2013 Ruling 2013-0498961R3 - Partner creating a professional corporation

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: Will the fees earned by a professional corporation created by a partner to provide professional services to the professional partnership (as an independent contractor) be considered specified partnership income?

Position: Question of fact. Generally no, if certain conditions are met.

Reasons: Consistent with prior rulings.

XXXXXXXXXX
2013-049896

XXXXXXXXXX, 2013

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
XXXXXXXXXX (collectively the "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 understand that, to the best of your knowledge and that of the Partnership and the Named Partners (collectively the "Taxpayers"), none of the issues involved in this 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 previously filed tax return of 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 expired; and
v. the subject of a ruling previously issued by the Income Tax Rulings Directorate to any of the Taxpayers or a related person, with the exception of the 2010 Ruling (as defined below).

This document is based solely on the facts and proposed transactions described below. Any information or documentation submitted in the course of processing 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.

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 all terms and conditions used herein that are defined in the Act have the meaning given in such definitions 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:

"2010 Ruling" refers to advance income tax ruling #XXXXXXXXXX, which was issued to the Partnership and the Incorporated Partners on XXXXXXXXXX, 2010;

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

"Contract" refers to the sub-contracting agreement which will be used to set out the terms and conditions by which a ProCorp will provide Professional Services to the Partnership;

"CRA" refers to the Canada Revenue Agency;

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

"Fees" refers to the fees to be charged under the Contract by a ProCorp to the Partnership;

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

"Incorporated Partners" refers to those Partners each of whom has elected under the Partnership Agreement to provide his or her Professional Services through a PA ProCorp in accordance with the 2010 Ruling;

"Non-PA Electing Partner" refers to a Partner who does not elect under the Partnership Agreement to provide his or her Professional Services through a PA ProCorp;

"Non-Incorporated Partners" refers to Partners, including the Named Partners, who currently provide their Professional Services through the Partnership;

"Non-Professional Services" means the responsibilities and tasks associated with the carrying on of the practice of XXXXXXXXXX other than the provision of Professional Services, which include (i) finding new business and new clients for the Partnership, (ii) maintaining a direct and material principal connection with clients of the Partnership and delegating work to other Partners, associates or PA ProCorps, (iii) building client service teams, (iv) practicing efficiently, (v) developing new areas of expertise, (vi) promoting and contributing to the growth of the Practice, (vii) conducting management functions, (viii) participating in hiring, educating and training XXXXXXXXXX and staff, (ix) enhancing the Partnership's profile, and (x) collecting accounts from the Partnership's clients with which a Partner has a direct and material relationship;

"PA Electing Partner" refers to a Partner (including an Electing Partner) who elects under the Partnership Agreement to provide his or her Professional Services through a PA ProCorp;

"Partner" refers to a partner of the Partnership;

"Partnership Agreement" refers to the existing partnership agreement by which the Partnership is governed;

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

"PA ProCorp" means the corporation (including a ProCorp) formed by a PA Electing Partner and through which the PA Electing Partner provides Professional Services as an employee of that corporation, and collectively the "PA ProCorps";

"ProCorp" means the corporation to be formed by an Electing Partner and through which the Electing Partner will provide Professional Services as an employee of that corporation, and collectively the "ProCorps";

"Professional Services" means the XXXXXXXXXX services provided by the Partnership or the PA ProCorps (including the ProCorps) or the individual, as the case may be;

"Province" means the Province of XXXXXXXXXX;

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

XXXXXXXXXX;

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

"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.

Our understanding of the facts, the proposed transactions and the purpose of the proposed transactions is as follows:

FACTS

1. The Partners, currently XXXXXXXXXX in total, are the only partners of the Partnership. The Partnership has been carrying on business since XXXXXXXXXX under various versions of the current Partnership Agreement. However, it had been carrying on business under predecessor partnership agreements for many years prior to XXXXXXXXXX.

2. The Partnership’s business number is XXXXXXXXXX. The Partnership and the Named Partners file their information and tax returns with the XXXXXXXXXX Tax Centre and deal with the XXXXXXXXXX Tax Services Office. The main office of the Partnership is located at XXXXXXXXXX.

3. The Named Partners are all individuals resident in Canada for the purposes of the Act and none of them are Related Persons.

4. Currently, the Non-Incorporated Partners provide their Professional Services through the Partnership and the Incorporated Partners provide their Professional Services through their respective PA ProCorp. The Non-Incorporated Partners and the Incorporated Partners provide their Non-Professional Services exclusively through the Partnership.

5. The Partnership is governed by the Partnership Agreement, the terms of which include the following:

(a) Each Partner is permitted to elect to provide his or her Professional Services through a PA ProCorp engaged by the Partnership as an independent contractor, and where a Partner so elects, he or she is no longer permitted to provide any Professional Services to the Partnership in his or her capacity as a Partner.

(b) Each Partner has the right to elect, by notice in writing to the Partnership to be delivered not less than XXXXXXXXXX days prior to the effective date of the notice (or such lesser period of time as mutually agreed to between the parties), to provide his or her Professional Services through a PA ProCorp controlled by that Partner.

(c) The transfer, conveyance or issuance of an interest in the Partnership to a PA ProCorp is prohibited.

(d) The carrying out of Non-Professional Services by a PA ProCorp is prohibited.

(e) The allocation of Income for a Taxation Year to a PA Electing Partner is dependent solely on factors connected to the Non-Professional Services carried out by the PA Electing Partner on behalf of the Partnership. The calculation of a PA Electing Partner’s Income for a Taxation Year does not take into account any Professional Services provided by the PA Electing Partner’s PA ProCorp and does not take into account any time spent by the PA Electing Partner performing Professional Services in his or her capacity as an employee of his or her PA ProCorp.

(f) All Non-PA Electing Partners are to provide their Professional Services directly to the Partnership.

(g) The allocation of Income for a Taxation Year to a Non-PA Electing Partner is dependent on factors connected to the Professional Services and Non-Professional Services carried out by the Non-PA Electing Partner on behalf of the Partnership.

(h) Provided that there is net Partnership income to be allocated to Partners in respect of Non-Professional Services for a particular year,

(i) no Partner shall be allocated a negative amount, and

(ii) in the event that a Partner does not collect sufficient amounts of Partnership client billings for which he or she is responsible, there will be no requirement or mechanism for that Partner to reimburse any amount to the Partnership or to the other Partners at any point in time.

(i) PA Electing Partners and their respective PA ProCorps are not restricted from competing with the Partnership with respect to Professional Services. For greater certainty, there are no terms in the Partnership Agreement, or any other agreement (oral or otherwise), that would prohibit the PA Electing Partners or their respective PA ProCorps from competing with the Partnership in respect of the provision of Professional Services.

PROPOSED TRANSACTIONS

6. Each Electing Partner will elect, by providing notice in writing to the Partnership to be delivered not less than XXXXXXXXXX days prior to the effective date of the notice, to provide his or her Professional Services through a ProCorp controlled by such Electing Partner.

7. Each Electing Partner will incorporate a ProCorp which will comply with the following requirements:

(a) It will be incorporated pursuant to the laws of the Province and will obtain a permit from the XXXXXXXXXX that will authorize it to practice XXXXXXXXXX in the Province.

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

(c) It will be controlled by the Electing Partner, who will be the legal and beneficial owner of all of the voting shares of the particular ProCorp. Non-voting shares may be held by the Electing Partner, his or her spouse or his or her children, or any combination thereof. All shareholders legally or beneficially owning voting and non-voting shares of the ProCorp will be residents of Canada.

(d) The Electing Partner will be the sole director of his or her ProCorp. He or she will also be an employee of the ProCorp pursuant to a written employment contract, and will be entitled to receive a salary.

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

(f) No two ProCorps will be Related Persons.

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

(a) The ProCorp will provide Professional Services on behalf of the Partnership in return for Fees. The amount of Fees will based on the fair market value of the Professional Services provided by the ProCorp to the Partnership and may take into account the level of difficulty and the experience and areas of specialty of the Electing Partner whose ProCorp is providing Professional Services to the Partnership’s clients. The Fees will relate only to the level of work performed by the ProCorp and will not take into account the success of collected billings in respect of that work.

(b) The initial term of the Contract will terminate at the end of the Taxation Year. Thereafter, the Contract will be automatically and continuously renewed for XXXXXXXXXX-year terms, with any mutually agreed upon amendments, subject to the termination provisions.

(c) The parties may jointly determine an estimate of the Fees payable to the ProCorp for the Taxation Year. Based on this estimate, the Partnership will pay the ProCorp a periodic payment on account of the estimated fees payable. The Partnership could, from time to time, make additional payments to the ProCorp in respect of a Taxation Year as may be necessary to top up the periodic payment 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 ProCorp. At the end of the Taxation Year, the parties will conduct a final reconciliation, and adjust as necessary.

(d) The ProCorp will invoice the Partnership from time to time for Professional Services rendered under the Contract.

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

(f) Provided that the ProCorp fully discharges its responsibilities under the Contract, the ProCorp will not be restricted from providing Professional Services to other persons or otherwise be prohibited from competing with the Partnership.

(g) The Fees will be offset by the fair market value of any supplies, facilities, and equipment provided by the Partnership with respect to the provision of Professional Services under the Contract.

(h) The ProCorp will also be responsible for, among other things, certain of the following expenses connected to the business of the ProCorp:

(i) professional membership fees and insurance;

(ii) continuing professional education;

(iii) wireless communication;

(iv) maintaining the professional standards set by the XXXXXXXXXX and the Partnership (to the extent necessary for the ProCorp to fulfill the Contract);

(v) expenditures on personal practice preferences of the ProCorp;

(vi) entertainment expenses connected to the business of the ProCorp; and

(vii) travel expenses, including car, accommodation and meal expenses.

(i) Both the ProCorp and the Partnership may terminate the Contract at any time by providing notice to the other party of not less than XXXXXXXXXX days (or such lesser period of time as mutually agreed to between the parties).

(j) In the event of:

(i) the death of the Electing Partner;

(ii) the bankruptcy of the ProCorp or the Electing Partner; or

(iii) a material breach by the ProCorp of a term under the Contract;

the Partnership shall have the right to immediately terminate the Contract.

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

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

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

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

10. Within six months of this Ruling, each Electing Partner will establish his or her respective ProCorp and will elect under the Partnership Agreement to provide Professional Services through such ProCorp. Immediately thereafter, each such ProCorp will enter into a Contract with the Partnership for the purpose of providing such Professional Services.

11. All Electing Partners will continue in their capacity as Partners to carry out the Non-Professional Services for the Partnership.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to allow the Electing Partners to provide their Professional Services through ProCorps with the following advantages:

(i) to permit each Electing Partner to benefit from amendments to the laws of the Province which permit XXXXXXXXXX to render professional services through a professional corporation;

(ii) to provide each Electing Partner with an increased level of control over his or her participation in the Practice through individual management of personal practice preferences;

(iii) to permit each Electing Partner to have control over expenditures where such expenditures may not be in the interest of all Partners;

(iv) to provide each Electing Partner with more control over his or her own estate and financial planning; and

(v) to enhance the Partnership’s ability to retain the Electing Partners.

RULINGS

Provided that

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions,

(b) the proposed transactions are completed in the manner described above, and

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

we rule as follows:

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

B. Provided that an Electing Partner’s ProCorp was not a member of any partnership in the relevant year in respect of the provision of Professional Services to the Partnership, the Fees earned by the particular ProCorp will not be specified partnership income as defined in subsection 125(7) of the Act.

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

D. The undertaking of the proposed transactions 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 ProCorp under the Contract to be taxed as income in the hands of the particular Electing Partner.

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

F. 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.

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 Electing 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 of 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.

The above advance income tax rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 Advance Income Tax Rulings, dated 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 above rulings. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly, that the CRA has agreed to or accepted the fair market value or reasonableness of any amounts, including the Fees, and whether the Partnership is a partnership at law.

COMMENTS

Whether or not a particular Electing Partner would, if his or her ProCorp did not exist, be an employee of the Partnership or an independent contractor who has entered into a contract for service with the Partnership is a question of fact that can only be determined after a review of the actual agreements entered into between the particular ProCorp and the Partnership and between the particular ProCorp and the particular Electing Partner. This review and determination is the responsibility of the particular Electing Partner's local tax services office.

The attribution rules in sections 74.1 to 74.4 of the Act apply in situations where property is transferred or lent, directly or indirectly, to a spouse or child. These rules may apply to any income received by a spouse or a child who has not attained the age of 18 years before the end of a particular taxation year. Whether or not these rules will apply in respect of the possible ownership of any shares of an Electing Partner's ProCorp is a question of fact that can only be determined at the time that the shares are issued or property is lent or transferred to such a shareholder. Furthermore, subsection 56(2) of the Act may apply to any amounts paid by such ProCorp to a family member of the Electing Partner. Also, section 120.4 of the Act may apply with respect to taxable dividends or trust income in respect of taxable dividends from a ProCorp received in a taxation year by a family member of the Electing Partner who has not attained the age of 17 years before that year.

OPINION

The application of subsection 256(2.1) of the Act is determined on a year-to-year basis. We are therefore unable to rule that this provision will never apply to a ProCorp. In general, where a particular function of a professional partnership that was previously carried on by the partnership is subsequently carried on by a partner's professional corporation, and no longer in partnership, for bona fide reasons other than income tax, this fact, in and of itself, would generally not cause subsection 256(2.1) of the Act to be applicable. The reasons for the separate existence of two or more professional corporations or the reasons for a change in the functions performed directly by the partners of the professional partnership is a question of fact that can only be determined on a case-by-case basis. However, based on the facts and proposed transactions described herein, it is our view that the incorporation of ProCorps to provide the Professional Services to the Partnership will not, in and of itself, cause subsection 256(2.1) of the Act to be applicable to the ProCorps.

The foregoing opinion is not a ruling and, as noted in Information Circular 70-6R5, is not binding on the CRA.

Yours truly,

XXXXXXXXXX
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch