such that the Partnership's proceeds of disposition and Newco's cost of Asset (or group or class of Assets) will be deemed by paragraph 85(1)(a) (read with such modifications as the circumstances require) to be the agreed amounts in respect thereof.

B. Provided that the Partnership winds up its affairs within 60 days from the date of the transfer of Assets (described in paragraph 3 of the Facts) immediately before the winding-up there was no Partnership property other than money or property received from Newco as consideration for the disposition, the provisions of paragraphs 85(3)(d) to (h) of the Act will apply.

C. Newco will be entitled to claim a deduction in computing its income from its business under subsection 9(1) of the Act within the limitations imposed by paragraph 18(1)(a) and section 67 of the Act in respect of the amounts payable by it for the professional services rendered to it by Professional Employees, the Contracting Professionals or the Contracting Companies.

D. Provided that a Principal carrying out the services described in paragraph 3 of the Facts above through a Contracting Company does not provide services to Newco in his/her capacity as an employee or officer of Newco, we confirm that the Contracting Company will not be considered to be carrying on a "personal services business" as defined in subsection 125(7) of the Act in a situation where five or less full time employees are engaged by the Contracting Company.

E. Provided that a partnership does not exist between Newco or any Contracting Company pursuant to XXXXXXXXXX of the Partnership Act of the Province, the income and any Contracting Company will not be considered "specified partnership income" within the meaning of subsection 125(7) of the Act.

F. Subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given.

CAVEAT

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3 (the "Circular") issued by the CCRA on December 30, 1996, and are binding provided the proposed transactions are completed on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

OPINION

A direction in accordance with subsection 256(2.1) of the Act is based on the facts on a year-to-year basis, and therefore we are not able, pursuant to paragraph 15(j) of IC-70-6R3, to rule that this provision will not be applied. However, we are prepared to offer the following general comments. Where a business that was previously carried on in a partnership is subsequently carried on by the former partners and no longer in partnership for reasons other than tax reasons, this fact, in and of itself, would generally not cause subsection 256(2.1) of the Act to be applicable should the former partners incorporate their business activities. A particular determination of the reasons for such reorganization would be a question of fact. However, based on the facts disclosed in this Ruling, when the partners of the Partnership incorporate their business activities, it is our opinion that this fact will not, in and of itself, cause subsection 256(2.1) of the Act to be applicable.

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of IC-70-6R3 and are not binding on the CCRA.

Nothing in this letter should be construed as implying that CCRA has agreed to or accepted:

(i) the determination of FMV, ACB or UCC of any property referred to in this letter;

(ii) the GST implications of any of the proposed transactions;

(iii) the classification for income tax purposes of the amount of any excess paid in accordance with 35 above; and

(iv) any other tax consequences arising from the facts or proposed transactions described herein, other than those specifically confirmed in the rulings given.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

XXXXXXXXXX