2008 Ruling 2007-0245931R3 - Partnership Reorg-Personal Services Business

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  									2007-024593

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX , as amended in your letter we received XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of XXXXXXXXXX and its partners. We also acknowledge the additional information provided to us in your numerous electronic mail transmissions, letters, and during our telephone conversations (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 Partnership, any of the Partners or a related person;
(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed return of the Partnership, any of the Partners 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.

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

DEFINITIONS

In this letter, unless otherwise expressly stated:

(a) "Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th Supplement), c.1, as amended to the date hereof;

(b) "associated" when used in connection with a Corporate Partner or a Contracting Company has the meaning described in subsection 256(1) of the Act;

(c) "Association" means the XXXXXXXXXX ;

(d) "Annual Professional Service Fee" means the annual fee paid to a Contracting Company for the Professional Services it provides to the Partnership (see Paragraph 11); XXXXXXXXXX

(e) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7) of the Act;

(f) "CCOwner" means the Individual Partner or Principal, as the case may be, who is the sole owner of the Class A Shares issued by their particular Contracting Company, as described in Paragraph 10;

(g) "Class A Shares" means the only shares issued by a Contracting Company. They will be voting, common Class A shares of the Contracting Company;

(h) "Contracting Company" means a company that each Principal and each Individual Partner will incorporate, as more fully described in Paragraphs 8 and 9. Collectively, they are referred to as "Contracting Companies";

(i) "Corporate Partner" means a corporation that is currently a partner of the Partnership. Each Corporate Partner is a Canadian-controlled private corporation and a taxable Canadian corporation. Collectively they are referred to as the "Corporate Partners". A current list of the Corporate Partners was included in your electronic mail transmission sent to us on XXXXXXXXXX ;

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

(k) "Individual Partner" means an individual who is currently a partner of the Partnership. Collectively they are referred to as the "Individual Partners". Each of the Individual Partners is a Canadian resident living in XXXXXXXXXX . A current list of the Individual Partners was included in your electronic mail transmission sent to us on XXXXXXXXXX ;

(l) "XXXXXXXXXX Services" include the following:

XXXXXXXXXX

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

(n) "Partner" means an Individual Partner or a Corporate Partner, as the case may be, that is currently a partner of the Partnership. Collectively they are referred to as the "Partners";

(o) "Partnership" means the partnership, which currently carries on the Practice under the firm name "XXXXXXXXXX ". It is an XXXXXXXXXX partnership as described in Paragraphs 1-3;

(p) "Partnership Agreement" means the Amended and Restated agreement between the Partners, dated as of XXXXXXXXXX ;

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

(r) "Principal" means an individual XXXXXXXXXX who is a controlling shareholder of their respective Corporate Partner, as of the date hereof. Collectively they are referred to as the "Principals". Each of the Principals is a Canadian resident living in XXXXXXXXXX ;

(s) "Practice" means the professional XXXXXXXXXX practice currently carried on by the Partnership. It includes the Professional Services provided by the Partnership to its clients, such as XXXXXXXXXX . It also includes the Promotional and Management Functions conducted by the Partners on behalf of the Partnership;

(t) "Professional Services" means the XXXXXXXXXX Services rendered to the Partnership's clients in the course of the operation of the Partnership's Practice;

(u) "Promotional and Management Functions" do not include any of the functions defined as Professional Services, but do include all activities

• with existing and prospective clients to promote the present and future business of the Partnership,
• relating to the management of the ongoing day to day operations of the business of the Partnership,
• relating to the long term strategic planning and related future vision of the Partnership, and
• relating to the administration of the Partnership;

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

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

(x) "Services Agreement" means the services agreement to be entered into between the Partnership and each Contracting Company, as more particularly described in Paragraph 11;

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

(z) "Tax Year" means the fiscal period of the Partnership for income tax purposes, being XXXXXXXXXX ; and

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

FACTS

1. The Partnership is a XXXXXXXXXX services firm with offices only in XXXXXXXXXX . The Partnership's filer identification number is XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. The main office of the Partnership is located at XXXXXXXXXX .

2. The Partnership was formed as an XXXXXXXXXX general partnership over XXXXXXXXXX years ago. It has been and will continue to operate in XXXXXXXXXX as a partnership. The Partnership is governed by the terms of the Partnership Agreement.

3. There are currently XXXXXXXXXX Corporate Partners and XXXXXXXXXX Individual Partners. All of the Partners are XXXXXXXXXX or professional corporations owned by XXXXXXXXXX . All of the XXXXXXXXXX are licensed by the Association to practice XXXXXXXXXX in XXXXXXXXXX . No Partner is a related person to any other Partner.

4. Each Corporate Partner is engaged in the practice of XXXXXXXXXX issued by the Association. Each Corporate Partner is also responsible for delivering Professional Services to the Partnership's clients, on behalf of the Partnership, as required by the Partnership Agreement. Each Principal performs these Professional Services as an employee of their Corporate Partner. Each Principal remains personally responsible for their respective Corporate Partner's obligation to abide by the bylaws and rules of professional conduct of the Association. Each Principal is also responsible for indemnifying the Partners for any losses, claims, expenses, costs and damages suffered by the Partners as a result of the Principal's, or their Corporate Partner's, breach of the Partnership Agreement.

5. Each Individual Partner is engaged in the practice of XXXXXXXXXX issued by the Association. They are also personally responsible to abide by the bylaws and rules of professional conduct of the Association and for delivering Professional Services to the Partnership's clients, on behalf of the Partnership, as required by the Partnership Agreement. Each Individual Partner is also responsible for indemnifying the Partners for any losses, claims, expenses, costs and damages suffered by the Partners as a result of the Individual Partner's breach of the Partnership Agreement.

6. Currently, the Partnership's income for a particular year is calculated in accordance with generally accepted accounting procedures. Each Partner is allocated and paid a share of the Partnership's income based on the number of units awarded to the Partner for that year, divided by the total number of Partnership units issued, multiplied by the Partnership's income available for allocation. All full equity Partners have XXXXXXXXXX Partnership units. New partners generally start with XXXXXXXXXX Partnership units. These units increase at XXXXXXXXXX units per year until the maximum units of XXXXXXXXXX are obtained. The starting number of units and rate of increase of the units are established when a partner first joins the Partnership, commensurate with their experience.

PROPOSED TRANSACTIONS

7. The Partnership Agreement will be amended to, inter alia,

(a) delete paragraph 20(b), which refers to adjustments to sharing of Partnership income for depreciation based on a Partners' share of depreciable assets. It is our understanding that no such adjustments are currently being made and that presently each Partner's share of the Partnership's income for a Tax Year is allocated and paid as stipulated above in Paragraph 6,

(b) provide that, as long as a Contracting Company fully discharges its responsibilities under the Services Agreement, the Contracting Company will not be restricted from providing Professional Services to other persons or otherwise prohibited from competing with the Partnership,

(c) differentiate between the only two functions that each Partner performs for the Partnership: (i) Professional Services and (ii) Promotional and Management Functions,

(d) prohibit the performance of Promotional and Management Functions by anyone other than the Partners themselves. All Partners will continue in their capacity as Partners to conduct Promotional and Management Functions for the Partnership,

(e) provide that, where an Individual Partner or a Principal of a Corporate Partner opts to use a Contracting Company to provide Professional Services to the Partnership, as described in Paragraphs 8 and 11, the calculation of the relevant Partner's share of Partnership income for a year will be dependent on the Promotional and Management functions conducted for the Partnership for that year. More specifically, the calculation of that Partner's share of Partnership income will not take into account the Professional Services provided by that Individual Partner's Contracting Corporation, or the Principal's Contracting Company, nor will it take into account time spent performing Professional Services by the Individual Partner or the Principal, as the case may be, in his or her capacity as an employee of the relevant Contracting Company, and

(f) although not contemplated in these proposed transactions, provide that if any Individual Partner or Principal chooses not to incorporate a Contracting Corporation, that Individual Partner or the relevant Corporate Partner, as the case may be (the "Non-CC Partner"), will continue to provide their Professional Services directly to the Partnership. A Non-CC Partner's allocation of Partnership income for any year would be dependent on that Non-CC Partner's services provided on behalf of the Partnership, being the Professional Services and the Promotional and Management Functions.

8. Each Individual Partner will incorporate a Contracting Corporation and will no longer provide any Professional Services to the Partnership in his or her capacity as a Partner. Each Principal will incorporate a Contracting Corporation and will no longer provide any Professional Services to the Partnership through his or her Corporate Partner, or in his or her capacity as a Principal of the Corporate Partner. Notwithstanding this arrangement, the Individual Partners and the Corporate Partners will also remain as Partners and will continue to earn income for the Partnership by providing the Promotional and Management Functions on behalf of the Partnership.

9. Each of the Contracting Companies will be a Canadian-controlled private corporation and a taxable Canadian corporation. The Contracting Companies will each obtain a license from the Association authorizing it to engage in the practice of offering XXXXXXXXXX Services to the public in XXXXXXXXXX . None of the Contracting Companies will be related persons, and none of the Contracting Companies will be, or will become, a partner in the Partnership. Each Principal's Corporate Partner will be a related person, and will also be associated, with that Principal's Contracting Company.

10. Each of the Individual Partners and the Principals will be the sole shareholder of their respective Contracting Company and will own all of their respective Class A shares. No Individual Partner and no Principal will be an employee, officer, director, or shareholder, either legally or beneficially, of more than one Contracting Corporation.

11. Each Contracting Company will enter into a separate written Services Agreement with the Partnership to provide the Partnership's clients, on behalf of the Partnership, with Professional Services only. The Services Agreement will provide that:

(a) the Services Agreement shall be for a fixed period ending on

XXXXXXXXXX of each year. It may be renewed each year and it may also be terminated by either party upon XXXXXXXXXX days notice;

(b) the particular Contracting Company shall make available the XXXXXXXXXX services of the Individual Partner or the Principal that owns the Class A Shares of the Contracting Company, as the case may be, in order to provide the Professional Services as required by the Partnership;

(c) the obligation of the particular Contracting Company shall be set out in a negotiated practice profile, expressed as the Professional Services that the Contracting Company will provide over the term of the contract;

(d) in return for providing the Professional Services, each Contracting Company will be paid an Annual Professional Service Fee, as defined in the Services Agreement. The amount of the Annual Professional Service Fee will represent a fair market value amount, taking into account the XXXXXXXXXX expertise required by, and provided to, the Partnership. The amount of the fee will be tied to the level of work performed, and not to the success in collecting billings in respect of that work;

(e) the particular Contracting Company shall be compensated on the last day of each month for the Professional Services provided to the Partnership. To the extent that the Contracting Company's monthly level of Professional Services is substantially complete, in keeping with the set practice profile, the Contracting Company will be paid a pro rata amount of the established Annual Professional Service Fee;

(f) all payments from third parties in respect of Professional Services provided by a Contracting Company, for the benefit of the Partnership, shall be made directly to the Partnership;

(g) the Partnership shall supply certain supplies, XXXXXXXXXX , facilities, and equipment required in the provision of Professional Services by the Contracting Company. The amount of the Annual Professional Service Fee will be reduced by the fair market value amount attributable for the use of these items by the Contracting Company; and

(h) the particular Contracting Company shall be responsible for providing Professional Services to the Partnership and, in addition to the cost of supplies, XXXXXXXXXX , facilities, and equipment referred to above in Paragraph 11(g), shall bear responsibility for the following activities and related expenses incurred:

• registration of professional membership fees and insurance;
• professional XXXXXXXXXX insurance;
• continuing professional education and training;
• transportation;
• communication;
• maintaining the professional standards set by the Association from time to time; and
• expenditures on personal practice preferences of the Contracting Company.

12. Each CCOwner will be an employee of his or her own Contracting Corporation. The employment relationship will be evidenced by a written employment agreement. The respective CCOwner will provide Professional Services for the benefit of their Contracting Corporation, pursuant to the terms of the relevant Services Agreement between their Contracting Corporation and the Partnership. The Contracting Company and the employee will independently negotiate the amount of the compensation that a particular Contracting Company will pay to its employee.

PURPOSE OF THE PROPOSED TRANSACTIONS

13. The primary objective of the proposed transactions is to restructure the professional practices of the Partners such that each Partner can choose, without any adverse tax consequences to any other Partner, the appropriate structure from which to satisfy his or her professional obligations of the Practice while:

(a) minimizing, to the maximum extent possible, the exposure to each Partner from the joint and several liabilities inherent in providing both Professional Services and other commercial operating activities;

(b) providing each Individual Partner and each Principal with the opportunity to become an independent contractor and as such allowing each of them increased business efficiencies through individual management of personal practice preferences;

(c) permitting greater control over expenditures reflecting personal practice preferences where such expenditures may not be in the interest of all participants in the Practice;

(d) providing each Individual Partner and each Principal with greater control over his or her own estate and financial planning;

(e) facilitating ease of entry to, and exit from, the Partnership by future and existing partners; and

(f) enhancing the Partnership's ability to retain current Partners and admit new partners.

14. The proposed transactions will allow Individual Partners and Principals to use, if they so choose, a professional corporation to earn Professional Services income derived from the Partnership's practice without negatively effecting the business arrangements between the other partners of the Partnership.

RULINGS

Provided that

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes 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 for purposes of the Act.

B. Subject to sections 18 and 67 of the Act, the Annual Professional Service Fee payable by the Partnership to a particular Contracting Company pursuant to a Services Agreement, as described in Paragraph 11, will be deductible by the Partnership in its determination of the Partnership's income for purposes of subsection 96(1) of the Act.

C. The proposed transactions undertaken as described above, and in particular the Annual Professional Service Fee payments described in Paragraph 11, will not in and of themselves cause subsection 56(2) of the Act to apply so as to cause an amount of the Annual Professional Service Fee received by a Contracting Company under a Services Agreement to be taxed as income in the hands of the respective CCOwner.

D. A Contracting Company that supplies Professional Services to the Partnership, as described in Paragraph 11, will not be considered to be carrying on a personal services business. This is only so provided the CCOwner of that Contracting Company would not, if the particular Contracting Company did not exist, reasonably be regarded as an officer or employee of the Partnership in respect of those services.

E. Provided a particular Contracting Company was not a member of any partnership in the relevant year, the Annual Professional Service Fee income earned by the particular Contracting Company pursuant to a Services Agreement, as described in Paragraph 11, will not be specified partnership income.

F. Implementation of the proposed transactions described above, will not, in and of 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.

ADDITIONAL COMMENTS

Whether or not a CCOwner who is providing his or her Professional Services to the Partnership through a Contracting Company would, but for the existence of that Contracting Company, reasonably be regarded as 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 CCOwner. This review and determination is the responsibility of the CCOwner's local tax services office.

Although not referred to in the proposed transactions, we note that subsection 56(2) of the Act may apply to any amounts paid by a Contracting Company to a family member of the CCOwner who incorporated the Contracting Company. 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, it is our view that the incorporation of the Contracting Companies 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 Companies. We note that, as stated in Paragraph 9, a Principal's Corporate Partner will be a related person, and will also be associated, with that Principal's Contracting Company.

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