2008 Ruling 2007-0251531R3 - Partnership Restructuring

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 sole shareholder of a partner of a professional XXXXXXXXXX partnership creates another professional corporation through which professional XXXXXXXXXX services are provided to clients, will this corporation be carrying on a personal services business and/or earning specified partnership income?

Position: Question of fact. Generally no, if certain conditions are met.

Reasons: Income Tax Act. Consistent with previous rulings.

XXXXXXXXXX 								2007-025153

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Request for an Advance Tax Ruling:

XXXXXXXXXX (the "Partnership")
XXXXXXXXXX

We are writing in reply to your letter dated XXXXXXXXXX , requesting an advance income tax ruling on behalf of the Partnership and its Named Partners. We also acknowledge the additional information provided to us in your XXXXXXXXXX email and various telephone conversations (XXXXXXXXXX ).

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.

a) "Canadian-Controlled Private Corporation" has the meaning assigned by subsection 125(7);
b) "Contract" refers to the professional services contract to be entered into between the Partnership and a Contracting Company, as described in paragraphs 23 to 36 below;
c) "Contracting Company" means each of the corporations that will be incorporated, as permitted pursuant to the laws of the Province of XXXXXXXXXX , by an Electing Principal and that will be hired by the Partnership to provide Professional Services as independent contractors;
d) "CRA" means the Canada Revenue Agency;
e) "Distributable Net Income", as this term is used in the Partnership Agreement, means the Net Income of the Partnership after deducting preliminary income allocations, bonuses and interest, if any, on the Named Partners' capital accounts;
f) "Electing Principal" means each of, or any of, the Principals who 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 23.
i) "Management/Administrative Services" refers to the management and administrative activities as carried on by the Partnership;
j) "Management Committee" refers to those Named Partners which are responsible for the day-to-day management of the Partnership;
k) "Net income", as this term is used in the Partnership Agreement, means the income of the Partnership computed on an accrual basis after deducting all expenses of the Partnership but such expenses shall exclude the preliminary income allocations, bonuses and interest paid on the capital accounts of the Named Partners;
l) "Paragraph" refers to a numbered paragraph in this letter;
m) "Named Partner" means each of, or any of, the current partners of the Partnership, namely:
XXXXXXXXXX
Collectively, they are referred to as the "Named Partners".
n) "Partnership" means the existing general partnership of XXXXXXXXXX ;
o) "Partnership Agreement" means the Amended and Restated Partnership Agreement dated XXXXXXXXXX , by which the Partnership is governed;
p) "Personal Services Business" has the meaning assigned by subsection 125(7);
q) "Practice" means the practice of XXXXXXXXXX currently carried on by the Partnership;
r) "Principal" means (i) each of, or any of, the individuals who are controlling shareholders of Professional Corporations that are Named Partners of the Partnership as of the date hereof and (ii) each of, or any of, the individuals who are controlling shareholders of a Contracting Company and "Principal" means any one of them. Collectively, they are referred to as the "Principals". For greater certainty, a Principal is authorized to engage in the practice of XXXXXXXXXX ;
s) "Professional Corporation" means each of, or any of, the Named Partners of the Partnership, each of which is a corporation that is incorporated under the laws of the Province of XXXXXXXXXX and licensed to carry on the practice of XXXXXXXXXX ;
t) "Professional Services" means the professional services of the practice of XXXXXXXXXX ;
u) "Related Persons" has the meaning assigned by subsection 251(2);
v) "Small Business Deduction" has the meaning assigned by subsection 125(1);
w) "Specified Partnership Income" has the meaning assigned by subsection 125(7);
x) "Subject Transactions" means the transactions listed in paragraphs 10 to36;
y) "Taxable Canadian Corporation" has the meaning assigned by subsection 89(1);

Our understanding of the facts, Subject Transactions and the purpose of the Subject Transactions is as follows.

FACTS

1. The Partnership was originally formed in XXXXXXXXXX to carry on the Practice under the name XXXXXXXXXX . Since that time, all of the founding partners have retired and the Partnership has on several occasions changed the firm name. The Partnership last changed its name on XXXXXXXXXX , and currently operates under the name XXXXXXXXXX

2. The Partnership carries on a professional XXXXXXXXXX practice as a general partnership in the city of XXXXXXXXXX . There are currently XXXXXXXXXX Named Partners all of whom are Professional Corporations and all of whom are general partners. This present ruling is only in respect of the Partnership, the Named Partners and the particular Contracting Company of each Electing Principal.

3. The activities of the Named Partners can be classified into two general categories, which are Professional Services and Management/Administrative Services.

4. The Principals are controlling shareholders of the Professional Corporations that are Named Partners of the Partnership.

5. Currently, all of the Principals provide their Professional Services through their respective Professional Corporations.

6. The Partnership's identification number is XXXXXXXXXX and its address is XXXXXXXXXX .

7. The Partnership files its return with the XXXXXXXXXX Tax Centre. The Named Partners file their corporate tax returns at the XXXXXXXXXX Tax Centre.

8. The Partnership is governed by a written Partnership Agreement most recently updated on XXXXXXXXXX , the key terms of which are as follows:

a) The business of the Partnership is carried on in the city of XXXXXXXXXX and such other places in XXXXXXXXXX as the Partnership may from time to time determine.

b) The ownership of the Partnership name, clientele, and all other tangible and intangible property owned by the Partnership is vested in the Partnership.

c) All changes to the Named Partners in the firm do not dissolve the Partnership unless otherwise provided for in the Partnership Agreement.

d) Each Named Partner must be devoted to serving professionally the Partnership and its clients and shall devote substantially all of its normal business time to such services.

e) Each Named Partner must cause the Partnership to charge reasonably for all Professional Services rendered, however each Named Partner may serve any relative or with the consent of the Management Committee may serve without charge or at less than regular charges any civic, educational, religious or charitable organization.

f) The Partnership is responsible for the costs to maintain the Principals' and the Named Partners' registration in good standing under the XXXXXXXXXX .

g) The interests of each Named Partner in the Partnership are represented by units in the Partnership.

h) The Distributable Net Income is allocated amongst the Named Partners based on their units in the Partnership.

i) Each Named Partner is entitled to one vote at partnership meetings regardless of the number of units of the Partnership held by that Named Partner.

j) Most partnership matters requiring approval of the Named Partners require the vote of a simple majority. There are, however, certain matters which require a XXXXXXXXXX % majority vote to pass.

k) The day-to-day management and affairs of the Partnership is carried out by the Management Committee.

l) A Named Partner shall retire and terminate all of its interest in the Partnership at the end of the year after the Principal of the Named Partner becomes XXXXXXXXXX years of age, but the Partnership shall not dissolve.

m) Upon leaving the Partnership, the Principal of a Named Partner is subject to a non-competition and non-solicitation covenant for a period of XXXXXXXXXX years.

n) Upon leaving the Partnership, a Named Partner is entitled to be paid certain amounts including his balance in the capital account, and his share of the Distributable Net Income of the Partnership for the year in which the withdrawal occurs.

9. All of the Named Partners are resident in Canada and none of the Named Partners are Related Persons.

SUBJECT TRANSACTIONS

10. The Partnership Agreement will be amended to allow each 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. To implement this change, the Partnership Agreement will differentiate between the Professional Services and the Management/Administrative Services carried on by each Professional Corporation. This present ruling is only in respect of the Partnership, the Named Partners and each of the Principal's particular Contracting Company.

11. 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 .

12. No two Contracting Companies will be Related Persons as defined in the Act.

13. None of the Contracting Companies will be existing Professional Corporations that are Named Partners of the Partnership;

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

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

16. Each Contracting Company will qualify as a Taxable Canadian Corporation ("TCC") and Canadian Controlled Private Corporation ("CCPC"), as defined in the Act, carrying on an active business. Where an Electing Principal is the controlling shareholder of a Named Partner of the Partnership and the controlling shareholder of a Contracting Company, the Named Partner and the Contracting Company will be related to each other.

17. All of the voting and non-voting shares of each Contracting Company will be owned by the Electing Principal that incorporated the Contracting Company.

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

19. Upon receipt of the election referred to in Paragraph 10, 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;

20. Prior to signing the Contract, a Contracting Company must first obtain approval from the XXXXXXXXXX to practice and provide the services of a XXXXXXXXXX . Each Contracting Company will be licensed to carry on the practice of XXXXXXXXXX .

21. Each Electing Principal will be an employee of his 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 capacity of employee pursuant to the terms of the Contract with the Partnership. Pursuant to the Employment Contract between an Electing Principal and his Contracting Company, the Electing Principal shall be entitled to a salary from his Contracting Company.

PARTNERSHIP AGREEMENT

22. The Partnership Agreement will be amended as follows:

a) An elective provision will be added to allow a Principal to provide Professional Services through a Contracting Company.

b) A provision will be added such that a Contracting Company cannot become a partner of the Partnership.

c) The non-competition clause indicating that upon leaving the Partnership, a Principal of a Named Partner is subject to a non-competition and non-solicitation covenant for a period of two years, will be deleted.

d) The provision indicating that each Named Partner must be devoted to serving professionally the Partnership and its clients and shall devote substantially all of his normal business time to such services, will be deleted.

e) A provision will be added to allow the Contracting Company to compete with the Partnership.

f) A provision will be added to ensure that all Named Partners must devote and spend the time required to complete any Non-Professional Services due to the Partnership.

g) 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 connected to the Named Partner's other services provided on behalf of the Partnership, including the Non-Professional Services. 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 Professional Services, either directly or indirectly.

h) A provision will be added to ensure that any Principal who chooses not to provide his Professional Services through a Contracting Company will be allocated a greater share of Partnership profits to reflect the fact that the non-Electing Principal's Professional Corporation will receive both the Professional Services and Management/Administrative Services components in their partnership allocation as opposed to the Management/Administrative Services component only for an Electing Principal.

i) The provision indicating that each Named Partner may serve any relative or with the consent of the Management Committee may serve without charge or at less than regular charges any civic, educational, religious or charitable organization, will be deleted.

j) The provision indicating that the Partnership is responsible for the costs to maintain the Principals' and the Named Partners' registration in good standing under the XXXXXXXXXX , will be deleted.

CONTRACT

23. The Partnership will enter into a written Contract with each of the Electing Principal's Contracting Company. This Contract will provide that the Contracting Company will provide Professional 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 Professional Services that the Contracting Corporation provides. The Management/Administrative Services of the Partnership will continue to be conducted by the Named Partners who hold an interest in the Partnership.

24. 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.

25. The initial term of the Contract will be for a period of XXXXXXXXXX years and thereafter to be automatically and continually renewed every year thereafter, with any mutually agreed upon amendments if any.

26. The Partnership and the Contracting Company will jointly determine an estimate of the fees payable to the Contracting Company for each fiscal year. Based upon this estimate, the Contracting Company will be allowed bi-monthly to invoice the Partnership for Professional Services rendered (or to be rendered). The Contracting Company may from time to time, invoice the Partnership for such services as may become necessary if the actual time and fees incurred exceed the estimated fee amount. At the end of each fiscal year, a final reconciliation will be conducted if necessary to compare actual service fees with the estimated amounts. The Contracting Company shall invoice the shortfall or shall reimburse the Partnership for fees in excess of services provided.

27. 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.

28. 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.

29. 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 Professional Services, including, without limitation, professional membership fees, continuing education, transportation, communication (cellular telephone), 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.

30. In the event that a Contracting Company or an employee of a Contracting Company commits an offence XXXXXXXXXX , or the Contracting Company fails to comply with the terms of the Consulting Service Agreement (either of which constitutes a "Default"), the Partnership may suspend the terms of the Contract. The Contracting Company will be provided a period of time (the "Suspension Period") in which to rectify to Default to the satisfaction of the Partnership. If the Default has been rectified prior to the end of the Suspension Period, the Partnership shall reinstate the Contract. If, however, the Default is not rectified to the satisfaction of the Partnership, the Partnership may terminate the Contract.

31. The Partnership or the Contracting Company may terminate the Contract at any time by providing the other party with not less then XXXXXXXXXX days written notice. In the event of a material breach of the Contract, the other party may terminate the Contract without notice.

32. 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, then the Partnership may terminate the Contract.

33. 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.

34. 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.

35. 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.

36. Within six 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 on the terms and conditions outlined in the paragraphs above.

PURPOSE OF THE SUBJECT TRANSACTIONS

37. The purpose of the Subject Transactions is to allow one or more Electing Principal of a Named Partner to use a Contracting Company to earn business income, by providing Professional Services to the Partnership, as an independent contractor with minimal disruptions to the business arrangements of the Partnership. In addition, the Subject Transactions will provide a number of other business advantages including:

a) allowing the Partnership a greater ability to attract and retain highly qualified professional partners;
b) providing each Electing Principal with an increased level of control over his 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 in the Partnership; and
d) allowing each Electing Principal more control over their individual estate and financial planning matters.

RULINGS GIVEN

Provided that

a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, Subject Transactions and the purpose of the Subject Transactions,
b) the Subject 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 Subject 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.

B. Provided that an Electing Principal of a Named Partner 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 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 23, 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 23, will be deductible by the Partnership in its determination of the Partnership's income pursuant to subsection 96(1).

E. The Subject Transactions undertaken in paragraphs 10 to 36, 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) or 246(1) 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.

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 Subject Transactions.

G. The execution and implementation of the Subject 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 Subject Transactions described above, will not, in and of themselves, result in the application of the provisions of subsection 245(2) 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 Subject 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 Subject 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) or the allocation of the Partnership's income (see paragraph 8).

ADDITIONAL COMMENTS

Whether or not a Principal who is providing his Professional 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 Principal. This review and determination is the responsibility of the 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 17, 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 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 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.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted any of the tax consequences relating to the facts and Subject Transactions described above except as expressly stated in the rulings. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly, that the CRA has agreed to or accepted the fair market value or reasonableness of any amounts, including and not limited to, the Fee paid by the Partnership to each particular Contracting Company.

OPINION

The application of subsection 256(2.1) 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 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) 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 Subject 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 Professional Services to the Partnership will not, in and of itself, cause subsection 256(2.1) 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.

XXXXXXXXXX
For Director
Business and Partnerships Division
Income Tax Rulings Directorate