2015-0612921R3 Partnership contracting out to professional corps

Principal Issues: Partnership reorganization such that a partnership allows partners to incorporate professional corporations and the partnership enters into service agreements with the professional corporations to provide professional services to the partnership. Would the partner's professional corporation be considered to be carrying on a personal services business as defined in subsection 125(7) of the Act? Would the services fees earned by the professional corporation be specified partnership income as defined in subsection 125(7) of the Act?

Position: No. No.

Reasons: The proposed transactions conform to our requirements for these types of partnership reorganization rulings.

Author: XXXXXXXXXX
Section: 125(7); 245; 256(2)

XXXXXXXXXX                                                                                      2015-061292

XXXXXXXXXX, 2016

Dear XXXXXXXXXX:

Re:   XXXXXXXXXX
        Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers (the “Taxpayers”). We also acknowledge the information provided in various emails and telephone conversations.

To the best of your knowledge and that of the Taxpayers, none of the issues involved in the ruling request is:

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

iii.  under objection by any 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; or

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

The Taxpayers have confirmed that the proposed transactions described herein will not result in the Taxpayers or any person related to the Taxpayers being unable to pay any of their outstanding tax liabilities.

Unless specified otherwise, all statutory references herein are to provisions or parts of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c. 1, as amended to the date hereof (the “Act”), and all references to monetary amounts are in Canadian dollars.

This document is based solely on the facts described below. Any documentation submitted with your request does not form part of the facts except as expressly referred to herein, and any references thereto are otherwise provided solely for the convenience of the reader.

DEFINITIONS

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

“CCPC” means a “Canadian-controlled private corporation” as defined under subsection 125(7) of the Act;

“CRA” refers to the Canada Revenue Agency;

“Income” refers to the income or loss for a particular taxation year of the Partnership as computed under subsection 96(1) of the Act;

“Non-Professional Services” means the responsibilities and tasks associated with the carrying on of the practice of Partnership other than the provision of Professional Services, and include for greater certainty XXXXXXXXXX;

“Partner” means a partner of the Partnership;

“Partnership” means XXXXXXXXXX;

“Partnership Agreement” means the original partnership agreement dated XXXXXXXXXX by which the Partnership is currently governed;

“Practice” means the XXXXXXXXXX practice currently carried on by the Partnership and encompasses both Professional Services and Non-Professional Services;

“ProCorp” means a corporation that is incorporated under the XXXXXXXXXX and that has obtained a XXXXXXXXXX;

“Professional Services” means the XXXXXXXXXX services provided by the Partnership, the Taxpayers or the ProCorps as the case may be;

“Related Persons” has the meaning ascribed to that term in subsection 251(2) of the Act;

“Services Agreement” means the contract between a ProCorp and the Partnership setting out the terms and conditions by which a ProCorp will provide Professional Services to the Partnership;

“Service Fees” means the fees to be charged under the Services Agreement by a ProCorp to the Partnership; and

“TCC” refers to a “taxable Canadian corporation” as defined under subsection 89(1) of the Act.

FACTS

1.    The Practice is currently carried on by the Partnership as a limited liability partnership in XXXXXXXXXX.  The Partnership files an annual information return with the XXXXXXXXXX Tax Centre and deals with XXXXXXXXXX Tax Services Office.  The taxation year of the Partnership ends on XXXXXXXXXX.  The Partners file annual income tax returns with the XXXXXXXXXX Tax Centre and deal with the XXXXXXXXXX Tax Services Office.

2.    The Partnership has been carrying on business since XXXXXXXXXX. There are currently XXXXXXXXXX Partners of the Partnership.

3.    The Partnership’s business number is XXXXXXXXXX.  The main office of the Partnership is located at XXXXXXXXXX.

4.    The Partners are all individuals resident in Canada for purposes of the Act and none of them are Related Persons in reference to each other.

5.    The Partnership carries on the Practice. The management of the Partnership is overseen by the Partners. The Partners provide their Professional Services, as well as their Non-Professional Services, through the Partnership.

6.    All Professional Services are paid for by clients of the Partnership.

7.    Each Partner acquires clients in the marketplace and performs his client service tasks independently.  All clients are invoiced by the Partnership.

8.    The Partners are required by the Partnership Agreement to devote their full working time and attention to the business of the partnership.

PROPOSED TRANSACTIONS

9.    The Partnership Agreement will be amended to provide the following:

(a)   The Partnership Agreement will differentiate between Professional Services and Non-Professional Services.

(b)   A Partner will not be permitted to transfer an interest in the Partnership to his ProCorp, and a ProCorp whose shareholder is an existing Partner of the Partnership will not be issued any units or other interest in the Partnership.  For greater certainty, a professional corporation will not be permitted to become a Partner of the Partnership.

(c)   The Partners will continue to provide Non-Professional Services to the Partnership.  No ProCorp will provide Non-Professional Services to the Partnership.

(d)   A Partner’s income from the Partnership will be dependent solely on the Non-Professional Services carried out by him for the Partnership.  In particular and for greater certainty, the allocation and determination of a Partner’s income from the Partnership will not take into account the Professional Services provided by such Partner’s ProCorp nor the individual’s employment by his ProCorp.

(e)   As long as a ProCorp satisfies the terms of the Services Agreement with the Partnership, the ProCorp will not be restricted from competing with the Partnership in respect of Professional Services.  Partners will similarly not be restricted from competing with the Partnership in respect of Professional Services.

10.   Each Partner will form a ProCorp which will comply with the following:

(a)   It will be incorporated pursuant to the XXXXXXXXXX and will obtain a XXXXXXXXXX.

(b)   It will qualify as a TCC and as a CCPC.

(c)   It will be controlled by a Partner, who will be the legal and beneficial owner of all of the voting shares of the particular ProCorp.

(d)   Non-voting shares may be held by a Partner or his or her family, where family is defined as those individuals connected by blood relationship, marriage, common-law partnership or adoption, as those terms are defined in subsection 251(6) of the Act.  All shareholders legally or beneficially owning voting and non-voting shares of the ProCorp will be residents of Canada.

(e)   For greater certainty, voting or non-voting shares cannot be held by a trust, corporation or partnership but can only be held by an individual.

(f)   The Partner will be the sole director of his ProCorp.  The Partner will also be an employee of the ProCorp pursuant to a written employment agreement and will be entitled to receive a salary.

(g)   The Partner will not be an employee, director, officer or shareholder, legal or beneficial, of more than one ProCorp.

(h)   No ProCorps will be Related Persons in reference to each other.

11.   The Partnership will enter into a Services Agreement with the ProCorp of each Partner.  The Services Agreement will provide for the following:

(a)   The ProCorp will provide Professional Services to the Partnership in return for Service Fees.  The amount of Service Fees will be based on the fair market value of the Professional Services provided by the ProCorp to the Partnership and may take into account the level of difficulty and the experience and areas of specialty of the Partner whose ProCorp is providing Professional Services to the Partnership’s clients. The Service Fees will relate only to the level of work performed by the ProCorp and will not take into account the success of collected billings in respect of that work.

(b)   The term of the Services Agreement will be based on the fiscal period of the Partnership and will initially terminate at the end of the fiscal period of the Partnership immediately following implementation of the proposed transactions.  Thereafter, the Services Agreement will be automatically renewed for one year terms, subject to any mutually agreed upon amendments.

(c)   The ProCorp will invoice the Partnership from time to time for Professional Services rendered under the Services Agreement.

(d)   All payments received by the Partnership from third parties in respect of Professional Services provided by the ProCorp under the Services Agreement will be for the benefit of the Partnership, and if the ProCorp receives any such amounts, they will be remitted to the Partnership.

(e)   Provided that the ProCorp fully discharges its responsibilities under the Services Agreement, the ProCorp will not be restricted from providing Professional Services to other persons or otherwise be prohibited from competing with the Partnership.

(f)   The Service Fees will be offset by the fair market value of any supplies, facilities, and equipment provided by the Partnership with respect to the provision of Professional Services under the Services Agreement.

(g)   The ProCorp will also be responsible for, among other things, certain of the following expenses connected to the business of the ProCorp:

i.    professional membership fees and insurance;

ii.   continuing professional education;

iii.  wireless communication (including the acquisition of and operation of wireless communication devices);

iv.   maintaining the professional standards set by XXXXXXXXXX and the Partnership (to the extent necessary for the ProCorp to fulfill the Services Agreement);

v.    expenditures on personal practice preferences of the ProCorp;

vi.   promotion or entertainment expenses related to the business of the ProCorp; and

vii. travel expenses, including car, accommodation and meal expenses.

(h)   Both the ProCorp and the Partnership may terminate the Services Agreement at any time by providing notice to the other party of not less than XXXXXXXXXX days (or such lesser period of time as mutually agreed to between the parties). The Services Agreement will terminate immediately upon (i) the dissolution or winding-up of the ProCorp; (ii) the ProCorp ceasing to hold a valid XXXXXXXXXX; (iii) the shareholder of the ProCorp ceasing to be a Partner of the Partnership; or (iv) the death of the shareholder of the ProCorp who was a Partner of the Partnership.

12.   The relationship of the ProCorp to the Partnership will be that of independent contractor and nothing in the Contract should be construed as constituting the parties as partners, joint venturers, co-owners or otherwise participants in a joint or common undertaking.

13.   Within XXXXXXXXXX months of this Ruling, each Partner will establish his respective ProCorp and will elect under the Partnership Agreement to provide Professional Services through such ProCorp. Immediately thereafter, each such ProCorp will enter into a Services Agreement with the Partnership for the purpose of providing such Professional Services.

14.   All individuals will continue in their capacity as Partners to provide Non-Professional Services to the Partnership.

PURPOSE OF THE PROPOSED TRANSACTIONS

15.   The purpose of the proposed transactions is:

(a)   to allow each Partner more control over his own estate and financial planning;

(b)   to enable each Partner to have more control over expenditures which may not be in the interest of all Partners; and

(c)   to enable each Partner to have better control over his participation in the Practice.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purposes of the Proposed Transactions and provided further that the Proposed Transactions are carried out as described above, we rule as follows:

A.    Provided that a Partner would not, if his or her ProCorp did not exist, reasonably be regarded as an officer or employee of the Partnership in respect of the provision of Professional Services, the Partner’s ProCorp 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 Partner’s ProCorp was not a member of any partnership in the relevant year in respect of the provision of Professional Services to the Partnership, the Service Fees earned by the particular ProCorp 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 Service Fees payable by the Partnership to a ProCorp will be deductible by the Partnership in the determination of Income pursuant to subsection 96(1) of the Act.

D.    The undertaking of the proposed transactions above, and in particular the payment of the Service 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 a Partner’s ProCorp under the Services Agreement to be taxed as income in the hands of the particular Partner.

E.    Provided that the amount of 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 a Partner being allowed, pursuant to amendments to the Partnership Agreement, to incorporate a ProCorp and to provide all of his or her Professional Services to the Partnership through that ProCorp for Service Fees.

F.    The execution and implementation of the proposed transactions described above, in and of themselves will not constitute a disposition of part or all of an interest in the Partnership by any of the Partners.

G.    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.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R6 dated August 29, 2014 and are binding on the CRA provided that the Proposed Transactions are completed prior to XXXXXXXXXX. The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, 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 above 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 Service Fees and whether the Partnership is a partnership at law.

COMMENTS

Whether or not a particular Partner would, if his or her ProCorp did not exist, be an employee of the Partnership or an independent contractor who has entered into a contract for service with the Partnership is a question of fact that can only be determined after a review of the actual agreements entered into between the particular ProCorp and the Partnership and between the particular ProCorp and the particular Partner. This review and determination is the responsibility of the particular 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 a particular Partner’s ProCorp 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 ProCorp to a family member of the particular 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 ProCorp received in a taxation year by a family member of the particular Partner who has not attained the age of 17 years before that year.

OPINION

The application of subsection 256(2.1) of the Act is determined on a year-to-year basis.  We are therefore unable to rule that this provision will never apply to a ProCorp.  In general, where a particular function of a professional partnership that was previously carried on by the partnership is subsequently carried on by a partner’s professional corporation, and no longer in partnership, for bona fide reasons other than income tax, this fact, in and of itself, would generally not cause subsection 256(2.1) of the Act to be applicable.  The reasons for the separate existence of two or more professional corporations or the reasons for a change in the functions performed directly by the partners of the professional partnership is a question of fact that can only be determined on a case-by-case basis.  However, based on the facts and proposed transactions described herein, it is our view that the incorporation of ProCorps to provide the Professional Services to the Partnership will not, in and of itself, cause subsection 256(2.1) of the Act to be applicable to the ProCorps.

The foregoing opinion is not a ruling and, as noted in paragraph 19(f) of Information Circular 70-6R6, is not binding on the CRA.

Yours sincerely,

XXXXXXXXXX
for Director
Partnerships and Corporate Financing Section
International Division
Income Tax Rulings Directorate

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