2002 Ruling 2002-0133063 - PARTNERSHIP-INCORPORATION

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

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

Reasons: same as 2001-0102663 and E 9915403, with some additional reorgs (use of an holdco)

XXXXXXXXXX 2002-013306

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of XXXXXXXXXX.

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

(a) dealt with in an earlier return of the taxpayer(s) or a related person,

(b) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer(s) or a related person,

(c) under objection by the taxpayer(s) or a related person,

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

(e) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

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

"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 specified Part or provision of the Act;

"ACo" means the company to be incorporated under the provisions of the Company Act, R.S.B.C. 1996, c.62, as amended, as described in Paragraph 5;

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

"CCRA" means the Canada Customs and Revenue Agency;

"Holdco" means the company to be incorporated under the provisions of the XXXXXXXXXX, as amended, as described in Paragraph 7;

"XXXXXXXXXX Company" means any company that will be incorporated under the provisions of the XXXXXXXXXX, as amended, for the benefit of any individual Partner and which will qualify as a "XXXXXXXXXX corporation", as defined by XXXXXXXXXX.

"Limited Partnership" means the limited partnership formed pursuant to that agreement, dated XXXXXXXXXX, for the purpose of providing administrative and management services to the Partnership;

"Paragraph" refers to a numbered paragraph in this letter;

"Partners" means the partners of the Partnership and "Partner" refers to any partner of the Partnership;

"Partnership" means XXXXXXXXXX;

"Practice" means the professional practice of XXXXXXXXXX presently carried on by the Partnership;

"Professional" refers to each individual XXXXXXXXXX who presently provides professional services to the Partnership as required in the Practice, whether as a Partner, an employee of the Partnership, or as an independent contractor in respect of the Partnership; and

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

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

Facts

1. The Partnership is comprised at present of XXXXXXXXXX, each of whom is a Partner. The Partnership also employs a number of XXXXXXXXXX as employees of the Partnership to assist the Partnership in offering its XXXXXXXXXX services to the public. Furthermore, there are a number of self-employed XXXXXXXXXX who provide various professional XXXXXXXXXX services to the Partnership and these persons are neither employees of the Partnership nor Partners. The taxpayers that are applying for this advance income tax ruling are all of the Partners (see Schedule "A"). The Partners file their respective income tax returns and the Partnership files its information returns with the XXXXXXXXXX Tax Services Office of the CCRA.

2. The Limited Partnership employs the administrative, accounting, and secretarial staff in support of the business of the Partnership and leases various equipment to the Partnership. The limited partners of the Limited Partnership may be a Partner, a person who is related (within the meaning of section 251 of the Act) to a Partner, or a trust whose beneficiaries may include a Person or a person related to such Partner.

3. The Partners are bound by the terms of a written partnership agreement, dated XXXXXXXXXX (the "Partnership Agreement"). The key terms of the Partnership Agreement include the following:

(a) The Partnership appoints a management committee ("Management Committee"), comprised of XXXXXXXXXX Partners, for the purpose of managing the affairs of the Partnership. Each member of the Management Committee is appointed to serve a general term of XXXXXXXXXX years;

(b) Each Partner is entitled to one vote in all matters requiring a vote of the Partnership, regardless of the number of years that the Partner has been a Partner and regardless of whether the Partner is a member of the Management Committee;

(c) Each Partner is entitled to a share of the profits of the Partnership as determined on an annual basis by a compensation committee comprised of XXXXXXXXXX Partners and approved by the Partnership. The amount so determined for each Partner forms the basis for monthly draws received by each Partner;

(d) Each Partner must contribute the same amount of capital to the Partnership regardless of his or her share of the profits of the Partnership;

(e) Each Partner is entitled to XXXXXXXXXX weeks of vacation per calendar year;

(f) The fiscal year end of the Partnership is XXXXXXXXXX;

(g) Each Partner must retire from the Partnership upon reaching the age of XXXXXXXXXX years unless the Partnership determines otherwise;

(h) Upon retirement from the Partnership, each partner is entitled to a return of his or her capital of the Partnership and a certain amount of retirement income. These amounts may be paid in instalments by the Partnership; and

(i) A Partner may be expelled from the Partnership by a special resolution of the Partnership in the case that the Partner is no longer contributing to the Partnership or is guilty of conduct which is unbecoming of a XXXXXXXXXX.

4. All of the Partners are residents of Canada for purposes of the Act and deal with each other at arm's length for purposes of the Act.

Proposed Transactions

5. ACo will be incorporated under the laws of the Province of XXXXXXXXXX having an authorized capital comprised of XXXXXXXXXX classes of shares, the most relevant of which are as follows:

(a) XXXXXXXXXX Class A common shares with a par value of $XXXXXXXXXX each ("Class "A" Shares"),

(b) XXXXXXXXXX Class B common shares with a par value of $XXXXXXXXXX each ("Class "B" Shares"), and

(c) XXXXXXXXXX Class D Preferred shares with a par value of $XXXXXXXXXX ("Class "D" Shares") each.

The Class "A" Shares are essentially voting but not participating shares whereas the Class "B" Shares are non-voting but participating as to dividends and liquidation amounts. The Class "D" Shares are "high-low" preferred shares with nominal capital for corporate law purposes.

6. Upon the incorporation and organization of ACo, each Partner will subscribe for, and ACo will issue one Class "A" Share at a price equal to its fair market value of $XXXXXXXXXX each. ACo will be a Canadian-controlled private corporation and a taxable Canadian corporation.

7. Holdco will be incorporated under the laws of the Province of XXXXXXXXXX having an authorized capital comprised of XXXXXXXXXX classes of shares, the most relevant of which are as follows:

(a) XXXXXXXXXX Class "A" common shares with a par value of $XXXXXXXXXX each; and

(b) XXXXXXXXXX Class "B" common shares with a par value of $XXXXXXXXXX each.

The rights and restrictions associated with these shares will be similar to the Class "A" Shares and Class "B" Shares respectively of ACo.

8. Upon the incorporation and organization of Holdco, each of the Partners will subscribe for and be issued one Class "A" common share of Holdco for its fair market value of $XXXXXXXXXX each.

9. A discretionary trust, the terms of which will qualify as a "personal trust" as defined in the Act, will be established for the benefit of the Partners and this trust will subscribe for and be issued XXXXXXXXXX Class "B" Shares of Holdco at a subscription price equal to its fair market value of $XXXXXXXXXX each. It is anticipated that Holdco will be used to acquire "key man" life insurance on the lives of the Partners.

10. Holdco will subscribe for and be issued XXXXXXXXXX Class "B" Shares of ACo at a subscription price equal to its fair market value of $XXXXXXXXXX each.

11. The Partnership will sell all of its assets (the "Assets") used in the Practice for proceeds equal to the fair market value of the Assets to ACo and in consideration of such sale, ACo will:

(a) assume all of the liabilities and obligations of the Partnership, including its obligations to the Limited Partnership (the "Assumed Debt");

(b) execute and deliver an interest-free demand promissory note (the "Note") having a principal amount equal to the difference between the aggregate cost amount of the Assets to the Partnership immediately before the time of sale for purposes of the Act and the amount of the Assumed Debt; and

(c) issue XXXXXXXXXX Class "D" Shares having an aggregate redemption amount equal to the difference between the fair market value of the Assets and the aggregate cost amount of the Assets to the Partnership immediately before the time of sale.

12. Aco and all of the Partners will jointly elect pursuant to subsection 85(2) of the Act, in the form prescribed under the Act, and within the time permitted by subsection 85(6) of the Act in respect of each of the Assets of the Partnership that is an "eligible property" as defined in subsection 85(1.1) of the Act (other than cash or accounts receivable of the Partnership). An election under section 22 of the Act will be made regarding the accounts receivable transferred from the Partnership to ACo. Insofar as the election made under section 85 of the Act is concerned, 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(1)(c.1)(i) and (ii) of the Act, 85(1)(d)(i), (ii) and (iii) of the Act, 85(1)(e)(i), (ii) and (iii) of the Act, 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 amount permitted by paragraph 85(1)(b) of the Act.

13. On the day immediately following the sale of the Assets to ACo, the Partnership will wind up its affairs. Immediately before the winding up, the Partnership will have no assets other than property received from ACo as consideration for the sale of the Assets referred to in Paragraph 11. Specifically, the only property owned by the Partnership will be the XXXXXXXXXX Class "D" Shares and the Note. Upon the winding up of the Partnership, each Partner will receive, in complete satisfaction of his or her capital interest in the Partnership, a pro rata share of the Class "D" Shares, and Note, based on his or her respective capital interest in the Partnership. In accordance with paragraph 2 of Interpretation Bulletin IT- 378R, winding up of a Partnership ("IT-378R"), dated February 15, 1980, and for legal simplification and administrative ease:

(a) the XXXXXXXXXX Class "D" Shares shall be issued in the names of the Partners, instead of in the name of the Partnership, so that each Partner will have that number of Class "D" Shares issued in his or her name that corresponds to the pro rata capital interest of that Partner in and to the XXXXXXXXXX Class "D" Shares (rounded to the nearest whole number), and

(b) a series of promissory notes each having terms similar to the Note executed by ACo having an aggregate principal amount equal to the principal amount of the Note will be delivered in the names of the Partners, and the principal amount of a particular note so delivered in the name of a particular Partner will correspond to the pro rata capital interest of that Partner in and to the Note.

It is the intent of ACo, the Partners and the Partnership to have the Class "D" shares and the Note beneficially owned by the Partnership and not by the individual Partners themselves at the time of issue or execution. It is also intended (see paragraph 2 of IT-378R) that this procedure will not invalidate the application of section 22, subsection 85(2) of the Act or the subsequent application of subsection 85(3) of the Act.

14. The shareholders of ACo will elect the directors for ACo and it is anticipated that each holder of a Class A Share will be a director of ACo. The directors of ACo will elect the officers of ACo, which may include the office of president, vice-president, secretary and treasurer.

15. A "shareholders' agreement" will be prepared and signed by all of the shareholders of ACo. It will create the main rules that will exist between the shareholders of ACo and ACo itself and will include the following key provisions:

(a) The business of ACo will be the Practice;

(b) ACo will carry out its professional services by contracting with independent contractors, employees, and XXXXXXXXXX Companies;

(c) Each shareholder of ACo may be required to contribute, loan or guarantee additional working capital for ACo if such contribution is unanimously agreed to by all of the shareholders of ACo;

(d) The board of directors of ACo will have the sole discretion to issue Class "A" Shares to a new shareholder of ACo;

(e) At the sole right discretion of the board of directors of ACo, the net profits of ACo will be available for distribution annually in the form of dividends on the outstanding Class "B" Shares, as well as in the form of director's fees;

(f) The issued shares of ACo shall not be transferred, repurchased or redeemed, as the case may be, except with the approval of the board of directors of ACo and except in the following situations:

(i) upon the death or retirement of an individual who owns a Class "A" Share;

(ii) upon the transfer of the shares, other than Class "A" Shares, of ACo to a company, controlled and owned by the transferor; and

(iii) upon the termination of XXXXXXXXXX services provided by the transferor (or a XXXXXXXXXX Company of the transferor) to ACo; and

(g) To ensure that ACo has sufficient working capital, the holders of any shares or indebtedness of ACo agree not to demand repayment or redemption of the indebtedness or shares, as the case may be, unless such holders or a XXXXXXXXXX Company of such holders will cease to provide XXXXXXXXXX services to ACo.

16. ACo will conduct its Practice by providing professional XXXXXXXXXX services to the public in the following ways:

(a) Through individuals who are XXXXXXXXXX, employed by ACo to provide such services;

(b) Through individuals who are XXXXXXXXXX, engaged by ACo as independent contractors to provide such services to ACo; and

(c) Through XXXXXXXXXX Companies engaged by ACo as independent contractors to provide services to ACo.

17. Each Partner or existing independent contractor presently providing XXXXXXXXXX services to the Partnership will have the choice of providing professional XXXXXXXXXX services to ACo by:

(a) entering into an employment agreement with ACo,

(b) entering into a contract as an independent contractor with ACo, or

(c) forming a XXXXXXXXXX Company to enter into a contract to provide XXXXXXXXXX services as an independent contractor to ACo.

Each existing employee of the Partnership will have no choice but to enter into an employment agreement with ACo.

18. The Professionals that choose or are required to enter into an employment arrangement with ACo will be required to sign a written employment agreement. This employment agreement will provide, but will not be limited to, the following conditions:

(a) ACo will provide a detailed description of the position of employment and control the duties that the employee would be required to perform;

(b) Upon completion of a XXXXXXXXXX probationary period and assuming that the employee has satisfactorily met all of the requirements for employment with ACo, the period of employment would continue indefinitely until either ACo or the employee terminates the employment contract. Either party would be required to provide the other party with at least XXXXXXXXXX written notification before terminating the contract;

(c) The employee will be paid an annual salary, which will be determined each year during the employee's annual review process. ACo will pay the employee on a monthly, semi-monthly or biweekly basis, and will withhold source deductions, specifically, income taxes, employment insurance premiums and Canada Pension Plan contributions;

(d) ACo will be responsible for paying all professional expenses related to the employee's services, including but not limited to the following:

(i) professional membership fees and dues;

(ii) professional insurance;

(iii) travel expenses, including motor vehicle, accommodations and meal expenses;

(iv) professional development courses or seminars that ACo requires the employee to participate in; and

(v) any entertaining expenses that ACo requires the employee to incur;

(e) ACo will provide all tools, equipment, books and supplies that are necessary to the employee to carry out their terms of employment;

(f) The employee is entitled to XXXXXXXXXX maternity/paternity leave during each calendar year; and

(g) An employee's vacation entitlement each year is dependent upon the number of years of service that they have provided. Employees are generally eligible for XXXXXXXXXX paid vacations.

19. The Professionals that choose to enter into a contractual arrangement with ACo as an independent contractor will be required to sign a written independent contractor agreement. This independent contractor agreement will provide, but will not be limited to, the following conditions:

(a) The Professional will provide XXXXXXXXXX services to ACo and will be compensated based on:

(i) the amount of fees collected by ACo and attributable to hours of services rendered by the Professional; and

(ii) the amount of fees collected by ACo and attributable to work referred to ACo by the Professional.

At the commencement of every taxation year of ACo, the amount of compensation for each Professional will be estimated and calculated as an annual amount in advance and will be negotiated by ACo with each Professional. A portion of such annual amount may be paid by ACo in monthly instalments to the Professional subject to working capital requirements of ACo. In general, the amount of compensation received by the Professional will vary depending on the volume of hours of service rendered by the Professional. In other words, the more fees collected by ACo based on work performed by the Professional, the more revenue for the Professional. After the end of each particular taxation year of ACo, there will be a final adjustment to the compensation paid to the Professional for such year as the financial accounts of ACo would have been completed and the volume of service and referrals of the Professional for that year can be accurately determined.

(b) ACo and the contracting Professional shall agree to consider their relationship to be that of hirer and independent contractor. The contracting Professional shall provide the XXXXXXXXXX services as required by ACo for its Practice;

(c) The contract will be for a fixed period of one year and can be renegotiated on a renewal basis if both parties decide to continue with the working relationship;

(d) Either ACo or the independent contractor may terminate the contract. The party terminating the contract must provide the other party with written notification of his or her termination at least XXXXXXXXXX days prior to his or her date of leaving;

(e) The requirements of the independent contractor shall be mutually agreed upon between ACo and the independent contractor. There will be a minimum number of workdays per year that the Professional agrees to provide to ACo. The Professional can determine what days and hours they will work, without ACo setting the hours that they will work. If the Professional performs no services in the year to ACo, he or she will not be paid;

(f) Within a reasonable period of time after the end of each fiscal year of ACo, the independent contractor will provide an invoice to ACo specifying the amount of services provided to ACo for the year and the amount of work referred to ACo for the year;

(g) All payments made by third parties for professional services provided by an independent contractor for the benefit of ACo will be paid directly to ACo;

(h) ACo will provide the Professional with an office located at the business premises of ACo and secretarial support where needed. ACo will also furnish the office occupied by the contractor with standard furniture, telephone systems, and computer equipment required by the independent contractor in providing their professional services;

(i) the Professional will be responsible for incurring such expenditures, including but not limited to the following, as follows in the performance of his or her professional services to ACo:

(i) professional membership fees and dues;

(ii) professional insurance;

(iii) travel expenses, including motor vehicle, accommodations and meal expenses;

(iv) professional development courses or seminars;

(v) any entertaining expenses related to his or her profession; and

(j) the Professional will not be entitled to any paid vacations or leaves for maternity or paternity purposes.

20. The Professionals that choose to form a XXXXXXXXXX Company to provide services to ACo, will cause the XXXXXXXXXX Company to provide professional services upon the same basis as the independent contractors discussed above, and evidenced by a written contract between ACo and the XXXXXXXXXX Company, having terms substantially similar to those outlined in Paragraph 19.

21. For greater certainty, ACo requires that each XXXXXXXXXX Company be a taxable Canadian corporation and a Canadian-controlled private corporation.

22. The Professionals of a XXXXXXXXXX Company will be employees of the XXXXXXXXXX Company pursuant to a written employment contract between the XXXXXXXXXX Company and the Professionals.

23. ACo shall prepare a budget each year to calculate its approximate revenues and expenses for the year. ACo will determine its payments to the contracting professionals and contracting companies, as set out in each contractual agreement. ACo will endeavour to operate in such a manner that will result in annual net profits to ACo. The directors of the company will have the sole discretion to:

(a) have the taxable income of ACo limited to the maximum amount of the "business limit" as defined in subsection 125(2) of the Act or other amount as may be revised from time to time;

(b) distribute any excessive taxable income of ACo to the directors of ACo in the form of a bonus;

(c) pay consulting fees to any retired Professional that continues to provide services to ACo;

(d) pay a dividend on the XXXXXXXXXX class B shares held by Holdco; or

(e) carry out a combination of points (a), (b) and (c) above.

Purposes of the Proposed Transactions

The purposes of the proposed transactions are to restructure the Partnership to provide the following advantages to the Professionals:

(a) To provide more options and control to each Professional for estate and succession planning. As well, it is generally easier and less costly to transfer shares in a company than it is to dispose of a partnership interest;

(b) To provide more flexibility and control to each Professional:

(i) in determining the hours and days that he or she will work;

(ii) in deciding on an individual basis the amount of effort and time that he or she wants to exert in his or her practice;

(iii) in incurring expenditures related to the profession;

(iv) to see a direct result between effort and time put into the practice and his or her earnings;

(v) to take leave for study and courses; and

(vi) to take vacations;

(c) Each Professional will be responsible for the financing, investing, directing and operating of his or her own practice either as an independent contractor or as an employee of a XXXXXXXXXX Company. This structure provides the opportunity for each Professional to manage the overall profitability and well being of his or her own practice;

(d) The new structure provides increased flexibility in determining the level of income earned personally by those Professionals that decide to provide their services through a XXXXXXXXXX Company. Any income that is not needed personally can be taxed and reinvested in the corporation; and

(e) The restructuring will improve the position of each Professional with respect to joint and several liability inherent in providing professional XXXXXXXXXX services through a general partnership.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all 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 follows:

A. Subsection 85(2) and subsection 85(3) of the Act will apply to the sale of the Assets and wind-up of the Partnership as referred to in Paragraph 11 and Paragraph 13 respectively.

B. Where, in a taxation year of ACo, a XXXXXXXXXX Company is hired as an independent contractor to provide XXXXXXXXXX services to ACo as described in Paragraph 19, and Paragraph 20, the amount of compensation paid by ACo to XXXXXXXXXX Company will be deductible under section 9 of the Act in computing the income of Aco within the limitations imposed by paragraph 18(1)(a) and section 67 of the Act.

C. Provided that a XXXXXXXXXX providing XXXXXXXXXX services through a XXXXXXXXXX Company does not provide such services to ACo in his or her capacity as an employee or officer of Aco, a XXXXXXXXXX Company will not be considered to be carrying on a "personal services business", as defined in subsection 125(7) of the Act, in relation to the XXXXXXXXXX services it provides to ACo in that taxation year.

D. Provided that a partnership does not exist between ACo and any XXXXXXXXXX Company, the income of ACo and any XXXXXXXXXX Company will not be considered "specified partnership income" within the meaning of subsection 125(7) of the Act.

E. Provided that the dividend described in paragraph 23(d) above is a taxable dividend, such dividend received on the class B shares held by Holdco will not be subject to tax under Part IV of the Act, except as provided by paragraph 186(1)(b) of the Act.

F. Subsection 245(2) of the Act will not apply to redetermine the tax consequences described in the rulings given.

These rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R4, issued by the CCRA on January 29, 2001, and are binding on the CCRA, provided that the proposed transactions described herein are completed by XXXXXXXXXX.

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

OPINION

A direction in accordance with subsection 256(2.1) of the Act is based on a year-to-year basis, and therefore we are unable, pursuant to paragraph 15(j) of Information Circular 70-6R4, to rule that this provision will not be applied. However, we are prepared to offer the following 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. 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 as is contemplated in this Ruling, 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 represent our general views and as indicated in paragraph 22 of Information Circular 70-6R4, the above opinions do not constitute an income tax ruling and accordingly are not binding on the CCRA. Our practice is to make this disclaimer in all instances in which we provide an opinion.

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

(i) the determination of cost, fair market value, adjusted cost base, cumulative eligible capital, or undepreciated capital cost of any property referred to in this letter;

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

(iii) 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