5 December 1994 Internal T.I. 9420577 - PARTNERSHIP LOSSES

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

		December 5, 1994

	HALIFAX DISTRICT OFFICE	HEAD OFFICE
N. B. Squires, Director	Rulings Directorate
F.B. Fontaine
Attention: M. Chiasson	(613) 957-8953
           Technical Advisor

7-942057

XXXXXXXXXX
Partnership Losses & Attribution Rules

This is in reply to your memorandum dated August 4, 1994 concerning the above named individuals in which you request our comments regarding the situation described below.

Although you attached a copy of a letter addressed to your office from XXXXXXXXXX (the "taxpayer"), you have confirmed, during our telephone conversation (Fontaine/Chiasson), that you will reply directly to the XXXXXXXXXX following the receipt of our response to your comments.

Our understanding of the situation is as follows:

XXXXXXXXXX

XXXXXXXXXX

At the time of the transfer of the units to the spouse, the adjusted cost base ("ACB") of the units was negative.

3.In 1993, the taxpayer claimed a 1992 limited partnership loss which was disallowed and the taxpayer questioned the reason for disallowing his claim.

You raised the following issues:

(1)Because the ACB of the units was negative and the taxpayer transferred the units for nil proceeds, he opted out of electing under subsection 73(1) of the Income Tax Act (the "Act"). Accordingly, the units were transferred to the spouse at their negative ACB.

(2)The limited partnership losses are business losses and are, therefore, not subject to attribution.

(3)The taxpayer may be able to claim the 1992 limited partnership loss in his 1993 return.

(4)All limited partnership losses from 1993 onward will be the spouse's losses subject to the at-risk rules. However, since her ACB will be nil, it is unlikely that she will be able to claim any of those losses.

(5)The spouse may be able to transfer the units back to the taxpayer using subsection 73(1) of the Act. In this case, since the taxpayer's ACB would be nil, he would not be able to claim any future limited partnership losses.

(6)The spouse may transfer the units back to the taxpayer at an enhanced fair market value ("FMV") for the purpose of creating a capital gain thereon for herself and an enhanced ACB to the taxpayer. This, you feel, would trigger the application of section 69 of the Act.

(7)Also, you consider that subsection 74.1(1) of the Act may apply where the FMV of the units is legitimately above zero.

Our comments are as follows:

(A)Paragraph 54(d) of the definition "adjusted cost base" of the Act provides that "in no case shall the adjusted cost base of any property at the time of its disposition by the taxpayer be less than nil". Accordingly, at the time of disposition of the units by the taxpayer to his spouse, the ACB thereof must be nil, notwithstanding that previous to the disposition the ACB was negative.

(B)Property, other than depreciable property, transferred by a taxpayer to the taxpayer's spouse pursuant to subsection 73(1) of the Act is deemed to be disposed of for proceeds equal to its ACB, unless the taxpayer elects not to have subsection 73(1) apply. Since, as indicated in (A) above, the ACB of the units at the time of disposition could only have been nil which also represented the proceeds of disposition to the taxpayer, it is our view that the taxpayer transferred the units to his spouse at their ACB and that he did not elect to opt out the provisions of subsection 73(1) of the Act. In any event, if he had opted out of subsection 73(1) of the Act, the units would have been transferred at their FMV. But the taxpayer did not state the FMV of the units nor did he indicate that the transfer was made at FMV.

(C)Subsection 74.1(1) of the Act refers to the attribution of any income or loss arising "...from the property or property substituted therefor". Commencing for the 1989 taxation year, subsection 96(1.8) of the Act provides that where a person is a specified member of a partnership for a fiscal period, for the purposes of section 74.1, among other provisions of the Act, that person's share of the income or loss of the partnership for that period is deemed to be income or loss from property. A specified member of a partnership includes a limited partner. Accordingly, although partnership losses generally may be considered as business losses, for the purposes of subsection 74.1(1), any income or loss of the partnership in respect of the units transferred to the spouse would be attributed to the taxpayer. See Interpretation Bulletin IT-511R.

(D)We suspect that the taxpayer was unable to claim the 1992 losses from the partnership in the 1992 taxation year because the losses may have been considered as limited partnership losses, described under subsection 96(2.1) of the Act. If they were, we agree that the taxpayer may be able to claim them in the 1993 taxation year subject to the restriction in respect of the at-risk amount imposed by paragraph 111(1)(e) of the Act. However, the at-risk rules provided under subsections 96(2.1) to 96(2.7) of the Act may not apply to the taxpayer (or the spouse) if the limited partnership interest held in the partnership represented (or in the case of the spouse, may represent) an "exempt interest" under subsection 96(2.5). See paragraphs (a) to (d) below for further comments in this regard.

(E)We agree that the spouse may be able to transfer the units back to the taxpayer under subsection 73(1) of the Act subject to the provisions of subsection 96(2.1) and paragraph 111(1)(e) of the Act, where the at-risk rules apply, with regard to partnership losses. Also, we agree that any such transfer of the units in excess of their FMV, at the time of the transfer, would trigger the application of paragraph 69(1)(a) of the Act to the taxpayer. Any such excess is a matter to be determined on the basis of a valuation of the units (by your Business Valuations Division) at the particular time.

(F)The application of subsection 74.1(1) of the Act is not dependent, in and by itself, on the amount of the ACB or the FMV of the particular property. By virtue of paragraph 74.5(1)(a), subsection 74.1(1) would not apply to a transfer of the units from the spouse to the taxpayer, if the transfer was made for consideration equal to the FMV at the time of the transfer.

As described in (C) above, the application of subsection 74.1(1) of the Act with regard to the deduction of partnership losses by the taxpayer or his spouse would depend on the application of subsection 96(1.8) of the Act.

(G)Pursuant to subsection 40(3) of the Act, a negative adjusted cost base of a partnership interest is not required to be included in computing income of the holder. However, upon the disposition of such property, any negative adjusted cost base must be brought into income pursuant to subsection 100(2) of the Act. Commencing after February 21, 1994, the negative adjusted cost base of a limited partner's partnership interest may be required to be included in income even though the interest has not been disposed of. Such provision is contained under new subsection 40(3.1) of the Act, as described in the draft legislation released on September 27, 1994 by the Ministry of Finance.

Although they were not specifically requested, we provide these comments which relate to paragraph (D) above and the implications of subsections 96(2.5) of the Act.

(a)Subsection 96(2.5) may apply to exempt the taxpayer from the at-risk rules which came into force on February 26, 1986.

(b)Where the partnership had commenced its business prior to February 26, 1986 and carried on the business continuously thereafter to a time including the time at which the partnership interest was disposed of by the taxpayer, the taxpayer's partnership interest could be an exempt interest. It is our view that the "continuously thereafter" requirement would not be lost during the time in which the business was placed in receivership provided that the business had not ceased during that time.

(c)If the taxpayer's interest was an exempt interest, the taxpayer would not be a "limited partner" as the term is used in subsection 96(2.4) of the Act and, accordingly, his partnership losses would not be restricted by virtue of subsection 96(2.1) and paragraph 111(1)(e) of the Act. Also, as a result of the decision in the Signum Communications case (91 DTC 5360), the restriction imposed under paragraph 20 of Interpretation Bulletin IT-138R no longer represents the Department's position. On this basis, the taxpayer would be able to deduct the 1992 partnership loss in 1992 or 1993 from other income without the restrictions described above.

(d)However, the taxpayer's partnership interest would not be an exempt interest if during the period from February 27, 1986 to the time of disposition of the units there was a substantial contribution of capital to, or a substantial increase in the indebtedness of, the partnership. This could have resulted, for example, from a significant expansion of the partnership's activity. This would be a matter to be determined in the particular circumstance.

We hope the above information will be of assistance.

for Director
Manufacturing Industries,
Partnerships and Trusts Division
Rulings Directorate
Policy and Legislation Branch