1 February 2005 External T.I. 2004-0105951E5 - Principal-Business Corporation

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.

Principal Issues: Whether a corporate general partner in a partnership formed to develop a wind farm project may qualify as a principal-business corporation due to the activities carried on through the partnership such that Canadian exploration expense incurred by the partnership, and intended to be wholly allocated to the general partner, could ultimately be available for renunciation to investors in flow-through shares issued by the corporate general partner.

Position: Potentially, subject to various determinations including: whether a valid partnership exists; the nature and extent of business operations conducted by the relevant corporation; whether the provisions of section 103 would apply to the intended allocation of all CEE incurred by the partnership to the corporate partner; and whether the "anti-warehousing" rule contained in subsection 66(19) would apply to prohibit the corporation from renouncing amounts in respect of the CEE originally incurred by the partnership.

Reasons: Based upon the relevant legislative provisions and the nature of the determinations to be made.

2004-010595
XXXXXXXXXX A.A. Cameron
(613) 347-1361
February 1, 2005

Dear XXXXXXXXXX:

Re: Principal-Business Corporation

We are writing further to your electronic mail message of December 1, 2004 regarding the definition of the term "principal-business corporation" ("PBC"), as defined in subsection 66(15) of the Income Tax Act (the "Act"), and certain comments contained in our technical interpretation (file number 5-5822) dated November 16, 1989.

You have described a situation where a limited partnership is formed in Canada to develop a wind farm project (the "Project") and will incur Canadian renewable and conservation expense ("CRCE", as defined in subsection 66.1(6) of the Act) with respect thereto. The general partner to this partnership (the "GP") will be a private corporation (as defined in subsection 89(1) of the Act) the sole activity of which will be to carry out its functions as general partner to the limited partnership. Pursuant to the partnership agreement, the GP will be obliged to contribute a predetermined share of funds to the limited partnership for the start up phase of the Project. You further indicate that all of the Canadian exploration expense ("CEE", as defined in subsection 66.1(6) of the Act) to be incurred by the partnership will be allocated to the GP who has agreed to finance 100% of the CEE phase of the Project.

Having regard to the above situation, you have requested clarification as to whether the GP can satisfy the PBC definition as a result of the activities that it carries out as GP to the limited partnership such that it can issue flow-through shares to finance its contributions to the limited partnership.

Our Comments

Written confirmation of the income tax implications inherent in proposed transactions is given by this Directorate only where the transactions are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following general comments that may be of assistance.

The definition of PBC contained in subsection 66(15) of the Act provides, in part, that such term "means a corporation the principal business of which is any of, or a combination of," certain specified activities including:

(h) the generation of energy using property described in Class 43.1 of Schedule II to the Income Tax Regulations, and

(i) the development of projects for which it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in each project would be the capital cost of property described in Class 43.1 of Schedule II to the Income Tax Regulations..."

In addition, existing jurisprudence [such as the decision of the Federal Court of Appeal in the Robinson Trust case (98 DTC 6065) to which you have referred] suggests that where a business is carried on through a partnership, all of the members thereof, whether general or limited partners, would generally be considered to carry on that business.

In light of the above factors, it is our view that where the principal business of the partnership is the generation of electricity or the development of projects described in paragraphs (h) or (i) above, or a combination thereof, it is possible that a corporation which is a general partner in such partnership may be able to qualify as a PBC. However, such a determination would have to be made based upon the facts and circumstances relevant to the particular situation.

An initial determination would be whether a bona fide partnership exists. Although the Act does not define the term "partnership", the Canada Revenue Agency (the "CRA") has indicated, under the heading "Partnership Issues" on page 12 of Income Tax Technical News No. 25 dated October 30, 2002, that:

It is a question of fact and law as to whether a partnership exists. The Courts have now established the following general criteria (which is based on the definition of partnership under the relevant provincial law) when determining whether a partnership exists:

- there must be a business;

- this business must be carried on by 2 or more persons;

- there must be a view to profit.

Where a corporation is a member of a valid partnership, the CRA has indicated in paragraph 12 of Interpretation Bulletin IT - 400 Exploration and Development Expenses - Meaning of Principal-Business Corporation, that for purposes of determining whether the corporation qualifies as a PBC, the business operations carried on through the partnership are regarded as being carried on by the corporation directly, to the extent of the corporation's interest in the partnership. It is also indicated, at paragraph 14 of the Bulletin, that the CRA is of the view that as a general rule a corporation engaged in business operations that qualify under the definition of PBC as well as business operations that do not, will qualify as a PBC if, when considered together, the corporation's qualifying activities represent a larger or more important business operation than all other activities of the corporation combined. It is further stated in paragraph 14 of the Bulletin that the determination of the size and importance of the business operations of the type qualifying under the PBC definition in relation to a corporation's other business operations is determined by an examination and comparison of all the facts concerning each of the business operations in which the corporation is engaged (that paragraph also lists some criteria considered important for making such a determination).

It should also be noted that at the end of paragraph 15 to IT - 400, it is indicated the CRA is of the view that " in considering whether a corporation qualifies as a principal-business corporation for a particular year, regard may be had to a future plan of the corporation only to the extent that it is implemented in the year."

With respect to the allocation of all CEE relating to the development of the Project by the partnership solely to the general partner, the CRA indicated in Income Tax Technical News No. 30 dated May 21, 2004 at question number 6 under the heading "Computation / Allocation of Partnership Income and Losses" that:

In our view, there is no impediment to the creation of partnership interests that carry different entitlements to share in the income, loss or other attributes of the partnership. However, the sharing of these tax attributes is subject to section 103 of the Act. In considering the application of section 103, we would examine whether one of the principal reasons for the separate interests was the reduction or postponement of tax, or in the case where two or more members of the partnership are not dealing with each other at arm's length, whether the amount of income or loss allocated to [the taxpayer having a "preferred" partnership interest] was reasonable having regard to the circumstances, including capital invested and work performed.

Whether or not the provisions of section 103 of the Act would apply in a particular situation would have to be determined based upon a review of all the facts and circumstances relevant to that situation.

Where a corporate general partner qualifies as a PBC, it can issue a share in its capital stock (other than a "prescribed share" within the meaning of section 6202.1 to the Income Tax Regulations) which may qualify as a "flow-through share" ("FTS" as defined in subsection 66(15) of the Act). Subject to various requirements and limitations contained in the Act, where a PBC issues a FTS to an investor the PBC may be able to renounce amounts in respect of CEE it incurs to that investor. However, pursuant to the above-mentioned definition of FTS, amounts may only be renounced to the investor in respect of CEE incurred by the PBC on or after the date the agreement in writing relating to the acquisition of the FTS was made.

In general terms, pursuant to paragraph (h) to the definition of CEE and subject to the provisions of subsection 66.8 of the Act (which contains limitations in respect of limited partners), a taxpayer's share of CEE incurred by a partnership in a particular fiscal period of the partnership will be included in the taxpayer's CEE if, at the end of that period, the taxpayer is a member of the partnership. Subsection 66(18) of the Act also provides that the expenses included in a partner's CEE are deemed to be made or incurred by the partner at the end of the relevant fiscal period of the partnership.

Finally, we would note that subsection 66(19) of the Act contains an "anti-warehousing" rule the effect of which, in part, is to prevent a PBC from renouncing to an investor in FTS amounts in respect of an expense, such as CEE, which represent any part of the PBC's share of an expense made or incurred by a partnership, of which the PBC is a member or a former member, prior to the PBC entering into the FTS agreement with the investor.

We trust that these comments will be of assistance. However, as stated in paragraph 22 of Information Circular 70-6R5, this opinion is not a ruling and consequently is not binding on the CRA in respect to any particular situation.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch