20 November 2003 External T.I. 2003-0033545 - partnership dissolution

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Where partnership, which was claiming reserves under 20(1)(m) and (n), dissolves and 98(5) applies, can sole proprietor continue to claim these reserves.

Position: Yes

Reasons: Per final 12(1)(e) inclusion of partnership, proprietor's share of the relevant amounts have been included in proprietor's income. May also elect under 20(24) for purposes of 20(1)(m).

2003-003354
XXXXXXXXXX B.G. Dodd
(613) 957-8953
November 20, 2003

Dear XXXXXXXXXX:

Re: Partnerships - Reserves

We are writing in reply to your enquiry dated August 5, 2003 concerning the reserves provided in paragraphs 20(1)(m) and (n) of the Income Tax Act (the "Act").

You refer to circumstances described in subsection 98(5) of the Act in which a partnership dissolves and its business is carried on by a former partner as sole proprietor. You enquire whether reserves under paragraphs 20(1)(m) and (n) of the Act which had been deducted by the partnership in its final taxation year prior to its dissolution may continue to be claimed by the sole proprietor.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5 dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only and are not binding on the Canada Customs and Revenue Agency with respect to any particular situation.

Our Comments

Paragraph 20(1)(m) of the Act provides for the deduction in a taxation year of a reserve in circumstances where amounts have been included in computing the taxpayer's income from a business for the year or a previous year pursuant to paragraph 12(1)(a). The reserve is determined with reference to, among other things, goods to be delivered, or services to be rendered, after the end of the year. Paragraph 20(1)(n) of the Act provides for a reserve, determined with reference to the profit element, where an amount has been included in business income for the year or a preceding year in respect of property sold and the amount is payable to the taxpayer after the end of the year. Paragraph 12(1)(e) of the Act requires the inclusion in income in a taxation year of any reserve deducted in the immediately preceding year under paragraphs 20(1)(m) and (n).

Where a partnership is dissolved as described in subsection 98(5) of the Act, the partnership would, pursuant to paragraph 12(1)(e), be required to include in its income for its final taxation year the amount of any reserve deducted by it under paragraphs 20(1)(m) and (n) in the immediately preceding year. The partnership would not be entitled to a reserve under paragraph 20(1)(m) or (n) in its final taxation year. As a result, each partner of the partnership would include in computing income his or her proportionate share of the amount included in the partnership's income under paragraph 12(1)(e) for its final taxation.

It is our position that the former partner who carries on the partnership business as a sole proprietor as described in subsection 98(5) of the Act may claim a reserve under paragraph 20(1)(m) in respect of his or her proportionate share of the partnership's final year income inclusion under paragraph 12(1)(e) which relates to the partnership's preceding year reserve under paragraph 20(1)(m), provided the sole proprietor is responsible for the related obligations which gave rise to the partnership's reserve under paragraph 20(1)(m). Similarly, the sole proprietor may claim a reserve under paragraph 20(1)(n) of the Act in respect of his or her proportionate share of the partnership's final year income inclusion under paragraph 12(1)(e) which relates to the partnership's preceding year reserve under paragraph 20(1)(n), provided the amounts payable after the year as described in paragraph 20(1)(n) are payable to the sole proprietor.

It is our view that the sole proprietor could claim reserves under paragraph 20(1)(m) and (n) as described above only to the extent that the partnership would have been entitled to deduct the reserves had the winding-up not occurred. For example, by virtue of paragraph 20(8)(b) of the Act, the maximum period for which a reserve under paragraph 20(1)(n) may be claimed in respect of a sale of property is three years. In our view, the particular three-year period applicable with respect to the partnership would continue to be applicable with respect to the sole proprietor. In addition, entitlement to these reserves would be subject to any other statutory limitations or restrictions, including subsections 20(6), (7) and (8) of the Act.

We also note that in our view, a partnership may be regarded as a taxpayer or person for purposes of subsection 20(24) of the Act. As such, where a partnership pays to the partner who will continue the business as a sole proprietor as described in subsection 98(5) a reasonable amount for undertaking to assume the partnership's obligations described in paragraph 12(1)(a), an election may be available to the partnership and the sole proprietor under subsection 20(24). Where a valid election is made, the partnership would be entitled to deduct the amount of the payment in computing its income for the year of payment and with respect to the sole proprietor, the amount received would be deemed to be an amount described in paragraph 12(1)(a) of the Act, thereby entitling the sole proprietor to a reserve under paragraph 20(1)(m) to the extent provided therein.

We hope this will be of assistance to you.

Yours truly,

Daryl Boychuk, LL.B
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

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