23 February 1990 Ministerial Correspondence 59374 F - Income Attribution Rules

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.

February 23, 1990

Dear Sirs:

Re:  The Income Attribution Rules Subsections 74.1 and 103(1.1) of the Income Tax Act (the "Act")

This is in reply to your letter concerning the attribution rules in section 74.1 of the Act.

You point out that the attribution rules in section 74.1 do not apply to business income.  You also state that these rules do not apply where a transfer from one spouse to another takes place at fair market value based on subsection 74.5(l) of the Act.  With respect to the latter we would point out that this is true only to the extent, as set out in paragraph 21 of Interpretation Bulletin IT-5ll, that the consideration received for the transfer by one spouse to the other is also valued at fair market value and the other condition in subparagraphs (b) and (c) are met.

You mention that you have encountered on several occasions the following situations:

Husband owns a farm and farms as a proprietor for several years. After several years, he decides to transfer his farm as well as the rest of his farm proprietorship assets to a farm partnership consisting of himself and his wife under section 97(2).  The husband receives a capital interest for full fair market value of his assets minus liabilities transferred in.  However in the allocation of future annual profits, he does not receive a full interest benefit on his excess capital employed in the partnership compared to that of his spouse.  This is a common occurrence because he does not receive a full return on his equity as a proprietorship either.

You ask that we confirm in these situations that the wife would be entitled to report her proportionate share based on the partnership agreement of any gain accruing after the 97(2) transfer on ultimate sale by the partnership without worry about the attribution rules in the Income Tax Act.

Our Comments

Whether or not a particular arrangement is a partnership or whether or not a particular partnership exists are questions of fact the determination of which can only be ascertained by an examination of all relevant facts and information.  Similarly, the basis for the sharing of income from partnerships by partners who do not deal at arm's length can only be ascertained from an examination of all the facts of a particular situation.  However, if you refer to paragraph 2 of Interpretation Bulletin IT-23lR you will note that the Department may alter the sharing of income from partnerships where the parties are not dealing at arm's length and the circumstances dictate that such action is required.  This position is reiterated in the answer to Question 40 on pages 621 and 622 of the 1980 Revenue Canada Round Table.

In essence subsection 103(1.1) of the Act requires a reallocation if the net income, loss, or other amount from the partnership is not reasonable in the circumstances, having regard to the capital invested in or work performed for the partnership by the members thereof, and such other factors as may be relevant.  As in the past, the Department will continue to challenge the income allocation where one spouse neither actively engages in nor invests his or her own property in the partnership business. This same principle will apply to any gain on the subsequent sale of the partnership.

We trust this is the information you require.  However, if you have a particular fact situation and proposed transaction in mind, you may wish to apply for an Advance Income Tax Ruling in accordance with the guidelines set out in Information Circular IC 70-6R.

Yours truly,

for DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch