Section 103

Partner B (a corporation) is assessed under s. 103 on the basis that 40% rather than 10% of the income of the LP should have been included in its income (so that the share of Partner A, who is a related individual, should have been 60% rather than 90%). Is the income allocated to B required to be reimbursed by the taxpayer (i.e., A) who received the income? CRA stated:

[S. 103 does] not provide for a reimbursement obligation by a taxpayer where a benefit was allocated or where income was attributed to another taxpayer. …

[I]f under civil law or common law, as applicable, partner A did not obtain a loan nor become the debtor of the partnership or of partner B by reason of distributions in favour of partner A under the partnership agreement, the conditions for the application of subsection 15(2)…would not be satisfied. …[T]here is not enough information to reach a conclusion as to the application of subsection 15(1)… .

The Taxpayer entered into the "Purchase Agreement" for the purchase of a limited partnership (the "Partnership") with substantial current losses from its partners, principally the "Trust" holding essentially all the LP units. The TSO reduced the Partnership loss allocated at year end to the Taxpayer by allocating a pro rata portion of the loss (based on the days in the year up to the sale) to the Trust.

In finding that this approach was not justified by s. 103(1) or (1.1), the Directorate quoted with approval a statement at the 1985 CTF Annual Roundtable that "the income or loss of any partner for income tax purposes in respect of a particular year of partnership operations will be his share of the partnership's income or loss allocated to him pursuant to the partnership agreement, notwithstanding the fact that he may not have been a partner throughout the whole of the fiscal period of the partnership," and then stated:

the allocation made to the Taxpayer for the fiscal year in question does not appear to be unreasonable in the circumstances as the Taxpayer continued to be a partner in the Partnership in subsequent years.

The professional income generated by an individual was earned, at least in part, by a limited liability partnership (SENCRL) of which one of the partners was a trust for the benefit of related minors, that received distributions of such income, and another partner was a services corporation that incurred the relevant expenses. After finding that the pre-2014 version of the split income rules in s. 120.4 did not apply in this situation, CRA went on to paraphrase s. 103(1) and state (TaxInterpretations translation):

[A]n argument could be made that there does not appear to be any real reason for implementing the structure other than income splitting.

After also noting that s. 103(1.1) might apply, CRA then stated:

[T]he GAAR should not apply to the situation in this case because subsections 103(1) and (1.1) are of sufficient breadth to adjust the income-sharing terms agreed between the partners of the partnership.

A majority of the shares of BCo (a taxable Canadian corporation) are held by ACo (also a taxable Canadian corporation), while the balance of the shares of BCo are held by arm's length shareholders (the Vendors) with ACo or persons who are related to ACo being obligated to acquire all of the Vendors' shares over a specified period. BCo currently is unprofitable and ACo has been funding it with loans, and the business requires further funding until it becomes profitable.

BCo will transfer its business on a rollover basis to a newly formed subsidiary limited partnership (New LP) in consideration for the assumption of liabilities and the issuance of Class A units; and ACo will fund New LP from time to time in consideration for the issuance of Class B units (which are not described in the letter to have much difference from the Class A units – including equal per-unit allocations of income or loss - except as described below) at a subscription price equal to a valuation of the NAV per Class A unit and Class B unit.

The limited partnership agreement provides that after distributions of accumulated income which have been allocated proportionately to the number of units held

any further distributions may then be credited by the general partner to the capital account of each partner as a return of capital, at the discretion of the general partner.

When BCo becomes a wholly-owned subsidiary of ACo, it may be wound-up into ACo or amalgamated with it.

Ruling that s. 103(1) or (1.1) will not apply.

CRA continues to accept that where a partner has contributed knowledge or know-how to the partnership rather than making a financial contribution, the value of that knowledge or contribution should be taken into account in determining the partner's share of partnership profits.

After indicating that an agreement to allocate income to a retired partner generally would be respected but for there being no partnership net income, CRA went on to state:

Generally …CRA … does not question the validity of a partnership sharing agreement that is based on the contribution of each partner.

In connection with a query on the implications of holding a preferred unit in a partnership, i.e., a unit that confers on its holder a preferred share of the partnership's profits or losses, CRA noted that division of a partnership interest into preferred and common units does not affect it being a single property, and stated:

[T]here is nothing to prevent the creation of units with different rights with respect to the sharing of income, losses or other attributes of the partnership. To use your example, one of the two partners would be entitled to priority income of $40,000, and the remaining taxable income of the partnership, $60,000 (in your example), would be allocated equally to the two partners. This is a profit-sharing arrangement that gives one of the two partners a preferred share ($40,000 in your example) of the profits. The CRA would not object to such a sharing agreement unless its main purpose was to reduce taxes or defer the payment of taxes that might otherwise have been or become payable under the Act as provided in section 103.

A partnership in whose farming business the partners are actively involved owns the residence of one of the partners, who does not pay rent, but pays all the annual expenses of the residence. After paraphrasing s. 103(1), CRA stated:

One of the factors to be considered in an analysis of whether the division of profits between partners is reasonable is the personal use by a partner of partnership property.

A limited partnership (LP) with various limited partners received a contribution of a building (with a UCC of $3 million and an FMV of $4 million) from two corporate partners (Corporations 1 and 2) on a s. 97(2) rollover basis, with it being agreed that they would bear the deferred tax liability. Subsequently, the property was sold for $3.5 million at a time that the UCC was $2.8 million. As the LP had an operating loss of $200,000, the two corporations were allocated income of $500,000.

CRA stated:

[T]he possible sharing, as described in your letter, seems reasonable on its face, although we do not have enough information to determine whether the main purpose of the income sharing is to reduce taxes or to defer the payment of taxes and whether the allocation of income should be modified under subsection 103(1).

Adverse comments on a situation where all the income allocable to one of the two partners of a resource partnership comprised income purportedly attributable to a particular property of the partnership (in order to maximize deduction by that partner of its successored pools).

Under the terms of a limited partnership agreement, corporate shares held by the partnership would be allocated among the partners, and gains or losses from the disposition of particular shares would be allocated only to those partners to whom such shares had been allocated. CCRA indicated that there would need to be a valid reason for allocating capital gains differently than dividend income, and stated:

[S]ubsection 103(1) would not apply if the creation by the limited partnership of capital accounts for each partner to which are allocated separate assets that may or may not be sold at the partner's option and that give entitlement to the income or losses from those separate assets had a principal purpose other than the reduction or deferral of tax for the partners.

The use of a services partnership (the members of which includes inter vivos trusts for the benefit of members of the families of various members of the professional firm) to provide non-professional services to a professional firm may be acceptable, although the examination of a actual arrangement would be necessary to determine whether there is an avoidance of s. 103 of the Act.

S.103(1) or (1.1) likely would apply where a corporation that was carrying on an R&D project formed a general partnership, transferred its assets to the partnership under s. 97(2), the other members of the partnership contributed capital by way of cash and services to finance completion of the project, and losses of the partnership were allocated to all the partners except the corporation until such time as the aggregate losses allocated to the other partners equalled their capital contributions.

"Revenue Canada could argue that it is not reasonable to allocate to the limited partners the losses referable to the partnership property for the payout, and in effect, treat the limited partners as owners of the property in that period, when they cease to have any substantial equity interest in the property after payout. This argument would be more persuasive if the sharing of income and losses was changed after payout to provide that the limited partners were entitled to only, say, a 1% interest in the profits and losses of the partnership. However, the more sophisticated agreements provide that the limited partners will share pro rata following the payout of the creditor/partner."

A minimum return on capital paid to a partner may be considered interest income of the partner even though no deduction is available to the partnership.

Where two partners in a partnership each contribute capital at a minimum rate or a return on capital is paid to only one partner, s. 103 potentially can apply.

CRA confirmed that the tax on split income is inapplicable to a family partnership that invested in the stock market where the children had not contributed anything or participated in the trading decisions or other management of the partnership, given the exclusions from “split income” for dividends on shares listed on designated stock exchanges and for taxable capital gains realized on such shares. However, given such lack of contribution by them, CRA would review the application of inter alia ss. 103(1). 103(1.1), 74.1 and 96(1.8).

On September 1, 2015, Mr. X, who held 50% of the units of an LP (“SENC”), transferred his units to a wholly-owned corporation ("Xco"). On December 31, 2015, SENC allocated its 2015 income to the other partner (Mr. Y) and Xco on a 50-50 basis. Would CRA apply ss. 96(1.01) and 103(1.1) to reallocate income to Mr. X? CRA responded:

When a taxpayer ceases to be a partner of a partnership in the course of a fiscal period of the partnership, the deeming rule in paragraph 96(1.01)(a) applies so as to deem the taxpayer – for purposes inter alia of subsection 96(1) and section 103 – to be a partner of the partnership at the end of its fiscal period. Therefore, the specific anti-avoidance rules of section 103 could apply to ensure that income was allocated to X for the year of X’s withdrawal from the partnership. However, …we cannot comment [on any application of s. 103] without first having examined all the facts….

Most of the income of a partnership has been allocated and distributed to a partner which is a personal trust, but CRA reallocates most of such income under s. 103 to the other partner, which is a corporation (subject to a lower tax rate than the trust). Notwithstanding that the trust partner has enjoyed income on which it is not subject to tax, CRA acknowledges that there is no obligation for the trust to make any reimbursement payment to the other partner. More generally, CRA acknowledges that the operation of s. 15(1), 51(2), 69(1), 74.1(1) or (2), 74.4(2), 75(2), 85(1)(e.2), 86(2), or 103 to attribute income of one taxpayer to a second taxpayer does not obligate the first taxpayer to reimburse the second taxpayer therefor.

The professional income generated by an individual was earned, at least in part, by a limited liability partnership (SENCRL) of which one of the partners was a trust for the benefit of related minors, that received distributions of such income, and another partner was a services corporation that incurred the relevant expenses. After finding that the pre-2014 version of the split income rules in s. 120.4 did not apply in this situation, CRA noted that s. 103(1) could apply, paraphrased s. 103(1.1) and stated (TaxInterpretations translation):

[A]n argument could be made that inasmuch as the agreed sharing is not reasonable since it does not take into account the fact that one of the partners, namely, the corporation, has assumed all the expenses related to the practice of the profession, of approximately $XXXXXXXXXX per annum. It seems to us that additional facts should be obtained to support this position. …

[T]he GAAR should not apply to the situation in this case because subsections 103(1) and (1.1) are of sufficient breadth to adjust the income-sharing terms agreed between the partners of the partnership.

CRA was asked whether, in the determination of the reasonableness of income allocated to one of the partners of a partnership, CRA considers that the importance of the work accomplished by a partner in connection with partnership activities depends on the number of employees of the partnership (with a higher number reducing the relative value of the work performed by the partner). CRA stated (TaxInterpretations translation):

Although the CRA reserves the right to revise the share of income or loss of a partner in a partnership to be an amount that is reasonable under subsection 103(1.1), the number of employees of a partnership is not necessarily a relevant factor in the context of this determination. In particular, we believe that it is preferable to examine the contribution of each partner in the light of the contribution of the other partners in order to determine if the income or loss which is allocated to the partner is reasonable.

A parent donates money to the parent’s adult children, who jointly invest those amounts in a family partnership newly-formed by them, with income being distributed and allocated to each in proportion to the respective amounts invested. Could s. 103(1.1) apply? CRA responded:

Determining a reasonable allocation of income of a partnership among non-arm's length partners for the purposes of subsection 103(1.1) is a question of fact that depends on the circumstances of each case.

Thus, it appears to us that in your example, subsection 103(1.1) could apply even if the partnership agreement provides for a prorated share of the amounts invested by each partner.

A father and son effect the equivalent of an estate freeze on their 50-50 partnership, so that each receives a preferred partnership interest, then all the sons (or, in the alternative, a family trust) subscribe a nominal amount for common units. The allocation of the partnership's profit will be made first in payment of the return on the preferred interests and the balance of the profit will be allocated to the sons. Is this allocation reasonable, so that ss. 103(1) and (1.1) will not apply? CRA stated:

[T]he allocation of partnership income must recognize the capital contribution, as well as the non-cash contribution of each partner. Otherwise, subsections 103(1) or 103(1.1) could apply to modify the allocation of the partnership's income, loss or other partnership attributes provided for in the partnership agreement. …Krauss ... supports that position.

…[Y]our example is similar to the situation in Krauss and that subsection 103(1.1) could apply in your example.

A couple (Mr. and Mrs. A), who hold 80% and 20%, respective interests in, and devote themselves full time to the business of, a general partnership ("SENC"), transfer 1% of their units to a corporation whose common shares are owned by them on an 80% /20%.basis – and they and the two other employees become employees of the corporation. The income of SENC (over and above a return of 1% on each partner's capital) is shared among the three partners in the proportions: Mr. A - 4%; Mrs. A - 1%; Corporation - 95%. However, gains (or losses) are allocated (based on the capital invested) to: Mr. A - 79%; Mrs. A - 20%; and Corporation - 1%. CRA stated:

[Our] long-standing position … is that subsection 103(1) or (1.1) could apply if the allocation of partnership income does not take into account the contribution of each partner. …

… [W]e are of the view that, on the face of it, the allocation of income does not take into account the contribution of each partner.

Consequently … the Agreement could result in the application of subsections 103(1) or 103(1.1).

A couple (Monsieur and Madame) formed a farming partnership. Monsieur contributed all of the farming business (which previously had been carried on by him as sole proprietor, and whose net assets were valued at $500,000) to the partnership, and she contributed $100. Monsieur and Madame were equally and actively involved in the farming business on a regular, continuous and substantial basis.

The first $100,000 of partnership income was shared equally, the next $100,000 was allocated to Monsieur to compensate him for his $500,000 contribution and, thereafter, was shared equally.

After noting that any application of s. 103(1.1) was within the remit of the TSO based on a factual review, CRA stated:

[T]he allocation of income on the basis stated in this letter does not seem reasonable given the work done and the capital invested by Monsieur in the partnership in relation to the work performed by Madame