28 May 2002 External T.I. 2002-0131535 - incorporation-professional

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. Would a lawyer's newly incorporated professional corporation be eligible for the small business deduction?

2. Would the lawyers' management corporation be eligible for the small business deduction?

3. Would any of the corporations be associated and have to share the "business limit" for ``the year?

Position:

1. Yes, as long as the corporation is not carrying on a "personal services business", as defined in subsection 125(7) of the Act.

2. Not enough information to comment.

3. Subject to the possible application of subsection 256(2.1), they do not appear to be associated and therefore would not have to share the business limit.

Reasons:

1. If it carried on a personal services business, income earned would not be from an active business. Consequently it would not have any "specified partnership income" and it would not have any income subject to the small business deduction in subsection 125(1) of the Act.

2. Insufficient information to provide comments, other than our comments with respect to issue 3.

3. Reading of sections 125 and 256 of the Act.

XXXXXXXXXX 		2002-013153
		Allan Nelson, C.M.A.
(613) 443-7253
May 28, 2002

Dear XXXXXXXXXX:

Re: Technical Opinion Request

We are writing in reply to your letter to us dated March 19, 2002, concerning the taxation of professional corporations and their management services entity.

You have asked us to consider the following hypothetical set of facts:

? Mr. A, Mr. B and Mr. C (collectively referred to as the "Original Partners") are unrelated Canadian resident individuals who are partners in a limited liability partnership practicing law in Canada ("the Law Partnership"). They each own a one-third interest in the Law Partnership;

? ManagementCo was incorporated a number of years ago and solely provides administrative support services to the Law Partnership, and bills the Law Partnership on a cost + 15% basis. The Original Partners each own one-third of the shares of ManagementCo. All non-professional staff that would otherwise be employed by the Law Partnership are employed by ManagementCo;

? As a result of recent changes to the Ontario Business Corporations Act, the creation of professional corporations is now permitted. Consequently, on the first day of the current taxation year, Mr. A, Mr. B and Mr. C will each transfer their particular interest in the Law Partnership into a separate professional corporation of which each individual will be the sole shareholder (i.e., "Aco", "Bco" and "Cco", respectively. In this letter these corporations are collectively referred to as the "Professional Corporations"). Each of the Partners will file a valid election under subsection 85(1) of the Act to carry out this transfer to their particular Professional Corporation at the adjusted cost base of their respective interest in the Law Partnership;

? The Professional Corporations and ManagementCo will all be taxable Canadian corporations and Canadian-controlled private corporations;

? Each Original Partner will become the sole employee of his respective Professional Corporation. The Professional Corporations will use their respective employees (i.e., the Original Partners) to provide the professional services on behalf of the Law Partnership that were previously carried out by the Original Partners. These transactions and the existence and operation of the Professional Corporations are fully compliant with the bylaws of the Law Society of Upper Canada; and

? The Law Practice generates net income for the current year, of which one-third is allocated to each of the Professional Corporations, under the terms of the Law Partnership agreement. Each of the Original Partners draws a reasonable salary from their respective Professional Corporation, leaving each Professional Corporation with taxable income to report.

Your View

You have asked us to confirm your view that

a) the Professional Corporations will have specified partnership income for the purposes of subparagraph 125(1)(a)(ii) of the Act and will be eligible for the small business deduction,

b) ManagementCo will also qualify for the small business deduction, and

c) ManagementCo will not be associated with any of the Professional Corporations under section 256 of the Act and therefore would not be required to share the annual business limit with any of the Professional Corporations under subsection 125(3) of the Act.

Our Comments

As explained in Information Circular 70-6R4, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. If your situation involves a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments, which may be of some assistance to you.

Where individual partners who were previously carrying on a law practice in a Canadian partnership transfer their respective partnership interests to their newly incorporated corporations, become employees of their respective corporations, and subsequently carry on the law practice in Canada using the revised structure, such as is described above, generally, this will not in and of itself result in

a) a Professional Corporation being denied the small business deduction, in subsection 125(1) of the Act, to the extent that the Professional Corporation is not carrying on a "personal services business", within the meaning of subsection 125(7) of the Act,

b) the elimination of ManagementCo's entitlement to claim the small business deduction, as otherwise provided for in section 125 of the Act, or

c) ManagementCo being associated with any of the Professional Corporations under section 256 of the Act. Consequently, so long as they are not associated in the year with any other Canadian-controlled private corporation, each of the Professional Corporations and ManagementCo could have their own "business limit", as provided by subsection 125(2) of the Act. These comments are subject to the possible application of subsection 256(2.1) of the Act to associate two or more of the corporations. Subsection 256(2.1) of the Act will apply if it may reasonably be considered that one of the main reasons for the separate existence of the corporations in a taxation year is to reduce the amount of taxes that would otherwise be payable under the Act or to increase the amount of refundable investment tax credit under section 127.1 of the Act. A determination of the reasons for the incorporation of the Professional Corporations would have to be made to see if subsection 256(2.1) was applicable.

Ultimately, all of the above matters involve a question of fact that must be addressed before conclusive answers can be given. We do not have sufficient information to comment further at this time.

Additional Comments

In accordance with paragraph 22 of Information Circular 70-6R4, the above comments are only an expression of opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on the Canada Customs and Revenue Agency.

We hope the above will be of assistance to you.

Yours truly,

Milled Azzi, C.A.

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