Section 34.2

A taxpayer departed a partnership in respect of which he had been annually deducting a reserve from income on December 31, 1995 to join another existing partnership that performed similar services. The Directorate noted that former s. 34.2(3) likely permitted the taxpayer to continue claiming the reserve.

A newly-appointed judge is provided with a numerical example "which reflects that the allocation of income between the year of appointment and the year subsequent to the year of appointment would be approximately the same whether the appointment to the bench occurs in 1994, when the provisions of former section 24.1 and subsection 99(2) applied, or the appointment to the bench occurs in 1996 and the provisions of paragraph 249.1(1)(b) in section 34.2 of the Act apply".

"It is unlikely that the services of a financial planner would be considered to be similar to those of an accountant. In any event, in your particular case, the fact that the taxpayer is precluded from providing accounting services would also appear to prevent the taxpayer from meeting the all or substantially all test."

CRA considered that an amount included in a corporation’s income under s. 34.2(2) will not be added to the adjusted cost base of its partnership interest, given that s. 53(1)(e)(i) only boosts ACB for a pro rata share of income earned at the partnership level rather than (imputed) income earned directly by the partner.

Corp A, which has a significant interest in a partnership which, like Corp A, has a calendar year end, amalgamates on august 1, 2014 so that it has tow 2014 year ends on July 31 and December 31. Does Corp A have an income inclusion under s. 34.2(2) for its July 31, 2014 year? CRA stated:

Corp A will not have an income inclusion under subsection 34.2(2) in respect of the partnership for its taxation year ending July 31, 2014 since no fiscal period of the partnership ends in that short taxation year. Furthermore, Amalco will not have an income inclusion under subsection 34.2(2)…since there will be no misalignment between its taxation year-end and the partnership's fiscal period end (i.e. both end December 31, 2014).

Current structure

Sub1 and Sub2 (both taxable Canadian corporations and wholly-owned subsidiaries of Parent who, like them, has a calendar year end) are currently the sole partners of a general partnership (“Partnership”). Following the purchase of Sub2 by Parent, Partnership was formed by a predecessor by amalgamation to Parent and Subco2 in order for income from the Partnership business to be allocated to Sub2, which had non-capital losses. Parent and Sub2 made a “single-tier fiscal period alignment,” as a consequence of which each had “eligible alignment income” which was included in “qualifying transitional income” and each was eligible to claim a transitional reserve under s. 34.2(11). S. 34.2(14) preserved Parent’s eligibility to continue to claim the reserve after Parent’s transfer of its interest in Partnership to Corp1 (a corporation related to Parent). Sub1 was indebted to Partnership under the demand non-interest bearing “Sub1-Partnership Note”), and Parent was indebted to Partnership under the “Parent-Partnership Note,” which was interest bearing and payable on demand.

Proposed transactions

Sub2 will transfer its interest in Partnership to Sub1 in consideration for Sub1 Preferred Shares and a non-interest bearing promissory note (the “Sub1 Note”), jointly electing under s. 85(1). As a consequence Partnership will cease to exist, Sub1 will become the sole owner of all the Partnership property and Sub1 will become subject to all the remaining obligations of Partnership, and immediately after the time that Partnership ceased to exist, Sub1 will carry on alone the business that was the business of Partnership.

Rulings

Parent will be deemed, for purposes of s. 34.2(13)(a) to be a member of Partnership continuously until the end of Parent’s taxation year ending on XXXXXXXXXX. Parent and Sub2 may, in computing its income for its taxation year ending on XXXXXXXXXX, claim a reserve as provided in s. 34.2(11). Neither s. 34.2(13) nor s. 34.2(18) will apply to deny Parent’s or Sub2’s claim under s. 34.2(11) in computing its income for its taxation year ending on XXXXXXXXXX.

Can a corporation with qualifying transitional income respecting a partnership in which it has a significant interest claim a transitional reserve (in circumstances where there is no multi-tier alignment) under s. 34.2(11) when the partnership realizes a loss in the first taxation year ending after March 22, 2011 and earns income in the second and third taxation years? CRA stated (TaxInterpretations translation):

Given the wording of subsections 34.2(11) and 34.2(16), and the tax policy underlying the transitional relief provided for in subsection 34.2(11), we are of the view that a corporation, in the above situation, generally can claim a transitional reserve in the course of the second or third taxation year ending after March 22, 2011 if the partnership in which it hold a significant interest generates income in the course of those two taxation years, if all the conditions contemplated in subsection 34.2(11) are satisfied and if the reserve is neither limited by the application of subparagraph 34.2(11)(a)(iii) nor is prohibited by the terms of subsection 34.2(13).

The only source of income of ABC, a CCPC, is its interest in a partnership with a fiscal period end of XX. ABC has an income inclusion under s. 34.2(2) and claims a reserve under s. 34.2(11).

CRA confirmed that the claiming of the s. 34.2(11) reserve and its amount was in the discretion of ABC.

The units of an LP (LP1) which already has earned profits for the year and which holds most of the units of LP2 will be transferred to a Lossco (which is affiliated and related by virtue of a common indirect parent) before the fiscal year end of LP1 – so that most of those LP1 profits will be allocated to Lossco. CRA ruled that s. 34.2(14) will deem Profitco to be a member of LP1 continuously until the end of its XX taxation year for purposes of s. 34.2(13)(a).

See summary under s. 111(1)(a).