18 April 1990 Internal T.I. 59317 F - Partnership Taxation

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.

April 18, 1990

Dear Sirs:

Re:  Partnership Taxation

We are writing in reply to your letter of December 21, 1989 wherein you requested our technical interpretation on several matters regarding the taxation of partnerships.

In particular, you have requested our interpretation of the application of subsections 98(5) and 53(1)(e) of the Income Tax Act (the "Act") as they apply to a situation in which there are two partners in a partnership ("A" and "B") and B disposes of its partnership interest to A so that the partnership no longer exists because there would be only one person carrying on the partnership business.  Based on this situation you have asked:

1.     Under these circumstances, would subsection 98(5) of the Act apply Co A and to the partnership if the partnership business  is continued to be carried on by A immediately after the acquisition of B's partnership interest?  Would this be the case if A carried on the business after the acquisition of B's interest, but then disposed of the business prior to the end of the three-month period referred to in subsection 98(5) of the Act?

2.     In the above situation, the partnership profits for the portion of the year up to the time when it ceases to exist would be allocated between A and B.  Would the portion of the profits allocated to B be included under subparagraph 53(1)(e)(i) of the Act in computing the adjusted cost base to B of its partnership interest immediately before the disposition of this interest to A?

3.     If in the above example, B disposed of its partnership interest to C instead of A, the partnership would continue to exist with A and C as partners.  In this case, depending on the partnership agreement, B could nevertheless be allocated a share of partnership profits for the fiscal period of the sale and B would be taxable on those profits under 96(1) of the Act.  However, for the purposes of computing B's capital gain on the disposition of its partnership interest to C, it appears that B's share of the partnership profits for the current fiscal period are not included in the adjusted cost base of its partnership interest under subparagraph 53(1)(e)(i) of the Act because the fiscal period of the partnership would not have ended prior to the disposition. Does Revenue Canada deny the addition of these profits to B's adjusted cost base in this situation?

4.     Where B disposes of its partnership interest to C but maintains a right to receive a nominal amount of partnership property which would be payable to B by the partnership within a specified time after B ceases to be a partner, would section 98.1 of the Act apply to deem B to continue to have an interest in the partnership until the end of the fiscal period so that B's share of the partnership profits for the fiscal period would be added to B's adjusted cost base under subparagraph 53(1)(e)(i) of the Act?  If this treatment is correct, would Revenue Canada apply subsection 245 of the Act to deny this result?

Our comments

1.     In the situation where B disposes of its partnership interest to A, subsection 98(5) would apply if A, within three months, carries on by itself the business that was the business of the partnership and continues to use, in the course of the business, any property that was, immediately before B disposed of its partnership interest to A, partnership property.  However, in order to satisfy the requirement that A continues to use the property, A must carry on the business for a reasonable length of time.  The determination of a reasonable length of time is a question of fact, however, disposition of the business within the three-month period would likely raise questions about reasonableness.  In some circumstances, it is possible that we would consider the application of section 245 to redetermine the tax consequences.

2.     In order for the provisions of subsection 98(5) to apply a partnership must have ceased to exist.  Subsection 99(1) provides that, subject to an election under subsection 99(2), where a partnership ceases to exist, the fiscal period shall be deemed to have ended immediately before that time. Subparagraph 53(1)(e)(i) includes in computing the adjusted cost base of a partner's partnership interest, the partner's share of income for any fiscal period of the partnership ending before that time.  In the situation where B disposes of its partnership interest to A and the partnership ceases to exist, in our view, B's share of the partnership profits for that fiscal period should be included in B's adjusted cost base at the time of disposition.

3.     We confirm your interpretation of the application of subparagraph 53(1)(e)(i) where B disposes of its partnership interest to C and the partnership continues to exist. Subparagraph 53(1)(e)(i) provides for the addition to the adjusted cost base of a partner's partnership interest of a partner's share of partnership income for each fiscal period of the partnership ending before that time. This does not include income allocated to a partner for a fiscal period of a partnership where the partner disposes of its partnership interest during that fiscal period.

4.     When a partner ceases to be a member of a partnership at a time when his rights in any partnership property in satisfaction of his partnership interest are not satisfied, the partner has a residual interest in the partnership pursuant to section 98.1 of the Act. In our view, a partner who has disposed of its partnership interest to a third party may retain a residual interest in the partnership to be satisfied by the partnership after such disposition.  For example, partnership income allocated to the original partner under the terms of the partnership agreement and owing to the partner after disposition of its interest may be considered a residual interest.  The facts of each particular situation would need to be known in order to determine whether the partner had a residual interest in the partnership.  In the situation where B maintains the right to receive a nominal amount of partnership property, we would question whether this amounted to a residual interest to which subsection 98.1 of the Act applied or, alternatively, we would consider the application of section 245 to redetermine the tax consequences.

We trust that these comments will be of assistance.

Yours truly,

for DirectorBusiness and General DivisionSpecialty Rulings Directorate Legislative and Intergovernmental Affairs Branch