7 November 1989 External T.I. 58390 F - Allocation of Partnership Income/Loss

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.

November 7, 1989

Dear Sirs:

Re:  Allocation of Partnership Income/Loss

We are writing in reply to your letter of July 10, 1989 concerning the allocation of the income/loss of a partnership.

In your letter you refer to a hypothetical situation where Mr. Y is a limited partner in partnership and X Limited is the general partner.  Mr. Y contributed $100,000 to the partnership and X Limited contributed $200.  The partnership agreement states that in the first fiscal year Mr. Y will receive 99% of the income/loss of the partnership both in actual payout and for income tax purposes, the general partner will receive only 1%.  In year two and all subsequent years, Mr. Y will receive 40% of the income/loss and X Limited will receive 60%

Based on the above hypothetical situation you have posed the following two questions:

1)     Is there any reason why under the Income Tax Act (the "Act") such an arrangement will not be accepted or could attract adverse tax ramifications?

2)     Is there a disposition of the partnership for income tax purposes at the end of year one?

Our Comments

Our comments related to the above questions are as follows:

1)     In our opinion, the provisions contained in subsections 103(1) and 103(1.1) of the Act could apply to the above situation.

     Subsection 103(1) of the Act allows the Department to reallocate the 11 location of income or loss of a partnership where the principal reason for the agreed upon allocation may reasonably be considered to be a reduction or postponement of the tax that might otherwise have been or become payable under the Act.  As it is a question of fact whether it is reasonable to conclude that the allocation was to reduce or postpone tax payable by Mr. Y, we cannot determine whether subsection 103(1) of the Act would apply without knowing all of the facts related to a particular case. However, in the above hypothetical situation it would appear that the allocation in the first year might be to allow Mr. Y to deduct anticipated first year losses and receive a reduction in the tax he might otherwise have paid in that year.  If that were the case the Department would presumably use subsection 103(1) of the Act to reallocate part of the loss to X Limited.

     If Mr. Y and X Limited do not deal with each other at arm's length subsection 103(1.1) of the Act provides for a reasonable allocation of incomes, losses or other amounts relevant to the computation of the partner's incomes or taxable incomes.  Interpretation Bulletin IT-23lR2 discusses the sharing of income by partners who do not deal at arm's length. The allocation of the incomes, losses or other amounts must be made having regard to capital invested in and work performed for the partnership and such other factors as may be relevant.  If an allocation is unreasonable subsection 103(1.1) of the Act will apply even where the allocation is in accordance with a partnership agreement.  Again, whether an allocation is reasonable is a question of fact which can only be determined when all of the facts of a given situation are known.  In the above situation if Mr. Y and X Limited were not acting at arm's length subsection 103(1.1) of the Act would have to be considered.

     If either subsection 103(I) or 103(1.1) of the Act were to apply the applicable subsection could reallocate the first year allocation, the subsequent years allocations or allocations for all years.

2)     In our opinion, it is also a question of fact as to whether a disposition has occurred.  In situations where subsections 103(1) and 103(1.1) of the Act apply to reallocate amounts, the Department will generally not consider a disposition to have occurred as the reallocations will normally result in each partner receiving the same percentage of any income or loss throughout the years involved.  Where subsections 103(I) and 103(1.1) of the Act do not apply, the Department will review the facts related to each particular situation.  In reviewing the facts, the Department will also consider the application of any provincial laws which may govern partnership dispositions and at that time determine whether a disposition has occurred for Income Tax purposes.

We trust that our comments will be of assistance.

for DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch