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: 1. Whether an allocation to a retired partner of a share of the partnership's work in progress, all in accordance with the partnership agreement is the type of agreement contemplated in 96(1.1)?
2. Whether drawings taken before ceasing to be a partner would be taken under an agreement contemplated in 96(1.1)?
Position: In both instances - insufficient information to conclude. General comments provided.
Reasons: These matters involve questions of fact. Best addressed when all the relevant facts are available.
2005-016058
XXXXXXXXXX Allan Nelson, C.M.A
(613) 443-7253
May 29, 2006
Dear XXXXXXXXXX:
Re: Subsection 96(1.1) and Retired Partners
Technical Opinion Request
This is in reply to your letter to us dated November 21, 2005 and our numerous telephone conversations (XXXXXXXXXX/Nelson). You have asked for our views concerning whether subsection 96(1.1) of the Income Tax Act (the "Act") would apply to the allocation of certain amounts of work in progress ("WIP") to a former member of a partnership.
Background
You describe a situation where the principal activity of a Canadian partnership of professionals (the "Partnership") is carrying on a business in Canada. The Partnership is profitable and has not reported a loss for any year. A written partnership agreement (the Partnership Agreement") between all the parties provides for the method used to annually report income for accounting and income tax purposes, the annual amount of available drawings for the partners, and the allocation of income to retired partners, all as described below.
The Partnership includes the value of its WIP when computing its net income for accounting purposes. Annually, the accounting net income is allocated to all of the partners who withdraw their pro rata share (i.e., each year the total drawings from the Partnership equals the amount of accounting net income for that year). Consequently, each year this results in the partners taking drawings equal to their share of the annually updated Partnership WIP.
Pursuant to an election made under section 34 of the Act, the Partnership excludes the value of its WIP when determining its income for tax purposes. This revised net income amount is allocated each year to the partners to be reported by them for income tax purposes.
When a partner retires from the Partnership, the Partnership Agreement dictates that the Partnership will allocate to that former member, in one or more fiscal periods commencing after the fiscal period of retirement, the aggregate of that former member's share of the Partnership WIP at the time of their retirement. No amount is paid to the former member with respect to this allocation of WIP, during or after the fiscal years in which such allocations are made. This is due to the fact that the former member will have already received all amounts in respect of their share of the WIP in the form of drawings before leaving the Partnership, as explained above. Ultimately, this reporting and allocation methodology results in each retired member reporting cumulative net income from the Partnership for income tax purposes equal to their share of the cumulative net Partnership income reported for accounting purposes.
Questions
You have asked us to confirm your views that
1. Pursuant to the terms of the Partnership Agreement, the allocations of WIP to a former partner in fiscal periods after they ceased to be a member of the Partnership would be amounts contemplated in an agreement referred to in subsection 96(1.1) of the Act. Thus, paragraph 96(1.1)(b) of the Act would require the amount that is the share of the income so allocated in a particular fiscal period of the Partnership to be included in computing the former partner's income for the taxation year in which that fiscal period of the Partnership ends, and
2. Notwithstanding that the allocations of WIP to a former partner are made in a fiscal period(s) after they cease to be a member of the Partnership, the drawings in respect of the annually updated WIP that are taken by the partner before they cease to be a partner would be viewed as being amounts received on account of or in lieu of payment of, or in satisfaction of, a distribution of the former partner's share of the income of the Partnership that is contemplated under paragraph 96(1.1)(b) and referred to in 1, above. Accordingly, the exception in subparagraph 53(2)(c)(v) of the Act would apply to exclude the amount of drawings related to the WIP from reducing the adjusted cost base ("acb") of the interest in the Partnership.
As explained in Information Circular 70-6R5, dated May 17, 2002, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Where the transactions are completed, the enquiry should be submitted along with all relevant facts and documentation to your local Tax Services Office for their views.
Determining whether subsection 96(1.1) of the Act applies in any particular scenario always involves a question of fact. Accordingly, we cannot comment with certainty on your particular situation without knowing all of the relevant facts and reviewing the relevant agreements and documents. However, we are prepared to provide you with the following information, which may be of some assistance to you.
Generally, subparagraph 53(2(c)(v) of the Act provides for a reduction in computing a partner's acb of their partnership interest at any time, equal in amount to their share of what will be referred to in this letter as the "drawings" from the partnership for each fiscal period of the partnership ending after 1971 and before that time. The same paragraph excludes the partner's share of drawings made under an agreement referred to in subsection 96(1.1) of the Act from reducing their acb in the partnership.
Subsection 96(1.1) of the Act reads as follows:
"96(1.1)(a) where...a partnership...its members have entered into an agreement to allocate a share of the income or loss of the partnership...to any taxpayer who at any time ceased to be a member of (i) the partnership...the taxpayer...shall be deemed to be a member of the partnership; and
(b) all amounts...equal to the share of the income or loss...allocated to a taxpayer from a partnership in respect of a particular fiscal period of the partnership shall...be included in computing the taxpayer's income for the taxation year in which that fiscal period of the partnership ends."
Depending on the facts, it is possible for a partnership agreement to be an agreement that is contemplated by subsection 96(1.1) of the Act. This could be the case where, for example, in addition to all the other requirements of the subsection being met, the partnership agreement is entered into by all partners and it clearly states the intention of all parties that there will be an allocation of a their pro rata share of the partnership's WIP, that has not been reported for income tax purposes, to each partner who retires from the partnership. Further, this amount will be computed at the time of retirement and the allocation will be made after they cease to be a member of the partnership. If it so qualifies, paragraph 96(1.1)(b) of the Act would require the amount allocated in a particular fiscal period of the partnership to be included in computing the former partner's income for the taxation year in which that fiscal period of the Partnership ends.
It is your stance that drawings under the Partnership Agreement, referred to above, would be taken pursuant to an agreement contemplated in subsection 96(1.1) of the Act. Accordingly, the exception in subparagraph 53(2)(c)(v) of the Act would apply to exclude the amount of drawings related to the WIP from reducing the acb of the interest in the Partnership. This would be so regardless of whether the drawings are taken any time while they are a partner [depending on the facts, perhaps even excluding decades of drawings from reducing the acb].
While we understand your arguments, we have not encountered a situation like you have described and are not presently in a position to agree with your perspective concerning the tax treatment of the drawings related to the WIP. In our view this question would best be dealt with in the context of an advance income tax ruling request, where we would have opportunity to fully develop our position after reviewing all the facts and relevant agreements in a set of proposed transactions.
If this is a course of action that you would interest you, we would be pleased to entertain such an application.
We hope this information will be of assistance to you.
Yours truly,
Robin Maley
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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