2003 Ruling 2003-0009513 - PARTNERSHIP - WIND-UP

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: The Promoter proposes to create a master partnership that will invest in a lower-tier operating partnership. The lower-tier partnership will use the funds raised to acquire an XXXXXXXXXX business. After a start-up period estimated to last between XXXXXXXXXX months, the lower-tier partnership will transfer the business to a newly formed taxable Canadian corporation in exchange for preferred shares. Both the lower-tier and master partnership will wind-up and the partners will receive an undivided interest in the preferred shares of the corporation. The shares will be partitioned such that the undivided interest in the shares will become a divided interest. The partners will then exchange these preferred shares for common shares of the corporation.

The main issues raised were as follows:

1) Are the units of the master or lower-tier partnership a tax shelter?

2) Will section 54.2 of the Act apply on the transfer of the business of the lower-tier partnership to a taxable Canadian corporation to deem the shares received to be capital property?

3) Will subsection 98(3) of the Act apply to the wind-up of the master partnership?

4) Will subsection 248(21) of the Act apply to the partition of shares received on the winding up of the master partnership?

5) Will subsection 51(1) of the Act apply to the exchange of the preferred shares for common shares?

6) Does GAAR apply?

Position: 1) No; 2) Yes; 3) Yes; 4) Yes; 5) Yes; 6) GAAR will not apply.

Reasons: 1) Losses allocated under the master and lower-tier partnerships during the first four years will not exceed 99% of the cost of the partnership units; 2) Meets the requirements of section 54.2; 3) Meets the requirements of subsection 98(3); 4) The partitioning complies with subsection 248(21) of the Act; 5) The conversion complies with subsection 51(1) of the Act; 6) GAAR not applicable as it may reasonably be considered that the proposed transactions do not misuse any provisions of the Act or abuse the Act read as a whole.

XXXXXXXXXX 2003-000951

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Offering Partnership")

This is in response to your letters dated XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted Offering Partnership and the persons who will become members of the Offering Partnership.

To the best of your knowledge, and that of the general partner of the Offering Partnership, none of the issues contained in this ruling request is:

(i) dealt with in an earlier return of any prospective member of the Offering Partnership or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of any prospective member of the Offering Partnership or a related person;

(iii) under objection or appeal by any prospective member of the Offering Partnership or a related person; or

(iv) before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has expired.

Except as otherwise noted, all statutory references in this letter are to the Income Tax Act (Canada), R.S.C. 1985 c.1 (5th Supp.), as amended (hereinafter referred to as the "Act").

Except as otherwise noted, all dollar amounts described herein are to the Canadian dollar.

DEFINITIONS

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

"adjusted cost base" has the meaning assigned by section 54 of the Act;

"agreed amount" means the amount agreed upon by a partnership and a taxable Canadian corporation in respect of an election under subsection 85(2) of the Act;

"at-risk amount" has the meaning assigned by subsection 96(2.2) of the Act;

"Canadian partnership" has the meaning assigned by subsection 102(1) of the Act;

"capital property" has the meaning assigned by section 54 of the Act;

"CCRA" means the Canada Customs and Revenue Agency;

"eligible property" means property described in subparagraphs 85(2)(a)(i) to (iii) in respect of an election under subsection 85(2);

"General Partner" means the general partner of the Offering Partnership as defined in paragraph 9 below;

"Limited Partner(s)" means a limited partner(s) of the Offering Partnership;

"Note" means the promissory note as described in paragraph 30 below;

"Offering Limited Partnership Agreement" means the agreement governing the Offering Partnership;

"Offering Memorandum" means the document which governs the issuance of the units of the Offering Partnership;

"Offering Partnership" means XXXXXXXXXX as described in paragraph 7 below;

"paid-up capital" has the meaning assigned by subsection 89(1) of the Act;

"proceeds of disposition" has the meaning assigned by section 54 of the Act;

"Promoter" means XXXXXXXXXX;

"taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act; and

"tax shelter" has the meaning assigned by section 237.1 of the Act.

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

FACTS:

1. The Promoter of the Offering Partnership

a) is an XXXXXXXXXX citizen who has been living in XXXXXXXXXX for about XXXXXXXXXX years;

b) XXXXXXXXXX; and

c) is currently the principal in a XXXXXXXXXX for companies in the XXXXXXXXXX area.

2. The Promoter intends to raise funds to invest in areas which offer attractive economic incentives XXXXXXXXXX.

3. The Promoter perceives the realities of the XXXXXXXXXX economy are as follows:

XXXXXXXXXX.

4. The Promoter's business objective is to create a Canadian limited partnership with Canadian limited partners to take advantage of the synergy available when the partnership takes an early stage interest in the development of products, which it will later market, directly or indirectly. Among other things, the synergy would be achieved by attracting Canadian investors who have the ability to deduct losses relating to the business, subject to the limitations described in subparagraph 10(d) below.

5. The limited partners will only benefit financially from the proposed transactions set out below in the event that the underlying business acquired by the partnership generates value. That is, there is no intention to generate a "fiscal profit" by obtaining tax deductions in excess of cash invested and at risk.

6. XXXXXXXXXX.

PROPOSED TRANSACTIONS

7. A limited partnership, XXXXXXXXXX (the "Offering Partnership"), will register as an XXXXXXXXXX limited partnership.

8. Limited partnership units in the Offering Partnership will be sold to eligible subscribers (criteria for eligible subscribers are based on relevant provincial securities legislation). All of the Offering Partnership's partners will be residents of Canada. Therefore, the Offering Partnership will be a Canadian partnership. Under the terms of the Offering Limited Partnership Agreement, a partner will be required to dispose of his or her units prior to becoming a non-resident of Canada.

9. The general partner of the Offering Partnership ("General Partner") will be XXXXXXXXXX, a company incorporated under the Business Corporations Act (XXXXXXXXXX).

10. The Offering Partnership will have the following relevant attributes:

a) There will be two classes of partnership units. All limited partnership units will have equal entitlements to income. In addition, there will be general partnership units with an income entitlement described in d) and e) below.

b) The Offering Partnership will not incur any debt, other than relatively small amounts of debt incurred in the ordinary course of business and based on arm's length commercial terms for which the partnership will be fully at risk.

c) The Offering Limited Partnership Agreement will provide for the allocation of income and losses on the same basis for accounting and tax purposes.

d) The Offering Limited Partnership Agreement will provide for the allocation of income and losses as well as taxable capital gains and net capital losses of the Offering Partnership for each fiscal year among the partners of record at the end of the fiscal year as follows:

(i) income and taxable capital gains to be allocated:

(I) XXXXXXXXXX% to the General Partner; and

(II) XXXXXXXXXX% to the Limited Partners in proportion to the number of limited partnership units held by each Limited Partner at the end of the fiscal period of the Offering Partnership.

(ii) all of the losses of the Offering Partnership for each fiscal year to be allocated among Limited Partners in proportion to the number of limited partnership units held by each Limited Partner at the end of the fiscal period of the partnership, however, the total allocations to any particular Limited Partner for the fiscal periods of the partnership ending within 4 years after the subscription date for the limited partnership units shall not exceed the lesser of:

(I) 99% of the cost (within the meaning in subsection 237.1(1) of the Act) of the limited partnership unit(s) to the particular Limited Partner; and

(II) the "at-risk" amount of the particular Limited Partner, as computed under subsection 96(2.2) of the Act.

e) Cumulative losses in excess of the limits computed in paragraph d) above, if any, will be allocated to the General Partner.

11. The principal reason for allocating losses exclusively to the Limited Partners, within the limits described in subparagraphs 10 d) and 10 e) above, is to reduce the economic risk to the Limited Partners, who are bearing the financial cost of the investments.

12. The Offering Memorandum will include a statement that the income tax ruling obtained from the CCRA contains caveats.

13. Under the terms of the Offering Memorandum, pursuant to which investors will acquire their limited partnership units, the Offering Partnership will issue, in XXXXXXXXXX, a maximum of XXXXXXXXXX units at a subscription price of $XXXXXXXXXX per unit and will include an express agreement whereby Limited Partners undertake that they will not incur any debt with respect to the acquisition of their units.

14. The Promoter and his management team intend to provide management and consulting services under a contract to the Offering Partnership for an estimated fee of $XXXXXXXXXX until at least XXXXXXXXXX. These management services will include identifying investments and providing management services in respect of the business or businesses acquired by the Operating Partnership (described in paragraph 21 below).

15. The Offering Partnership will invest the net subscription proceeds in XXXXXXXXXX businesses that meet agreed upon investment criteria, which criteria include:

a) technical feasibility, including the ability to generate a marketable product in a niche area with a relatively low and achievable budget;

b) marketing potential;

and at least one of the following:

c) receipt prior to investment of, or eligibility for government financing under standard terms and repayable from any source of revenue generated from sales of product, know how or rights therein,

d) previous third party investment; and

e) having a ready to market product.

16. There will not be, at any time, any prescribed benefits, as described in subparagraph (b)(ii) of the definition of "tax shelter" in subsection 237.1(1) of the Act, in respect of any Offering Partnership Unit or any property acquired by the Offering Partnership.

17. Any government financing (referred to in paragraph 15 above) received by, or to be received, in respect of an investee business would not have been made or will not be made for the purpose of reducing the impact of any loss that a Limited Partner may sustain directly or indirectly, in any matter whatever, because the Limited Partner is a member of the Offering Partnership. In addition, such government financing would not have been made or will not be made for the purpose of reducing the impact of any loss that a Limited Partner may sustain directly or indirectly, in any matter whatever, by virtue of holding or disposing an interest in the Offering Partnership.

18. The Offering Partnership will acquire, through a second limited partnership (see paragraph 21 below), an interest in the assets of an investee business.

19. The initial investment in each investee business is expected to range between $XXXXXXXXXX and $XXXXXXXXXX.

20. The Promoter has negotiated terms for the first investee business, XXXXXXXXXX ("InvesteeCo"), a corporation incorporated and resident in XXXXXXXXXX.

21. Under the terms negotiated with InvesteeCo, a new XXXXXXXXXX limited partnership (the "Operating Partnership") will be formed. The limited partner of the Operating Partnership will be the Offering Partnership and the general partner will be a taxable Canadian corporation, wholly-owned by InvesteeCo ("InvesteeSub").

22. The Offering Partnership will subscribe for limited partnership units and special partnership units for a total investment of $XXXXXXXXXX and InvesteeSub will subscribe for general partnership units.

23. The special partnership units will be entitled to a preferential allocation and distribution of XXXXXXXXXX% of the initial income of the Operating Partnership, until a pre-determined income entitlement of $XXXXXXXXXX is reached.

24. Once the pre-determined income entitlement has been reached, no other allocation will be made on the special partnership units and the income of the Operating Partnership will be allocated between the limited partner (the Offering Partnership) and the general partner (InvesteeSub) on a sharing ratio of XXXXXXXXXX in favour of the general partner.

25. No distributions will be made to the Offering Partnership on the special partnership units at any time if the fair market value of the assets owned by the Operating Partnership less any liabilities of the Operating Partnership (other than the principal amount of the Note and any interest accrued thereon) would, following the distribution, be less than the principal amount of the Note and any interest owing thereon.

26. All losses generated by the Operating Partnership will be allocated to the Offering Partnership at the end of each fiscal period of the Operating Partnership to the extent that the total allocations to the Offering Partnership for the fiscal periods of the Operating Partnership ending within 4 years after the subscription date for the partnership units do not exceed the lesser of:

a) 99% of the cost (within the meaning in subsection 237.1(1) of the Act) to the Offering Partnership of its limited partnership unit of the Operating Partnership; and

b) The "at-risk" amount of the Offering Partnership, as computed under subsection 96(2.2) of the Act.

27. Cumulative losses of the Operating Partnership in excess of the limits computed in paragraph 26 above, if any, will be allocated to the general partner, InvesteeSub.

28. The Operating Limited Partnership Agreement will provide for the allocation of income and losses, as described in paragraphs 23 to 27 above, on the same basis for accounting and tax purposes.

29. The principal reason for the allocations of income and losses as described in paragraphs 23 to 27 above, is to reduce the economic risk to the Offering Partnership, which is bearing the financial cost of the investment in InvesteeCo's business.

30. InvesteeCo will sell, at fair market value, all of its business assets and operations, including all of its intellectual property (the "Business Assets"), to the Operating Partnership. The consideration for that transfer will be a promissory note (the "Note") payable to InvesteeCo. The Note will bear interest at arm's length commercial terms and be secured by the Business Assets. The Note will be required to be repaid, in full, no later than 4 years from the date of issuance.

31. There will not be, at any time, any prescribed benefits, as described in subparagraph (b)(ii) of the definition of "tax shelter" in subsection 237.1(1) of the Act, in respect of any Operating Partnership Unit or any property acquired by the Operating Partnership.

32. Any government financing received by InvesteeCo, or to be received in respect of the business carried on by the Operating Partnership, was not made or will not be made for the purpose of reducing the impact of any loss that the Offering Partnership may sustain, directly or indirectly in any manner whatever, by virtue of being a member of the Operating Partnership or by virtue of holding or disposing of its interest in the Operating Partnership.

33. All of the losses generated by the Operating Partnership will be allocated to the Offering Partnership. To the extent that other income in the Offering Partnership does not offset such losses, the Offering Partnership's losses will be allocated to the Limited Partners pursuant to the Offering Limited Partnership Agreement. However, due to the limitation on expenditures subject to paragraph 20(1)(e) of the Act, during the first four years the total losses allocated to the Limited Partners of the Offering Partnership will be less than the capital invested to acquire those interests.

34. The Operating Partnership will carry on the business with a view to profit for a period of time (the "Initial Period"), which is expected to range from XXXXXXXXXX months, depending on budgeted expenditures, working capital, etc. While it is anticipated that, the Operating Partnership will operate at a deficit during the Initial Period, it is possible that the Operating Partnership could earn a profit.

35. Immediately following the Initial Period, a taxable Canadian corporation ("Canco") will be incorporated by InvesteeSub. Canco will issue one or more common shares to InvesteeSub upon incorporation for $XXXXXXXXXX per share. Each common share will have a paid-up capital equal to the subscription price. The Operating Partnership will then transfer all of the Business Assets to Canco, in exchange for preferred shares of Canco and other non-share consideration. The preferred shares will be redeemable by Canco and will have a redemption value equal to the amount by which the fair market value of the Business Assets transferred exceeds the fair market value of the non-share consideration. The Operating Partnership and Canco will jointly elect pursuant to subsection 85(2) of the Act in prescribed form and within the time referred to in subsection 85(6) in respect of the eligible property transferred to Canco. For greater certainty, the agreed amount in respect of any eligible property included in the subsection 85(2) election will not exceed the fair market value of such property and will not be less than the fair market value of any non-share consideration received by the Operating Partnership in respect of the transfer.

36. The Operating Partnership will be wound up within XXXXXXXXXX days after the transfer of the Business Assets and the property of the Operating Partnership (consisting only of the preferred shares of Canco) will be distributed such that subsection 85(3) of the Act will apply. Under the terms of the distribution, the Offering Partnership will receive preferred shares with a fair market value equal to the difference between the amount equal to the pre-determined income entitlement described in paragraph 23 above and the amount, if any, distributed to the Offering Partnership on the special partnership units prior to the winding up, plus XXXXXXXXXX% of any remaining preferred shares.

37. InvesteeSub will receive, on the distribution, preferred shares not distributed to the Offering Partnership.

38. The Offering Partnership will wind-up prior to XXXXXXXXXX, and distribute to each partner in proportion to their partnership units, an undivided interest in the Canco preferred shares (i.e., each partner will receive an undivided proportionate interest in each preferred share).

39. The General Partner will receive an undivided XXXXXXXXXX% interest in the preferred shares distributed, and the Limited Partners will receive an undivided XXXXXXXXXX % interest in the preferred shares distributed.

40. Pursuant to subsection 98(3) of the Act, each partner will jointly elect in prescribed form and within the time referred to in subsection 96(4) of the Act, such that each partner's proceeds of disposition of his or her interest in the Offering Partnership, the cost to each such partner of his or her undivided interest in the preferred shares and the Offering Partnership's proceeds of disposition of the preferred shares shall be determined in accordance with the rules in subsection 98(3) of the Act.

41. Following the dissolution of the Offering Partnership, the former partners will, in conjunction with Canco, partition each of the preferred shares and as a consequence thereof:

a) each partner's respective undivided interest in any particular preferred share will become a divided interest (the "Divided Interest") in such particular preferred share, and

b) each partner's Divided Interest in such particular preferred share will have a fair market value which immediately after the partition, expressed as a percentage of the fair market value of all the Divided Interests in such particular preferred share immediately after the partition, will be equal to the fair market value of such partner's undivided interest in such particular preferred share immediately before the partition, expressed as a percentage of the fair market value of all the undivided interests in such particular preferred share immediately before the partition (the "Partition").

42. Pursuant to subsection XXXXXXXXXX of the Business Corporations Act (XXXXXXXXXX), Canco will issue certificates for any fractional shares created as a result of the Partition.

43. A Shareholders' Register will be maintained indicating fractional shares held by each shareholder to the extent necessary to reflect the Partition.

44. The holders of preferred shares of Canco, will exchange their preferred shares for common shares of Canco with a fair market value equal to the fair market value of the shares exchanged.

45. Canco will purchase for cancellation any fractional common shares held by the former Limited Partners in circumstances that no shareholder will receive more than $XXXXXXXXXX in cash.

46. The Promoter will assist the investors as a group in maximizing the value of their investment by pursuing various "liquidity options". There are not currently any specific arrangements, agreements or other relationships to implement any liquidity options at this time. However, following the dissolution of the Offering Partnership any shares received by the investors will become subject to a shareholders' agreement, which will include "drag along obligations" - i.e. a requirement that if there is an offer for a significant percentage of the shares of the investee corporation then all investors will be required to tender their shares. The Promoter's first option to be pursued will be an exchange of shares with a public corporation - but he will not commence serious evaluation of that option until well after closing.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to raise funds through the sale of units of an Offering Partnership to provide a source of financing for XXXXXXXXXX enterprises using a structure that permits such investors to deduct, within the limits provided in the Act, losses allocated by the Offering Partnership, with a potential to receive an investment return by way of future dividends or a future sale of shares.

RULINGS GIVEN

Provided that: (a) the facts, proposed transactions and their purposes have been fully disclosed and, as described above, are accurate, (b) each of the Offering Partnership and the Operating Partnership is a valid and subsisting partnership at law for any period of time covered by these rulings, and (c) the proposed transactions are carried out as described above, our rulings are as follows:

A. Provided there are no prescribed benefits, as referred to in subparagraph (b)(ii) of the definition of "tax shelter" in subsection 237.1(1) of the Act, in respect of any Offering Partnership unit or Operating Partnership unit or any property acquired by the Operating Partnership or the Offering Partnership, none of the Offering Partnership Units or Operating Partnership Units will be a tax shelter, within the meaning assigned by subsections 18.1(1) and 237.1(1) of the Act, nor a tax shelter investment, within the meaning assigned by subsection 143.2(1) of the Act.

B. Non-capital losses for a taxation year of the Operating Partnership, computed in accordance with the provisions of the Act, for a particular taxation year, which are allocated to the Offering Partnership by the Operating Partnership, in accordance with the terms of the Operating Limited Partnership Agreement, as described in paragraphs 26 and 27 above, will, subject to paragraph 96(1)(g) of the Act, be deductible in computing the income or loss of the Offering Partnership at the end of the taxation year of the Offering Partnership in which such taxation year of the Operating Partnership ends.

C. Non-capital losses for a taxation year of the Offering Partnership, computed in accordance with the provisions of the Act, for a particular taxation year, which are allocated by the Offering Partnership to its Partners, in accordance with the terms of the Offering Limited Partnership Agreement as described in paragraph 10 above, will, subject to paragraph 96(1)(g) of the Act, be deductible in computing the income or loss of each partner for such partner's taxation year in which such taxation year of the Offering Partnership ends, to the extent of the "at-risk amount" of each partner at the end of that taxation year.

D. Provided that none of the principal reasons for the allocation of income as described in paragraphs 23 to 27 above is for the reduction or postponement of tax that might otherwise have been or become payable under the Act, subsection 103(1) of the Act will not apply to redetermine the allocation of any income or loss of the Operating Partnership.

E. Provided that none of the principal reasons for the allocation of income as described in subparagraphs 10 d) and 10 e) above is for the reduction or postponement of tax that might otherwise have been or become payable under the Act, subsection 103(1) of the Act will not apply to redetermine the allocation of any income or loss of the Offering Partnership.

F. Section 54.2 of the Act will apply on the transfer, by the Operating Partnership, of its Business Assets to Canco, as described in paragraph 35 above, to deem the preferred shares of Canco received by the Operating Partnership on the transfer of such assets to be capital property.

G. Provided that the Offering Partnership is a Canadian partnership, as defined in subsection 102(1) of the Act, at the time it ceases to exist, subsection 98(3) of the Act will apply to the dissolution, as described in paragraph 38 above, to determine the amount of each partner's proceeds of disposition of his or her interest in the Offering Partnership, the cost to each partner of his or her undivided interest in each property of the Offering Partnership, including the preferred shares, and the Offering Partnership's proceeds of disposition of the preferred shares.

H. Subsection 248(21) of the Act will apply to the Partition, as described in paragraph 41 above, such that subsection 248(20) of the Act will not apply with respect thereto and each partner's Divided Interest in a particular preferred share will be deemed to be a continuation of each such partner's undivided interest in such preferred share immediately before its partition.

I. Provided the preferred shares represent capital property to the former Limited Partners, subsection 51(1) of the Act will apply to the conversion of the preferred shares into common shares, as described in paragraphs 44 and 45 above, such that the conversion will be deemed not to be a disposition of the preferred shares.

J. As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given above.

CAVEAT

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2003 and are binding on the CCRA provided the distribution of the units of the Offering Partnership and the transactions described in paragraphs 21 to 30 above are implemented on or before XXXXXXXXXX. More specifically, the rulings are binding on the CCRA only in respect of the specific transactions as described herein. These rulings are based on the Act and the Income Tax Regulations in their present form and do not take into account the effect of any proposed amendments thereto.

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

(a) the reasonableness of any expenditures referred to in this letter;

(b) the fair market value of any property referred to in this letter;

(c) whether or not any persons referred to in this ruling deal at arm's length;

(d) that proposed section 3.1 of the Act (as described in Department of Finance News Release 2003-055, dated October 31, 2003), if enacted, will not operate to deny a deduction for any expenses incurred by the Operating or Offering Partnerships

(e) whether any property acquired by the Operating Partnership constitutes a tax shelter;

(f) whether a Unit of the Offering Partnership held by a partner is held on income or capital account and whether an outlay or expense is on account of income or capital;

(g) the GST implications of any of the proposed transactions; and

(h) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate