2008 Ruling 2007-0251731R3 - Partnership Reorganization

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  							2007-025173

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Request for an Advance Income Tax Ruling
XXXXXXXXXX ("Partnership")
Business Number: XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the Partnership. We also acknowledge receipt of information in XXXXXXXXXX .

To the best of your knowledge and that of Partnership, none of the issues involved in the ruling request is:

(i) in an earlier return of the taxpayer 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 the taxpayer or a related person;
(iii) under objection by the taxpayer 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 the taxpayer 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.

DEFINITIONS

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

a) "Associate" refers to self-employed XXXXXXXXXX that provide Professional Services to the Partnership and who are not Partners of the Partnership. Collectively, they are referred to as the "Associates";

b) "Associate Agreement" refers to the agreement that governs the relationship between the Associates and the Partnership;

c) "C.C. Partner" refers to each of the following Partners who will elect to provide Professional Services to the Partnership through a Contracting Company:

Name of Partner
Social Insurance Number

XXXXXXXXXX
XXXXXXXXXX

Collectively, the Partners listed above are referred to as the "C.C. Partners".

d) "CCPC" refers to the expression "Canadian-Controlled Private Corporation" as defined in subsection 125(7);

e) XXXXXXXXXX

f) "Code" refers to the XXXXXXXXXX ;

g) "Contracting Company" means each of the C.C. Partners' professional corporation that will be incorporated, as permitted pursuant to the laws of the Province for the benefit of an existing Partner of the Partnership, and that will be engaged by the Partnership to provide Professional Services as an independent contractor. Collectively, they are referred to as the "Contracting Companies". It is understood that the expression "Contracting Company" also refers to the corporations of XXXXXXXXXX which are in existence as of the date of this ruling.

h) "CRA" refers to the Canada Revenue Agency;

i) "LLP" refers to Limited Liability Partnership;

j) XXXXXXXXXX

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

l) "Partnership" is a reference to the existing partnership of XXXXXXXXXX , which was formed pursuant to the laws of the Province. This term also refers to the Partnership once it chooses to carry on its business as a LLP.

m) "Partnership Agreement" refers to the current agreement dated XXXXXXXXXX that governs the operations of the Partnership;

n) "Personal Services Business" has the meaning assigned by subsection 125(7);

o) "Practice" means the provision of XXXXXXXXXX services currently provided by the Partnership;

p) "Professional Fees" refers to the fees paid by the Partnership to each Contracting Company for the provision of Professional Services;

q) "Professional Services" means the XXXXXXXXXX services rendered to the Partnership's XXXXXXXXXX in the course of the operation of the Partnership's practice;

r) "Province" means the Province of XXXXXXXXXX ;

s) XXXXXXXXXX

t) "Regulation" refers to the XXXXXXXXXX

u) "Related Persons" has the meaning assigned by subsection 251(2);

v) "Services other than Professional Services" refers to the services rendered by the Partners to the Partnership but does not include the Professional Services;

w) "Specified Partnership Income" has the meaning assigned by subsection 125(7);

x) "TCC" refers to the expression "Taxable Canadian Corporation" as defined in subsection 89(1).

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

FACTS

1. The Practice is currently carried on by the Partnership. The Partnership has been carrying on business since XXXXXXXXXX under the Partnership Agreement. However, it had been carrying on business under predecessor partnership agreements for several years prior to XXXXXXXXXX . The Partners, XXXXXXXXXX in total, provide Professional Services to the Partnership. All of the Partners are individuals.

2. The Partnership's identification number is XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Taxation Center and deals with the XXXXXXXXXX Tax Services Office.

3. This present Ruling is only in respect of the Partnership, the C.C. Partners and each of the C.C. Partners' particular Contracting Company.

4. There are a number of Associates who provide Professional Services to the Partnership pursuant to the Associate Agreement. Each Associate is paid a percentage of his or her gross production. None of the Associates are covered by this present Ruling.

5. In the past, the Partners provided their Professional Services through the Partnership.

6. The Partnership operates the Practice on a "fee for service" basis. Remuneration for Professional Services provided to XXXXXXXXXX of the Partnership is paid by the XXXXXXXXXX and related and unrelated companies.

7. The Partnership is governed by the Partnership Agreement, the principal terms of which are :

a) The net profits and losses of the Partnership are divided and borne by the Partners in proportion of their "participation units" attributed for the period in which the income is earned;

b) The number of units attributed is function of the number of days during which Professional Services and Services other than Professional Services are provided by the Partners to the Partnership;

c) Capital accounts are maintained for each Partner;

d) The profits of the Partnership are paid to the Partners, and the losses of the Partnership are borne by the Partners, in proportion to their interest in the Partnership;

e) Upon the death or retirement of a Partner (for whatever reason) the deceased or retiring Partner is entitled to the Partner's capital account together with the Partner's undrawn profits in the Partnership at the date of such death or retirement but is not entitled to any goodwill of the Partnership;

f) The Partnership, on behalf of the Partners, processes all bills, receives payments and other income, and distributes the funds to cover the costs of operating the Partnership, with the balance, if any, being available to the Partners; and

g) All of the Partners are residents of Canada. No one Partner is a Related Person to any other Partner.

PROPOSED TRANSACTIONS

8. Within six months of the date of this ruling and after having obtained the requisite authorizations from the XXXXXXXXXX , the Partnership will carry on its business as a LLP. All of the requirements and procedures provided for in the Code and in the Regulation will have to be respected.

9. The Partnership Agreement will be amended such that each Partner, at his or her sole discretion, will be permitted to provide Professional Services through a Contracting Company engaged by the Partnership to provide Professional Services as an independent contractor and will be paid Professional Fees based on a per diem basis reflecting the fair market value of the Professional Services rendered. The Contracting Companies of XXXXXXXXXX were constituted prior to the date of this ruling, although inactive. XXXXXXXXXX has never provided Professional Services to the Partnership through his Contracting Company, which is in existence as of the date of this ruling.

10. Each Contracting Company will be incorporated by a C.C. Partner pursuant to the laws of the Province.

11. Each Contracting Company engaged will hold a valid certificate of authorization issued by the XXXXXXXXXX . Each Contracting Company will employ an individual licensed to practice in XXXXXXXXXX . None of the Contracting Companies will be Related Persons.

12. Each C.C. Partner of the Contracting Company he incorporates will be the sole Director and President of that Contracting Company.

13. All C.C. Partners will continue in their capacity as Partners of the Partnership to conduct all of the Services other than Professional Services of the Partnership.

14. Each Contracting Company will be a TCC and a CCPC. No two Contracting Companies will be Related Persons.

15. No C.C. Partner will be an employee, officer, director, or shareholder, either legally or beneficially, of more than one Contracting Company.

16. Only the C.C. Partner will be entitled to hold the voting shares of his or her Contracting Company. The Contracting Company may issue, directly or indirectly non-voting shares to the C.C. Partner's spouse, adult children and parents. All persons legally or beneficially owing shares of a Contracting Company will be residents of Canada and will not be a legal or beneficial shareholder of another Contracting Company. Related Persons of a C.C. Partner may not be shareholders of any Contracting Company other than the Contracting Company in which that Partner owns shares.

17. Each C.C. Partner will be an employee of his or her own Contracting Company. The employment relationship will be evidenced by a written employment agreement. A C. C. Partner will provide Professional Services for the benefit of his Contracting Company pursuant to the terms of the relevant Contract between his Contracting Company and the Partnership. A C.C. Partner who provides services for the benefit of his Contracting Company will be entitled to receive a salary from his Contracting Company for such service provided. The sole officer and director of each Contracting Company will be the respective C.C. Partner.

18. The Partnership Agreement will be amended as follows:

a) An elective provision will be added to allow a Partner 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) A provision will be added to allow the Contracting Company to compete with the Partnership.

d) A provision will be added to ensure that all C.C. Partners must devote and spend the time required to complete any Services other than Professional Services due to the Partnership.

e) A C.C. Partner who incorporates a Contracting Company will no longer provide any Professional Services to the Partnership in his or her capacity as a Partner.

f) The C.C. Partners that incorporate a Contracting Company will remain as Partners of the Partnership and will be allocated residual income based on their capital contribution to the Partnership and factors connected to the provision by the C.C. Partner of other services provided on behalf of the Partnership, including the Services other than Professional Services. The calculation of the Partners' residual 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) Any Partner that chooses not to incorporate a Contracting Company (a "Non-incorporated Partner") will continue to provide Professional Services directly to the Partnership. A Non-incorporated Partner's allocation of Partnership income for any year will reflect the fact that the Non-incorporated Partner will receive both the Professional Services and Services other than Professional Services components in their Partnership income allocation. The residual income allocation will be based on the Partners' capital contribution.

19. Each Contracting Company will be required to enter into a written contract for service (the "Contract") with the Partnership. The Contract will provide that the amount of the fee for the Professional Services provided by the Contracting Company to the Partnership will be negotiated on a case-by-case basis. The amount of the fee will be equal to the fair market value for the Professional Services provided by the Contracting Company to the Partnership. The Contract shall be for a fixed period of twelve months. The Contract may be renewed each year at the option of either party and either party, upon a one-month notice period, may terminate it. All C.C. Partners will continue in their capacity as Partners to conduct all of the Services other than Professional Services of the Partnership.

20. All payments from the XXXXXXXXXX and other sources received by the Partnership in respect of services provided to the Partnership by the Contracting Companies will be for the benefit of the Partnership and if a Contracting Company receives any such amount, it will remit such amount to the Partnership.

21. The Contracting Company shall be responsible for providing all equipment, tools and XXXXXXXXXX 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.

22. 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 21, shall bear responsibility for the following activities and related expenses incurred:

a) registration of professional membership fees and insurance;
b) continuing professional education and training;
c) transportation;
d) communication;
e) maintaining the professional standards set by the XXXXXXXXXX ;f) expenditures on personal practice preferences of the Contracting Company.

23. 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, persons involved in a joint venture, co-owners or otherwise participants in a joint or common undertaking.

24. So long as the Contracting Company fully discharges its responsibilities under the agreement with the Partnership, the Contracting Company will not be restricted from providing services to other persons or otherwise prohibited from competing with the Partnership.

25. So long as the C.C. Partner fully discharges his responsibilities under the employment contract with his Contracting Company, the C.C. Partner will not be restricted from providing services similar to the Professional Services to other persons or otherwise prohibited from competing with the Contracting Company or the Partnership.

26. Within six months of the date of this ruling, a C.C. Partner 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 PROPOSED TRANSACTIONS

27. The primary purpose of the proposed transaction 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) allowing each C.C. Partner to benefit from the amendment by the Province which permits XXXXXXXXXX to render professional services through a corporation;
b) providing each Partner and each C.C. Partner with an increased level of control over their participation in the Practice through individual management of personal practice preferences;
c) permitting a C.C. Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Practice;
d) providing a C.C. Partner with more control over his/her own estate and financial planning; and
e) enhancing the Partnership's ability to retain current and recruit additional XXXXXXXXXX .

RULINGS PROVIDED

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. 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 or any C.C. Partner for purposes of the Act.

B. The Contracting Company will not be considered to be carrying on a Personal Services Business, as defined in subsection 125(7). This is only so provided the C.C. Partner 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.

C. Subject to sections 18 and 67, the Per Diem Fees payable by the Partnership to the Contracting Company will be deductible by the Partnership in its determination of the Partnership's income pursuant to subsection 96(1).

D. Provided a particular Contracting Company was not a member of any partnership in the relevant year, the income earned by a Contracting Company, in particular, the Per Diem Fees, will not be Specified Partnership Income as defined in subsection 125(7).

E. The transactions undertaken in paragraphs 8 through 26 above, and in particular the payment of the Per Diem Fees, will not in and of themselves cause subsections 56(2), 56(4) or 246(1) to apply so as to cause an amount received by the Contracting Company under the Professional Services Contract to be taxed as income in the hands of the C.C. Partner.

F. Provided that the amount of the Partnership income allocated to each Partner is reasonable, having regard to all the relevant circumstances, the sharing of the income between the Partners will not be subject to adjustment pursuant to subsection 103(1) solely as a result of the Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a Contracting Company and to provide all of his or her Professional Services to the Partnership through that Contracting Company for Per Diem Fees.

G. 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) to re-determine the tax consequences confirmed in the rulings given above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transactions are implemented on or before XXXXXXXXXX . These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein. 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 proposed 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 the Per Diem Fee, and whether the Partnership is a limited partnership at law.

COMMENTS

Whether or not the Partner would, but for the existence of the Contracting Company, be an employee of the Partnership or an independent contractor who has entered into a contract of services with the Partnership is a question of fact that can only be determined after a review of the actual agreements entered into between the Contracting Company and the Partnership and between the Contracting Company and the Partner. This review and determination is the responsibility of the particular Partner'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 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 possible ownership of any shares of the Partner's Contracting Company 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 such Contracting Company to a family member of the Partner. 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 the Partner who has not attained the age of 17 years before that year.

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 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) 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) 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,

for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch