2007 Ruling 2007-0223121R3 - 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 									2007-022312

XXXXXXXXXX , 2007

Dear XXXXXXXXXX:

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

We are writing in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the Partnership and the Named Partner. We also acknowledge the information provided in your letters dated XXXXXXXXXX, and in our various telephone conversations and emails (XXXXXXXXXX).

We understand that to the best of your knowledge and that of Partnership and Named Partner (collectively the "Taxpayers"), none of the issues involved in the ruling request is:

i. in an earlier return of one of the Taxpayers or a related person;

ii. being considered by a tax services office or a tax centre in connection with a tax return already filed by one of the Taxpayers or a related person;

iii. under objection 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 Directorate to one of the Taxpayers or a related person.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), 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 definitions unless otherwise indicated.

Our understanding of the facts, the proposed transactions and the purpose of the proposed transactions is as follows:

Definitions

In this letter, the following terms have the meanings specified:

(a) "Canadian-controlled private corporation" ("CCPC") has the meaning set forth in subsection 125(7) of the Act;

(b) "XXXXXXXXXX Services" means XXXXXXXXXX;

(c) XXXXXXXXXX;

(d) "Contract" refers to the professional services contract to be entered into between the Partnership and a Contracting Company as described in Paragraph 15;

(e) "Contracting Company" means each of the corporations that will be or is already incorporated, as permitted pursuant to the laws of the Province, by a Partner and that will be hired by the Partnership to provide XXXXXXXXXX Services as independent contractors;

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

(g) "Employment Contract" means the written employment contract to be entered into between a Contracting Company and the particular XXXXXXXXXX Shareholder;

(h) "Facility" means XXXXXXXXXX;

(i) "Fee" means the fair market value fee to be paid by the Partnership to a particular Contracting Company in return for XXXXXXXXXX Services rendered by the Contracting Company, as described in Paragraph 15;

(j) "Non-XXXXXXXXXX Services" refers to the research, teaching and administrative activities as carried on by the Partnership;

(k) "Other Partnership" means XXXXXXXXXX, which is a partnership;

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

(m) "Partners" means XXXXXXXXXX Partners and the Other Partnership, which together comprise all of the partners of the Partnership;

(n) "Partnership Agreement" refers to the amended and restated partnership agreement dated XXXXXXXXXX, by which the Partnership is governed;

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

(p) "XXXXXXXXXX Partners" refers to the individuals who are partners of the Partnership, and any one is referred to as a "XXXXXXXXXX Partner". For greater certainty, XXXXXXXXXX Partners includes the Named Partner, but excludes the Other Partnership;

(q) "XXXXXXXXXX Shareholder" refers to a XXXXXXXXXX Partner in his or her capacity as shareholder of the Contracting Company that he or she incorporates;

(r) "Practice" means the practice of providing XXXXXXXXXX Services and Non-XXXXXXXXXX Services;

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

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

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

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

(w) XXXXXXXXXX.

Facts

1. The Partnership was originally formed on XXXXXXXXXX, to carry on the Practice. Its filer identification number is XXXXXXXXXX and its address is XXXXXXXXXX.

2. The Partnership and the Named Partner file information and tax returns, as the case may be, with the XXXXXXXXXX Tax Centre and deal with the XXXXXXXXXX Tax Services Office.

3. The Partnership is bound by the Partnership Agreement, as amended on XXXXXXXXXX. The Partnership currently consists of XXXXXXXXXX Partners (all of which are XXXXXXXXXX) and the Other Partnership. The partners of the Other Partnership are XXXXXXXXXX but are not XXXXXXXXXX. The partners of the Other Partnership and the XXXXXXXXXX Partners are mutually exclusive. None of the Partners are related persons and all are resident in Canada.

4. This present ruling is only in respect of the Partnership, the Named Partner and the Named Partner's Particular Contracting Company. Accordingly, any opinions, ruling or comments made herein have no bearing on the Other Partnership, which obtained its own ruling from CRA in a letter dated XXXXXXXXXX, 2006, our file #2006-019752.

5. XXXXXXXXXX.

6. The purposes of the Partnership are as follows:

(a) to function as a group XXXXXXXXXX practice for the XXXXXXXXXX Partners;

(b) to support and fulfil the Mission Statement XXXXXXXXXX as follows:

To provide excellence and innovation in three areas:

XXXXXXXXXX

(c) to collect all fees for professional services rendered by XXXXXXXXXX Partners; and

(d) to account for and distribute all monies received by the Partnership.

7. Each XXXXXXXXXX Partner performs such duties as he or she may be required to perform to achieve the acknowledged purposes of the Partnership.

8. As a Partner, the Other Partnership agrees:

(a) to assist where possible in the advancement of the XXXXXXXXXX, research and teaching mission XXXXXXXXXX;

(b) to provide accounting and administrative services as are required by the Partnership, including, without limitation, billing, bookkeeping, depositing monies received to the credit of the Partnership in one or more bank accounts designated by the Partnership and other such similar services, but excluding the services to be provided by the accountant retained by the Partnership; and

(c) as a result of certain business/research relationships between the two partnerships, at times to provide research and teaching funding to the Partnership. In this regard, sometimes the Other Partnership receives funding from the government or other sources to do research or teaching. When part of that work requires the expertise of XXXXXXXXXX, the Other Partnership will subcontract the work out to the Partnership. One or more XXXXXXXXXX Partners will be selected to do the research/teaching [i.e., Non-XXXXXXXXXX Services] and while they do this task they are relieved of all XXXXXXXXXX Services. During this time, the XXXXXXXXXX Partner(s) will enhance their skills and knowledge base in the field of XXXXXXXXXX.

The Other Partnership provides research funding to the Partnership through one of its components known as XXXXXXXXXX In those instances, XXXXXXXXXX pays the XXXXXXXXXX Partners directly for their time spent doing the research. The Partnership does not report this income. However, it is reported by the XXXXXXXXXX Partners using T4A slips issued to them by XXXXXXXXXX/Other Partnership. The relevant XXXXXXXXXX Partners' share of Partnership income for the particular year will be adjusted to reflect the time they spent and money they directly earned performing these Non-XXXXXXXXXX Services.

When the Other Partnership subcontracts with the Partnership to provide teaching, an agreement is negotiated between the parties concerning the amount of funding for those services. At the end of the year, the Other Partnership's share of the Partnership's net income is reduced by this agreed amount of teaching funding. Again, the relevant XXXXXXXXXX Partners' share of Partnership income for the particular year will be adjusted to reflect the time they spent performing these Non-XXXXXXXXXX Services.

9. Overall, the Other Partnership has an integral part in the Partnership's business, providing many tangible and intangible benefits for both parties. It is beneficial for the Other Partnership to be able to demonstrate that it has been involved in funding research and teaching. This allows the Other Partnership to receive additional funding in subsequent years. The Other Partnership's role as a Partner can be broken down into two main categories; academic and administrative.

The academic commitment includes direct teaching and mentorship of XXXXXXXXXX Partners, coordination of various general teaching/lecture sessions for educational purposes, arranging for and incurring the cost of invited speakers, and providing resource personnel to assist XXXXXXXXXX Partners with research projects.

Administratively, the Other Partnership manages all aspects of the Partnership's business office, including billings and alternative funding arrangements. The Other Partnership also exercises its authority over the allocation of clerical and administrative personnel, office space, equipment and XXXXXXXXXX facilities at XXXXXXXXXX and the Facility to ensure the Partnership is provided access to personnel and use of physical facilities sufficient to conduct its business.

10. The business affairs of the Partnership are supervised by a "Finance Committee", which is comprised of XXXXXXXXXX.

11. The Partnership derives its revenue from the activities and efforts of the Partners. Revenue sources include, but are not limited to revenue from consultations, XXXXXXXXXX, stipends, and salary support from research studies, scholarship, honoraria or fees for lectures, fees on account of insurance reports and legal consultations, XXXXXXXXXX, radio or television fees, royalties, and awards or prizes.

12. Each year, net Partnership income is allocated to the Partners as follows:

(a) to the XXXXXXXXXX Partners

(i) each XXXXXXXXXX Partner will be allocated the net income earned from XXXXXXXXXX , after deducting an amount to be determined each year for the Partnership's overhead,

(ii) each XXXXXXXXXX Partner will be allocated a percentage [presently XXXXXXXXXX%, but can be amended annually by a vote of the XXXXXXXXXX Partners] of the income earned by that XXXXXXXXXX Partner for the Partnership from such sources as teaching, honoraria, prizes or awards, non-XXXXXXXXXX consultative work, XXXXXXXXXX, fees from books, papers, reviews and preparation material, and XXXXXXXXXX , and

(iii) after deducting the share of net Partnership income allocated above in (i) and (ii), and to the Other Partnership for the year, as noted below in (b), the remaining Partnership net income for the year will be allocated to each XXXXXXXXXX Partner based on a notional points rating system. XXXXXXXXXX

(b) to the Other Partnership, the aggregate of

(i) XXXXXXXXXX% (or such other percentage as may be agreed upon from time to time by the Other Partnership and XXXXXXXXXX Partners having at least XXXXXXXXXX % of the votes of all XXXXXXXXXX Partners) of the gross income of the Partnership, minus the negotiated amount of teaching funding the Other Partnership agreed to provide to the Partnership, as noted in Paragraph 8(c), and

(ii) $XXXXXXXXXX on account of accounting and administrative services provided by the Other Partnership to the Partnership, as noted in Paragraph 8(b).

The above-noted percentages and amounts may be adjusted annually.

13. The Partnership Agreement provides that:

(a) a XXXXXXXXXX Partner may, in his or her discretion, elect to provide XXXXXXXXXX Services through a Contracting Company. Those who so elect, will not be restricted from competing with the Partnership in respect of the provision of XXXXXXXXXX Services,

(b) a XXXXXXXXXX Partner who provides XXXXXXXXXX Services through a Contracting Company will no longer provide any such services to the Partnership in his or her capacity as a Partner. As the Contracting Companies will only be providing XXXXXXXXXX Services, all of the XXXXXXXXXX Partners (including those who have incorporated Contracting Companies) will continue to perform the Non-XXXXXXXXXX Services through the Partnership in their capacity as Partners. XXXXXXXXXX Partners who choose not to establish Contracting Companies will continue to provide their XXXXXXXXXX Services directly through the Partnership;

(c) the ownership interest of a XXXXXXXXXX Partner in the Partnership cannot be transferred, conveyed or issued to a Contracting Company, and

(d) a XXXXXXXXXX Partner's allocation of Partnership income for any year during which a Contracting Company provides that XXXXXXXXXX Partner's XXXXXXXXXX Services to the Partnership will depend solely on the XXXXXXXXXX Partner's capital contribution to the Partnership and factors connected to the Non-XXXXXXXXXX Services provided by the XXXXXXXXXX Partner. In particular, the calculation of such XXXXXXXXXX Partner's income allocation from the Partnership for that year will not take into account, either directly or indirectly, any XXXXXXXXXX Services provided by that XXXXXXXXXX Partner through his or her Contracting Company.

Proposed Transactions

14. One or more Contracting Companies will be formed as follows:

(a) each Contracting Company will be incorporated by a XXXXXXXXXX Partner pursuant to the laws of the Province;

(b) each Contracting Company will qualify as a TCC and CCPC;

(c) all of the voting shares of each Contracting Company will be legally and beneficially owned by the particular XXXXXXXXXX Partner that incorporated the Contracting Company, and, if applicable, by his or her spouse who is also a member of XXXXXXXXXX. The particular XXXXXXXXXX Partner's family members may own non-voting shares of the Contracting Company. For the 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;

(d) all persons legally or beneficially owning shares of a Contracting Company will be residents of Canada;

(e) each XXXXXXXXXX Partner will be an officer and director of his or her Contracting Company and, in accordance with the Business Corporation Act XXXXXXXXXX, any other shareholder of the Contracting Company who is a member of XXXXXXXXXX may also be an officer or director of that Contracting Company;

(f) no two Contracting Companies will be related persons; and

(g) each Contracting Company will be licensed to carry on the practice of XXXXXXXXXX in the Province.

15. Upon notification from a XXXXXXXXXX Partner that he or she elects to provide XXXXXXXXXX Services to the Partnership through a Contracting Company, the Partnership will enter into a Contract with the respective Contracting Company, which will provide as follows:

(a) the Contracting Company will provide XXXXXXXXXX Services to the Partnership in return for a Fee. The amount of the Fee to be paid by the Partnership to a Contracting Company will be equal to the fair market value of the XXXXXXXXXX Services that the Contracting Corporation provides;

(b) the Fee will paid in equal monthly instalments;

(c) the Contract will be for a period of one year and will renew automatically every year. The Contract may be terminated by either party upon twelve months prior written notice to the other party without cause, or earlier for cause;

(d) all payments from third parties received by the Partnership in respect of XXXXXXXXXX Services provided by the Contracting Companies will be for the benefit of the Partnership and if a Contracting Company receives any amounts, they will be remitted to the Partnership;

(e) the Contracting Company shall be responsible for providing all equipment, tools and instruments used in the performance of the XXXXXXXXXX Services at its expense. Pursuant to a written agreement and in consideration for a fair market value fee, the Partnership will provide the Contracting Company with certain facilities, equipment, supplies and personnel that are required to provide the XXXXXXXXXX Services.

(f) the Contracting Company shall also be responsible for all expenses required to maintain the professional standards required by the Partnership or by the XXXXXXXXXX and all fees and expenses necessary to perform the XXXXXXXXX Services, including, without limitation, all professional membership fees and insurance, continuing education expenses and transportation expenses. The Contracting Company agrees that to the extent that such expenses are paid by the Partnership, it shall reimburse the Partnership; and

(g) the Contracting Company's relationship to the Partnership is that of an independent contractor and nothing in the Contract should be construed as

(i) allowing either party the authority to assume or create any obligation whatsoever, expressed or implied, in the name of the other nor to bind the other in any manner whatsoever,

(ii) giving either party the power to direct and control the day-to-day activities of the other party or any of their respective employees or agents, or

(iii) constituting the parties as partners, joint venturers, co-owners or otherwise participants in a joint or common undertaking.

16. Each Contracting Company will enter into an Employment Agreement with its respective XXXXXXXXXX Shareholder, whereby the latter will be hired to provide XXXXXXXXXX Services for their Contracting Company with a view to fulfilling the Contracting Company's obligations under the relevant Contract. That XXXXXXXXXX Shareholder will be entitled to receive a salary from his or her Contracting Company for such services.

17. Provided a Contracting Company fully discharges its responsibilities under the Contract, the Contracting Company will not be restricted from providing services to other persons or otherwise prohibited from competing with the Partnership.

18. Within six months of the date of this ruling, the Named Partner will provide the Partnership with a notice of his intention to provide XXXXXXXXXX Services through a Contracting Company (the "Particular Contracting Company") and will incorporate the Particular Contracting Company for such purposes on the terms and conditions outlined above in Paragraphs 13 to 17.

Purpose of the Proposed Transactions

19. The purpose of the proposed transactions is to allow a XXXXXXXXXX Partner to take advantage of the recent legislative amendments by the Province, which permits XXXXXXXXXX to renderXXXXXXXXXX services through a Professional Services Corporation, thereby providing the following benefits:

(i) an increased level of control by a XXXXXXXXXX Partner over his or her participation in the Practice through individual management of personal practice preferences;

(ii) control by a XXXXXXXXXX Partner over expenditures where such expenditures may not be in the interest of all participants in the Practice; and

(iii) more control by a XXXXXXXXXX Partner over his or her own estate and financial planning.

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. Provided that the Named Partner providing XXXXXXXXXX Services to the Partnership 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 the Partnership in respect of those services, then the Particular Contracting Company will not be considered to be carrying on a personal services business.

B. 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 Contract, as described in Paragraph 15, will not be specified partnership income.

C. Subject to sections 18 and 67 of the Act, the Fees payable by the Partnership to the Particular Contracting Company pursuant to a Contract, as described in

Paragraph 15, will be deductible by the Partnership in its determination of the Partnership's income for purposes of subsection 96(1) of the Act.

D. The transactions undertaken in Paragraphs 13 to 18, and in particular the payment of Fees to the Particular Contracting Company, 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 of the Fees received by the Particular Contracting Company under a Contract to be taxed as income in the hands of the Named Partner.

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

F. 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 of the XXXXXXXXXX Partners.

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 XXXXXXXXXX Partners with respect to sharing the Partnership income for income tax purposes.

H. Implementation of the proposed transactions as described above will not, in and by themselves, 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.

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, including the Fee, or the appropriateness or reasonableness of the present method used to compute the Partnership's income (see Paragraph 8(c)) or the allocation of the Partnership's income (see Paragraph 12).

Additional Comments

Whether or not a XXXXXXXXXX Partner who is providing his or her XXXXXXXXXX Services to the Partnership through a Contracting Company 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 all of the relevant facts, including the actual agreements entered into between the Contracting Company and the Partnership, and between the Contracting Company and the XXXXXXXXXX Partner. This review and determination is the responsibility of the 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 14, 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 XXXXXXXXXX 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 a XXXXXXXXXX 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) 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 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 the Partnership will not, in and of itself, cause subsection 256(2.1) of the Act 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