2007 Ruling 2006-0213701R3 - 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: Question of fact. Generally, yes, if certain conditions are met.

Reasons: Reading of relevant legislation and consistent with other rulings.

XXXXXXXXXX 									2006-021370

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: 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 XXXXXXXXXX and its partners. We also acknowledge the additional information provided to us in your XXXXXXXXXX letter, the electronic mail transmissions dated XXXXXXXXXX, and during our telephone conversation (XXXXXXXXXX) on 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 any of the taxpayers or related persons;

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed return of any of the taxpayers 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) "active business carried on by a corporation" has the meaning assigned by subsection 125(7);

(b) "XXXXXXXXXX Agreement" means the agreement entered into by XXXXXXXXXX;

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

(d) XXXXXXXXXX;

(e) "XXXXXXXXXX Services" means the XXXXXXXXXX, currently provided by the Partners through Partnership A;

(f) XXXXXXXXXX;

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

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

(i) "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;

(j) XXXXXXXXXX;

(k) "Members" means XXXXXXXXXX, Partnership A, and the Other Partnerships. Individually, any one is referred to as a "Member";

(l) XXXXXXXXXX;

(m) "Named Partner" means XXXXXXXXXX, as more fully described in Paragraph 2;

(n) XXXXXXXXXX;

(o) XXXXXXXXXX;

(p) XXXXXXXXXX;

(q) "Other Partner" means XXXXXXXXXX a member of one of the Other Partnerships, and collectively they are referred to as the "Other Partners". They are not the subject of this advance income tax ruling;

(r) "Other Partnerships" means, collectively, Partnership B, Partnership C, Partnership D, Partnership E, Partnership F, and Partnership G. They are not the subject of this advance income tax ruling;

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

(t) "Partner" means a XXXXXXXXXX member of Partnership A, and collectively they are referred to as the "Partners". Your letter to us dated XXXXXXXXXX, provided us with a list of the names and social insurance numbers of the Partners;

(u) "Partnership A" means the XXXXXXXXXX, a partnership formed pursuant to the laws of the Province. It was previously named the XXXXXXXXXX;

(v) "Partnership A Agreement" means the agreement governing the business activities of Partnership A, dated XXXXXXXXXX;

(w) "Partnership B" means the XXXXXXXXXX, a partnership formed pursuant to the laws of the Province;

(x) "Partnership C" means the XXXXXXXXXX, a partnership formed pursuant to the laws of the Province;

(y) "Partnership D" means the XXXXXXXXXX, a partnership formed pursuant to the laws of the Province. It is the subject of an advance income tax ruling similar to this letter (our file #2007-022176);

(z) "Partnership E" means the XXXXXXXXXX, a partnership formed pursuant to the laws of the Province. It is the subject of an advance income tax ruling similar to this letter (our file #2007-022178);

(aa) "Partnership F" means the XXXXXXXXXX, a partnership formed pursuant to the laws of the Province. It is the subject of an advance income tax ruling similar to this letter (our file #2007-022177);

(bb) "Partnership G" means the XXXXXXXXXX, a partnership formed pursuant to the laws of the Province. It is the subject of an advance income tax ruling similar to this letter (our file #2007-022179);

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

(dd) XXXXXXXXXX;

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

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

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

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

(ii) XXXXXXXXXX.

FACTS

1. Partnership A has approximately XXXXXXXXXX Partners. It files its information returns with the XXXXXXXXXX. Partnership A's identification number is XXXXXXXXXX.

2. The Named Partner is a Partner. The Named Partner's social insurance number is XXXXXXXXXX and his address is XXXXXXXXXX. The Named Partner files his income tax returns with the XXXXXXXXXX Taxation Centre.

3. 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 any Partners who are spouses of each other. Each Partner is a member of the XXXXXXXXXX and is authorized to practice XXXXXXXXXX in the Province. None of the Partners are employees of Partnership A, XXXXXXXXXX. No Partners are also members of any of the Other Partnerships.

4. Each year the Partners elect a business manager and an office manager for Partnership A. The activities of Partnership A can be classified into four general categories: XXXXXXXXXX Services, XXXXXXXXXX and administrative duties. The Partners currently provide their XXXXXXXXXX Services through Partnership A.

5. XXXXXXXXXX.

6. XXXXXXXXXX.

7. XXXXXXXXXX receives all funds from XXXXXXXXXX under the XXXXXXXXXX Agreement, most of which it distributes to each of Partnership A and the Other Partnerships in the amounts determined at the outset of the XXXXXXXXXX Agreement. XXXXXXXXXX expenses for the administration of the XXXXXXXXXX Agreement (e.g., business manager, legal and accounting fees) are deducted from the amounts transferred to Partnership A and the Other Partnerships. Smaller amounts are allocated from time to time to Partnership A and the Other Partnerships to recognize recruitment or net changes in the number of Partners or Other Partners, as the case may be. Partnership A and the Other Partnerships are responsible for distributing the funds among their partners in accordance with their written practices, policies, or guidelines.

8. XXXXXXXXXX continues to be responsible for the administration of the XXXXXXXXXX Agreement, as agent of the Members. In particular, XXXXXXXXXX role is to:

(a) assist the Members to enhance the quality and delivery of the activities of Partnership A and the Other Partnerships;

(b) support Members in the implementation of new methods of organizing and financing XXXXXXXXXX that combine the activities of Partnership A and the Other Partnerships;

(c) enable Members to develop and implement innovative alternatives to the present method of compensation for XXXXXXXXXX involved in the delivery of the activities of Partnership A and the Other Partnerships;

(d) aid in establishing policies with regard to allocation of resources provided under the XXXXXXXXXX Agreement; and

(e) assist the Members to monitor the ongoing effectiveness of activities within the scope of an XXXXXXXXXX Agreement.

9. XXXXXXXXXX.

10. A few Partners and Other Partners receive limited compensation directly from the XXXXXXXXXX for certain administrative functions, XXXXXXXXXX. The compensation, if any, received by Partners from this source is not included in computing the income of Partnership A. However, it may be taken into account in determining the amount of Partnership A's income allocated to each Partner (see Paragraph 15).

11. XXXXXXXXXX.

12. A few Partners receive modest compensation from the XXXXXXXXXX. Those Partners are treated as employees by the XXXXXXXXXX and are paid directly by the XXXXXXXXXX for their services. The amounts received are not included in Partnership A's income. However, these amounts are generally taken into account in determining the amount of Partnership A's income allocated to each Partner (see Paragraph 15).

13. Partnership A may periodically receive direct funding from the XXXXXXXXXX in the form of XXXXXXXXXX. These amounts do not relate to employment services provided by any Partner and are included in computing Partnership A's income.

14. For greater certainty, any service provided by a Partner to the XXXXXXXXXX, and any compensation earned by a Partner from the XXXXXXXXXX, relates only to XXXXXXXXXX Services provided by the Partners, including XXXXXXXXXX and administrative services. A Services Contract (see Paragraph 18) will not cover these XXXXXXXXXX Services.

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

(a) the gross income of Partnership A generally includes all the income arising from the usual professional activities of the Partners, or by reason of their training as XXXXXXXXXX, including fee for service payments from the XXXXXXXXXX and payments under the XXXXXXXXXX Agreement. Any professional income generated by a Partner during approved time off from Partnership A (XXXXXXXXXX) is not included in Partnership A's gross income;

(b) the profits of Partnership A are determined by deducting all of Partnership A's expenses payable from its gross income;

(c) the profits and losses of Partnership A are allocated to the Partners in proportion to their full-time equivalent status. The term "full-time equivalent status" generally means at least XXXXXXXXXX hours per week of XXXXXXXXXX services and related teaching, XXXXXXXXXX and administrative activities provided by a XXXXXXXXXX;

(d) each Partner who provides XXXXXXXXXX Services is allocated a share of the profits generated from such services in proportion to their XXXXXXXXXX workload; and

(e) each Partner's drawings are determined based on anticipated profits of Partnership A. The portion of Partnership A's profits that is attributable to payments under the XXXXXXXXXX Agreement are paid to Partners on a monthly basis, while any surplus amounts are paid to Partners on a quarterly basis.

PROPOSED TRANSACTIONS

16. The Partnership A Agreement will be amended to give each Partner the choice of whether to provide XXXXXXXXXX Services to Partnership A through a Contracting Company. If a Partner so chooses, that Partner would only have one Contracting Company through which only they would provide XXXXXXXXXX Services to the Partnership. Each Contracting Company will hold a valid certificate of authorization issued by the XXXXXXXXXX. Consequential amendments to the Partnership A Agreement will provide that a Partner who incorporates a Contracting Company will no longer provide XXXXXXXXXX Services to Partnership A in his or her capacity as a Partner.

17. Each Contracting Company will be engaged by Partnership A to provide XXXXXXXXXX Services as an independent contractor. Each Contracting Company will employ a Partner who is an individual 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.

18. Each Contracting Company will be required to enter into a written contract for services (a "Services Contract") with Partnership A in respect of the XXXXXXXXXX Services that will be provided by the Contracting Company to Partnership A. 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 equal the fair market value of the XXXXXXXXXX Services provided by the Contracting Company to Partnership A. The fees will be paid regularly throughout the year.

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

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

21. All payments received by Partnership A in respect of XXXXXXXXXX Services provided by a Contracting Company pursuant to a Services Contract with Partnership A will be for the benefit of Partnership A and if any such amounts are received by a Contracting Company, they will be remitted to Partnership A.

22. Pursuant to a written agreement and in consideration for a fair market value fee, Partnership A 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 Partnership A or by the XXXXXXXXXX; and

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

23. XXXXXXXXXX. As noted in Paragraph 16, only the particular Partner (not the spouse) would provide XXXXXXXXXX Services to Partnership A through their Contracting Company. XXXXXXXXXX. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada.

24. 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 XXXXXXXXXX may also be an officer or director of that Contracting Company.

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

26. 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 Partnership A.

27. A Partner who provides XXXXXXXXXX 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.

28. As the Contracting Companies will only be providing XXXXXXXXXX Services, all of the Partners (including those who have incorporated Contracting Companies) will continue to perform the XXXXXXXXXX Services through Partnership A, being those services required by XXXXXXXXXX and administrative functions of Partnership A's business. Partners who choose not to establish Contracting Companies will continue to provide their XXXXXXXXXX Services directly through Partnership A.

29. Consequential amendments to the Partnership A Agreement will provide that a Partner's allocation of Partnership A's income for any year during which a Contracting Company performs that Partner's XXXXXXXXXX Services will be dependent on the Partner's capital contribution to Partnership A and factors connected to the Partner's XXXXXXXXXX Services, including XXXXXXXXXX and administrative activities. In particular, the calculation of the Partner's allocation of Partnership A's income for that year will not take into account any of that Partner's XXXXXXXXXX Services.

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

31. The Particular Contracting Company will enter into a Services Contract with Partnership A in respect of XXXXXXXXXX Services to be provided by the Particular Contracting Company. The fees payable to the Particular Contracting Company by Partnership A will be determined as described in Paragraph 18.

32. 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 Partnership A in accordance with its Services Contract with Partnership A.

PURPOSE OF THE PROPOSED TRANSACTIONS

33. The primary objective of the proposed transactions is to restructure Partnership A to allow Partners to render XXXXXXXXXX Services through Contracting Companies XXXXXXXXXX, while at the same time ensuring minimal disruption to the existing arrangements between the Partners, Partnership A, the Other Partnerships, XXXXXXXXXX and third-parties, XXXXXXXXXX. Other purposes include:

(a) to provide a Partner with an increased level of control over their participation in the XXXXXXXXXX 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 XXXXXXXXXX practice;

(c) to provide a Partner with more control over his or her own estate and financial planning; and

(d) to enhance Partnership A's ability to retain current and recruit additional professionals.

RULINGS

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 Partnership A by any of the Partners.

B. Provided that the Named Partner providing XXXXXXXXXX Services to Partnership A through the Particular Contracting Company would not, but for the existence of the Particular Contracting Company, reasonably be regarded as an officer or employee of Partnership A in respect of those services, then the Particular Contracting Company will not be considered to be carrying on a personal services business.

C. Provided the Particular Contracting Company was not a member of any partnership in the relevant year, the fee income earned by the Particular Contracting Company pursuant to a Services Contract, as described in Paragraph 18, will not be specified partnership income.

D. Subject to sections 18 and 67, the fees payable by Partnership A to the Particular Contracting Company pursuant to a Services Contract, as described in Paragraph 18, will be deductible in computing Partnership A's income pursuant to subsection 96(1).

E. The transactions undertaken in Paragraphs 16 to 18, and 30 to 32, and in particular the fee payments described in Paragraph 18, will not in and of themselves cause subsections 56(2), 56(4) or 246(1) to apply so as to cause an amount of the fees received by the Particular Contracting Company under a Services Contract to be taxed as income in the hands of the Named Partner.

F. Provided the amount of Partnership A's income allocated to the Named Partner is otherwise reasonable, having regard to all the relevant circumstances, the Named Partner's share of Partnership A's income will not be altered, pursuant to subsection 103(1), solely as a result of the Named Partner choosing to provide, pursuant to amendments to the Partnership A Agreement, all of their XXXXXXXXXX Services to Partnership A through the Particular Contracting Company, all as described above in the proposed transactions.

G. The execution and implementation of the proposed transactions described above, will not, in and of themselves, create a non-arm's length relationship between the Named Partner and the other Partners with respect to sharing Partnership A's income for income tax purposes.

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

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5, issued by the CRA on May 17, 2002, and are binding on the CRA provided the proposed transactions are entered into on or before XXXXXXXXXX. These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly that the CRA has agreed to or accepted the reasonableness or fair market value of any fees or expenditures referred to in this letter.

ADDITIONAL COMMENTS

Whether or not a Partner who is providing his or her XXXXXXXXXX Services to Partnership A through a Contracting Company would, but for the existence of that corporation, be an employee of Partnership A, or an independent contractor who has entered into a contract for services with Partnership A, is a question of fact that can only be determined after a review of all of the relevant facts, including the actual agreements entered into between the Contracting Company and Partnership A, and between the Contracting Company 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 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 Company, as described in Paragraph 23, 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) may apply to any amounts paid by a Contracting Company to a family member of the Partner who incorporated the Contracting Company. Also, section 120.4 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 a Partner who has not attained the age of 17 years before that year. At this time we do not have sufficient information to make any such determinations.

OPINION

The application of subsection 256(2.1) 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) 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, if more than one Contracting Company is incorporated, it is our view that the incorporation of the Contracting Companies to provide the XXXXXXXXXX Services to Partnership A will not, in and of itself, cause subsection 256(2.1) to be applicable to the Contracting Companies.

In accordance with paragraph 22 of Information Circular 70-6R5, the comments in the immediately preceding paragraph are only an expression of opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on the CRA.

Yours truly,

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