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: Can a partner be allocated a larger loss than that incurred by a partnership? In this case, the loss incurred by the partnership was augmented by "salary" paid to one of the partners.
Position: No. However, if the taxpayers relied, to their detriment, on the position stated in IT-138R (cancelled) the TSO has the discretion to accept the taxpayers' partnership allocation for the taxation year in question.
Reasons: Modifications to IT-Bulletins that are not favourable to taxpayers are normally effective for the year the modification was made and subsequent taxation years. The allocation is not clearly inconsistent with the example in IT-138R, paragraph 11.
February 13, 2003
NEWFOUNDLAND & LABRADOR HEADQUARTERS
TAXATION SERVICES OFFICE Bob Naufal, CMA
(613) -957-2744
Attention: Debbie Anderson
2002-017691
Allocation of partnership income / loss
We are writing in response to your memorandum dated December 2, 2002 wherein you requested our views with respect to the allocation of partnership income / loss in a situation where only one partner is active in carrying on the business of the partnership.
You advised us that the taxpayers, a husband and wife, are the only members of a partnership that carries on a business venture engaged in the XXXXXXXXXX. Each taxpayer has a 50% interest in the partnership. The husband is involved full-time in carrying on the business of the partnership, while the wife is not active in the business. In recognition of the husband's efforts and skills in running the operations, for each fiscal period, the taxpayers agreed to allocate $XXXXXXXXXX "salary" to him, and then split the residual income or loss of the partnership equally between them. In determining the allocation formula, the taxpayers relied on information and examples set out in Interpretation Bulletin, IT-138R, Computation and flow-through of partnership income, dated January 29, 1979, which was cancelled (see the Index to Interpretation Bulletins and Technical News (the "Index") dated December 31, 2000).
For the fiscal period ended December 31, 2000, the partnership reported a loss of $XXXXXXXXXX before the "salary" allocation. Using paragraphs 10 and 11 of IT-138R as reference, the taxpayers allocated $XXXXXXXXXX as income to the husband and then allocated the residual loss (the amount determined by deducting $XXXXXXXXXX from the initial loss) on a 50/50 basis. The Newfoundland & Labrador Tax Services Office (the "TSO") reassessed the taxpayers, disallowing the $XXXXXXXXXX income allocation to the husband and split the partnership loss before "salary" 50/50. The taxpayers have objected to the reassessments, referring to the inconsistencies between IT-138R and other technical interpretations issued by the CCRA.
You have asked us whether the taxpayers may rely on IT-138R for the taxation year in question.
Computation and Allocation of Partnership Income
Subsection 96(1) of the Income Tax Act (the "Act") provides for the calculation of partnership income and loss at the partnership level, with resulting income or loss of the partnership allocated to each member of the partnership in accordance with paragraphs 96(1)(f) and 96(1)(g) of the Act.
Generally, a partner's share of the income or loss from a partnership depends on the partner's contribution of capital or other services rendered in the course of the partnership business and is generally set out in the partnership agreement. The partnership agreement may provide that one partner is entitled to receive a greater share of the profits than the other partners where that one partner has invested more capital or performs more work than the other partners. However, where two or more partners not dealing at arm's length have agreed to share any income or loss from any activity of the partnership in unreasonable proportions, subsection 103(1.1) of the Act provides that each partner's share of income is deemed to be the amount that is reasonable in the circumstances.
"Salaries" Paid to Partners
The Partnership Act of Newfoundland and Labrador states that a partnership is the relation that exists between persons carrying on a business in common with a view to a profit. In our view, paying a "salary" to one of the partners is inconsistent with the concept of carrying on a business. This view was conveyed by the CCRA most recently at the 2002 Canadian Tax Foundation Annual Conference. Therefore, a "salary" paid to a partner is not deductible in computing the income of the partnership.
Interpretation Bulletin, IT-138R
IT-138R, which contained the CCRA's interpretative position with respect to the computation and allocation of income of a partnership, was cancelled on December 31, 2000 because much of the information contained in that Bulletin was considered out of date. The information contained in the Bulletin was also considered redundant since information on the computation of partnership income could be found in Guide T4068, Guide for the Partnership Information Return.
Prior to the cancellation of IT-138R, paragraph 10 of that Bulletin stated that the income of a partnership in a fiscal period might be less than the amount paid to a partner under the terms of the partnership agreement. It further stated that the excess of the salaries over such income was considered as a deduction in the partner's capital account, and, in addition, allowed as a deduction in determining the allocation of income / loss of the partnership to the partner. Paragraph 11 of the Bulletin provided an example of the computation of partnership income or losses in circumstances where a "salary" paid to one partner actually created a loss allocable to the other partner. In our view, the example set out in paragraph 11 of the Bulletin could have mislead the taxpayers into believing that the salary paid to the husband would be deductible in computing the income of the partnership.
Paragraph 5 of the Index provides that an interpretation described in a bulletin applies as of the date the bulletin is published, unless otherwise specified. Where there is a change in a previous interpretation or position, in situations where the change is not favourable to taxpayers, the change is normally effective for the current and subsequent taxation years. With respect to IT-138R, the taxpayers could rely on statements therein, provided the fiscal period of the partnership ended on or before December 31, 2000.
Although it is not possible for a partner to be allocated an amount of income or loss greater than the income or loss realized by a partnership, we are of the view that, if the taxpayers relied on IT-138R to their detriment, the TSO has the discretion to accept the taxpayers' filing position for the taxation year in question.
Should you wish to discuss this matter further, do not hesitate to contact us.
Daryl Boychuk, LL.B
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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