11 February 1999 External T.I. 9808185 - SECTION 34.2 RESERVE34.2

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.

Principal Issues:

Cessation of a partnership by an individual who joined another partnership in the year. Application of 34.1(1) and (2) re additional income inclusion and continuation of a deduction of the reserve under 34.2(4) where the new business is a substituted business for the purposes of 34.2(3).

Position:

General comments provided setting out the application of 34.1(1) and (2), the availability of the reserve under 34.2(4) and the continuation thereof where 34.2(3) applies and also the requirement to have a deemed December 31, 1995 income under 34.1(4) or (5) for such purpose.

Reasons:

Situation appears to be a completed transaction. Hence, response limited to general comments as above.

XXXXXXXXXX 						F.B. Fontaine, FCCA
      						980818
Attention:  XXXXXXXXXX 

February 11, 1999

Dear Sirs:

Re: Sections 34.1 and 34.2 of the Income Tax Act (the “Act”)

This is in reply to your letter dated March 26, 1998 concerning the above-captioned subject.

You described a situation which involves the partner of a professional partnership who had been a member since 1988 but ceased to carry on that business on March 25, 1998 and joined another partnership. Among other things, the partner had filed an election under subsection 249.1(4) of the Act and had claimed a reserve under subsection 34.2(4) of the Act in respect of his December 31, 1995 income. All of the partner’s rights under the first partnership were settled during the 1998 taxation year.

You asked us to confirm the partner’s income from both partnerships for 1998 and 1999 and also the partner’s additional income under subsection 34.1(1) of the Act.

The situation that you have described appears to be an actual fact situation. Paragraph 22 of Information Circular 70-6R3 (the Circular) outlines the procedure to be followed where a situation involves a completed or a contemplated transaction. Accordingly, while we are unable to provide confirmation of the income tax effects of the particular situation, we are prepared to offer the following general comments:

(1) An individual (other than a testamentary trust) carrying on business in partnership, all of the members of which are individuals, in a taxation year, where the fiscal period of the partnership ends after the year and the individual has made a valid election under subsection 249.1(4) of the Act, is required to include an additional amount under subsection 34.1(1) of the Act in computing the individual’s income for the year. However, pursuant to subsection 34.1(8) of the Act, no additional amount would be included in computing the individual’s income for a year from a business where the individual ceases to carry on the business in the year.

(2) Pursuant to subsection 34.1(2) of the Act, an individual (other than a testamentary trust) would include, in computing income for a year, additional income which may be a designated amount in respect of a new business commencing in the year to which subsection 34.2(3) of the Act applies. However, where the new business has a December 31 year end, paragraph 249.1(1)(b) of the Act would apply and the requirement in subsection 34.1(2) of the Act that the individual elect under 249.1(4) of the Act would not be met. Accordingly, no additional income would be included in computing the individual’s income in respect of the new business.

(3) Because of the additional income inclusion under subsection 34.1(1) or 34.1(2) of the Act, an individual would be able to claim a reserve for a year in respect of a business, pursuant to subsection 34.2(4) of the Act, on his/her deemed December 31, 1995 income determined in accordance with subsection 34.1(4) or 34.1(5) of the Act. The amount of such reserve would be based on the applicable “specified percentage” (as defined under subsection 34.2(1) of the Act) in respect of the business for the particular year.

Generally, an individual would be able to deduct a reserve in a year in respect of a business for which another business was substituted pursuant to subsection 34.2(3) of the Act. Such deduction would be available provided that the individual had December 31, 1995 income in respect of the business and subparagraph 34.2(6)(c)(i) of the Act did not apply.

(4) An amount included in computing an individual’s income from a business under subsection 34.1(1) or 34.1(2) of the Act for a taxation year would be deducted under subsection 34.1(3) of the Act in computing the individual’s income therefrom for the following year. Also, a reserve deducted under subsection 34.2(4) of the Act in computing a taxpayer’s income for a taxation year from a business would be included under subsection 34.2(5) of the Act in computing the taxpayer’s income therefrom for the following year.

(5) Pursuant to paragraph 98.1(1)(b) of the Act, where a taxpayer has ceased to be a member of a partnership in a fiscal period and his/her rights in the partnership are fully satisfied before the end of the fiscal period, the taxpayer would be considered to have disposed of his interest in the partnership at the end of that fiscal period. However, as a result of this provision, such taxpayer could be subject to a capital gain arising under paragraph 98.1(1)(c) of the Act from a disposition of his/her “residual interest” in the partnership at the end of the fiscal period. For this purpose, paragraphs 53(1)(e) and 53(2)(c) of the Act would apply in determining the adjusted cost base of the taxpayer’s residual interest.

(6) Income or loss allocated to a taxpayer for a fiscal period in which the taxpayer ceased to be a member would be included in computing the taxpayer’s income for the taxation year in which the fiscal period ends.

The comments above represent an expression of opinion which, as indicated in paragraph 22 of the Circular, 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