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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

(1) Whether Taxpayer an employee, self-employed or carrying on business as a partnership.

(2) Whether certain expenses are deductible in computing income.

Position:

(1) Question of fact

(2) Yes, if not personal expenses.

Reasons:

(1) The facts of each specific situation will determine whether employee/employer relationship exists and whether there is a partnership.

(2) Expenses incurred to earn business income are deductible, net of any personal use.

		December 19, 2001

	XXXXXXXXXX  Tax Services Office	HEADQUARTERS
	Verification and Enforcement Division	A. Seidel, CMA
	XXXXXXXXXX 	(613) 957-2058

2001-009790

Partnership or Employee

This is in reply to your memorandum, dated August 20, 2001, requesting our views as to whether XXXXXXXXXX (hereinafter referred to as the "Taxpayer") is carrying on a computer consulting business in partnership with his spouse (hereinafter referred to as the "Partner"), whether it is a sole proprietorship or whether the Taxpayer's income is earned in circumstances where there is an employee/employer relationship such that the income earned by the Taxpayer is income from employment.

Background

1. The Taxpayer is a computer analyst/programmer/consultant whose main source of income, in XXXXXXXXXX, was from contracts with XXXXXXXXXX. The Taxpayer was working with a consulting firm after XXXXXXXXXX.

2. The Taxpayer has reported the income from these contracts as business income earned through a partnership. In XXXXXXXXXX, the partnership is reported as having been operated under the name XXXXXXXXXX (hereinafter referred to as the "Partnership"). The Partnership was registered as a partnership on XXXXXXXXXX. The original contract was negotiated XXXXXXXXXX. The Partnership profits were allocated XXXXXXXXXX% to the Taxpayer and XXXXXXXXXX% to the Partner in XXXXXXXXXX.

3. The Taxpayer contributes design, testing and maintenance of computer systems and other computer programming work to the Partnership. The Partner contributes all of the administrative duties related to the Partnership including preparing and filing reports to the federal government, invoicing, banking and requesting/submitting amendments to existing contracts. The Taxpayer had previously used an agency to do these administrative tasks. The agency had charged an administration fee equal to XXXXXXXXXX% of the contract they administered.

4. The Taxpayer engaged the services of a CGA to help set up the books and records for the Partnership. The Taxpayer has used "shrink-wrap" computer software to prepare the T1 tax returns.

Issue

Is the contract income earned by the Taxpayer in XXXXXXXXXX income from employment, business income of the Taxpayer or income from carrying on business through the XXXXXXXXXX Partnership? If a partnership does not exist, are the expenses claimed in respect of computer equipment personal expenses of the Taxpayer such that they are not deductible in computing the Taxpayer's income by virtue of paragraph 18(1)(h) of the Act?

Analysis

Whether a person is an employee or self-employed is a question of fact. Many factors must be taken into consideration in establishing whether or not there is an employee/employer relationship. One of the key factors is the determination of whether the contract between the parties is a contract of service, such as would exist between an employer and an employee, or is a contract for services, that is, the engagement of a self-employed individual. A contract of service generally exists if the person for whom the services are performed has the right to control the amount, the nature and the management of the work to be done and the manner of doing it. A contract for services exists when a person is engaged to achieve a defined objective and is given all the freedom required to attain the desired result.

In this respect, the courts have established four tests to determine whether a particular contract is a contract of service (employee) or a contract for services (self-employed). These four tests are as follows:

(a) Control Test

The objective of this test is to assess if the individual is limited or restricted under a master-servant relationship. It recognizes that in most cases, the degree of control of an employer over the employee is greater than what which is exercised in an independent contractor relationship. For instance, in a master-servant relationship, the master can order or require not only what is to be done, but how and when it shall be done. In contrast, an independent contractor is usually allowed to choose the manner in which the services are performed.

(b) Integration Test

This test acknowledges that work performed by an employee under an employment contract is done as an integral part of the business, whereas under a contract for services, the work, although done for the business, is not integrated into it, but is only accessory to it.

(c) Economic Reality Test

This test assesses the economic aspects of the relationship between the parties to determine whether the taxpayer is carrying on business for himself/herself or for someone else. The objective of the test is to verify the existence of various factors of an economic nature and, using these facts, attempt to assess the nature of the relationship. Factors to be considered in applying this test include the required investments to be made by the individual, permanency of the relationship, and the skill required by the individual.

(d) Specified Results Test

This test acknowledges that an independent contractor relationship usually involves the undertaking of a specific task after which the relationship ceases and it does not usually require that the undertaking be carried out by a particular individual. In contrast, in an employer-employee relationship, the employee makes himself/herself available to the employer to be used by the employer without reference to a specified result.

In this regard, the contract between the parties, which sets out the rights and obligations of each of the parties, provides important information in determining the type of relationship that exists. However, even more important than the contract is the actual circumstances surrounding the performance of services and whether such findings of facts agree with what is stated in the contracts.

Finally, not all of the foregoing tests will be relevant or have the same degree of importance and no single test will in all circumstances be viewed as conclusive.

Our Comments

Applying the above tests to the current situation, it is reasonable to conclude that the Taxpayer was not an employee of XXXXXXXXXX. The following factors support this view:

(a) The Taxpayer worked as a consultant for an agency prior to the XXXXXXXXXX contracts and went to work for a consulting firm by XXXXXXXXXX. It was only during this short period that the Taxpayer carried on business through a partnership.

(b) The contract signed in XXXXXXXXXX provides that the contractor will be paid for the services provided and an amount in respect of the goods and services tax (the "GST"). The contract goes on to provide that the contract price shall not exceed the lowest price charged by the contractor to any other customer. This indicates that XXXXXXXXXX did not control where the Taxpayer worked or how many other contracts could be entered into by the Taxpayer.

(c) The contract with XXXXXXXXXX was for a specific purpose, XXXXXXXXXX. The second amendment to the original contract was negotiated by XXXXXXXXXX. The Taxpayer was working as a consultant for them by XXXXXXXXXX.

(d) The Taxpayer had access to the XXXXXXXXXX offices but also worked from home. The Taxpayer acquired computers that were used at home in carrying on the consulting business.

Interpretation Bulletin IT-90 ("IT-90") discusses "What is a Partnership". As stated in paragraph 2 of IT-90, for guidance on whether a particular arrangement constitutes a partnership, reference should be made to the relevant provincial law on the subject. Nevertheless, as noted in paragraph 6 of IT-90, a partnership is a relationship that exists between persons carrying on a business for profit. The type and extent of a person's involvement in the business will be particularly relevant in determining whether a person is in fact a partner involved in the carrying on of the business of the partnership.

In determining the existence of a partnership, a rule which has been recognized ever since the case of Cox v. Hickman, (1860) 8 H.L. Cas. 268, is that regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case.

Osborn's Concise Law Dictionary (Sixth Edition) describes a partnership as follows:

"The relation which subsists between persons carrying on business in common with a view to profit. In general, every partner is entitled and bound to take part in the conduct of the business, unless it is otherwise agreed between them. Every partner is liable for the debts of the partnership to the whole extent of his property. As regards third persons, the act of every partner, within the ordinary scope of the business, binds his co-partners, whether they have sanctioned it or not."

The Taxpayer and the Partner have put forth that the Partner "takes care of the administrative side of things". This includes printing reports for XXXXXXXXXX, preparing the requests for contract extensions every six months, preparing the invoices for billings and doing the banking.

As discussed in paragraph 3 of Interpretation Bulletin IT-231R2, in determining a commensurate value attributable to work performed by a partner in the activities of the partnership, both the time expended and the expertise provided are taken into consideration. Generally, if the function performed by the partner does not require a specialized skill or training, it is expected that the partner's involvement will be on a regular basis and will require that a significant amount of time be spent in the enterprise. On the other hand, if a partner possesses special expertise relevant to the partnership's activities, such partner's involvement could be on an irregular basis with a lesser amount of time being spent.

A detailed review of the "value attributable to the work performed" by the Partner would support whether or not a partnership exists. This review could include the following:

? The Taxpayer and the Partner indicate that the Partner deals with contract extensions every six months. Is this in fact the case? The original contract was signed in XXXXXXXXXX. The second amendment to the contract occurred in XXXXXXXXXX and was negotiated by XXXXXXXXXX. We do not have the details of when and how the first amendment to the contract was made or whether the Partner was involved.

? Secondly, they indicate that the Partner does all of the banking. It would be helpful to find out whether or not a Partnership bank account exists, whether the monthly contract payments were being direct deposited to a bank account, and what other banking duties were performed by the Partner.

? Thirdly, it would be helpful to get a copy of the "reports" and "invoices" sent to XXXXXXXXXX to determine how many and how much work would have been involved to prepare these items.

? Finally, a determination of why the Partnership was registered on XXXXXXXXXX when the arrangement appears to have been terminated by XXXXXXXXXX. (See the contract amendment dated XXXXXXXXXX, signed by the president of XXXXXXXXXX.)

If the review of the "value attributable to the work performed" by the Partner supports the conclusion that a partnership exists, the allocation of the profits of the Partnership must still be reasonable relative to the value of the work performed by the Taxpayer and the Partner. Subsection 103(1.1) of the Act provides that "where two or more members of a partnership who are not dealing with each other at arm's length agree to share any income or loss of the partnership ... and the share of any such member of that income ... is not reasonable in the circumstances having regard to the capital invested in or work performed for the partnership by the members thereof or such other factors as may be relevant, that share shall, notwithstanding any agreement, be deemed to be the amount that is reasonable in the circumstances".

Once you have completed your review of the work performed by the Partner, you will be able to determine whether the allocation of the Partnership's income is reasonable in the circumstances. The determination of whether or not the allocation of the Partnership profits is reasonable could include the following:

? A comparison of income allocated to the Partner and the "salary" that would have been paid to an arm's length person for the performance of the work performed by the Partner.

? The Taxpayer has put forth the argument that he paid a XXXXXXXXXX% administration fee to the agency that he was working for prior to starting the Partnership and that it is therefore reasonable to allocate a similar amount to the Partner for her work as a replacement for the agency. A comparison of the services provided by the agency and the services performed by the Partner would be indicative of the value of the Partner's contribution to the Partnership.

? All of the income generated by the Partnership is from the computer programming done by the Taxpayer. The amount and value of the "administrative" work being done by the Partner will be relevant to the determination of whether or not allocating XXXXXXXXXX% of the Partnership's profits to the Partner's is reasonable.

Regardless of whether the Taxpayer is considered to be self-employed or a partner of the Partnership, the personal use of any property which is also used to earn income from a business is not deductible in computing income from that business pursuant to paragraph 18(1)(h) of the Act. For example, the Taxpayer has indicated that they use their living room and dining room as their office and therefore claim XXXXXXXXXX of their rent as office space. However, they also indicate that only XXXXXXXXXX% of the Taxpayer's work is done at home. Unless the living room and dining room are used exclusively for business use, a portion of the amount claimed as rent would be in respect of the personal use of that space and is, therefore, not deductible in computing business income. A review of each expense claimed as a business expense would determine whether there is any portion of the expense that is a personal or living expense and, as such, not deductible in computing business income by virtue of paragraph 18(1)(h) of the Act.

We hope our comments are of assistance. If you wish to discuss any of the above further, or if we can be of any further assistance after you have completed your review, do not hesitate to contact us at the above number.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at 613 957-0682. The severed copy will be sent to you for delivery to the client.

John Oulton, CA
Section Manager
Business and Individual Section
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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