2008 Ruling 2008-0270291R3 - Pro services by a partner's corp for 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 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: Generally no.

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

XXXXXXXXXX 2008-027029

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
XXXXXXXXXX (collectively 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 various emails and 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) "Agreement" refers to the agreement between the Partnership and XXXXXXXXXX pursuant to which the Partnership provides Professional Services;

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

(c) XXXXXXXXXX ;

(d) "Contract" refers to the sub-contracting agreement which will be used to set out the terms and conditions by which a ContractCo will provide Professional Services to the Partnership;

(e) "ContractCo" means each of the corporations to be formed by an Electing Partner and through which the Electing Partner will provide Professional Services as an employee of that corporation;

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

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

(h) XXXXXXXXXX ;

(i) "Hourly Fees" refers to the fee to be charged under the Contract by a ContractCo to the Partnership;

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

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

(l) "Non-Professional Services" encompass any service provided by Partners on behalf of the Partnership, other than Professional Services, including the promotion of the Practice.

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

(n) "Partnership Agreement" refers to the existing partnership agreement by which the Partners are currently bound;

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

(p) "Professional Services" means the practice of XXXXXXXXXX ;

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

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

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

(t) "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 has been carrying on the Practice for more than XXXXXXXXXX years and is a continuation 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 returns with the XXXXXXXXXX Centre and deals with the XXXXXXXXXX Tax Services Office. The Named Partners file their 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 , and amended on XXXXXXXXXX and XXXXXXXXXX .

4. The Professional Services are provided at the XXXXXXXXXX . The Partnership has entered into the Agreement with the XXXXXXXXXX for this purpose. Under the Agreement, the Partnership receives fixed annual compensation for rendering Professional Services at the XXXXXXXXXX and is provided with resources at the XXXXXXXXXX for this purpose, including all physical premises, facilities, plant, equipment, XXXXXXXXXX supplies, XXXXXXXXXX , auxiliary and support staff, administrative and other services necessary for the due, proper, and timely fulfilment by the Partnership of its obligations to provide the Professional Services. All of the foregoing resources are provided by XXXXXXXXXX .

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

6. All Partners are XXXXXXXXXX licensed to practice XXXXXXXXXX in the Province. Under the Partnership Agreement, the Partners are permitted to practice XXXXXXXXXX outside of the Partnership and indeed do so regularly.

7. The Partnership currently contracts with XXXXXXXXXX on a subcontract basis. These XXXXXXXXXX are paid on an hourly basis and are free to practice XXXXXXXXXX outside of this arrangement.

8. The Partnership may also contract with other XXXXXXXXXX from time to time (generally referred to as "XXXXXXXXXX "). XXXXXXXXXX are also compensated on an hourly basis, but there is no written contract for this purpose.

9. The Partnership Agreement provides for the establishment of an executive committee, the members of which are appointed by the Partners to manage the affairs of the Partnership.

10. Pursuant to the Partnership Agreement, at the end of each Taxation Year, the Partnership allocates to each Partner his or her share of Income, as follows:

(i) Partners at the end of the Partnership's Taxation Year, who have been Partners for the preceding twelve months and have been working in a full-time capacity throughout the entire Taxation Year, are entitled to equal proportions of Income.

(ii) If, at the end of the Partnership's Taxation Year, any Partner has not been in the Partnership for the twelve preceding months, such Partner will only be entitled to receive a pro-rata share of the Income for such Taxation Year based upon the portion of the twelve preceding months that he or she was a Partner.

(iii) A Partner working only part-time in a Taxation Year is entitled to share in the Income for that year computed as the product of:

(i) A full-time Partner's share for that year, and

(ii) The proportion that the number of hours which the part-time Partner has agreed to work during each XXXXXXXXXX period is of the designated number of hours that is considered to be full-time.

11. The Partnership maintains a capital account for each Partner. The capital account consists of all contributions made by the Partner plus or minus, as the case may be, the Partner's share of Income for any Taxation Year minus the withdrawals made by the Partner in the Taxation Year. On retirement from the Partnership, a Partner is entitled to the balance in their capital account. A retiring Partner is also entitled to his or her proportion of the established value of the Practice and his or her pro rata share of the Income for the Taxation Year in which he or she retires.

12. The Partnership Agreement contains no terms or conditions that prohibit or restrict a Partner from providing Professional Services to other persons or otherwise competing with the Partnership. Currently, a number of Partners provide professional XXXXXXXXXX services outside of the Partnership.

Proposed Transactions

13. 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 and licensed as a professional XXXXXXXXXX corporation with the XXXXXXXXXX in the Province, and that 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. All Partners will continue in their capacity as partners to carry out the Non-Professional Services for the Partnership.

(v) The formula for 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 solely 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's allocation of Income for a particular year will be based on the Non-Electing Partner's capital contribution and factors connected to the Professional Services and Non-Professional Services carried out by the Non-Electing Partner on behalf of the Partnership.

(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. The Partnership Agreement will also be amended to provide that Partners are not restricted from competing with the Partnership with respect to Professional Services.

14. Each ContractCo will be required to comply with the following requirements:

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 shareholder, legal or beneficial, of more than one ContractCo.

vi) No two ContractCos will be Related Persons with the exception of ContractCos incorporated by Partners that are spouses or common-law partners.

vii) A ContractCo will be licensed to carry on the practice of XXXXXXXXXX in the Province.

viii) A ContractCo cannot be a Partner in the Partnership.

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

i) The initial term of the Contract will not exceed one year but will be automatically and continuously renewed for additional one year terms, with any mutually agreed upon amendments. The Contract is also subject to specified termination provisions.

ii) ContractCo will provide Professional Services on behalf of the Partnership in return for Hourly Fees. Hourly Fees will be determined as an hourly rate equal to the fair market value of the XXXXXXXXXX services provided by ContractCo. The ContractCo will invoice the Partnership from time to time for professional XXXXXXXXXX services rendered under the Contract.

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. All fees for Professional Services provided by the ContractCo on behalf of the Partnership will be billed by the Partnership to its clients and will belong to 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) Subject to any legislative requirements, all clients and client information will remain property of the Partnership.

vi) ContractCo will be responsible for the cost of any supplies, personnel, facilities and equipment that are required by it to provide Professional Services, except where the resources are provided by XXXXXXXXXX pursuant to the Agreement. ContractCo is also responsible for professional membership fees, malpractice and other 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.

16. 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, each ContractCo will enter into a Contract with the Partnership for the purpose of providing such services.

Purpose of the Proposed Transactions

The purposes of the proposed transactions are:

(i) to allow Named Partners the flexibility to use corporations to earn professional income with minimum disruption to the existing business arrangements between the Partners and the Partnership.

(ii) to provide a Named Partner with more control over his or her estate and financial planning;

(iii) to permit a Named Partner to involve his or her immediate family in the Partner's commercial affairs;

(iv) to enhance the Partnership's ability to retain and recruit Partners; and

(v) to permit a Named 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 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 Named Partner's 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 in respect of the provision of Professional Services to the Partnership, the Hourly Fees earned by the particular 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 Hourly Fees payable by the Partnership to a ContractCo 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 13 to 16, and in particular the payment of the Hourly 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 the particular Named 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 a Named Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a ContractCo and to provide all of his or her Professional Services to the Partnership through that ContractCo for Hourly 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.

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 any of the Named Partners.

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 the Named Partners 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 Hourly Fees, and whether the Partnership is a 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 ContractCos and the Partnership and between the ContractCos and the Named Partners. This review and determination is the responsibility of the particular 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 Named Partner's 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 such ContractCo to a family member of the 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 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