CRA indicates guarded acceptance of distributions of LP profits as loans, followed by set-off against draws in January

When will CRA treat loans from a limited partnership received by a limited partner in order to avoid a gain under s. 40(3.1) as a distribution of partnership capital or profits per s. 53(2)(c)(v), so that such negative-ACB gain is not avoided?

CRA responded that it “will generally” not do so where the following five tests are satisfied:

1. “The loan is not made on account of or in full or partial payment of a withdrawal of a limited partner's capital contribution.”

2. The total amount of all loans received by the limited partner in respect of a fiscal period of the partnership does not exceed the total of (i) the limited partner's share of the adjusted net income of the partnership for the fiscal period (i.e., s. 53(1)(e)(i) additions minus 53(2)(c)(i) year losses), and (ii) the ACB of the limited partner's interest at the end of the fiscal year - “or, if there is an excess amount, it is not material in the circumstances”.

3. “Shortly after the end of the fiscal period, the partnership declares a distribution payable to the limited partner in an amount equal to the total amount of the loans received by the limited partner during the fiscal period and the distribution is used to settle the loans to the limited partner (in cash or by way of set-off).”

4. The loan (made in lieu of the cash payment of the distribution) is made primarily for the purpose of avoiding a deemed gain to the limited partner pursuant to s. 40(3.1) that would be realized at the end of the fiscal period of the partnership caused solely by the difference between the time of the addition of the limited partner's share of the adjusted net income of the partnership for the fiscal period, and the time of the deduction of distributions to the limited partner for the fiscal period pursuant to s. 53(2)(c)(v) (other than the mooted loans).

5. The partnership interest is not a tax shelter, and this is not part of a larger series of transactions that includes an avoidance transaction to which s. 245(2) should apply.

These tests are perhaps too corporate. Re the 1^st test (and assuming that it is saying something more than the 2^nd test), there is no clear distinction (or perhaps none at all) between capital and operating draws for partnerships as contrasted to corporations. Re the 3^rd test, the general partner of a limited partnership usually has general authority to act alone regarding all but extraordinary matters, so that it typically would not make the catch-up distribution pursuant to a partnership resolution.

That said, the general thrust appears to be accepting of loans to solve only the problem that cash distributions grind partnership interest ACB right away, whereas the ACB is not righted through an income allocation until the beginning of the following year.

Neal Armstrong. Summary of 7 October 2022 APFF Federal Roundtable, Q.5 under s. 40(3.1).