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: In a hypothetical situation, a taxpayer acquires a partnership interest in an arm's length transaction from two existing partners for $200,000. The taxpayer's capital account for accounting purposes was allocated $30,000 which reflected his one-third interest in the partnership. The fiscal year end of the partnership is December 31. The taxpayer incorporated a professional corporation with the intention of rolling the partnership interest to the corporation under section 85 of the Income Tax Act. How is the ACB of the partnership interest of the taxpayer calculated? What is the impact of proposed subsection 96(1.01)?
Position: General comments given.
Reasons: Question of fact.
2006-021441
XXXXXXXXXX J. Vis
(519) 457-4444
April 4, 2007
Dear Sir/Madame:
Re: Adjusted Cost Base of Partnership
This is in response to your correspondence of November 13, 2006, in which you inquired about the calculation of the adjusted cost base ("ACB") of a partnership interest prior to a transfer into a professional service corporation using section 85 of the Income Tax Act (the "Act").
Our understanding of the hypothetical situation is as follows. Mr. X acquired a partnership interest in an arm's length transaction from two existing partners on January 1, 2004, for $200,000. On the records of the partnership, Mr. X's capital account was allocated an amount of $30,000 on the same day, which reflected his one-third interest. The fiscal year end of the partnership is December 31. The partnership filed a section 34 election to value its year-end work in progress ("WIP") at nil. On June 1, 2006, Mr. X incorporated a professional corporation with the intention of rolling the partnership interest to this company under section 85 of the Act.
Specifically you inquired as to whether the proposed change to subsection 96(1.01) applied to the income earned from January 1, 2006, to May 31, 2006, and if so, its effect on subparagraph 53(1)(e)(i) of the Act. In addition, you requested clarification on the capital account amount and on the application of section 34 of the Act.
The Income Tax Rulings Directorate provides binding comments only with respect to proposed transactions and only in the context of an advance income tax ruling. Information about this service is available in Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at http://www.cra.gc.ca. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.
Acquisition Cost
If a person becomes a partner by acquiring another partner's interest, the cost of acquiring the partnership interest will equal the fair market value of the consideration given for that interest, usually the purchase price. It is not necessary that the ACB of a partnership interest for income tax purposes and the capital account of a partner, as calculated for accounting purposes, be the same. The capital account attributed to the partnership interest purchased is neither added nor deducted in the calculation of the ACB of a partnership interest for income tax purposes.
Adjustments to the ACB of a Partnership Interest
The ACB is defined in section 54 of the Act as cost plus or minus the adjustments listed in section 53. With respect to capital contributions and drawings of the partner, the adjustments to the ACB of the partnership interest are made at the time of the contribution or drawing, pursuant to subparagraph 53(2)(c)(v) of the Act. In contrast, the adjustments related to allocations of income are not made during the period in which the income arises. Rather, these adjustments to the ACB of a partnership interest are made on the first day of the following fiscal period. It is the allocation, not the receipt of funds, that creates income for the partners that is subject to tax. The partner's share of partnership income is included in income for tax purposes and added to the adjusted cost base of the partnership interest, pursuant to subparagraph 53(1)(e)(i) of the Act.
Income - Partial 2006 year
You have indicated that a corporation was created with the intention of rolling a partnership interest into it, but it is not clear whether the partner at issue ceased to be a member of the existing partnership. In addition, the question of whether there is any income to the partner for 2006 may be determined by the existing partnership agreement (which we have not reviewed). If the partnership agreement provides for an allocation of income or loss in the year a partner withdraws, the income would be allocated, for purposes of section 96, in respect of that year to that partner as outlined by the agreement.
In the event that the partnership agreement does not address the situation where there is no allocation of income for the year in which a partner withdraws and the partner at issue ceases to be a partner, the following comments may be helpful.
For the purpose of allocating partnership income or loss for the partial year just prior to the section 85 rollover date, proposed paragraph 96(1.01)(a) deems the 'former partner' to be a member of the 'former partnership' at the end of the normal fiscal period of that partnership. The primary purpose for this addition was to provide clarification as to the tax treatment of partial and/or final year's income of the former partner. This proposed amendment is effective for 1995 and subsequent taxation years. It is the CRA's longstanding practice to ask taxpayers to file on the basis of proposed legislation. Taxpayers that choose to file based on the wording of the existing law rather than the wording of the existing legislative proposals are expected to bring their tax affairs up-to-date, in a timely manner, once the legislative proposals become law.
Proposed paragraph 96(1.01)(a) does not require that partnership income or loss be calculated immediately after a member leaves the partnership. The income or loss allocation, including that of the former member, continues to be calculated after the end of the partnership's fiscal period.
ACB - and the Income Adjustment for 2006
Proposed paragraph 96(1.01)(b) clarifies that the income or loss allocation for the final and/or partial period is included in the calculation of the ACB of the partnership interest under subparagraph 53(1)(e)(i). This calculation is to be made to the ACB "immediately before the time that is immediately before the time" that the taxpayer ceased to be a member of the partnership, pursuant to proposed subparagraph 96(1.01)(b)(ii). Since adjustments to the ACB of a partnership interest related to the income allocation are normally made on the first day of the following fiscal period, this subparagraph mandates that the ACB be adjusted at the time the former member disposes of the interest. As a result, the partial and/or final period income is included in the ACB of the partnership interest prior to the section 85 rollover into the corporation.
Provided the partnership has a valid section 34 election in place, the partnership can exclude its WIP in computing its income for the fiscal period in which the partner withdraws. Please refer to the current version of Interpretation Bulletin IT-457R, Election by professionals to exclude work in progress from income, for further discussion regarding the income tax consequences when a partner withdraws.
We trust that these comments will be of assistance.
Yours truly,
Gwen Moore
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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