2009 Ruling 2009-0325051R3 - 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 									2009-032505

XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
Schedule "A" - List of 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 various emails and in the telephone conversations (XXXXXXXXXX ).

We understand that to the best of your knowledge and the Named Partners (collectively the "Taxpayers"), none of the issues involved in this 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 taxation centre in connection with a tax return previously 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; or

(v) the subject of a previously issued ruling by the Directorate to one of the Taxpayers or a related person.

Except as otherwise stated, a reference in this ruling request to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Income Tax Act (the "Act"), unless otherwise specified.

DEFINITIONS

(a) XXXXXXXXXX

(b) XXXXXXXXXX ;

(c) XXXXXXXXXX

(d) XXXXXXXXXX ;

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

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

(g) "Electing Partner" means the Equity Partners who elect to provide their Professional Services through a ServicesCorp;

(h) "Equity Partner" means a Partner who is required pursuant to the Partnership Agreement to invest capital in the Partnership;

(i) "Fees" means the fee to be charged under the Services Agreement by a ServicesCorp to the Partnership;

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

(k) "XXXXXXXXXX Partner" means a Partner who is duly qualified to carry on the practice of XXXXXXXXXX ;

(l) XXXXXXXXXX ;

(m) XXXXXXXXXX ;

(n) XXXXXXXXXX ;

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

(p) "Non-XXXXXXXXXX Partner" means a Partner other than a XXXXXXXXXX Partner;

(q) "Non-Professional Services" encompass any non-professional service provided by Partners on behalf of the Partnership. This will generally mean the administrative and managerial activities carried on by the Partners including business development, maintaining client relationships, promoting and contributing to the growth of the Practice, enhancing the profile of the Partnership, educating and managing staff and generally conducting management functions;

(r) "PA" means the Partnerships Act (XXXXXXXXXX ), as amended;

(s) "Partners" means individual XXXXXXXXXX Partners and Non-XXXXXXXXXX Partners that are currently members of the Partnership.

(t) "Partnership Agreement" refers to the existing Partnership Agreement by which the Partners are currently bound;

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

(v) "Professional Code" means the XXXXXXXXXX ;

(w) "Professional Requirements" means the XXXXXXXXXX ;

(x) "Professional Services" means the practice of XXXXXXXXXX ;

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

(z) "Services Agreement" refers to the sub-contracting agreement which will be used to set out the terms and conditions by which a ServicesCorp will provide Professional Services to the Partnership;

(aa) "ServicesCorp" 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;

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

(cc) "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 an Amended and Restated Partnership Agreement effective XXXXXXXXXX . Its principal office is located at XXXXXXXXXX . The Partnership's tax identification number is XXXXXXXXXX and its business number is XXXXXXXXXX . The Partnership carries on the practice from its principal office in XXXXXXXXXX , as well as from offices in 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 .

2. On XXXXXXXXXX , the Partnership was continued as a "limited liability partnership" pursuant to and in accordance with XXXXXXXXXX . The Partnership has been carrying on the business of the Practice since XXXXXXXXXX , under the Partnership Agreement. The Partnership has been carrying on the business of the Practice under predecessor partnership agreements since XXXXXXXXXX . There are XXXXXXXXXX employees in the Partnership, XXXXXXXXXX . This ruling is not applicable to any employees of the Partnership.

3. Effective as of XXXXXXXXXX , the Partnership has been organized as a XXXXXXXXXX to engage in the practice of XXXXXXXXXX and any XXXXXXXXXX . The management of the Partnership is overseen by an Executive Committee, and some of the Partnership's administration, human resource management and business operations have been sub-delegated to XXXXXXXXXX , being a partnership composed of partners who are related to the Partners. These services are provided at cost plus a mark-up at fair market value.

4. The Named Partners include XXXXXXXXXX Partners and Non-XXXXXXXXXX Partners all of whom are Equity Partners.

6. The Partners are resident in Canada for the purposes of the Act and are not Related Persons, XXXXXXXXXX .

7. The Partnership carries on the Practice. The Partners provide Professional Services and Non-Professional Services to the Partnership.

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

(a) Partners must devote substantially their full time, energy and ability to the Practice of the Partnership unless prevented by sickness or other reasonable cause.

(b) All clients of the Practice are clients of the Partnership.

(c) All XXXXXXXXXX Partners must, at all times, maintain their status as duly qualified to carry on the practice of XXXXXXXXXX and membership in good standing with the XXXXXXXXXX . All Non-XXXXXXXXXX Partners shall maintain their professional qualification as a XXXXXXXXXX and otherwise be duly qualified to carry on an XXXXXXXXXX and otherwise satisfy the XXXXXXXXXX

(d) Partners may not transfer, sell, assign or encumber the Partner's interest in the Partnership.

(e) New Partners may be admitted to the Partnership only if agreed to by the Partners in accordance with the Partnership Agreement.

(f) Capital accounts are maintained for each Equity Partner to which is credited the amount of all capital contributions and the amount of all income allocated to the Equity Partner, and to which is debited the amount of any loss allocated to the Equity Partner and any withdrawals made by the Equity Partner. The level of capital contribution required of the Equity Partners is determined from time to time by the Equity Partners in accordance with the Partnership Agreement.

(g) Each Partner's share of the net income or loss from the Partnership in a fiscal year is determined in accordance with methodology as decided from time to time by resolution of the Partnership's Allocation Committee, made up of selected Equity Partners. The methodology generally takes into account XXXXXXXXXX services, XXXXXXXXXX contributions and seniority of the partner.

(h) The amount of a Partner's regular and additional draws are determined from time to time by the Equity Partners pursuant to the Partnership Agreement.

(i) Each Partner has responsibilities with respect to the provision of Non-Professional Services to the Partnership. The Partnership may also engage others to provide management and administration services to the Partnership.

(j) Each member of the Partnership has an equal say in the decisions of the Partnership and significant decisions, but no changes to any of the following may be done without the approval of XXXXXXXXXX of the Equity Partners:

(i) any matter affecting any Equity Partner's capital in the Partnership;
(ii) the methodology of determining the division of the Partnership's profits and losses;
(iii) any policy concerning entitlement to a long term absence from the Partnership including disability leave, sabbatical leave and maternity leave;
(iv) any allowance which may be payable to a deceased or retiring Partner;
(v) any increase in the authorized level of borrowing of the Partnership;
(vi) controls for financial expenditures by the Partnership; and
(vii) any other matter relating to the financing of the Partnership or the capital accounts which the Partners decide from time to time shall be the subject of a resolution.

(k) A dissolution of the Partnership may occur upon the agreement of XXXXXXXXXX of the Partners agreeing to dissolve the Partnership.

PROPOSED TRANSACTIONS

9. 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 an Equity Partner to elect to provide his or her Professional Services as an independent contractor through a ServicesCorp controlled by him or her, and he or she will no longer be permitted to provide any Professional Services to the Partnership in his or her capacity as a Partner. An Electing Partner must provide a written notice setting out his or her intention to provide Professional Services through a ServicesCorp. An Electing Partner will remain a Partner of the Partnership.

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

(d) A provision will be added to prohibit the carrying out of Non-Professional Services by the ServicesCorps. 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 the Partnership's 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 the Electing Partner's Non-Professional Services conducted for 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 ServicesCorp, 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 ServicesCorp.

(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 Taxation Year will, subject to maintaining a minimum capital contribution, 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) A provision will be added to provide that, as long as a ServicesCorp fully discharges its responsibilities under the Services Agreement, the ServicesCorp 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 provide that Electing Partners 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 a ServicesCorp or the Electing Partners from competing with the Partnership in respect of the provision of Professional Services.

10. Each ServicesCorp will be required to comply with the following requirements:

(a) It will be incorporated pursuant to the laws of the Province of XXXXXXXXXX .

(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 voting shares of the particular ServicesCorp. If required by the Professional Requirements, all shares whether voting or non-voting shares, will be legally and beneficially held by the Electing Partners. All issued non-voting shares of a ServicesCorp, if any, will be owned directly by the Electing Partners or by the Electing Partner's family members. All shareholders of each ServicesCorp will be Canadian residents. For the purpose of this ruling request, "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.

(d) An Electing Partner will be the sole director of his or her ServicesCorp. He or she will also be an employee of ServicesCorp and may be paid a salary for his or her service. The Electing Partner's status as an employee of his or her ServicesCorp will be evidenced by a written employment agreement.

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

(f) No two ServicesCorps will be Related Persons, XXXXXXXXXX (referred to in paragraph 6).

11. Upon receipt of a written notice from an Electing Partner, the Partnership will enter into a written Services Agreement with the particular Electing Partner's ServicesCorp containing the following terms:

(a) The Services Agreement will be for an indefinite period but may be terminated by either party upon 30 days notice or upon any other event of termination as described therein.

(b) The ServicesCorp will provide Professional Services on behalf of the Partnership in return for Fees. The amount of the Fees will be tied to the level of work performed by the ServicesCorp, XXXXXXXXXX Further, the amount of the Fees will be based on the fair market value of the Professional Services provided by the ServicesCorp to the Partnership. The ServicesCorp will invoice the Partnership for such Fees. The Partnership and each ServicesCorp will jointly determine an estimate of the Fees payable to the ServicesCorp for a particular year. Based on the estimate, the Partnership will pay the ServicesCorp monthly or more frequent installments on account of the estimated Fees payable. The Partnership may, from time to time, make additional payments to the ServicesCorp in respect of a Taxation Year as may be necessary to top up the installments to the amount of Fees then estimated to be payable. Any such top up payments would be based on the fair market value of the Professional Services actually provided by the particular ServicesCorp. At the end of the Taxation Year, the parties will conduct a final reconciliation.

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

(d) Each ServicesCorp will be responsible for the cost of any general office expenses incurred by the Partnership that may reasonably be attributed to the particular ServicesCorp and the fair market value of such expenses will be charged as an offset against the Fees.

12. Each ServicesCorp will be responsible for the following expenses:

(a) Professional membership fees in respect of the Electing Partner;

(b) Professional liability insurance (to the minimum coverage level required by the Professional Requirements) and/or disability insurance for the particular Electing Partner;

(c) Continuing education costs;

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

(e) Communication expense, including cellphone and Blackberry devices;

(f) Office equipment and supplies; and

(g) Additional business expenditures relating to personal practice preferences of the particular ServicesCorp.

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

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Proposed Transactions is to allow the Named Partners to benefit from the legislative amendments by a Province which permits XXXXXXXXXX to render professional services through professional corporations. The Proposed Transactions also provide the following benefits to both XXXXXXXXXX Partners and Non-XXXXXXXXXX Partners:

(a) it provides those Partners with an increased level of control over their participation in the Practice through individual management of personal practice preferences;

(b) it permits those Partners to have more control over expenditures where such expenditures may not be in the interest of all Partners;

(c) it permits those Partners to have more control over their estate and financial planning;

(d) it enhances the Partnership's ability to retain current Partners and to recruit new Partners and other professionals to the Partnership; and

(e) it provides some further measure of asset protection to those Partners.

RULINGS GIVEN

A. Provided that an Electing Partner would not, if his or her ServicesCorp 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 ServicesCorp 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 ServicesCorp 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 ServicesCorp 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 ServicesCorp 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 9 to 13, 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 Electing Partner's ServicesCorp under the Services Agreement to be taxed as income in the hands of the particular Electing Partner.

E. Provided that the amount of Income allocated to each 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 an Electing Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a ServicesCorp and to provide all of his or her Professional Services to the Partnership through that ServicesCorp for Fees.

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

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 particular Electing Partner and any other Electing Partner with respect to the sharing of 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 give 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 an Electing Partner would, if the ServicesCorp 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 ServicesCorp and the Partnership and between the ServicesCorp and the Electing Named 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 the ServicesCorp 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 ServicesCorp 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 the ServicesCorp 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.

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 ServicesCorps. 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 ServicesCorps 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 ServicesCorps.

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