2003 Ruling 2003-0049893 - INCORPORATING A PARTNERSHIP

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 a professional corporation, providing medical services to another corporation, will be carrying on a "personal services business" within the meaning of subsection 125(7) of the Act.

Position: No.

Reasons: The former partners are providing services through a "Contracting Corporation". They do not provide services to Newco in his/her capacity as an employee or officer of Newco.

XXXXXXXXXX 2003-004989

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter, dated XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above partnership and the partners of XXXXXXXXXX.

We understand that, to the best of your knowledge, none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayer or a related person,

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

(iii) is under objection or appeal by the taxpayer or a related person,

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

(v) is the subject of a ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supplement), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

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

Definitions

(a) "CCRA" is the Canada Customs and Revenue Agency;

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

(c) "Contracting Professional Corporation" is a company that will be incorporated pursuant to XXXXXXXXXX;

(d) "Cost amount" has the meaning assigned by subsection 248(1) of the Act;

(e) "Eligible Property" has the meaning assigned by subsection 85(1.1) of the Act;

(f) "Newco" is a new corporation that will be incorporated under the laws of the Province of XXXXXXXXXX;

(g) "Partner" is a reference to each of, or any of, XXXXXXXXXX, and collectively they are referred to as the "Partners";

(h) "Partnership" is a reference to the existing partnership of "XXXXXXXXXX ." which was created pursuant to the laws of the province of XXXXXXXXXX;

(i) "Personal services business" has the meaning assigned by subsection 125(7) of the Act;

(j) "Practice" means the medical practice currently carried on by the Partnership;

(k) "Professional" refers to each individual doctor who currently provides professional services to the Partnership as required in the Practice;

(l) "Related persons" has the meaning assigned by subsection 251(2) of the Act;

(m) "Specified partnership income" has the meaning assigned by subsection 125(7) of the Act;

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

Facts

1. The Practice is carried on as a partnership. The Partnership has XXXXXXXXXX Partners. The Partners of the Partnership have been carrying on business since XXXXXXXXXX. The Partners provide XXXXXXXXXX services (the "professional services") to the Partnership.

2. The Partnership's identification number is XXXXXXXXXX. The Partnership files its information returns with the XXXXXXXXXX Taxation Center and deals with the XXXXXXXXXX Tax Services Office.

3. The Partners provide their services, through the Partnership, to the XXXXXXXXXX (the "Hospitals"). The Practice consists of various services provided to the Hospitals and includes XXXXXXXXXX. The Practice does not include the services provided by the Partners in respect of emergency on-call services.

4. The Partnership is bound by a written partnership agreement (the "Partnership Agreement") that was signed in XXXXXXXXXX . The Partnership is also governed by a set of rules and regulations, some of which are outlined in paragraph 6 below.

5. The major terms of the Partnership Agreement concerning the allocation of income are as follows:

(a) A Partner is entitled to draw funds from the Partnership to the extent of his or her current account balance;

(b) A Partner's current account is increased or credited for the Partner's share of the "General Services Fund" divided among the Partners in proportion to their respective "Work Units" (a measure of each Partner's contribution based upon effort expended in the Practice);

(c) A Partner's current account is reduced or debited for XXXXXXXXXX draws determined as a proportion of cash available for distribution based upon each Partner's percentage of Work Units, as a percentage of the total Work Units for all Partners.

6. The major rules and regulations of the Partnership include the following:

(a) The Partners agree to be available to perform duties, as assigned by an executive committee, on a regular basis (referred to as the "Rotation Schedule");

(b) All Partners will report all medical procedures performed on a weekly basis;

(c) Except as specifically permitted, each Partner must submit his/her name to the Emergency Call Roster in order to share in any of the Emergency Services Fund;

(d) All XXXXXXXXXX services performed for a fee by a Partner shall be done on behalf of the Partnership unless prior approval is obtained from the Executive Committee (e.g. emergency on-call services); and

(e) All Partners must respond to emergency calls for any patient in need of XXXXXXXXXX services.

7. Each of the Partners is a resident of Canada. None of the Partners is related to any other Partner.

8. The Partnership's relationship with the Hospitals is a complicated one. In general terms, the Hospitals provide the Partnership with physical space in which to provide its services, provide certain clerical and administrative staff and medical residents and provide certain equipment. The Partnership staff administers most of the monthly billing to the province's medical insurance organization on behalf of the Partnership.

This relationship between the Hospitals and the Partnership is not a master and servant relationship, as the Partners are not employees of the Hospitals. Instead, they make use of the Hospitals infrastructure and obtain payment from the province's medical insurance organization.

Proposed Transactions

9. Newco will be incorporated as a CCPC and a TCC.

10. Upon incorporation, Newco will be authorized to issue an unlimited number of voting common shares (the "Shares") without nominal or par value. One common voting share will be issued to each of the Partners. Newco will receive a $XXXXXXXXXX cash subscription from each Partner.

11. Newco will make an application to the XXXXXXXXXX (the "College") for a permit to practice medicine in XXXXXXXXXX. Section XXXXXXXXXX permits a corporation to engage in the practice of medicine upon having obtained a permit from the College.

12. After Newco obtains a permit from the College, the Partnership will sell all of its assets to Newco at fair market value. Newco will assume all of the liabilities of the Partnership, issue an additional XXXXXXXXXX Shares and issue a demand, non-interest bearing promissory note. The amount of the promissory note will be equal to the cost amount of the assets transferred to the Partnership less the amount of the liabilities assumed by Newco and the $XXXXXXXXXX of paid-up capital attributable to the additional Shares. Newco and each of the Partners will jointly elect, pursuant to subsection 85(2) of the Act, in prescribed form and within the time permitted by subsection 85(6) of the Act, to have the provisions of paragraphs 85(1)(a) to (i) of the Act apply, with such modifications as the circumstances require. The "agreed amount" for the assets transferred to Newco will not be less than the lesser of the amounts specified in subparagraphs 85(1)(c.1)(i) and (ii) of the Act, will not be less than the least of the amounts specified in subparagraphs 85(1)(d)(i), (ii) and (iii) of the Act and will not be less than the least of the amounts specified in subparagraphs 85(1)(e)(i), (ii) and (iii) of the Act. Furthermore, the "agreed amount" will not exceed the respective fair market value of each asset transferred to Newco nor will it be less than the amount permitted by paragraph 85(1)(b) of the Act.

13. The Partnership and Newco will file an election pursuant to the provisions of section 22 of the Act in respect of the accounts receivable transferred to Newco.

14. On the day immediately following the transfer of all of the assets of the Partnership to Newco, the Partnership will wind up its affairs in accordance with subsection 85(3) of the Act. Immediately before this winding-up, the Partnership will have no property other than the property received from Newco as consideration for the disposition to it of the Partnership's assets. Specifically, the only property in the Partnership will be the XXXXXXXXXX Shares of Newco and the promissory note received from Newco as consideration for the assets transferred. Each Partner will receive, in complete satisfaction of his or her interest in the Partnership, 1 Share of Newco and a pro rata share, based on his or her respective interest in the Partnership, of the promissory note issued to the Partnership by Newco.

15. For legal simplification, the XXXXXXXXXX Shares issued by Newco, as consideration for the transfer to it of the assets of the Partnership, shall be issued in the name of each Partner (1 Share each) instead of the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Shares.

16. For legal simplification, the promissory note issued by Newco, as consideration for the transfer to it of the Partnership property, shall be issued in the name of each Partner (based on a pro rata share) instead of the name of the Partnership. The Partnership, not to the individual Partners themselves, will be the beneficial owner of the promissory note.

17. The shareholders of Newco will elect the directors of the corporation. The shareholders of Newco anticipate that each shareholder will be a director.

18. The shareholders of Newco will enter into a Shareholder's Agreement that will provide, but not be limited to, the following:

(a) The business of Newco will be the carrying on of the existing Practice;

(b) Newco will carry out its business by entering into contracts with independent contractors and, if necessary, may also employ physicians and others (see paragraph 19 below);

(c) Each shareholder of Newco may, if he/she so requests, be a member of the board of directors of Newco;

(d) The directors of Newco will appoint an executive committee to manage the affairs of Newco;

(e) The officers of Newco will be elected by the directors of Newco;

(f) At the sole discretion of the directors of Newco, the net profits of Newco will, from time to time, be available for distribution in the form of dividends on the outstanding shares;

(g) The alienation or transfer of issued shares of Newco shall be restricted to the following circumstances:

(i) No shareholder shall be entitled to transfer his or her Shares in Newco without the prior written consent of a majority of the directors or shareholders of Newco;

(ii) A shareholder may demand that Newco purchase his/her Shares for fair market value;

(iii) Newco may, upon approval of a majority of the directors, purchase any Shares held by any shareholder, and any such shareholder shall sell such shares for fair market value.

19. Newco will carry on the Practice by providing the professional services in the following ways:

(a) Through individuals licensed to practice medicine in XXXXXXXXXX and employed by Newco to provide professional services;

(b) Through individuals engaged by Newco to provide professional services as independent contractors. These independent contractors will be licensed to practice medicine in the province of XXXXXXXXXX and will be engaged by Newco to provide such professional services on behalf of Newco; and

(c) Through Contracting Professional Corporations engaged by Newco to provide various professional services as independent contractors. The Contracting Professional Corporation will provide such professional services on behalf of Newco. Each Contracting Professional Corporation will employ an individual licensed to practice medicine in XXXXXXXXXX.

20. Section XXXXXXXXXX provides for the licensing of professional corporations to carry on the practice of medicine in its own name provided the persons who carry on medicine on behalf of the licensed corporation are members of the College. Each Partner will have the option of providing professional services to Newco by entering into a contract for service with Newco as an independent contractor or as a Contracting Professional Corporation.

21. Those Partners who choose to enter into a contractual relationship with Newco, whereby the Partner will agree to provide certain professional services as an independent contractor, will receive a fee that will be based upon the services performed. This arrangement will be evidenced in writing, and will provide, among other things, that the fee for professional services performed will be determined in a manner similar to the present determination of partnership income.

22. Those Partners who choose to enter into a contractual arrangement with Newco through a Contracting Professional Corporation will be required to enter into a signed written agreement with Newco. Each Partner will provide services for the benefit of his/her Contracting Professional Corporation. The agreement between Newco and each particular Partner's Contracting Professional Corporation will provide that the fee for services performed by the Contracting Professional Corporation will be determined in a manner similar to the present determination of partnership income. There will not be any other contractual relations between Newco and a Contracting Professional Corporation.

23. Each Contracting Professional Corporation will obtain a permit from the College. This will enable a Partner to provide professional services to Newco through such a Contracting Professional Corporation.

24. Each Contracting Professional Corporation will be controlled by the respective Partner who will be the legal and beneficial owner of all of the voting shares of the Contracting Professional Corporation. If any voting shares of a Contracting Professional Corporation are owned by another corporation, all of the voting shares of that corporation will be owned by the Partner. The sole officer and director of a Contracting Professional Corporation will be the respective Partner that incorporated the Contracting Professional Corporation.

Non-voting shares of each Contracting Professional Corporation may be owned by members of the Partner's family, and/or other dependents, and either directly, through an irrevocable discretionary trust for the benefit of such individuals or a holding corporation owned by such individuals. It is our understanding that none of these non-voting shares will be issued as part of the proposed transactions described herein.

All persons legally or beneficially owning shares of a Contracting Professional Corporation will be residents of Canada.

25. The sole officer and director of a Contracting Professional Corporation will be an employee of the Contracting Professional Corporation and will provide professional services for the benefit of the Contracting Professional Corporation pursuant to the terms of its contract with Newco. The employment relationship between the Partner and his/her respective Contracting Professional Corporation will be evidenced by a written employment agreement.

26. Each Partner will not be an employee, officer, director or shareholder, either legally or beneficially, of more than one Contracting Professional Corporation. As described in paragraph 24 above, related persons of a Partner may only be a shareholder of the Contracting Professional Corporation in which that Partner owns shares.

27. No legal or beneficial shareholder of a Contracting Professional Corporation will be a legal or beneficial shareholder of another Contracting Professional Corporation.

28. Only Partners of the Partnership will have the option to choose which contractual arrangement they will establish with Newco. The Board of Directors of Newco will determine, as the need arises, what contractual arrangements will be offered to individuals that are not currently associated with the Practice.

Purpose of the Proposed Transactions

29. The purpose of the proposed transactions is to restructure the Practice of the Partnership without adverse tax consequences. This will provide the following advantages:

(a) Eliminate joint and several liability inherent in providing the professional services through a partnership;

(b) Provide a vehicle through which an individual Partner may, if he or she so wishes, provide professional services external to the practice of Newco;

(c) Provide increased business efficiency for each Partner through individual management of personal practice preferences;

(d) Permit each Partner to have control over expenditures, where such expenditures may not be in the interest of all participants in the Practice;

(e) Provide each Professional with more options and more control in arranging estate and succession planning. It is generally easier and less costly to transfer shares in a company than it is to dispose of a partnership interest;

(f) Facilitate easier entry and exit of Professionals to the Practice;

Rulings

Provided that:

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) the proposed transactions are completed in the manner described above; and

(c) there are no other transactions which may be relevant to the rulings requested;

our rulings are as follows:

A. Subject to sections 18 and 67 of the Act, the fees payable by Newco to an independent contractor or to a Contracting Professional Corporation for professional services rendered, as described in paragraphs 19, 21 and 22 above, will be deductible by Newco in computing the profit or loss from its business pursuant to section 9 of the Act.

B. Provided that a former Partner providing professional services to Newco through a Contracting Professional Corporation would not, but for the existence of the Contracting Professional Corporation, be an officer or employee of Newco in respect of those professional services, then each such Contracting Professional Corporation will not be considered to be carrying on a "personal services business" as defined by subsection 125(7) of the Act.

C. Provided that a partnership does not exist between Newco and any Contracting Professional Corporation, the income earned by Newco or any Contracting Professional Corporation will not be "specified partnership income" as defined by subsection 125(7) of the Act.

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

Comments

In accordance with paragraph 2 of Interpretation Bulletin - IT 378R "Winding-up of a Partnership" ("IT-378R"), it is the CCRA's view that issuing the Shares in the name of each Partner, instead of the Partnership, as described in paragraphs 12 and 15 above, will not invalidate the application of subsection 85(2) of the Act nor the subsequent application of subsection 85(3) of the Act.

In accordance with paragraph 2 of Interpretation Bulletin - IT 378R "Winding-up of a Partnership" ("IT-378R"), it is the CCRA's view that issuing the promissory note in the name of each Partner, instead of the Partnership, as described in paragraphs 12 and 16 above, will not invalidate the application of subsection 85(2) of the Act nor the subsequent application of subsection 85(3) of the Act.

Subsection 256(2.1) of the Act is determined on a year-to-year basis. We are therefore unable to rule that this provision will never apply to Newco and each of the Contracting Professional Corporations. In general, where a business that was previously carried on in a partnership, is subsequently ca`rried on by the former partners and no longer in partnership, for reasons other than income tax, 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. Based on the facts and proposed transactions described herein, it is our view that the Partners incorporation of the Partnership's business activities will not, in and of itself, cause subsection 256(2.1) of the Act to be applicable.

Subsection 256(5.1) of the Act is determined "at any time where, at that time". We are therefore unable to rule that this provision will never apply to Newco and each of the Contracting Professional Corporations. Based on the facts and proposed transactions described herein, it is our view that, at the time that Newco acquires the Practice, no Contracting Professional Corporation will have sufficient direct or indirect influence of Newco to cause subsection 256(5.1) of the Act to apply at that time.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CCRA on May 17, 2002, and are binding on the CCRA provided that the proposed transactions are implemented on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.

Yours truly,

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

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