2009 Ruling 2008-0282411R3 - Professional Services Corporation

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 corporation from performing professional on behalf of a partnership of which the corporation's controlling shareholder is a member would be specified partnership income or income from a personal services business.

Position: No.

Reasons: Conforms to our requirements for these types of rulings as set out in other similar rulings.

XXXXXXXXXX
2008-028241
XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership") - 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 Partners. We also acknowledge the information provided in various emails and in 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) "CEO" means the chief executive officer of the Partnership, a post held by the XXXXXXXXXX or, during official leaves, his or her replacement;

(c) XXXXXXXXXX ;

(d) "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;

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

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

(g) XXXXXXXXXX ;

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

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

(j) "Non-Professional Services" refers to all services, including certain administrative duties, not covered by XXXXXXXXXX ;

(k) "Organization" refers to the XXXXXXXXXX ;

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

(m) "Partnership Agreement" refers to the existing partnership agreement by which the Partnership is currently bound, effective XXXXXXXXXX ;

(n) XXXXXXXXXX ;

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

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

(q) "Professional Services" refers to all services or duties covered by the XXXXXXXXXX ;

(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) of the Act;

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

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

(x) XXXXXXXXXX ; and

(y) "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 was formed on XXXXXXXXXX , and is currently governed by the terms of the Partnership Agreement dated XXXXXXXXXX . Its filer identification number is XXXXXXXXXX and its address is XXXXXXXXXX . It has a Taxation Year ending XXXXXXXXXX .

2. The Practice is currently carried on by the Partnership. The Partners are the only partners of the Partnership. The Partnership carries on business pursuant to the Partnership Agreement. Partners, currently approximately XXXXXXXXXX in total, provide Professional Services XXXXXXXXXX .

3. All the Partners are individuals resident in Canada and none of the Partners are Related Persons, with the exception ofXXXXXXXXXX , who are spouses of each other.

4. The Partnership files its information return with the XXXXXXXXXX Centre and deals with the XXXXXXXXXX Tax Services office. The Named Partners file their income tax returns with the XXXXXXXXXX Center and deal with the XXXXXXXXXX Tax Services office.

5. There are a number of self-employed XXXXXXXXXX who provide Professional Services to the Partnership either on a one-time basis or on a recurrent basis. These arrangements are governed by separate agreements. Such self-employed XXXXXXXXXX are not Partners of the Partnership and are paid for their services by the Partnership.

6. Currently, all the Partners provide their Professional Services through the Partnership, with the exception of those Partners who also provide their Professional Services through XXXXXXXXXX or otherwise by special agreement with the Partnership. The Partners also provide Non-Professional Services to the Partnership.

7. XXXXXXXXXX .

8. The Partners are bound by the Partnership Agreement, the terms of which include the following:

(i) Partners are either full-time Partners or part-time Partners.
(ii) XXXXXXXXXX
(iii) XXXXXXXXXX
(iv) XXXXXXXXXX
(v) XXXXXXXXXX
(vi) XXXXXXXXXX

Proposed Transactions

9. The Partnership Agreement will be amended to provide as follows:

(i) It will differentiate between Professional Services and Non-Professional Services.

(ii) A Partner will be allowed to elect to provide his or her Professional Services through a ProCorp authorized to carry on XXXXXXXXXX services in the Province. 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. The election will be exercisable by notice in writing to be delivered to the Partnership at least XXXXXXXXXX days prior to the effective date of the notice.

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

(iv) It will prohibit the performance of an Electing Partner's Non-Professional Services by ProCorps and further require 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 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) All Non-Electing Partners will continue to provide their Professional Services directly to the Partnership. The formula for the allocation of Income for a Taxation Year will provide that a Non-Electing Partner's allocation of Income for a particular Taxation Year will be dependent on the Non-Electing Partner's capital contribution and factors connected to the Non-Professional Services and Professional Services carried out by the Non-Electing Partner on behalf of the Partnership.

(vii) As long as a ProCorp fully discharges its responsibilities under the Contract, by providing the agreed upon level of Professional Services to the Partnership, 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 provide that Electing Partners are not restricted from competing with the Partnership in respect of Professional Services. For greater certainty, there will not be any terms in the Partnership Agreement, or any other agreement (oral or otherwise), that would prohibit the ProCorps or the Electing Partners from competing with the Partnership in respect of the provision of Professional Services, as noted above.

10. 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) 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 ProCorp. Non-voting shares of a ProCorp may be held by an Electing Partner's family, where family is defined as those individuals connected by blood relationship, marriage, common-law partnership or adoption, as those terms are defined in subsection 251(6) of the Act. All shareholders legally or beneficially owning voting and non-voting shares of the ProCorp will be residents of Canada.

(iv) 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.

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

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

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

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

(i) The Contract shall be for a fixed period of twelve months. The contract may be renewed each year and either party may also terminate it upon one month's notice. The Service Fee will be paid regularly throughout the year.

(ii) ProCorp will provide Professional Services on behalf of the Partnership in return for Service Fees. Service Fees will be negotiated between the ProCorp and the Partnership and will equal 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) Pursuant to a written agreement and in consideration for a fair market value fee, the Partnership will supply to the ProCorp certain supplies, personnel and equipment that are required to provide Professional Services XXXXXXXXXX .

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

a. professional membership fees and insurance including fees payable to the XXXXXXXXXX
b. continuing education
c. transportation
d. communication
e. maintaining the professional standards set by the Partnership or by XXXXXXXXXX
f. expenditures on personal practice preferences of the ProCorp.

12. Within six months of this Ruling, the Named Partners will establish ProCorps and will elect under the Partnership Agreement to provide Professional Services through such corporation. Immediately thereafter, each ProCorp will enter into a Contract with the Partnership for the purpose of providing such services.

13. XXXXXXXXXX

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to allow a Partner to provide his or her Professional Services through a professional corporation with the following advantages:

(i) to provide a Partner with an increased level of control over his or her participation in the Practice through individual management of personal practice preferences;
(ii) to permit a Partner to have more control over expenditures where such expenditures may not be in the interest of all Partners;
(iii) to provide a Partner with more control over his or her 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 in paragraphs 9 through 12 above, will not, in and of themselves, constitute a disposition of part or all of an interest in the Partnership by any of the Partners for purposes of the Act.

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

C. Provided that a particular ProCorp was not a member of any partnership in the relevant year in respect of the provision of Professional Services to the Partnership, the Service Fees earned by the particular ProCorp 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 Service Fees payable by the Partnership to ProCorps will be deductible in 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 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 ProCorps under the Contract to be taxed in the hands of a Named Partner.

F. Provided that the amount of income allocated to the Named Partners 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 Partners choosing, pursuant to amendments to the Partnership Agreement, to incorporate ProCorps and to provide all Professional Services to the Partnership through such ProCorps for Service Fees, as described in the proposed transactions 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 a 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 Service Fees, and also whether there is a disposition related to a change in the Partnership's status from a general partner to a limited partnership, as described in paragraph 14 above.

Additional Comments

Whether or not a Named Partner would, if his or her ProCorp 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 particular ProCorp and the Partnership and between the particular ProCorp 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 ProCorp 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 ProCorp 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 ProCorp 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 a ProCorp. 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 ProCorps 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 ProCorps.

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