2002 Ruling 2002-0134013 - PARTNERSHIP RESERVE AVOIDANCE

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 Principal will be entitled to 34.2(4) reserve after most of his interest in the partnership is transferred to a corporation that he controls
2. whether income in 34.2(4)(c) is limited to income earned as a partner

Position:1 only in the year when the Principal transfers 90%of his interest in the Partnership to his corporation. In subsequent years the Principal cannot claim a reserve

2. no - income will include income earned by the taxpayer through the corporation: see ITA (also see Dec 1995 technical notes "income ...(from all sources)"

Reasons: 1. in the year when the Principal transfers 90%of his interest in the Partnership to his corporation the criteria in 34.2(6)(c)(i) would be satisfied at the beginning of the year and the anti-avoidance rule would not apply at that time. However, in subsequent years the anti-avoidance rule in (7) would prevent the Principal from claiming a reserve

XXXXXXXXXX 2002-013401

XXXXXXXXXX, 2002

Re: XXXXXXXXXX
Advance Income Tax Ruling

Dear XXXXXXXXXX:

We are writing in response to your letter of XXXXXXXXXX, wherein you requested advance income tax rulings on behalf of the above taxpayer, your letter dated XXXXXXXXXX and our (XXXXXXXXXX) telephone conversations.

To the best of your knowledge, and that of the taxpayers involved, 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) "CCRA" means the Canada Customs and Revenue Agency;

(c) "Partnership" means XXXXXXXXXX;

(d) "Principal" means XXXXXXXXXX (social insurance number: XXXXXXXXXX), who resides at XXXXXXXXXX; and

(e) "Principal's Professional Corporation" ("PPC") means a corporation to be incorporated under the Canada Business Corporations Act, and is described in paragraph 5 below.

FACTS

1. Principal was a partner of XXXXXXXXXX operating throughout Canada.

2. On XXXXXXXXXX dissolved and distributed its assets proportionately, in accordance with the provisions of subsection 98(3) of the Act.

3. XXXXXXXXXX.

PROPOSED TRANSACTIONS

4. Principal will incorporate PPC. Principal will own all the shares of PPC.

5. In XXXXXXXXXX, Principal will transfer XXXXXXXXXX% of his partnership interest in the Partnership to the PPC, for non-share consideration equal to the adjusted cost base of Principal's interest in the Partnership and for common shares in PPC with a fair market value equal to the difference between the estimated fair market value and the adjusted cost base, as defined in section 54 of the Act, of Principal's interest in the Partnership. PPC will carry on the business of the Partnership. For cultural internal reasons, Partnership wishes that its partners remain as partners of the firm, even if a professional corporation is being used.

6. All income earned by PPC, net of expenses incurred to carry on the business and income taxes, shall be distributed to Principal, either by way of salary or by way of income from business. It is possible PPC may elect to retain its profits and not distribute them.

7. As a partner of the Partnership, the amount of income eligible for the small business deduction allocable to PPC will likely be less than $XXXXXXXXXX per annum.

PURPOSE OF PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to enable Principal to obtain the benefit of statutory provisions in Ontario that permit professionals to incorporate their practice, while enabling Principal to continue to claim the reserve in section 34.2 of the Act in 2002.

RULING GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant warranties in paragraphs (i) to (v) on page 1 of this advance income tax ruling, as well as 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 ruling is as set forth below:

Subject to the opinion below with respect to taxation years ending after XXXXXXXXXX, Principal's income from all sources, including income that it receives from PPC, for Principal's taxation year ending XXXXXXXXXX will be included in computing Principal's income for that year within the meaning assigned by paragraph 34.2(4)(c) of the Act.

CAVEAT

The above ruling is given subject to the general limitations and qualifications set out in Information Circular 70-6R4 issued by the CCRA on January 29, 2001, and is binding provided the proposed transactions described in paragraphs 4 and 5 above are completed on or before XXXXXXXXXX.

This ruling is based on the Act in its present form and does not take into account the effect of any proposed amendments to the Act. Nothing in this letter should be construed as implying that the CCRA has agreed to or accepted any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

OPINION

You have asked for a ruling that paragraph 34.2(6)(c) of the Act will not apply to preclude Principal from deducting a reserve in his taxation years ending after XXXXXXXXXX. As we advised you, we cannot provide this ruling. In our opinion we consider that it is reasonable to conclude that one of the main reasons Principal will be a member of Partnership is to avoid the application of subparagraph 34.2(6)(c)(i) of the Act and therefore subsection 34.2(7) of the Act will apply to preclude Principal from claiming a reserve under section 34.2(4) of the Act in computing his income for taxation years ending after XXXXXXXXXX.

Yours truly,

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