21 June 1991 Income Tax Severed Letter 910822 - 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.

C.R. Bowen (613) 957-2096

June 21, 1991

Dear Sirs:

Re: At-Risk Rules

We are writing in reply to your letters of March 21 and May 17, 1991, wherein you requested our comments regarding the application of "at-risk rules" in subsections 96 (2.2) and 96 (2.4) of the Income Tax Act (the "Act") to the hypothetical situations described below. We apologize for the delay in responding to your letter.

Our understanding of the facts given to illustrate the issues is as follows:

SITUATION 1

A Canadian bank loans $75 to a limited partner which the partner uses, along with $25 cash, to make a capital contribution to a limited partnership. The limited partnership guarantees the partner's $75 loan and provides security to the bank (i.e. fixed and/or floating charge on the partnership's property). The limited partner pays a reasonable guarantee fee to the partnership as consideration, as well as provides an indemnity saving the partnership harmless from any loss or cost it may suffer as a result of the guarantee. The indemnity acknowledges that the limited partner is fully liable to the partnership in respect of any amount the partnership may be required to pay the bank due to the guarantee and any cost associated with it.

In the above situation, the partners is willing to assume the full financial risk of the partnership's operation (represented by the capital contribution), but is not willing to assume other risks such as environmental liabilities, construction risks and tort risks. Therefore, the partnership's operations must be structured as a limited partnership. The bank wants the guarantee of and the security from the partnership since it owns the assets and the security on the partnership interest granted by the partner will not protect the bank if other liabilities arise within the partnership.

The Department's general position on this matter is outlined in question 7 on page 8:22 of the 1989 Corporate Management Tax Conference ("CMTC"):

"Where the partnership guarantees the debts of the limited partners, paragraphs 96 (2.2) (d) to (f) will generally reduce the `at-risk' amounts of the partners by the amount of the loan that is subject to the guarantee."

Question

1. Will the granting of the guarantee by the limited partnership in the above situation affect the limited partner's at-risk amount?

Your Opinion

Despite the Department's comment, it is your opinion that there will be no benefit to the limited partners since the limited partners are at-risk for the full amount of the loan and the guarantee does not reduce the limited partner's exposure to a potential loss in the partnership investment. If the partner becomes indebted to the partnership (i.e. due to subrogation of the partnership to the bank) paragraph 96 (2.2) (c) of the Act would apply to reduce the partner's at-risk amount at the time the amount actually becomes owing to the partnership. Paragraph 96 (2.2) (f) of the Act is unduly harsh in the situation where the guarantee given is less than the amount of the outstanding debt.

SITUATION 2

The two partners, ACo. and BCo., of a general partnership provide funds to the partnership as follows: an aggregate of $25 million by capital contributions and an aggregate of $25 million by loan. The loan to the partnership has the following terms:

(a) recourse limited to the assets of the partnership;

(b) convertible at the option of the lender into additional capital of the partnership; and

(c) a reasonable rate of interest given on (a) and (b).

The partnership will borrow $50 million additional funds from an arm's length corporation XCo. (the "XCo. Loan"). The terms of the XCo. Loan will be:

(a) recourse limited to the assets of the partnership;

(b) convertible at the option of XCo. into capital of the partnership; and

(c) a reasonable rate of interest given (a) and (b).

Questions

1. Will the general partners be considered limited partners by virtue of paragraph 96 (2.4) (b) of the Act as a result of the limited recourse financing, which has the option of being converted into capital of the partnership, provided by either a) the partners or b) XCo?

2. If XCo. exercises its option to convert its loan into capital of the partnership, will XCo. be considered to be a limited partner as defined in paragraph 96 (2.4) (b) of the Act by virtue of the limited recourse financing provided by the other partners?

SITUATION 3

Question

1. Where a partnership enters into leasing or rental arrangements with arm's length third parties, will such an arrangement be considered to be a benefit for the purpose of limiting any potential loss a partner may sustain as contemplated by paragraph 96 (2.2) (d) of the Act?

Our Comments

While we are unable to provide confirmation of the income tax effects of the particular situations described in your letter, we can offer the following general comments related to limited recourse financing and leasing arrangements entered into by a partnership.

SITUATION 1

1. The Department's comments presented at the 1989 CMTC still represent our position. It is also our opinion that paragraph 96 (2.2) (f) of the Act requires the reduction to the "at-risk" amount of limited partners by the full amount of the unpaid loan used to acquire the partnership interest, despite that fact that only a portion of the loan may have been guaranteed by the partnership.

SITUATION 2

1. It is our opinion that paragraph 96 (2.2) (d) of the Act generally will not apply with respect to the benefit that may arise by virtue of a general partnership obtaining non-recourse or limited recourse financing that arose as a result of legitimate commercial transactions unrelated to the general partner's acquisition of the partnership interest. Where this type of financing is provided as a loan by a general partner or an arm's length party with the option of being converted into capital of the partnership, paragraph 96 (2.4) (b) of the Act generally will not apply to cause a general partner to be considered a limited partner. However, it is not possible to state that this paragraph would never apply to such financing provided to a general partnership, as such a decision could only be rendered based on the facts of a particular case.

2. It is our opinion that paragraph 96 (2.4) (b) of the Act generally will not apply to a particular partner's interest in a general partnership with respect to the benefit that may arise by virtue of a general partnership obtaining non-recourse or limited recourse financing from another partner that arose as a result of legitimate commercial transactions unrelated to that particular partner's acquisition of the partnership interest. However, it is not possible to state that this paragraph would never apply to such financing provided to a general partnership, as such a decision could only be rendered based on the facts of a particular case.

SITUATION 3

1. It is your opinion that paragraph 96 (2.2) (d) of the Act generally will not apply to a particular partner's interest in a partnership with respect to the benefit that may arise by virtue of the partnership entering into leasing or rental arrangements with arm's length parties that arose as a result of legitimate commercial transactions unrelated to the partner's acquisition of the partnership interest. However, it is not possible to state that the paragraph would never apply to rental or leasing arrangements entered into by a partnership, as such a decision could only be rendered based on the facts of a particular case.

These comments represent our opinion of the law as it applies generally. As indicated in paragraph 21 of Information Circular 706R2 dated September 28, 1990, this opinion is not a ruling and accordingly, it is not binding on Revenue Canada, Taxation.

We trust these comments will be of assistance.

Yours truly,

for Director Business and General Division Rulings Directorate, Legislative and Intergovernmental Affairs Branch