4 October 2010 External T.I. 2010-0367231E5 F - Convention de partage d'une société de personnes
Principal Issues: [TaxInterpretations translation] Do the provisions of 103(1) or 103(1.1) change the sharing income from a SENC?
Position: Question of fact. In this case, possibly yes.
Reasons: We are of the view that, on the face of it, the sharing of income does not take into account the contribution of each partner. In addition, subsection 103(1) may be applied if the totality of all the facts of the case demonstrate that it is reasonable to consider that the main purpose of the Agreement is to reduce or defer tax under the Act.
XXXXXXXXXX 2010-036723 Anne Dagenais Advocate, M. Fisc. B.A.A October 4, 2010
Dear Sir,
Subject: Allocation of partnership income
This is in response to your letter of May 12, 2010, asking for our views on an agreement to share partnership income and the application of subsections 103(1) and 103(1.1) of the Income Tax Act (the "Act").
More specifically, you presented a specific situation in which Mr. and Mrs. A hold interests of 80% and 20%, respectively, in a general partnership ("SENC") that carries on a business of XXXXXXXXXX. Mr. and Mrs. A are spouses and the time they both devote to the activities of the SENC is more than comparable to a full-time job. In addition, the SENC employs two full-time employees. All assets used in the operation of the XXXXXXXXXX business are held by SENC. Mr. and Mrs. A plan to transfer, by way of sale, 1% of the units in SENC to a corporation. The participating and voting shares of the corporation will be held by Mr. and Mrs. A in respective proportions of 80% and 20%. The terms of the SENC agreement (the "Agreement") include the following:
- All the day-to-day tasks of operating the XXXXXXXXXX business are assigned to the corporation. In order to do so, the current employees of the SENC will become employees of the corporation as well as Mr. and Mrs. A and all will receive a salary for the work performed for the corporation;
- The partners of SENC will make all strategic decisions, including those that will have an impact on the business structure, investments in assets and financing;
To reflect the capital investments and the contribution of time and effort of the partners, the income of SENC would be allocated as follows:
- A return of 1% would be established on each partner's capital at the beginning of the year.
- The balance of the profits (losses) would be shared among the three partners in the following proportion:
o Mr. A 4%
o Mrs. A 1%
o Corporation 95%
- Partners will be able to make capital withdrawals and thus reduce the value of their interest. These withdrawals will be recorded on the SENC's statement of capital accounts and will not be considered as an expense of the SENC;
- Gains (losses) on net assets and gains (losses) on the sale of assets will be allocated in the following manner based on the capital invested:
o Mr. A 79%
o Mrs. A 20%.
o Corporation 1%
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
Our Comments
It appears to us that the situation described in your email could constitute an actual situation involving taxpayers. As explained in paragraph 22 of Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than through advance income tax rulings. If your situation involved specific taxpayers and one or more transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for its opinion. However, we are able to offer the following general comments that may be helpful to you.
The question of whether the sharing of partnership income, as described in your letter, is reasonable in the circumstances is a question of fact that we cannot answer definitively without considering all the circumstances of your particular situation. Such a review of a proposed transaction is not undertaken as part of a request for a technical interpretation. That determination should be reviewed by a Tax Services Office during an audit.
On the other hand, the long-standing position of the Canada Revenue Agency ("CRA") is that subsection 103(1) or (1.1) could apply if the allocation of partnership income does not take into account the contribution of each partner. Whether the allocation of income of an SENC takes into account the contribution of each partner is also a question of fact that must be determined on a case-by-case basis.
In addition, subsection 103(1) may be applied if the totality of all the facts of the case demonstrate that the principal reason for the agreement may reasonably be considered to be the reduction or postponement of tax under the Act. This is also a question of fact that will have to be considered by a Tax Services Office in the course of an audit.
Based on the information we have with respect to this situation, we are of the view that, on the face of it, the allocation of income does not take into account the contribution of each partner.
Consequently, in light of the foregoing, we are of the opinion that the Agreement could result in the application of subsections 103(1) or 103(1.1).
These comments do not constitute an advance income tax ruling and are not binding on the CRA in respect of any particular factual situation.
We hope that the above comments will be of assistance and answer your questions.
Best regards,
François Bordeleau, Advocate
Manager
Business and Partnerships Section
Income Tax Rulings Directorate.