2008 Ruling 2008-0279811R3 - Pro services by a partner's corporation 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 								2008-027981

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership") - XXXXXXXXXX
XXXXXXXXXX (the "Named Partner") - 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 and the Named Partner. We also acknowledge the information provided in your letter dated XXXXXXXXXX , and in various emails and telephone conversations (XXXXXXXXXX ).

To the best of your knowledge and that of the Partnership and the Named Partner (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 XXXXXXXXXX Agreement, an agreement entered into by XXXXXXXXXX ;

(b) "Association" refers to the XXXXXXXXXX ;

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

(d) XXXXXXXXXX ;

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

(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 ProCorp;

(h) "Fees" refers to the fair market value fees to be charged by a ProCorp to the Partnership;

(i) "Full Member" refers to a member of the Partnership other than an Introductory Member or a Junior Member;

(j) "Governance Org" means the XXXXXXXXXX ;

(k) XXXXXXXXXX

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

(m) XXXXXXXXXX

(n) "Introductory Member" refers to a member of the Partnership other than a Junior Member or a Full Member and who is remunerated by a fixed draw and has limited rights under the Partnership;

(o) "Junior Member" refers to a member of the Partnership other than an Introductory Member or a Full Member;

(p) XXXXXXXXXX

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

(r) "Non-Professional Services" refers to XXXXXXXXXX and administrative functions of the Partnership's business;

(s) "Other Partnerships" refers to the XXXXXXXXXX practices other than the Partnership which receive funding under the Agreement (and which are not the subject of this advance income tax ruling);

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

(u) "Partnership Agreement" refers to the existing partnership agreement by which the Partners are currently bound, effective XXXXXXXXXX ;

(v) XXXXXXXXXX

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

(x) "ProCorp" means each of the corporations through which an Electing Partner will provide Professional Services as an employee of that corporation; each ProCorp must hold a valid Certificate of Authorization issued by the XXXXXXXXXX ;

(y) "ProCorp1" refers to the particular ProCorp formed by the Named Partner;

(z) "Professional Group" means, collectively, the Partnership and the Other Partnerships;

(aa) "Professional Services" refers to XXXXXXXXXX services, and all direct and indirect services ancillary to the provision of XXXXXXXXXX services as provided by the Partners through the Partnership;

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

(cc) XXXXXXXXXX

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

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

(ff) "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; and
(gg) XXXXXXXXXX

Facts

1. The Partnership was originally formed in or about XXXXXXXXXX and is currently governed by the terms of the Partnership Agreement. Its address is XXXXXXXXXX , and it has a Taxation Year ending XXXXXXXXXX .

2. The Partnership files its information tax return with the XXXXXXXXXX Centre and deals with the XXXXXXXXXX Tax Services Office. The Named Partner files his income tax return with the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

3. All Partners, approximately XXXXXXXXXX in total, are resident in Canada for the purposes of the Act. None of the Partners are Related Persons, with the exception of Partners who are spouses or common-law partners of each other. Each Partner is a XXXXXXXXXX .

4. None of the Partners are employees of the Partnership, the Governance Org or XXXXXXXXXX

5. The Partnership is managed by the Partners, who meet at least XXXXXXXXXX times annually and vote on the various matters affecting the Partnership, including the allocation of Income to a Partner. The elected officers of the Partnership include a chairman, a managing partner, a secretary and one or more members-at-large.

6. XXXXXXXXXX

7. XXXXXXXXXX

8. XXXXXXXXXX

9. XXXXXXXXXX

10. XXXXXXXXXX

11. The Governance Org was established for the purposes of representing the interests of its members and ensuring the proper and efficient provision of their respective and mutual obligations under the Agreement. Its responsibilities include:

(i) ensuring that the Professional Group provide the level of XXXXXXXXXX services required under the Agreement;

(ii) receiving, managing, allocating and distributing to the Professional Group the funding received under the Agreement; and

(iii) reporting on the allocation and distribution of funding under the Agreement.

12. All funds received by the Governance Org from XXXXXXXXXX under the Agreement are allocated and distributed to the Professional Group, after deducting the expenses of the Governance Org. The Partnership is responsible for distributing the funds among the Partners in accordance with their written practices, policies or guidelines. However, the Agreement requires that the Partnership create a finance management
committee to manage the monies received from Governance Org pursuant to the Agreement.

13. XXXXXXXXXX

14. A few Partners receive modest compensation from the XXXXXXXXXX . Those Partners are treated as employees by the XXXXXXXXXX and are paid directly by the XXXXXXXXXX for their services. The amounts received are not included in Income. However, these amounts may be taken into account in determining the amount of the Income allocated to each Partner.

15. For greater certainty, any services provided by a Partner to the XXXXXXXXXX , and any compensation earned by a Partner from the XXXXXXXXXX , relates only to the Non-Professional Services provided by the Partner.

16. The Partnership Agreement includes the following terms:

(i) The gross income of the Partnership includes all income derived from the Professional Services, which includes but is not limited to all income from XXXXXXXXXX , amounts received under the Agreement, and all other income from professional sources. It does not include basic XXXXXXXXXX salaries, income from patents or copyright or income from sources unrelated to professional activities unless the total time required togenerate such non-related revenue exceeds two weeks in a year.

(ii) Any XXXXXXXXXX salaries received by a Partner may be taken into account by the Partnership in determining the Partner's overall compensation.

(iii) Income is determined by deducting from the gross income all legitimate expenses of the Partnership.

(iv) Partners, other than Introductory Members, are allocated income under one of two methods depending on the Partner's status as either a Full Member or a Junior Member. Introductory Members receive a fixed draw.

(v) XXXXXXXXXX

(vi) Income relating to XXXXXXXXXX services is allocated to the Partners who performed such services.

(vii) Amounts received by the Partnership pursuant to the Agreement are not subject to the income allocation method described above and, subject to paragraph 16(viii) below, are divided equally among all Partners based on their full-time equivalent status.

(viii) The Junior Member's income allocation method is calculated based on the Full Partner's mean income (including Agreement funds) unless the Junior Member receives a fixed income allocation.

(ix) In general, Partners receive draws from the Partnership on a XXXXXXXXXX basis.

17. In anticipation of implementing the proposed transactions, ProCorp1 has been incorporated and has obtained a Certificate of Authorization from the XXXXXXXXXX . The Named Partner is the only voting shareholder, director and officer of ProCorp1, while non-voting shares have been issued to his wife and his adult daughter only. However, no other proposed transactions have been undertaken as of the date of this ruling, and ProCorp1 has otherwise been inactive.

Proposed Transactions

18. 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 Partner other than an Introductory Member to elect to provide his or her Professional Services through a ProCorp controlled by him or her 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. Each ProCorp will be required to hold a valid Certificate of Authorization issued by the XXXXXXXXXX .

(iii) A provision will be added to prohibit the transfer, conveyance or issuance of an interest in the Partnership to any ProCorp.

(iv) A provision will be added to prohibit the performance of an Electing Partner's Non-Professional Services by ProCorps and further requiring that all Partners devote and spend the time and energy required to complete their portion of the Non-Professional Services.

(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 on the 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 ProCorp, 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 ProCorp.

(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 ProCorp fully discharges its responsibilities under the Contract, such ProCorp 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 specify that Electing Partners are not restricted from competing with the Partnership in respect of Professional Services.

19. Each ProCorp 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) XXXXXXXXXX

iv) All shareholders owning voting and non-voting shares of the ProCorp will be residents of Canada.

v) An Electing Partner will be the sole director of his or her ProCorp. He or she will also enter into a written employment agreement with ProCorp under which the Electing Partner will receive a salary in return for providing Professional Services for the benefit of the ProCorp.

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

vii) No two ProCorps will be Related Persons with the exception of ProCorps incorporated by Partners who are spouses or common-law partners.

viii) As set out in the proposed amendments to the Partnership Agreement, a ProCorp cannot be a partner in the Partnership.

20. A Contract between a Partnership and a ProCorp will contain the following terms:

i) The Contract will be for an indefinite term but either party may terminate the Contract at any time upon notice to the other within a pre-established time period. The Contract will also contain terms for automatic termination such as where the ProCorp is dissolved or ceases to hold a valid certificate from the XXXXXXXXXX or where the controlling shareholder of the ProCorp ceases to be a Partner.

ii) ProCorp will provide Professional Services on behalf of the Partnership in return for Fees. Fees will be negotiated between the ProCorp and the Partnership and will be equal to the fair market value of the Professional Services provided by the ProCorp to the Partnership.

iii) All payments received by the Partnership in respect of Professional Services provided by the ProCorp under the Contract will be for the benefit of the Partnership, and if any such amounts are received by a ProCorp, they will be remitted to the Partnership.

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

v) The Partnership will provide the ProCorps with certain supplies, personnel, facilities and equipment that are required by it to provide Professional Services. The fair market value cost of these items will be borne by each ProCorp and will be taken into account, by way of set-off or otherwise, in determining the Fees.

vi) Each ProCorp will be responsible for the following expenses:

a. professional membership fees and insurance

b. transportation

c. communication

d. maintaining the professional standards set by the Partnership or by the XXXXXXXXXX

e. expenditures on personal practice preferences of the ProCorp.

21. Within six months of this Ruling, the Named Partner will elect under the Partnership Agreement to provide Professional Services through ProCorp1. Immediately thereafter, ProCorp1 will enter into a Contract with the Partnership for the purpose of providing such services.

Purpose of the Proposed Transactions

The primary objective of the proposed transactions is to restructure the Partnership to allow Partners to render Professional Services through professional corporations XXXXXXXXXX , while at the same time ensuring minimal disruption to the existing arrangements between the Partners, the Partnership, the Other Partnerships, the Association and other third-parties, including XXXXXXXXXX . Other purposes include:

(i) to provide Partners with an increased level of control over their participation in the Practice through individual management of personal practice references;

(ii) to permit Partners to have more control over expenditures reflecting personal practice preferences where such expenditures may not be in the interest of all Partners;

(iii) to provide Partners with more control over their estate and financial planning; and

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

we rule 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 the Named Partner for purposes of the Act.

B. Provided that the Named Partner would not, if ProCorp1 did not exist, reasonably be regarded as an officer or employee of the Partnership in respect of the provision of Professional Services, ProCorp1 will not be considered to be carrying on a personal services business as defined in subsection 125(7) of the Act.

C. Provided that ProCorp1 was not a member of any partnership in the relevant year in respect of the provision of Professional Services to the Partnership, the Fees earned by ProCorp1 will not be specified partnership income as defined in subsection 125(7) of the Act.

D. Subject to sections 18 and 67 of the Act, the Fees payable by the Partnership to ProCorp1 will be deductible determining the Partnership's income pursuant to subsection 96(1) of the Act.

E. The undertaking of the proposed transactions above, and in particular the payment of the 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 ProCorp1 under the Contract to be taxed in the hands of the Named Partner.

F. Provided that the amount of income allocated to the Named Partner is reasonable, having regard to all the relevant circumstances, the Named Partner's share of Partnership's 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 ProCorp1 and to provide all Professional Services to the Partnership through ProCorp1 for Fees, as outlined in the proposed transactions described above.

G. 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 Partner and any other Partner with respect to sharing Income for income tax purposes.

H. 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.

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 Fees.

Additional Comments

Whether or not the Named Partner would, if ProCorp1 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 ProCorp1 and the Partnership and between ProCorp1 and the Named Partner. 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 ProCorp1 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 ProCorp1 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 ProCorp1 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.

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.

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 ProCorp1. 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 ProCorp1 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 ProCorp1.

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