2014-0545051E5 Subsections 98(1) and 98.1(1)

Principal Issues: Is only a person who was a partner at the time that the partnership ceased to exist deemed by paragraph 98(1)(a) not to have ceased to be a partner?

Position: Yes.

Reasons: Based on the text, context and purpose of the provision. Section 98.1 would govern in a situation where a partner has ceased to be a member of a partnership but continues to have a residual interest in the partnership.

Author: Tzortzis, Chrys
Section: 98(1), 98.1, 96(1.01), (1.1)

XXXXXXXXXX
                                                                                                                                         2014-054505
                                                                                                                                         Chrys Tzortzis, CPA, CA

January 26, 2015

Dear XXXXXXXXXX:

Re:  Subsection 98(1)

This is in response to your letter dated September 4, 2014 sent via email concerning the deeming provisions in subsection 98(1) of the Income Tax Act (the “Act”) and, more specifically, paragraph 98(1)(a) of the Act.

In your letter, you note that subsection 98(1) provides certain deeming rules that may apply where a partnership would otherwise be regarded as having ceased to exist.  Your concern specifically relates to paragraph 98(1)(a) which provides that, for income tax purposes, the partnership is deemed not to have ceased to exist and each person who was a partner is deemed not to have ceased to be a partner until such time as all the partnership property and any property substituted therefor has been distributed to the persons entitled by law to receive it.  In your view, paragraph 98(1)(a) would only deem a person who was a partner at the time that the partnership ceased to exist not to have ceased to be a partner and thus would not apply to a former partner.  For the purposes of our response, we will assume that the partnership did not cease to exist with the withdrawal of the partner i.e. the former partner had actually ceased to be a member of an ongoing partnership which later ceased to exist.

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Our Comments

Whether or not a partnership ceases to exist is a question of fact that generally depends on the partnership agreement as well as the partnership law that governs the partnership.  Notwithstanding that a partnership may have ceased to exist, subsection 98(1) provides certain deeming rules that apply for purposes of the Act.  As noted above, under paragraph 98(1)(a), “the partnership shall be deemed not to have ceased to exist, and each person who was a partner shall be deemed not to have ceased to be a partner” until such time as all the partnership property and any property substituted therefor has been distributed to the persons entitled by law to receive it.  Further, under paragraph 98(1)(b), “the right of each such person to share in that property shall be deemed to be an interest in the partnership”.  Thus, in general terms, subsection 98(1) extends the existence of the partnership and provides for the continuation of the partnership interest until all the partnership property has been distributed.  As a result, for purposes of the Act, there is no disposition of the partnership interest until that time (subject to the negative adjusted cost base rule contained in paragraph 98(1)(c)).  In Bow River Pipelines Ltd v. The Queen, 2000 DTC 6090, the Federal Court of Appeal explained the provision as follows:

However, the context of paragraph 98(1)(a) indicates that the entitlement to receive partnership property on dissolution and its distribution are not equivalent. In other words, entitlement implies an equitable right to the receipt of the property while distribution would indicate the transfer of legal title to the property.  The provision recognizes that, for purposes of the Income Tax Act, an event giving rise to dissolution does not automatically result in the distribution of the partnership property to the partners. A transaction distributing the property is required. Appellant's counsel pointed out that the role of paragraph 98(1)(a) is to ensure that tax consequences do not depend on whether a partnership terminated under partnership law before its assets are distributed.

Based on all the foregoing, in our view, paragraph 98(1)(a) would only deem a person who was a partner at the time the partnership ceased to exist not to have ceased to be a partner and thus would not apply to a former partner.  However, section 98.1 of the Act may be applicable to a former partner who continues to have a residual interest in the partnership.

In general, subsection 98.1(1) of the Act provides certain deeming rules where a partner has ceased to be a member of the partnership (a “former partner”) but all of the former partner's rights to partnership property for that partnership interest have not been satisfied in full.  In such a circumstance, the former partner would have a residual interest in that partnership by virtue of paragraph 98.1(1)(a).  More specifically, subject to certain provisions, paragraph 98.1(1)(a) deems the partnership interest not to have been disposed of by the former partner and to continue to be an interest in the partnership (a “residual interest”) until such time as all the former partner’s rights (other than a right to a share of the income or loss of the partnership under an agreement referred to in subsection 96(1.1) of the Act) to receive any property of or from the partnership in satisfaction of the former partner’s interest in the partnership immediately before the time at which the former partner ceased to be a member of the partnership are satisfied in full.  Thus, in general terms, the former partner’s partnership interest becomes a residual interest and the former partner is generally deemed not to have disposed of the interest until that specified time.  However, paragraph 98.1(1)(b) provides that where all the former partner's rights to partnership property are satisfied in full before the end of the partnership's fiscal period in which the former partner ceased to be a member, the former partner is deemed not to have disposed of the residual interest until the end of that fiscal period.  Similar to paragraph 98(1)(c), a negative adjusted cost base rule is contained in paragraph 98.1(1)(c).  Finally, although the former partner may have a residual interest in the partnership, paragraph 98.1(1)(d) deems the former partner not to be a member of the partnership (subject to certain exceptions). 

In the case of a former partner, notwithstanding paragraph 98.1(1)(d), subsection 96(1.01) of the Act clarifies that, although a partner may have ceased to be a member of a partnership before the end of the partnership's fiscal period, an amount of the income or loss of the partnership for that fiscal period is allocable to that former partner under subsection 96(1) of the Act.

Additionally, a former partner may also have an income interest in a partnership under subsection 96(1.1), as described in paragraph 10 of Interpretation Bulletin IT-242R, Retired Partners, which is separate and distinct from any residual interest in the partnership described in subsection 98.1(1).  For example, a former partner of a professional partnership may be entitled to receive payments from the partnership for a specified period after withdrawal and the payments are derived from the annual profits of the partnership.  In general terms, where the principal activity of the partnership is carrying on a business in Canada and the parties have entered into an agreement pursuant to which such payments constitute an allocation of a share of the income of the partnership within the meaning of subsection 96(1.1), amounts so allocated would be included in the former partner's income as an allocation of partnership income and excluded from the continuing partner’s income.  More specifically, where subsection 96(1.1) applies, the former partner would be deemed to be a member of the partnership for the purposes of certain provisions of the Act, including subsection 96(1), and amounts so allocated to the former partner in respect of a particular fiscal period of the partnership would be included in the former partner's income for the taxation year in which that fiscal period of the partnership ends.  A right to a share of the income or loss of a partnership under an agreement referred to in subsection 96(1.1) is deemed not to be capital property by virtue of subsection 96(1.4) of the Act.

In summary, we concur with your interpretation that paragraph 98(1)(a) would only deem a person who was a partner at the time that the partnership ceased to exist not to have ceased to be a partner and thus would not apply to a former partner.  In our view, section 98.1 would govern in a situation where a partner has ceased to be a member of a partnership but continues to have a residual interest in the partnership.  In that regard, we note that subsection 98.1(2) of the Act contemplates a situation where a former partner has a residual interest in a partnership that later ceases to exist (or would but for subsection 98(1) have ceased to exist) and provides for a continuation rule where the members of another partnership agree to satisfy all or part of the former partner’s rights described in paragraph 98.1(1)(a) in respect of the original partnership.

We trust the above comments will be of assistance.

Yours truly,

G. Moore
for Director
Partnerships & Corporate Financing Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2015

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2015