2007 Ruling 2006-0215851R3 - 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 								2006-021585

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Named Partner")
XXXXXXXXXX

Identification No. XXXXXXXXXX (the "Partnership")

This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted individual and partnership. We also acknowledge your letter 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:

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

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of one of the taxpayers or a related person;

(iii) under objection or appeal by one of the taxpayers or a related person;

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

(v) 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 will be incorporated pursuant to the Business Corporations Act (XXXXXXXXXX) and the 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) "Newco" is the new corporation that will be incorporated under the laws of the Province of XXXXXXXXXX;

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

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

(i) "Practice" means the XXXXXXXXXX practice currently carried on by the Partnership as described in Paragraph 1, below;

(j) "Principal" means the Partner who has incorporated a particular Contracting Professional Corporation;

(k) "Professional" refers to each individual XXXXXXXXXX who currently provides Professional Services to the Partnership as required in the Practice;

(l) "Professional Services" means XXXXXXXXXX services;

(m) "related persons" has the meaning assigned by subsection 251(2) of the Act;

(n) "specified partnership income" has the meaning assigned by subsection 125(7) of the Act; and

(o) "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 Practice is carried on as a partnership and consists of providing Professional Services to the XXXXXXXXXX (the "Department") of the XXXXXXXXXX.

2. The Partnership currently has XXXXXXXXXX Partners. The Partners provide Professional Services to the Partnership.

3. The Partnership's identification number is XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. The Named Partner files her income tax returns with the XXXXXXXXXX Tax Centre.

4. The Partnership is not governed by a written partnership agreement. The Department has a set of written rules and regulations which the Partnership has adopted (the "Rules and Regulations"), which are generally outlined in paragraphs 5 to 11 below.

5. The Rules and Regulations provide that the Chief of the Department ("Chief") is invested with the authority to discipline any member of his or her department if there is refusal to comply with the By-Laws of the XXXXXXXXXX, the Rules and Regulations of the Department or assignment of responsibilities by the Chief.

6. The Rules and Regulations adopted by the Partnership include the following:

(a) The Partners agree to abide by the XXXXXXXXXX.

(b) The Partners agree to provide required Professional Services in a competent and professional manner as follows:

(i) XXXXXXXXXX.

(ii) XXXXXXXXXX.

(iii) To ensure that there is a commitment to service, continuous quality improvement, and administrative responsibilities within the Department.

(iv) To observe all XXXXXXXXXX, Rules and Regulations, Policies, and Ethical Standards.

(v) To actively pursue the development of an atmosphere of flexibility and mutual respect among all XXXXXXXXXX within the Department.

(vi) To recognize that all XXXXXXXXXX professionals within the Department form an integral part of departmental activity and that working with those individuals in accordance with these principles is necessary to achieve success in the implementation of these principles.

(vii) To ensure the continued provision of high-quality XXXXXXXXXX on an ethical basis, in addition to performing the technical and interpretative functions of a XXXXXXXXXX.

(viii) To present a solid, supportive and constructive position, consistent with these principles, to all external bodies.

(ix) To develop internal policies and procedures whereby modification of, and changes to, existing practice can be secured on a consensual basis.

(x) To cooperate and work with all XXXXXXXXXX.

(xi) To actively develop external responsibilities in relation to professional bodies and the XXXXXXXXXX.

(c) All Professional Services performed for a fee by a Partner are done on behalf of the Partnership.

(d) Each Partner must obtain appropriate XXXXXXXXXX insurance under the XXXXXXXXXX.

7. XXXXXXXXXX.

8. A Partner is entitled to draw funds from the Partnership on a monthly basis in an amount determined by the level of services provided and years of service ("Draw").

9. Partners may be entitled to additional remuneration from the Partnership, referred to as XXXXXXXXXX.

10. Additional fees may be payable to a Partner where the XXXXXXXXXX is required to work an additional day or in the event vacation time booked includes a statutory holiday. Such flat rate fees paid are referred to as "XXXXXXXXXX".

11. The gross revenues of the Partnership in a fiscal year are used to pay all expenses of the Partnership. After paying all expenses of the Partnership for the fiscal year, as well as the Draw, XXXXXXXXXX, if any, the remainder of the profits of the Partnership are distributed to the Partners on the basis of Partnership status and monthly Draw entitlement.

12. The Partnership funds, within set limits, continuing XXXXXXXXXX education for Partners to acquire or improve XXXXXXXXXX which will benefit the Partnership. Decisions as to funding for continuing XXXXXXXXXX education are at the discretion of the Chief. Partners who have not previously received funding for continuing XXXXXXXXXX education will be given the right of first refusal provided the Chief determines it is logical for them to acquire the particular skills or training.

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

14. None of the Partners are related to any other Partner.

15. The Partnership contracts with and employs a limited number of staff. The Partnership currently contracts with XXXXXXXXXX and therefore not yet Partners in the Partnership.

16. XXXXXXXXXX The Partnership does not pay any fees to the XXXXXXXXXX. The relationship between the XXXXXXXXXX and the Partnership is not a master and servant relationship, as the Partners are not employees of the XXXXXXXXXX.

Proposed Transactions

17. Newco will be incorporated as a CCPC and a TCC.

18. Upon incorporation, Newco will be authorized to issue an unlimited number of voting common shares (the "Shares") without nominal or par value. One common voting share will be issued to the Named Partner. The Named Partner will receive $XXXXXXXXXX in cash as the subscription price from the Partnership.

19. XXXXXXXXXX.

20. XXXXXXXXXX, the Partnership will sell all of its assets to Newco at fair market value. The Assets of the Partnership are not substantial and consist mainly of cash and receivables from the XXXXXXXXXX (XXXXXXXXXX). Newco will assume all of the liabilities of the Partnership. In consideration for the sale, the Partnership will receive XXXXXXXXXX Shares. 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" 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 of the 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.

21. 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.

22. For legal simplification, the XXXXXXXXXX Shares issued by Newco as consideration for the transfer to it of the assets of the Partnership shall be issued in the name of each Partner (1 Share each) instead of the name of the Partnership. The Partnership, not the individual Partners themselves, will be the beneficial owner of the Shares.

23. The one share issued to the Named Partner in Paragraph 18, above, will be purchased for cancellation by Newco.

24. On the day immediately 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 Shares received as consideration for the assets transferred. Each Partner will receive, in complete satisfaction of his or her interest in the Partnership, 1 Share of Newco.

25. The shareholders of Newco will elect the directors of Newco.

26. The shareholders of Newco will enter into a Shareholder's Agreement that will include, but not be limited to, the following provisions:

(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 with independent contractors (see Paragraph 27 below);

(c) The directors of Newco will manage the affairs of Newco;

(d) The officers of Newco will be elected 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 shares;

(f) New shareholders, if any, will be issued shares for proceeds equal to fair market value.

(g) The alienation or transfer of issued shares of Newco shall be restricted to the following circumstances:

(i) No shareholder shall be entitled to transfer his or her Share in Newco; and

(ii) Where a shareholder ceases to provide Professional Services to Newco, either as an individual or through a Contracting Professional Corporation (see Paragraph 27, below), the shareholder must sell and Newco shall purchase from the shareholder his or her Share for proceeds equal to the subscription price.

27. Newco will carry on the Practice by providing Professional Services to its clients in the following ways:

(a) Through individuals engaged by Newco to provide Professional Services as independent contractors (the "Contracting Professionals"). These Contracting Professionals will be licensed to practice XXXXXXXXXX in the Province of XXXXXXXXXX and will be engaged by Newco to provide such Professional Services on behalf of Newco; and

(b) Through Contracting Professional Corporations engaged by Newco to provide Professional Services as independent contractors. Each Contracting Professional Corporation will provide such Professional Services on behalf of Newco. Each Contracting Professional Corporation will employ an individual licensed to practice XXXXXXXXXX in the Province of XXXXXXXXXX.

28. Newco will continue to provide Professional Services to arm's length third parties.

29. XXXXXXXXXX Each Partner will have the option of providing Professional Services to Newco by entering into a contract for service with Newco either directly as a Contracting Professional or indirectly through a Contracting Professional Corporation.

30. Those Partners who choose to enter into a contractual relationship with Newco, whereby the Partner will agree to provide Professional Services as a Contracting Professional, will receive a fee that will be based upon the fair market value of the services provided. The relationship between the Contracting Professional and Newco is intended to be one of independent contractor and hirer. This arrangement will be evidenced in writing (the "Individual Services Agreement"). The Individual Services Agreement will provide that additional remuneration will be payable under the terms and conditions in respect of XXXXXXXXXX that are described in Paragraphs 9 and 10, above.

31. Those Partners who choose to provide Professional Services to Newco through a Contracting Professional Corporation will be required to enter into a signed written agreement with Newco (the "Corporation Services Agreement"). The relationship between the Contracting Professional Corporation and Newco is intended to be one of independent contractor and hirer. Each Principal will provide Professional Services for the benefit of his or her Contracting Professional Corporation. The Corporation Services Agreement between Newco and a Principal's Contracting Professional Corporation will provide that the fee for Professional Services provided by the Contracting Professional Corporation will be based on the fair market value of those services. The Corporation Services Agreement will provide that additional remuneration will be payable under the terms and conditions in respect of XXXXXXXXXX that are described in Paragraphs 9 and 10, above.

32. All payments from third parties (including XXXXXXXXXX) in respect of services provided by a Contracting Professional Corporation or Contracting Professional for the benefit of Newco will be made directly to Newco.

33. XXXXXXXXXX.

34. The Contracting Professional Corporations and the Contracting Professionals will be responsible for all expenses incurred in respect of the following:

(a) Expenditures on personal practice preferences of the Contracting Professional Corporation or Contracting Professional;

(b) All membership dues and XXXXXXXXXX premiums; and

(c) Continuing professional education.

35. Newco will not pay any of the Contracting Professional Corporations' or Contracting Professional's XXXXXXXXXX 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 XXXXXXXXXX premiums.

36. Pursuant to the Services Agreement, a Contracting Professional Corporation (or its Principal) or a Contracting Professional, as the case may be, will not be restricted from providing services to other persons or otherwise prohibited from competing with Newco. Likewise, on the termination of a Contracting Professional Corporation's or Contracting Professional's association with Newco, the Contracting Professional Corporation (or its Principal) or Contracting Professional shall not be prohibited in any way from competing with Newco.

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

38. XXXXXXXXXX.

39. Each Contracting Professional Corporation will have one class of common voting shares and an unlimited number of classes of non-voting common shares. Each Contracting Professional Corporation will be controlled by its Principal, who will be the legal and beneficial owner of all of the voting shares of the Contracting Professional Corporation. The sole officer and director of a Contracting Professional Corporation will be its Principal. Non-voting common shares of each Contracting Professional Corporation may be owned by members of its Principal's family. The non-voting common shares of a Contracting Professional Corporation will be redeemable and retractable at $XXXXXXXXXX per share. The non-voting common shareholders will be entitled to discretionary dividends. The non-voting common shares will not be entitled to participate on the liquidation or dissolution of the Contracting Professional Corporation. None of these non-voting common shares will be issued as part of the proposed transactions described herein but will be issued at a later date. For purposes of this paragraph and Paragraph 42, 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.

40. All of the shareholders (voting and non-voting) will subscribe for shares of the Contracting Professional Corporation for the same subscription amount. The subscription amount will be nominal. A Contracting Professional Corporation may enter into a shareholders' agreement with all of the shareholders of the Contracting Professional Corporation.

41. The Principal of a particular Contracting Professional Corporation will be an employee of the Contracting Professional Corporation and will provide Professional Services for the benefit of the Contracting Professional Corporation in accordance with the terms of the corporation's Corporation Services Agreement with Newco. The employment relationship between a Principal and his or her Contracting Professional Corporation will be evidenced by a written employment agreement.

42. Each Partner will not be an employee, officer, director or shareholder, either legally or beneficially, of more than one Contracting Professional Corporation. A member of a Partner's family may only be a shareholder of the Contracting Professional Corporation in which that Partner owns shares.

43. No legal or beneficial shareholder of a Contracting Professional Corporation will be a legal or beneficial shareholder of another Contracting Professional Corporation, 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' families 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.

44. Only Partners of the Partnership will have the option to choose which contractual arrangement they will establish with Newco. The Directors of Newco will determine, as the need arises, what contractual arrangements will be offered to individuals who are not currently Partners.

45. 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, there may be an annual net profit to Newco. The directors of Newco will have the sole discretion to distribute the net profit in the form of dividends.

Purpose of the Proposed Transactions

46. 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 joint and several 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 business of Newco;

(c) Provide increased business efficiency for each Partner through individual management of personal practice preferences;

(d) Permit each Partner to have 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 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 30 and 31, 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 a Principal 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 22, 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 39 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 Principal 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 a Principal 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 agreements entered into between the Contracting Professional and Newco. Similarly, whether or not a Principal would be an employee of Newco or an independent contractor, but for the existence of the Contracting Professional Corporation, is a question of fact that can only be determined after a review of the actual agreements entered into between the Contracting Professional Corporation and Newco and between Newco and the Principal. This review and determination is the responsibility of the Contracting Professional's or Principal'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
Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch