2007 Ruling 2006-0212941R3 - Partnership Reorganization Personal Services Bus.

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 								2006-021294

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (the "Partnership")
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
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 also acknowledge your additional letter 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:

Facts

1. XXXXXXXXXX located in XXXXXXXXXX (the "Province"), that carries on a public XXXXXXXXXX practice (the "Practice"). The Partnership is a continuation of predecessor partnerships which originally began in XXXXXXXXXX and has been governed by written partnership agreements amongst the partners.

The physical address of the XXXXXXXXXX is:

XXXXXXXXXX.

2. The Partnership presently has XXXXXXXXXX individual partners as noted above (the "Partners"). Each of these Partners files his or her income tax return with the XXXXXXXXXX Tax Centre. No member of the Partnership is related to any other member and all partners are residents of the Province.

3. The Partnership business number is XXXXXXXXXX and the Partnership generally deals with the XXXXXXXXXX Tax Services Office.

4. At the present time, the Partners provide their professional services as XXXXXXXXXX ("Professional Services") through the Partnership.

5. The Partnership is one of collaboration whereby all Partners contribute their services to the Partnership and its clients as required. The philosophy of the Partnership is to value the professional expertise of all members equally and there is no element of profit sharing that is dictated by the particular professional expertise or professional performance of a Partner. The Partnership expects each Partner to have an ongoing responsibility as a business owner to provide the administrative, marketing, staff management, operational, and client retention efforts (the "Promotional and Management Functions") normally expected of anyone who is a principal in a service business, as well as delivery of Professional Services.

6. Profits are allocated among the Partners on fixed percentages relative to seniority and purchased interests. The allocation has historically valued all types of services provided by the partners to the partnership equally and no distinction is made for the amount of each type of service.

Proposed Transactions

7. The Partnership Agreement will be amended to recognize a distinction between a Partner's Promotional and Management Functions and the Professional Services he or she provides, and will allow Partners to provide their Professional Services to the Partnership through a corporation licensed to carry on the practice of XXXXXXXXXX as defined in the XXXXXXXXXX of the Province (a "Professional Corporation"). More specifically, each Partner shall have the option, exercisable by notice in writing to the Partnership to be delivered XXXXXXXXXX days prior to the effective date of the notice, to provide his or her Professional Services to the Partnership through a Professional Corporation controlled by that Partner (hereinafter referred to as the "Contracting Corporation").

8. Upon receipt of such notice, the Partnership will be required to enter into a written agreement for services with the Contracting Corporation (the "Services Agreement"). The Services Agreement will provide that the amount of the fee for the Professional Services provided by the Contracting Corporation 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 Corporation. The fee will be equal to the fair market value of the services, taking into account any facilities provided to the Contracting Corporation by the Partnership (see Paragraph 14, below). The payment terms for services rendered will be negotiated on an arm's-length basis acceptable to the parties. The Partnership Agreement will also be amended to prohibit the performance of the Promotional and Management Functions by anyone other than the Partners themselves and to prohibit the transfer or other conveyance of any interest in the Partnership to any Professional Corporation.

9. Consequential amendments to the Partnership Agreement will provide that the calculation of a Partner's share of profits for any year during which a Contracting Corporation provides that Partner's Professional Services will be dependent solely on the Partner's capital contribution and factors connected to the Promotional and Management Functions. In particular, the calculation of the Partner's share of profits for that year will not depend on hours worked, billed or collected for Professional Services. Partnership profits will be allocated to individual partners by a compensation committee using the following criteria:

(a) The partner's participation and contribution to administrative functions in the Partnership;

(b) The partner's participation in general XXXXXXXXXX management;

(c) The partner's willingness to participate and have a strong profile in the local business community and the effectiveness of such efforts;

(d) The marketing efforts of the Partner in bringing in new clients and maintaining existing XXXXXXXXXX clients;

(e) Contributions by the Partner in assisting in Human Resource recruitment and retention;

(f) Contribution by the Partner in professional development of staff;

(g) The Partner's general management practices including timeliness of Partnership billings and receivables and risk management; and

(h) The number of years the individual has been a Partner.

10. The Services Agreement between the Partnership and each Contracting Corporation may be renewed each year by the Partnership, and either party may terminate it upon XXXXXXXXXX days written notice.

11. Each Partner will elect to provide his or her Professional Services to the Partnership through a Contracting Corporation. Each Contracting Corporation will employ at least one individual licensed to practice XXXXXXXXXX in the Province. None of the Contracting Corporations will be related persons.

12. So long as a Contracting Corporation fully discharges its responsibilities under the Services Agreement with the Partnership, the Contracting Corporation will not be restricted from providing services to other persons or otherwise prohibited from competing with the Partnership. This right to compete applies equally to the Partner who incorporates the Contracting Corporation.

13. All payments received by the Partnership from clients in respect of services provided by the Contracting Corporations will be for the benefit of the Partnership.

14. The Partnership will provide certain supplies, personnel, facilities and equipment that are required to provide Professional Services to the clients of the Partnership. A Contracting Corporation will be responsible for the following expenses:

(a) professional membership fees and insurance;

(b) continuing education;

(c) transportation;

(d) communication;

(e) maintaining the professional standards set by the profession and, to the extent required to fulfil the terms of the Services Agreement, the Partnership; and

(f) expenditures on personal practice preferences of the Contracting Corporation.

15. The sole officer and director of each Contracting Corporation will be the Partner who incorporates that corporation. That Partner will also be an employee of that Contracting Corporation and will provide Professional Services for the benefit of the Contracting Corporation. The employment relationship between the Contracting Corporation and the Partner will be evidenced by a written employment agreement.

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

17. Each Contracting Corporation will be controlled by the Partner who incorporates that corporation, who will be the legal and beneficial owner of all of the voting shares of the corporation. Non-voting shares of a Contracting Corporation may be owned by members of the Partner's family. 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) of the Act. All persons legally or beneficially owning shares of a Contracting Corporation will be residents of Canada. In all cases, share ownership of each Contracting Corporation will meet the criteria of the XXXXXXXXXX of the Province.

18. A legal or beneficial shareholder of a Contracting Corporation will not be a legal or beneficial shareholder of another Contracting Corporation.

19. No Partner will be an employee, officer, or director of more than one Contracting Corporation. Related persons of a Partner may not be shareholders of any Contracting Corporation other than the Contracting Corporation in which that Partner owns shares.

20. Each Contracting Corporation will be a TCC and CCPC.

Purpose of the Proposed Transactions

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

(i) Allows a Partner to benefit from the recent legislative amendments by the Province which permit XXXXXXXXXX to render professional services through a Professional Corporation.

(ii) Provides a Partner with an increased level of control over his or her participation in the Practice through individual management of personal practice preferences.

(iii) Permits a Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Practice.

(iv) Provides a Partner with more control over his or her own estate and financial planning.

(v) Improves a Partner's ability to provide Professional Services to his or her own clients independent of the Partnership.

(vi) Enhances the Partnership's ability to retain current and recruit additional professionals by providing a flexible working structure.

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. The execution and implementation of the proposed transactions, in and of 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.

C. 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.

D. 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 8, above, will not be specified partnership income as defined in subsection 125(7) of the Act.

E. Subject to sections 18 and 67 of the Act, the fees payable by the Partnership to the Contracting Companies as described in Paragraph 8, above, will be deductible by the Partnership in its determination of the Partnership income for purposes of subsection 96(1) of the Act.

F. The transactions undertaken in Paragraphs 7, 8 and 9, above, and in particular the payments described in Paragraph 8, 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 Contracts to be taxed as income in the hands of a Partner.

G. 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 a Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a Contracting Corporation and provide all of his or her Professional Services to the Partnership through that Contracting Corporation for a fee.

H. Implementation of the proposed transactions, in and of 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.

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 Corporations. 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 Corporations 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 Corporations. Whether or not a Partner who is providing her or her Professional Services to the Partnership through a Contracting 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 for services with the Partnership is a question of fact that can only be determined after a review of the actual agreements entered into between the Contracting Corporation and the Partnership, and between the Contracting Corporation and the Partner. This review and determination is the responsibility of the 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 by 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 Corporation, as described in Paragraph 17, 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 Corporation to a family member of the Partner who incorporated the Contracting 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 Corporation received in a taxation year by a family member of a 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.

Yours truly,

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