2005 Ruling 2005-0157311R3 - 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.

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 "Contracting Company" do not provide services to Newco in his/her capacity as an employee or officer of Newco. See previous rulings issued.

XXXXXXXXXX 									2005-015731

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

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

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

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 Canada Revenue Agency.

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) "CRA" is the Canada Revenue Agency;

(b) "Province" is the Province of XXXXXXXXXX;

(c) "Partnership Agreement" is a reference to the XXXXXXXXXX partnership agreement entered into between the Partners practicing as XXXXXXXXXX and as a partnership, more fully described in paragraph 4, below;

(d) "Newco" is a new Corporation to be incorporated under the Canada Business Corporations Act;

(e) "Contracting Corporation" means each of the corporations that will be incorporated for the benefit of an existing Partner of the Partnership to carry on an independent XXXXXXXXXX and, collectively, they are referred to as the "Contracting Corporations";

(f) "Contracting Professional" means any of the existing Partners of the Partnership who may choose to enter into contractual relations with Newco for the provision of professional services as an independent contractor and, collectively, they are referred to as the "Contracting Professionals";

(g) "Practice" means the provision of XXXXXXXXXX services currently provided by the Partnership;

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

(i) "Business Limit" has the meaning assigned by subsection 125(2) of the Act;

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

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

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

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

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

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

Facts

1. The Practice is currently carried on by the Partnership as a general partnership. The Partners are the only partners of the Partnership. The Partners have been carrying on business pursuant to the Partnership Agreement. The Partners provide XXXXXXXXXX services (the "Professional Services") to the Partnership.

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

3. There are a number of XXXXXXXXXX who are employed by the Partnership. None of the employees will participate in the proposed transactions.

4. XXXXXXXXXX. The terms of the Partnership Agreement include the following:

(a) Any income earned by a Partner is treated as Partnership income;

(b) XXXXXXXXXX;

(c) XXXXXXXXXX thus, each Partner has a certain number of units of Income Capital;

(d) Each Partner has a Tangible Capital Account to which is credited the amount of all contributions of the Partner and the amount of any income allocated to the Partner and from which is debited the amount of any withdrawals made by the Partner and the amount of any loss allocated to the Partner;

(e) Each Partner's share of the profits and losses of the Partnership is calculated as follows:

(i) Each Partner is allocated an amount equal to a percentage (determined annually by the partners based on the rate of interest on the line of credit of the partnership plus a discretionary amount typically equal to XXXXXXXXXX%) of the amount in his or her Tangible Capital Account.

(ii) Each Partner is allocated profits or losses equal to his or her share, based on number of units of Income Capital, of the profits or losses of the Partnership after deducting the amounts paid out on the Tangible Capital Accounts and the amounts paid out to any partners in transition;

(f) Each Partner has a Goodwill Account, which represents his or her share of the goodwill of the Partnership. XXXXXXXXXX;

(g) Each Partner must employ himself or herself diligently and exclusively in the business of the Partnership and must use the utmost endeavours to promote the interests of the Partnership;

(h) Each Partner is entitled to receive the amounts of his or her Tangible and Goodwill Accounts upon his or her death, retirement, withdrawal or expulsion from the Partnership, the terms of payment to be determined at that time.

5. All of the Partners are residents of Canada. None of the Partners are related persons.

Proposed Transactions

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

7. Upon incorporation, Newco will be authorized to issue an unlimited number of voting common shares without nominal or par value. Newco will issue one such common share to the Partnership for XXXXXXXXXX. Newco will also be authorized to issue an unlimited number of Class A and Class B preferred shares without nominal or par value. Each Class A and Class B preferred share will

(a) be redeemable at the option of the issuer for a redemption amount equal to the fair market value of the consideration received in respect of the issuance of the share;

(b) be retractable at the option of the holder for a retraction amount equal to the redemption amount described in (a), above;

(c) entitle the holder to receive a dividend not exceeding XXXXXXXXXX% of the redemption amount described in (a), above, annually, as and when declared by the board of directors of the issuer; and

(d) be non-voting.

8. The Partnership will sell all of its assets to Newco at fair market value. In exchange, Newco will assume all of the liabilities of the Partnership, issue an additional XXXXXXXXXX voting common shares (the "Additional Shares"), issue a demand, non-interest bearing promissory note (the "Promissory Note"), and issue a number of Class A and Class B preferred shares.

9. The amount of the Promissory Note will be equal to the sum of the fair market value of the assets transferred to Newco to which section 85 does not apply (such as accounts receivable) and the amount of the deemed proceeds of disposition under paragraph 85(1)(a) (the "agreed amount") of the other assets transferred to Newco, less the amount of the liabilities assumed by Newco. The redemption amount of the Class A preferred shares will be equal to the fair market value of the assets other than goodwill transferred to Newco, less the portion of the Promissory Note and the amount of the liabilities assumed by Newco with respect to those assets. The redemption amount of the Class B preferred shares will be equal to the fair market value of the goodwill transferred to Newco less the portion, if any, of the Promissory Note and the amount of the liabilities assumed by Newco with respect to the transfer of the goodwill.

Newco will add a nominal amount to the stated capital account maintained for its voting common shares and its Class A and Class B preferred shares.

10. 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.

11. 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.

12. Newco will redeem the initial common share issued to the Partnership, following which Newco will only have the Additional Shares and the Class A and Class B preferred shares issued and outstanding.

13. For legal simplification, the Additional Shares will be issued in the name of each Partner (based on a pro-rata share of the Income Capital Account) instead of the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Additional Shares.

14. For legal simplification, the Promissory Note issued by Newco will be issued in the name of each Partner (based on a pro rata share of the Tangible Capital Account) instead of the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Promissory Note.

15. For legal simplification, the Class B preferred shares will be issued in the name of each Partner (based on a pro-rata share of the Goodwill Account) instead of the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Class B preferred shares.

16. For legal simplification, the Class A preferred shares will be issued in the name of each Partner (based on the sum of the values of each Partner's Income Capital Account, Tangible Capital Account and Goodwill Account, less the value of the Promissory Note, Additional Shares and Class B shares received by the Partner) instead of the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Class A preferred shares.

17. 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 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 respective interest in the Partnership, the Additional Shares, Class A preferred shares and Class B preferred shares originally issued in his or her name as described in paragraphs 13, 15 and 16, above, plus the portion of the Promissory Note described in paragraph 14, above.

18. The shareholders (the "Shareholders") of Newco will elect Newco's directors (the "Directors").

19. The Shareholders will enter into an agreement (the "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 employees to provide the Professional Services;

(c) Each Shareholder will be a member of the board of directors of Newco (the "Board of Directors");

(d) The officers of Newco will be elected by the Directors; and

(e) At the sole discretion of the Board of Directors, the net profits of Newco will, from time to time, be available for distribution in the form of dividends on the outstanding shares of Newco.

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

(a) Through individuals licensed to practice XXXXXXXXXX in the Province and employed by Newco to provide various Professional Services;

(b) Through individuals engaged by Newco to provide various Professional Services as independent contractors. These independent contractors will be licensed to practice XXXXXXXXXX in the Province and will provide such Professional Services on behalf of Newco; and

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

21. Each Partner will have the option of providing Professional Services to Newco in one of the following ways:

(a) As an employee of Newco;

(b) As a Contracting Professional; or

(c) As a Contracting Corporation entering into a contract for service with Newco.

22. The Partners who choose to enter into a contractual relationship with Newco, other than as employees, agree to provide certain Professional Services as a Contracting Professional and will receive a fee as compensation for the Professional Services provided to Newco. The amount of the fee will be negotiated on a case-by-case basis and will vary with the number and type of Professional Services to be provided by the Contracting Professional. This arrangement will be evidenced by a written contract which will provide that the fee for Professional Services performed will be based upon the total number of billable and non-billable hours provided to Newco during the year multiplied by a stipulated hourly rate. The Board of Directors may adjust this hourly rate at any time during the year.

23. So long as a Contracting Professional fully discharges his or her responsibilities under the services contract with Newco, he or she will not be restricted from providing services to other persons or otherwise prohibited from competing with Newco. Likewise, on the termination of a Contracting Professional's association with Newco, the Contracting Professional shall not be prohibited in any way from competing with Newco.

24. If a Partner chooses option (c) in paragraph 21, above, the Partner's Contracting Corporation will be required to enter into a signed written agreement with Newco. The agreement between Newco and the Contracting Corporation will provide that the fee for services performed by the Contracting Corporation will be determined in a manner similar to that determined for a Contracting Professional, as described in paragraph 23 above. There will not be any other contractual relations between or among any of Newco and the Contracting Corporations.

25. A Partner who provides services for the benefit of his or her Contracting Corporation will be entitled, if he or she so desires, to receive a salary from his or her Contracting Corporation for such services provided.

26. Each Contracting Corporation will be controlled by the Partner who incorporated that corporation, who will be the legal and beneficial owner of all of the voting shares of the corporation, except that voting shares of a Contracting Corporation may also be owned by another corporation, all of the voting shares of which are owned by the Partner. The sole officer and director of a Contracting Corporation will be the Partner who incorporated the Contracting Corporation.

Non-voting shares of a Contracting Corporation or of a corporation holding shares in a Contracting Corporation may be beneficially owned by members of the particular Partner's family.

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

27. A legal or beneficial shareholder of a Contracting Corporation will not be a legal or beneficial shareholder of another Contracting Corporation.

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

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

30. Newco will require that each Contracting Corporation be a TCC and a CCPC.

31. Only Partners of the Partnership will have the option to choose which contractual arrangement they will establish with Newco.

32. After payment of all expenses, including fees payable to employees, Contracting Professionals and Contracting Corporations for Professional Services, it is anticipated that Newco will, in any given taxation year, earn less than the Business Limit. To the extent Newco's taxable income for any particular taxation year exceeds the business limit, the excess will likely be distributed, at the absolute discretion of the Board of Directors, as fees, bonuses or similar payments.

Purpose of the Proposed Transactions

33. 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 and allow the Partners to benefit from the recent amendment by the Province which permits XXXXXXXXXX in the Province to render professional XXXXXXXXXX services through a corporation;

(b) provide each Partner with an increased level of control over their participation in the Practice through individual management of personal practice preferences;

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

(d) provide each Partner with more options and more control in arranging estate planning; and

(e) provide an incentive to Professionals and future recruits to the Practice.

Rulings Given

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 Corporation for Professional Services, as described in paragraphs 22 and 24, 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 Corporation would not, but for the existence of the Contracting Corporation, be an officer or employee of Newco in respect of those Professional Services, then each such Contracting 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 Corporation, the income earned by Newco or any Contracting Corporation will not be specified partnership income as defined in 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 Additional Shares and the Class A and Class B Shares in the name of each Partner, instead of the Partnership, as described in paragraphs 13, 15 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.

In accordance with paragraph 2 of IT-378R, it is the CRA's view that issuing the Promissory Note 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 Corporation, as described in paragraph 26 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 Corporation to a spouse or child of the Partner who owns the voting shares of the Contracting Corporation.

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