28 November 2024 Internal T.I. 2024-1014251I7 - Classification of Arizona Limited Partnerships

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 particular Arizona Limited Partnerships should be considered as corporations or partnerships for purposes of the Income Tax Act.

Position: Partnerships.

Reasons: The general characteristics of these entities more closely resemble partnerships than other forms of business entities or arrangements under Canadian law.

Glenn Leung								HEADQUARTERS
Reginal International Tax Auditor				Income Tax Rulings Directorate
International Advisory Service Section			Vicky Liu
International and Large Business Directorate		2024-101425
Compliance Program Branch	

Subject: Foreign Entity Classification of Arizona Limited Partnerships

This is in response to your request for our views with respect to the classification of two Arizona Limited Partnerships – XXXXXXXXXX (“Partnership I”) and XXXXXXXXXX (“Partnership II”) for purposes of the Income Tax Act (the “Act”).

Background

Our understanding of the situation is as follows:

1. Partnership I was formed as a limited partnership under the laws of the State of Arizona as of the XXXXXXXXXX. Its general partner (footnote 1) is XXXXXXXXXX.

2. Partnership II was formed as a limited partnership under the laws of the State of Arizona as of the XXXXXXXXXX. Its general partner is XXXXXXXXXX and its limited partner is Partnership I.

Issue

Whether Partnership I and Partnership II should be considered as corporations or partnerships for purposes of the Act.

Comments

In order to determine the status of an entity or arrangement for purposes of the Act, CRA generally follows the two-step approach described below:

1) Determine the characteristics of the foreign entity or arrangement under applicable foreign law, relevant constating documents, indentures, partnership agreement, contracts and other relevant terms or documentation .

2) Compare these characteristics with those of recognized categories of an entity or arrangement under relevant Canadian law in order to classify the foreign entity or arrangement under one of the categories around which the provisions of the Act and the Income Tax Regulations are drafted.

As part of this two-step approach, CRA examines the nature of the relationship between the various parties that are involved and their rights and obligations in respect of the foreign entity or arrangement under the applicable law and documentation.

In order to determine whether Partnership I and Partnership II should be considered as corporations or partnerships for purposes of the Act, it is necessary to identify their characteristics and then compare them to the characteristics of corporations and partnerships in Canada.

As Partnership I and Partnership II were created pursuant to the laws of a common law jurisdiction, the comparison should be made to the characteristics of corporations and partnerships created under Canadian common law.

A comparison shows that Partnership I and Partnership II have characteristics of both partnerships and corporations. On one hand, they have all of the following elements of common law partnerships in Canada (footnote 2) :

• they carry on a business (i.e., a real estate rental business in Arizona) (footnote 3) ;
• each entity was formed with at least two partners (one general partner and one or more limited partners) (footnote 4) ; each partner carries on the business of the partnership in common with a view to profit (footnote 5) ;
• the partners of each entity contribute money, property, effort, knowledge, skill or other assets to a common undertaking (footnote 6) ;
• each partner of a limited partnership created under Canadian common law carries on the business of the partnership as principal and as agent for each partner, binding the partnership in all matters within the partner’s authority. In the case of the limited partner who takes no part in the management of the partnership business, the general partners act on his behalf as well as on their own behalf (footnote 7) ;
• the partners are jointly or jointly and severally liable for the debts and obligations of the business, and in the case of a limited partner of a limited partnership, it generally has limited liability for the debts and obligations of the partnership unless the partner participates in the control of the business (footnote 8) ; and
• the filing of income tax returns as a partnership (footnote 9) .

On the other hand, we note that A.R.S.§ 29-1011 states that “[a] partnership is an entity distinct from its partners”.

Although a separate legal personality is generally a characteristic of corporations in Canada, it is the CRA’s view (footnote 10) that the existence of a separate legal personality will not, in and of itself, preclude an entity from being classified as a partnership for Canada income tax purposes.

The unlimited liability of the general partner of an Arizona Limited Partnership is an important characteristic that supports partnership status under the Act. Given the similarities between Partnership I and Partnership II with partnerships created under Canadian common law, Partnership I and Partnership II are considered partnerships for purposes of the Act.

We trust that the above comments are helpful to you.

Yours truly,

Charles Taylor
Section Chief
For Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 The use of terms such as “general partner” and “limited partner” in the “Background” section are not meant to be an indication that CRA considers the entities to be partners of a partnership, but rather, CRA is using these terms to be consistent with the terms used in the respective partnership agreements.

2 Refer to Income Tax Folio S4-F16-C1, What is a Partnership? - paragraphs 1.4 to 1.17.

3 See Clause 1.3 of the partnership agreement of Partnership I and Clause 1.3 of the partnership agreement of Partnership II, both of which state “the purpose of business of the Partnership shall be the ownership of real property”.

4 See the Arizona Revised Statutes (A.R.S.) which provides, in part, as follows:

• “7.“Limited partnership” and “domestic limited partnership” means a partnership formed by two or more persons under the laws of this state and having one or more general partners and one or more limited partners.” (A.R.S.§ 29-301).

5 See A.R.S.§ 29-329 which states:

“The profits and losses of a limited partnership shall be allocated among the partners, and among classes of partners, in the manner provided in writing in the partnership agreement. If the partnership agreement does not so provide in writing, profits and losses shall be allocated on the basis of the value as stated in the partnership records required to be kept pursuant to section 29-305 of the contributions made by each partner to the extent they have been received by the partnership and have not been returned.”

6 See A.R.S.§ 29-327 which states:

“[t]he contribution of a partner may be in cash, property or services rendered, or a promissory note or other obligation to contribute cash or property or to perform services.”

See also Clause 3.1 of the partnership agreement of Partnership I and Clause 3.1 of the partnership agreement of Partnership II , both of which state:

“Initial Capital Contributions. As of the date of this Agreement, the Partners have contributed to the capital of the Partnership cash or other valuable property, the amounts of which shall be credited to their respective Capital Accounts.”

7 In the case of a partnership without limited partners, “[e]ach partner has equal rights in the management and conduct of the partnership business.” (A.R.S.§ 29-1031, paragraph F),

In the case of a limited partnership, the general partners of a limited partnership are responsible for managing the business and affairs of the partnership. Limited partners, however, generally have little, if any, involvement in the management and conduct of the limited partnership. Paragraph A of A.R.S. § 29-319 provides that a limited partner who participates in the control of the business may become liable for the obligations of the partnership.

See also Clause 4.1.1 of the partnership agreement of Partnership I and Clause 4.1.1 of the partnership agreement of Partnership II, both of which state:

“…the Limited Partners shall take no part in the conduct or control over the business of the Partnership and shall have no authority or right to act for or bind the Partnership…the General Partner shall have the sole and exclusive right to manage the business of the Partnership and shall have all the rights and powers which may be possessed by the General Partner under the partnership laws of the State of Arizona. The General Partner shall have authority to execute any and all documents on behalf of the Partnership, including documents pertaining to the purchase, sale or finance of real property.”

8 A limited partner’s liability to third parties:

• “A. Except as provided in subsection D of this section, a limited partner is not liable for the obligations of a limited partnership unless he is also a general partner or, in addition to the exercise of his rights and powers as a limited partner, he participates in the control of the business. However, if the limited partner participates in the control of the business, he is liable only to persons who transact business with the limited partnership reasonably believing, based on the limited partner's conduct, that the limited partner is a general partner.” (A.R.S.§ 29-319)

The general powers and liabilities of a general partner:

• “A. Except as provided in this chapter or in the partnership agreement, a general partner of a limited partnership has the rights and powers and is subject to the restrictions of a partner in a partnership without limited partners.

B. Except as provided in this chapter, a general partner of a limited partnership has the liabilities of a partner in a partnership without limited partners to persons other than the partnership and the other partners.

C. Except as provided in this chapter or in the partnership agreement, a general partner of a limited partnership has the liabilities of a partner in a partnership without limited partners to the partnership and to the other partners.” (A.R.S.§ 29-324)

• “A. Except as otherwise provided in…, all partners [in a partnership without limited partners] are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law.” (A.R.S.§ 29-1026)

9 See Clause 6.1 of the partnership agreement of Partnership I and Clause 6.1 of the partnership agreement of Partnership II, both of which state that “Tax Treatment. The Partnership shall be treated as a partnership for federal and Arizona income tax purposes.”

See also Clause 6.2 of the partnership agreement of Partnership I and Clause 6.2 of the partnership agreement of Partnership II, both of which state that “Tax Allocation. Except as otherwise required by the Internal Revenue Code or applicable Treasury regulations, during any period in which the Partnership is treated as a partnership, any taxable income or loss (and any item thereof) of the Partnership shall be allocated to the Partners in accordance with their Percentage Interests and the Partnership shall maintain capital accounts for each Partner in accordance with Treasury Relation Section 1.704-1(b)(2).”

10 See CRA Documents 2018-0749481C6, 2021-0892121I7 and 2024-1007541C6.