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.
950865
XXXXXXXXXX Cal Brown
(613) 957-8980
Attention: XXXXXXXXXX
April 11, 1995
Dear Sirs:
This is in reply to your request of March 23, 1995 concerning an interpretation of the at-risk rules and the provisions set out in Bill C-59 which would include a limited partner's negative adjusted cost base in income.
You have asked us to consider a limited partnership arrangement where limited partners have invested approximately half of the necessary funds for a project by the purchase of partnership units. About 80% of the price that the limited partner pays for the partnership unit is provided by an arm's length full recourse bank loan due in 15 years. This period of 15 years represents the expected earnings period for the project and has been selected for that reason. The remainder of the unit price is provided by limited partners from their own resources. The other half of the funds necessary to carry out the project come from an arm's length full recourse loan provided directly to the limited partnership by a party who will own the completed project and will exploit it under a revenue sharing arrangement with the limited partnership.
The limited partnership has a reasonable expectation of profit. There are no arrangements in place that will guarantee the limited partnership revenue nor are there any arrangements intended to reduce the potential risk to a limited partner. However, there is an arrangement in place with respect to surplus partnership funds.
Although the expected income producing period of the project is estimated to be approximately 15 years, the historic pattern of revenue in such projects indicates that revenue, equal to approximately half the cost of the project, will be received by the end of the fourth year. The parties to this arrangement have agreed that the loan by the bank to the limited partner will take precedent over the loan to the limited partnership. Since the revenue accumulated by the fourth year is not needed to meet the limited partnership's expenses, it would be available for distribution to the limited partner to be used to reduce the limited partner's loan. However, the limited partnership has only recovered half of the project cost at this time and consequently the limited partners have been allocated losses which have substantially reduced the adjusted cost bases of their limited partnership units. If the revenue which is not needed for the limited partnership's business is distributed to the limited partners their adjusted cost bases would go negative.
In Bill C-59, the Department of Finance set out certain provisions intended to include a limited partner's negative adjusted cost base in income. As a result of these provisions, it makes no sense to distribute the funds to the limited partners until there is sufficient undistributed limited partnership earnings to add to the limited partners' adjusted cost bases so that the distribution will not cause the adjusted cost base to go negative. It is possible that this may not occur until near the end of the 15 year business cycle.
The bank is concerned with the security of these surplus funds and consequently as part of the original arrangement an investment agreement has been put in place. Essentially, this agreement is designed to come into play if the expected earnings materialize and are held in the limited partnership. The limited partnership will appoint an investment manager who is arm's length with the bank and who will manage the funds investing them on behalf of the limited partnership and distributing the earning each year. The securities authorized for investment will ensure (under normal conditions) that proportionately, the earnings on the limited partnership's investment will be in excess of the interest cost related to limited partners' loans. This will provide an additional source of income for the partnership but will generally not increase the limited partners' adjusted cost bases since it is intended that the annual earnings on the investment be distributed to the limited partners to provide funds to pay interest on the bank loan. In order to provide the bank with some element of security, the investments will be legally owned by the bank as bare trustee for the limited partnership. It is expected that the investment funds will be liquidated in year 15 when the bank loan is due.
Based on our understanding as set out above, there has not been a distribution of funds to the limited partners as a result of the limited partnership entering into the investment agreement nor has there been any receipt by the bank, constructive or otherwise, of its loan to the limited partners. Consequently, this investment agreement, in and by itself, will not result in any reduction of the limited partners adjusted cost bases. We also note that there are no provisions under Income Tax Act (the "Act") that would require or deem the limited partnership to have made a distribution of surplus funds to the limited partner. In view of this, the provision of subsections 40(3.1) and 40(3.2) of the Act would not apply solely as a result of the limited partnership making investments under the investment arrangement.
Since the investment agreement is another income source for the partnership and is subject to the normal portfolio risks that occur in entering into any investment arrangement, it would not be viewed as an amount or benefit for the purposes of paragraph 96(2.2)(d) of the Act.
This is an opinion only. In an actual case, the proper determination of the relationship created and the tax consequences would have be determined through an examination and analysis of the specific documents and arrangements as well as considering the intentions of the parties to the arrangement.
Yours truly,
for Director
Manufacturing Industries,
Partnerships and Trusts Division
Income Tax Rulings
and Interpretations
Directorate
Policy and Legislation Branch
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