2008 Ruling 2007-0246051R3 - 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 the partner of a professional partnership creates another professional corporation through which professional XXXXXXXXXX services are provided to clients, will this corporation be eligible for the small business deduction?

Position: Question of fact. Generally yes, if certain conditions are met.

Reasons: Income Tax Act. Consistent with previous rulings.

XXXXXXXXXX 							2007-024605

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Tax Ruling:

XXXXXXXXXX (the "Partnership") and
XXXXXXXXXX (the "Named Partners")

We understand that to the best of your knowledge, and that of the Partnership and Named Partners (collectively, the "Taxpayers") involved, 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 taxation centre in connection with a previously filed tax return of one or any of the Taxpayers or a related person;
(iii) under objection by one or any 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; or
(v) the subject of a ruling previously issued by the Income Tax Rulings 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.

The following terms used in this letter have the meanings assigned below.

DEFINITIONS

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

(b) "Contract" refers to the professional services contract to be entered into between the Partnership and a Contracting Company, as described in paragraphs 20 to 31 below;

(c) "Contracting Company" means a professional corporation that will be incorporated and authorized to practice XXXXXXXXXX in the Province of XXXXXXXXXX and that will be engaged by the Partnership to provide Professional Services as an independent contractor, collectively referred to as the "Contracting Companies";

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

(e) "Distributable Net Profits", as this term is used in the Partnership Agreement means the net profits of the Partnership after deducting all expenses, fees and taxes of every kind;

(f) "Electing Principal" means each of, or any of, the Named Partners who is an individual and have elected to provide their Professional services to the Partnership through a Contracting Company. Collectively, they are referred to as the "Electing Principals";

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

(h) "Fee" means the fair market value fee to be paid by the Partnership to a particular Contracting Company in return for Professional Services rendered by the Contracting Company, as described in paragraph 22;

(i) "Named Partner" is a reference to each of, or any of, the associate partners and the full partners of the Partnership requesting the ruling and, collectively, they are referred to as the "Named Partners". Your letter dated XXXXXXXXXX , and XXXXXXXXXX email, provided us with a list of names and social insurance numbers of the Partners. Each of the Named Partners is a Canadian resident living in Canada;

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

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

(l) "Partners" means the individuals who are the "Named Partners" and the other professional individuals who have not elected to provide Professional Services through a Contracting Company;

(m) "Partnership" is a reference to the existing partnership of the XXXXXXXXXX , which was formed pursuant to the laws of the Province of XXXXXXXXXX ;

(n) "Partnership Agreement" means the Partnership Agreement dated XXXXXXXXXX , by which the Partnership is governed, amended and restated on various occasions, more specifically in XXXXXXXXXX ;

(o) "Practice" means the professional XXXXXXXXXX practice currently carried on by the Partnership. It includes the Professional and Non-Professional Services conducted by the Partners on behalf of the Partnership;

(p) "Professional Services" means the XXXXXXXXXX services rendered to the Partnership's clients in the course of the Partnership's practice of XXXXXXXXXX ;

(q) "Proposed Transactions" means the transactions listed in paragraphs 10 to 31;

(r) "Related persons" has the meaning assigned by subsection 251(2) of the Act;

(s) "Small Business Deduction" has the meaning assigned by subsection 125(1) of the Act;

(t) "Specified Partnership Income" has the meaning assigned by subsection 125(7) of the Act;

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

(v) "Taxable Canadian Corporation" 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 Partnership is a XXXXXXXXXX firm. The Partnership's filer identification number is XXXXXXXXXX . Its main office is located at XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Taxation Center and deals with the XXXXXXXXXX Tax Services Office. The present ruling is only in respect of the Partnership, the Named Partners and the particular Contracting Company of each.

2. There are currently XXXXXXXXXX individual Partners. The Named Partners and other XXXXXXXXXX are the only partners of the Partnership. The Named Partners of the Partnership and their social insurance numbers are set out in Schedule B attached to the request of the advance income tax ruling and in the attached documents sent by email dated XXXXXXXXXX .

3. The Named Partners file their respective information returns with the Taxation Centers set out in Schedule B attached to the request of the advance income tax ruling and in the email dated XXXXXXXXXX .

4. The Partnership has been carrying on business since XXXXXXXXXX pursuant to a memorandum of agreement originally signed on XXXXXXXXXX , as amended and restated on numerous occasions including in XXXXXXXXXX .

5. The Partners provide Professional Services to the Partnership.

6. The activities of the Partners can be classified in two different categories: Professional Services and Non-Professional Services.

7. The Partnership operates the Practice on a "fee for service" and/or contract basis.

8. The key terms of the Partnership Agreement are as follows:

(a) The interests of the Partners in the Partnership are represented by units in the Partnership;

(b) Upon admission to the Partnership, the Associate Partner is deemed to be the owner of XXXXXXXXXX units of participation and is issued additional units each year following admission. A full equity Partner holds XXXXXXXXXX units of participation in the Partnership and has to be an active full-time staff member of XXXXXXXXXX ;

(c) The net distributable profits of the Partnership are divided amongst the Partners in proportion to their units of participation in the Partnership at the end of each fiscal year;

(d) Capital accounts are maintained for each Partner (although the capital accounts are not equal as between the Partners);

(e) Upon the death of a Partner, the deceased Partner's partnership interest is forfeited and the deceased Partner is entitled to the Partner's income profits in the Partnership for the period ended on the date of the death of the deceased Partner;

(f) Most partnership matters require approval by XXXXXXXXXX of majority of full equity Partners. Other Partnership matters require approval by a simple majority of Partners;

(g) Each Partner shall devote all of his or her whole time and attention to the Partnership Practice;

(h) No Partner shall be engaged, either alone or with any other person, directly or indirectly, in a business or practice that is the same or similar to the business or Practice carried on by the Partnership, without the written consent of the XXXXXXXXXX majority of the full equity Partners; and

(i) In the event that a Partner ceases to be a Partner, he or she will not carry on the Practice as a XXXXXXXXXX for a period of XXXXXXXXXX years within a radius of XXXXXXXXXX miles from any office of the Partnership.

9. None of the Partners are related persons for purposes of the Act and none of them are in a position to control the Partnership.

All of the Named Partners intend to complete the Proposed Transactions below.

PROPOSED TRANSACTIONS

10. Each Electing Principal will incorporate a Contracting Company under the laws of the province of XXXXXXXXXX . All Contracting Companies will be licensed to carry on the practice of XXXXXXXXXX in the Province of XXXXXXXXXX .

11. Each Electing Principal of the Contracting Company he or she incorporates will be the sole Director and President of that Contracting Company.

12. No Electing Principal will be an employee, officer, director or shareholder either legally or beneficially, directly or indirectly of more than one Contracting Company.

13. Each Contracting Company will qualify as a Taxable Canadian Corporation and Canadian Controlled Private Corporation, carrying on an active business. Where an Electing Principal is the controlling shareholder of a Contracting Company, the Named Partner and the Contracting Company will be related to each other.

14. The Electing Principal that incorporated the Contracting Company will own all of the voting shares of the Contracting Company. Other members of the Electing Principal's family that incorporated the Contracting Company will only be entitled to own the non-voting shares of the Contracting Company. For 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.

15. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada.

16. Upon receipt of the election referred to in Paragraph 19 (a), the Partnership will enter into a written Contract with the Contracting Company for the Professional Services required. All Named Partners will continue in their capacity as Partners to conduct all of the Non-Professional Services of the Partnership;

17. Each Electing Principal will be an employee of his or her Contracting Company in accordance with the Employment Contract between the Electing Principal and the Contracting Company. Each Electing Principal will provide Professional Services for the benefit of the Contracting Company in his or her capacity of employee pursuant to the terms of the Contract with the Partnership. Pursuant to the Employment Contract between an Electing Principal and his or her Contracting Company, the Electing Principal shall be entitled to a salary from his or her Contracting Company.

18. All of the Named Partners are resident in Canada.

PARTNERSHIP AGREEMENT

19. The Partnership Agreement will be amended as follows:

a) An elective provision will be added to allow each Electing Principal to elect to provide Professional Services to the Partnership through a Contracting Company engaged by the Partnership to provide such services as an independent contractor; A provision will be added to differentiate between the only two functions that each Partner performs for the Partnership: (1) Professional Services and (2) Non-Professional Services;

b) The non-competition provision, in paragraph XXXXXXXXXX of the Partnership Agreement, indicating that upon leaving the Partnership, a Partner will not carry on the practice of XXXXXXXXXX for a period of XXXXXXXXXX years, will be deleted;

c) The provision, in paragraph XXXXXXXXXX of the Partnership Agreement, indicating that each Partner must be devoted to serving professionally the Partnership and its clients and must devote substantially all of his or her normal business time to such services, will be deleted;

d) The non-competition clause, in paragraph XXXXXXXXXX of the Partnership Agreement, indicating that a Partner shall not be engaged, directly or indirectly in a business that is the same or similar to the business or practice carried on by the Partnership, will be deleted;

e) A provision will be added such that each Contracting Company will not be restricted from providing Professional Services to other persons or otherwise prohibited from competition with the Partnership.

f) A provision will be added to reflect the fact that a Named Partner's allocation of Partnership income for any year during which a Contracting Corporation performs that Named Partner's Professional Services will be dependent solely on the Named Partner's capital contribution to the Partnership and factors (including time) connected to the Named Partner's other Non-Professional services provided on behalf of the Partnership. In particular, the calculation of the Named Partner's income allocation from the Partnership for that year will not take into account any of his or her Professional Services, either directly or indirectly.

g) Although not contemplated in these Proposed Transactions, a provision will be added to ensure that any Partner who chooses not to provide his or her Professional Services through a Contracting Company will be allocated a greater share of Partnership profits to reflect the fact that the non-electing Partner will receive both the Professional Services and Non-Professional Services components in their partnership allocation as opposed to the Non-Professional Services component only for an Electing Principal.

h) A provision will be added to prohibit the provision of Non-Professional Services through or on behalf of the Partnership by any person other that the Partners themselves and will further prohibit the transfer or other conveyance of any interest in the Partnership to a Contracting Company.

CONTRACT

20. The Partnership will enter into a written Contract with each of the Electing Principal's Contracting Company. Each Contracting Company will enter into this contract with the Partnership to provide Professional Services to the Partnership's clients, on behalf of the Partnership.

21. The Contract shall be for a fixed period of XXXXXXXXXX months. It may be renewed each year and either party, upon XXXXXXXXXX days notice, may terminate it.

22. The Contract will provide that the Contracting Company will provide Professional Services to the Partnership in return for a Fee. The amount of a Fee to be paid by the Partnership to a Contracting Company will be equal to the fair market value of the Professional Services that the Contracting Company provides. The amount of the Fee will be tied to the level of work performed, and not based on the success of collected billings in respect of that work. The Non-Professional Services of the Partnership will continue to be provided by the Named Partners who hold an interest in the Partnership.

23. There will be a minimum number of work days and professional service hours per year that the Contracting Company agrees to provide to the Partnership.

24. All payments from third parties received by the Partnership in respect of Professional 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.

25. The Contracting Company shall be responsible for providing all equipment, tools and instruments used in the performance of the Professional Services at its expense. Pursuant to the Contract 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 Professional Services.

26. The Contracting Company shall be responsible for all expenses required to maintain the professional standards required by the Partnership and all fees and expenses necessary to perform the Professional Services, including, without limitation, professional membership fees, professional XXXXXXXXXX insurance, continuing education and training, transportation, communication, business entertainment connected to the business of the Contracting Company, travel expenses including automobile, accommodations and meals. The Contracting Company agrees that, to the extent that such expenses are paid by the Partnership, it shall reimburse the Partnership.

27. In the event that an Electing Principal suffers a physical or mental disability such that the Contracting Company is unable to provide the services required under the terms of the Contract, the Partnership shall have the right to terminate the Contract.

28. In the event of the death of an Electing Principal or the bankruptcy of the Contracting Company or its Electing Principal, the Partnership shall have the right to immediately terminate the Contract.

29. Provided the Contracting Company fully discharges and satisfies all of its responsibilities under the Contract, the Contracting Company will not be restricted from providing professional services to other persons or otherwise prohibited from competing with the Partnership.

30. 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.

31. Within XXXXXXXXXX months of the date of this ruling, an Electing Principal will provide the Partnership with a notice of intention to provide Professional Services through a Contracting Company (the "particular Contracting Company") and will incorporate the particular Contracting Company for such purposes in accordance with the terms and conditions outlined in the Paragraphs above.

PURPOSE OF THE PROPOSED TRANSACTIONS

32. The purpose of the Proposed Transactions is to allow a Named Partner to use a Contracting Company to earn business income, by providing Professional Services to the Partnership, as an independent contractor. In addition, the Proposed Transactions will provide a number of other business advantages including:

a) allowing the Partnership a greater ability to attract and retain highly qualified professionals;
b) providing each Electing Principal with an increased level of control over participation in the practice and management of the Partnership;
c) allowing each Electing Principal to have a greater degree of control over expenditures especially where such expenditures may not be otherwise approved by all members of the Partnership; and
d) allowing each Electing Principal more control over their individual estate and financial planning matters.

33. The Proposed Transactions will allow the Electing Principals to use, if they choose, a professional corporation to earn Professional Services income through a Contracting Company derived from the Partnership's practice without negatively affecting the business arrangements between the other Partners of the Partnership.

RULINGS GIVEN

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 of the Named Partners for purposes of the Act.

B. Provided that an Electing Principal that provides Professional Services to the Partnership through a 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.

C. Provided a 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 will not be Specified Partnership Income.

D. Subject to sections 18 and 67 of the Act, the Fees payable by the Partnership to the particular Contracting Company, pursuant to the Contract, as described in paragraph 22, will be deductible by the Partnership in its determination of the Partnership's income pursuant to subsection 96(1) of the Act.

E. The Proposed Transactions undertaken in paragraphs 10 to 31, and in particular the payment of Fees by the Partnership to the particular Contracting Company, will not in and of themselves cause subsections 56(2), 56(4) and 246(1) of the Act to apply so as to cause an amount of the Fees received by a particular Contracting Company under a Contract to be taxed in the hands of the respective Named Partner.

F. 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), solely as a result of the Named Partner choosing, pursuant to amendments to the Partnership Agreement, to provide all Professional Services to the Partnership through the particular Contracting Company, 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 Partners with respect to sharing the Partnership'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 subsection 245(2) of the Act to re-determine the tax consequences confirmed in the rulings given above.

These advance income tax 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 advance income tax 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.

ADDITIONAL COMMENTS

Whether or not an Electing Principal who is providing his or her Professional Services to the Partnership through a Contracting Company would, but for the existence of that Contracting Company, 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 Electing Principal. This review and determination is the responsibility of the Electing Principal'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 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) may apply to any amounts paid by a Contracting Company to a family member of the Electing Principal 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 Electing Principal 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 Named Partner's Contracting Company, 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 Named 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.

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