7 July 1991 Income Tax Severed Letter - Transition rules of paragraph 28(1)(c) — mandatory inventory rules dealing with the arm's length concept as it relates to partnerships

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.

Dear Sirs:

Re: Arm's Length

This is in reply to your letter of March 15, 1991, in which you request further clarification of the transitional rules of paragraph 28(1)(c) of the Income Tax Act (the "Act"). You seek our views on four hypothetical situations concerning the application of the mandatory inventory rules dealing specifically with the concept of arm's length as it relates to partnerships.

Situation 1

Partnership A acquires a specified animal from partnership B. All interests in both partnerships are owned by related parties. Would partnership A be considered to have acquired a specified animal from a person with whom it was not dealing at arm's length?

Our Comments

Since the two partnerships are controlled by a group of related persons where all persons in partnership A are related to all persons in partnership B, it is our opinion that partnership A would be considered to have acquired a specified animal from a person with whom it was not dealing at arm's length. Individuals connected by blood relationships, marriage or adoption and related persons are deemed by paragraph 251(1)(a) of the Act not to deal with each other at arm's length.

Situation 2

Partnership C acquires a specified animal from partnership D. Partnerships C and D are both controlled by related parties since at least 50% of the total outstanding partnership interests are owned by related parties. Would partnership C be considered to have acquired a specified animal from a person with whom it was not dealing at arm's length?

Our Comments

Although it is a question of fact as to when persons deal at arm's length, it is our opinion that where a group of related persons control the interests of two partnerships that these two partnerships would be considered to be dealing with each other at non-arm's length. This conclusion assumes a situation where the one partnership is comprised of a related group that is related to all members of the second partnership (For example two husband and wife partnerships where the husbands are brothers). In all other cases it is a question of fact whether the members of a partnership deal at arm's length with all the members of the second partnership. Paragraph 251(1)(a) of the Act deems related persons not to deal with each other at arm's length regardless of the possibility that, they may, in fact, conduct their mutual transactions on that basis. Related persons include individuals connected by blood relationship marriage or adoption.

Situation 3

Partnership E acquires a specified animal from partnership F. Various persons own interests in these partnerships such that it could not be said that both partnerships are controlled by the same person or related parties. However, both are limited partnerships and have a common general partner. The general partner could be said to control the operations of both partnerships. Would partnership E be considered to have acquired a specified animal from a person with whom it was not dealing at arm's length?

Our Comments

Again it is a question of fact whether the two partnerships deal at arm's length. In paragraph 15 of Interpretation Bulletin IT-419, it is stated that "in situations where one partner is in a position to control a partnership, either through ownership of a controlling interest or through a mandate vested in him by his partners, the Department considers such person not to deal at arm's length with that partnership". When applying this to a limited partnership, as the general partner has the control of the business of the partnership, we take the position that when there is only one general partner of a limited partnership that general partner does not deal at arm's length with that limited partnership for the purposes of paragraph 96(2.2)(c) of the Act. Paragraph 251(1)(a) of the Act deems related persons not to deal with each other at arm's length. In our view, the relationship existing between the parties could lead one to conclude that the general partner and limited partnership will usually not deal at arm's length. In M.N.R. v. Merritt Estate, [[1969] C.T.C. 207] 69 DTC 5199 (Ex. Ct.), the court held that the parties were not dealing at arm's length for the purposes of the Estate Tax Act. At pages 5165-5166, Mr. Justice Gattanach summarized the relevant principles as follows.

"In my view, the basic premise on which this analysis is based is that, where the "mind" by which the bargaining is directed on behalf of one party to a contract is the same "mind" that directs the bargaining on behalf of the other party, it cannot be said that the parties are dealing at arm's length. In other words where the evidence reveals that the same person was "dictating" the "terms of the bargain" on behalf of both parties, it cannot be said that the parties were dealing at arm's length."

These remarks would no doubt be applicable in many cases where the same general partner transacts the businesses of two limited partnerships.

However, whether two limited partnerships controlled by the same general partner deal with each other at arm's length is a question of fact that can only be determined from an analysis of those facts.

Situation 4

Partnership G acquires a specified animal from corporation H. Both entities are controlled by the same person. Would partnership G be considered to have acquired a specified animal from a person with whom it was not dealing at arms length.

Our Comments

It is a question of fact whether a partnership and a corporation controlled by the same person are dealing with each other at arm's length. The statutory relationship between persons and corporations is found in paragraph 251(2)(b) of the Act. For a non-arm's length relationship to exist between a person and a corporation there must be an element of control, either singly (subparagraph 251(2)(b)(i) of the Act) or through a related group (subparagraph 251(2)(b)(ii) of the Act. Furthermore a person, related to any person who is related to a corporation pursuant to subparagraphs 251(2)(b)(i) and (ii) of the Act, is also related to that corporation. The Department's views on control of a corporation are outlined in IT-64R, paragraphs 14 to 25. The criteria which have been constantly examined by the courts in determining whether or not a transaction is at arm's length are as follows:

• (a) the existence of a common mind which directs the bargaining for both parties to a transaction.
• (b) parties to a transaction acting in concert without separate interests, and
• (c) "de facto" control.

Accordingly, it is our opinion, that partnership G could be considered to have acquired a specified animal from a person from whom it was not dealing at arm's length. It will be a question of fact in every case.

We caution that our replies are not advance income tax rulings but are merely opinions based solely on the information given. These opinions might very well change upon a review of all of the facts and particularly after an examination of all pertinent documentation.

We trust our comments will prove helpful.