2006 Ruling 2006-0201551R3 - Incorporating a XXXXXXXXXX Practice

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 XXXXXXXXXX partnership creates a professional corporation through which professional XXXXXXXXXX services are provided to XXXXXXXXXX , will the corporation be carrying on a personal services business and/or earning specified partnership income?

Position: Question of fact. Generally, no, if certain conditions are met.

Reasons: Reading of relevant legislation and consistent with other rulings.

XXXXXXXXXX 									2006-020155

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the XXXXXXXXXX and its partners. We also acknowledge the additional information provided to us through various letters, electronic mail transmissions and our telephone conversations (XXXXXXXXXX ).

Unless otherwise stated, all references to a statute are to the Income Tax Act, R.S.C. 1985 (5th Supplement), 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 definition unless otherwise indicated.

DEFINITIONS

In this letter, unless otherwise expressly stated:

• "CCPC" means "Canadian-controlled private corporation" and has the meaning assigned to that term by subsection 125(7) of the Act;
• "Contracting Corporation" means a professional corporation that is incorporated by a Partner, as permitted pursuant to the laws of the Province for the benefit of an existing Partner. It will be engaged by the Partnership to provide Professional Services to the Partnership as an independent contractor, as described in Paragraph 7. Collectively, they are referred to as the "Contracting Corporations";
• "CRA" means the Canada Revenue Agency;
• "Married Partners" means two Partners who are married to one another;
• "Paragraph" refers to a numbered paragraph in this letter;
• "Partner" means each of, or any of, the approximately XXXXXXXXXX operating through a corporation, specializing in XXXXXXXXXX that are partners of the Partnership. Collectively, they are referred to as the "Partners";
• "Partnership" means the existing partnership of XXXXXXXXXX;
• "Partnership Agreement" means the partnership agreement entered into by the Partners on XXXXXXXXXX, as amended from time to time;
• "Partnership Revenue" means gross revenue earned by the Partnership as described in Paragraph 4(a) and Paragraph 6; XXXXXXXXXX;
• "Personal services business" has the meaning assigned to that term by subsection 125(7) of the Act;
• "Practice" means the XXXXXXXXXX practice currently carried on by the Partnership;
• "Professional Services" means the XXXXXXXXXX services currently provided to XXXXXXXXXX by the Partners through the Partnership;
• "Province" means the Province of XXXXXXXXXX;
• "Related persons" has the meaning assigned to that term by subsection 251(2) of the Act;
• "Specified partnership income" has the meaning assigned to that term by subsection 125(7) of the Act; and
• "TCC" means "Taxable Canadian corporation" and has the meaning assigned to that term by subsection 89(1) of the Act.

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

FACTS

1. To the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling

a) is in an earlier return of the taxpayer(s) or a related person,

b) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer(s) or a related person,

c) is under objection by the taxpayer(s) or a related person,

d) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired, and

e) is the subject of a ruling previously issued by Revenue Canada, the CCRA or the CRA.

2. The Practice is currently carried on by the Partnership. Its fiscal period ends on XXXXXXXXXX. The Partners are the only partners of the Partnership and they are all residents of Canada. The Partnership has been carrying on business under the Partnership Agreement since XXXXXXXXXX. Before that time it had been carrying on business for XXXXXXXXXX years as the XXXXXXXXXX. All the Partners, except one, are individuals. Except for the Married Partners, no two Partners are Related persons.

3. The Partnership's identification number is XXXXXXXXXX. The Partnership files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Offices.

4. The salient terms of the Partnership Agreement, which binds the Partnership, includes the following:

(a) Partnership Revenue is derived primarily from Professional Services. Currently, XXXXXXXXXX associates of the Partnership also provide XXXXXXXXXX services to XXXXXXXXXX on behalf of the Partnership. In consideration for these services the Partnership pays the associates a per-diem amount or a negotiated fee-for-service. Partnership Revenue is also derived for work done by Partners, as independent contractors, during the time when a Partner is designated to be on duty for the Partnership, XXXXXXXXXX;

(b) each Partner has contributed $XXXXXXXXXX toward the capital of the Partnership for each full Partnership "Unit" allocated to them. The capital contribution was adjusted proportionately in the event that a partial Unit was allocated to a Partner;

(c) at a meeting of Partners, each Partner shall have one vote for each Unit or percentage of Unit owned by them;

(d) the Partnership Agreement provides for the creation of an "Executive Committee" which will be responsible for the affairs of the Partnership, including the day-to-day business and collecting all billings generated by the Partners and employees of the Partnership for XXXXXXXXXX services. Partners typically prepare individual XXXXXXXXXX bills daily, which are collected and remitted by staff of the Partnership on a weekly basis and billed to the XXXXXXXXXX;

(e) the Partnership, on behalf of the Partners, processes all XXXXXXXXXX bills, receives XXXXXXXXXX payments and other income, and distributes the funds to cover the costs of operating the Partnership, with the balance, if any, being available to the Partners;

(f) the net profits and losses of the Partnership in a fiscal year are allocated on a pro rata basis in accordance with the number of Units and part Units owned. The Executive Committee may adjust such allocation based upon the ratio of the number of days worked by each Partner during the fiscal year to the total days worked by all Partners during the fiscal year;

(g) there shall be paid to the Partners a monthly (and/or such other periodic) drawing per Unit to be fixed by the Executive Committee from time to time;

(h) the amount by which any net profits allocated to a Partner exceeds the monthly drawings paid to them in respect of a fiscal year shall be paid to the Partner on or before XXXXXXXXXX of the following year; and

(i) a Partner is entitled to the balance of the Partner's capital account at the date the Partner ceases to be a Partner. This amount shall be paid to a former Partner or such Partner's personal representatives in XXXXXXXXXX consecutive monthly instalments.

5. The activities of the Partners can be classified into four general categories, which are Professional Services, XXXXXXXXXX, teaching and "Management Functions".

6. Approximately XXXXXXXXXX% of the Partnership Revenue is generated through XXXXXXXXXX services, XXXXXXXXXX. The remaining XXXXXXXXXX% of the Partnership Revenue is generated from other sources, such as XXXXXXXXXX and teaching.

PROPOSED TRANSACTIONS

7. The Partnership Agreement will be amended such that each Partner, at his or her sole discretion, will be permitted to provide Professional Services to the Partnership through a Contracting Corporation engaged by the Partnership as an independent contractor. Notwithstanding this arrangement, the Partners that do incorporate a Contracting Corporation will also remain as Partners. Each Contracting Corporation will hold a valid certificate of authorization issued by the XXXXXXXXXX.

8. Consequential amendments to the Partnership Agreement will provide that

(a) the Contracting Corporations cannot become Partners,

(b) a Partner who incorporates a Contracting Corporation will no longer provide any Professional Services to the Partnership in his or her capacity as a Partner. Notwithstanding this arrangement, the Partners that do incorporate a Contracting Corporation will also remain as Partners and will continue to earn income for the Partnership by providing services such as XXXXXXXXXX, teaching and Management Functions on behalf of the Partnership,

(c) a Partner's allocation of Partnership income for any year during which a Contracting Corporation performs that Partner's Professional Services, will be dependent solely on the Partner's capital contribution to the Partnership and factors connected to the Partner's other services provided on behalf of the Partnership, being the teaching, XXXXXXXXXX and Management Functions. In particular, the calculation of the Partner's income allocation from the Partnership for that year will not take into account any of his or her Professional Services, either directly or indirectly, and

(d) any Partner that chooses not to incorporate a Contracting Corporation (a "Non-incorporated Partner") will continue to provide their Professional Services directly to the Partnership. A Non-incorporated Partner's allocation of Partnership income for any year will be dependent solely on that Non-incorporated Partner's capital contribution to the Partnership and factors connected to that Partner's other services provided on behalf of the Partnership, being the Professional Services, teaching, XXXXXXXXXX and Management Functions.

9. To date XXXXXXXXXX Partners (individually referred to in this letter as the "C.C. Partner" and collectively as the "C.C. Partners") have indicated that they will incorporate.

Exhibit C, attached to your ruling request provided us with a list of the names and social insurance numbers of those Partners.

10. Each Contracting Corporation will be a TCC and a CCPC. None of the Contracting Corporations will be Related persons, with the exception of Contracting Corporations that may be set up by individuals who are spouses.

11. Each Contracting Corporation will enter into a written contract for service (the "Contract") with the Partnership. The Contract will provide that the amount of the fee payable by the Partnership for the Professional Services provided by the Contracting Corporation to the Partnership will vary annually with the time devoted to Professional Services by the Contracting Corporation. The amount of the fee will be equal to the fair market value for the Professional Services provided by the Contracting Corporation to the Partnership. The Contract shall be renewed each year and may be terminated upon the Contracting Corporation giving XXXXXXXXXX-months notice.

12. Only the C.C. Partner will be entitled to hold the voting common shares of his or her Contracting Corporation. The Contracting Corporation may issue non-voting shares to the C.C. Partner's spouse, adult children and parents. Other than Married Partners that may own shares in their spouse's Contracting Corporation, no Partner will be an employee, officer, director, or shareholder, either legally or beneficially, of more than one Contracting Corporation. All persons legally or beneficially owning shares of a Contracting Corporation will be residents of Canada and, other than Married Partners that may own shares in their spouse's Contracting Corporation, will not be a legal or beneficial shareholder of another Contracting Corporation.

13. Each C.C. Partner will be an employee of his or her own Contracting Corporation. The employment relationship will be evidenced by a written employment agreement. A C.C. Partner will provide Professional Services for the benefit of their Contracting Corporation pursuant to the terms of the relevant Contract between their Contracting Corporation and the Partnership. A C.C. Partner who provides services for the benefit of their Contracting Corporation will be entitled to receive a salary from their Contracting Corporation for such service provided. The sole officer and director of each Contracting Corporation will be the respective C.C. Partner.

14. All payments from XXXXXXXXXX and other sources received by the Partnership in respect of services provided to the Partnership by the Contracting Corporations will be for the benefit of the Partnership.

15. The Partnership will provide administrative services to the Contracting Corporations. This will be done pursuant to a written agreement that will provide for a fair market value fee for these services. These services will include billing and collecting all receivables, providing financial accounts on an on-going basis and paying all shared expenses (e.g., office associates and billing support system).

16. Each Contracting Corporation will be responsible for the following expenses:

(a) professional membership fees and insurance;

(b) continuing education;

(c) transportation;

(d) communication;

(e) maintaining the professional standards set by the Partnership or by the XXXXXXXXXX; and

(f) expenditures on personal practice preferences of the Contracting Corporation.

17. So long as the Contracting Corporation fully discharges its responsibilities under the Contract, the Contracting Corporation will not be restricted from providing services similar to the Professional Services to other persons or otherwise prohibited from competing with the Partnership.

18. So long as the C.C. Partner fully discharges their responsibilities under the employment contract with their Contracting Corporation, the C.C. Partner will not be restricted from providing services similar to the Professional Services to other persons or otherwise prohibited from competing with the Contracting Corporation or the Partnership.

PURPOSES OF THE PROPOSED TRANSACTIONS

19. The Proposed Transactions will allow a C.C. Partner to provide his or her Professional Services through a Contracting Corporation to the Partnership with the following advantages:

(a) to allow a C.C. Partner to benefit from the statutory amendments by the Province which permits XXXXXXXXXX to render Professional Services through a corporation, which may or may not have certain non-voting shareholders;

(b) provide a C.C. Partner with an increased level of control over his or her participation in the Practice through individual management of personal practice preferences;

(c) permit a C.C. Partner to have control over expenditures where such expenditure may not be in the interest of all participants in the Practice;

(d) provide a C.C. Partner with more control over his/her own estate and financial planning; and

(e) to enhance the Partnership's ability to retain current and recruit new XXXXXXXXXX.

RULINGS

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,

our rulings are as follows:

A. Provided that a Partner providing Professional Services to the Partnership through a Contracting Corporation would not, but for the existence of the Contracting Corporation, be an officer or employee of the Partnership in respect of those services, then the Contracting Corporation will not be considered to be carrying on a Personal services business.

B. Provided that a partnership does not exist between any of the Contracting Corporations, the fee income earned by a Contracting Corporation pursuant to the Contracts, as described in Paragraph 11, will not be Specified partnership income.

C. Subject to sections 18 and 67 of the Act, the fees payable by the Partnership to the Contracting Corporations pursuant to the Contracts, as described in Paragraph 11, will be deductible in computing the Partnership's income pursuant to subsection 96(1) of the Act.

D. The transactions undertaken in Paragraphs 7, 8 and 11, and in particular the payments described in Paragraph 11, 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 the Contracting Corporations under the Contracts to be taxed as income in the hands of a Partner.

E. Provided the amount of Partnership income allocated to each Partner is reasonable having regard to all the relevant circumstances, the sharing of Partnership income between the Partners will not be altered, pursuant to subsection 103(1) of the Act, solely as a result of the proposed transactions, and in particular the proposed amendments to the Partnership Agreement in Paragraphs 8(c) and (d).

F. Implementation of the proposed transactions, in and by themselves, will not 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 general limitations and qualifications set forth in Information Circular 70-6R5, issued by the CRA on May 17, 2002, and are binding on the CRA provided the proposed transactions are entered into on or XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly that the CRA has agreed to or accepted the reasonableness, fair market value, or proper tax treatment of any fees

or expenditures referred to in this letter.

OPINION

The application of subsection 256(2.1) is determined on a year-to-year basis. We are therefore unable to rule that this provision will never apply to the Contracting Corporations. 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 Corporations 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 Corporations.

In accordance with paragraph 22 of Information Circular 70-6R5, the above comments 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