2007 Ruling 2007-0223291R3 - Partnership reorganization

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: Where a partner of a professional partnership creates a professional corporation through which professional services will be provided to the partnership, will the corporation be eligible for the small business deduction?

Position: Yes.

Reasons: As long as the partner in his or her role of an employee of the professional corporation providing the services of the "professional function" would not, but for the corporation, be considered an employee of the partnership, then the business of the corporation is not a personal services business. Also, provided that the professional corporations are not themselves carrying on business in partnership, there is no specified partnership income. This ruling is the same as previous rulings given. See 2006-0199731R3 and 2006-0170321R3.

XXXXXXXXXX 									2007-022329

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
XXXXXXXXXX (the "Named Partner")

We are writing in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the Partnership and the Named Partner. We also acknowledge the information provided in your various emails and in our telephone conversations (XXXXXXXXXX).

To the best of your knowledge and that of Partnership and Named Partner (collectively the "Taxpayers"), none of the issues involved in the ruling request is:

i. in an earlier return of one of the Taxpayers or a related person;

ii. being considered by a tax services office or a tax centre in connection with a tax return already filed by one of the Taxpayers or a related person;

iii. under objection by one of the Taxpayers or a related person;

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

v. the subject of a ruling previously issued by the Directorate to one of the Taxpayers or a related person.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), 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 definitions unless otherwise indicated.

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

Definitions

In this letter, the following terms have the meanings specified:

(a) "active business carried on by a corporation" has the meaning set forth in subsection 125(7);

(b) "Billings Revenue" refers to income generated by each Partner XXXXXXXXXX;

(c) "Canadian-controlled private corporation" ("CCPC") has the meaning set forth in subsection 125(7) of the Act;

(d) "Contracting Company" means each of the corporations that will be or already is incorporated, as permitted pursuant to the laws of the Province, by a Partner and that will be engaged by the Partnership to provide Professional Services as independent contractors;

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

(f) "Facility" means XXXXXXXXXX;

(g) "General Partner" refers to XXXXXXXXXX, the general partner of the Partnership;

(h) "Non-Professional Services" refers to the XXXXXXXXXX activities as carried on by the Partnership;

(i) XXXXXXXXXX;

(j) "Partner" refers to a limited partner of the Partnership;

(k) "Partnership Agreement" refers to the limited partnership agreement by which the Partnership was created;

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

(m) "Per Diem Fee" refers to the daily per diem fee to be charged by a Contracting Company to the Partnership;

(n) "Practice" means the services currently provided by the Partnership, which includes both Professional Services and Non-Professional Services;

(o) "Professional Services" means XXXXXXXXXX services as provided by the Partnership;

(p) "Professional Services Contract" refers to the agreement to be entered into between the Partnership and a Contracting Company as described in paragraph 19 below;

(q) "Province" means the Province of XXXXXXXXXX;

(r) XXXXXXXXXX;

(s) "related persons" has the meaning assigned by subsection 251(2) of the Act;

(t) XXXXXXXXXX;

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

(v) "taxable Canadian corporation" ( "TCC") has the meaning assigned by subsection 89(1) of the Act; and

(w) "Units" refers to the limited partnership units of the Partnership.

Facts

1. The Partnership was originally formed on XXXXXXXXXX, to carry on the Practice. Its filer identification number is XXXXXXXXXX and its address is XXXXXXXXXX.

2. The Partnership and the Named Partner file information and tax returns, as the case may be, with the XXXXXXXXXX Tax Centre and deal with the XXXXXXXXXX Tax Services Office.

3. The Partnership is bound by the Partnership Agreement that was signed by the Partners and General Partner on XXXXXXXXXX, and amended on XXXXXXXXXX. The amendment served to provide a more flexible structure with respect to the rights and responsibilities of each Partner.

4. Each Unit represents an initial capital contribution of $XXXXXXXXXX. The General Partner holds one Unit while the remaining Units are held by the Partners as follows:

XXXXXXXXXX

5. Each of the Partners owns an equal share of the issued voting shares of the General Partner.

6. The ownership of Units by the Partners corresponds with each Partner's duties within the Partnership. A Partner who owns XXXXXXXXXX Units has the rights and responsibilities to the full extent of the Partnership Agreement. A Partner owning fewer than XXXXXXXXXX Units has a pro rata reduction in his or her required hours with respect to XXXXXXXXXX , together with a corresponding reduction in his or her portion of administrative/financial obligations, Partnership net income, distributable cash, and paid vacation time under the Partnership Agreement.

7. All Partners and the General Partner are resident in Canada for the purposes of the Act. None of the Partners are related persons.

8. The Practice is carried on at the Facility, at which the Partners are provided the use of space, equipment and staff.

9. All Partners are XXXXXXXXXX. The Partnership allows the Partners to share their mutual responsibilities in such a way as to encourage the individual and collective commitment to XXXXXXXXXX service and administration.

10. The Partnership's revenue sources include all fees as a result of work at the Facility, all royalties and patents as a result of work performed in XXXXXXXXXX, all honoraria relating to the practice of XXXXXXXXXX, all salary support from XXXXXXXXXX. Specifically excluded from the revenue of the Partnership are XXXXXXXXXX fees earned by any of the Partners while they are on vacation.

11. In regard to Non-Professional services, the Partnership receives fees from the Alternative Funding Program of the Province in order to compensate the Partnership for non-billable services rendered by the Partners in connection with its duties as a XXXXXXXXXX facility. In addition, the Partnership receives stipends from the XXXXXXXXXX.

12. The professional revenue received by the Partnership in respect of Professional and XXXXXXXXXX services is as follows:

i) XXXXXXXXXX;
ii) XXXXXXXXXX;
iii) XXXXXXXXXX;
iv) XXXXXXXXXX; and
v) XXXXXXXXXX.

In addition to the above, the Partnership earns a small amount of interest income on cash held by the Partnership.

13. The Partnership Agreement stipulates that the General Partner is entitled to XXXXXXXXXX% of annual net income. The remaining net income is allocated to each Partner based on the proportion that his or her limited partnership units are to the total of limited partnership units held by all Partners. Net income or net loss is determined for accounting purposes in accordance with generally accepted accounting principles consistently applied.

14. The Partnership has retained the services of an individual to administer the affairs of the Partnership. This includes the preparation of the daily billings for Professional Services and the performance of other administrative and office functions. The compensation received by the individual is included in the Partnership's expenses.

Proposed Transactions

15. The Partnership Agreement will be amended to provide that a Partner may elect to provide his or her Professional Services through a Contracting Company controlled by the particular Partner (the "Controlling Shareholder") and licensed to carry on the practice of XXXXXXXXXX in the Province, and that where a Partner so elects, he or she will no longer be permitted to provide any Professional Services in his or her capacity as Partner. These amendments will not affect the provision of Non-Professional Services, which will continue to be wholly provided by the Partners in their capacity as Partners.

16. The Partnership Agreement will also be amended to provide that a Partner who provides Professional Services through a Contracting Company will be allocated Non-Professional income only, such allocation being based on the amount of Units owned by the particular Partner, which in turn determines the Partner's contribution of Non-Professional Services. For greater certainty, this means that a Partner's income allocation for that year will not take into account any Professional Services provided by him or her indirectly through a Contracting Company.

17. One or more Contracting Companies will be formed as follows:

i) It will be incorporated by the Controlling Shareholder pursuant to the laws of the Province.

ii) It will qualify as a TCC and a CCPC.

iii) The Contracting Company will be controlled by the Controlling Shareholder, who will be the legal and beneficial owner of all of the voting shares of a Contracting Company; however, non-voting shares of Contracting Companies may be issued to family members. All shareholders owning voting and non-voting shares of the Contracting Company will be residents of Canada.

iv) A Partner cannot be an employee, officer, director or shareholder, legal or beneficial, of more than one Contracting Company.

v) No two Contracting Companies will be related persons.

vi) It will be licensed to carry on the practice of XXXXXXXXXX in the Province.

18. A Partner must provide a written notice to the Partnership setting out his or her intention to provide Professional Services through a Contracting Company.

19. Upon receipt of a written notice from a Partner (as described in the preceding paragraph), the Partnership will enter into a Professional Services Contract with that Partner's Contracting Company which will provide as follows:

i) The Contracting Company will provide Professional Services to the Partnership in return for the Per Diem Fee.

ii) The contract will be for an indefinite period but may be terminated by either party upon XXXXXXXXXX notice.

iii) The Per Diem Fee will be based on the fair market value of the services provided.

iv) Each month, the Contracting Company will bill the Partnership based on the number of days in the month that it provided Professional Services times the Per Diem Fee.

v) The Contracting Company will be responsible for the following expenses:

a) professional membership fees in respect of the Partner;

b) insurance;

c) continuing education costs; and

d) additional business expenditures relating to a personal practice preference of the Contracting Company.

vi) An amount, based on the fair market value of the general office expenses incurred by the Partnership that may reasonably be attributed to the Contracting Company, will be charged as an offset against the Per Diem Fee.

20. Each Contracting Company will enter into a written employment agreement with the Controlling Shareholder whereby the latter will be hired to provide Professional Services for the Contracting Company with a view to fulfilling the latter's obligations under the Professional Services Contract.

21. Provided a Contracting Company fully discharges its responsibilities under the Professional Services Contract, the Contracting Company will not be restricted from providing services to other persons or otherwise prohibited from competing with the Partnership. Further, the proposed amendments to the Partnership Agreement will not result in any change to a Partner's current right to compete with the Partnership, which allows a Partner to compete against the Partnership provided that he or she fulfills his or her obligations as a Partner under the Partnership Agreement. For example, on days off, a Partner is entitled to provide services outside the Partnership.

22. Within XXXXXXXXXX months of the date of this ruling, the Named Partner will provide the Partnership with a notice of his intention to provide Professional Services through a Contracting Company and will incorporate a company for such purpose on the terms and conditions outlined above for Contracting Companies.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to allow a Partner to take advantage of the recent legislative amendments by the Province which permits XXXXXXXXXX to render professional services through a Professional Corporation, which provides the following benefits:

(i) it provides a Partner with an increased level of control over his or her participation in the Practice through individual management of personal practice preferences;

(ii) it permits a Partner to have control over expenditures where such expenditures may not be in the interest of all participants in the Practice; and

(iii) it provides a Partner with more control over his or her own estate and financial planning.

Rulings Provided

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,

we rule as follows:

A. Provided that the Named Partner would not, but for the existence of the Contracting Company, be an officer or employee of the Partnership in respect of the provision of Professional Services, the Contracting Company will not be considered to be carrying on a personal services business, as defined in subsection 125(7) of the Act.

B. Provided that a partnership does not exist between the Named Partner's Contracting Company and another Contracting Company, the income earned by a Contracting Company, in particular, the Per Diem Fees, will not be specified partnership income as defined in subsection 125(7) of the Act.

C. Subject to sections 18 and 67 of the Act, the Per Diem Fees payable by the Partnership to the Contracting Company will be deductible by the Partnership in its determination of the Partnership's income pursuant to subsection 96(1) of the Act.

D. The transactions undertaken in paragraphs 15 through 19 above, and in particular the payment of the Per Diem Fees, will not in and of themselves cause subsections 56(2), 56(4) or 246(1) of the Act to apply so as to cause an amount received by the Contracting Company under the Professional Services Contract to be taxed as income in the hands of the Named Partner.

E. Provided that the amount of the Partnership income allocated to each Partner is reasonable, having regard to all the relevant circumstances, the sharing of the income between the Partners will not be subject to adjustment pursuant to subsection 103(1) of the Act solely as a result of the Named Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a Contracting Company and to provide all of his or her Professional Services to the Partnership through that Contracting Company for Per Diem Fees.

F. Implementation of the proposed transactions as described above will not, in and by themselves, result in the application of the provisions of subsection 245(2) of the Act to re-determine the tax consequences confirmed in the rulings given above.

Comments

Whether or not the Named Partner would, but for the existence of the Contracting Company, be an employee of the Partnership or an independent contractor who has entered into a contract of services with the Partnership is a question of fact that can only be determined after a review of the actual agreements entered into between the Contracting Company and the Partnership and between the Contracting Company and the Named Partner. This review and determination is the responsibility of the particular Named Partner's local tax services office.

The attribution rules in sections 74.1 to 74.4 of the Act apply in situations where property is transferred or lent, directly or indirectly, to a spouse or child. These rules may apply to any income received by a spouse or a child who has not attained the age of 18 years before the end of a particular taxation year. Whether or not these rules will apply in respect of the possible ownership of any shares of the Named Partner's Contracting Company is a question of fact that can only be determined at the time that the shares are issued or property is lent or transferred to such a shareholder. Furthermore, subsection 56(2) of the Act may apply to any amounts paid by such Contracting Company to a family member of the Named Partner. Also, section 120.4 of the Act may apply with respect to taxable dividends or trust income in respect of taxable dividends from a Contracting Company received in a taxation year by a family member of the Named Partner who has not attained the age of 17 years before that year.

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.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted any of the tax consequences relating to the facts and proposed transactions described above except as expressly stated in the rulings. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly, that the CRA has agreed to or accepted the fair market value or reasonableness of any amounts, including the Per Diem Fee, and whether the Partnership is a limited partnership at law.

Yours truly,

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