13 October 1998 External T.I. 9801445 - ALLOCATION OF PARTNERSHIP INCOME

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.

XXXXXXXXXX 						F.B. Fontaine, FCCA
							980144
October 13, 1998

Dear Sir:

Re: Allocation of Partnership Income to a Non-resident Retired Partner

This is in reply to your letter of January 13, 1998 concerning a retired and former member of a Canadian partnership who was a Canadian resident, now resides in the U.S. (the “taxpayer”) and receives a monthly payment from the partnership which carries on business in Canada.

The partnership agreement provides that the monthly payment be made to the taxpayer upon retirement (or to the surviving spouse), calculated on the taxpayer’s share of the partnership’s profits for the years during which he/she was a member. The payment to the taxpayer is treated, for accounting and tax purposes, as an allocation of the partnership’s business profits. You acknowledged that the payment would be taxable to the taxpayer as business income under Part I of the Income Tax Act (the “Act”). Based on the technical explanations of Article VII(6) of the Canada-U.S. Income Tax Convention (1980) (the “Treaty”), it is your view that the payments could be considered as “pensions” and “annuities” under the Treaty definitions of these terms in Article XVIII thereof. You asked:

(i) whether Article XVIII would take precedence over Article VII of the Treaty; and

(ii) if Article VII takes precedence, whether the business income would not be attributable to a permanent establishment (“PE”) in Canada through which the taxpayer carries on business.

Our Comments

It is our view that payments representing allocations of income of a partnership carrying on business in Canada would constitute business profits in accordance with Article VII of the Treaty. The payments would not meet the definitions of “annuities” or “pensions” and would not be regarded as “other retirement arrangement” included in the latter definition under Article XVIII of the Treaty. Our reasons for such view are as follows:

(1) The facts do not support that the payments to the taxpayer are made pursuant to a superannuation, pension or retirement arrangement. Rather, they are allocations of income of a partnership paid to a taxpayer pursuant to a partnership agreement under which the payment may be terminated where the taxpayer engages in a business that competes with the partnership. Normally, we would not expect the payment of a “pension” or an “annuity” to be subject of termination because of a competitive or non-competitive restriction. Moreover, the payments are subject to a year’s aggregate being limited to a fixed percentage of net profits of the partnership. Such conditions attached to the payment, in our opinion, also do not support a pension or an annuity payment but supports instead a payment made in respect of a business or the carrying on of a business.

(2) Because of the fixed percentage of net profit limitation described in (1) above, it is uncertain what payments, if any, would be made to the taxpayer if a net loss or a lower than expected net profit is achieved. In this case, there would be some doubt that all the payments made in the year would be “a stated sum paid periodically” in the definition of “annuity” under paragraph 4 of Article XVIII of the Treaty.

(3) Also, a payment that is an “annuity” must be made in return for full consideration, other than services rendered. Payments made to a member of a partnership (other than a limited partner) based on the member’s share of profits during the time he/she was a member would, in our opinion, be for services rendered to the partnership.

(4) We agree that the payments would constitute an allocation of the business profits of the partnership, paid under the partnership agreement and would be subject to Part I tax pursuant to subsections 96(1.1), 96(1.6), 2(3) and section 115 of the Act. This would be so by virtue of Article VII of the Treaty which provides that business profits arising from carrying on a business by a taxpayer through a PE in Canada would be taxable in Canada.

(5) It is the Department’s position that each member of a partnership would have a PE in a province in Canada where the partnership, carrying on a business, has a PE. Accordingly, where a member of such partnership is deemed to be carrying on a business in Canada pursuant to subsection 96(1.6), for the purposes of subsection 2(3) of the Act, the member would carry on such business through that PE. In this regard, any business profits of the partnership earned in a particular PE in Canada and allocated to a member of the partnership pursuant to subsections 96(1.1) and 96(1.6) of the Act would be attributable to that PE in respect of the member.

Based on our understanding of the facts, we note that the taxpayer, upon ceasing to be resident in Canada, would have a deemed disposition of a right to income under paragraph 128.1(4)(b) of the Act, the proceeds of which would be required to be included in computing the taxpayer’s income under subsection 96(1.2) and which would be subject to a deduction described under subsection 96(1.3) of the Act.

The comments above represent an expression of opinion which, as indicated in paragraph 22 of Information Circular 70-6R3, is not an advance income tax ruling and, accordingly, is not binding on Revenue Canada.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch