2003 Ruling 2002-0169973 - INCORPORATING A PARTNERSHIP

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Whether a professional corporation, which provides XXXXXXXXXX services to another corporation, will be carrying on a personal services business.

Position: No - specified shareholder of the professional corporation would not, but for the existence of the company, be considered to be an employee.

Reasons: Same as - 2002-0133063; 2001-0102663; see also 2002-0152593, 2001-0080983 & E9915403

XXXXXXXXXX 2002-016997

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling

XXXXXXXXXX

We are writing in reply to your letter dated XXXXXXXXXX requesting an advance income tax ruling on behalf of the above taxpayers. We also acknowledge the receipt of additional information sent by you on XXXXXXXXXX.

You advise that to the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of any of the taxpayers or a related person;

(iii) under objection by any of the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

The following terms used in this letter have the meanings assigned below.

(a) "Act" means the Income Tax Act, R.S.C 1985 c.1 (5th Supp.) as amended to the date hereof;

(b) "Current Partners" means XXXXXXXXXX;

(c) "Exiting Partners" means XXXXXXXXXX;

(d) "Newco" means XXXXXXXXXX, a body corporate and professional corporation incorporated on the XXXXXXXXXX , pursuant to the Business Corporations Act (XXXXXXXXXX), and which is, at the time of this request, an inactive Corporation with no issued shares. Newco was incorporated to reserve the name, "XXXXXXXXXX";

(e) "Partnership" means the partnership known as XXXXXXXXXX the members of which are of the Current Partners;

(f) "Practice" means the practice of XXXXXXXXXX carried on by the Partnership and to be carried on by the Reorganized Partnership and Newco once the proposed transactions, as contemplated herein, are completed;

(g) "Principal" means the sole shareholder of each Exiting Partner which is a professional corporation and:

(i) in the case of XXXXXXXXXX;

(ii) in the case of XXXXXXXXXX;

(iii) in the case of XXXXXXXXXX;

(iv) in the case of XXXXXXXXXX;

(v) in the case of XXXXXXXXXX

(vi) in the case of XXXXXXXXXX.

(h) "Reorganized Partners" means XXXXXXXXXX;

(i) "Reorganized Partnership" means the Partnership known as XXXXXXXXXX and comprised of XXXXXXXXXX, as Partners, and which Partnership will carry on the practice of XXXXXXXXXX in the City of XXXXXXXXXX, in the Province of XXXXXXXXXX; and
(j) "Shareholder" means an owner of Class "A" Shares in the capital stock of Newco and specifically includes XXXXXXXXXX.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows.

FACTS

1. The Partnership is a partnership governed by the laws of XXXXXXXXXX. The members of the Partnership are the Current Partners. There are also a number of associate XXXXXXXXXX who are employees of the Partnership and who provide XXXXXXXXXX services for and on behalf of the Partnership, but who are not partners. In addition to the associate XXXXXXXXXX, the Partnership employs a number of support staff.

2. The Current Partners are composed of one individual XXXXXXXXXX and six professional corporations authorized to practice XXXXXXXXXX in the Province of XXXXXXXXXX.

3. The Partnership is governed by a written Partnership Agreement that was signed on or about the XXXXXXXXXX. The relevant terms of the Partnership Agreement provide as follows:

a) There are presently XXXXXXXXXX Current Partners who share equally in the profits of the Partnership regardless of their respective fees billed or contributions made;

b) Partnership profits are paid in the form of monthly draws to each of the Current Partners ("the Monthly Draws") and additional withdrawals ("Overage") paid at the discretion of the Partnership. The basic Monthly Draw per Current Partner is $XXXXXXXXXX per month. For the year end of XXXXXXXXXX, the Overage amounted to approximately $XXXXXXXXXX per Current Partner;

c) There are various provisions which provide for the payment to a Current Partner by the Partnership should that partner retire, withdraw, be expelled or become incapacitated.

4. The Partnership Agreement also provides for the payment of Monthly Draws and Overage to a Current Partner while that partner may be disabled for up to XXXXXXXXXX months, which is the equivalent of the waiting period pursuant to the terms of the long term disability policies of insurance carried by each Current Partner.

5. Each of the Current Partners is a resident of Canada.

6. None of the Current Partners are related to another Current Partner within the meaning of paragraph 251(2)(a) of the Act.

PROPOSED TRANSACTIONS

7. The Exiting Partners will transfer their XXXXXXXXXX interest in and to the Partnership at a fair market value to the respective Principals of the Exiting Partners. Following the transfers, the members of the Partnership (hereinafter referred to as the "Reorganized Partnership") will be the Reorganized Partners.

8. Newco has been incorporated pursuant to the provisions of the Business Corporations Act (XXXXXXXXXX ) and is authorized to issue an unlimited number of Class "A", "B" and "C" Common Shares without nominal or par value and an unlimited number of Class "D" and Class "E" Preferred Shares. Newco will be a Canadian-controlled private corporation and a taxable Canadian corporation within the meanings assigned by subsections 125(7) and 89(1) of the Act respectively. The initial director of the corporation will be the individual who is the Managing Partner of the Reorganized Partnership.

9. The Reorganized Partnership will then sell at fair market value all of its assets (the "Assets") to Newco. In return, Newco will issue to the Reorganized Partnership XXXXXXXXXX of its Class "A" Common Shares. In addition, Newco will assume the Reorganized Partnership's debts and will issue to the Reorganized Partnership a demand non-interest bearing promissory note (the "Promissory Note"). The amount of the Reorganized Partnership's debt assumed by Newco and the amount of the Promissory Note will not exceed, in total the Reorganized Partnership's cost amounts of the Assets. Newco and each Reorganized Partner will jointly elect, in prescribed form and within the time referred to in subsection 85(6) of the Act. Specifically, the agreed amount for each Asset (or group or class of Assets) in respect of such election will not be less than the least of the amounts specified in subparagraphs 85(1)(c.1)(i) and (ii), 85(1)(d)(i), (ii) and (iii), 85(1)(e)(i), (ii) and (iii), and will not exceed the respective fair market value of each Asset (or group or class of Assets), nor will it be less than the amount permitted by paragraph 85(1)(b).

10. The Reorganized Partnership will wind up its affairs the day immediately following the transfer of the Assets to Newco. At the time of this wind-up, the Reorganized Partnership will have no assets other than the said XXXXXXXXXX Class "A" Common Shares in Newco and the Promissory Note from Newco. Each Reorganized Partner will receive, in full satisfaction of his or her respective interest in the Reorganized Partnership, XXXXXXXXXX Class "A" Common Shares of Newco and XXXXXXXXXX of the Promissory Note from Newco.

11. As provided in paragraph 2 of Interpretation Bulletin IT-378R, Winding-up of a Partnership:

a) The Class "A" Common Shares of Newco issued on the acquisition of the Reorganized Partnership property will be issued directly in the names of the Reorganized Partners, so that each Reorganized Partner will have XXXXXXXXXX Class "A" Common Shares of Newco issued in his or her name;

b) The Promissory Note issued by Newco on the sale of the Assets, as described in Paragraph 9, will be issued in the names of the Reorganized Partners, on a pro rata basis in accordance with his or her respective interest in the Reorganized Partnership (XXXXXXXXXX each), instead of in the name of the Reorganized Partnership.

It is the intent of Newco, the Reorganized Partners and the Reorganized Partnership to have the Class A common shares of Newco and the Promissory Note beneficially owned by the Reorganized Partnership and not by the Reorganized Partners at the time of issue. It is also intended (as further indicated in paragraph 2 of IT-378R) that this procedure will not invalidate the application of subsection 85(2) or the subsequent application of subsection 85(3).

12. Following the winding-up of the Reorganized Partnership, the shareholders of Newco will elect the directors of Newco. It is anticipated that each shareholder of Newco will be a director.

13. The directors of Newco will appoint the officers and it is expected that the President of Newco will be the individual who was the managing partner of the Reorganized Partnership.

14. Newco and each of its Shareholders will enter into a Shareholder's Agreement which will provide, among other things:

a) The business of Newco will be the Practice;

b) Newco will conduct the Practice by contracting with independent contractors and employees (as discussed further in paragraph 16) for the provision of services;

c) Each Shareholder of Newco may be a member of the Board of Directors should he or she so desire;

d) The President of Newco shall be the individual who formerly held the position of Managing Partner with the Reorganized Partnership;

e) The after-tax profits of Newco available for distribution (in the discretion of the directors) shall be distributed annually by way of dividends on the outstanding shares; and

f) For the purchase and sale of a Shareholder's shares in Newco, upon the death, retirement, withdrawal, disbarment, incapacity or expulsion of a Shareholder.

15. Newco will conduct its Practice by providing the professional services through:

a) Individuals authorized to practice XXXXXXXXXX in the Province of XXXXXXXXXX employed by Newco to provide such services;

b) Individuals authorized to practice XXXXXXXXXX in the Province of XXXXXXXXXX engaged by Newco as independent contractors to perform such services on behalf of Newco ("Contracting Professionals"); and

c) Corporations engaged by Newco as independent contractors to provide the services of individuals authorized to practice XXXXXXXXXX in the Province of XXXXXXXXXX ("Contracting Companies").

16. Each Reorganized Partner will have the option of providing professional services to Newco in respect of the Practice by entering into an employment agreement with Newco, entering into a contract for services with Newco (as a Contracting Professional), or using a corporation to enter into a contract for services with Newco (as a Contracting Company). Other professionals may practice with Newco upon such terms as the respective professional and Newco may agree.

17. Those Reorganized Partners and professionals who choose to enter into an employment relationship with Newco will do so pursuant to a written employment agreement. The employment agreement will provide that, among other things, Newco is responsible for paying professional fees and liability insurance premiums, for paying for all equipment required in the performance of the employee's duties, and for providing vacation, sick leave and disability leave for the employee.

18. Those Reorganized Partners and professionals who provide XXXXXXXXXX services to Newco with respect to the Practice by entering into a contract for service with Newco as Contracting Professionals or through Contracting Companies ("the Contracting Parties") will do so by entering into a written contract with Newco. That contract will provide among other things, that:

a) Newco will provide all supplies, instruments, equipment and office space to the Contracting Parties as required by the Contracting Parties to provide XXXXXXXXXX services for and on behalf of Newco. The Contracting Parties will be responsible for the payment of all professional membership fees and insurance costs incurred by the Contracting Parties in the performance of their professional services.

b) The Contracting Parties will provide the required XXXXXXXXXX services for Newco on a fee per diem basis. The amount of the per diem fee will be negotiated on a case by case basis and will vary with the level and type of professional service to be provided and will be invoiced monthly or at such other times as the Contracting Party and Newco agree upon. The per diem rate will be established for each type of XXXXXXXXXX service provided and will take into account such factors as difficulty, risk to the practitioner, experience, expertise and the requirements to work outside normal office hours.

c) The Contracting Parties will submit monthly invoices at the end of each month, to Newco, for XXXXXXXXXX services provided by the Contracting Parties to or on behalf of Newco, in amounts agreed upon by the Contracting Parties and Newco. The Contracting Parties may only submit further and additional invoices and Newco will only pay such additional invoices for XXXXXXXXXX services provided by the Contracting Partners that are approved by a unanimous resolution of the Directors of Newco.

d) There will be a Restrictive Covenant which will prevent each Contracting Party from providing XXXXXXXXXX services for and on behalf of itself or any third party other than for and on behalf of Newco without the unanimous consent of the Directors of Newco and while each Contracting Party's principal and XXXXXXXXXX is a Shareholder of Newco.

19. It is the intent and expectation of the Contracting Parties and Newco that while the per diem fees billed by each of the Contracting Partners may vary in amount, the invoices submitted by the Contracting Parties to Newco will be in equal amounts based on the opinion of the Directors of Newco, with the Agreement of the Contracting Parties, that the combined value of the marketing, administrative duties/services, community service and XXXXXXXXXX services provided by each of the Contracting Parties in relation to each other and their value to the Practice is equal in value;

20. Newco will employ support staff and XXXXXXXXXX for the provision of XXXXXXXXXX services to the public by Newco.

21. All payments from third parties in respect of services provided by a Contracting Party on behalf of Newco in the Practice shall be made directly to Newco. The Contracting Parties will be restricted from providing XXXXXXXXXX services to other persons or entities or otherwise competing with Newco for the provision of XXXXXXXXXX services except as provided for in paragraph 18(d) aforesaid.

22. Each Contracting Party which is a Professional Corporation will be controlled by the respective Principal who will be the sole legal and beneficial owner of the issued shares and the sole Director of the Professional Corporation. Each Principal will be a resident of Canada.

23. The Principals of the Professional Corporations which are Contracting Parties will also be Shareholders and Directors of Newco.

24. Each Professional Corporation which will be a Contracting Party will have obtained a Permit from the XXXXXXXXXX authorizing it to practice XXXXXXXXXX in the Province of XXXXXXXXXX which it was doing as an Existing Partner of the Partnership.

25. Any Principal will not be an Employee, Officer, Director or Shareholder (whether legally or beneficially) of any other Professional Corporation which is a Contracting Party.

PURPOSE OF THE PROPOSED TRANSACTIONS

26. The purpose of the proposed transactions is to restructure the professional practices of the Partners without adverse tax consequences, to meet their professional obligations in respect of the Practice while:

a) eliminating joint and several liability inherent in providing professional services throughout the Partnership;

b) providing each Partner with the opportunity to become an independent contractor and as such, having control over his or her own level of participation in the Practice;

c) providing increased business efficiency for each Partner through individual management or personal practice preferences and expenses; and

d) facilitating ease of entry into the Practice by other Professionals and exit from the Practice by the Partners.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purposes thereof and provided the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Subsection 85(2) and subsection 85(3) of the Act will apply to the sale of the Assets and wind-up of the Reorganized Partnership as described in Paragraphs 9 and 10.

B. Subject to sections 10, 18 and 67 of the Act, the fees payable by Newco to the Contracting Company or Contracting Professional as described in paragraph 18 above, will be deductible in computing the income of Newco.

C. Provided that a Principal providing XXXXXXXXXX services through a Contracting Company would not, but for the existence of the Contracting Company, reasonably be considered to be an employee or officer of Newco in respect of those XXXXXXXXXX services, a Contracting Company will not be considered to be carrying on a "personal services business" as defined in subsection 125(7) of the Act.

D. Provided that a partnership does not exist between Newco and any Contracting Company, the income of Newco and any Contracting Company will not be considered "specified partnership income" within the meaning of subsection 125(7) of the Act.

E. As a result of the proposed transactions, in and by themselves, the provisions of subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given above.

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2002 and are binding on the Canada Customs and Revenue Agency provided the proposed transactions are implemented on or before XXXXXXXXXX. These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments thereto.

Nothing in this letter should be construed as implying that the CCRA has agreed to or accepted:

(a) the reasonableness of any expenditure referred to in this letter;

(b) the determination of cost, fair market value, adjusted cost base, cumulative eligible capital or undepreciated capital cost of any property referred to in this letter;

(c) whether or not any persons referred to in these rulings are related or otherwise deal with each other at arm's length;(d) the GST implications of any of the proposed transactions; or

(e) any other tax consequences of the proposed transactions or of related transactions or events that is not described herein.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate