9 May 1991 Ministerial Letter 903248 F - Limited Partnership At-risk Rules

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.

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We are writing in reply to your memorandum of November 19, 1990, wherein you requested our comments on whether the at-risk rules in subsection 96(2.2) of the Income Tax Act (the "Act") would apply to a partnership interest acquired by a Canadian taxpayer in a non- resident limited partnership.  We apologize for the delay in responding to your memo.

Background

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Your Opinion

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the Act.  This legal opinion is supported, in part, by comments made in the court case Oceanfront Carriers Limited, 87 DTC 5102 (F.C.A.) which imply that a partnership's activities prior to the purchase of a partnership interest by a Canadian taxpayer are irrelevant for the purpose of the Act.  Also in support of your opinion is a letter dated April 6, 1988 to 24(1) from Specialty Rulings Directorate which indicates, in summary, that subsection 10(2) of the Act would not be available to value inventory at the end of the immediately preceding year where at the end of the year there was not a Canadian partner as a member of a non-resident partnership.

Our Comments

A) Application of subsection 96(2.5) of the Act.

We have reviewed several court cases dealing with the effect of activities carried on outside Canada for Canadian income tax purposes, including Panda Merali, 88 DTC 6172 (FCTD), Oceanspan Carriers, Holiday Luggage Mfg. Co., 86 DTC 6601 (FCTD) and Lea-Don Canada Limited, 70 DTC 6271 (SCC).  We agree that they support the above statements that prior to the time when a Canadian taxpayer becomes a member of a non-resident partnership carrying on business outside of Canada, the income or loss determination of such a partnership is not relevant for the purpose of the Act.

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It is our opinion that the purpose of subsection 96(2.5) of the Act is to provide grandfathering protection for all functioning partnerships in existence actively carrying on business at the time the legislation was introduced.  A non-resident partnership can be a partnership carrying on business in the years prior to it having a Canadian member.  The tests to be met by a partnership are related to its size and activity at the time the legislation was introduced and not whether it was actively carrying on business in Canada or had a Canadian taxpayer as a member.  Therefore, it is our opinion that a Canadian taxpayer that acquires an interest after February  26, 1986 in a non-resident partnership actively carrying on business outside Canada can acquire an "exempt interest", if that partnership otherwise meets the criteria in subsection 96(2.5) of the Act.

The grandfathering rules in the subsection are intended to limit the size of a business to that which existed prior to February 26, 1986.  As we have not been provided with enough information to determine whether such is the case, we have provided general comments on the subject.  The requirement that a partnership was "actively carrying on a business" will generally be met as long as the partnership is carrying out activities which are necessary to or consistent with the business for which it was formed.

In order for an interest in a partnership to continue to be an exempt interest, there must not be a substantial increase in the indebtedness in the partnership after February 26, 1986 or a substantial contribution of capital to the partnership after February 26, 1986.

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In that regard, generally, expenditures for assets under construction made pursuant to the terms of a  written agreement entered into prior to February 26, 1986 will not be considered to be substantial.  In addition, any cash deficiency payments used to repay a loan referred to in that paragraph, would not be considered to be substantial increase in the indebtedness of the partnership.  However, that paragraph would not apply to exempt an increase in capital contributions to or  an increase in the indebtedness of the partnership that has been made by way of cash deficiency call payments for operating requirements.

It is the Department's position that losses incurred by a partnership after February 26, 1986, even where the partnership interest is an exempt interest, are still restricted by the partner's equity position as outlined in paragraph 20 of Interpretation Bulletin IT-138R.  Although the Department lost the court case Signum Communications Inc., 88 DTC 6427 (FCTD) which challenged our assessing position, this case is under appeal and should be heard in May of this year at the Federal Court of Appeal.  Until this issue is resolved by the courts, we will continue to assess taxpayers having an exempt interest on the basis of our position in IT-138R (as confirmed in the 1988 Canadian Tax Foundation Conference Report at page 53:10).

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Prior to the enactment of paragraph 111(1)(e) of the Act applicable to losses subject to the at-risk rules, there was no provision in the Act that would allow a limited partner to carry forward a non-deductible loss of a prior year to a following taxation year.

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B) Application of subsection 103(1.1) of the Act

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This allocation is generally considered to be reasonable because the capital contribution made by the general partner is usually nominal, e.g. $100 and the majority of the capital is contributed by the limited partners.  In addition, the general partner is often paid a fee (as opposed to an allocation of the partnership's income) by the partnership for its management and administrative services provided. Limited partners do not usually contribute may work or services to the partnership as provincial limited partnership law restricts the nature and extent of their involvement in the operations of the partnership.  Subject to section 103 of the Act, the Department accepts that a partner at the end of a fiscal period of the partnership is entitled to be allocated his share of the partnership's income or loss for the entire fiscal period of the partnership, in accordance with the partnership agreement, regardless of when he became a member of the partnership.

Subsection 103(1.1) of the Act reallocates income or losses between the non-arm's length partners where the ratio is not reasonable having regard to the capital invested in, work performed by the members or other relevant factors.

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C) In Summary

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We trust these comments will be of assistance.

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch

INCLUDED FOR CONTINUITY PURPOSES AND NOT INCLUDED IN COSTING

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