2009 Ruling 2009-0318261R3 - Ptnsp contracting out pro services to ptner 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 the active business income earned by a professional corporation carrying out services for a partnership as an independent contractor, where the sole common shareholder is a partner of the partnership, would qualify for the small business deduction and not be restricted under the rules for specified partnership income or personal services business.

Position: No, provided the facts are accurate and the proposed transactions are carried out as described.

Reasons: The facts and proposed transactions, as described, conform to our requirements as laid out in respect of such proposed transactions.

XXXXXXXXXX 						2009-031826

XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
XXXXXXXXXX (the " Electing 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 Electing Partners. We also acknowledge the information provided in various emails and telephone conversations (XXXXXXXXXX ).

To the best of your knowledge and that of the Partnership and the Electing 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) "Contract" refers to the sub-contracting agreement which will be used to set out the terms and conditions by which a ProCorp will provide Professional Services to the Partnership;

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

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

(e) "Fees" refers to the fee to be charged under the Contract by a ProCorp to the Partnership;

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

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

(h) "Non-Professional Services" includes the promotion of the Practice, as well as any other service provided by the Partners on behalf of the Partnership that is not part of the Professional Services;

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

(j) "Partnership Agreement" refers to the existing partnership agreement by which the Partnership is governed, dated XXXXXXXXXX ;

(k) "Practice" means the XXXXXXXXXX practice currently carried on by the Partnership and encompasses both Professional Services and Non-Professional Services;

(l) "ProCorp" means each of the corporations to be formed by an Electing Partner and through which an Electing Partner will provide Professional Services as an employee of that corporation;

(m) "Professional Services" means the XXXXXXXXXX services provided by the Partnership;

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

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

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

(q) "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 is governed by the Partnership Agreement, effective XXXXXXXXXX , and has been carrying on the Practice since XXXXXXXXXX . It carries out the Practice from XXXXXXXXXX . Its filer identification number is XXXXXXXXXX and its fiscal period end is XXXXXXXXXX .

2. The Partnership files its information returns with the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office. The Electing Partners file their individual income tax returns with various tax centres and deal with various tax services offices.

3. The Electing Partners named above are the only partners of the Partnership.

4. The Electing Partners are resident in Canada for the purposes of the Act and are not Related Persons.

5. The key terms of the Partnership Agreement are as follows:

(a) The interests of the Partners are represented by units (the "Units").

(b) Upon admission to the Partnership, a person acquires a certain number of Units. Additional Units may be distributed among the Partners based on their performance and contributions to the Partnership.

(c) XXXXXXXXXX % of the annual profit of the Partnership is distributed among the Partners based on the proportionate share of the Units held, while the other XXXXXXXXXX % is allocated to a "Bonus Pool", which is distributed among the Partners based on discretionary criteria. The discretionary criteria are based on both objective and subjective measurement criteria.

(d) Capital accounts are maintained for each Partner and "interest" is paid on such capital accounts. For income tax purposes, such interest is treated as an allocation of Partnership profits.

(e) Upon the death of a Partner, the deceased Partner is considered to have "withdrawn" from the Partnership and the deceased Partner's estate is entitled to his or her:

(i) share of estimated Partnership profits to the date of withdrawal;

(ii) balance of capital account,

(iii) share of work-in-progress, and

(iv) share of any net assets whose fair market value is in excess of that recorded in the books of the Partnership.

The Units owned by a deceased Partner at the time of his or her death are deemed to have been surrendered at such time as the Estate of the deceased Partner has been paid in full for his or her interest in the Partnership. The Units of a deceased Partner are not entitled to a vote.

(f) Most Partnership matters ("Ordinary Resolutions") require a simple majority of votes of the Partners. Some Partnership matters ("Special Resolutions") require the approval of Partners holding XXXXXXXXXX % of the outstanding Units holding voting rights.

(g) Each Partner must devote his or her full time, energy and ability to the business of the Partnership unless prevented by sickness or other reasonable cause. No Partner can carry on any practice as XXXXXXXXXX for his or her own private advantage, but any such business must be carried on for the benefit of the Partnership only.

(h) When a Partner voluntarily withdraws from the Partnership, he or she is entitled to certain amounts from the Partnership. If such Partner does not agree in writing not to establish a new XXXXXXXXXX or otherwise compete in any way with the Partnership within a radius of XXXXXXXXXX miles from the Partnership's principal place of business for a period of XXXXXXXXXX months following the date of withdrawal, such Partner will lose his or her entitlement to receive:

(i) his or her share of work-in-progress, and

(ii) his or her share of any net assets whose fair value is in excess of that recorded in the books.

Proposed Transactions

6. The Partnership Agreement will be amended as follows:

(a) A provision will be added to differentiate between Professional Services and Non-Professional Services.

(b) A provision will be added to allow a Partner to elect to provide his or her Professional Services through a ProCorp controlled by him or her, and 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. A Partner must provide a written notice setting out his or her intention to provide Professional Services through a ProCorp.

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

(d) A provision will be added to prohibit the carrying out of Non-Professional Services by the ProCorps. All Electing Partners will continue in their capacity as Partners to carry out the Non-Professional Services for the Partnership.

(e) 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 Taxation Year will be dependent solely on 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.

(f) 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's allocation of Income for a particular year will be based on factors connected to the Professional Services and Non-Professional Services carried out by the Non-Electing Partner on behalf of the Partnership.

(g) All non-competition clauses will be deleted. Instead, the Partnership Agreement will provide that, as long as a ProCorp fully discharges its responsibilities under the Contract, 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 themselves are not restricted from competing with the Partnership with respect to 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 ProCorps or the Electing Partners from competing with the Partnership in respect of the provision of Professional Services.

7. Each ProCorp will be required to comply with the following requirements:

(a) It will be incorporated pursuant to the laws of the Province and will be licensed to carry on the practice of XXXXXXXXXX in the Province.

(b) It will qualify as a TCC and a CCPC.

(c) It will be controlled by an Electing Partner, who will be the legal and beneficial owner of all of the shares of the particular ProCorp, whether voting or non-voting shares. All shareholders legally or beneficially owning voting and non-voting shares of the ProCorp will be residents of Canada.

(d) An Electing Partner will be the sole director of his or her ProCorp. He or she will also be an employee of ProCorp.

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

(f) No two ProCorps will be Related Persons.

8. Upon receipt of a written notice from an Electing Partner, the Partnership will enter into a written Contract with the particular Electing Partner's ProCorp containing the following terms:

(a) The Contract will be for a fixed period equal to the lesser of 12 months or the period until the next fiscal period of the Partnership. It may be renewed each year but may be terminated by either party upon 60 days notice. In the event that an Electing Partner suffers a physical or mental disability such that the ProCorp is unable to provide the services required under the terms of the Contract, the Partnership will have the right to terminate the Contract. Also, in the event of the death of an Electing Partner or the bankruptcy of a ProCorp or its Electing Partner, the Partnership will have the right to immediately terminate the Contract.

(b) The ProCorp will provide Professional Services on behalf of the Partnership in return for Fees. The amount of the Fees will based on the fair market value of the Professional Services provided by the ProCorp to the Partnership. In this regard, the Fees will relate only to the level of work performed by ProCorp and will not take into account the success of XXXXXXXXXX

(c) All payments received by the Partnership from third parties in respect of Professional Services provided by the ProCorp under the Contract will be for the benefit of the Partnership, and if a ProCorp receives any such amounts, they will be remitted to the Partnership.

(d) 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.

(e) Each ProCorp will be responsible for providing all equipment, tools and instruments used in the performance of the Professional Services at its expense. The fair market value of any facilities, equipment, supplies and personnel that are provided by the Partnership to the ProCorps to enable them to provide Professional Services will be charged to the ProCorps.

(f) Each ProCorp will be responsible for all expenses required to maintain the professional standards required of them and all fees and expenses necessary to perform the Professional Services, and, to the extent that such expenses are paid by the Partnership, the ProCorps will reimburse the Partnership. Without restricting the generality of the foregoing, such expenses include expenses in respect of:

(i) Professional membership in respect of the Electing Partner;

(ii) Professional liability insurance;

(iii) Continuing education and training costs;

(iv) Transportation;

(v) Travel, including car, accommodation and meal expenses;

(vi) Communication;

(vii) Business entertainment connected to the business of the ProCorp; and

(viii) Additional business expenditures relating to personal practice preference of the particular ProCorp.

9. The ProCorp's relationship to the Partnership is that of an independent contractor and nothing in the Contract should be construed as:

(a) allowing either party the authority to assume or create any obligation whatsoever, express or implied, in the name of the other nor to bind the other in any manner whatsoever,

(b) giving either party the power to direct and control the day-to-day activities of the other party or any of their respective employees or agents, or

(c) constituting the parties as partners, joint venturers, co-owners or otherwise participants in a joint or common undertaking.

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

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to allow an Electing Partner to use a ProCorp to earn business income by providing Professional Services to the Partnership, as an independent contractor, which will provide a number of other business advantages including:

(i) allowing the Partnership a greater ability to attract and retain highly qualified professionals;

(ii) providing the Electing Partners with an increased level of control over their participation in the Practice through individual management of personal practice preferences;

(iii) permitting the Electing Partners to have more control over expenditures where such expenditures may not be otherwise approved by all members of the Partnership; and

(iv) permitting the Electing Partners to have more control over their estate and financial planning.

Rulings Provided

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

B. Provided that an Electing 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 the particular ProCorp will not be specified partnership income as defined in subsection 125(7) of the Act.

C. Subject to sections 18 and 67 of the Act, the Fees payable by the Partnership to a ProCorp will be deductible by the Partnership in the determination of Income pursuant to subsection 96(1) of the Act.

D. The undertaking of the proposed transactions in paragraphs 6 to 10, 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 Electing Partner's ProCorp under the Contract to be taxed as income in the hands of the particular Electing Partner.

E. Provided that the amount of Income allocated to each Electing Partner is reasonable, having regard to all the relevant circumstances, the sharing of the Income between the Electing Partners will not be subject to adjustment pursuant to subsection 103(1) of the Act solely as a result of an Electing Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a ProCorp and to provide all of his or her Professional Services to the Partnership through that ProCorp for Fees.

F. 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.

G. The execution and implementation of the proposed transactions described above, in and of themselves, will not constitute a disposition of part or all of an interest in the Partnership by any of the Electing Partners.

H. The execution and implementation of the proposed transactions described above, will not, in and of themselves, create a non-arm's length relationship between an Electing Partner and any other Partner with respect to sharing Income for income tax purposes.

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, and whether the Partnership is a partnership at law.

Additional Comments

Whether or not a particular Electing 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 particular Electing Partner. This review and determination is the responsibility of the particular Electing 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 an Electing 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 such ProCorp to a family member of the Electing 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 Electing Partner who has not attained the age of 17 years before that year.

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 the 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