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.
Principal Issues: Where a partner of a professional partnership creates a professional corporation through which professional services will be provided to the partnership, will the corporation be eligible for the small business deduction?
Position: Question of Fact. Generally yes, if certain conditions are met.
Reasons: Relevant legislation and consistent with other similar rulings.
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2010-035408
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XXXXXXXXXX , 2010
Dear XXXXXXXXXX :
Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership") XXXXXXXXXX
Appendix "1" - "Named Partners"
This is in reply to your letter dated XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the Partnership and the Named Partners. We also acknowledge the additional information provided to us by electronic mail transmissions, letters, and telephone conversations (XXXXXXXXXX ).
We understand that to the best of your knowledge and that of the Partnership and the Partners (collectively the "Taxpayers"), none of the issues involved in this ruling request:
(i) is in an earlier return of one of the Taxpayers or a related person;
(ii) is being considered by a tax services office or taxation centre in connection with a tax return previously filed by any of the Taxpayers or a related person;
(iii) is under objection by any of the Taxpayers or a related person;
(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or
(v) is the subject of a ruling previously considered by the Directorate to one of the Taxpayers or a related person.
This document is based solely on the facts and proposed transactions described herein. Any documentation submitted with your request does not form part of the facts and proposed transactions and any reference thereto are provided solely for the convenience of the reader.
Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c. 1. as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definitions unless otherwise indicated.
Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:
DEFINITIONS
(a) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7) of the Act;
(b) "Contract" refers to the professional services contract to be entered into between the Partnership and a Contracting Company, as described below;
(c) "Contracting Company" means each of the corporations that will be incorporated by an Electing Partner and authorized to practice XXXXXXXXXX in the province of XXXXXXXXXX , and that will be engaged by the Partnership to provide Professional Services as an independent contractor, collectively referred to as the "Contracting Companies";
(d) "CRA" is the Canada Revenue Agency;
(e) "Electing Partner" is a reference to each of, or any of, the Named Partners of the Partnership who elects to provide his or her Professional Services through a Contracting Company. Each of the Named Partners is listed in Appendix 1;
(f) "Employment Contract" means the written employment contract to be entered into between a Contracting Company and the particular Electing Partner;
(g) "Fee" means the fair market value fee to be paid by the Partnership to a particular Contracting Company in return for Professional Services rendered by the Contracting Company, as described in Paragraph 21;
(h) "Limited Liability Partnership" means a partnership formed pursuant to the Partnership Act and registered under the Business Names Act as a limited liability partnership;
(i) "Net Profit" as this term is used in the Partnership Agreement, means the net profit of the Partnership after deducting all expenses, fees and taxes of every kind;
(j) "Non-Electing Partner" means any Partner who is not an "Electing Partner";
(k) "Non-Professional Services" refers to the Partnership's management and administrative activities and any other activity carried on by the Partnership that is not part of Professional Services;
(l) "Paragraph" refers to a numbered paragraph in this ruling request;
(m) "Partner" means an individual who is a Partner in the Partnership;
(n) "Partnership" is a reference to the existing partnership of XXXXXXXXXX , which was formed pursuant to the laws of the Province of XXXXXXXXXX . The Partnership also provides certain Professional Services under the name XXXXXXXXXX ;
(o) "Partnership Agreement" means the Partnership Agreement dated XXXXXXXXXX , by which the Partnership is governed;
(p) "Practice" means the professional XXXXXXXXXX practice currently carried on by the Partnership. It includes the Professional and Non-Professional Services conducted by the Partners on behalf of the Partnership;
(q) "Professional Services" means the Partnership's practice of XXXXXXXXXX ;
(r) "Proposed Transactions" means the transactions listed in paragraphs 10 to 30;
(s) "Related Persons" has the meaning assigned in subsection 251(2) of the Act;
(t) "Small Business Deduction" has the meaning assigned by subsection 125(1) of the Act;
(u) "Specified Partnership Income" has the meaning assigned by subsection 125(7) of the Act;
(v) "Tax Year" means the fiscal period of the Partnership which, for tax purposes is the calendar year;
(w) "Taxable Canadian Corporation" has the meaning assigned by subsection 89(1) of the Act;
FACTS
1. The Partnership operates as one business under the names XXXXXXXXXX and XXXXXXXXXX . The Partnership is a limited liability partnership carrying on the practice of XXXXXXXXXX . The Partnership's filer identification number is XXXXXXXXXX . Its office is located at XXXXXXXXXX . The Partnership files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. The present ruling is only in respect of the Partnership, the Electing Partners and the particular Contracting Company of each.
2. There are currently XXXXXXXXXX Partners. The Named Partners and their social insurance numbers are set out in Appendix 1. The Partnership has XXXXXXXXXX employed associates and XXXXXXXXXX employed XXXXXXXXXX students.
3. The Named Partners file their respective information returns with the XXXXXXXXXX Taxation Centre.
4. The Partnership has been carrying on business since XXXXXXXXXX . It has done so under the style XXXXXXXXXX since XXXXXXXXXX and is currently governed by the Partnership Agreement.
5. The Partners provide Professional Services to the Partnership.
6. The activities of the Partners can be classified in two different categories: Professional Services and Non-Professional Services.
7. The Partnership operates the Practice on a "fee for service" and/or contract basis.
8. The key terms of the Partnership Agreement are as follows:
(a) The interests of the Partners in the Partnership are represented by the Partner's "Tax-Paid Capital" as defined in the Partnership Agreement.
(b) Each Partner is required to maintain a minimum amount of Tax-Paid Capital, determined in accordance with the provisions of the Partnership Agreement. The minimum level of Tax- Paid Capital is currently $XXXXXXXXXX per Partner which is the level provided in the XXXXXXXXXX Partnership Agreement.
(c) The Net Profits of the Partnership are divided amongst the Partners giving consideration to the billings and collections attributed to the Partners, the overhead attributed to the Partners, the business relationships between the Partners and clients, the generation of work by the Partners for associates and employed XXXXXXXXXX and the contribution of the Partners to the operation of the Partnership. The distribution is determined annually by approval of not less than XXXXXXXXXX % of the Partners.
(d) Capital accounts are maintained for each Partner with capital amounts varying between Partners from time to time due to undistributed net profits.
(e) Upon the death of a Partner, the deceased Partner's partnership interest is forfeited and the deceased Partner's estate is entitled to XXXXXXXXXX % of the Partner's Tax-Paid Capital and any distributable but unpaid profits allocated to the deceased Partner in respect of the portion of the current or prior fiscal periods preceding death. The Partnership Agreement also outlines the amounts to be paid to departing Partners as a result of expulsion, withdrawal from the Partnership for the purpose of competing, and withdrawal from the Partnership for the purpose of a XXXXXXXXXX .
(f) Ordinary partnership matters require approval of a majority of the Partners. Unanimous approval is required with respect to any decision to admit a new Partner, to distribute capital to the Partnership, or remove capital from the Partnership.
(g) Each Partner shall devote his or her full time, energy and ability to the business and affairs of the Partnership unless prevented from doing so by sickness or other reasonable cause.
9. None of the Partners are Related Persons for purposes of the Act and none are in a position to control the Partnership.
PROPOSED TRANSACTIONS
10. Each Electing Partner will incorporate a Contracting Company under the laws of the province of XXXXXXXXXX . Each Contracting Company will be authorized to practice XXXXXXXXXX in the province of XXXXXXXXXX .
11. The Electing Partner will legally and beneficially, directly own all of the issued and outstanding shares of the Contracting Company he incorporates.
12. Each Electing Partner will be the sole Director and President of the Contracting Company he incorporates.
13. No Electing Partner will be an employee, officer, director or shareholder, either legally or beneficially, directly or indirectly, of more than one Contracting Company.
14. Each Contracting Company will qualify as a Taxable Canadian Corporation and Canadian Controlled Private Corporation, carrying on an active business. The Electing Partner and the Contracting Company will be Related Persons.
15. Upon receipt of the election referred to in Paragraph 18(a), the Partnership will enter into a written contract with the Contracting Company for the Professional Services required. All Electing Partners will continue in the capacity as Partners to conduct Non-Professional Services of the Partnership.
16. Each Electing Partner will be an employee of his Contracting Company in accordance with the Employment Contract between the Electing Partner and the Contracting Company. Each Electing Partner will provide Professional Services for the benefit of the Contracting Company in his capacity of employee pursuant to the terms of the Contract with the Partnership. Pursuant to the Employment Contract between an Electing Partner and his Contracting Company, the Electing Partner shall be entitled to a salary from his Contracting Company.
17. All persons legally or beneficially owning shares of a Contracting Company will be residents of Canada. No two Contracting Companies will be Related Persons.
Partnership Agreement
18. The Partnership Agreement will be amended as follows:
a) an elective provision will be added to allow each Electing Partner to elect to provide Professional Services to the Partnership through a Contracting Company engaged by the Partnership to provide such services as an independent contractor; a provision will be added to differentiate between the only two functions that each Partner performs for the Partnership: (1) Professional Services and (2) Non-Professional Services; a provision will be added that no Electing Partner may provide a Professional Service to the Partnership other than through a Contracting Company;
b) the provision, in paragraph XXXXXXXXXX that each Partner devote substantially his or her full time to the business of the Partnership shall be deleted;
c) a provision will be added such that, as long as a Contracting Company fully discharges its responsibilities under the Contract, the Contracting Company will not be restricted from providing Professional Services to other persons or otherwise prohibited from competition with the Partnership. For greater certainty, there will be no terms in the Partnership Agreement, or any other agreement (oral or otherwise), that would prohibit any Contracting Company or the Electing Partners from competing with the Partnership in respect of the provision of Professional Services;
d) a provision will be added to reflect the fact that an Electing Partner's allocation of Partnership income for the year will be dependent solely on the Electing Partner's capital contribution to the Partnership and factors (including time) connected to the Electing Partner's Non-Professional Services provided on behalf of the
Partnership; in particular, the calculation of the Electing Partner's income allocation from the Partnership for that year will not take into account any of his Professional Services, either directly or indirectly;
e) a provision will be added to prohibit the carrying out of Non-Professional Services by the Contracting Companies and requiring that all Partners devote and spend the time and energy required to complete their portion of the Non-Professional Services;
f) a provision will be added to ensure that any Named Partner who chooses not to provide his or her Professional Services through a Contracting Company will be allocated a share of Partnership profits which will reflect the fact that the Non-Electing Partner will receive both the Professional Services and Non-Professional Services components in their partnership allocation as opposed to the Non-Professional Services component only in the case of an Electing Partner; and
g) a provision will be added to prohibit the transfer or other conveyance of any interest in the Partnership to a Contracting Company, or to permit any Contracting Company to otherwise become a member of the Partnership.
Contract
19. The Partnership will enter into a written Contract with each Electing Partner's Contracting Company. Each Contracting Company will enter into this contract with the Partnership to provide Professional Services to the Partnership's clients, on behalf of the Partnership.
20. The Contract shall be for a fixed period of XXXXXXXXXX months coinciding with the calendar year, with the possible exception of the XXXXXXXXXX year. It may be renewed each year and either party, upon XXXXXXXXXX days notice, may terminate it.
21. The Contract will provide that the Contracting Company will provide Professional Services to the Partnership in return for a Fee. The amount of a Fee to be paid by the Partnership to a Contracting Company will be equal to the fair market value of the Professional Services that the Contracting Company provides. The amount of the Fee will be tied to the level of work performed, and not based on the success of collected billings in respect of that work. The Non-Professional Services of the Partnership will continue to be provided by the Electing and Non-Electing Partners who hold an interest in the Partnership.
22. There will be a minimum number of work days and professional service hours per year that the Contracting Company agrees to provide to the Partnership.
23. All payments received by the Partnership in respect of Professional Services provided by a Contracting Company pursuant to the Contract will be for the benefit of the Partnership and if a Contracting Company receives any of these amounts, they will be remitted to the Partnership.
24. The Contracting Company shall be responsible for providing all equipment, tools and instruments used in the performance of the Professional Services at its expense.
Pursuant to the Contract and in consideration for a fair market value fee, the Partnership will provide the Contracting Company with certain facilities, equipment, supplies and personnel that are required to provide the Professional Services.
25. The Contracting Company shall be responsible for all expenses required to maintain the professional standards required by the Partnership and all fees and expenses necessary to perform the Professional Services, including, without limitation, professional membership fees, professional malpractice and other insurance, continuing education and training, transportation, communication, business entertainment connected to the business of the Contracting Company, travel expenses including automobile, accommodations and meals. The Contracting Company agrees that, to the extent that such expenses are paid by the Partnership, it shall reimburse the Partnership.
26. In the event that an Electing Partner suffers a physical or mental disability such that the Contracting Company is unable to provide the services under the terms of the Contract, the Partnership shall have the right to terminate the Contract.
27. In the event of the death of an Electing Partner or the bankruptcy of the Contracting Company or its Electing Partner, the Partnership shall have the right to immediately terminate the Contract.
28. Provided the Contracting Company fully discharges and satisfies all of its responsibilities under the Contract, the Contracting Company will not be restricted from providing professional services to other persons or otherwise prohibited from competing with the Partnership.
29. The Contracting Company's relationship to the Partnership is that of an independent contractor and nothing in the Contract should be construed as (i) allowing either party the authority to assume or create any obligation whatsoever, expressed or implied, in the name of the other nor to bind the other in any manner whatsoever, (ii) giving either party the authority to direct and control the day-to-day activities of the other party or any of their respective employees or agents, or (iii) constituting the parties as Partners, joint venturers, co-owners or otherwise participants in a joint or common undertaking.
30. Within XXXXXXXXXX months of the date of this letter, an Electing Partner will provide the Partnership with notice of intention to provide Professional Services through a
Contracting Company (the "particular Contracting Company") and will incorporate the particular Contracting Company for such purposes in accordance with the terms and conditions outlined in the paragraphs above. Immediately thereafter, the Contracting Companies will enter into contracts with the Partnership for the purpose of providing such services.
PURPOSE OF PROPOSED TRANSACTIONS
31. The purpose of the Proposed Transactions is to allow an Electing Partner to use a Contracting Company to earn business income, by providing Professional Services to the Partnership, as an independent contractor. In addition, the Proposed Transactions will provide a number of other business advantages including:
a) allowing the Partnership a greater ability to retain highly qualified professionals;
b) allowing each Electing Partner to have a greater degree of control over expenditures especially where such expenditures may not be otherwise approved by all members of the Partnership; and
c) allowing each Electing Partner more control over their individual estate and financial planning matters.
32. The Proposed Transactions will allow the Electing Partners to use, if they choose, a professional corporation to earn Professional Services income through a Contracting Company derived from the Partnership's practice without negatively affecting the business arrangements between the other Partners of the Partnership.
RULINGS GIVEN
Provided that
(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the proposed transactions,
(b) the proposed transactions are completed in the manner described above, and
(c) there are no other transactions which may be relevant to the rulings requested,
we rule as follows:
A. The execution and implementation of the Proposed Transactions described above, in and of themselves, will not constitute a disposition of part or all of an interest in the Partnership by any of the Electing Partners for purposes of the Act.
B. Provided that an Electing Partner would not, if his Contracting Company did not exist, reasonably be regarded as an officer or employee of the Partnership in respect of the provision of Professional Services, the Electing Partner's Contracting Company will not be considered to be carrying on a personal services business as defined in subsection 125(7) of the Act in respect of the Professional Services provided to the Partnership.
C. Provided a particular Contracting Company was not a member of any partnership in the relevant year, the Fee income earned by the particular Contracting Company pursuant to a Contract will not be specified partnership income as defined in subsection 125(7) of the Act.
D. Subject to sections 18 and 67 of the Act, the Fees payable by the Partnership to the particular Contracting Company, pursuant to the Contract, as described in paragraph 21, will be deductible by the Partnership in its determination of the Partnership's income pursuant to subsection 96(1) of the Act.
E. The Proposed Transactions undertaken in paragraphs 10 to 30 will not in and of themselves cause subsections 56(2), 56(4), and 246(1) of the Act to apply so as to cause an amount of the Fees received by a particular Contracting Company under a Contract to be taxed in the hands of the respective Electing Partner.
F. Provided the amount of the Partnership's income allocated to the Electing Partner is otherwise reasonable, having regard to all the relevant circumstances, the Electing Partner's share of the Partnership's income will not be altered, pursuant to subsection 103(1), solely as a result of the Electing Partner choosing, pursuant to amendments to the Partnership Agreement, to provide all Professional Services to the Partnership through the particular Contracting Company, as described above in the Proposed Transactions.
G. The execution and implementation of the Proposed Transactions described above, will not, in and of themselves create a non-arm's length relationship between the Partners with respect to sharing the Partnership's income for income tax purposes.
H. Implementation of the Proposed Transactions described above, will not, in and of themselves, result in the application of subsection 245(2) of the Act to re-determine the tax consequences confirmed in the rulings requested above.
These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided that the Proposed Transactions are implemented on or before XXXXXXXXXX. These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.
Nothing in this letter should be construed as implying that the CRA has agreed to or accepted any of the tax consequences relating to the facts and Proposed Transactions described above except as expressly stated in the rulings. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly, that the CRA has agreed to or accepted the fair market value or reasonableness of any amounts, including the Fees.
Whether or not an Electing Partner would, if the Contracting Company did not exist, be an employee of the Partnership or an independent contractor who has entered into a contract of services with the Partnership is a question of fact that can only be determined after a review of the actual agreements entered into between the Contracting Company and the Partnership and between the Contracting Company and the Electing Partner. This review and determination is the responsibility of the particular Electing Partner's local tax services office.
The attribution rules in sections 74.1 to 74.4 of the Act apply in situations where property is transferred or lent, directly or indirectly, to a spouse or child. These rules may apply to any income received by a spouse or a child who has not attained the age of 18 years before the end of a particular taxation year. Whether or not these rules will apply in respect of the possible ownership of any shares of the Contracting Company is a question of fact that can only be determined at the time that the shares are issued or property is lent or transferred to such a shareholder. Furthermore, subsection 56(2) of the Act may apply to any amounts paid by Contracting Company to a family member of the Electing Partner. Also, section 120.4 of the Act may apply with respect to taxable dividends or trust income in respect of taxable dividends from the Contracting Company received in a taxation year by a family member of the Electing Partner who has not attained the age of 17 years before that year.
OPINION
The application of subsection 256(2.1) of the Act is determined on a year-to-year basis. We are therefore unable to rule that this provision will never apply to the Contracting Companies. In general, where a particular function of a professional partnership that was previously carried on by the partnership is subsequently carried on by a partner's professional corporation, and no longer in partnership, for bona fide reasons other than income tax, this fact, in and of itself, would generally not cause subsection 256(2.1) of the Act to be applicable. The reasons for the separate existence of two or more professional corporations or the reasons for a change in the functions performed directly by the partners of the professional partnership is a question of fact that can only be determined on a case-by-case basis. However, based on the facts and Proposed Transactions described herein, it is our view that the incorporation of the Contracting Companies to provide the Professional Services to the Partnership will not, in and of itself, cause subsection 256(2.1) of the Act to be applicable to the Contracting Companies.
In accordance with paragraph 22 of Information Circular 70-6R5, the comments in the immediately preceding paragraph are only an expression of opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on the CRA.
Yours truly,
XXXXXXXXXX
for Director
Business and Partnership Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Appendix 1 - Named Partners
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