1999 Ruling 9915403 - INCORPORATION OF A PARTNERSHIP

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: Members of a XXXXXXXXXX partnership setting up corporations to provide their services

Position: Question of fact as to whether employed or self-employed. Incorporating a business not subject to GAAR.

Reasons: Cannot rule on a question of fact. IC 88-2, par 11.

XXXXXXXXXX 991540

Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear Sirs:

Re: Request for an Advance Income Tax Ruling

We are writing in response to your letter dated XXXXXXXXXX wherein you requested an advance income tax ruling in respect of a number of individual taxpayers listed in Schedule A of this ruling. We also acknowledge your letter dated XXXXXXXXXX and our several telephone conversations.

To the best of your knowledge and that of the individual taxpayers, none of the issues involved in this ruling request are under objection or appeal nor are they being considered by any tax services office or taxation centre in connection with any tax returns previously filed.

In this letter, unless otherwise expressly stated:

"Act" means the Income Tax Act of Canada;

XXXXXXXXXX;

"Contracting Companies" means the companies, yet to be incorporated for the benefit of individual Principals, which will carry on the independent practice of XXXXXXXXXX, and which will enter into contractual relations with Newco for the provision of professional services. Contracting Companies are further described under the heading "Proposed Transactions" below;

"Contracting Professionals" means the Professionals who choose to enter into contractual relations with Newco for the provision of professional services in the Practice as independent contractors, as described under the heading "Proposed Transactions";

"Department" means the Department of National Revenue;

XXXXXXXXXX;

"Newco" means a new company to be incorporated pursuant to the laws of the Province;

"Partnership" means the existing partnership ofXXXXXXXXXX currently carrying on the Practice under the firm name and style of "XXXXXXXXXX", a registered partnership name pursuant to the laws of the Province;

"Practice" means the professional practice of XXXXXXXXXX at various locations within the Province currently carried on by the Partnership, XXXXXXXXXX, conducting research to further the science of XXXXXXXXXX;

"Principal" means each individual who is a partner of the Partnership as of the date hereof;

"Professional" means each individual XXXXXXXXXX who currently provides professional services to the Partnership as required in the Practice, whether in his or her capacity as a partner of the Partnership (being the Principals), an employee of the Partnership, or an independent contractor;

"Professional Employee" means a Professional who chooses to enter into an employment relationship with Newco for the provision of employment services;

"Province" means the Province of XXXXXXXXXX;

XXXXXXXXXX.

Our understanding of the relevant facts, proposed transactions and purpose of the proposed transactions is as follows:

Relevant Facts

1. The Partnership is a partnership of XXXXXXXXXX. There are also a number of self-employed XXXXXXXXXX who provide services to the Partnership, but are not Partners. XXXXXXXXXX. The taxpayers applying for this ruling are a representative sample of the Professionals.

2. The Professionals provide XXXXXXXXXX.

3. The Partnership is governed by a written partnership agreement that was signed in XXXXXXXXXX as well as a set of rules and regulations. The major terms of the Partnership agreement are as follows:

(i) Partners are either "full partners" or "part time partners". There are currently XXXXXXXXXX full partners and XXXXXXXXXX part time (designated as XXXXXXXXXX%) partners;

(ii) Full partners share equally in the profits of the Partnership regardless of contribution;

(iii) Part time partners are paid a fixed share of profits based on their designated participation percentage, regardless of their actual contribution;

(iv) Partnership profits are paid in the form of distributions ("basic division") paid monthly and additional distributions ("overage") paid at the discretion of the Partnership. The basic division is approximately $XXXXXXXXXX per partner per month (i.e. $XXXXXXXXXX annually). For the year ended XXXXXXXXXX the overage amounted to approximately $XXXXXXXXXX per partner per year; and

(v) he Partnership may also engage XXXXXXXXXX as independent contractors (XXXXXXXXXX independent contractors are currently engaged). These independent contractors are not members of the partnership and are paid an agreed monthly amount.

4. The Rules and Regulations of the Partnership include the following:

(a) Principals are entitled to full income support while disabled for up to a XXXXXXXXXX month period. This XXXXXXXXXX month period may be accumulated to cover recurrent disability;

(b) Principals are entitled to XXXXXXXXXX weeks maternity leave with partial participation in Partnership profits;

(c) Principals granted sabbatical leave are entitled to up to XXXXXXXXXX months leave while being paid the full basic division, and another XXXXXXXXXX months where paid XXXXXXXXXX of the basic division; and

(d) Each Principal is entitled to take paid annual vacation equal to XXXXXXXXXX working days.

5.

XXXXXXXXXX

XXXXXXXXXX

6. All of the Principals are residents of Canada. None of the Principals are "related" to another Principal within the meaning of paragraph 256(2)(a) of the Act.

Proposed Transactions

7. Newco will be incorporated under the laws of the Province, being authorized to issue XXXXXXXXXX common or ordinary shares without nominal or par value, of which one (1) common share will be issued for the benefit of a Principal for which Newco will receive future consideration from the Partnership. Newco will be a Canadian controlled private corporation ("CCPC") and a taxable Canadian corporation ("TCC"). The terms CCPC and TCC, as used here and subsequently, have the meanings assigned by subsections 125(7) and 89(1) of the Act, respectively.

8.

XXXXXXXXXX

9. XXXXXXXXXX, the Partnership will sell at fair market value all of its assets to Newco in return for XXXXXXXXXX common shares of Newco (inclusive of the one (1) common share issued upon incorporation) and debt in an amount equal to the cost amounts of such assets to the Partnership. Newco and each Partner will jointly elect pursuant to subsection 85(2) of the Act, in prescribed form and within the time permitted by subsection 85(6) of the Act. Specifically, the agreed amount in respect of the transfer will not be less than the least of the amounts specified in subparagraphs 85(1)(c.1)(i) and (ii) of the Act.

In each case the agreed amount will not be less than the amount permitted by paragraph 85(1)(b) of the Act.

10. The Partnership will wind up its affairs the day immediately following the transfer of all of its assets to Newco. At the time of this wind up, the Partnership will have no assets other than the said XXXXXXXXXX common shares of Newco and debt from Newco in an amount equal to the cost amounts of the assets transferred to Newco. Each Principal will receive, in full satisfaction of their respective interests in the Partnership, one (1) common share of Newco (inclusive of the initial subscriber's share) and XXXXXXXXXX of the debt from Newco.

11. For administrative convenience and in accordance with the comments in IT-378R, Winding-up of a partnership:

(a) the common shares of Newco issued on the acquisition of the Partnership property shall be issued directly in the names of the Principals, so that each Principal shall have one (1) common share of Newco issued in his or her name (inclusive of the one (1) common share issued upon incorporation of Newco); and

(b) once the cost amounts of the Partnership property are determined, a promissory note in the amount of XXXXXXXXXX of the cost amounts will be issued by Newco directly to each Principal.

The intent is that the shares and promissory note will beneficially belong to the Partnership and not to the partners themselves at the time of issue.

12. The shareholders of Newco will elect directors from among themselves. It is expected that each shareholder will be a director. The directors will elect the officers and it is expected that the President of Newco will the individual who is currently the managing partner of the Partnership.

13. Newco and each of its shareholders (being all the Principals) will enter into a Shareholders' Agreement which shall provide, among other things:

(a) The business of Newco shall be the Practice;

(b) Newco will conduct the Practice by contracting with independent contractors to provide the required services, and may also employ XXXXXXXXXX and others (discussed more fully below);

(c) Each shareholder of Newco may be a member of the board of directors, should he or she so desire;

(d) The president of Newco shall normally be the individual who holds the position of the XXXXXXXXXX.

(e) Newco will not enter into any contracts which conflict with the responsibilities of the position of the XXXXXXXXXX.

(f) The net profits of Newco available for distribution (in the discretion of the directors) shall be distributed annually by way of dividends on the outstanding shares from time to time; and

(g) The alienation or transfer of issued shares of Newco shall be restricted to the following circumstances:

i. A shareholder may demand that Newco purchase his or her shares for fair market value; or

ii. Newco may, upon approval of XXXXXXXXXX vote of the shareholders, purchase any shares held by any shareholder, and such shareholder shall sell such shares, for fair market value.

14. Newco will carry on the Practice by providing the professional services through:

(a) individuals XXXXXXXXXX in the Province employed by Newco to provide such services;

(b) individuals XXXXXXXXXX in the Province engaged by Newco as independent contractors to perform such services on behalf of Newco ("Contracting Professionals"); and/or

(c) companies engaged by Newco as independent contractors to provide the services of XXXXXXXXXX in the Province to provide such services on behalf of Newco ("Contracting Companies").

15. XXXXXXXXXX. Each Principal will have the option of providing professional services to Newco in respect of the Practice by entering into an employment arrangement with Newco, entering into a contract for service with Newco (as an independent contractor), or forming a new company to enter into a contract for service with Newco (as an independent contractor). Other Professionals may practice with Newco upon such terms as the respective Professional and Newco may agree.

16. Some of the Professionals (including some Principals) may elect to enter into an employment relationship with Newco (as contemplated in paragraph 14(a) above) pursuant to a written employment agreement. The employment agreement will provide, among other things:

(a) The employee shall perform such duties as Newco may direct from time to time in respect of the Practice;

(b) The term of employment shall be from year to year, and may be terminated by either party by XXXXXXXXXX days notice;

(c) The amount of annual salary will be negotiated from year to year in respect of each employee and will be paid monthly, subject to the usual source deductions;

(d) Newco shall pay all expenses related to the employee's services, including professional membership fees and insurance costs;

(e) Newco shall supply all supplies, instruments and equipment as required in the performance of the employee's duties;

(f) The employee shall be entitled to compassionate leave and up to XXXXXXXXXX months disability leave with pay;

(g) The employee shall be entitled to XXXXXXXXXX days leave with pay to attend conventions and continuing professional education as approved by Newco;

(h) The employee shall be entitled to XXXXXXXXXX weeks maternity leave with pay equal to XXXXXXXXXX of the usual remuneration;

(i) The employee shall be entitled to XXXXXXXXXX working days vacation each calendar year; and

(j) The employee shall agree not to compete with Newco during the term of the employment and for a period of XXXXXXXXXX thereafter.

17. Professionals may, as contemplated in paragraph 14(b) above, enter into a contractual relationship with Newco, whereby the Professional, as an independent contractor, agrees to provide certain professional services required in the Practice on a fee per diem basis. The amount of the per diem fee will be negotiated on a case by case basis and will vary with the level and type of professional service to be provided (i.e. XXXXXXXXXX). This arrangement will be evidenced by a written contract, which provides, among other things:

(a) The Contracting Professional and Newco agree toXXXXXXXXXX in association, whereby the Contracting Professional shall provide certain professional services required by Newco in the Practice;

(b) The contract shall be for a fixed period, but may be terminated by either party upon ninety (90) days notice;

(c) The obligation of the Contracting Professional shall be set out in a negotiated practice profile, expressed as the number of work days per year the Contracting Professional provides each of the following professional services, with a per diem rate for each type of service:

i. XXXXXXXXXX;

ii. XXXXXXXXXX;

iii. Research;

iv. Teaching;

v. Administration; and

vi. Other;

(d) The per diem rates will be established for each type of service, and will take into account such factors as difficulty, risk to the practitioner, and the requirement to work outside of normal hours;

(e) The Contracting Professional shall be compensated for each type of service based upon the established per diem rate, to be paid by Newco to the Contracting Professional on the last day of each month, provided the Contracting Professional's level of service is substantially complete (as defined by the agreement) in keeping with the set practice profile;

(f) All payments from third parties in respect of services provided by a Contracting Professional for the benefit of Newco in the Practice shall be made directly to Newco;

(g) Newco shall supply certain supplies, instruments, and equipment required in the provision of professional services by the Contracting Professional, but the contracting individual shall be responsible for all expenses incurred in respect of the following:

i. Professional membership fees and insurance;

ii. Continuing professional education;

iii. Transportation;

iv. Communication;

v. Maintaining the professional standards set by XXXXXXXXXX from time to time; and

vi. Expenditures on personal practice preferences of the Contracting Professional.

18. The particulars of the Contracting Professional's practice profile, the per diem compensation rate for services and the definition of "substantial completion" will be negotiated on an individual basis each year of the term of the arrangement.

19. The Contracting Professional will not be restricted from providing professional services to other persons or otherwise prohibited from competing with Newco. In fact, it is expected that some Contracting Professionals will do so.

20. Some Professionals will incorporate companies to provide professional services to Newco (as contemplated by paragraph 14(c) above) upon the same basis as with Contracting Professionals, mutatis mutandis, which arrangement between Newco and each Contracting Company will be evidenced in writing.

21. Each Contracting Company will be controlled by the respective Professional, who will be the legal and beneficial owner of the majority of issued shares and the majority of issued voting shares, and the sole officer and director of that Contracting Company. The common shares of each Contracting Company will be beneficially owned by the respective Professional and, in some cases by his or her family members and/or other dependents. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada. The respective Professional will be an employee of the Contracting Company and will provide professional services for the benefit of the Contracting Company pursuant to the terms of its contract with Newco. The employment relationship will be evidence by a written Employment Agreement.

22. XXXXXXXXXX is a Principal. He is also the managing partner of the Partnership and has also been appointed XXXXXXXXXX. He will be a shareholder and director of Newco and will probably be elected President by the directors of Newco. Newco shall pay him a reasonable salary for acting in his capacity as President of Newco.

XXXXXXXXXX carries on a XXXXXXXXXX as a partner for the benefit of the Partnership. XXXXXXXXXX will incorporate a company ("XXXXXXXXXX") under the laws of the Province. XXXXXXXXXX will become a Contracting Company.

23. XXXXXXXXXX is a Principal who carries on a XXXXXXXXXX as a partner for the benefit of the Partnership. XXXXXXXXXX will be a shareholder and director of Newco. XXXXXXXXXX will incorporate a new company ("XXXXXXXXXX") under the laws of the Province. XXXXXXXXXX will become a Contracting Company.

24. XXXXXXXXXX is a Principal who carries on a XXXXXXXXXX as a partner for the benefit of the Partnership. XXXXXXXXXX will be a shareholder and director of Newco. XXXXXXXXXX will incorporate a new corporation ("XXXXXXXXXX") under the laws of the Province. XXXXXXXXXX will become a Contracting Company.

25. XXXXXXXXXX is not a Principal. He carries on a XXXXXXXXXX as an independent contractor, in association with the Partnership. He will not initially be a shareholder, officer or director of Newco. He will incorporate a new corporation ("XXXXXXXXXX") under the laws of the Province. XXXXXXXXXX will become a Contracting Company.

26. Each of XXXXXXXXXX will be a taxable Canadian corporation and a Canadian controlled private corporation, as those terms are defined in subsections 89(1) and 125(7) of the Act, respectively.

27. No legal or beneficial shareholder of a Contracting Company will be a legal or beneficial shareholder of another Contracting Company.

28. Each Contracting Company will obtain a permit XXXXXXXXXX prior to entering into a contract with Newco to provide professional services.

29. As the change from Partner to Contracting Professional or Contracting Company will entail a significant increase in certain types of business risk, as a transitional provision Principals will be offered the option to elect either self-employment (either directly as a Contracting Professional through a corporation as a Contracting Company) or an employment arrangement as a Professional Employee. This will allow each Principal the ability to independently manage risks relating to the transition; they can elect either to enter into a self-employment arrangement with more risks and a higher compensation or to become an employee with fewer risks but reduced compensation.

30. Professionals who are not currently Principals will not have the same transitional provision; the decision about what contractual arrangements offered will depend on the needs of Newco as determined by its board. Similarly, XXXXXXXXXX wishing to provide services in future may be offered a limited range of options depending on the needs of Newco at the time.

31. There will not be any contractual relations between or among any of Newco and the Contracting Companies other than the agreements described above.

32. Any one Professional will not be an employee, officer, director or shareholder (whether legally or beneficially) of more than one (1) Contracting Company.

33. Persons related to a Professional (within the meaning of subsection 251(2) of the Act), shall be shareholders, if at all, of only the Contracting Company controlled by the particular Professional.

34. Newco shall estimate its annual revenues and endeavour to contract with the Contracting Professionals and the Contracting Companies in such a manner that will result in an annual profit to Newco. To the extent Newco's taxable income for any particular taxation year exceeds XXXXXXXXXX the excess will likely be distributed (in the absolute discretion of the directors) as bonuses to the directors of Newco.

Purpose of the Proposed Transactions

1. The purpose of the proposed transactions is to restructure the professional practices of the Principals, without adverse tax consequences, so that they meet their professional obligations in respect of the Practice while:

• Eliminating joint and several liability inherent in providing professional services through a partnership;
• Providing each Principal with the opportunity to become an independent contractor and, as such, having increased control over his or her individual level of participation in the Practice;
• Providing each Principal with a better congruence between effort put into the Practice and the financial return received from his or her respective professional practice;
• Providing a vehicle through which an individual Principal may, if he or she so desires, provide professional services external to the Practice;
• Providing increased business efficiency for each Principal through individual management of personal practice preferences and expenses;
• Permitting each Principal to have control over expenditures reflecting personal practice preferences, where such expenditures may not be in the interest of all participants in the Practice;
• Providing more flexibility for estate planning on the part of each individual Principal; and
• Facilitating ease of entry to the Practice by other professionals and exit from the Practice by the Principals.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the proposed transactions and the purposes of the proposed transactions and the proposed transactions are carried out as described herein and in accordance with the documents and agreements submitted in respect of this request and that there are no material difference in the terms and conditions of the final signed documents and agreements from the drafts submitted with this request, our rulings are as follows:

A. Newco will be entitled to claim a deduction in computing its income from its business under subsection 9(1) of the Act, within the limitations imposed by paragraph 18(1)(a) and section 67 of the Act, in respect of the amounts payable by it for the professional services rendered to it by Professional Employees, the Contracting Professionals or the Contracting Companies.

B. Provided that a Principal carrying out XXXXXXXXXX activities through a Contracting Company does not provide such services to Newco in his\her capacity as an employee or officer of Newco, we confirm that the Contracting Company will not be considered to be carrying on a "personal service business" as defined in subsection 125(7) of the Act in a situation where five or less full time employees are engaged by the Contracting Company.

C. Provided that a partnership does not exist between Newco or any Contracting Company, the income of Newco and any Contracting Company will not be considered "specified partnership income" within the meaning of subsection 125(7) of the Act.

D. Subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 ("IC-70-6R") and are binding on Revenue Canada, provided that the proposed transactions described herein are completed by XXXXXXXXXX.

Our rulings are based on the Act in its present form and do not take into consideration any proposed amendments to the Act.

Comment

A direction in accordance with subsection 256(2.1) of the Act is based on the facts on a year-to-year basis, and therefore we are not able, pursuant to paragraph 15(j) of IC-70-6R3, to rule that this provision will not be applied.

Yours truly,

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

XXXXXXXXXX

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