2009 Ruling 2009-0343391R3 - 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 								2009-034339

XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
Appendix "A" - "Electing Partners"

We are writing in response to your letter dated 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 your various emails.

We understand 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 request:

(i) is in an earlier return of one of the Taxpayers or a related person;

(ii) is being considered by a tax services office or taxation centre in connection with a tax return previously filed by any of the Taxpayers or a related person;

(iii) is under objection by any of the Taxpayers or a related person;

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and

(v) is the subject of a ruling previously considered 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, proposed transactions and the purpose of the proposed transactions is as follows:

DEFINITIONS

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

(b) "Contract" refers to the professional services contract to be entered into between the Partnership and a Contracting Company, as described in Paragraphs 20 - 31 below;

(c) "Contracting Company" means each of the corporations that will be incorporated by an Electing Partner and authorized to practice XXXXXXXXXX in the province of XXXXXXXXXX , and that will be engaged by the Partnership to provide Professional Services as an independent contractor, collectively referred to as the "Contracting Companies";

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

(e) "Distributable Net Profits" as this term is used in the Partnership Agreement, means the net profits of the Partnership after deducting all expenses, fees and taxes of every kind;

(f) "Electing Partner" is a reference to each of, or any of, the Partners of the Partnership who elects to provide his or her Professional Services through a Contracting Company. Each of the "Electing Partners" is listed in Appendix A;

(g) "Employment Contract" means the written employment contract to be entered into between a Contracting Company and the particular Electing Partner;

(h) "Fee" means the fair market value fee to be paid by the Partnership to a particular Contracting Company in return for Professional Services rendered by the Contracting Company, as described in Paragraph 22;

(i) "Management Agreement" refers to the agreement dated XXXXXXXXXX between XXXXXXXXXX and the Partnership, pursuant to which XXXXXXXXXX provides management services to the Partnership;

(j) "Non-Professional Services" refers to the Partnership's management and administrative activities and any other activity carried on by the Partnership that is not part of Professional Services;

(k) "Non-Electing Partner" means any Partner who is not an "Electing Partner";

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

(m) "Partner" means an individual who is a Partner in the Partnership;

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

(o) "Partnership Agreement" means the Partnership Agreement dated XXXXXXXXXX , by which the Partnership is governed;

(p) "Practice" means the professional XXXXXXXXXX practice currently carried on by the Partnership. It includes the Professional and Non-Professional Services conducted by the Partners on behalf of the Partnership;

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

(r) "Proposed Transactions" means the transactions listed in Paragraphs 11 to 31;

(s) "Related Persons" has the meaning assigned in subsection 251(2) of the Act;

(t) "Small Business Deduction" has the meaning assigned by subsection 125(1) of the Act;

(u) "Specified Partnership Income" has the meaning assigned by subsection 125(7) of the Act;

(v) "Tax Year" means the fiscal period of the Partnership which, for tax purposes is the calendar year;

(w) "Taxable Canadian Corporation" has the meaning assigned by subsection 89(1) of the Act;

(x) "XXXXXXXXXX " refers to XXXXXXXXXX ., a Taxable Canadian Corporation incorporated under the laws of XXXXXXXXXX , and which is a CCPC carrying on the active business of providing support services to the Partnership.

FACTS

1. The Partnership is a limited liability partnership carrying on the practice of XXXXXXXXXX . The Partnership's filer identification number is XXXXXXXXXX . Its office is located at XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. The present ruling is only in respect of the Partnership, the Electing Partners and the particular Contracting Company of each.

2. There are currently XXXXXXXXXX individual Partners. The Electing Partners and the Non-Electing Partners are the only Partners of the Partnership. The Electing Partners and Non-Electing Partners and their social insurance numbers are set out in Appendix A. The Partnership has XXXXXXXXXX contract associates and employs one employee.

3. The Electing Partners file their respective information returns with the XXXXXXXXXX Taxation Centre.

4. The Partnership has been carrying on business since XXXXXXXXXX . It has done so under the name XXXXXXXXXX since XXXXXXXXXX , pursuant to the Partnership Agreement dated XXXXXXXXXX . The Partners have remained the same since inception except for the admission of an additional Partner by Extraordinary Resolution of the Partners on XXXXXXXXXX .

5. The Partners provide Professional Services to the Partnership.

6. The activities of the Partners can be classified in two different categories: Professional Services and Non-Professional Services.

7. The Partnership operates the Practice on a "fee for service" and/or contract basis.

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

(a) The interests of the Partners in the Partnership are represented by the Partner's Tax-Paid Capital.

(b) Each Partner is required to maintain a minimum amount of Tax-Paid Capital, determined in accordance with the provisions of the Partnership Agreement. The minimum level of Tax-Paid Capital is currently $XXXXXXXXXX per Partner which is the level provided in the XXXXXXXXXX Partnership Agreement.

(c) The Distributable Net Profits of the Partnership are divided amongst the Partners in proportion to each Partner's overall cumulative contribution to the Partnership as determined annually by resolution approved by not less than XXXXXXXXXX of the Partners.

(d) Capital accounts are maintained for each Partner with capital amounts varying between Partners from time to time due to undistributed income.

(e) Upon the death of a Partner, the deceased Partner's partnership interest is forfeited and the deceased Partner's Estate is entitled to the Partner's Tax-Paid Capital and any distributable but unpaid profits allocated to the deceased Partner in respect of the portion of the current or prior fiscal periods preceding death. Similar provisions apply to the voluntary or involuntary withdrawal of a Partner except that a Partner removed for just cause will only be entitled to the return of their Tax-Paid Capital.

(f) Ordinary partnership matters require approval of not less than XXXXXXXXXX % of the Partners. Special matters require approval of not less than XXXXXXXXXX of the Partners. Extraordinary matters must be approved by not less than XXXXXXXXXX % of the Partners.

(g) Each Partner shall devote substantially his or her full time, energy and ability to the business and affairs of the Partnership. No Partner shall carry on any practice as XXXXXXXXXX for his or her private advantage.

9. None of the Partners are related persons for purposes of the Act and none are in a position to control the Partnership.

10. XXXXXXXXXX provides support services to the Partnership pursuant to a management agreement under which it receives a fee. XXXXXXXXXX is owned by persons who are related to the Partners by marriage, who are the adult children of a Partner, or in one instance by a Partner himself, with each Partner or person(s) related to a Partner having an equal interest in the issued and outstanding shares.

PROPOSED TRANSACTIONS

11. Each Electing Partner will incorporate a Contracting Company under the laws of the province of XXXXXXXXXX . Each Contracting Company will be authorized to practice XXXXXXXXXX in the province of XXXXXXXXXX .

12. The Electing Partner that incorporated the Contracting Company will own all of the voting shares of the Contracting Company. Other members of the Electing Partner's family that incorporated the Contracting Company will only be entitled to own the non-voting shares of the Contracting Company. For purposes of this Paragraph, "family" means individuals connected by blood relationship, marriage, common-law partnership or adoption, as those terms are described in subsection 251(6) of the Act.

13. Each Electing Partner will be the sole Director and President of the Contracting Company that he or she incorporates.

14. No Electing Partner will be an employee, officer, director or shareholder, either legally or beneficially, directly or indirectly, of more than one Contracting Company.

15. Each Contracting Company will qualify as a Taxable Canadian Corporation and Canadian Controlled Private Corporation, carrying on an active business. The Electing Partner and the Contracting Company will be related to each other.

16. Upon receipt of the election referred to in Paragraph 19(a), the Partnership will enter into a written contract with the Contracting Company for the Professional Services required. All Electing and Non-Electing Partners will continue in their capacity as Partners to conduct all of the Non-Professional Services of the Partnership.

17. Each Electing Partner will be an employee of his or her Contracting Company in accordance with the Employment Contract between the Electing Partner and the Contracting Company. Each Electing Partner will provide Professional Services for the benefit of the Contracting Company in his or her capacity of employee pursuant to the terms of the Contract with the Partnership. Pursuant to the Employment Contract between an Electing Partner and his or her Contracting Company, the Electing Partner shall be entitled to a salary from his or her Contracting Company.

18. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada. None of the Partners are Related Persons. No two Contracting Companies will be Related Persons.

Partnership Agreement

19. The Partnership Agreement will be amended as follows:

a) an elective provision will be added to allow each Electing Partner to elect to provide Professional Services to the Partnership through a Contracting Company engaged by the Partnership to provide such services as an independent contractor;

b) a provision will be added to differentiate between the only two functions that each Partner performs for the Partnership: (1) Professional Services and (2) Non-Professional Services;

c) a provision will be added that no Electing Partner may provide a Professional Service to the Partnership other than through a Contracting Company;

d) the provision in paragraph XXXXXXXXXX that each Partner devote substantially his or her full time to the business of the Partnership shall be deleted;

e) the provision in paragraph XXXXXXXXXX that no Partner shall carry on any practice as XXXXXXXXXX for his or her own private advantage shall be deleted;

f) the provision in paragraph XXXXXXXXXX that compensation received by a Partner for services rendered in his or her capacity as XXXXXXXXXX will be considered as income of the Partnership shall be deleted;

g) the provision providing for retiring allowances for Electing Partners will be amended to reflect that such a determination will not be based on Professional Services;

h) a provision will be added such that, as long as a Contracting Company fully discharges its responsibilities under the Contract, the Contracting Company will not be restricted from providing Professional Services to other persons or otherwise prohibited from competition with the Partnership. For greater certainty, there will be no terms in the Partnership Agreement, or any other agreement (oral or otherwise), that would prohibit any Contracting Company or the Electing Partners from competing with the Partnership in respect of the provision of Professional Services;

i) a provision will be added to reflect the fact that an Electing Partner's allocation of Partnership income for the year will be dependent solely on the Electing Partner's capital contribution to the Partnership and factors (including time) connected to the Electing Partner's other Non-Professional Services provided on behalf of the Partnership; in particular, the calculation of the Electing Partner's income allocation from the Partnership for that year will not take into account any of his or her Professional Services, either directly or indirectly;

j) a provision will be added to prohibit the carrying out of Non-Professional Services by the Contracting Companies and requiring that all Partners devote and spend the time and energy required to complete their portion of the Non-Professional Services;

k) a provision will be added to ensure that any Partner who chooses not to provide his or her Professional Services through a Contracting Company will be allocated a share of Partnership profits which will reflect the fact that the Non-Electing Partner will receive both the Professional Services and Non-Professional Services components in their partnership allocation as opposed to the Non-Professional Services component only in the case of an Electing Partner;

l) a provision will be added to prohibit the transfer or other conveyance of any interest in the Partnership to a Contracting Company, or to permit any Contracting Company to otherwise become a member of the Partnership;

Contract

20. The Partnership will enter into a written Contract with each Electing Partner's Contracting Company. Each Contracting Company will enter into this contract with the Partnership to provide Professional Services to the Partnership's clients, on behalf of the Partnership.

21. The Contract shall be for a fixed period of XXXXXXXXXX months coinciding with the calendar year, with the possible exception of the first year. It may be renewed each year and either party, upon XXXXXXXXXX days notice, may terminate it.

22. The Contract will provide that the Contracting Company will provide Professional Services to the Partnership in return for a Fee. The amount of a Fee to be paid by the Partnership to a Contracting Company will be equal to the fair market value of the Professional Services that the Contracting Company provides. The amount of the Fee will be tied to the level of work performed, XXXXXXXXXX . The Non-Professional Services of the Partnership will continue to be provided by the Electing and Non-Electing Partners who hold an interest in the Partnership.

23. There will be a minimum number of work days and professional service hours per year that the Contracting Company agrees to provide to the Partnership.

24. All payments received by the Partnership in respect of Professional Services provided by a Contracting Company pursuant to the Contract will be for the benefit of the Partnership and if a Contracting Company receives any of these amounts, they will be remitted to the Partnership.

25. The Contracting Company shall be responsible for providing all equipment, tools and instruments used in the performance of the Professional Services at its expense. Pursuant to the Contract and in consideration for a fair market value fee, the Partnership will provide the Contracting Company with certain facilities, equipment, supplies and personnel that are required to provide the Professional Services.

26. The Contracting Company shall be responsible for all expenses required to maintain the professional standards required by the Partnership and all fees and expenses necessary to perform the Professional Services, including, without limitation, professional membership fees, professional malpractice and other insurance, continuing education and training, transportation, communication, business entertainment connected to the business of the Contracting Company, travel expenses including automobile, accommodations and meals. The Contracting Company agrees that, to the extent that such expenses are paid by the Partnership, it shall reimburse the Partnership.

27. In the event that an Electing Partner suffers a physical or mental disability such that the Contracting Company is unable to provide the services under the terms of the Contract, the Partnership shall have the right to terminate the Contract.

28. In the event of the death of an Electing Partner or the bankruptcy of the Contracting Company or its Electing Partner, the Partnership shall have the right to immediately terminate the Contract.

29. Provided the Contracting Company fully discharges and satisfies all of its responsibilities under the Contract, the Contracting Company will not be restricted from providing professional services to other persons or otherwise prohibited from competing with the Partnership.

30. The Contracting Company's relationship to the Partnership is that of an independent contractor and nothing in the Contract should be construed as (i) allowing either party the authority to assume or create any obligation whatsoever, expressed or implied, in the name of the other nor to bind the other in any manner whatsoever, (ii) giving either party the authority to direct and control the day-to-day activities of the other party or any of their respective employees or agents, or (iii) constituting the parties as Partners, joint venturers, co-owners or otherwise participants in a joint or common undertaking.

31. Within 6 months of the date of this ruling, an Electing Partner will provide the Partnership with notice of intention to provide Professional Services through a Contracting Company and will incorporate the particular Contracting Company for such purposes in accordance with the terms and conditions outlined in the paragraphs above. Immediately thereafter, the Contracting Companies will enter into contracts with the Partnership for the purpose of providing such services.

PURPOSE OF PROPOSED TRANSACTIONS

32. The purpose of the Proposed Transactions is to allow an Electing Partner to use a Contracting Company to earn business income, by providing Professional Services to the Partnership, as an independent contractor. In addition, the Proposed Transactions will provide a number of other business advantages including:

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

b) allowing each Electing Partner to have a greater degree of control over expenditures especially where such expenditures may not be otherwise approved by all members of the Partnership; and

c) allowing each Electing Partner more control over their individual estate and financial planning matters.

33. The Proposed Transactions will allow the Electing Partners to use, if they choose, a professional corporation to earn Professional Services income through a Contracting Company derived from the Partnership's practice without negatively affecting the business arrangements between the other Partners of the Partnership.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purpose of the proposed transactions, the proposed transactions are completed in the manner described above and there are no other transactions that may be relevant to the rulings given, our rulings are as follows:

A. 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 for purposes of the Act.

B. Provided that an Electing Partner would not, if his or her Contracting Company 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 Contracting Company will not be considered to be carrying on a personal services business as defined in subsection 125(7) of the Act in respect of the Professional Services provided to the Partnership.

C. 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 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 particular Contracting Company, pursuant to the Contract, as described in Paragraph 22, will be deductible by the Partnership in its determination of the Partnership's income pursuant to subsection 96(1) of the Act.

E. The Proposed Transactions undertaken in Paragraphs 11 to 31 will not in and of themselves cause subsections 56(2), 56(4), and 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 in the hands of the respective Electing Partner.

F. Provided the amount of the Partnership's income allocated to the Electing Partner is otherwise reasonable, having regard to all the relevant circumstances, the Electing 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 the Electing Partner choosing, pursuant to amendments to the Partnership Agreement, to provide all Professional Services to the Partnership through the particular Contracting Company, as described above in the Proposed Transactions.

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 Partners with respect to sharing the Partnership's income for income tax purposes.

H. Implementation of the Proposed Transactions described above, will not, in and of themselves, result in the application 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 an Electing Partner would, if the Contracting Company 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 Company and the Partnership and between the Contracting Company and the 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 the Contracting Company 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 Company 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 Contracting Company 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 paragraphs are only an expression of opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on the CRA.

OPINION

The application of subsection 256(2.1) of the Act is determined on a year-to-year basis. We are therefore unable to rule that this provision will never apply to 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