2009 Ruling 2008-0302121R3 - Partnership Reorg-Personal Services 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: Relevant legislation and consistent with other similar rulings.

XXXXXXXXXX  						2008-030212

XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: XXXXXXXXXX
Partners [See Appendix "A" for a list of Partners]
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX , and your other correspondence, in which you requested an advance income tax ruling on behalf of the above-noted taxpayers.

You have advised that to the best of your knowledge and that of the Partnership and the Partners (collectively "the Taxpayers"), none of the issues involved in this Ruling is:

(i) in an earlier return of the Taxpayers or a related person;
ii) being considered by a tax services office (TSO) or taxation centre (TC) in connection with a previously filed tax return of the Taxpayers or a related person;
(iii) under objection by 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 expired; or
(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

You have also advised that to the best of your knowledge, and that of the Taxpayers, that the proposed transactions will not result in the Taxpayers or any related person described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

"Act" means the Income Tax Act R.S.C. 1985 (5th Supp.) c.1 as amended from time to time and consolidated to the date of this letter and unless otherwise expressly stated every reference herein to a part, section or subsection, paragraph or subparagraph, and clause or subclause is a reference to the relevant provision of the Act;

"BCA" means the Business Corporations Act (XXXXXXXXXX );

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

"Contracting Professional Corporation" means a corporation that is or will be incorporated pursuant to the BCA and licensed by XXXXXXXXXX to carry on the practice of XXXXXXXXXX in the Province and engaged by the Partnership to provide Professional Services as independent contractors;

"Controlling Shareholder" means an Electing Partner who will provide Professional Services to the Partnership as an employee of the particular Contracting Professional Corporation;

XXXXXXXXXX

"CRA" means the Canada Revenue Agency;

"Electing Partner" means a Partner who elects to provide Professional Services to the Partnership through a Contracting Professional Corporation;

"Fees" means the fair market value to be paid by the Partnership to a particular Contracting Professional Corporation as consideration for Professional Services rendered by the Contracting Professional Corporation;

XXXXXXXXXX

"Income Distribution Plan" means the agreement entered into by the Partners dated XXXXXXXXXX , which is effective as of XXXXXXXXXX , and which is deemed to form part of the Partnership Agreement.

"Net Expense Allocation" has the meaning described in the Income Distribution Plan;

"Non-Electing Partner" means a Partner who does not elect to provide Professional Services to the Partnership through a Contracting Professional Corporation;

"Non-Professional Services" means any service provided by the Partners on behalf of the Partnership, other than Professional Services, including the administrative and managerial activities currently carried on by the Partners;

"Paragraph" refers to a numbered paragraph in this advance income tax ruling;

"Partner" means each of, or any one of, the XXXXXXXXXX and who is a member of the Partnership, and collectively such persons are referred to as the "Partners";

"Partner Adjusted Income" has the meaning described in Income Distribution Plan;

"Partnership" means the XXXXXXXXXX

"Partnership Agreement" means the signed written partnership agreement entered into by the Partners dated XXXXXXXXXX .

"personal service business" has the meaning assigned by subsection 125(7);

"Practice" means the business carried on by the Partnership of providing both Professional Services and Non-Professional Services;

"Professional Services" means the practice of XXXXXXXXXX in the Province;

"Proposed Transactions" means the transactions described in paragraphs 7 to 14;

"Province" means the Province of XXXXXXXXXX ;

"Related Corporations" mean the XXXXXXXXXX ("Aco"), XXXXXXXXXX ("Bco") and XXXXXXXXXX . ("Cco")

"related persons" has the meaning assigned by subsection 251(2);

"Services Agreement" means the contractual arrangements entered into between a Contracting Professional Corporation and the Partnership for the provisions of Professional Services to the Partnership;

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

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

Our understanding of the facts, proposed transactions and the purposes of the proposed transactions are as follows:

FACTS

1. The Practice is carried on as a general partnership in the Province of XXXXXXXXXX . The Partnership's identification number is XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Centre and deals with the XXXXXXXXXX TSO. The fiscal year of the Partnership ends on XXXXXXXXXX . The Partnership has been carrying on the business of the Practice under predecessor partnership agreements since XXXXXXXXXX .

2. The Partnership carries on the business of providing XXXXXXXXXX services to the public through the operation of a XXXXXXXXXX . The Partners provide Professional Services to clients of the Partnership on behalf of the Partnership subject to the terms of the Partnership Agreement. The Partnership currently has XXXXXXXXXX Partners. None of the Partners are related persons. Each of the Partners is a resident of Canada for the purposes of the Act.

3. The Partnership contracts and/or employs a limited number of staff. The Partnership currently contracts with XXXXXXXXXX associates, each of whom is a XXXXXXXXXX that is licensed by XXXXXXXXXX to practice XXXXXXXXXX in the Province. None of the associates are Partners in the Partnership or are the subject to the Proposed Transactions. The Partnership also employs approximately XXXXXXXXXX full-time and part-time secretarial, administrative and other professional staff members such as XXXXXXXXXX .

4. The Partnership holds the shares in the capital stock of three Related Corporations either directly or indirectly. In particular, the Partners and/or their spouses own all of the issued and outstanding shares of the Aco, Bco and Cco.

5. The Partnership is governed by a written partnership agreement recently amended and effective as of XXXXXXXXXX (the "Partnership Agreement"). The key terms of the Partnership Agreement are as follows:

(a) There are three categories of Partners:

(i) Full Partners with equal rights, privileges and responsibilities as defined in the Partnership Agreement;
(ii) Semi-Retired Partners which includes Partners who have completed XXXXXXXXXX years of "Association" with the Partnership and who have been granted such status after making an application as required under the terms of the Partnership Agreement; and
(iii) Retired Partners which includes Partners who have completed XXXXXXXXXX years of "Association" with the Partnership and who have attained XXXXXXXXXX years of age whose application for such status has been accepted by the Partnership.

(b) Each Partner has at least one vote in the decisions of the Partnership and most decisions shall be made by simple majority of the votes cast. Other decisions with respect to the following matters require the approval of XXXXXXXXXX % of the Partners present:

(i) any amendment to the Partnership Agreement;
(ii) any amendment to the Income Distribution Plan;
(iii) the admission of a new Partner; and
(iv) the expulsion of a Partner.

(c) Voting rights are awarded as follows:

(i) new Partners shall have one vote immediately upon commencing Association with the Partnership;
(ii) after completion of XXXXXXXXXX years of Association, Partners shall have XXXXXXXXXX votes;
(iii) upon completion of XXXXXXXXXX years of Association with the Partnership, each Partner shall have XXXXXXXXXX votes;

(d) "Association" is a defined term and accrues as determined under the provisions of the Partnership Agreement. "Association" means association with the Practice, as a Partner or full-time Associate. "Association" also accrues for mature partners on the basis of a deemed one-half year of Association for each year of full time practice for the first XXXXXXXXXX years in a similar practice as that of the Practice, and deemed one year of Association for each year of full time practice for all years after the first XXXXXXXXXX years in a similar practice as that of the Practice.

(e) A quorum of XXXXXXXXXX % of all Partners is required at a duly constituted business meeting with respect to any decisions of the Partners. Partners unable to attend a duly constituted business meeting may appoint a Partner as a proxy for the specific meeting.

(f) An Executive Committee may be established comprising of no fewer than XXXXXXXXXX Partners for the purposes of conducting the administrative tasks related to the business of the Partnership. The current Executive Committee consists of XXXXXXXXXX

(g) Financial Statements must be prepared annually in accordance with generally accepted accounting principles consistently applied from year to year. Each Partner's capital account is credited with the amount of such Partner's proportionate share of the Partnerships profits and capital contributed by such Partner as determined under the Income Distribution Plan.

(h) Each Partner is entitled to draw funds from the Partnership based on total fees billed for Professional Services performed by such Partner and as determined under the terms of the Income Distribution Plan.

(j) A Partner may be expelled from the Partnership by reason of being convicted for committing any criminal offence involving moral turpitude or objectionable social or professional conduct. Any Partner may also be expelled from the Partnership by reason of inadequate performance of his or her duties, insufficient contribution to the revenues of the Partnership and, or loss of XXXXXXXXXX and loss of the right to practice XXXXXXXXXX .

(k) A Partner may retire from the Partnership by giving XXXXXXXXXX days written notice of his or her intention to do so.

(1) Upon the death of a Partner, the deceased Partner's capital account will be calculated and the amount, if any, paid to the deceased's estate in XXXXXXXXXX equal consecutive XXXXXXXXXX instalments.

(m) A Partner may engage in the Practice of XXXXXXXXXX outside his/her minimum hours of work and retain all remuneration there from provided that:

(i) Such XXXXXXXXXX practice shall not conflict with a Partner's duties and obligations to the Partnership XXXXXXXXXX ;
(ii) Upon request of the Partnership, he/she shall devote all professional time and attention outside his/her minimum hours of work in the event of XXXXXXXXXX ;

(n) Upon a sale of XXXXXXXXXX or any of the Partnership's ancillary services, including the XXXXXXXXXX , the profits of each such sale shall be divided and distributed among the Partners who have been Partners of the Partnership for a period in excess of XXXXXXXXXX years.

6. The Income Distribution Plan is an agreement dated XXXXXXXXXX , and effective as of XXXXXXXXXX . Paragraph XXXXXXXXXX of the Partnership Agreement deems the Income Distribution Plan to form part of the Partnership Agreement. The terms of the Income Distribution Plan are as follows:

(a) each Partner shall, in each year, unless otherwise indicated, be entitled to receive income from the Partnership calculated on the basis of the aggregate of the following amounts:

(i) total fees billed for Professional Services performed by such Partner;
(ii) the aggregate of the amounts which represent a percentage of the fees billed XXXXXXXXXX ;
(iii) an allowance for courses for continuing XXXXXXXXXX education attendance up to a maximum;
(iv) disability benefits paid by the Partnership as described in Paragraph XXXXXXXXXX and
(v) a business allowance representing payment for Non- Professional Services on behalf of XXXXXXXXXX as approved by the Executive Committee;

such income is referred to a "Partner Adjusted Income" ("PAI").

(b) Each Partner's PAI is reduced by such Partner's share of the Net Expense Allocation ("NBA") allocated to that Partner pursuant to the terms of the Income Distribution Plan. The NBA is determined by the Practice's Managing Director based on fixed and variable expenses of the Partnership. Such NBA reduces each Partner's draw of Partnership income.

PROPOSED TRANSACTIONS

7. The Partnership Agreement will be amended to permit each Partner to provide their professional services as an independent contractor through their own Contracting Professional Corporation that is authorized by XXXXXXXXXX and enter into a Services Agreement with the Partnership. To implement this change, the Partnership Agreement will differentiate between the two functions that each Partner performs, that being Professional Services and Non-Professional Services. The Partnership Agreement will also be amended to provide as follows:

(a) An Electing Partner will no longer be permitted to provide any Professional Services to the Partnership in his or her capacity as Partner. These amendments will not affect the provision of Non-Professional Services, which will continue to be wholly provided by the Electing Partners to the Partnership in their capacity as Partners. A provision will be added to clearly differentiate between Professional Services and Non-Professional Services.

(b) An Electing Partner who provides Professional Services to the Partnership through a Contracting Professional Corporation will be allocated income in respect of Non-Professional Services only. For greater certainty, this means that an Electing Partner's income allocation for that year from the Partnership will not take into account any Professional Services provided by such Partner directly or indirectly through a Contracting Professional Corporation to the Partnership. A Non-Electing Partner's share of the profits of the Partnership will be based upon the Non-Electing Partner's Non-Professional Services rendered to the Partnership as well as the Professional Services rendered to the Partnership.

(c) Electing Partners will be responsible for their own disability insurance expenses, which may be arranged independently of the Partnership or through the Partnership. The Partnership Agreement and the Income Distribution Plan will be amended to provide that Electing Partners will not be entitled to the allowance for continuing XXXXXXXXXX education course attendance or disability benefits.

(e) A provision will be added to prohibit the transfer, conveyance or issuance of an interest in the Partnership to any Contracting Professional Corporation.

8. An Electing Partner who wishes to provide Professional Services to the Partnership through a Contracting Professional Corporation will incorporate, or will have already incorporated, a new corporation pursuant to the laws of the Province that will qualify as a TCC and CCPC. For greater certainty, any Contracting Professional Corporation that has already been incorporated is dormant and was incorporated in anticipation of entering into the proposed transactions noted below and obtaining this ruling. All of the issued and outstanding voting shares of the capital stock of an Electing Partner's Contracting Professional Corporation must be legally and beneficially owned by that Electing Partner. However, non-voting shares of an Electing Partner's Contracting Professional Corporation may be issued to one or more persons who is a "family member" of that Electing Partner. For these purposes, a "family member" is defined as an individual who is a resident of Canada for the purposes of the Act and who is a related person in relation to the particular Electing Partner by reason of paragraph 251(6). All shareholders will be residents of Canada.

9. An Electing Partner cannot be an employee, officer, director or legal of beneficial shareholder of more than one Contracting Professional Corporation and no two Contracting Professional Corporations will be related persons.

10. Each Contracting Professional Corporation will hold a certificate of authorization issued by XXXXXXXXXX .

11. An Electing Partner must provide a written notice to the Partnership setting out his or her intention to provide Professional Services through a Contracting Professional Corporation.

Upon receipt of such written notice the Partnership will enter into a Services Agreement with that Electing Partner's Contracting Professional Corporation for the provision of Professional Services to the Partnership by the Contracting Professional Corporation. The terms of a Services Agreement entered into between the Partnership and each Contracting Professional Corporation will be negotiated separately. The Services Agreements will provide for the following:

a) The Services Agreement will be for an indefinite period but may be terminated by the Contracting Professional Corporation upon XXXXXXXXXX days written notice or any other event of termination as negotiated by the parties;

b) Professional Services will be rendered by the Contracting Professional Corporation to the Partnership in return for Fees paid directly to the Contracting Professional Corporation;

c) The Fees will be based on the fair market value of the Professional Services provided by the Contracting Professional Corporation to the Partnership. For greater certainty, 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;

d) An amount, based on the fair market value of the general office expenses incurred by the Partnership, including personnel, facilities and equipment provided to a particular Contracting Professional Corporation will be included in the computation of the Fees to be paid to that Contracting Professional Corporation, causing a reduction in the amount of the Fees paid to that Contracting Company.

e) The Contracting Professional Corporation will be responsible for the following expenses:

• Professional membership fees in respect of the Controlling Shareholder;
• Professional liability insurance, life and/or disability insurance for the Controlling Shareholder, if any;
• Continuing XXXXXXXXXX education costs;
• Travel expenses, including car, accommodation and meal expenses;
• Communication expenses except as required under Services Agreement;
• Maintaining professional standards set by XXXXXXXXXX and by the Partnership;
• Office equipment and supplies; and
• Additional business expenditures relating to personal practice preference of the Contracting Professional Corporation;

f) The Contracting Professional Corporation will invoice the Partnership monthly in arrears for the Fees for Professional Services rendered that month;

g) any payments received by the Partnership from third parties in respect of Professional Services provided by the Contracting Professional Corporation will be for the benefit of the Partnership and if a Contracting Professional Corporation receives any amounts, they will be remitted to the Partnership;

12. Each Contracting Professional Corporation will enter into a written Employment Agreement with the Electing Partner whereby the Electing Partner will be hired in the capacity of an employee to provide Professional Services for and on behalf of the Contracting Professional Corporation with a view to fulfilling the latter's obligations under the Services Agreement. Each Electing Partner will be entitled to receive a salary from his or her Contracting Professional Corporation.

13. Provided a Contracting Professional Corporation fully discharges its responsibilities under the Services Agreement, the Contracting Professional Corporation and Electing Partner will not be restricted from providing Professional Services to other persons or otherwise prohibited from competing with the Partnership. 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 Electing Partner from competing with the Partnership in respect of the provision of Professional Services.

14. Within 6 months of the date of this Ruling, at least one Partner who wishes to provide services through a Contracting Professional Corporation will provide the Partnership with a written notice of his or her intention to provide Professional Services through a Contracting Professional Corporation and will incorporate a corporation for such purpose on the terms and conditions outlined above for Contracting Professional Corporations.

PURPOSE OF THE PROPOSED TRANSACTIONS

The primary purpose of the proposed transactions is to allow a Partner to take advantage of the recent legislative amendments by the Province of XXXXXXXXXX which permits XXXXXXXXXX to render professional services through a Professional Corporation, which provides the following benefits:

• It provides a Partner with an increased level of control over his or her participation in the Practice through individual management of personal practice preferences;
• It permits a Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Practice; and
• It provides a Partner with more control over his or her own estate and financial planning.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, Proposed Transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are set forth below.

A. The execution and implementation of the proposed transactions described herein, in and of themselves, will not constitute a disposition of part or all of an interest in the Partnership by any Partner for the purposes of the Act.

B. Provided that an Electing Partner would not, but for the existence of the Contracting Professional Corporation, be an officer or employee of the Partnership in respect of the provision of Professional Services, the Contracting Professional Corporation 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 partnership does not exist between an Electing Partner's Contracting Professional Corporation and another Contracting Professional Corporation, the income earned by a Contracting Professional Corporation, in particular, the Fees, 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 the Contracting Professional Corporation as described in Paragraphs 11(c) and 11(d) herein, will be deductible by the Partnership in the determination of the Partnership's income pursuant to subsection 96(1) of the Act.

E. The transactions undertaken in Paragraphs 7 through 14 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 the Contracting Professional Corporation under the Services Agreement to be taxed as income in the hands of the Controlling Shareholder of such Contracting Professional Corporation.

F. Provided that the amount of the Partnership income allocated to each Named Partner is reasonable, having regard to all the relevant circumstances, the sharing of the income between the Partners will not be subject to adjustment pursuant to subsection 103(1) of the Act solely as a result of the Partners being allowed, pursuant to amendments to the Partnership Agreement described herein, to incorporate a Contracting Professional Corporation and to provide all of his or her Professional Services to the Partnership through that Contracting Professional Corporation in consideration for the Fees.

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 Taxpayers and the remaining Partners with respect to the sharing of Partnership income for income tax purposes.

H. Implementation of the Proposed Transactions as described above will not, in and by themselves, result in the application of the provisions of subsection 245(2) of the Act to re-determine the tax consequences confirmed in the rulings given above.

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 a Named Partner would, if the Contracting Professional Corporation 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 Contracting Professional Corporation and the Partnership and between the Contracting Professional Corporation and the Named Partner. This review and determination is the responsibility of the particular 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 the Contracting Professional Corporation 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 Contracting Professional Corporation to a family member of the Partner. Also, section 120.4 of the Act may apply with respect to taxable dividends or trust income in respect of taxable dividends from the Contracting Professional Corporation received in a taxation year by a family member of the 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 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

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