2003 Ruling 2003-0050493 - 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, providing XXXXXXXXXX services to another corporation, will be carrying on a "personal services business" within the meaning of subsection 125(7) of the Act.

Position: No.

Reasons: The former partners are providing services through a "Contracting Company". They do not provide services to "Newco" in his/her capacity as an employee or officer of Newco.

XXXXXXXXXX 2003-005049

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter, dated XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above partnership, and the partners of XXXXXXXXXX.

We understand that, to the best of your knowledge, none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayer or a related person,

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person,

(iii) is under objection or appeal by the taxpayer or a related person,

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

(v) is the subject of a ruling previously issued by the Directorate.

Furthermore, no "Professional" (as defined below) has started any transactions that are related to the proposed transactions contained in this request for an advance income tax ruling, nor has any Professional started any transactions that may be considered to be part of a series of transactions that would include the proposed transactions.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supplement), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

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

Definitions

(a) "CRA" is the Canada Revenue Agency;

(b) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7) of the Act;

(c) "Contracting Company" is a company that will be incorporated as a XXXXXXXXXX;

(d) "Cost amount" has the meaning assigned by subsection 248(1) of the Act;

(e) "Eligible Property" has the meaning assigned by subsection 85(1.1) of the Act;

(f) "Newco" is a new corporation that will be incorporated under the laws of the Province of XXXXXXXXXX;

(g) "Partner" is a reference to each of, or any of, XXXXXXXXXX, and collectively they are referred to as the "Partners";

(h) "Partnership" is a reference to the existing partnership of "XXXXXXXXXX" which was created pursuant to the laws of the province of XXXXXXXXXX;

(i) "Personal services business" has the meaning assigned by subsection 125(7) of the Act;

(j) "Practice" means the professional XXXXXXXXXX practice currently carried on by the Partnership;

(k) "Professional" refers to each individual XXXXXXXXXX who currently provides professional services to the Partnership as required in the Practice, whether as a Partner of the Partnership, an employee of the Partnership, or as an independent contractor;

(l) "Professional Employee" means a Professional who chooses to enter into an employment relationship with Newco for providing employment services;

(m) "Related persons" has the meaning assigned by subsection 251(2) of the Act;

(n) "Specified partnership income" has the meaning assigned by subsection 125(7) of the Act;

(o) "Taxable Canadian corporation" ("TCC") has the meaning assigned by subsection 89(1) of the Act.

Facts

1. The Practice is carried on as a partnership. The Partnership has XXXXXXXXXX Partners. The Partners of the Partnership have been carrying on business since XXXXXXXXXX. The Partners provide various XXXXXXXXXX services to the Partnership, including, but not limited to, XXXXXXXXXX.

2. The Partnership's identification number is XXXXXXXXXX. The Partnership files its information returns with the XXXXXXXXXX Taxation Center and deals with the XXXXXXXXXX Tax Services Office.

3. There are a number of self-employed XXXXXXXXXX who provide various professional XXXXXXXXXX services to the Practice, but they are not partners of the Partnership. These XXXXXXXXXX provide the same types of XXXXXXXXXX services as are outlined in paragraph 1 above.

4. The Partnership is bound by a written partnership agreement (the "Partnership Agreement") that was signed on, and became effective as of, XXXXXXXXXX.

5. Pursuant to paragraphs XXXXXXXXXX of the Partnership Agreement, each Partner is entitled to draw up to XXXXXXXXXX percent, or such other percentage as from time to time determined by the Partnership, of the monies that the Partner collects in the course of his or her practice of XXXXXXXXXX or other business, against each Partner's share of Partnership profits for the fiscal year. The Partners will divide the profits of the Partnership so that each Partner receives the same percentage return on his or her own collected monies as every other Partner receives on his or her own collected monies. A distribution of undistributed profits will be made at such time or times as the Partnership shall determine.

6. Pursuant to paragraph XXXXXXXXXX of the Partnership Agreement, a Partner will be entitled to receive an amount, to be determined at the time, upon the death, retirement, withdrawal or expulsion of the Partner.

7. Each of the Partners is a resident of Canada. None of the Partners is related to any other Partner.

Proposed Transactions

8. Newco will be incorporated as a CCPC and a TCC.

9. Upon incorporation, Newco will be authorized to issue an unlimited number of Class A voting common shares (the "Shares") without nominal or par value. One Class A voting common share of Newco will be issued to the Partnership for $XXXXXXXXXX.

10. The Partnership will sell all of its assets to Newco at fair market value. Newco will issue an additional XXXXXXXXXX of its Shares and a demand, non-interest bearing promissory note in an amount equal to the cost amount of the assets transferred from the Partnership to Newco. Newco and each of the Partners will jointly elect, pursuant to subsection 85(2) of the Act, in prescribed form and within the time permitted by subsection 85(6) of the Act, to have the provisions of paragraphs 85(1)(a) to (i) of the Act apply, with such modifications as the circumstances require. The "agreed amount" for the assets transferred to Newco will not be less than the lesser of the amounts specified in subparagraphs 85(1)(c.1)(i) and (ii) of the Act, not less than the least of the amounts in subparagraphs 85(1)(d)(i), (ii) and (iii) of the Act and not less than the least of the amounts in subparagraphs 85(1)(e)(i), (ii) and (iii) of the Act. Furthermore, the "agreed amount" will not exceed the respective fair market value of each asset transferred to Newco nor will it be less than the amount permitted by paragraph 85(1)(b) of the Act.

11. On the day immediately following the transfer of all of the assets of the Partnership to Newco, the Partnership will wind up its affairs in accordance with subsection 85(3) of the Act. Immediately before this winding-up, the Partnership will have no property other than the property received from Newco as consideration for the disposition to it of the Partnership's assets. Specifically, the only property in the Partnership will be the XXXXXXXXXX Shares of Newco and the promissory note received from Newco as consideration for the assets transferred. Each Partner will receive, in complete satisfaction of his or her interest in the Partnership, XXXXXXXXXX Shares of Newco and a pro rata share, based on his or her respective interest in the Partnership, of the promissory note issued to the Partnership by Newco.

12. For legal simplification, the XXXXXXXXXX Shares issued by Newco, as consideration for the transfer to it of the assets of the Partnership, shall be issued in the name of each Partner (XXXXXXXXXX Shares each) instead of the name of the Partnership. However, the Partnership, not the individual Partners themselves, will be the beneficial owner of the Shares at the time that they are issued.

13. For legal simplification, the promissory note issued by Newco, as consideration for the transfer to it of the Partnership property, shall be issued in the name of each Partner (based on a pro rata share) instead of the name of the Partnership. However, the Partnership, not the individual Partners themselves, will be the beneficial owner of the promissory note at the time it is issued.

14. The shareholders of Newco will elect the directors of the corporation. The shareholders of Newco anticipate that each shareholder will be a director. The shareholders will elect the officers of Newco, including the President, Vice-President, Secretary and Treasurer. Newco will pay these officers a reasonable salary for the services they provide to Newco.

15. The shareholders of Newco will enter into a Shareholder's Agreement that will provide, but not be limited to, the following:

(a) The business of Newco will be the carrying on of the existing Practice;

(b) Newco will carry out its business by entering into contracts with the Contracting Companies, entering into contracts with independent contractors and by hiring employees (see paragraph 16 below);

(c) Each shareholder of Newco may, if he/she so requests, be a member of the board of directors of Newco;

(d) The officers of Newco will be elected by the shareholders of Newco;

(e) At the sole right of the elected officers of Newco, the net profits of Newco will be available for distribution annually in the form of dividends on the outstanding shares and/or in the form of director's fees;

(f) No shareholder shall be entitled to transfer his or her Shares in Newco without the prior written approval of the Board of Directors of Newco;

(g) The Shares owned by a shareholder in the capital stock of Newco will be purchased for cancellation if any designated event occurs, including:

(i) The bankruptcy of a shareholder;

(ii) The Shares of a shareholder are seized by a secured creditor or by court order;

(iii) The license of a shareholder to practice XXXXXXXXXX is cancelled or suspended;

(iv) The death of a shareholder;

(v) The shareholder fails to subscribe for additional Shares in the capital stock of Newco as required by the Board of Directors of Newco; and

(vi) The Board of Directors of Newco vote to have the Shares of the shareholders purchased for cancellation ;

(h) Any additional Shares of Newco shall be purchased at fair market value in the manner described in the Shareholder's Agreement.

16. Newco will carry on the Practice by providing professional XXXXXXXXXX services in the following ways:

(a) Through individuals employed by Newco to provide a variety of receptionist, filing and other secretarial services;

(b) Through individuals employed by Newco to provide various XXXXXXXXXX services. XXXXXXXXXX;

(c) Through individuals engaged by Newco to provide various XXXXXXXXXX services as independent contractors. XXXXXXXXXX; and

(d) Through Contracting Companies engaged by Newco to provide various XXXXXXXXXX services as independent contractors. The Contracting Companies will provide such XXXXXXXXXX services on behalf of Newco.

17. Each Partner of the Partnership will have the choice of providing professional XXXXXXXXXX services to Newco by entering into an employment agreement with Newco, entering into a contract as an independent contractor or by forming a Contracting Company that will enter into a contract to provide services to Newco as an independent contractor. Other professionals who are required by the XXXXXXXXXX Practice may provide services under such terms and arrangements that are agreed upon by Newco.

18. The individuals who choose to enter into an employment arrangement with Newco, as described in paragraph 16(b) above, will be required to sign a written employment agreement. This employment agreement will include, but not be limited to, the following conditions:

(a) Newco will provide a detailed position description and control the duties that the employee will be required to perform. As well, Newco will provide the employee with information as to whom the employee will report and have his/her performance evaluation conducted by;

(b) Upon completion of a XXXXXXXXXX-month probationary period throughout which the employee must satisfactorily meet all of the requirements specified by Newco, the period of employment will continue indefinitely until either Newco or the employee terminate the employment contract. Either party will have to provide the other party with at least XXXXXXXXXX months written notification of the termination of the contract;

(c) A provision that each employee will be paid an annual salary. The amount thereof will be determined each year during the employee's annual review process. Newco will pay the employee on a XXXXXXXXXX basis and will withhold source deductions, specifically, income taxes, employment insurance premiums and Canada pension plan contributions, as required by the CRA;

(d) Newco will be responsible for paying certain professional expenses related to the employee's services, including, but not limited to, the following:

(i) XXXXXXXXXX of professional membership fees and dues;

(ii) Professional insurance;

(iii) Travel expenses, including motor vehicle, accommodations and meal expenses;

(iv) Professional development courses or seminars that Newco requires the employee to participate in; and

(v) Any entertaining expenses that Newco requires the employee to incur;

(e) Newco will provide all tools, equipment, instruments, books and supplies that are necessary for the employee to carry out his/her terms of employment;

(f) The employee will be entitled to a reasonable number of compassionate days as determined by the directors of Newco;

(g) The employee is entitled to accumulate XXXXXXXXXX per month as "sick days" during the year;

(h) An employee will earn vacation entitlement at XXXXXXXXXX. Vacation entitlement is measured from XXXXXXXXXX and is prorated for part years.

19. The individuals who choose to enter into a contractual arrangement with Newco, as described in paragraph 16(c) above, will be required to sign a written independent contractor agreement. This independent contractor agreement will include, but not be limited to, the following conditions:

(a) The professional will provide services to Newco on a per diem fee basis. The per diem fee will be negotiated with each professional. The per diem amount will vary, based upon the level and the type of service to be provided. For example, a specialist will receive a higher rate than a general practitioner;

(b) Newco and the independent contractor shall agree to consider his/her relationship to be that of hirer and independent contractor. The contracting professional shall provide the professional services as required by Newco for its professional XXXXXXXXXX Practice. It will be a set time (of XXXXXXXXXX) contract for services and not an indefinite period contract of services (as will apply for employees);

(c) The contract will be for a fixed period of XXXXXXXXXX. It can be renegotiated on an XXXXXXXXXX basis if both parties decide to continue with the working relationship;

(d) Either Newco or the independent contractor may terminate the contract. The party terminating the contract must provide the other party written notification XXXXXXXXXX prior to his or her date of leaving;

(e) The requirements of the independent contractor shall be mutually agreed upon between Newco and the independent contractor. There will be a minimum number of workdays per year that the professional agrees to work. The professional can determine which days and hours they will work, without Newco setting the hours that they will work. If the professional performs no services, he/she will not be paid. The professional may provide any of the following services with a per diem rate established for each service:

XXXXXXXXXX.

(f) The per diem rates established for each type of service provided will be determined by a number of factors including the specialized knowledge and additional educational and practical requirements needed and the amount of time required by the independent contractor to provide the service;

(g) Newco will pay the independent contractor his or her per diem rate on a XXXXXXXXXX basis. The independent contractor must fulfill the requirements of his or her mutually agreed upon written independent contractor agreement. There will be no payment to the independent contractor if no services have been performed. However, the independent contractor will be given all the freedom required to achieve the desired result;

(h) All payments made by third parties, for professional services provided by an independent contractor for the benefit of Newco, will be paid directly to Newco; and

(i) Newco will provide for some supplies, instruments and equipment required by the independent contractors in providing their professional services. The independent contractor will be responsible for other expenditures, including, but not limited to, the following incurred in the performance of his/her professional services:

(A) Professional membership fees and dues.

(B) Professional insurance;

(C) Travel expenses, including motor vehicle, accommodations and meal expenses;

(D) Professional development courses or seminars; and

(E) Any entertaining expenses.

20. The independent contractors will not be restricted to providing XXXXXXXXXX services to Newco. The independent contractors will be entitled to compete with Newco.

21. The Partners who choose to provide services to Newco through a Contracting Company, as described in paragraph 16(d) above, will provide professional services upon the same basis as the independent contractors discussed in paragraphs 19 and 20 above. Newco will enter into a written signed contractual arrangement with each Contracting Company.

22. Each Partner will not be an employee, officer, director or shareholder of more than one Contracting Company. As described in paragraph 23(b) below, related persons of a Partner may only be a shareholder of the Contracting Company in which that Partner owns shares.

23. XXXXXXXXXX.

24. For greater certainty, Newco will require each Contracting Company to be a TCC and a CCPC.

25. Each Partner who has incorporated a Contracting Company will be an employee of his/her Contracting Company. Newco will require a written employment contract which will provide the details of the employment relationship between the Partner and his/her Contracting Company. Each Partner will provide services for the benefit of his/her Contracting Company pursuant to the terms of a written agreement between Newco and each particular Partner's Contracting Company. There will not be any other contractual relations between Newco and a Contracting Company.

26. Only Partners of the Partnership will have the option to choose which contractual arrangement they will establish with Newco. The contractual arrangement to be offered to those individuals who are not Partners will be determined on an individual-by-individual basis and will depend on the requirements of Newco. The Board of Directors of Newco will determine, as the need arises, which contractual arrangements will be offered to individuals who are not currently associated with the Practice.

27. Newco will prepare a budget each year to calculate its approximate revenues and expenses for the year. After Newco has made all payments due to the independent contractors and Contracting Companies, as set out in each contractual agreement, there may be an annual net profit to Newco. The directors of Newco will have the sole discretion to:

(i) Reduce the net profit in Newco, for income tax purposes, to a maximum of the "business limit", as defined in subsection 125(2) of the Act, or pay income tax on such other amount as may be determined from time to time;

(ii) Distribute the amount in excess of the business limit to the directors of Newco in the form of an annual bonus;

(iii) Pay consulting fees to any retired professional who continues to provide XXXXXXXXXX services to Newco; or

(iv) Carry out any combination of (i), (ii) and (iii).

Purpose of the Proposed Transactions

28. The purpose of the proposed transactions is to restructure the Practice of the Partnership. This will provide the following advantages:

(a) It will provide each Professional with more options and more control in arranging estate and succession planning. It is generally easier and less costly to transfer shares in a company than it is to dispose of a partnership interest;

(b) It will facilitate easier entry and exit of Professionals to the Practice;

(c) It will provide more flexibility and control to each Partner:

(i) In determining the hours and days that he or she will work;

(ii) In deciding on an individual basis the amount of effort and time that he or she wants to exert for the practice;

(iii) In incurring expenditures in the Contracting Company as it provides services to Newco;

(iv) To see a direct result between effort and time put into the Practice and his or her earnings in the Contracting Company;

(v) To take leave for study and courses; and

(vi) To take vacations;

(e) Each independent contractor and each Partner will be responsible for the financing, investing, directing and operating of his/her own practice. This structure provides the opportunity for each such individual to manage the overall profitability and well being of his/her own practice;

(f) The proposed structure provides increased flexibility in determining the level of income earned personally by those Partners who decide to provide their services through a Contracting Company. Any income that is not needed personally can be taxed and reinvested in the Contracting Company;

(g) To provide each independent contractor and each Partner, if he or she decides to do so, with the opportunity to provide XXXXXXXXXX services to other parties. This gives each such individual the ability to increase his/her earnings beyond what is available from the current Practice;

(h) The restructuring will improve the joint and several liability inherent in providing professional services through a partnership.

Rulings

Provided that:

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) the proposed transactions are completed in the manner described above; and

(c) there are no other transactions which may be relevant to the rulings requested;

our rulings are as follows:

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

B. Provided that a partnership does not exist between Newco and any Contracting Company, the income earned by Newco or any Contracting Company will not be "specified partnership income" as defined by subsection 125(7) of the Act.

C. 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 re-determine the tax consequences confirmed in the rulings given above.

Comments

The deductibility of any fee payable by Newco to an independent contractor or a Contracting Company, as described in subparagraphs 16(c) and (d) above, will be restricted whenever sections 18 and/or 67 of the Act are applicable.

In accordance with paragraph 2 of Interpretation Bulletin - IT 378R "Winding-up of a Partnership" ("IT-378R"), it is the CRA's view that issuing the Class A voting common shares in the name of each Partner, instead of the Partnership, as described in paragraph 12 above, will not invalidate the application of subsection 85(2) of the Act nor the subsequent application of subsection 85(3) of the Act.

In accordance with paragraph 2 of Interpretation Bulletin - IT 378R "Winding-up of a Partnership" ("IT-378R"), it is the CRA's view that issuing the promissory note in the name of each Partner, instead of the Partnership, as described in paragraph 13 above, will not invalidate the application of subsection 85(2) of the Act nor the subsequent application of subsection 85(3) of the Act.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided that 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 any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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