10 September 2014 External T.I. 2014-0522551E5 - Income for retired partner

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: Does section 34.1 of the Act apply in the taxation year that a partner retires if an agreement related to a partner's retirement income is made after that taxation year.

Position: Yes.

Reasons: Subsection 96(1.6) of the Act refers to the time that a taxpayer ceases to be a member of the partnership.

XXXXXXXXXX
2014-052255
J. Gibbons

September 10, 2014

Dear XXXXXXXXXX:

Re: Subsections 34.1(1) and 96(1.1)

This is in reply to your email dated February 25, 2014, concerning the application of subsection 34.1(1) of the Income Tax Act (the "Act") to a retired partner.

In particular, you describe the following hypothetical scenario:

• A partnership (the "Partnership") made up of individuals has an off-calendar fiscal period ending January 31 pursuant to an election under subsection 249.1(4) of the Act.
• A partner (the "Retired Partner") retires from the Partnership at the end of the Partnership's fiscal period ending on January 31, 2014.
• The partnership agreement for the Partnership does not contain any provision for the allocation of a portion of the Partnership's income to the Retired Partner.
• In January 2015 (i.e., subsequent to the end of the Partnership's fiscal period ending January 31, 2014, but before the end of the Partnership's subsequent fiscal period ending January 31, 2015), all of the partners, including the Retired Partner, enter into an agreement (the "Retirement Agreement") to allocate a share of the income of the Partnership to the Retired Member starting with the fiscal period ending January 31, 2015.

Your question is whether subsection 34.1(1) of the Act would apply to the Retired Partner in 2014 even if the Retirement Agreement is entered into in January 2015. In your view, subsection 34.1(1) would only apply to the Retired Partner's 2014 taxation year if the Retirement Agreement is entered into before December 31, 2014. If the Retirement Agreement is entered into in January 2015, it is your view that subsection 34.1(1) would only apply to the Retired Partner's 2015 and subsequent taxation years. In the latter case, instead of reporting 12 months of Partnership income in the 2014 taxation year (i.e., the actual Partnership income for 12 months plus the additional income under subsection 34.1(1) representing 11 months of income for the period February 1, 2014, to December 31, 2014, minus the deduction under subsection 34.1(3) for the amount of additional income included under subsection 34.1(1) in the 2013 taxation year, which also represents 11 months of income), the Retired Partner would only report one month of Partnership income in the 2014 taxation year. In this regard, in the 2014 taxation year, the Retired Partner would include a share of the Partnership's actual income for the 12 month fiscal period ending January 31, 2014, but would be entitled to a deduction under subsection 34.1(3) for an amount that would represent the 11 months of additional income reported in the previous taxation year. Accordingly, the Retired Partner would be able to defer 11 months of Partnership Income in 2014.

Our comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, Advance Income Tax Rulings.

Subsection 249.1(1) defines "fiscal period" for the purposes of the Act. In general terms, paragraph 249.1(1)(b) provides restrictions on the timing of fiscal periods to ensure that certain businesses will have a fiscal period end at the end of the calendar year. Subparagraph 249.1(1)(b)(ii) applies to the fiscal period of certain partnerships including a partnership that has an individual (subject to certain exclusions) or a professional corporation (as defined under subsection 248(1) of the Act) as a member. However, where certain conditions are met, an election is available under subsection 249.1(4) to have paragraph 249.1(1)(b) not apply and thus allow a partnership to retain an off-calendar fiscal period end. Where the election is made, the "additional business income" rules under section 34.1 are applicable. In general, these rules were introduced in 1995 to limit tax deferral opportunities that existed for individuals who carry on business through a partnership or sole proprietorship.

Subsection 96(1.6) ensures that a retired partner with an income interest in a partnership is subject to subsection 34.1(1). This subsection provides as follows:

"If a partnership carries on a business in Canada at any time, each taxpayer who is deemed by paragraph (1.1)(a) to be a member of the partnership at that time is deemed to carry on the business in Canada at that time for the purposes of subsection 2(3), sections 34.1 and 150 and (subject to subsection 34.2(18)) section 34.2."

According to subsection 96(1.6), a retired member is deemed to carry on the business of the partnership in Canada at any time that the retired member is deemed to be a member of the partnership pursuant to paragraph 96(1.1)(a). Thus, the timing of the deeming rule in subsection 96(1.6) is linked directly to the timing of the deeming rule in paragraph 96(1.1)(a).

Subsection 96(1.1), which sets out the rules where a retired partner continues to share in the income of a partnership, provides as follows:

"(a) where the principal activity of a partnership is carrying on a business in Canada and its members have entered into an agreement to allocate a share of the income or loss of the partnership from any source or from sources in a particular place, as the case may be, to any taxpayer who at any time ceased to be a member of

(i) the partnership, or

(ii) a partnership that at any time has ceased to exist or would, but for subsection 98(1), have ceased to exist, and either

(A) the members of that partnership, or

(B) the members of another partnership in which, immediately after that time, any of the members referred to in clause (A) became members

have agreed to make such an allocation

or to the taxpayer's spouse, common-law partner, estate or heirs or to any person referred to in subsection (1.3), the taxpayer, spouse, common-law partner, estate, heirs or person, as the case may be, shall be deemed to be a member of the partnership; and

(b) all amounts each of which is an amount equal to the share of the income or loss referred to in this subsection allocated to a taxpayer from a partnership in respect of a particular fiscal period of the partnership shall, notwithstanding any other provision of this Act, be included in computing the taxpayer's income for the taxation year in which that fiscal period of the partnership ends."

[Our emphasis.]

According to the highlighted portion of subsection 96(1.1) above, a taxpayer who at any time ceased to be a member of the partnership is deemed to be a member of the partnership provided that the members have entered into an agreement to allocate a share of the income or loss of the partnership. Since the time referred to in paragraph 96(1.1)(a) is the time that the retired member ceased to be a member, it is our view that a retired member would be subject to this provision starting at that time even if the agreement referred to in that provision is entered into after that time.

Based on the foregoing, it is our view that subsection 34.1(1) of the Act would apply to the Retired Partner in the 2014 taxation year in the hypothetical scenario outlined in your email. In this regard, even if the Retirement Agreement were only signed in January 2015, the Retired Member ceased to be a member of the Partnership after the end of the Partnership's fiscal period ending on January 31, 2014, and would be entitled to an allocation of a share of the Partnership's income starting at that time. Thus, the Retired Partner would report a full 12 months of Partnership income in the 2014 taxation year and would be prevented from deferring any partnership income as intended by the rules in section 34.1 of the Act.

We trust these comments will be of assistance.

Yours truly,

G. Moore
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch