2007 Ruling 2006-0201311R3 - Incorporation of professional 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: As long as the former partners that are providing services through a professional corporation do not provide services to Newco in the capacity of employees or officers of Newco, the new structure does not create a personal services business.

XXXXXXXXXX 								2006-020131

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling

XXXXXXXXXX , Partnership Identification No. XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above noted partnership. We also acknowledge your letters of XXXXXXXXXX, and our telephone conversations and email correspondence with you (XXXXXXXXXX).

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

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

(b) 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;

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

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

(e) the subject of a ruling previously issued by the Canada Revenue Agency (the "CRA");

Definitions

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 is or will be incorporated pursuant to the laws of the Province of XXXXXXXXXX and is or will be licensed to carry on the practice of XXXXXXXXXX in the Province of 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) "Existing Contracting Professional Corporation" is a Contracting Professional Corporation that is a Partner;

(g) "Individual Partner" is a Partner who is an individual or the shareholder of an Existing Contracting Professional Corporation who is an individual authorized to practice XXXXXXXXXX in the Province of XXXXXXXXXX and who currently provides Professional Services to the Partnership through that corporation

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

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

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

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

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

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

(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.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

Facts

1. The Partnership's business number is XXXXXXXXXX and its partnership 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 (the "Professional Services") to the public. The Partnership currently has XXXXXXXXXX Partners. XXXXXXXXXX of the Partners are corporations. The Partnership has been carrying on business since XXXXXXXXXX.

3. The Partnership is governed by a written partnership agreement (the "Partnership Agreement") that was signed in XXXXXXXXXX, some of the provisions of which are outlined in paragraph 7, below.

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

5. 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 XXXXXXXXXX .

(b) XXXXXXXXXX.

6. The Partnership pays for Partners and XXXXXXXXXX to attend continuing XXXXXXXXXX education courses and conferences, and to prepare and present papers and other work at courses and conferences.

7. 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) Each Partner agrees to report all charges for XXXXXXXXXX services rendered by him or her to the Partnership. The Partners agree that all amounts paid by the clients of the Partnership to any Partner and all amounts paid by the clients of the Partnership in respect of any XXXXXXXXXX services provided by any Partner will be included in the computation of the Partnership's profits;

(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 professional liability insurance as approved by the Management Committee and the XXXXXXXXXX.

8. Each of the Partners is a resident of Canada.

9. The Partnership contracts with and employs a limited number of XXXXXXXXXX The Partners currently employ XXXXXXXXXX who are not partners in the Partnership ("Associate Staff").

10. The Partnership pays for all of the Partners' and Associate Staff's professional liability insurance premiums and their professional membership dues.

11. The Managing Partner is responsible for managing all of the XXXXXXXXXX needs and for ensuring that all XXXXXXXXXX and professional activities are performed.

12. The Management Committee is responsible for supervising the day-to-day operations of the Partnership.

Proposed Transactions

13. Newco will be incorporated under the laws of the Province of XXXXXXXXXX. It will be a CCPC and a TCC. It will be licensed to carry on the practice of XXXXXXXXXX by the XXXXXXXXXX.

14. Upon incorporation, Newco will be authorized to issue, inter alia, an unlimited number of voting common shares (the "Common Shares") without nominal or par value, an unlimited number of non-participating voting shares (the "Voting Shares") with a par value of $XXXXXXXXXX each and a redemption value of $XXXXXXXXXX per share and an unlimited number of non-voting preferred shares (the "Preferred Shares") with a par value of $XXXXXXXXXX each and a redemption value equal to the fair market value of any property received by Newco as consideration for such shares less all liabilities assumed by Newco relating to such shares. Upon incorporation, XXXXXXXXXX Voting Share will be issued to the Partnership by Newco for consideration of $XXXXXXXXXX.

15. The Partnership will sell all of its assets to Newco at fair market value (the "Assets"). The Assets of the Partnership consist mainly of cash and receivables from the Partnership's clients in respect of XXXXXXXXXX work performed, XXXXXXXXXX. In exchange, Newco will assume all of the liabilities of the Partnership and the Partnership will receive XXXXXXXXXX Common Shares and XXXXXXXXXX Preferred Shares of Newco, and a note equal to the tax cost of the Assets transferred from the Partnership less the liabilities assumed by Newco (the "Note"). The redemption value of the Preferred Shares will be equal to the fair market value of the assets transferred less the total of the liabilities assumed and the Note.

16. 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 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 Common Shares and Preferred 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 (XXXXXXXXXX Common Shares and XXXXXXXXXX Preferred Shares each) instead of in the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Common Shares and the Preferred Shares. Once the Common Shares and the Preferred Shares have been issued, Newco will redeem the initial Voting Share issued to the Partnership, following which Newco will only have the Common and Preferred Shares issued and outstanding.

19. On the day which is XXXXXXXXXX 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 XXXXXXXXXX Common Shares and XXXXXXXXXX Preferred Shares and the Note received as consideration for the Assets transferred. Each Partner will receive, in complete satisfaction of his or her interest in the Partnership, XXXXXXXXXX Common Shares and XXXXXXXXXX Preferred Shares of Newco and XXXXXXXXXX of the Note.

20. The shareholders of Newco will elect the directors of Newco. The directors of Newco are expected to be the Partners of the Partnership as it was prior to the winding-up.

21. The shareholders of Newco will enter into a Shareholders' 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) The officers of Newco will be selected by the directors of Newco;

(e) 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 Common Shares;

(f) Upon the recommendation of the Executive Committee, the shareholders of Newco, by majority vote, will allow new shareholders to subscribe for shares of Newco. No shareholder will be entitled to hold more Common Shares of Newco than any other shareholder;

(g) 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 shares 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 either Newco or the other shareholders must purchase from the shareholder his or her shares of Newco.

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

(a) Newco will engage individuals as independent contractors. The 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. 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. Where an individual Partner chooses to provide Professional Services as a Contracting Professional, the Contracting Professional will be required to enter into a signed written agreement with Newco (the "Services Agreement"). The relationship between the Contracting Professional and Newco is intended to be one of independent contractor and hirer. The agreement between Newco and each particular Contracting Professional will provide that the fee for XXXXXXXXXX services performed by the Contracting Professional will be an amount determined by agreement between the Contracting Professional and the Executive Committee. The amount of the fee will be equal to the fair market value of the Professional Services provided by the Contracting Professional to Newco and will reflect any facilities provided by Newco to the Contracting Professional. There will not be any other contractual relations between Newco and any of the Contracting Professionals.

26. Where an individual Partner chooses to provide Professional Services through a Contracting Professional Corporation, the Partner's Contracting Professional Corporation will be required to enter directly into a Services Agreement with Newco. The relationship between the Contracting Professional Corporation and Newco is intended to 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 XXXXXXXXXX services performed by the Contracting Professional Corporation will be an amount determined by agreement between the Contracting Professional Corporation and the Executive Committee. The amount of the fee will be equal to the fair market value of the Professional Services provided by the Contracting Professional Corporation to Newco and will reflect any facilities provided by Newco to the Contracting Professional Corporation. The fee will be paid by Newco directly to the Contracting Professional Corporation. There will not be any other contractual relations between Newco and any of the Contracting Professional Corporations.

27. Where a Partner is an Existing Contracting Professional Corporation, that corporation will be required to enter into a Services Agreement with Newco to provide Professional Services directly to Newco. The statements in Paragraph 26, above, apply equally to an Existing Contracting Professional Corporation, except that a reference to a particular Partner shall be read as a reference to the corporation's shareholder who is authorized to practice XXXXXXXXXX in the Province of XXXXXXXXXX and who currently provides Professional Services to the Partnership through the corporation.

28. All payments from third parties for services provided by a Contracting Professional Corporation or Contracting Professional for the benefit of Newco will be made directly to Newco.

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

30. Newco will not pay any of the Contracting Professional Corporations' or Contracting Professionals' 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 insurance premiums, as well as paying for any continuing professional education.

31. Pursuant to the Services Agreement, as long as a Contracting Professional Corporation or Contracting Professional, as the case may be, fully discharges its, his or her responsibilities under the Services Agreement with Newco, the Contracting Professional Corporation or the Contracting Professional will be not be restricted from providing services to other persons or otherwise prohibited from competing with Newco, except that:

(a) a Contracting Professional Corporation or Contracting Professional cannot undertake a new contract in competition with Newco in circumstances that would infringe upon XXXXXXXXXX; and

(b) a Contracting Professional Corporation or Contracting Professional cannot provide services to an existing client of Newco while the contractor is contracted to Newco or for a period of XXXXXXXXXX years after the contract is terminated.

32. XXXXXXXXXX states that:

"XXXXXXXXXX."

XXXXXXXXXX

33. Each Contracting Professional Corporation will be a TCC and a CCPC.

34. Each Contracting Professional Corporation will have at least three classes of shares: voting shares, non-voting common shares, and preferred 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 or a trust for the Partner's family. For purposes of this paragraph and paragraph 37, below, "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. All persons legally or beneficially owning shares of a Contracting Professional Corporation will be residents of Canada.

35. 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.

36. 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.

37. 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 as that term is defined in subsection 248(1) of the Act ("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.

38. 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.

39. 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

40. 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 the 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 direct 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 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. 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, 26 and 27, 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 an Individual 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 with respect to Professional Services will not be "specified partnership income" as defined by subsection 125(7) of the Act.

D. The proposed transactions, in and of themselves, will not cause the provisions of subsection 245(2) of the Act to 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 18, 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 34 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 family member of the Individual Partner who owns the voting shares of the Contracting Professional Corporation. Also, section 120.4 of the Act may apply with respect to taxable dividends or trust income in respect of taxable dividends from a Contracting Professional Corporation received in a taxation year by a family member of an Individual Partner who has not attained the age of 17 years before that year.

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
Legislative Policy and Regulatory Affairs Branch