2012 Ruling 2011-0421261R3 - Partnership Allocation

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 subsections 103(1) and (1.1) will apply to redetermine the allocation of any income or loss from the manner described in the partnership agreement.

Position: No.

Reasons: The allocation of income and loss is proportionate based on the ownership of units which is considered reasonable in the circumstances.

XXXXXXXXXX
2011-042126

XXXXXXXXXX, 2012

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (collectively the "Taxpayers")
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX , as amended on XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-named parties. We also acknowledge the information provided during our telephone conversations, meetings and correspondence concerning your request.

We understand that, to the best of your knowledge and that of the Taxpayers, none of the issues involved in the ruling request is:

(i) in an earlier return of the Taxpayers or a related person,
(ii) being considered by a tax services office or taxation centre 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, and
(v) the subject of a ruling previously considered by the Income Tax Rulings Directorate for the Taxpayers or a related person.

This document is based solely on the facts, transactions and additional information described below. Any information or documentation submitted in the course of processing your request does not form part of the facts, transactions and additional information and any references thereto are provided solely for the convenience of the reader.

DEFINITIONS

Unless otherwise expressly stated, every reference herein to the “Act” or to a part, subdivision, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Income Tax Act (Canada), R.S.C., 1985, c.1 (5th Supp.), as amended from time to time and consolidated to the date of this letter, and the Income Tax Regulations thereunder are referred to as the "Regulations".

All monetary amounts are expressed in Canadian dollars unless otherwise indicated.

In this letter, the following terms or expressions have the meaning specified and, where the circumstances so require, words reporting the singular include the plural and vice versa:

“ACB” means “adjusted cost base” as defined in subsection 248(1);

“affiliated” has the meaning assigned by subsection 251.1(1);

“arm's length” has the meaning assigned by subsection 251(1);

“Canadian partnership” has the meaning assigned by subsection 102(1);

“capital property” has the meaning assigned by section 54;

“CBCA” means the Canada Business Corporations Act, R.S.C., 1985, c. C-44, as amended through the date hereof;

“CRA” means the Canada Revenue Agency;

“FMV” means fair market value;

“GAAR” means the general anti-avoidance rule in section 245;

“Paid-up capital” or “PUC” has the meaning assigned by subsection 89(1);

“Proposed Transactions” means the transactions described in paragraphs 16 to 23;

“related persons” has the meaning assigned by section 251;

“Subject Transactions” means the transactions described in paragraph 15; and

“taxable Canadian corporation” has the meaning assigned by subsection 89(1).

Our understanding of the facts, transactions and the purpose of the Subject Transactions and Proposed Transactions is as follows:

FACTS

1. XXXXXXXXXX (“Holdco”) is a taxable Canadian corporation. Holdco is resident in Canada and is a wholly-owned subsidiary of the XXXXXXXXXX that is resident in Canada.

2. XXXXXXXXXX (“ACo”) is a wholly-owned subsidiary of Holdco. ACo’s taxation year end is XXXXXXXXXX and its address is XXXXXXXXXX. ACo’s business number is XXXXXXXXXX and it deals with the XXXXXXXXXX Tax Services Office. ACo is a taxable Canadian corporation and resident in Canada.

3. XXXXXXXXXX (“BCo”), formerly XXXXXXXXXX, is a taxable Canadian corporation and resident in Canada. BCo’s taxation year end is XXXXXXXXXX and its address is XXXXXXXXXX. BCo’s business number is XXXXXXXXXX and it deals with the XXXXXXXXXX Tax Services Office.

4. The business of BCo is to XXXXXXXXXX (the “Operating Business”). XXXXXXXXXX. The Operating Business is strongly aligned to the long term strategy of the XXXXXXXXXX, Holdco and their related entities (collectively referred to herein as the “Related Group”) XXXXXXXXXX .

5. Under an asset purchase agreement dated XXXXXXXXXX, a wholly-owned subsidiary of Holdco, XXXXXXXXXX (“Acquireco”), acquired certain XXXXXXXXXX from an unrelated party, XXXXXXXXXX. (“Opco”), a company incorporated under the Business Corporations Act of XXXXXXXXXX.

6. On XXXXXXXXXX, the Related Group entered into a share purchase agreement (the “Agreement”) to purchase (over time) XXXXXXXXXX% of the outstanding shares (of multiple classes) of Opco from the shareholders of the company (the “Vendors”), who deal at arm’s length with the Related Group. On XXXXXXXXXX, the Related Group acquired XXXXXXXXXX% of the then outstanding shares of Opco pursuant to the Agreement. The Agreement required that the Related Group acquire the remaining XXXXXXXXXX% of the outstanding shares (at XXXXXXXXXX% per year), beginning in XXXXXXXXXX and continuing through to XXXXXXXXXX at a price determined by formula in the share purchase agreement.

7. On XXXXXXXXXX an amalgamation of Opco and Acquireco occurred, after which the Related Group owned XXXXXXXXXX common shares of the newly amalgamated Opco and the Vendors owned XXXXXXXXXX common shares.

8. Since XXXXXXXXXX various corporate amendments resulted in:

(a) Opco being continued into federal jurisdiction (under the CBCA);
(b) Opco undergoing name changes, ultimately to BCo; and
(c) a conversion of the common shares of the company into Class A Common shares and the creation of a new class of shares, Class B Common Shares.

9. The authorized share capital of BCo currently consists of an unlimited number of Class A Common Shares, an unlimited number of Class B Common Shares (collectively, the Class A Common Shares and the Class B Common Shares of BCo will be referred to as the “Common Shares”), and an unlimited number of Preferred Shares. XXXXXXXXXX.

10. The issued and outstanding shares of BCo currently consists of XXXXXXXXXX Class A Common Shares, and XXXXXXXXXX Class B Common Shares. As at the date of this letter, ACo owns XXXXXXXXXX of the XXXXXXXXXX outstanding Class A Common Shares of BCo – XXXXXXXXXX were acquired in XXXXXXXXXX as described in paragraph 6 above, XXXXXXXXXX acquired in XXXXXXXXXX, and XXXXXXXXXX acquired in XXXXXXXXXX and the Vendors own XXXXXXXXXX Class A Common Shares. ACo and BCo are affiliated and related persons under the Act.

11. The Class B Common Shares of BCo were issued for cash consideration to ACo (or a predecessor company) and the Vendors in XXXXXXXXXX, and are currently owned as follows:

Shareholder Consideration in XXXXXXXXXX $ Number of Class B
Common Shares Issued

ACo XXXXXXXXXX XXXXXXXXXX
Vendors XXXXXXXXXX XXXXXXXXXX
Total XXXXXXXXXX XXXXXXXXXX

12. ACo (or a predecessor company) has been funding the activities of BCo, by way of loans, since XXXXXXXXXX. As at XXXXXXXXXX, BCo owed $XXXXXXXXXX to ACo. XXXXXXXXXX was loaned to BCo, such that BCo owed $XXXXXXXXXX to ACo at XXXXXXXXXX. XXXXXXXXXX was loaned to BCo, such that BCo owed $XXXXXXXXXX to ACo at XXXXXXXXXX.

13. Since XXXXXXXXXX, the only cash funding of BCo by the Vendors was as set out in paragraph 11 above.

14. The Operating Business will require ongoing funding to support the projected operating losses anticipated in the years XXXXXXXXXX. ACo is willing to continue to invest in the business activities of BCo because of the strategic importance of the Operating Business to the Related Group and the anticipated profitability of this business.

BCo and ACo wish to continue carrying on the Operating Business (which is currently carried on by BCo) in a limited partnership. BCo will contribute the Operating Business to the limited partnership and ACo will fund the on-going operations of the Operating Business by subscribing for units of the limited partnership for cash.

Management’s current financial projections (as at XXXXXXXXXX) for the Operating Business for the XXXXXXXXXX fiscal periods anticipate that the business will sustain losses in XXXXXXXXXX, but will have operating income commencing in XXXXXXXXXX, as follows:

Year Projected Operating Income (Loss) in XXXXXXXXXX $

XXXXXXXXXX XXXXXXXXXX

Total projected income XXXXXXXXXX

SUBJECT TRANSACTIONS

15. ACo has caused a new Canadian corporation (“GP Co”) to be incorporated under the CBCA. GP Co will be resident in Canada at all relevant times. The authorized share capital of GP Co consists of an unlimited number of voting common shares. ACo has subscribed for and GP Co has issued XXXXXXXXXX common shares of GP Co to ACo for an aggregate consideration of $XXXXXXXXXX.

PROPOSED TRANSACTIONS

16. A limited partnership (“New LP”) will be formed under XXXXXXXXXX. New LP will have a fiscal period end of XXXXXXXXXX for purposes of the Act and will be a Canadian partnership.

17. The capital of New LP will consist of XXXXXXXXXX interest of the general partner, GP Co, and two classes of limited partnership units, Class A Units and Class B Units. On formation of New LP, GP Co will subscribe for and be issued XXXXXXXXXX general partnership interest for $XXXXXXXXXX and BCo will subscribe for and be issued XXXXXXXXXX Class A Unit of New LP for $XXXXXXXXXX.

18. The subscription price of a Class A Unit and a Class B Unit will be set at $XXXXXXXXXX for any units acquired from the time of formation of New LP to XXXXXXXXXX. A valuation will be undertaken to determine the value of New LP each year as at XXXXXXXXXX. This valuation will be used to determine the subscription price for additional partnership units for the period XXXXXXXXXX following the valuation date, based on the aggregate number of outstanding Class A and Class B Units as at the date of the valuation.

19. The limited partners of New LP (the “Limited Partners”) will be:

(a) BCo, which will subscribe for XXXXXXXXXX Class A Unit upon formation of New LP. BCo will receive additional Class A Units of New LP as consideration for the transfer of assets by BCo to New LP, as described in paragraph 21 below, and

(b) ACo, which intends to subscribe for Class B Units of New LP for cash consideration from time to time as funds are required by New LP. It is the intention of ACo to provide funding for the normal business operations of New LP for a period of XXXXXXXXXX years, through an acquisition of additional Class B Units. Normal business operations will include funding of losses from regular operations (but excluding any liabilities relating to lawsuits or other similar claims) and any required working capital and capital expenditures.

Each of GP Co, BCo and ACo will hold its respective partnership interest in New LP as capital property for purposes of the Act.

20. Under the terms of New LP’s limited partnership agreement:

(a) Net income and net losses of New LP will be allocated in the following manner:

i. XXXXXXXXXX% of the net income or loss arising in a particular year shall be allocated to GP Co, the general partner of New LP;

ii. Net income or loss arising in a particular year, after the allocation described in (i) above, shall be allocated to the Class A Unit holders and to the Class B Unit holders at the end of each year, proportionately, based on the number of units held by each at the end of the particular year.

(b) The income or loss for income tax purposes will be allocated in the same proportions as net income or loss for accounting purposes described in (a) above in respect of a particular year.

(c) Distributions from New LP will be made when determined by the general partner. Any such distributions will be made in the following manner:

i. distributions of accumulated income of New LP to the Limited Partners will be proportionate to the aggregate net income and losses previously allocated to the Limited Partners and not previously distributed, and

ii. any further distributions may then be credited by the general partner to the capital account of each partner as a return of capital, at the discretion of the general partner.

(d) New LP’s partnership agreement will provide that New LP will continue upon admission of a partner or withdrawal of a partner.

21. BCo will enter into an agreement of purchase and sale with New LP whereby BCo will agree to sell and New LP will agree to purchase all of the assets and undertaking of BCo (except cash) at fair market value. As consideration, New LP will assume XXXXXXXXXX obligations (estimated to be $XXXXXXXXXX) of BCo and issue that number of Class A Units to BCo that is equal to the fair market value of the net assets transferred (the FMV of the assets transferred less the liabilities assumed by New LP) divided by the subscription price for each Class A Unit of $XXXXXXXXXX. A valuation of the assets of BCo will be undertaken to determine the number of Class A Units to be issued by New LP to BCo.

All of the cash on hand and all of the liabilities (other than XXXXXXXXXX obligations) of BCo (including XXXXXXXXXX, and any amounts owing by BCo to ACo) will remain property or liabilities, as the case may be, of BCo.

XXXXXXXXXX.

All of the members of New LP will jointly elect, in prescribed form, within the time referred to in subsection 96(4), to have subsection 97(2) apply to the transfer by BCo of its capital property, eligible capital property and inventory to New LP.

22. After the transfer of assets by BCo to New LP, ACo will subscribe for and New LP will issue to ACo that number of Class B Units of New LP that is equal to the cash consideration paid by ACo divided by $XXXXXXXXXX. The projected cash requirement for the Operating Business for XXXXXXXXXX is approximately $XXXXXXXXXX. ACo intends to subscribe for additional Class B Units of New LP for cash consideration from time to time, as required by New LP, to fund the normal business operations of New LP.

23. New LP will enter into a management services agreement with GP Co under which GP Co will manage the business affairs of New LP. Under this agreement, New LP will agree to compensate GP Co for any services provided to New LP XXXXXXXXXX. For greater certainty, none of the services provided by GP Co to New LP will be provided by GP Co in its capacity as a general partner of New LP.

ADDITIONAL INFORMATION

When all the shares of BCo are owned by ACo (i.e. BCo becomes a wholly-owned subsidiary of ACo), there may be an amalgamation of these two companies or a winding-up of BCo into ACo.

XXXXXXXXXX

PURPOSE OF THE SUBJECT TRANSACTIONS AND THE PROPOSED TRANSACTIONS

BCo requires funding to allow it to continue the Operating Business, which is an important business to the Related Group. ACo is willing to continue to fund the Operating Business because it believes it will be profitable. The Proposed Transactions are structured to allow the Operating Business to be carried on in a limited partnership structure by a group of affiliated corporations and ACo and BCo to be allocated their proportionate share of any income or loss.

RULINGS

Provided that

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts and additional information, transactions and purposes of the Subject Transactions and Proposed Transactions,

(b) the Subject Transactions and Proposed Transactions are completed in the manner described above,

(c) there are no other transactions which may be relevant to the rulings requested, and

(d) New LP is a partnership at law,

we rule as follows:

A. Subsections 103(1) and 103(1.1) of the Act will not apply to redetermine the allocation of any income or loss of New LP from the manner described in paragraph 20 above.

B. The Proposed Transactions, in and of themselves, will not result in the application of subsection 245(2) of the Act to redetermine the tax consequences confirmed in the ruling given above.

The above advance income tax rulings, which are based on the Act and Regulations in their present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 Advance Income Tax Rulings, dated May 17, 2002, and are binding on the Canada Revenue Agency provided that the Proposed Transactions are completed on or before XXXXXXXXXX.

OTHER COMMENTS

Unless otherwise expressly confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed, made any determination or accepted any method for determination in respect of:

a. the PUC of any share or the ACB or FMV of any property referred to herein;

b. whether or not any persons or partnerships referred to in this letter deal at arm’s length;

c. the reasonableness or FMV of any fees or expenditures referred to herein;

d. whether or not a person or partnership is carrying on a business or a particular business;

e. whether or not any property constitutes a “tax shelter” within the meaning provided under subsection 237.1(1) or 18.1(1) of the Act or a “tax shelter investment” within the meaning provided under subsection 143.2(1) of the Act or a “computer tax shelter property” within the meaning provided under subsection 1100(20.2) of the Regulations, or any tax consequences if such definitions were to apply;

f. the at-risk amount of any member of New LP under subsection 96(2.2) of the Act and the tax consequences of subsection 96(2.1) of the Act;

g. the tax consequences, if any, related to the transfer of property to New LP and the formation of New LP; or

h. any other tax consequence relating to the facts, Subject Transactions, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above, including whether any of the Subject Transactions and the Proposed Transactions would also be included in a series of transactions or events that include other transactions or events that are not described in this letter.

Yours truly,

XXXXXXXXXX
For Director
Business and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch