2012 Ruling 2012-0447491R3 - Professional corporation contracting with partshp

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 income earned by a professional corporation from providing professional services to a partnership in which the professional is a partner will qualify for the small business deduction and will not be restricted under the rules for specified partnership income and personal services business.

Position: Yes.

Reasons: The facts and proposed transactions conform to the requirements set out in similar rulings.

XXXXXXXXXX
2012-044749

XXXXXXXXXX, 2012

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership") and the "Equity Partners" (see Appendix A).

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 Equity Partners. We also acknowledge the information provided in various emails.

To the best of your knowledge and that of the Partnership and the Equity Partners (collectively the "Taxpayers"), none of the issues involved in the ruling request is:

i. in an earlier return of any 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 any of the Taxpayers or a related person;
iii. under objection by any 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 any 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.

This document is based solely on the facts and proposed transactions described below. The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

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" refers to a "Canadian-controlled private corporation" as defined under subsection 125(7) of the Act;

(b) "CRA" refers to the Canada Revenue Agency;

(c) "Electing Partner" refers to an Equity Partner who elects to provide his or her Professional Services through a ServicesCorp;

(d) "Equity Partner" means those persons listed in Appendix "A" who are partners in the Partnership and who are required pursuant to the Partnership Agreement to invest capital in the Partnership;

(e) "Fees" refers to the fair market value fee to be charged under the Services Agreement by a ServicesCorp 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) "LSA" means the Law Society Act (XXXXXXXXXX), as amended;

(h) "XXXXXXXXXX" means the XXXXXXXXXX or any successor thereto;

(i) "XXXXXXXXXX Requirements" means, collectively, the LSA, the regulations, by-laws and rules of practice and procedure promulgated under the LSA and the XXXXXXXXXX, policies and guidelines of the XXXXXXXXXX, as amended, supplemented or replaced from time to time;

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

(k) "Non-Equity Partner" means a Partner who is not required pursuant to the Partnership Agreement to invest capital in the Partnership;

(l) "Non-Professional Services" means 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;

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

(n) "Partners" means both Equity Partners and Non-Equity Partners;

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

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

(q) "Professional Requirements" means the XXXXXXXXXX Requirements governing the practice of law in XXXXXXXXXX;

(r) "Professional Services" means the practice of law;

(s) "Province" means XXXXXXXXXX;

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

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

(v) "ServicesCorp" means a corporation to be formed by an Electing Partner and through which an Electing Partner will provide Professional Services as an employee of that corporation;

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

(x) "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, and it has a fiscal period ending XXXXXXXXXX. The Partnership carries on the practice from its principal office in XXXXXXXXXX, as well as from offices in XXXXXXXXXX.

2. On XXXXXXXXXX, the Partnership was continued as a "limited liability partnership" pursuant to and in accordance with section 44.1(2) of the PA and section 61.1 of the LSA.

3. The management of the Partnership is overseen by an Executive Committee.

4. Partners of the Partnership may be either Equity Partners or Non-Equity Partners and no other persons may be Partners of the Partnership.

5. The persons listed in Appendix A are the only Equity Partners of the Partnership, and this ruling is only applicable to such Equity Partners.

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

7. The Partnership carries on the Practice. The Partners provide Professional Services, as well as 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. No Partner shall carry on the practice of law for the Partner's own private advantage apart from the Partnership.

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

(c) All Partners must, at all times, maintain their status as duly qualified to carry on the practice of law and in good standing with the XXXXXXXXXX or any law society in any other jurisdiction.

(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) The level of capital contribution required of the Partners is determined from time to time by the 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 the Executive Committee unless otherwise determined by resolution of the Partners.

(h) The amount of each Partner's regular and additional draws are determined from time to time by the Executive Committee 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 Partner of the Partnership has a say in the decisions of the Partnership (including the annual election of the Executive Committee of the Partnership) based on such Partner's proportionate percentage interest in the net profits of the Partnership in the fiscal year, but no changes to any of the following may be done without the approval of the Partners holding an aggregate percentage interest in the net profits of the Partnership in the fiscal year of not less than XXXXXXXXXX%:

i. the admission or expulsion of a Partner;
ii. the dissolution of the Partnership;
iii. any amendment or supplement to the Partnership Agreement; and
iv. any change in the fiscal year end of 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 where an Equity 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 an Equity 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 as 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 with the intent that a ServicesCorp cannot become a Partner of the Partnership.

(d) A provision will be added to prohibit the carrying out of Non-Professional Services by the ServicesCorp. All Electing Partners will continue in their capacity as Equity 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 be based on factors connected to the Professional Services, as well as Non-Professional Services carried out by the Non-Electing Partner on behalf of the Partnership.

(g) The provision that requires Partners to devote substantially their full time, energy and ability to the Practice of the Partnership will be amended to replace "Partners" by "Non-Electing Partners."

(h) 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 be 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 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. All voting shares will be legally and beneficially held by the Electing Partners. If not restricted by the Professional Requirements, 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. 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) For greater certainty, voting or non-voting shares will not be held by a trust, corporation or partnership but will be held by an individual only.

(e) 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.

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

(g) No two ServicesCorp will be Related Persons.

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 XXXXXXXXXX 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, and not to the success of collecting the revenue billed to the Partnership's clients in respect of the Professional Services provided by the particular ServicesCorp to the Partnership. 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.

(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.

(e) Each ServicesCorp will be responsible for the following expenses:

i. professional membership fees in respect of the Partner;
ii. professional liability insurance (to the minimum coverage level required by the Professional Requirements) and/or disability insurance for the particular Partner;
iii. continuing education costs;
iv. travel expenses, including car, accommodation and meal expenses;
v. communication expense, including cellphone and Blackberry device;
vi. office equipment and supplies; and
vii.additional business expenditures relating to personal practice preference of the particular ServicesCorp.

12. Within XXXXXXXXXX months of this Ruling, the Equity Partners will each establish a ServicesCorp and will elect under the Partnership Agreement to provide Professional Services through such corporations. Immediately thereafter, each Equity 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 Partners to take advantage of the legislative amendments which permit lawyers to render professional services through professional corporations, and which provides the following benefits to the 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;

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

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 Equity 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 Equity 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 a 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 above, and in particular the payment of the Fees, will not in and of themselves cause subsections 56(2), 56(4) or 246(1) of the Act to apply so as to cause an amount received by an 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 Equity 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 Equity Partner being allowed to incorporate a ServicesCorp pursuant to the Partnership Agreement 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, in and of themselves, will not constitute a disposition of part or all of an interest in the Partnership by any of the Equity 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 any Equity Partner and any other Partner with respect to sharing Income for income tax purposes.

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

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transactions are implemented on or before XXXXXXXXXX. These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted any of the tax consequences relating to the facts and proposed transactions described above except as expressly stated in the rulings. In addition, nothing in this letter should be interpreted as confirming, either expressly or implicitly, that the CRA has agreed to or accepted the fair market value or reasonableness of any amounts, including the Fees.

Additional Comments

Whether or not a particular Equity Partner would, if his or her ServicesCorp did not exist, be an employee of the Partnership or an independent contractor who has entered into a Services Agreement 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 ServicesCorp and the Partnership and between the particular ServicesCorp and the particular Equity Partner. This review and determination is the responsibility of the particular Equity 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 any 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 a ServicesCorp to a family member of the Equity 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 ServicesCorp received in a taxation year by a family member of the Equity 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 ServicesCorp. 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 a ServicesCorp by an Equity Partner 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 Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

APPENDIX A

Name Address S.I.N. Taxation Centre

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