2014-0547321C6 Q.6 97(2) Canadian Partnership Requirement

Principal Issues: In order for the rollover in subsection 97(2) to be available, the requirement of a “Canadian partnership” must be met. A “Canadian partnership” is defined in subsection 102(1) as “a partnership all of the members of which were, at any time in respect of which the expression is relevant, resident in Canada.” Does the formation of a partnership with only Canadian partners in order to meet the requirement of a “Canadian partnership” under subsection 97(2) followed by the admission of a non-resident as a partner soon after (e.g. the next day) jeopardize the rollover?

Position: See response.

Reasons: See response.

Author: Tzortzis, Chrys
Section: 97(2), 100(1), (1.4), (1.5), 245

2014 CTF Annual Tax Conference
November 30 – December 2, 2014
CRA Round Table

Q6 – Subsection 97(2) Canadian Partnership requirement

In order for the rollover in subsection 97(2) of the Income Tax Act to be available, the requirement of a “Canadian partnership” must be met.  A “Canadian partnership” is defined in subsection 102(1) as “a partnership all of the members of which were, at any time in respect of which the expression is relevant, resident in Canada.”  Does the formation of a partnership with only Canadian partners in order to meet the requirement of a “Canadian partnership” under subsection 97(2) followed by the admission of a non-resident as a partner soon after (e.g. the next day) jeopardize the rollover?

Response

Recently, an advance income tax ruling request (the “ATR request”) involving such planning went to the GAAR Committee.  The facts in the ATR request included the formation of a partnership with only Canadian partners, the transfer of assets to the partnership and the admission of a non-resident as a partner immediately after the transfer. 

Example

Corp A is a taxable Canadian corporation that is carrying on a business outside of Canada.  Corp A intends to transfer the business into a partnership of which a non-resident will be a member.  If the partnership is formed with the non-resident as an initial partner, the conditions in subsection 97(2) would not be met.  In an attempt to secure the rollover under subsection 97(2), Corp A forms a partnership with its wholly-owned Canadian subsidiary (Corp B).  Corp A contributes $99 for 99 partnership units (99%) and Corp B contributes $1 for 1 partnership unit (1%).  Corp A transfers depreciable property with a cost of $100,000, FMV of $100,000 and UCC of $50,000 to the partnership in exchange for a promissory note of $50,000 and 50,000 partnership units with a FMV of $50,000.  The elected amount is $50,000.  Absent the rollover under subsection 97(2), pursuant to subsection 97(1), the disposition of the depreciable property to the partnership would be at its FMV of $100,000 resulting in recapture of $50,000 to Corp A. 

The next day, the non-resident becomes a partner by contributing $50,000 for 50,000 partnership units (49.95%) which contribution is then used by the partnership to repay the promissory note of $50,000 to Corp A.  With the admission of the non-resident as a partner, Corp A’s interest in the partnership is reduced to 50.04%.  As part of the series of transactions, there is a dilution on a percentage basis in favour of a non-resident but without any Canadian tax recognition of the latent income gain.  The new anti-avoidance rules under subsections 100(1.4) and (1.5) do not yield taxation to Corp A on the admission of the non-resident as a partner because there is no dilution of its partnership interest on a fair market value basis (i.e. the FMV of Corp A’s partnership interest is still $50,099).  If instead there had been a direct disposition by Corp A to the non-resident of part (49.95%) of its partnership interest, amended subsection 100(1) would have resulted in a fully taxable gain to Corp A of $24,975, which amount is also equivalent to 49.95% of the latent recapture in the depreciable property of $50,000. 

The CRA will challenge such an arrangement by applying the GAAR.  In our view, the determination of a misuse or abuse of the Act must be made having regard to the 2012 amendments to subsection 100(1) that extend its application to acquisitions by non-residents and the addition of the anti-avoidance dilution provisions contained in new subsections 100(1.4) and (1.5).

Chrys Tzortzis 
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