2008 Ruling 2008-0269991R3 - Partner creating contracting company

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: Will a contracting company created by a partner to deliver professional services to a partnership be considered specified partnership income?

Position: Question of fact, but generally no if a number of specified conditions are met.

Reasons: Reading of relevant legislation and consistent with other rulings.

XXXXXXXXXX 								2008-026999

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
XXXXXXXXXX ( collectively the "Partners")

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

To the best of your knowledge and that of the Partnership and the 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 to be formed by a Principal and through which the Principals will provide Professional Services;

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

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

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

(g) "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;

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

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

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

(k) "Principal" refers to i) in the case of an incorporated Partner, an individual in his or her capacity as controlling shareholder of a Procorp, and ii) in the case of an unincorporated Partner, the Partner;

(l) "Procorp" means a Partner of the Partnership that is a corporation;

(m) "Professional Services" means XXXXXXXXXX services;

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

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

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

(q) "TCC" refers to a "taxable Canadian corporation" as defined under subsection 89(1) of the Act; and

(r) "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 under the Partnership Agreement since XXXXXXXXXX . The Partners are the only Partners of the Partnership. XXXXXXXXXX . Its address is XXXXXXXXXX . It has a fiscal period ending XXXXXXXXXX .

2. The Partnership deals with the XXXXXXXXXX Tax Services Office. The Partners file their income tax returns with the XXXXXXXXXX Tax Centre and deal with the XXXXXXXXXX Tax Services Office.

3. All Partners are resident in Canada for the purposes of the Act. None of the Partners are related persons.

4. All Principals are licensed to practice XXXXXXXXXX in the Province.

5. The Partnership Agreement includes the following terms:

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

(b) Each calendar month, a Partner is entitled to a "Monthly Income Allocation" based on XXXXXXXXXX % of all funds received in that month to the account of fees billed and collected by that Partner. In addition, at the conclusion of any month, quarter or year, the Partnership will determine its surplus cash on hand, if any, which is equal to the funds remaining at the end of the period after all expenses and the Monthly Income Allocations have been paid and the Partnership's cash requirement has been set aside. XXXXXXXXXX percent of any surplus on hand will be divided equally amongst all Partners, and the remaining XXXXXXXXXX percent of the surplus will also be divided amongst the Partners, each Partner receiving an amount that takes into account the Partner's ratio of gross revenue to the Partnership's gross revenue during the period.

(c) Capital accounts are maintained for each Partner.

(d) Upon the withdrawal of a Partner, the Partner is entitled to receive the value of the Partner's participating interest in the Partnership's equity assessed at the withdrawal date.

(e) XXXXXXXXXX of the Partnership Agreement specifies that a Partner must devote substantially his or her full time and energy and ability to the business of the Partnership unless prevented by sickness or other reasonable cause. XXXXXXXXXX of the Partnership Agreement specifies that a Partner cannot perform any XXXXXXXXXX services outside the Partnership. XXXXXXXXXX of the Partnership Agreement specifies that no Partner may carry on any practice as XXXXXXXXXX for his or her own private advantage, as any such business may be carried on for the benefit of the Partnership only.

Proposed Transactions

6. The Partnership Agreement will be amended as follows:

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

(ii) A provision will be added to allow a Principal to elect to provide his or her Professional Services through a ContractCo controlled by him or her and that where a Principal so elects, he or she will no longer be permitted to provide any Professional Services to the Partnership directly or through his or her ProCorp, as the case may be.

(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 performance of Non-Professional Services by anyone other than the Partners and requiring that all Partners devote and spend the time and energy required to complete their portion of the Non-Professional Services.

(v) The formula XXXXXXXXXX of the Partnership Agreement for the allocation of Income for a Taxation Year will be amended to provide that a Partner's allocation of Income for a particular Taxation Year will be dependent solely on the Non-Professional Services carried out by the Partner on behalf of the Partnership. For greater certainty, the Partnership Agreement will make it clear that the calculation of an Electing Principal's Income for a Taxation Year will not take into account any Professional Services provided by the Electing Principal'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 Principals will continue to provide their Professional Services directly to the Partnership or through their ProCorps, as Partners. Further, the Partnership Agreement will clarify that a Non-Electing Principal will be allocated a greater share of Income to take into account that he or she, or his or her ProCorp, as the case may be, has provided both Professional and Non-Professional Services.

(vii) The provisions XXXXXXXXXX of the Partnership Agreement that currently restrict a Partner from competing fully with the Partnership, as described in paragraph 5(e) above, will be removed. In its place, 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.

(viii) All provisions setting out the terms and conditions for vacation entitlements will be removed.

7. 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 Principal, 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 Principal's spouse or children. All shareholders owning voting and non-voting shares of the ContractCo will be residents of Canada.

iv) An Electing Principal 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.

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

v) No two ContractCos will be related persons.

vi) A ContractCo cannot be a partner in the Partnership.

8. 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 and will be automatically renewed each year unless notice to terminate has been received within the twelve-month term. Either party may terminate the Contract at any time upon XXXXXXXXXX 's notice to the other.

ii) ContractCo will provide Professional Services on behalf of the Partnership in return for Service Fees. 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, with the understanding that the Service Fees will be equal to 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 .

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

Purpose of the Proposed Transactions

The primary purpose of the proposed transactions is to allow Principals the flexibility to earn professional income through a corporation with minimum disruption to the existing business arrangements between the Partners and the Partnership. Other objectives of the proposed transactions are:

(i) to provide a Partner with more control over his or her estate and financial planning;
(ii) to enhance the Partnership's ability to retain and recruit Partners; and
(iii) 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 Provided

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,

we rule as follows:

A. Provided that a Principal 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, his or her 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 ContractCo was not a partner of any partnership in the relevant period, the Service Fees 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 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 in paragraphs 6 to 9, and in particular the payment of the Service Fees, 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 as income in the hands of a Partner.

E. Provided that the amount of 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) of the Act solely as a result of the Principals being allowed, pursuant to amendments to the Partnership Agreement, to incorporate ContractCos and to provide all Professional Services to the Partnership through those ContractCos for Service Fees.

F. 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) of the Act 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 Service Fees, and whether the Partnership is a limited partnership at law.

Additional Comments

Whether or not a Principal would, if his or her particular 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 a ContractCo and the Partnership and between a ContractCo and a Principal. This review and determination is the responsibility of the particular Principal'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 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 ContractCo to a family member of the Partner. Also, section 120.4 of the Act may apply with respect to taxable dividends or trust income in respect of taxable dividends from ContractCo received in a taxation year by a family member of the Partner who has not attained the age of 17 years before that year.

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