2009 Ruling 2008-0269731R3 - Partner's pro corp providing services to ptnshp

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: Whether the active business income earned by a partner's professional corporation from providing professional services to a partnership of which the partner is a member would be restricted under the rules for specified partnership income or personal services business.

Position: No, as long as the facts and proposed transactions set out in the ruling request are accurate.

Reasons: The facts and proposed transactions, as described, conform to our requirements as set out in other similar rulings.

XXXXXXXXXX 2008-026973

XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership") - BN XXXXXXXXXX
XXXXXXXXXX (the "Named Partners")

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

To the best of your knowledge and that of the Partnership and the Named Partners (collectively the "Taxpayers"), none of the issues involved in the ruling request is:

i. in an earlier return of one of the Taxpayers or a related person;
ii. being considered by a tax services office or a tax centre in connection with a tax return already filed by one of the Taxpayers or a related person;
iii. under objection by one of the Taxpayers or a related person;
iv. before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and
v. the subject of a ruling previously issued by the Directorate to one of the Taxpayers or a related person.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended (the "Act"), and all terms and conditions used herein that are defined in the Act have the meaning given in such definitions unless otherwise indicated.

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

Definitions

The following definitions have been used in this letter:

(a) "CCPC" means a "Canadian-controlled private corporation" as defined under subsection 125(7) of the Act;

(b) "Contract" refers to the written agreement between a ContractCo and the Partnership which will set out the terms and conditions by which a ContractCo will provide Professional Services to the Partnership;

(c) "ContractCo" means each of the corporations through which an Electing Partner will provide Professional Services as an employee of that corporation;

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

(e) "Electing Partner" refers to a Partner who elects to provide his or her Professional Services through a ContractCo;

(f) "Income" refers to the Partnership's income or loss for a particular Taxation Year as computed under subsection 96(1) of the Act;

(g) "Non-Electing Partner" refers to a Partner who does not elect to provide Professional Services using a ContractCo;

(h) "Non-Professional Services" includes the Partnership's management and administrative activities, as well as any other activity carried on by the Partnership that is not part of Professional Services;

(i) "Partner" refers to a partner of the Partnership;

(j) "Partnership Agreement" refers to the existing partnership agreement by which the Partnership is currently bound;

(k) "Practice" means both Professional Services and Non-Professional Services;

(l) "Professional Services" means XXXXXXXXXX services;

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

(n) "Related Persons" has the meaning assigned by subsection 251(2) of the Act;

(o) "Service Fees" refers to the fair market value fees to be charged by a ContractCo to the Partnership;

(p) "TCC" refers to a "taxable Canadian corporation" as defined under subsection 89(1) of the Act; and
(q) "Taxation Year" means the Partnership's taxation year for income tax purposes which is defined in paragraph 96(1)(b) of the Act as the Partnership's fiscal period.

Facts

1. The Partnership is a limited liability partnership that has been carrying on the Practice for XXXXXXXXXX and is a continuation of the original partnership through numerous changes in membership over the years. Its filer identification number is XXXXXXXXXX and its address is XXXXXXXXXX . It has a fiscal period ending XXXXXXXXXX .

2. The Partnership files its information tax return with the XXXXXXXXXX Centre and deals with the XXXXXXXXXX Tax Services Office. The Named Partners files their income tax returns with the XXXXXXXXXX Tax Centre and deal with the XXXXXXXXXX Tax Services Office.

3. The Partnership is bound by the Partnership Agreement that was signed by the Partners on XXXXXXXXXX , as amended from time to time.

4. All Partners, approximately XXXXXXXXXX in total, are resident in Canada for the purposes of the Act. None of the Partners are Related Persons.

5. The Partnership values the professional expertise of all of the Partners and requires that it be made available to the Partnership to conduct its business. It also recognizes the need of each Partner, as a business owner, to delegate to an executive committee and staff the responsibility for all the administration, marketing, human resource management, operations and customer retention efforts expected from anyone who is a principal in a service business. The executive committee currently sub-delegates some of the Partnership's administration, human resource management, and operations to XXXXXXXXXX , a partnership composed of partners who are related to the Partners. These services are provided at cost plus a mark-up at fair-market-value.

6. The Partnership Agreement includes the following terms:

(i) The Income of the Partnership is divided amongst the Partners in such manner as may be agreed upon from time to time.

(ii) Each Partner's share of Income takes into account the Partner's ratio of gross production to total Partners' production annually and over time, as well as contributions to firm management and delegation and referrals of work to other Partners in the firm.

(iii) Capital accounts are maintained for each Partner.

(iv) Upon the death or retirement of a Partner (for whatever reason), the deceased or retiring Partner is entitled to draw all or a portion of the Partner's capital account together with the Partner's undrawn Income.

7. The Province's XXXXXXXXXX permits XXXXXXXXXX to render Professional Services through a professional corporation.

Proposed Transactions

8. The Partnership Agreement will be amended as follows:

(i) A provision will be added to differentiate between Professional Services and Non-Professional Services.

(ii) A provision will be added to allow a Partner to elect to provide his or her Professional Services through a ContractCo controlled by him or her. Where a Partner so elects, he or she will no longer be permitted to provide any Professional Services to the Partnership in his or her capacity as a Partner.

(iii) A provision will be added to provide that a ContractCo cannot become a partner of the Partnership.

(iv) A provision will be added to prohibit the carrying out of Non-Professional Services by the ContractCos and requiring that all Partners devote and spend the time and energy required to complete their portion of the Non-Professional Services.

(v) The allocation of Income for a Taxation Year will be amended to provide that an Electing Partner's allocation of Income for a particular Taxation Year will be dependent on the Electing Partner's capital contribution and factors connected to the Non-Professional Services carried out by the Electing Partner on behalf of the Partnership. For greater certainty, the Partnership Agreement will make it clear that the calculation of an Electing Partner's Income for a Taxation Year will not take into account any Professional Services provided by the Electing Partner's ContractCo, nor will it take into account any time spent by the Electing Partner performing Professional Services in his or her capacity as an employee of his or her ContractCo.

(vi) A provision will be added to ensure that all Non-Electing Partners will continue to provide their Professional Services directly to the Partnership. Further, the Partnership Agreement will clarify that a Non-Electing Partner will be allocated a greater share of Income to take into account that he or she has provided both Professional and Non-Professional Services.

(vii) A provision will be added to provide that, as long as a ContractCo fully discharges its responsibilities under the Contract, ContractCo will not be restricted from providing Professional Services to other persons or otherwise prohibited from competing with the Partnership. For greater certainty, there will not be any terms in the Partnership Agreement, or any other agreement (oral or otherwise), that would prohibit ContractCo or the Electing Partners from competing with the Partnership in respect of the provision of Professional Services.

9. Each ContractCo will be required to have the following properties:

(i) It will be incorporated pursuant to the laws of the Province.

(ii) It will qualify as a TCC and a CCPC.

(iii) It will be controlled by an Electing Partner, who will be the legal and beneficial owner of all of the voting shares of the particular ContractCo. Non-voting shares of a ContractCo may be held by an Electing Partner's spouse or children. All shareholders owning voting and non-voting shares of the ContractCo will be residents of Canada.

(iv) An Electing Partner will be the sole director of his or her ContractCo. He or she will also be an employee of ContractCo and will be paid a salary for his or her service.

(v) An Electing Partner cannot be an employee, officer, director, or legal or beneficial shareholder of more than one ContractCo.

(vi) No two ContractCos will be Related Persons.

(vii) A ContractCo cannot be a partner in the Partnership.

10. A Contract between a Partnership and a ContractCo will contain the following terms:

(i) The Contract will be for a fixed period of twelve months coinciding with the calendar year, with the possible exception of the first year, and will be automatically renewed each year unless one month's prior notice is given by one of the parties. Either party may terminate the Contract at any time upon one month's notice to the other.

(ii) ContractCo will provide Professional Services on behalf of the Partnership in return for Service Fees. The amount of Service Fees will be tied to the level of work performed by ContractCo and will not relate in any way to the success XXXXXXXXXX in respect of that work. Further, Service Fees will be negotiated on a case-by-case basis and will vary with the number and type of the Professional Services to be provided by ContractCo and will equal the fair market value of the Professional Services so provided.

(iii) All payments received by the Partnership in respect of Professional Services provided by the ContractCo under the Contract will be for the benefit of the Partnership.

(iv) Provided that ContractCo fully discharges its responsibilities under the Contract, ContractCo will not be restricted from providing Professional Services to other persons or otherwise be prohibited from competing with the Partnership.

(v) ContractCo will be responsible for the cost of any supplies, personnel, facilities and equipment that are required by it to provide Professional Services. This includes professional membership fees, professional insurance, and continuing education costs. If the Partnership has paid or in any way borne any of these costs on behalf of ContractCo, fair market value reimbursement must be provided by ContractCo to the Partnership.

11. Within six months of this Ruling, the Named Partners will establish ContractCos and will elect under the Partnership Agreement to provide Professional Services through such corporations. Immediately thereafter, the ContractCos will enter into Contracts with the Partnership for the purpose of providing such services.

Purpose of the Proposed Transactions

One of the purposes of the proposed transactions is to allow Partners the flexibility to earn professional income through a corporation without having to forgo the limited protection offered by its limited liability status and with minimum disruption to the existing business arrangements between the Partners and the Partnership. Other purposes of the proposed transactions are:

(i) to provide a Partner with more control over his or her estate and financial planning;
(ii) to permit a Partner to involve his or her immediate family in the Partner's commercial affairs;
(iii) to enhance the Partnership's ability to retain and recruit Partners; and
(iv) to permit a Partner to have more control over expenditures reflecting personal practice preferences where such expenditures may not be in the interest of all Partners.

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. Provided that a Named Partner would not, if his or her ContractCo did not exist, reasonably be regarded as an officer or employee of the Partnership in respect of the provision of Professional Services, the ContractCo will not be considered to be carrying on a personal services business as defined in subsection 125(7) of the Act.

B. Provided that a particular ContractCo was not a member of any partnership in the relevant year, the Service Fees income earned by the ContractCo will not be specified partnership income as defined in subsection 125(7) of the Act.

C. Subject to sections 18 and 67 of the Act, the Service Fees payable by the Partnership to the ContractCos will be deductible by the Partnership in the determination of Income pursuant to subsection 96(1) of the Act.

D. The undertaking of the proposed transactions above, in particular the payment of the Service Fees by the Partnership to the ContractCos, will not in and of themselves cause subsections 56(2), 56(4) or 246(1) of the Act to apply so as to cause an amount received by a ContractCo under the Contract to be taxed in the hands of the Named Partner.

E. Provided that the amount of Income allocated to a Named Partner is reasonable, having regard to all the relevant circumstances, the Named Partner's share of the Income will not be subject to adjustment pursuant to subsection 103(1) of the Act solely as a result of the Named Partner choosing, pursuant to amendments to the Partnership Agreement, to incorporate a ContractCo and to provide all Professional Services to the Partnership through such ContractCo for Service Fees.

F. Implementation of the proposed transactions as 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.

G. 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 the Named Partners for purposes of the Act.

H. The execution and implementation of the proposed transactions described above, will not, in and of themselves, create a non-arm's length relationship between a Named Partner and any other Partner with respect to sharing Income for income tax purposes.

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 Service Fees, and whether the Partnership is a limited partnership at law.

Additional Comments

Whether or not a Named Partner would, if his or her ContractCo did not exist, 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 ContractCo and the Partnership and between the ContractCo and the Named Partner. This review and determination is the responsibility of the Named Partner's local tax services office.

The attribution rules in sections 74.1 to 74.4 of the Act apply in situations where property is transferred or lent, directly or indirectly, to a spouse or child. These rules may apply to any income received by a spouse or a child who has not attained the age of 18 years before the end of a particular taxation year. Whether or not these rules will apply in respect of the possible ownership of any shares of a ContractCo is a question of fact that can only be determined at the time that the shares are issued or property is lent or transferred to such a shareholder. Furthermore, subsection 56(2) of the Act may apply to any amounts paid by a ContractCo to a family member of a Named Partner. Also, section 120.4 of the Act may apply with respect to taxable dividends or trust income in respect of taxable dividends from a ContractCo received in a taxation year by a family member of the Named Partner who has not attained the age of 17 years before that year.

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 a ContractCo. 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 ContractCos 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 ContractCos.

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