2005 Ruling 2005-0146161R3 - Incorporation of 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.

Principal Issues: Whether a professional corporation, providing XXXXXXXXXX services to another corporation, will be carrying on a "personal services business" within the meaning thereof in subsection 125(7) of the Act.

Position: No.

Reasons: The former partners that are providing services through a professional corporation will not provide services to Newco in the capacity of employees or officers of Newco. See previous rulings issued.

XXXXXXXXXX 								2005-014616

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX

We are writing in response to your letters of XXXXXXXXXX, wherein you requested an advance income tax ruling. We also acknowledge your revised ruling request of XXXXXXXXXX.

To the best of the your knowledge and that of the taxpayers involved, none of the issues contained herein:

(a) is in an earlier return of the taxpayers or a related person;

(b) is being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of the taxpayers or a related person;

(c) is under objection or appeal by the taxpayers or a related person;

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

(e) is the subject of a ruling previously issued by Revenue Canada, the Canada Customs and Revenue Agency or the Canada Revenue Agency (the "CRA").

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

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the specified Part or provision of the Act;

(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 the Business Corporations Act (XXXXXXXXXX) and the 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) XXXXXXXXXX;

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

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

(i) "Partnership" is a reference to the existing partnership of the XXXXXXXXXX which was created pursuant to the laws of the Province of XXXXXXXXXX;

(j) "personal service business" has the meaning assigned by subsection 125(7) of the Act;

(k) "Practice" means the XXXXXXXXXX practice currently carried on by the Partnership;

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

(m) XXXXXXXXXX;

(n) "related persons" has the meaning assigned by subsection 251(2) of the Act;

(o) "specified partnership income" has the meaning assigned by subsection 125(7) of the Act; and

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

FACTS

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

2. The Practice is carried on as a partnership and consists of providing XXXXXXXXXX services to the XXXXXXXXXX. The Partnership currently has XXXXXXXXXX Partners. The Partnership has been carrying on business since XXXXXXXXXX.

3. The Partners provide XXXXXXXXXX services (the "Professional Services"), through the Partnership, to the XXXXXXXXXX. In addition, the majority of the Partners, through the Partnership, conduct XXXXXXXXXX

4. The Partnership is governed 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 8 below.

5. The Partnership Agreement provides for the establishment of a management committee ("Management Committee"), the members of which are appointed by the Partners to manage the financial affairs of the Partnership.

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

(a) A Partner is entitled to receive funds from the Partnership (the "Draw"). The amount of the Draw is established bi-monthly by the Partnership's Management Committee. Each Partner in the Partnership receives the same Draw from the Partnership, based on a full-time equivalency. In other words, those Partners who work five days a week receive 100% of the Draw. Those Partners who work four days a week receive 80% of the Draw, and those who work three days a week, receive 60% of the draw. XXXXXXXXXX

(b) All Partners are also entitled to receive additional funds from the Partnership, if the Partner provides Professional Services during non-business hours ("XXXXXXXXXX Services").

(c) The gross revenues of the Partnership in a fiscal year are used to pay all expenses of the Partnership. After paying all expenses of the Partnership for the fiscal year and the Draw, the remainder of the revenues of the Partnership, if any, are distributed to the Partners in accordance with the formula specified in the budget of the Partnership for the year (which is determined by the Management Committee).

7. The Partnership pays, within set limits, for Partners and staff members to present research papers and other academic work at conferences. The Partnership also approves Partners' and staff members' requests for academic time to work on their academic and research projects. All of this is monitored by a committee composed of appointed Partners ("Academic and Research Committee") which makes recommendations to the Partnership regarding the approval of the requests for academic time.

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

(a) The Partners agree to provide required XXXXXXXXXX services in a competent and professional manner;

(b) The Partners agree to report all charges for services rendered by him or her to the Partnership. The Partners agree that all gross salary or other remuneration amounts paid by the XXXXXXXXXX to any Partner and all amounts paid by the XXXXXXXXXX to or in respect of any services provided by any Partner will be included in the computation of the Partnership's profits. Additional compensation is provided to the Partner for providing XXXXXXXXXX Services. Honorariums received for presentations, book writing, or memberships in XXXXXXXXXX communities are not included in the profits of the Partnership;

(c) All XXXXXXXXXX services performed for a fee by a Partner are done on behalf of the Partnership; and

(d) All Partners must obtain appropriate XXXXXXXXXX insurances as approved by the Management Committee and the XXXXXXXXXX.

9. Each of the Partners is a resident of Canada. Except for XXXXXXXXXX, none of the Partners is related to any other Partner.

10. The Partnership contracts and employs a limited number of staff. The Partnership currently contracts with XXXXXXXXXX who are not yet partners in the Partnership ("XXXXXXXXXX Staff"). The remaining employed staff are administrative and financial.

11. The Partnership pays for all of the Partners' and XXXXXXXXXX Staff's XXXXXXXXXX insurance premiums and some of their professional membership dues. The Partners have many professional membership dues. XXXXXXXXXX

12. The XXXXXXXXXX and the Partnership's Managing Partner have entered into an agreement whereby the Managing Partner is responsible for managing all of the XXXXXXXXXX needs and for ensuring that all XXXXXXXXXX and academic activities are performed. XXXXXXXXXX The Partnership is responsible for hiring and paying the XXXXXXXXXX Staff. The Partnership does not pay any fees to the XXXXXXXXXX. The relationship between the XXXXXXXXXX and the Partnership is not a master and servant relationship, as the Partners are not employees of the XXXXXXXXXX.

PROPOSED TRANSACTIONS

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

14. Upon incorporation, Newco will be authorized to issue an unlimited number of voting common shares (the "Shares") without nominal or par value. Newco will issue one such common share to the Partnership for consideration of $XXXXXXXXXX

15. XXXXXXXXXX

16. XXXXXXXXXX, the Partnership will sell all of its assets to Newco at fair market value. The Assets of the Partnership are not substantial and consist mainly of cash and receivables from the XXXXXXXXXX in respect of XXXXXXXXXX. In consideration for the sale, Newco will assume all of the liabilities of the Partnership and the Partnership will receive XXXXXXXXXX shares of Newco (the "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" (that is, the amount of the deemed proceeds of disposition under paragraph 85(1)(a)), 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.

17. 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.

18. For legal simplification, each of the Shares issued by Newco as consideration for the transfer to it of the assets of the Partnership, shall be issued in the name of a Partner (one Share each) instead of the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Shares. Once the Shares have been issued, Newco will redeem the initial voting common share issued to the Partnership, following which Newco will only have the Shares issued and outstanding.

19. 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 Shares received as consideration for the assets transferred. Each Partner will receive, in complete satisfaction of his or her interest in the Partnership, one Share of Newco.

20. The shareholders of Newco will elect the directors of Newco. The directors of Newco will likely be the members of the Partnership's Management Committee as it was prior to the winding-up.

21. 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 for the Professional Services with independent contractors (see paragraph 22 below);

(c) The directors of Newco will appoint an executive committee (the "Executive Committee") to manage the affairs of Newco;

(d) There will continue to be an Academic and Research Committee and it will be made up of the XXXXXXXXXX and XXXXXXXXXX other shareholders appointed by the XXXXXXXXXX.

(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) Upon the recommendation of the Executive Committee, the shareholders of Newco, by majority vote, will allow new shareholders to subscribe for shares of Newco. The subscription price for one common share in Newco will be $XXXXXXXXXX No shareholder will be entitled to hold more than one common share of Newco.

(h) The alienation or transfer of issued shares of Newco shall be restricted as follows:

(i) No shareholder shall be entitled to transfer his or her share in Newco; and

(ii) Where a shareholder ceases to provide services to Newco, either as an independent contractor or through a Contracting Professional Corporation, the shareholder must sell and Newco must purchase from the shareholder his or her share of Newco for proceeds equal to $XXXXXXXXXX plus or minus certain amounts set out in the Shareholder Agreement.

22. Newco will carry on the Practice by providing the Professional Services in the following ways:

(a) Newco will engage individuals as independent contractors. These independent contractors will be licensed to practice XXXXXXXXXX in the Province of XXXXXXXXXX and will be engaged by Newco to provide the Professional Services on behalf of Newco (the "Contracting Professionals"); and

(b) Newco will engage Contracting Professional Corporations as independent contractors. Each Contracting Professional Corporation will provide the Professional Services on behalf of Newco. Each Contracting Professional Corporation will employ an individual licensed to practice XXXXXXXXXX in the Province of XXXXXXXXXX.

23. Newco will continue to provide XXXXXXXXXX services to arm's length third parties.

24. XXXXXXXXXX. Each Partner will have the option of providing Professional Services to Newco by entering into a contract for service with Newco as a Contracting Professional or through a Contracting Professional Corporation.

25. Those Partners who choose to enter into a contractual relationship with Newco as a Contracting Professional, will receive a fee that will be based upon the services performed. The relationship between the Contracting Professional and Newco will be one of independent contractor and hirer. This arrangement will be evidenced in writing, and will provide, among other things, that the fee for Professional Services performed will be determined based on a per diem rate determined by the Executive Committee. This per diem rate is the same for all Contracting Professionals and Contracting Professional Corporations performing Professional Services. With respect to XXXXXXXXXX Services, each Contracting Professional will receive an additional fee determined on a special per diem rate for XXXXXXXXXX Services, determined by the Executive Committee. The Contracting Professional will receive the fees XXXXXXXXXX.

26. Where a Partner chooses to provide Professional Services through a Contracting Professional Corporation, the Partner's Contracting Professional Corporation will be required to enter into a signed written agreement with Newco (the "Services Agreement"). The relationship between the Contracting Professional Corporation and Newco will be one of independent contractor and hirer. Each Partner will provide services for the benefit of his or 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 on a per diem rate determined by the Executive Committee. This per diem rate will be the same for all Contracting Professionals and Contracting Professional Corporations. Where the Contracting Professional Corporation performs XXXXXXXXXX Services, it will receive an additional fee, based on a per diem rate for XXXXXXXXXX Services, determined by the Executive Committee. The Contracting Professional Corporation will receive the fees XXXXXXXXXX. There will not be any other contractual relations between Newco and any of the Contracting Professional Corporations.

27. All payments from third parties (including XXXXXXXXXX) in respect of services provided by a Contracting Professional Corporation or Contracting Professional for the benefit of Newco will be made directly to Newco.

28. XXXXXXXXXX

29. Each Contracting Professional Corporation and Contracting Professional will be responsible for any expenditures in respect of personal practice preferences.

30. Newco will not pay any of the Contracting Professional Corporations' or Contracting Professionals' XXXXXXXXXX insurance premiums or any of their professional membership dues, including membership with the XXXXXXXXXX. The Contracting Professional Corporations and Contracting Professionals will bear and pay their own membership dues and XXXXXXXXXX premiums.

31. Newco will support research and academic time in a manner similar to what is described in paragraph 7, above. The Academic and Research Committee (as constituted in accordance with the Shareholders' Agreement), will recommend requests for academic time to the Executive Committee.

32. Pursuant to the Services Agreement, as long as a Contracting Professional Corporation or Contracting Professional, as the case may be, fully discharges its, or his or her responsibilities under the services contract with Newco, the Contracting Professional Corporation or the Contracting Professional will not be restricted from providing services to other persons or otherwise prohibited from competing with Newco. Likewise, on the termination of the Contracting Professional Corporation's or Contracting Professional's association with Newco, the Contracting Professional Corporation or Contracting Professional shall not be prohibited in any way from competing with Newco.

33. Newco will require each Contracting Professional Corporation to be a TCC and a CCPC.

34. XXXXXXXXXX

35. Each Contracting Professional Corporation will have two classes of shares: voting and non-voting common shares. Each Contracting Professional Corporation will be controlled by the Partner who incorporated the corporation, and that Partner will be the legal and beneficial owner of all of the voting shares of that corporation. The sole officer and director of a Contracting Professional Corporation will be the Partner who incorporated the corporation. Non-voting common shares of each Contracting Professional Corporation may be owned by members of the Partner's family. None of these non-voting shares will be issued as part of the proposed transactions described herein but will be issued at a later date. All persons legally or beneficially owning shares of a Contracting Professional Corporation will be residents of Canada.

36. The sole officer and director of a particular Contracting Professional Corporation (that is, the particular Partner), 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 that corporation's contract with Newco. The employment relationship between a Partner and his or her Contracting Professional Corporation will be evidenced by a written employment agreement.

37. A Partner will not be an employee, officer, director or shareholder, either legally or beneficially, of more than one Contracting Professional Corporation. Related persons of a Partner may only be a shareholder of the Contracting Professional Corporation in which that Partner owns shares.

38. No legal or beneficial shareholder of a Contracting Professional Corporation will be a legal or beneficial shareholder of another Contracting Professional Corporation at any time when the first Contracting Professional Corporation is providing services to Newco, except that if two shareholders of Newco are married to each other or are common-law partners ("Married Shareholders"), then members of such shareholders' family may own non-voting shares in both of such shareholders' Contracting Professional Corporations unless they themselves own voting shares in a Contracting Professional Corporation. For greater certainty, Married Shareholders cannot be legal or beneficial shareholders of each other's Contracting Professional Corporation. For purposes of this paragraph, "family" means individuals connected by blood relationship, marriage, common-law partnership or adoption, as those terms are described in subsection 251(6) of the Act.

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

40. Each year, Newco will estimate its annual revenues and expenses for the year. After Newco has made all payments due to the Contracting Professionals and Contracting Professional Corporations and has paid all expenses, such as rent of the premises, there may be an annual net profit to Newco. The directors of Newco will have the sole discretion to distribute such net profit in the form of dividends.

PURPOSE OF THE PROPOSED TRANSACTIONS

41. The purpose of the proposed transactions is to restructure the Practice of the Partnership. The Partners will continue to provide the Professional Services of the Practice, however, the new structure will

(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; and

(f) facilitate easier entry and exit of Professionals to and from the Practice.

RULINGS PROVIDED

Provided that

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purposes 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 a Contracting Professional or a Contracting Professional Corporation for Professional Services, as described in paragraphs 25 and 26, 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 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 in 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 apply 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 CRA's view that issuing the Shares in the name of each Partner, instead of the Partnership, as described in paragraph 14, above, will not invalidate the application of subsection 85(2) of the Act nor the subsequent application of subsection 85(3) of the Act.

The attribution rules in sections 74.1 to 74.4 of the Act apply in situations where property is transferred or lent, directly or indirectly, to a spouse or child. These rules may apply to any income received by a spouse, or a child who has not attained the age of 18 years before the end of a particular taxation year. Whether or not these rules will apply in respect of the ownership of any non-voting shares of a Contracting Professional Corporation, as described in paragraph 35 above, is a question of fact that can only be determined at the time that the shares are issued or property is lent or transferred to such a shareholder. Furthermore, subsection 56(2) of the Act may apply to any amounts paid by a Contracting Professional Corporation to a spouse or child of the Partner who owns the voting shares of the Contracting Professional Corporation.

The application of 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 carried 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.

The application of subsection 256(5.1) 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 over Newco to cause Newco to be considered to be controlled by a Contracting Professional Corporation at that time, pursuant to subsection 256(5.1).

Whether or not a Contracting Professional is an employee of Newco or is an independent contractor who has entered into a contract for services with Newco is a question of fact that can only be determined after a review of the actual agreement entered into between the Contracting Professional and Newco. This review and determination is the responsibility of the Contracting Professional's local tax services office.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA 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 Planning Branch