2008 Ruling 2008-0292231R3 - Partnership Reorg-Personal Service Business

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: Where a partner of a professional partnership creates a professional corporation through which professional services will be provided to the partnership, will the corporation be eligible for the small business deduction?

Position: Question of fact. Generally, yes, if certain conditions are met.

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

XXXXXXXXXX 2008-029223

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: XXXXXXXXXX [Partnership BN XXXXXXXXXX ] and
Partners [See Appendix 'A' for list of Partners]
Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of XXXXXXXXXX and its partners. We also acknowledge the additional information provided to us in your electronic mail transmissions, letters, and during our telephone conversations (XXXXXXXXXX ).

We understand that, to the best of your knowledge, and that of the taxpayers involved, none of the issues described herein is:

(i) in an earlier return of the Partnership, any of the Partners or a related person;
(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed return of the Partnership, any of the Partners or a related person;
(iii) the subject of any notice of objection;
(iv) before the courts or, if a judgment has been issued, the time limit for appeal has not expired; or
(v) the subject of a previously issued ruling.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

DEFINITIONS

In this letter, unless otherwise expressly stated:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to this date of this letter;

(b) "Administrative Responsibilities" means all of the administrative obligations that are, and will continue to be, carried out by the Partners to carry on the Practice. For greater certainty, these do not include a Partner's Professional Services;

(c) "arm's length" has the meaning assigned by subsection 251(1) of the Act;

(d) "BN" means the tax identification number assigned by the CRA to Partnership in respect of GST and payroll remittances;

(e) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7) of the Act;

(f) "Contract" means the contract pursuant to which a Contracting Company renders Professional Services to the Partnership, as described in Paragraph 8;

(g) "Contracting Company" means each of the companies incorporated (or to be incorporated, as the case may be), as permitted pursuant to the laws of one of the Provinces and licensed by a Regulatory Body, for the benefit of and controlled by an existing Partner and that will be engaged by the Partnership to provide Professional Services as independent contractors and, collectively, they are referred to as the "Contracting Companies". For greater certainty, any Contracting Company that has already been incorporated is dormant and was incorporated in anticipation of entering into the proposed transactions noted below and obtaining this ruling;

(h) "CRA" means the Canada Revenue Agency;

(i) "Family" means individuals connected by blood relationship, marriage, common-law partnership, or adoption, as those terms are defined in subsection 251(6) of the Act;

(j) "fair market value" means the highest price available in an open and unrestricted market, between informed prudent parties, acting at arm's length and with no compulsion to act, expressed in terms of cash;

(k) "GST" means the goods and services tax as imposed by Part IX of the Excise Tax Act (Canada);

(l) "Paragraph" refers to a numbered paragraph in this letter;

(m) "Partner(s)" means the individual XXXXXXXXXX who are currently members of the Partnership. More particularly, the Partners are as listed in Appendix 'A', attached to this letter;

(n) "Partnership" refers to the existing partnership of "XXXXXXXXXX ", which was formed pursuant to the laws of the Province of XXXXXXXXXX ;

(o) "Partnership Agreement" refers to the partnership agreement for the Partnership made between the Partners, as approved by the Partners on XXXXXXXXXX , practicing as a XXXXXXXXXX and as a partnership, as more fully described in Paragraph 5;

(p) "personal services business" has the meaning assigned by subsection 125(7) of the Act;

(q) "Practice" means the services currently provided by the Partnership, being the provision of Professional Services and also includes the Administrative Responsibilities conducted by the Partners that are necessary to carry on the professional practice;

(r) "Professional Services" means the professional services of the practice of XXXXXXXXXX ;

(s) "Proposed Transactions" means the transactions described in Paragraphs 6 to 14;

(t) "Provinces" means the provinces of XXXXXXXXXX ;

(u) "Regulatory Body" means XXXXXXXXXX ;

(v) "related person" has the meaning assigned by section 251 of the Act;

(w) "specified partnership income" has the meaning assigned by subsection 125(7) of the Act; and

(x) "TCC" has the meaning of "taxable Canadian corporation" assigned by subsection 89(1) of the Act.

FACTS

1. The Partnership is a general partnership registered with the XXXXXXXXXX

2. The Partnership's tax identification number is XXXXXXXXXX . The Partnership's BN is XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. The fiscal year of the Partnership ends on XXXXXXXXXX .

3. The Partnership carries on the business of the Practice. The Partners are the only partners of the Partnership. The Partnership has been carrying on the business of the Practice since XXXXXXXXXX , under the Partnership Agreement. The Partnership has been carrying on business of the Practice under predecessor partnership agreements since XXXXXXXXXX . The Partners, currently XXXXXXXXXX in total, provide professional services to clients of the Partnership on behalf of the Partnership. All of the Partners are individuals. No Partner is related to another Partner, other than the following Partners who couples:

XXXXXXXXXX

4. In addition to the Partners, there are a number of XXXXXXXXXX who are employed by the Partnership. In addition, many former partners and other XXXXXXXXXX act as counsel to XXXXXXXXXX as independent contractors either as individuals or through a corporation controlled by the relevant XXXXXXXXXX and in this regard receive payments from the Partnership upon which GST is charged. None of these XXXXXXXXXX will participate in the Proposed Transactions.

5. The terms of the Partnership Agreement include the following, with capitalized terms having the meaning assigned by the Partnership Agreement:

(i) each of the Partners must devote substantially all of their time and abilities to the practice of XXXXXXXXXX at the Partnership;

(ii) each year the net profits and losses of the Partnership are allocated to the Partners, generally in accordance with his or her profit sharing percentage determined by the Partnership's Profit Allocation Committee. There are provisions to increase those allocations in accordance with certain merit bonus arrangements adopted by the Partnership from time to time;

(iii) capital accounts are maintained for each Partner to which is credited the amount of all capital contributions and the amount of all income allocated to the Partner, and to which is debited the amount of any loss allocated to the Partner and any withdrawals made by the Partner;

(iv) Partners that withdraw from the Partnership are paid upon the surrender of their partnership interest an amount equal to the balance of the capital account of the Partner plus the undistributed share of income earned by the Partner for the year of departure in accordance with the Partnership Agreement;

(v) the Partnership Agreement provides for the creation of a Board of Directors of the Partners. The Board of Directors consists of XXXXXXXXXX Partners selected by the Partners. The Board of Directors is required to, subject to the terms of the Partnership Agreement, manage and supervise the affairs of the Partnership; and

(vi) income earned by a Partner for services rendered as a director, author, executor and/or lecturer are not included in the revenue of the Partnership. These amounts are reported directly by the particular Partner in the computation of their income for tax purposes, in addition to their share of the income from the Partnership.

PROPOSED TRANSACTIONS

6. The Partnership Agreement will be amended to permit each Partner to provide their professional expertise in XXXXXXXXXX services as an independent contractor through their own Contracting Company. To implement this change, the Partnership Agreement will differentiate between the two functions that each Partner performs, that being Professional Services and Administrative Responsibilities. The Partnership Agreement will also be amended to

(i) provide that a Partner who has ownership of a Contracting Company will no longer provide Professional Services to the Partnership in his or her capacity as a Partner. However, that person will remain a Partner in the Partnership,

(ii) prohibit Administrative Responsibilities from being conducted by anyone other than the Partners themselves [all Partners will continue in their capacity as Partners to conduct Administrative Responsibilities for the Partnership],

(iii) provide that, unless there is no contract then in force between the Partnership and a Contracting Company controlled by that Partner, the calculation of a Partner's share of Partnership profits for a year will be dependent solely on their Administrative Responsibilities conducted for the Partnership. More specifically, the calculation of each Partner's share of Partnership profits will not depend on the Professional Services provided by the Partner's Contracting Company, or time spent on professional activities by the Partner in his or her role as an employee of their Contracting Company, and

(iv) prohibit the transfer, conveyance, or issuance of an interest in the Partnership to any Contracting Company.

7. It is intended that all Partners will choose to provide their Professional Services to the Partnership through their own Contracting Company. Each Partner is an individual licensed to practice XXXXXXXXXX in one or more of the Provinces and will be the sole employee, officer and director of their Contracting Company. Each Partner will also be the sole voting shareholder of their Contracting Company. Non-voting shares of a Contracting Company, if any, will only be directly owned by members of the Partner's Family and such Family members will only be a shareholder of the Contracting Company in which the Partner owns voting shares. All shareholders of each Contracting Company will be Canadian residents. No Partner will be an employee, officer, director or shareholder, either legally or beneficially, of more than one Contracting Company. None of the Contracting Companies will be related to each other, with the exception of Contracting Companies controlled by XXXXXXXXXX (i.e., the couples referred to in Paragraph 3).

8. Each Contracting Company will be required to enter into a written Contract with the Partnership. The Contract will state that the Contracting Company will provide Professional Services to the Partnership as required by the Partnership for its Practice. Administrative Responsibilities for the Partnership will continue to be conducted by the Partners and not by the Contracting Companies. In return for these Professional Services, the Partnership will pay monthly fees (the "Fees") directly to the Contracting Company. The terms of each Contract will be negotiated by the Partnership separately with each Contracting Company. The amount of the Fees will be tied to the amount and level of work performed by that Contracting Company. The Fees will be paid monthly and will be equal in amount to the fair market value of the Professional Services that the particular Contracting Company provided to the Partnership during the previous fiscal month, plus applicable GST. The amount of the Fees will not be based in any way on the success of collecting the revenue billed to the Partnership's clients in respect of the Professional Services provided by the particular Contracting Company to the Partnership. The Contract shall be for a fixed period of XXXXXXXXXX months. It may be renewed each year and either party may, upon XXXXXXXXXX months written notice, terminate the Contract.

9. As long as a Contracting Company fully discharges its responsibilities under the Contract by providing the agreed upon level of Professional Services to the Partnership, the Contracting Company will not be restricted from providing services to other persons or otherwise prohibited from competing with the Partnership. Consequential amendments to the Partnership Agreement will be made so that Partners, who provide Professional Services through a Contracting Company, are not restricted from competing with the Partnership in respect of those 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 any Contracting Company or any Partner from competing with the Partnership in respect of the provision of Professional Services, as noted above.

10. All payments from third parties received by the Partnership in respect of Professional Services provided by the Contracting Companies under the Contracts will be for the benefit of the Partnership and if a Contracting Company receives any amounts, they will be remitted to the Partnership.

11. The Partnership will supply certain supplies, personnel, facilities and equipment that are required to provide Professional Services to the clients of the Partnership. The fair market value in respect of the particular supplies, personnel, facilities, and equipment provided to a particular Contracting Company will be included in the computation of the Fees to be paid to that Contracting Company, causing a reduction in the amount of the Fees paid to that Contracting Company. A Contracting Company will be separately responsible for the following expenses:

(i) professional membership fees and insurance;

(ii) continuing education;

(iii) transportation;

(iv) communication, specifically including the acquisition and operation of wireless communication devices;

(v) maintaining the professional standards set by the Partnership or by the Regulatory Body to which the Contracting Company is subject; and

(vi) expenditures on personal practice preferences of the Contracting Company.

12. The sole officer and director of each of the Contracting Companies will be a Partner and will provide Professional Services for the benefit of their Contracting Company pursuant to the terms of the Contract with the Partnership. The employment relationship between the Contracting Company and the Partner will be evidenced by a written employment agreement.

13. A Partner who chooses to provide services for the benefit of his/her Contracting Company will be entitled, but not required, to receive a salary from his/her Contracting Company for such services provided.

14. Each Contracting Company will be a TCC and a CCPC.

PURPOSE OF PROPOSED TRANSACTIONS

15. The purpose of the proposed transaction will be to allow a Partner to provide his or her Professional Services through a Contracting Company to the Partnership with the following advantages:

(i) to allow a Partner to benefit from the amendment by the Provinces which permits XXXXXXXXXX to render professional services through a corporation;

(ii) to provide a Partner with an increased level of control over their participation in the Practice through individual management of personal practice preferences;

(iii) to permit a Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Practice;

(iv) to provide a Partner with more control over his/her own estate and financial planning; and

(v) to enhance the Partnership's ability to retain current and recruit additional XXXXXXXXXX .

RULINGS

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,

our rulings are as follows:

A. A particular Contracting Company that supplies Professional Services to the Partnership, as described above in the proposed transactions, will not be considered to be carrying on a personal services business. This is only so provided the particular Partner that provides Professional Services to the Partnership through their Contracting Company would not, if that Contracting Company did not exist, reasonably be regarded as an officer or employee of the Partnership in respect of those services.

B. Provided a particular Contracting Company was not a member of any partnership in the relevant year, the Fee income earned by the particular Contracting Company pursuant to a Contract, as described in Paragraph 8, will not be specified partnership income.

C. 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 particular Partner that provides Professional Services to the Partnership through their Contracting Company and the other Partners with respect to sharing the Partnership's income for income tax purposes.

D. Subject to sections 18 and 67 of the Act, the Fee payable by the Partnership to a particular Contracting Company pursuant to a Contract, as described in Paragraph 8, will be deductible by the Partnership in its determination of the Partnership's income for purposes of subsection 96(1) of the Act.

E. The proposed transactions undertaken as described above, and in particular the Fee payments described in Paragraph 8, 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 of the Fees received by a particular Contracting Company under a Contract to be taxed as income in the hands of a Partner.

F. Provided the amount of the Partnership's income allocated to a particular Partner that provides Professional Services to the Partnership through their Contracting Company is otherwise reasonable, having regard to all the relevant circumstances, that Partner's share of the Partnership's income will not be altered, pursuant to subsection 103(1) of the Act, solely as a result of that Partner choosing, pursuant to amendments to the Partnership Agreement, to provide all of its Professional Services to the Partnership through a Contracting Company, all as described above in the proposed transactions.

G. Implementation of the proposed transactions 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 general limitations and qualifications set forth in Information Circular 70-6R5, issued by the CRA on May 17, 2002, and are binding on the CRA provided the proposed transactions are entered into on or before XXXXXXXXXX . These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly that the CRA has agreed to or accepted the reasonableness or fair market value of any fees or expenditures referred to in this letter.

ADDITIONAL COMMENTS

Whether or not a Partner who is providing his or her Professional Services to the Partnership through a Contracting Company would, but for the existence of that Contracting Company, be an employee of the Partnership, or an independent contractor who has entered into a contract for services with the Partnership, is a question of fact that can only be determined after a review of all of the relevant facts, including the actual agreements entered into between the Contracting Company and the Partnership, and between the Contracting Company and the Partner. This review and determination is the responsibility of the 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 ownership of any shares of a Contracting Company, as described in Paragraph 7, 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 Contracting Company to a family member of the Partner who incorporated the Contracting Company. Also, section 120.4 of the Act may apply with respect to taxable dividends from a Contracting Company received in a taxation year by a family member of a Partner who has not attained the age of 17 years before that year. At this time we do not have sufficient information to make any such determinations.

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 the Contracting Companies. 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 the Contracting Companies 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 Contracting Companies.

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
XXXXXXXXXX