2010 Ruling 2010-0363991R3 - Ptnsp contracting out pro services to ptner corp

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: Whether the active business income earned by a professional corporation that carries out services for a partnership as an independent contractor, where the sole common shareholder of the professional corporation is a partner of the professional corporation, would qualify for the small business deduction and not be restricted under the rules for specified partnership income, personal services business or other anti-avoidance provisions.

Position: Yes, provided the facts are accurate and the proposed transactions are carried out as described in the ruling.

Reasons: The facts and the proposed transactions, as described, conform to the requirements established by ITRD for these types of reorganizations.

XXXXXXXXXX
									2010-036399
									XXXXXXXXXX 

XXXXXXXXXX , 2010

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
XXXXXXXXXX ("Named Partner 1") XXXXXXXXXX ;
XXXXXXXXXX ("Named Partner 2") XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the Partnership and the Named Partners. We also acknowledge the information provided in various emails.

To the best of your knowledge and that of the Partnership and the Named Partners (collectively the "Taxpayers"), none of the issues involved in the ruling request is:

i. in an earlier return of any of the Taxpayers or a related person;

ii. being considered by a tax services office or a tax centre in connection with a tax return already filed by any of the Taxpayers or a related person;

iii. under objection by any of the Taxpayers or a related person;

iv. before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and

v. the subject of a ruling previously issued by the Directorate to any of the Taxpayers or a related person.

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.

This document is based solely on the facts and proposed transactions described below. The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

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

Definitions

The following definitions have been used in this letter:

(a) "CCPC" means a "Canadian-controlled private corporation" as defined under subsection 125(7) of the Act;

(b) "Contract" refers to the sub-contracting agreement which will be used to set out the terms and conditions by which a ProCorp will provide Professional Services to the Partnership;

(c) "CRA" is the Canada Revenue Agency;

(d) "Electing Partner" refers to a Partner who elects to provide his or her Professional Services through a ProCorp;

(e) "Fees" refers to the fee to be charged under the Contract by a ProCorp to the Partnership;

(f) "Income" refers to the Partnership's income or loss for a particular Taxation Year as computed under subsection 96(1) of the Act;

(g) "Non-Electing Partner" refers to a Partner who does not elect to provide Professional Services through a ProCorp;

(h) "Non-Equity Partner" refers to a partner who has a restricted interest in the Partnership, such that his or her share of Partnership income is limited by formula and he or she is not required to contribute capital to the Partnership;

(i) "Non-Professional Services" means any service provided by Partners on behalf of the Partnership, other than Professional Services, including the promotion of the Practice;

(j) "Partner" refers to a partner of the Partnership other than a Non-Equity Partner;

(k) "Partnership Agreement" refers to the existing partnership agreement by which the Partnership is governed;

(l) "Practice" means the XXXXXXXXXX practice currently carried on by the Partnership and encompasses both Professional Services and Non-Professional Services;

(m) "ProCorp" means any of the corporations to be formed by an Electing Partner and through which an Electing Partner will provide Professional Services as an employee of that corporation;

(n) "ProCorp 1" means XXXXXXXXXX , incorporated by Named Partner 1 on XXXXXXXXXX .

(o) "ProCorp 2" means XXXXXXXXXX which was incorporated by Named Partner 2 on XXXXXXXXXX .

(p) "Professional Services" means the practice of XXXXXXXXXX ;

(q) "Province" means the Province of XXXXXXXXXX ;

(r) "Related Persons" has the meaning assigned by subsection 251(2) of the Act;

(s) "Society" means the XXXXXXXXXX Society of the Province;

(t) "TCC" refers to a "taxable Canadian corporation" as defined under subsection 89(1) of the Act; and

(u) "Taxation Year" means the Partnership's taxation year for income tax purposes which is defined in paragraph 96(1)(b) of the Act as the Partnership's fiscal period.

Facts

1. The Partnership is a XXXXXXXXXX firm registered as a limited liability partnership in the Province. The Partnership currently has XXXXXXXXXX Partners and XXXXXXXXXX Non-Equity Partners. The Partnership has been carrying on business since XXXXXXXXXX under various versions of the Partnership Agreement, the current version of which has been in place since XXXXXXXXXX .

2. The Partnership does not have a filer identification number as it has not previously filed or been required to file a T5013 Partnership Information Return. The Partnership and the Named Partners deal with the XXXXXXXXXX Centre Tax Services Office, and the Named Partners file their individual income tax returns with the XXXXXXXXXX Tax Centre. The main office of the Partnership is located at XXXXXXXXXX .

3. Currently, the Partners provide all of their Professional Services through the Partnership.

4. The Partners are all individuals resident in Canada for the purposes of the Act and none of them are Related Persons.

5. The Partnership is governed by the Partnership Agreement, the terms of which include the following:

(a) Most Partnership matters ("Ordinary Resolutions") require a simple majority of the votes, i.e., XXXXXXXXXX %, while other Partnership matters ("Special Resolutions") require unanimous approval of the Partners.

(b) The interests of the Partners in the Partnership are represented by the capital contributions made by the Partners in the Partnership.

(c) Upon admission to the Partnership, a Partner is required to make a capital contribution, the amount and payment of which is determined by Special Resolution.

(d) XXXXXXXXXX percent of the annual profit of the Partnership is distributed among the Partners based on percentages determined by Special Resolution.

(e) Capital accounts are maintained for each Partner.

(f) Upon the death of a Partner, the Partnership acquires the interest of the former Partner by paying:

(i) an amount equal to the share of the estimated Partnership profit to the end of the month during which such Partner ceased to be a member of the Partnership less all amounts drawn by such Partner in respect of such year, and

(ii) an amount equal to the credit balance of such Partner's individual capital account.

(g) Each Partner is required to devote his whole time and attention to the business of the Partnership and all employments, offices and appointments held by a Partner is for the benefit of the Partnership.

(h) If a Partner voluntarily withdraws or is expelled from the Partnership and he or she continues to practice XXXXXXXXXX in XXXXXXXXXX subsequent to such withdrawal or expulsion, other than as an employee of a federal, provincial or municipal government or agency or as a member of a corporate legal department, the amount otherwise payable to such Partner under the Partnership Agreement is reduced as follows:

(i) by XXXXXXXXXX % within the first XXXXXXXXXX years of being bound by the Partnership Agreement;

(ii) by XXXXXXXXXX % within the next XXXXXXXXXX years thereafter, and

(iii) by XXXXXXXXXX % within the next XXXXXXXXXX years thereafter.

6. In anticipation of implementing the proposed transactions, Named Partner 1 has incorporated ProCorp 1 and Named Partner 2 has incorporated ProCorp 2. Named Partner 1 is the only voting shareholder, director and officer of ProCorp1, and Named Partner 2 is the only voting shareholder, director and officer of ProCorp 2. Other than the incorporation of these two entities, no other proposed transactions have been undertaken by the Taxpayers and ProCorp1 and ProCorp2 have otherwise been inactive.

Proposed Transactions

7. The Partnership Agreement will be amended as follows:

(a) A provision will be added to differentiate between Professional Services and Non-Professional Services.

(b) A provision will be added to allow a Partner to elect to provide his or her Professional Services through a ProCorp engaged by the Partnership as an independent contractor, and where a Partner so elects, he or she will no longer be permitted to provide any Professional Services to the Partnership in his or her capacity as a Partner.

(c) A provision will be added to prohibit the transfer, conveyance or issuance of an interest in the Partnership to a ProCorp.

(d) A provision will be added to prohibit the carrying out of Non-Professional Services by the ProCorps. All Electing Partners will continue in their capacity as Partners to carry out the Non-Professional Services for the Partnership.

(e) The formula for the allocation of Income for a Taxation Year will be amended to provide that an Electing Partner's allocation of Income for a Taxation Year will be dependent solely on the Electing Partner's capital contribution to the Partnership and factors (including time) connected to the Non-Professional Services carried out by the Electing Partner on behalf of the Partnership. For greater certainty, the Partnership Agreement will make it clear that the calculation of an Electing Partner's Income for a Taxation Year will not take into account any Professional Services provided by the Electing Partner's ProCorp, nor will it take into account any time spent by the Electing Partner performing Professional Services in his or her capacity as an employee of his or her ProCorp.

(f) A provision will be added to ensure that all Non-Electing Partners will continue to provide their Professional Services directly to the Partnership. Further, the Partnership Agreement will clarify that a Non-Electing Partner's allocation of Income for a particular year will be based on the Non-Electing Partner's capital contribution to the Partnership and factors connected to the Professional Services and Non-Professional Services carried out by the Non-Electing Partner on behalf of the Partnership.

(g) The provision requiring partners to devote their full time and attention to the Partnership, as described in paragraph 5(g) above, will be deleted.

(h) The non-competition provision described in paragraph 5(h) above will be deleted.

(i) A provision will be added to provide that, as long as a ProCorp fully discharges its responsibilities under the Contract, ProCorp will not be restricted from providing Professional Services to other persons or otherwise prohibited from competing with the Partnership. The Partnership Agreement will also provide that Electing Partners themselves are not restricted from competing with the Partnership with respect to Professional Services. For greater certainty, there will not be any terms in the Partnership Agreement, or any other agreement (oral or otherwise), that would prohibit ProCorps or the Electing Partners from competing with the Partnership in respect of the provision of Professional Services.

8. Each ProCorp will be required to comply with the following requirements:

(a) It will be incorporated pursuant to the laws of the Province and will be licensed to carry on the practice of XXXXXXXXXX in the Province.

(b) It will qualify as a TCC and a CCPC.

(c) It will be controlled by an Electing Partner, who will be the legal and beneficial owner of all of the voting shares of the particular ProCorp. All shareholders legally or beneficially owning voting and non-voting shares of the ProCorp will be residents of Canada.

(d) An Electing Partner will be the sole director of his or her ProCorp. He or she will also be an employee of ProCorp pursuant to a written employment contract and will be entitled to receive a salary.

(e) An Electing Partner cannot be an employee, officer, director or shareholder, legal or beneficial, of more than one ProCorp.

(f) No two ProCorps will be Related Persons.

9. Upon receipt of a written notice from an Electing Partner, the Partnership will enter into a written Contract with the particular Electing Partner's ProCorp containing the following terms:

(a) The ProCorp will provide Professional Services on behalf of the Partnership in return for Fees. The amount of the Fees will be based on the fair market value of the Professional Services provided by the ProCorp to the Partnership. The Fees will relate only to the level of work performed by ProCorp and will not take into account the success of collected billings in respect of that work.

(b) The Contract will be for a fixed period equal to the lesser of XXXXXXXXXX months or the period ending at the end of the Partnership's fiscal period. A Contract may be renewed each year and either party may, upon XXXXXXXXXX days notice, terminate a Contract.

(e) All payments received by the Partnership from third parties in respect of Professional Services provided by the ProCorp under the Contract will be for the benefit of the Partnership, and if a ProCorp receives any such amounts, they will be remitted to the Partnership.

(g) Provided that ProCorp fully discharges its responsibilities under the Contract, ProCorp will not be restricted from providing Professional Services to other persons or otherwise be prohibited from competing with the Partnership.

(h) ProCorps will be responsible for providing all equipment, tools, and instruments used in the performance of the Professional Services at their expense. Pursuant to the Contract and in consideration for a fair market value fee, the Partnership will provide the ProCorps with certain, facilities, equipment, supplies and personnel that are required in the provision of Professional Services.

(i) The ProCorps will also 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:

(i) professional membership fees;

(ii) professional malpractice and other insurance premiums;

(iii) continuing education and training expenses;

(iv) transportation expenses;

(v) communication expenses;

(vi) business entertainment expenses connected to the business of the ProCorp; and

(vii) travel expenses, including car, accommodation and meal expenses;

(k) In the event that an Electing Partner suffers a physical or mental disability such that a ProCorp is unable to provide the services required under the term of the Contract, the Partnership will have the right to terminate the Contract.

(l) In the event of the death of an Electing Partner or the bankruptcy of the Contracting Company or its Electing Partner, the Partnership will have the right to immediately terminate the Contract.

10. The ProCorp's relationship to the Partnership is that of an independent contractor, and nothing in the Contract should be construed as:

(a) allowing either party the authority to assume or create any obligation whatsoever, express or implied, in the name of the other nor to bind the other in any manner whatsoever,

(b) giving either party the power to direct and control the day-to-day activities of the other party or any of their respective employees or agents, or

(c) constituting the parties as partners, joint venturers, co-owners or otherwise participants in a joint or common undertaking.

11. Within XXXXXXXXXX months of this Ruling, Named Partner 1 and Named Partner 2 will elect under the Partnership Agreement to provide Professional Services through ProCorp 1 or ProCorp 2, as the case may be. Immediately thereafter, ProCorp 1 and ProCorp2 will enter into Contracts with the Partnership for the purpose of providing Professional Services.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to allow the Named Partners to earn Professional Services income through ProCorps without negatively affecting the business arrangements between the other Partners of the Partnership, with the following advantages:

(i) to provide the Partnership with a greater ability to retain its Named Partners;

(ii) to provide a Named Partner with an increased level of control over his or her participation in the practice and management of the Partnership;

(iii) to permit each Named Partner with an increased level of control over expenditures, especially where such expenditures may not otherwise be approved by all members of the Partnership; and

(iv) to provide each Named Partner with more control over his or her own estate and financial planning.

Rulings Provided

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. Provided that a Named Partner would not, if his or her ProCorp did not exist, reasonably be regarded as an officer or employee of the Partnership in respect of the provision of Professional Services, the Named Partner's ProCorp will not be considered to be carrying on a personal services business as defined in subsection 125(7) of the Act.

B. Provided that neither ProCorp 1 nor ProCorp 2 was a member of any partnership in the relevant year in respect of the provision of Professional Services to the Partnership, the Fees earned by either of these ProCorps will not be specified partnership income as defined in subsection 125(7) of the Act.

C. Subject to sections 18 and 67 of the Act, the Fees payable by the Partnership to ProCorp 1 and ProCorp2 will be deductible by the Partnership in the determination of Income pursuant to subsection 96(1) of the Act.

D. The undertaking of the proposed transactions above, and in particular the payment of the Fees, will not in and of themselves cause subsections 56(2), 56(4) or 246(1) of the Act to apply so as to cause an amount received by a Named Partner's ProCorp under the Contract to be taxed as income in the hands of the particular Named Partner.

E. Provided that the amount of Income allocated to each Electing Partner is reasonable, having regard to all the relevant circumstances, the sharing of the Income between the Named Partners will not be subject to adjustment pursuant to subsection 103(1) of the Act solely as a result of a Named Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a ProCorp and to provide all of his or her Professional Services to the Partnership through that ProCorp for Fees.

F. 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 Named Partners.

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 any Named Partner and any other Partner with respect to sharing Income for income tax purposes.

H. Implementation of the proposed transactions as described above will not, in and by themselves, result in the application of the provisions of subsection 245(2) of the Act to re-determine the tax consequences confirmed in the rulings given 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, and whether the Partnership is a partnership at XXXXXXXXXX .

Additional Comments

Whether or not a particular Named Partner would, if his or her ProCorp 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 particular ProCorp and the Partnership and between the particular ProCorp and the particular Named Partner. This review and determination is the responsibility of the particular Named 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 ProCorp 1 and ProCorp 2 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 such ProCorp 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 a ProCorp received in a taxation year by a family member of the Named 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 a ProCorp 1 or ProCorp 2. 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 ProCorp 1 and ProCorp 2 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 ProCorps.

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 Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch