Section 34 - Professional business

A professional partnership (Partnership) with a calendar taxation year end makes the s. 34 election for the 2017 year. If a partner transfer’s a partnership interest to personal corporation (Partnerco) on December 31, 2017 or January 1, 2018, would that election apply to Partnerco? CRA responded:

The making of the section 34 election is not excluded by paragraph 96(1)(d) ….

[T]he election to exclude work in progress must be made for the taxation year that straddles March 22, 2017. All members of the Partnership during the year will be deemed to have made the election by virtue of subsection 96(3). Since Partnerco became a member of the Partnership on December 31, 2017, i.e., during the Partnership's taxation year in which the election was made, the election would be valid for Partnerco.

Should Partnerco become a member of the Partnership on January 1, 2018 …paragraph 34(b) would apply … [so that] Partnerco, as a member of the Partnership, would therefore be subject to an election made in the previous taxation year by the Partnership.

[T]he province of Ontario and the Law Society of Upper Canada have created a two tiered system: the practice of law by barristers and solicitors (and members of the Barreau du Québec) and the provision of legal services by paralegals. Accordingly, as paralegals in Ontario are not barristers or solicitors, they do not meet the definition of "lawyer" in the Act and may not make the work in progress election under section 34.

On June 30 of Year 1, individual partners of a Canadian professional partnership who have made the s. 34 election in accordance with s. 96(3) withdraw from the partnership and form a new partnership with a fiscal year end of July 11 of Year 1. The s. 249.1(4) rule applies. After adverting to the application of ss. 98(5) and (6) in the context of the redacted facts, CRA stated (TaxInterpretations translation):

In the case of a general partnership (société en nom collectif), if all of the former partners or some of them form a new partnership, they will normally be required to make a new election under paragraph 34(a), if they do not wish to include, in the income of the new corporation at the end of the first taxation year or a subsequent taxation year, amounts relating to work in progress.

The exception to this rule, however, is the case where all or some of the former partners of a Canadian partnership continue to carry on the designated professional business as a new Canadian corporation and the provisions of subsection 98(6) are satisfied, or where the designated professional services business that was previously operated by a Canadian partnership is now operated by one of the former partners as the sole owner and the provisions of subsection 98(5) are applicable ... in respect of the former partner carrying on the business of the former partnership.

Thus ... an election can be made by the partners forming [the new partnership] in order to exclude from their income for the fiscal year ending on July 11 of Year 1 the WIP which was allocated to them on their departure from the [former partnership].

Under paragraph 34(a), no particular form is prescribed for making the election. The taxpayer can make the election with respect to a particular professional partnership by attaching a letter to the taxpayer's return of income in which the election is specified with respect to the practice or by indicating clearly in the financial statements, or in a joint net income reconciliation, that the election is made.

CRA indicated that in determining the FMV of an interest in a professional partnership that had been transferred on a s. 85(1) rollover basis, normally the WIP that had been elected upon under s. 34 would be discounted for income taxes.

A newly incorporated corporation at the end of its first year of operating a professional business, had work in progress ("WIP") with a billable value of $25,000 and accounting profit for the year of $14,000. Would it be permitted to recognize an $11,000 loss in that year by making the s. 34 election? CRA responded:

In accordance with section 34, the corporation may elect not to include in its income from the practice of a profession the total amount of WIP valued at the end of the year at $25,000. … A business loss can be generated by electing to exclude WIP under section 34.

Can a partnership make the s. 34 election where it carries on a single business but earns income from two types of activities, one of which is not one of the listed professions? CRA responded:

[W]here a taxpayer carries on a single business, the taxpayer would generally be able to make an election under section 34 if the principal activity of that business is the practice of one of the professions referred to in that section. The question of whether the principal activity is the practice of one of the professions covered is a question of fact. However, certain criteria such as the distribution of income, assets and workforce of each activity will be considered in making that determination.

Can a corporation with accountant shareholders use the s. 34 election where it is carrying on an insolvency practice? CRA responded:

[A] corporation that carries on an insolvency business, which is a separate business and not an ancillary activity within a corporation that also carries on a business of practising accountancy, is not a business of practising accountancy within the general meaning of the term "accountant". …

The election … is therefore not permitted … .

The s. 34 election is not available to a taxpayer who carries on an insolvency practice as his primary practice, rather than as an incidental part of his accounting practice.

No s. 34 election is available for the business of a patent agency even if the business is carried on by a partnership of which a lawyer is a partner.

The total cost of professional labour including employee benefits will be work in progress, but fixed or indirect overhead costs such as rental, secretarial and general office expenses will not be included.