2008 Ruling 2008-0289491R3 - Ptnshp contracting out pro services to ptnr's corp

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 a corporation's income derived from professional services performed for a partnership, of which the corporation's controlling shareholder is a partner, would qualify for the small business deduction.

Position: Question of fact; however, if certain conditions are met, the fact that the partnership is contracting out its professional services to a partner's corporation, will not prevent the corporation from claiming the small business deduction on active business income.

Reasons: Identical to other rulings provided for similar proposed transactions.

XXXXXXXXXX 								2008-028949

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership") Identification Number XXXXXXXXXX
XXXXXXXXXX (respectively the "First Named Partner" and the "Second Named Partner" or, 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 your letter XXXXXXXXXX , and 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 XXXXXXXXXX Agreement, an agreement entered into by XXXXXXXXXX ;

(b) XXXXXXXXXX ;

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

(d) XXXXXXXXXX ;

(e) XXXXXXXXXX ;

(f) "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;

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

(h) XXXXXXXXXX ;

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

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

(k) "Funds" refers to any funds received by the Partnership, directly or indirectly, from the Government of XXXXXXXXXX pursuant to the provisions of the Agreement;

(l) XXXXXXXXXX ;

(m) XXXXXXXXXX ;

(n) XXXXXXXXXX ;

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

(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 and the Second Partnership which receive funding under the Agreement (and which are not the subject of this advance income tax ruling);

(t) "Partner" refers to an individual partner of the Partnership, and includes partners of the Second Partnership, who will become direct partners of the Partnership after the dissolution of the Second 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 XXXXXXXXXX ;

(y) "ProCorp1" refers to the particular ProCorp that will be formed by the First Named Partner;

(z) "ProCorp2" refers to the particular ProCorp formed by the Second Named Partner in anticipation of the proposed transactions below;

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

(bb) "Professional Services" refers to XXXXXXXXXX services as provided by the Partners through the Partnership and the Second Partnership;

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

(dd) "XXXXXXXXXX Funds" means any funds received by the Partnership, directly or indirectly, from XXXXXXXXXX pursuant to the Agreement;

(ee) XXXXXXXXXX ;

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

(gg) "Second Partnership" means the XXXXXXXXXX , a partnership formed pursuant to the laws of the Province and that is currently a member of the Partnership;

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

(ii) "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

(kk) XXXXXXXXXX .

Facts

1. The Partnership is governed by the terms of the Partnership Agreement, effective XXXXXXXXXX . 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 Partners file their income tax returns with the XXXXXXXXXX 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, XXXXXXXXXX .

4. None of the Partners are employees of the Partnership, the Second Partnership, the XXXXXXXXXX .

5. XXXXXXXXXX

6. The purpose of the Partnership is to XXXXXXXXXX . All of the members of XXXXXXXXXX are members of the Partnership, either directly or indirectly. The XXXXXXXXXX are members of the Second Partnership, which itself is a member of the Partnership. The members of the Second Partnership derive XXXXXXXXXX %, of their Professional Services income from the Second Partnership. The income of the Second Partnership includes the income allocated from the Partnership to the Second Partnership.

7. XXXXXXXXXX

8. The Partnership is managed by its Partners, who meet at least four times annually and vote on the various matters affecting the Partnership, including the determination of professional income of a Partner. The activities of the Partnership can be classified into four general categories: XXXXXXXXXX Services, XXXXXXXXXX and administrative duties. The Partners of the Partnership currently provide only a portion their XXXXXXXXXX Services through the Partnership. The members of the Second Partnership provide all of their XXXXXXXXXX Services through the Second Partnership.

9. XXXXXXXXXX

10. XXXXXXXXXX

11. XXXXXXXXXX

12. XXXXXXXXXX

13. The XXXXXXXXXX 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:

(a) ensuring that the Professional Group provide the level of XXXXXXXXXX services required under the Agreement;
(b) receiving, managing, allocating and distributing to the Professional Group the funding received under the Agreement; and
(c) reporting on the allocation and distribution of funding under the Agreement.

14. All Funds are allocated and distributed to the Professional Group, XXXXXXXXXX . The Partnership is responsible for distributing the Funds among the Partners in accordance with its written practices, policies or guidelines. However, the Agreement requires that the Partnership create a finance management committee to manage the Funds received from XXXXXXXXXX pursuant to the Agreement.

15. XXXXXXXXXX

16. A few Partners receive modest compensation from XXXXXXXXXX . Those Partners are treated as employees by XXXXXXXXXX and are paid directly by XXXXXXXXXX for their services. The amounts received are not included in Income.

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

18. The major terms of the Partnership Agreement concerning the computation and allocation of income are as follows:

(a) Each Partner shall be entitled to receive their share of the Funds equal to the amount of the funds received by the Partnership generated by the fee for service billings of the Partnership.

(b) The balance of the Funds, after payment of any Partnership expenses, as approved by the Partnership, shall be distributed to the Partners in accordance with an allocation formula established by committee.

(c) In general, Partners receive draws from the Partnership on a monthly basis.

19. In anticipation of implementing the proposed transactions, the Second Named Partner has incorporated ProCorp2 XXXXXXXXXX . The Second Named Partner is the only voting shareholder, director and officer of ProCorp2, while non-voting shares have been issued to XXXXXXXXXX . However, no other proposed transactions have been undertaken as of the date of this ruling, and ProCorp2 has otherwise been inactive.

Proposed Transactions

20. As a result of the increased role of the XXXXXXXXXX , the Second Partnership will be dissolved shortly after the Ruling is received, such that the members of the Second Partnership will become direct Partners of the Partnership. The purpose of this transaction is to simplify the current operating structure of XXXXXXXXXX . All Partners who wish to provide Professional Services to the Partnership through a ProCorp will be direct members of the Partnership prior to entering into a Contract with the Partnership. The dissolution of the Second Partnership will be governed by subsection 98(2) of the Act and will result in the fair market value disposition of interests in the Second Partnership by the partners of that partnership. No ruling has been requested with respect to any of the transactions related to the dissolution of the Second Partnership and the subsequent admission of the partners of the Second Partnership as direct members of the Partnership.

21. 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 any Partner to elect to provide Professional Services through a ProCorp controlled by the Partner. If the Partner so elects the Partner will no longer be permitted to provide any Professional Services to the Partnership in his or her capacity as a Partner. 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 as an employee of the 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.
(viii) 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.

22. 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. 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 and will also enter into a written employment agreement with ProCorp to 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) XXXXXXXXXX .
viii) As set out in the proposed amendments to the Partnership Agreement, a ProCorp cannot be a partner in the Partnership.

23. 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 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.

24. Within six months of this Ruling, the Named Partners will elect under the Partnership Agreement to provide Professional Services through ProCorp1 and ProCorp2, respectively. Immediately thereafter, ProCorp1 and ProCorp2 will enter into Contracts 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, XXXXXXXXXX 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 paragraphs 21 through 23 will not, in and of themselves, constitute a disposition of part or all of an interest in the Partnership by either of the Named Partners for purposes of the Act.

B. Provided 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 Named Partner's 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 Named Partner's ProCorp 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 such 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 Fees payable by the Partnership to a Named Partner's ProCorp 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 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 Named Partner's ProCorp under the Contract to be taxed in the hands of the Named Partner.

F. 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 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 a ProCorp and to provide all Professional Services to the Partnership through ProCorp 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 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.

The above 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 income tax consequences, if any, related to the dissolution of the Second Partnership and the admission of the its members as direct Partners in the Partnership, or the fair market value or reasonableness of any amounts, including the Fees.

Additional Comments

Whether or not a Named Partner would, if the Named Partner's 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 ProCorp and the Partnership and between the 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 a Named Partner's 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 the Named Partner's 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 paragraphs 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 Named Partner's 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 a Named Partner's ProCorp 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 that ProCorp.

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