2007 Ruling 2006-0206431R3 - 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.

XXXXXXXXXX 									2006-020643

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("The Partnership")
The "Named Partners" in the attached Schedule A
Advance Income Tax Ruling

This is in reply to your letter 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 and that of the taxpayers involved, none of the issues involved in this ruling request herein is:

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

(c) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(d) the subject of a ruling previously issued by the Income Tax Rulings Directorate to the taxpayer or a related person.

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:

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

XXXXXXXXXX.

"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 XXXXXXXXXX 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".

"CRA" is the Canada Revenue Agency.

"Facilities" means the real estate at XXXXXXXXXX, out of which The Partnership and XXXXXXXXXX currently operate.

"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.

"Limited" means XXXXXXXXXX.

"Named Partners" means the XXXXXXXXXX Partners who propose to complete the Proposed Transactions, and listed in Schedule A to this letter.

XXXXXXXXXX.

"Partner" is a reference to each of, or any of, the partners of The Partnership and, collectively, they are referred to as the "Partners".

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

XXXXXXXXXX.

"XXXXXXXXXX Partner" is a reference to each of, or any of, the Partners of The Partnership who is a member of the XXXXXXXXXX and, collectively, they are referred to as the "XXXXXXXXXX Partners".

"Practice" means the provision of XXXXXXXXXX services, currently provided by The Partnership.

"Professional Services" means XXXXXXXXXX services.

"Proposed Transactions" means the transactions set out in paragraphs 15 to 33.

"Province" is the Province of XXXXXXXXXX.

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

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

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

"The Fund" is a reference to the existing partnership of XXXXXXXXXX, which was formed pursuant to the laws of the Province.

"The Partnership" is a reference to the existing partnership of XXXXXXXXXX, which was formed pursuant to the laws of the Province.

FACTS:

1. The Practice is currently carried on by The Partnership. The XXXXXXXXXX Partners provide Professional Services to the XXXXXXXXXX.

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

3. The XXXXXXXXXX Partners provide their Professional Services to the Partnership at the Facilities.

4. The partners of The Partnership consist of the XXXXXXXXXX Partners, of which there are currently XXXXXXXXXX, and Limited.

5. There are a number of self-employed XXXXXXXXXX ("Associates") who provide Professional Services to The Partnership. The Associates are not partners of The Partnership.

6. The Partnership provides the Professional Services largely on a "fee for service" basis. XXXXXXXXXX.

7. The partners of The Partnership are bound by a written partnership agreement (the "Partnership Agreement") that was signed by the Partners on XXXXXXXXXX . Previous agreements date back to XXXXXXXXXX.

8. Included among the terms of the Partnership Agreement are the following:

a) Each XXXXXXXXXX Partner is required to personally hire and pay for his/her own XXXXXXXXXX and/or reception or other staff that he/ she may from time to time require;

b) The Partnership requires certain minimum coverage for disability insurance for the XXXXXXXXXX Partners. The XXXXXXXXXX Partners may join the partnership's plan or arrange their own extra coverage for short and long-term disability as they may decide. The XXXXXXXXXX Partners are responsible for obtaining and paying for their own professional overhead expense insurance;

c) Each XXXXXXXXXX Partner is required to contribute a stipulated amount of capital to The Partnership;

d) The XXXXXXXXXX Partners are obligated to devote their entire professional time to the business of The Partnership to the best of their skill and their ability;

e) Limited is not entitled to any of the XXXXXXXXXX income derived by The Partnership. Limited is entitled to the net rental income from external sources from the Facilities and any net profit from the sale of the Facilities. Limited may not dispose of its partnership interest other than to other Partners;

f) Each XXXXXXXXXX Partner is entitled to receive back his/her capital contribution and no more, upon the death, retirement, withdrawal or expulsion of the XXXXXXXXXX Partner; and

g) A XXXXXXXXXX Partner may be entitled to acquire for his/her own practice equipment with a cost exceeding $XXXXXXXXXX. All fees for the use of such equipment accrue to the said XXXXXXXXXX Partner as an individual and are not included in the income of the partnership.

9. In allocating the profits of The Partnership, each XXXXXXXXXX Partner receives credit for his or her actual share of Professional Services revenues attributable to his or her practice. Each partner is charged with a share of The Partnership's expenses and profits from The Partnership's activities other than the practices of the XXXXXXXXXX Partners and Associates are allocated in accordance with the formula set out in the partnership agreement.

10. The Fund was originally created in XXXXXXXXXX. The Fund's only investment is its ownership of all XXXXXXXXXX common (the only class issued) shares outstanding in Limited. Each XXXXXXXXXX Partner of The Partnership owns an equal capital interest in The Fund that collectively amounts to a total investment therein of $XXXXXXXXXX. When a new XXXXXXXXXX Partner is admitted to The Partnership, he/she is required to contribute a small amount of capital to The Fund, and upon leaving The Partnership he/she receives only his/her capital investment at that time. A new XXXXXXXXXX Partner to The Partnership does not pay fair market value for his/her interest in The Fund. Upon leaving The Partnership, a repayment of that XXXXXXXXXX Partner's capital interest in The Fund would not necessarily represent fair market value of that capital interest. The Fund can be considered to be essentially a parallel partnership to The Partnership.

11. Limited was incorporated under the laws of XXXXXXXXXX on XXXXXXXXXX, and is a CCPC. The Fund owns all of the shares of Limited.

12. Limited acquired a partnership interest in The Partnership in XXXXXXXXXX when it transferred the Facilities to The Partnership.

13. The Partnership owns XXXXXXXXXX % of the shares of XXXXXXXXXX.

14. All of the Partners are residents of Canada. None of the XXXXXXXXXX Partners are related persons with the exception of XXXXXXXXXX spouses who are XXXXXXXXXX Partners.

PROPOSED TRANSACTIONS

The Partnership:

15. The Partnership Agreement will be amended to give each XXXXXXXXXX Partner the choice to provide Professional Services to The Partnership only through a Contracting Company. Each Contracting Company will arrange to obtain a valid certificate of authorization to do so issued by the XXXXXXXXXX. Consequential amendments to the Partnership Agreement will provide that a XXXXXXXXXX Partner who incorporates a Contracting Company will no longer provide any Professional Services to The Partnership in his or her capacity as a Partner (see in particular paragraph 30, below).

16. Each Contracting Company will be engaged by The Partnership to provide the Professional Services as an independent contractor. Each Contracting Company will employ an individual licensed to practice XXXXXXXXXX in the Province. 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.

17. Each Contracting Company will be required to enter into a written contract for service (the "Services Contract") with The Partnership in respect of the Professional Services that will be provided by the Contracting Company to 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 the fair market value for the Professional Services provided by the Contracting Company to The Partnership. The proposed fee to be paid by The Partnership to the Contracting Companies for the Professional Services provided will be determined in the same manner, and paid in the same time frame, as the fee paid to Associates. The Services contract shall be for a fixed period of one year. The contract may be renewed each year and either party upon XXXXXXXXXX days notice may also terminate it.

18. Consequential amendments to the Partnership Agreement will be made to prohibit the transfer, conveyance or issuance of an interest in The Partnership to any Contracting Company.

19. Provided 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. Consequential amendments to the Partnership Agreement will be made so that XXXXXXXXXX Partners, who provide Professional Services through a Contracting Company, are not restricted from competing with The Partnership in respect of those Professional Services.

20. All payments from XXXXXXXXXX and third party agencies received by The Partnership in respect of all Professional Services provided by the Contracting Companies to the XXXXXXXXXX will be for the benefit of The Partnership.

21. The Partnership will provide certain supplies, personnel, XXXXXXXXXX, facilities and equipment that are required to provide Professional Services to the XXXXXXXXXX of The Partnership. A Contracting Company will be responsible for all expenses incurred in respect of the following:

a) professional membership fees;

b) insurance, legal and accounting fees;

c) continuing professional education;

d) travel, including motor vehicle, accommodations, and meals;

e) communication;

f) maintaining the professional standards set by The Partnership or the XXXXXXXXXX from time to time; and

g) expenditures on personal practice preferences of the Contracting Professional.

22. Each Contracting Company will be controlled by the respective XXXXXXXXXX Partner who will be the legal and beneficial owner of all of the voting shares of the Contracting Company. The sole officer and director of a Contracting Company will be the respective XXXXXXXXXX Partner that incorporated the Contracting Company.

23. Members of the XXXXXXXXXX Partner's family may own non-voting shares of his/her Contracting Company. However, none of these non-voting shares will be issued as part of the Proposed Transactions. For the purpose of this letter, "family" means individuals connected by blood relationship, marriage, common-law partnership or adoption, as those terms are described in subsection 251(6).

24. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada. For greater certainty, each Contracting Company will be a TCC and a CCPC.

25. A legal or beneficial shareholder of a Contracting Company will not be a legal or beneficial shareholder of another Contracting Company.

26. The sole officer and director of a Contracting Company will be an employee of the Contracting Company and will provide Professional Services for the benefit of the Contracting Company pursuant to the terms of its contract with The Partnership. The employment relationship will be evidenced by a written employment agreement.

27. A XXXXXXXXXX Partner who provides services for the benefit of his/her Contracting Company will be entitled to receive a salary from his/her Contracting Company for such services provided.

28. Each XXXXXXXXXX Partner will not be an employee, officer, director or shareholder, either legally or beneficially, of more than one Contracting Company. Family members of a XXXXXXXXXX Partner may only be shareholders of the Contracting Company in which that Partner owns shares, unless that family member is a member of the XXXXXXXXXX, in which case he or she may be a shareholder of his or her own Contracting Company.

29. As the Contracting Companies will only be providing Professional Services, all of the Partners except Limited (including those who have incorporated Contracting Companies) will continue to provide the services that are not Professional Services, that is, those services required in the following businesses and functions of The Partnership:

• XXXXXXXXXX;
• XXXXXXXXXX;
• XXXXXXXXXX;
• Administrative services for fee provided to XXXXXXXXXX;
• Investment in XXXXXXXXXX;
• Rental operation of the Facilities;
• Investment of the surplus funds held by the partnership; and
• Executive committee membership and other partnership management roles.

Partners who choose not to establish a Contracting Company will continue to provide their Professional Services through The Partnership.

30. Consequential amendments to the Partnership Agreement will be made to 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 non-Professional Services. In particular, the calculation of that 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

31. The Named Partners will each (the "Named Partner") incorporate a Contracting Company (the "Particular Contracting Company").

32. The Particular Contracting Company will enter into a Services Contract with The Partnership in respect of Professional 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.

33. The Particular Contracting Company will employ the Named Partner to provide Professional 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.

Facilities Transaction

34. We understand that you anticipate the sale of the Facilities (the "Facilities Transaction") and the move of the partnership practice to new premises in XXXXXXXXXX years. However, you have informed us that this transaction is separate from and not materially relevant to the Proposed Transactions or the rulings requested with respect to the Proposed Transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS:

35. The purpose of the proposed transactions is to allow a XXXXXXXXXX Partner to provide his/her Professional Services through a Contracting Company to The Partnership with the following advantages:

(a) Allow The Partnership to attract, and retain, XXXXXXXXXX who wish to conduct their practice through a professional corporation, an opportunity only recently made available in the Province and the tax benefit of which has been enhanced under measures recently enacted by the Province, in an environment where XXXXXXXXXX are extremely difficult to attract;

(b) Provide each XXXXXXXXXX Partner with an increased level of control over his/her participation in the Practice through individual management of personal practice preferences;

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

(d) Provide each XXXXXXXXXX Partner with more options and more control in arranging his/her estate and financial planning.

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, 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 Professional 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 17, 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 17, above, will be deductible in computing The Partnership's income pursuant to subsection 96(1) of the Act.

E. The transactions undertaken in paragraphs 15 and 17, and in particular the payments described in paragraph 17, 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. Provided that the amount of partnership income allocated to each XXXXXXXXXX Partner is reasonable having regard to all the relevant circumstances, the sharing of the income between the XXXXXXXXXX Partners of The Partnership will not be subject to adjustment pursuant to subsection 103(1) solely as a result of a Named Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a Contracting Company and to provide all of his or her Professional Services to The Partnership through that Contracting Company for a fee.

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 the Proposed Transactions described herein, it is our view that the incorporation of the Contracting Companies to provide the Professional 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. Whether or not a XXXXXXXXXX Partner who is providing his or her professional services to The Partnership through a professional corporation would, but for the existence of that corporation, be an employee of The Partnership or an independent contractor who has entered into a contract of services with The Partnership is a question of fact that can only be determined after a review of the actual agreement entered into between the professional corporation and The Partnership and that between the professional corporation and the XXXXXXXXXX Partner. This review and determination is the responsibility of the said XXXXXXXXXX Partner's local tax services office.

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 shares of a Contracting Company, as described in paragraph 23 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 Company to a family member of the Named Partner who incorporated the Contracting Company. 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 Company received in a taxation year by a family member of the Named Partner who has not attained the age of 17 years before that year.

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 as they relate to The Partnership, the Named Partners, The Fund or Limited. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly that the CRA has agreed or accepted the reasonableness, fair market value, or proper tax treatment of any amount including any fees or expenditures referred to in this letter.

Yours truly,

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

Attachment: Schedule A, Named Partners

SCHEDULE "A"

NAMED PARTNERS

XXXXXXXXXX