28 June 1989 Ruling 57861 F - Limited Partnership At-Risk Rule

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.

June 28, 1989

Dear sirs:

24(1)

We are writing in reply to your letter of March 14, 1989, wherein you requested an advance income tax ruling for the above-noted business venture.  Your accountant, 19(1) subsequently advised us in a telephone conversation on April 12, 1989 that the request for an advance ruling was withdrawn and replaced by a request for an opinion letter.

Our understanding of the facts of the situation and the proposed transaction s is as follows:

1.

2.     24(1)

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5.     24(1)

Your Questions

1.     May the limited partners of the partnership deduct their respective share of the business loss of the partnership allocated to them, as a business loss in computing their net income or loss for income tax purposes?

2.     May the limited partners deduct interest expense incurred in respect of the money borrowed to acquire their units of the partnership in computing their respective net income or loss for income tax purposes?

3.     Will there be a taxable capital gain to the limited partners in respect of the transfer of their partnership units to Newco. in accordance with subsection 85(1) of the Act?

4.     (a) Will a capital gain realized by a qualified individual on the sale of his partnership units qualify for purposes of the capital gains deduction under subsection 110.6(3) of the Act?

     (b) Will a capital gain realized by a qualified individual on the sale of his shares of Newco qualify for the capital gains deduction that applies in respect of qualifies small business corporation shares under subsection 110.6(2.1) of the Act?

5.     Will a capital loss on the disposition of shares of hares qualify as a business investment loss for purposes of paragraph 39(1)(c) of the Act, subject to the limitation set out in subsection 39(9) of the Act?

Our Comments

We can only confirm the income tax effects of a particular proposed transaction by way of an advance income tax ruling.  However, we can provide the following general comments related tot he operation of a limited partnership which is a partnership for the purposes of the Act, where it is assumed that the facts outlined above apply and that the limited partnership units and the shares of Newco represent capital property to the taxpayer.

1.     Subsection 96(1) of the Act requires that, in general, the income or loss of a partnership is calculated at the partnership level and allocated to the partners, preserving its source characteristics.  Subject to the provisions of subsections 96(2.1) to (2.7) of the Act, a limited partner to whom the net income or loss of a partnership is allocated according to the partnership agreement will be required to include the amount of such income or loss of the partnership in computing his income or loss for the year pursuant to paragraphs 96(1)(f) and 96(1)(g) of the Act, respectively.

     A limited partner who disposes of his partnership interest by redeeming all or part of his partnership units during a fiscal period will normally be considered to have a residual interest in such partnership within the meaning of section 98.1 of the Act and will not be considered to have disposed of his partnership interest for the purposes of the Act until the end of the partnership's fiscal period during which all his rights to receive property of or from the partnership in satisfaction of his partnership interest are satisfied.  In such event, the income or loss allocated to the limited partner according to the terms of the partnership agreement of or the fiscal period during which he disposed of his partnership interest will be 1)  reported in his income or loss, and 2) either added to or deducted from the adjusted cost base of his partnership interest under the provisions of paragraph 53(1)(e) or paragraph 53(2)(c) of the Act, respectively for the purpose of determining the limited partner's gain or loess on the disposition of his partnership interest.

2.     The amount paid or payable in respect of taxation year of a limited partner (depending upon the method regularly followed by the limited partner in computing his income) by the limited partner pursuant to a legal obligation to pay interest on funds borrowed by the limited partner to acquire his units in the partnership will be deductible by such limited partner in computing his income for the taxation year pursuant to paragraph 20(1)(c) of the Act to the extent that such amount is reasonable.  This interest is deductible provided the limited partner continues to own throughout the period during which the interest accrues, all the partnership units (or shares of partnering) so acquired with such borrowed funds.

3.     Where a limited partner transfers his partnership units to a Canadian corporation in accordance with subsection 85(1) of the Act and files the required election in accordance with subsection 85(6) of the Act, there will not normally be a capital gain to the transferor where the amount agreed upon does not exceed the adjusted cost base of the partnership units transferred and the non-share consideration does not exceed the adjusted cost base of the partnership units.

     Partnership property may be transferred to a Canadian corporation in exchange for shares by using subsection 85(2) of the Act.  The partnership must then be wound up in accordance with subsection 85(3) of the Act within 60 days of the exchange of the corporation's shares for the partnership assets, so that the partners receive those shares for the corporation held by the partnership. Using this method, a partner will not normally realize a capital gain on the disposition of a partnership interest as long as the adjusted cost base of the partnership interest is equal to or greater than the fair market value of the non-share property (including cash) received from the partnership.  Each partner must meet this test in order to have a tax-free rollover. The corporation and all the members of the partnership must jointly elect on the prescribed form and within the time referred to in subsection 85(6) of the Act.

     Although we have provided comments in items 4 and 5 below in respect of the lifetime capital gains exemption contained in section 110.6 of the Act and the business investment loss described in paragraph 39(1)(c) of the Act, we cannot comment on whether a partner's interest in a partnership or the shares of held by a taxpayer will constitute capital property as this determination will be dependant upon the facts of the particular situation for each partner.  The determination of whether the shares of the corporation acquired by the limited partners on the distribution pursuant to either a rollover under subsection 85(1) of the Act or a rollover under subsection 85(2) of the Act and wind-up under subsection 85(3) of the Act described in paragraph 4 above, are capital property of the partners will not be affected solely by the fact, in and of itself, that the partners entered into an exchange of their partnership interest for shares in a corporation.  The capital gains deduction contained in section 110.6 of the Act is available only to residents of Canada throughout the year in which the property is disposed of, subject to the deeming provision of subsection 110.6(5) of the Act.  The comments indicated below are based on the assumption that the individuals meet this test.

4.     Subject to subsections 110.6(6) and 110.6(7) of the Act, and provided that the partnership units are capital property of the holder, an individual limited partner will be entitled to include in his annual gains limit and cumulative gains limit as defined in subsection 110.6(1) of the Act, a capital gain, if any, realized on the sale of his partnership interest.

     In order for the capital gains deduction contained in subsection 110.6(2.1) of the Act to apply, there must be a disposition by an individual of a qualified small business corporation share as defined in subsection 110.6(1) of the Act. We cannot confirm that a share of the capital stock of i will be a "qualified small business corporation share" as defined in subsection 110.6(1) of the Act, as such determination is a question of fact based on the various factual tests set out in that provision being met at the determination time referred to in the provision and for the period described therein.  Subject to subsections 110.6(6) to 110.6(8) of the Act, and provided the shares are capital property of the individual shareholder, that shareholder will be entitled to include in his annual gains limit and cumulative gain, if any, realized on the sale of a qualified small business corporation share.

5.     A taxpayer's "business investment loss" as defined in paragraph 39(1)(c) of the Act is his loss from the disposition to an arm's length person of a share of capital stock of a small business corporation.  The determination as to whether the vendor and purchaser of the shares are dealing at arm's length can only be made after a review of all the relevant facts of the situation.  Where a taxpayer disposes of shares of a small business corporation which are capital property to the taxpayer to an arm's length can only be made after a review of all the relevant facts of the situation.  Where a taxpayer disposes of shares of a small business corporation which are capital property to the taxpayer to an arm's length person, subject to Subsection 39(9) of the Act, the capital loss on the disposition of shares of Newco, will qualify as business investment loss for the purpose of paragraph 39(1)(c) of the Act.

These comments represent our opinion of the law as it applies generally and do not take into account considerations that might arise in the context of a specific factual situation.  as indicated in paragraph 24 of Information Circular 70-6R dated December 18, 1978, this opinion is not a ruling and accordingly is not binding on Revenue Canada, Taxation.

We trust the foregoing comments will be of assistance to you.

Yours truly,

for Director,Small Business and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch