2006 Ruling 2006-0198551R3 - 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 2006-019855

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (the "Partnership")
XXXXXXXXXX and
XXXXXXXXXX (together referred to as the "Named Partners")
Advance Income Tax Ruling

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

We understand that, to the best of your knowledge, and that of the taxpayers involved, none of the issues described herein is:

(i) in an earlier return of the taxpayer or related person;

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed return of the taxpayer or a related person;

(iii) the subject of any notice of objection;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal has not expired; or

(v) the subject of a previously issued ruling. 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) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7);

(b) XXXXXXXXXX;

(c) "Contracting Company" means each of the professional corporations that will be incorporated, as permitted pursuant to the laws of the Province, for the benefit of an existing Partner of the Partnership and that will be engaged by the Partnership to provide Professional Services as independent contractors and, collectively, they are referred to as the "Contracting Companies";

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

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

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

(g) "Personal Services Business" has the meaning assigned by subsection 125(7) of the Act;

(h) "Professional Services" means XXXXXXXXXX services, XXXXXXXXXX;

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

(j) "Related Persons" has the meaning assigned by subsection 251(2) of the Act;

(k) "Specified Partnership Income" has the meaning assigned by subsection 125(7) of the Act;

(l) "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. The Partners are the only partners of the Partnership. The Partnership carries on business pursuant to a partnership agreement (the "Partnership Agreement"). The Partners, currently approximately XXXXXXXXXX in total, provide Professional Services XXXXXXXXXX. All the Partners are individuals resident in Canada and none of the Partners are Related Persons.

2. The Partnership's identification 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 self-employed XXXXXXXXXX who provide Professional Services to the Partnership. These arrangements are governed by separate agreements. Such self-employed XXXXXXXXXX are not Partners of the Partnership; each such individual is paid for his or her services by the Partnership.

4. Currently, all the Partners provide their Professional Services through the Partnership. The Partners also provide XXXXXXXXXX services to and through the Partnership, such as promotional, teaching, management and administrative activities.

5. The Partnership operates the Practice on a "fee for service" basis or on a contract basis. XXXXXXXXXX.

6. The Partners are bound by the Partnership Agreement, the terms of which include the following:

a. The net profits and losses of the Partnership are to be divided and borne by the Partners as may be agreed upon from time to time;

b. Each Partner's share of the net profits of the Partnership is based on his or her XXXXXXXXXX contributions to the Partnership;

c. Capital accounts are to be maintained for each Partner;

d. Upon the death or retirement of a Partner, the deceased or retiring Partner is entitled to the amount in the Partner's capital account together with the Partner's share of undistributed profits in the Partnership, however, the deceased or retiring Partner is not entitled to any goodwill of the Partnership.

7. The Partnership Agreement provides for the creation of a "Management Committee" of the Partners. The Management Committee currently consists of XXXXXXXXXX Partners. Subject to the Partnership Agreement, this committee manages and supervises the affairs of the Partnership.

PROPOSED TRANSACTIONS

Partnership

8. By XXXXXXXXXX, the Partnership Agreement will be amended to give each Partner the option, exercisable by notice in writing to be delivered to the Partnership at least XXXXXXXXXX days prior to the effective date of the notice, to perform his or her Professional Services through a Contracting Company controlled by that Partner and licensed to carry on XXXXXXXXXX services in the Province. Consequential amendments to the Partnership Agreement will provide that a Partner who incorporates a Contracting Company will no longer provide any Professional Services to the Partnership in his or her capacity as a Partner. The Partnership Agreement will also be amended to prohibit the performance of the XXXXXXXXXX services currently provided by such a Partner (see Paragraph 4, above), by any person other than the Partner, and to prohibit the transfer or other conveyance of any interest in the Partnership to a Contracting Company.

9. The Contracting Companies will be engaged by the Partnership to provide the Professional Services as independent contractors. Each Contracting Company will employ an individual licensed to practice XXXXXXXXXX in the Province. None of the Contracting Companies will be Related Persons.

10. Each Contracting Company will be required to enter into a written contract for service (the "Services Contract") with the Partnership. The Services Contract will provide that the amount of the fee for the Professional Services provided by the Contracting Company to the Partnership 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 Company. The amount of the fee will be equal to the fair market value for the Professional Services provided by the Contracting Company to the Partnership. The contract shall be for a fixed period of XXXXXXXXXX months. The contract may be renewed each year and either party may also terminate it upon XXXXXXXXXX month's notice.

11. So long as a Contracting Company fully discharges its responsibilities under the agreement 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 Professional Services through a Contracting Company are not restricted from competing with the Partnership in respect of those XXXXXXXXXX Services.

12. All payments from the XXXXXXXXXX and other sources of revenue received by the Partnership in respect of any services provided by the Contracting Companies will be for the benefit of the Partnership.

13. The Partnership will supply to the Professional Corporation certain supplies, personnel and equipment that are required to provide Professional Services to patients. A Contracting Company will be responsible for the following expenses:

a. professional membership fees and insurance including fees payable to the XXXXXXXXXX;

b. continuing education;

c. transportation;

d. communication;

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

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

14. The sole officer and director of each Contracting Company will be the Partner who incorporated the Contracting Company. This Partner will provide Professional Services for the benefit of the Contracting Company in accordance with the terms of his or her employment agreement, which agreement will be in writing.

15. 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.

16. Each Contracting Company will be controlled by the Partner (and in some cases, his or her spouse where that spouse is also a member of the XXXXXXXXXX), who will be the legal and beneficial owner of all of the voting shares of the Contracting Company. Non-voting shares of a Contracting Company may be owned by members of the Partner's family, but only as permitted under the incorporation restrictions set forth by the XXXXXXXXXX and by the Province. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada. 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).

17. 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 Professional Services will be dependent solely on the Partner's capital contribution to the Partnership and factors connected to the Partner's XXXXXXXXXX services, including promotional, teaching, management 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 Professional Services, either directly or indirectly.

Named Partners

18. The Named Partners will incorporate Contracting Companies (the "Particular Contracting Companies").

19. The Particular Contracting Companies will enter into Services Contracts with the Partnership in respect of XXXXXXXXXX Services to be provided by the Particular Contracting Companies. The fees payable to the Particular Contracting Companies by the Partnership will be determined as described above.

20. Each of the Particular Contracting Companies will employ one of the Named Partners to provide XXXXXXXXXX Services for its benefit, 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

21. The purpose of the proposed transaction is to allow a Partner to provide his or her Professional Services through a Contracting Company to the Partnership with the following advantages:

a. To allow a Partner to benefit from the amendment by the Province which permits XXXXXXXXXX to render Professional Services through a corporation.

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 a 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 XXXXXXXXXX.

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. 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.

B. 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 10, above, will not be specified partnership income as defined in subsection 125(7) of the Act.

C. Subject to sections 18 and 67 of the Act, the fees payable by the Partnership to the Contracting Companies as described in Paragraph 10, above, will be deductible by the Partnership in its determination of the Partnership income for purposes of subsection 96(1) of the Act.

D. The transactions undertaken in Paragraphs 8 and 10, above, and in particular the payments described in paragraph 10, 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.

E. The sharing of income between the Partners of the Partnership will not be subject to adjustment pursuant to subsection 103(1) of the Act solely as a result of the proposed transactions and in particular the proposed amendments to the Partnership Agreement in Paragraph 17, above.

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

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

H. 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.

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