2006 Ruling 2006-0197521R3 - Partnership Reorganization

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: Where a partner of a professional partnership creates a professional corporation through which professional services will be provided to the partnership, will the corporation be eligible for the small business deduction?

Position: Yes.

Reasons: As long as the partner in his or her role of an employee of the professional corporation providing the services of the "professional function" would not, but for the corporation, be considered an employee of the partnership, then the business of the corporation is not a personal services business. Also, provided that the professional corporations are not themselves carrying on business in partnership, there is no specified partnership income. This ruling is the same as previous rulings given, in particular see our document E2006-0170321R3.

XXXXXXXXXX 		2006-019752

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

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

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

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

(i) dealt with in an earlier return of the above-named taxpayers or a related person;

(ii) 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;

(iii) under objection by the taxpayers or a related person;

(iv) before the courts;

(v) the subject of a ruling previously issued by the CRA; or

(vi) being considered by a Tax Services Office in connection with a GST/HST return already filed.

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 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) "active business carried on by a corporation" has the meaning assigned by subsection 125(7);

(b) "Board" means the Board of Directors of the Partnership;

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

(d) "XXXXXXXXXX Services" means the XXXXXXXXXX services (currently provided by the Partners through the Partnership);

(e) XXXXXXXXXX;

(f) XXXXXXXXXX;

(g) "CRA" means the Canada Revenue Agency;

(h) "Contracting Company" means each of the professional corporations that will be incorporated under the XXXXXXXXXX for the benefit of an existing Partner of the Partnership and that will be engaged by the Partnership to provide XXXXXXXXXX Services as an independent contractor and, collectively, these corporations are referred to as the "Contracting Companies";

(i) "Department" means XXXXXXXXXX;

(j) "Division" means a Division within the Department that has a least one XXXXXXXXXX who is a XXXXXXXXXX Partner;

(k) "ETA" means the Excise Tax Act R.S.C. 1985, c. E-15, as amended;

(l) "fair market value" means the highest price, expressed in terms of money or money's worth obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length, neither party being under any compulsion to transact;

(m) "XXXXXXXXXX Partner" means XXXXXXXXXX;

(n) "XXXXXXXXXX Salary" means the salary and benefits received by a XXXXXXXXXX Partner from the XXXXXXXXXX;

(o) "GST/HST" means the goods and services tax and harmonized sales tax levied under Part IX of the ETA;

(p) XXXXXXXXXX;

(q) XXXXXXXXXX;

(r) XXXXXXXXXX;

(s) XXXXXXXXXX;

(t) "Paragraph" refers to a numbered paragraph in this letter;

(u) "Partners" means the XXXXXXXXXX Partners and XXXXXXXXXX Partners, and any one is referred to as a "Partner";

(v) "Partnership" means the existing general partnership XXXXXXXXXX;

(w) "Partnership Agreement" means the XXXXXXXXXX Agreement dated XXXXXXXXXX;

(x) "personal services business" has the meaning assigned by subsection 125(7);

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

(z) "Professional Revenue" means gross revenue earned by the Partnership as described in Paragraph 7;

(aa) "Province" means the Province of XXXXXXXXXX;

(bb) "related persons" has the meaning assigned by subsection 251(2);

(cc) "specified partnership income" has the meaning assigned by subsection 125(7);

(dd) "taxable Canadian corporation" ("TCC") has the meaning assigned by subsection 89(1);

(ee) XXXXXXXXXX;

(ff) "XXXXXXXXXX Partner" means XXXXXXXXXX.

FACTS

1. The Practice is currently carried on by the Partnership. The Partners are the only partners of the Partnership. The Partners, approximately XXXXXXXXXX in total, currently provide their XXXXXXXXXX Services through the Partnership.

2. All of the Partners are individuals resident in Canada for the purposes of the Act. None of the Partners are related persons, with the exception of a few sets of spouses who are Partners. Each Partner is a member of XXXXXXXXXX.

3. The Partnership's identification number is XXXXXXXXXX and its GHT/HST registration number is XXXXXXXXXX. The Partnership files its information returns with the XXXXXXXXXX . The Named Partner files his income tax return with the XXXXXXXXXX Taxation Centre.

4. All of the Partners have XXXXXXXXXX . However, only a small portion of the Partners (approximately XXXXXXXXXX in total) receive a XXXXXXXXXX Salary. The Named Partner is a XXXXXXXXXX Partner.

5. XXXXXXXXXX.

6. The Partnership's Board is composed of a director from each Division that has XXXXXXXXXX who are XXXXXXXXXX Partners. There are currently several Divisions within the Partnership, including: XXXXXXXXXX.

7. The activities of each Partner can be classified into four general categories: XXXXXXXXXX, research, teaching and administrative duties. Professional Revenue refers to the gross revenue received by the Partnership in respect of all these activities and duties and includes, but is not limited to, revenue from:

a. fee for service payments from the XXXXXXXXXX in respect of specific services rendered by a Partner;

b. XXXXXXXXXX payments provided by the XXXXXXXXXX, which payments are not based on the number of specific services that are provided by the Partners, but rather are based on XXXXXXXXXX;

c. financial contributions from the XXXXXXXXXX and/or XXXXXXXXXX for secretarial support;

d. stipends and financial support from research studies;

e. honoraria or fees for lectures;

f. fees on account of insurance reports;

g. fees on account of legal consultations;

h. XXXXXXXXXX;

i. radio or television fees;

j. royalties; and

k. awards or prizes.

8. The major terms of the Partnership Agreement concerning the computation and allocation of income are as follows:

a. The gross income of the Partnership includes all Professional Revenue earned by the Partners.

b. The following portion of the Partnership's gross income is allocated to fund general expenses of the Partnership:

(i) XXXXXXXXXX percent (XXXXXXXXXX%) of all Professional Revenue of the XXXXXXXXXX Partners;

(ii) a sum equal to the gross value of all XXXXXXXXXX Salaries;

(iii) all financial contributions from the XXXXXXXXXX and/or XXXXXXXXXX for secretarial support for XXXXXXXXXX Partners;

(iv) XXXXXXXXXX percent (XXXXXXXXXX%) of all Professional Revenue earned by the XXXXXXXXXX Partners in the XXXXXXXXXX; and

(v) other Department revenue not allocated to a particular Division, Partner or group of Partners.

If the amounts described above exceed the Partnership's general expenses, the excess shall be allocated to the Partners in such a manner as determined by the Partnership;

c. Additional Partnership expenses are determined by each Division. The Division expenses might include secretarial support, XXXXXXXXXX fees, professional membership and other licensing fees as the Division may determine.

d. Each Division determines how its share of the net income of the Partnership is to be distributed and allocated to the XXXXXXXXXX Partners in that Division. Any Partnership net income that would otherwise have been received by a XXXXXXXXXX Partner is reduced by an amount equal to the gross value of his or her XXXXXXXXXX Salary;

e. Each XXXXXXXXXX Partner's monthly draw is to be determined for each fiscal year at the beginning of the fiscal year by the Board based on his or her estimated income for that year with input from the Division and the Partner. Subject to contrary determination by the Board, XXXXXXXXXX (XXXXXXXXXX%) percent of the estimated annual income is paid in equal monthly instalments, and the remaining XXXXXXXXXX (XXXXXXXXXX%) percent at intervals as determined by the Board with input from the Divisions.

f. Each XXXXXXXXXX Partner's share of Partnership net income is generally equal to such Partner's Professional Revenue earned in the XXXXXXXXXX, less XXXXXXXXXX percent (XXXXXXXXXX%) for general Partnership expenses (as outlined in Paragraph 8(b)) and any amount allocated to cover Division expenses.

PROPOSED TRANSACTIONS

Partnership

9. The Partnership Agreement will be amended to give each Partner the choice to provide XXXXXXXXXX Services to the Partnership only through a Contracting Company. Each Contracting Company will hold a valid certificate of authorization issued by the XXXXXXXXXX. Consequential amendments to the Partnership Agreement will provide that a Partner who incorporates a Contracting Company will no longer provide any XXXXXXXXXX Services to the Partnership in his or her capacity as a Partner (see in particular paragraph 22, below).

10. Each Contracting Company will be engaged by the Partnership to provide the XXXXXXXXXX Services as an independent contractor. Each Contracting Company will employ an individual who is XXXXXXXXXX and who is a Partner. None of the Contracting Companies will be related persons with the exception of the Contracting Companies that may be set up by individuals who are spouses.

11. Each Contracting Company will be required to enter into a written contract for services (a "Services Contract") with the Partnership in respect of the XXXXXXXXXX Services that will be provided by the Contracting Company to the Partnership. The fees payable to a Contracting Company under a Services Contract will be negotiated on a case-by-case basis and will vary with the number and type of XXXXXXXXXX Services to be provided by the Contracting Company; the fees will be equal to the fair market value of the XXXXXXXXXX Services provided by the Contracting Company to the Partnership.

12. The Partnership Agreement will be amended to prohibit the transfer, conveyance or issuance of an interest in the Partnership to any Contracting Company.

13. Provided a Contracting Company fully discharges its responsibilities under the Services Contract with the Partnership, the Contracting Company will not be restricted from providing services to other persons or otherwise prohibited from competing with the Partnership. The Partnership Agreement will be amended so that Partners who provide XXXXXXXXXX Services through a Contracting Company are not restricted from competing with the Partnership in respect of those XXXXXXXXXX Services.

14. All payments received by the Partnership in respect of XXXXXXXXXX Services provided by the Contracting Company pursuant to a Services Contract with the Partnership will be for the benefit of the Partnership.

15. The Partnership will provide the Contracting Companies with certain supplies, personnel, facilities and equipment that are required to provide XXXXXXXXXX Services. However, each Contracting Company will be responsible for the following expenses:

a. professional membership fees and insurance;

b. transportation;

c. communication;

d. maintaining the professional standards set by the Partnership or by the XXXXXXXXXX; and

e. expenditures on personal practice preferences of the Contracting Company.

16. All of the voting shares of a particular Partner's Contracting Company will be legally and beneficially owned by the Partner and, if applicable, a spouse who is also a member of the XXXXXXXXXX. Non-voting shares of a Contracting Company may be owned by members of the Partner's family. For the 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). All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada.

17. Each Partner will be an officer and director of his or her Contracting Company and, in accordance with the XXXXXXXXXX, any other shareholder of the Contracting Company who is a member of the XXXXXXXXXX may also be an officer or director of that Contracting Company.

18. Each Contracting Company will be a TCC and CCPC.

19. The employment relationship between a Partner and his or her Contracting Company will be evidenced by a written employment agreement. A Partner who has incorporated a Contracting Company will provide XXXXXXXXXX Services for the benefit of the Contracting Company in accordance with the terms of his or her employment agreement. These services will generally be related to the requirements of the Services Contract between the Contracting Company and the Partnership.

20. A Partner who provides services for the benefit of his or her Contracting Company will be entitled to receive a salary from his or her Contracting Company for such services.

21. As the Contracting Companies will only be providing XXXXXXXXXX Services, all of the Partners (including those who have incorporated Contracting Companies) will continue to provide the non-XXXXXXXXXX Services, that is, those services required by the research, teaching and administrative functions of the Partnership business. Partners who choose not to establish a Contracting Company will continue to provide their XXXXXXXXXX Services through the Partnership.

22. Consequential amendments to the Partnership Agreement will provide that a Partner's allocation of income for any year during which a Contracting Company performs that Partner's XXXXXXXXXX Services will be dependent solely on the Partner's capital contribution to the Partnership and factors connected to the Partner's non-XXXXXXXXXX Services, including research, teaching and administrative activities. In particular, the calculation of the Partner's income allocation for that year will not take into account any of his or her XXXXXXXXXX Services, either directly or indirectly.

Named Partner

23. The Named Partner will incorporate a Contracting Company (the "Particular Contracting Company").

24. The Particular Contracting Company will enter into a Services Contract with the Partnership in respect of XXXXXXXXXX Services to be provided by the Particular Contracting Company. The fees payable to the Particular Contracting Company by the Partnership will be determined as described above.

25. The Particular Contracting Company will employ the Named Partner to provide XXXXXXXXXX Services for the benefit of the Particular Contracting Company, pursuant to a written employment agreement, with a view to fulfilling its obligations to the Partnership in accordance with its Services Contract with the Partnership.

PURPOSE OF THE PROPOSED TRANSACTIONS

26. The primary objective of the proposed transactions is to restructure the Partnership to allow Partners to render XXXXXXXXXX Services through a Contracting Company in accordance with recent amendments to the XXXXXXXXXX, while at the same time ensuring minimal disruption to the existing arrangements between the Partners, the Partnership and third-parties, including the XXXXXXXXXX. Other purposes include:

a. To provide a Partner with an increased level of control over their participation in the Practice through individual management of personal practice preferences;

b. To permit a Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Practice;

c. To provide the Partner with more control over his or her own estate and financial planning;

d. To enhance the Partnership's ability to retain current and recruit additional professionals;

e. To allow a Partner the opportunity to benefit from the ability to render XXXXXXXXXX Services through a corporation including, without limitation, the limited liability protection that a Contracting Company would provide with respect to non-XXXXXXXXXX activities.

RULINGS GIVEN

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. The execution and implementation of the proposed transactions described above, in and of themselves, will not constitute a disposition of part or all of an interest in the Partnership by any Partner.

B. Provided that a Partner providing XXXXXXXXXX Services to the Partnership through a Contracting Company would not, but for the existence of the Contracting Company, be an officer or employee of the Partnership in respect of those services, then the Contracting Company 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 any of the Contracting Companies, the income earned by a Contracting Company, and in particular the income described in paragraph 11, above, will not be specified partnership income as defined in subsection 125(7) of the Act.

D. Subject to sections 18 and 67, the fees payable by the Partnership to the Contracting Companies pursuant to the Services Contracts, as described in paragraph 11, above, will be deductible in computing the Partnership's income pursuant to subsection 96(1) of the Act.

E. The transactions undertaken in paragraphs 9 and 11, and in particular the payments described in paragraph 11, will not in and of themselves cause subsections 56(2), 56(4) or 246(1) of the Act to apply so as to cause an amount received by the Contracting Companies under the Services Contracts to be taxed as income in the hands of a Partner.

F. Sharing of income between the Partners of the Partnership will not be subject to adjustment pursuant to subsection 103(1) solely as a result of the proposed transactions and in particular the proposed amendments to the Partnership Agreement in paragraph 22, above.

G. The execution and implementation of the proposed transactions, of and by themselves, will not be sufficient to create a non-arm's length relationship between the Partners with respect to sharing the Partnership profits for income tax purposes.

H. Implementation of the proposed transactions, in and by themselves, will not result in the application of the provisions of subsection 245(2) to re-determine the tax consequences confirmed in the rulings given above.

COMMENTS

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 the Contracting Companies. In general, where a particular function of a professional partnership that was previously carried on by the partnership is subsequently carried on by a partner's professional corporation, and no longer in partnership, for bona fide 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. The reasons for the separate existence of two or more professional corporations or the reasons for a change in the functions performed directly by the partners of the professional partnership is a question of fact that can only be determined on a case-by-case basis. However, based on the facts and proposed transactions described herein, it is our view that the incorporation of the Contracting Companies to provide the XXXXXXXXXX Services to the Partnership will not, in and of itself, cause subsection 256(2.1) of the Act to be applicable to the Contracting Companies.

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
Section Manager
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch