28 November 2002 Internal T.I. 2002-0174427 - PARTNER STUB PERIOD EARNINGS PART 1.3

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:

Is it appropriate to determine the amount of a corporate partner's stub period undistributed earnings that should be excluded from the computation of the corporate partner's capital for purposes of Part I.3 of the Act, by simply taking the change in the partner's equity account during the stub period.

Position: No

Reasons:

While such an approach may give the correct adjustment amount, it will give an incorrect adjustment amount where the corporate partner has made contributions to the partnership during the stub period or has withdrawn non-stub period earnings during the stub period.

			November 28, 2002

	CALGARY TSO	HEADQUARTERS
	V& E Division		Financial Industries
	Abu Dandia		  Division
			Alison Campbell
(613) 957-3496

2002-017442

Part I.3 Partnership Earnings Issue

We are writing in reply to your enquiry related to proposed adjustments in the amount of earnings from a partnership of which the taxpayer is a member, that should be included in computing the taxpayer's capital for the purposes of Part I.3 of the Income Tax Act (the "Act").

The Income Tax Rulings Directorate most recently commented on the treatment of partnership earnings in computing the capital of a corporate partner in documents 2001-0078917 and 2001-0074287. In general, earnings of the partnership for the fiscal period of the partnership that ends in the corporate partner's fiscal period are to be included in the capital of the corporate partner for purposes of computing capital under Part I.3 of the Act. This is true whether or not the earnings of the partnership for its fiscal period end have been distributed to the corporate partner or not.

The inclusion of stub period earnings of the partnership will generally depend upon whether the earnings from the stub period have been distributed to the corporate partner or not. By "stub period" we are referring to the period from the end of the partnership's fiscal period end and the corporate partner's fiscal period end. Where a partnership distributes some or all of its stub period earnings to a corporate partner prior to the end of the corporate partner's fiscal period, the distribution is in respect of amounts earned by the partnership during the stub period (i.e. not a distribution of amounts earned in prior fiscal period(s) of the partnership), and the amount of the distribution has been recorded in the corporate partner's accounts in accordance with GAAP by a debit to cash and a credit to retained earnings, our general view is that the amount of the distribution should be included in the capital of the corporate partner under paragraph 181.2(3)(a). This same result would occur if the distribution were characterized as an advance. With respect to undistributed stub period earnings of a partnership, it is our general view that such amounts would not be included in the corporate partner's taxable capital.

We have reviewed the information you provided to us and have the following comments:

1) Adjusting the corporate partner's computation of capital for purposes of Part I.3 tax, by the change in the corporate partner's partnership equity account during the stub period can lead to an incorrect adjustment for stub period earnings. This will be the case if there were any partnership contributions or distributions of non-stub period earnings.

2) For the years for which you have provided information, we note that there do not appear to have been any distributions of any kind to, nor any contributions by the corporate partner. Therefore, except for the wrong proportion being applied in the 1994 reassessment (i.e. 100% rather than 98%), it appears that the adjustment in respect of stub period earnings made in respect of the 1994 and 1995 taxation years were correct.

3) In respect of any taxation years at issue, for which you have not provided information to us, the adjustment to capital in respect of undistributed stub period partnership earnings should be the actual undistributed stub period earnings and not simply the change in the partner's equity account during the stub period.

We have attached to this memo, our analysis of the corporate partner's equity changes from December 31, 1993 to December 31, 1995, which we hope will be of assistance to you in determining the appropriate adjustments for any subsequent periods.

With respect to the issue of waiving interest on the proposed reassessment, we understand that your TSO has a committee that is responsible for making determinations on such issues under the fairness package. Accordingly, your fairness committee should make the determination as to whether any interest charges should be waived.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. 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 electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

We trust that our comments have been assistance to you.

F. Lee Workman
Manager
Financial Industries Division
Income Tax Rulings Directorate
Policy & Legislation Branch