15 August 1991 Ministerial Letter 911308 F - Income Allocated to a Retiring Partner

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.

Dear sirs:

We are writing in reply to your letter of May 9, 1991, wherein you requested our comments regarding the application of the Income Tax Act (the "Act") to income allocated to a retiring partner.  We apologize for the delay in responding to your letter.

Our understanding of the facts given to illustrate the issues is as follows:

1.     

2.     24(1)

3.                                                            

4.     24(1)

5.     

Your Question

1.     What is the income tax treatment to the Taxpayer of all amounts receivable by him provided under the SA?

Our Opinion

1.     As supported by the court case Stephen R. Dacen, 89 DTC 5297,    the remuneration amount with respect to the Relevant Fiscal Year should be included in the Taxpayer's income in his taxation year during which the Relevant Fiscal Year ended (by virtue of paragraph 96(1)(f) of the Act).

24(1)

24(1)

It is your opinion that support for this position is found in the court case Philippe E. Delesalle, 85 DTC 5613.

Our Comments

While we are unable to provide confirmation of the income tax effects of the particular situation described in your letter, we can offer the following general comments related to income allocated to a retiring partner from a partnership.  It is assumed that the partnership does not cease to exist pursuant to the applicable provincial partnership law or the partnership agreement as a result of the withdrawal of the partner.  In addition, it is assumed that the payments to the retiring partner for the partnership interest are made by the partnership as opposed to the situation where the remaining partners purchase that interest from the retiring partner.  Finally, it is assumed that no WIP cases of the partnership are transferred to the retiring partner in partial satisfaction of the partnership interest.

1.     In general, the allocation of income of a partnership (or a change to it) must be carried out in accordance with a) the applicable provincial partnership law and b) the written or tacit partnership agreement.  The method of income allocation can be superseded by another legally binding agreement entered by the partnership, such as an agreement to allocate income to a retiring partner.  It is a question of fact dependant on the circumstances of the situation as to whether a particular  written agreement supersedes another written or implied    agreement or whether an agreement entered into by certain  partners is binding on the partnership.

     Income allocated to a partner from a partnership for a fiscal period during which that person was a partner will be included in that person's taxable income pursuant to paragraph 96(1)(f) of the Act in the taxation year during which the fiscal year of the partnership ends.  As indicated in paragraph 10 of Interpretation Bulletin IT-457R, where a partner withdraws from a partnership but the partnership does not cease to exist, the election made under paragraph 34(a) of the Act continues to be valid for the remaining partners.  The income calculated by a partnership pursuant to paragraph 96(1)(f) of the Act must take into consideration the partnership's election under paragraph 34(a) of the Act.  Consequently, the amount to be included in a person's income pursuant to paragraph 96(1)(f) of the Act can not include a portion of WIP excluded in computing the partnership's income.  

      In the Dacen case, the court held that the income to be reported pursuant to subsection 96(1.1) of the Act by the retired partner could not be computed by choosing a closing WIP figure as at a point in time after the partner retires, unless an agreement to that effect has been entered into by the partnership and the retiring partner.  While subsection 96(1.1) of the Act refers to the members of a partnership agreeing to make an allocation, similar wording in not found in paragraph 96(1)(f) of the Act.  Therefore, it is our opinion that the reasoning of this case does not directly support your position that an agreement to allocate income for a period during which the retired partner was a partner can not be altered without the consent of all parties.

2.     Even though a person is not a partner at the end of the fiscal period of a partnership, income allocated to that former partner at the end of the fiscal period in respect of the portion of the fiscal period during which that individual was a partner will be included in that former partner's taxable income (pursuant to paragraph 96(1)(f) of the Act) in the taxation year in which the fiscal period of the partnership ends.

3.     Where the members of a partnership have entered into an agreement, pursuant to subsection 96(1.1) of the Act, to make a allocation to a retired partner of income arising from the partnership's operations after the withdrawal of that partner, that income will be included in the former partner's taxation year in which the fiscal period of the partnership ends.  In our opinion, the court cases of C. Laferriere (currently under appeal),[1985] 2 CTC 190 (FCTD), Delesalle, Dacen and S. Valo and L. Barsky, 89 DTC 223 (TCC) support the position that in order for an amount to be included in the income of a retired partner under subsection 96(1.1) of the Act, the agreement to allocate that income must have been entered into by both the retiring partner and the partnership. This agreement can not be unilaterally amended without the consent of both parties.

4.     A person who retires and disposes of the partnership interest at any time during a fiscal period of the partnership will have residual interest in the partnership pursuant to paragraph 98.1(1)(a) of the Act where either: a) that person is allocated a share of the partnership income (accruing during the time the person was a member) at the end of the fiscal period of the partnership, or b) the rights to receive property in respect of the partnership interest have not been satisfied at the time of ceasing to be a member of the partnership. As a result, the partnership interest is deemed not to be disposed of on retirement but rather becomes a residual interest, the adjusted cost base of which is that of the partner's partnership interest immediately before retirement.  Therefore, the former partner will be entitled to increase or decrease the adjusted cost base of the residual interest (pursuant to paragraph 53(1)(e) of the Act) with respect to the share of income or loss in respect of the portion of the fiscal period of the partnership during which the retired partner was a member.

A repayment of capital made after the date of retirement and before the end of the fiscal period of the partnership to a former partner that has a residual interest is deducted from  the adjusted cost base of the residual interest at the time of the  payment pursuant to subparagraph 53(2)(c)(v) of the Act.  However, should the adjusted cost base of the residual  interest become negative as a result, the negative amount would be deemed not to be a gain for the purposes of subsection 40(3) of the Act until the end of the fiscal period of the partnership (by virtue of paragraph 98.1(1)(c) of the Act).

Where a former partner's rights described in paragraph 98.1(1)(a) of the Act are satisfied in full before the end of the fiscal period of the partnership, the partner shall be deemed to a) be a partner until the end of the fiscal year and

b)      have disposed of the residual interest at the end of such fiscal period (pursuant to paragraph 98.1(1)(b) of the Act). Accordingly, any capital loss resulting from the disposition of the residual interest must be recognized at the end of the fiscal period. That capital loss or the capital gain referred to in the above paragraph will be included in that former partner's taxation year in which the fiscal period of the partnership ends.

As indicated in paragraph 16(b) of IT-457R, where a partner withdraws from a continuing partnership which has WIP, in respect of which an election under paragraph 34(a) of the Act is in force, the partnership may purchase the withdrawing partner's partnership interest which includes the partner's interest in the partnership's WIP.  Any payment by the partnership in respect of that WIP will be in partial satisfaction of the former partner's partnership interest and represents a capital receipt to the withdrawing partner and a capital outlay to the continuing partners.

Where there is an agreement made pursuant to subsection 96(1.1) of the Act, paragraph 13 of IT-242 indicates that there may allocated to a retired partner an amount that represents WIP that has not been included in the income of any partner as an election pursuant to paragraph 34(a) of the Act has been made. Whether that allocation represents income or capital to the retired partner depends on the agreement between the retired partner and the other members of the partnership.

In our opinion, the court case Delesalle supports the position that where an agreement has been entered between the partnership and the retiring partner as to nature of the payment to be made by the partnership in respect of the balance in the capital account of the retiring partner, that treatment can not be subsequently altered by the partnership to be a payment made pursuant to subsection 96(1.1) of the Act without the consent of the retiring partner.

These comments represent our opinion of the law as it applies generally.  As indicated in paragraph 21 of Information Circular 706R2 dated September 28, 1990, this opinion is not a ruling and accordingly, it is not binding on Revenue Canada, Taxation.

We trust these comments will be of assistance.

Yours truly,

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch