29 May 2006 External T.I. 2005-0160891E5 - 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.

Principal Issues: 1. Whether a non-compete clause between the professional, the professional corporation and Newco that operated for the duration of contract for services would cause a business to be a "personal services business".

2. Whether remunerating professional corporations on the basis of an estimate of the value of services that they will provide in a month and discretionary dividends would cause a business to be a "personal services business" or raise other concerns.

Position: 1. Insufficient information to conclude. However, the competition restrictions are one indicator that the incorporated employee [i.e., the incorporated professional] would reasonably be regarded as an officer or employee of the corporation to whom services were ultimately provided. Depending on all of the relevant facts, this could result in a determination that the professional corporation is carrying on a personal service business.

2. Insufficient information to conclude. General comments given re: fees. No position regarding the discretionary shares. Should be considered in the context of a ruling request.

Reasons: Reading of the legislation.

							Allan Nelson, CMA
XXXXXXXXXX 						2005-016089
(613) 443-7253
May 29, 2006

Dear XXXXXXXXXX:

Re: Incorporating a Partnership

We are writing in response your letter dated November 25, 2005, where you refer to our advance income tax ruling #2004-008431, dated XXXXXXXXXX, 2004 (the "Ruling"). We also acknowledge our telephone conversation on May 16, 2006 (XXXXXXXXXX/Nelson).

You have asked whether we would issue a ruling analogous to the Ruling in your hypothetical scenario involving a newly incorporated professional corporation (the "Contracting Corporation"). You note that we can assume the facts in your hypothetical scenario would be similar to those in the Ruling with the following exceptions:

1. in your situation there would be certain competition restrictions imposed between the relevant parties;

2. fees received by a Contracting Corporation for the professional services it provides to Newco would be computed as being equal to the fair market value of those services [as opposed to being computed at a stipulated hourly rate]; and

3. instead of Newco issuing voting common shares, it would issue voting, non-participating shares. Newco would also issue shares (the "Discretionary Shares") so that each shareholder would own Newco shares of a class that would be distinct from every other class owned by any other Newco shareholder. At its sole discretion, the management committee would declare and distribute dividends in respect of each class of the Discretionary Shares. The amount of dividends paid to the holder of each class of the Discretionary Shares would not necessarily be the same.

As explained in paragraph 9 of Information Circular 70-6R5, dated May 17, 2002, an advance income tax ruling applies only to the taxpayer(s) identified in the ruling and to the transactions specified. Also, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. As such, we cannot confirm whether we would be able to issue a ruling similar to the Ruling. However, we are prepared to offer the following comments, which may be of some assistance to you.

Competition Restrictions

Personal services business carried on by a corporation in a taxation year is defined in subsection 125(7) of the Income Tax Act (the "Act") to mean

...a business of providing services where
(a) an individual who performs services on behalf of the corporation...referred to as an "incorporated employee",

...would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation, unless...

(c) the corporation employs...more than five full-time employees, or
(d) the amount paid...to the corporation...is received...from a corporation with which it was associated in the year;

Determining whether a corporation, such as a Contracting Corporation, is carrying on a personal services business involves a question of fact that can only be determined after a review of all the relevant information and legal agreements.

One of the factors in making the above determination would be whether the Contracting Corporation and the incorporated employee are allowed to compete with Newco. If not, this can be one of the indicators that

(i) the incorporated employee would reasonably be regarded as an officer or employee of Newco but for the existence of the Contracting Corporation, and

(ii) consequently, the Contracting Corporation is carrying on a personal services business.

In this regard, it may be useful to refer to the Canada Revenue Agency's guide entitled "RC4110 - Employee or Self Employed?". The guide includes a detailed discussion of the numerous factors considered in determining whether a particular individual is an employee or self employed. You can obtain a copy on our web site at www.cra-arc.gc.ca.

Fees

The fact that remuneration received by a Contracting Corporation for the professional services it provides to Newco would be computed as being equal to the fair market value of those services [as opposed to being computed at a stipulated hourly rate] would not, in and of itself, cause the Contracting Corporation to be a personal services business.

Discretionary Shares and Discretionary Dividends

We have not seen Discretionary Shares issued in the context of these sorts of transactions before and presently do not have a position. There are numerous issues to contemplate, such as the possible application of subsection 245(2) of the Act or certain other "benefit" provisions. In our view this question would best be dealt with in an advance income tax ruling request, where we would have an opportunity to fully develop our position after reviewing all the facts and relevant agreements in a set of proposed transactions. If this is a course of action that you would interest you, we would be pleased to entertain such an application.

The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Revenue Agency.

We hope the above will be of assistance to you.

Yours truly,

Robin Maley
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch