Principal Issues: Do monthly payments received from a partnership by a retiring partner constitute income or a right to partnership property?
Position: General comments provided as a question of fact. If the intention of the parties was solely to compensate the withdrawing partner for the goodwill, the payments to the taxpayer could be of a capital nature. However, if the intention of the parties was to distribute the partnership profits, the payments to the retiring partner would be income.
Reasons: Question of fact. We are not able to confirm in the particular situation that the partnership wished to compensate the retiring partner for work in progress, goodwill, or other compensation under Article XXXXXXXXXX of the original partnership agreement. Similarly, we cannot confirm that subsection 96(1.1) of the Income Tax Act does not apply to the particular situation.
2009-031312
XXXXXXXXXX Lucie Allaire, Advocate,
CGA, D. Fisc.
December 18 2009Dear Sir,
Re: Qualification of amounts received from a partnership by a retiring partner
This is in response to your request for a technical interpretation dated March 4, 2009, in which you asked for our opinion on the tax treatment of amounts you received from a partnership when you retired as a member of the partnership. We apologize for the delay in responding to your request.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
Specifically, you described a situation where you were a member of a partnership from XXXXXXXXXX to XXXXXXXXXX. You indicated that you were governed by a partnership agreement dated XXXXXXXXXX (the "Original Agreement") and an addendum to that agreement dated XXXXXXXXXX.
You represented that when you voluntarily withdrew as a member of the partnership, the partnership agreed to pay you monthly payments of $XXXXXXXXXX (for an annual total of $XXXXXXXXXX), starting in XXXXXXXXXX (for an annual total of $XXXXXXXXXX). In your opinion, these amounts were paid solely to compensate for the value of the goodwill. You added that you had little or no work in progress as of XXXXXXXXXX.
Under paragraph XXXXXXXXXX of the Original Agreement, in the event of a partner's death, disqualification, bankruptcy, disability, or any other cause beyond a partner's control, the partnership will pay to the partner, as compensation for the value of the partner's work-in-progress, goodwill, or any other damages, an amount equal to the average annual income of the partner in question during the XXXXXXXXXX years preceding the withdrawal. In addition, paragraph XXXXXXXXXX of the Original Agreement refers to the same compensation in the case of a partner's retirement, while paragraph XXXXXXXXXX of the same agreement reduces the compensation by half in the event of a partner's withdrawal or voluntary departure.
Our Comments
It appears to us that the situation described in your letter and summarized below could constitute an actual situation involving taxpayers. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for its opinion. However, we can offer the following general comments that may be helpful. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. As a result, and given that your letter only briefly describes a particular situation, the comments we make below may not apply in full in a particular situation.
In this case, we do not believe that the compensatory provision in the Original Agreement can help us determine the nature of the amounts you received from the partnership in the XXXXXXXXXX taxation year.
Rather, we are of the view that it is an agreement, written or unwritten, between a person who ceases to be a partner and the other members of the partnership that determines which of subsection 96(1.1) or section 98.1 applies.
If a partner ceases to be a member of the partnership and all the partner’s rights to partnership property are not extinguished, the partner retains a residual interest in the partnership by virtue of paragraph 98.1(1)(a).
For example, if a person who ceases to be a partner, demonstrates that the person contributed to the creation of goodwill and receives payments in respect thereof, the payments could be consideration for the former partner's rights to partnership property and would, therefore, be payments of capital. These payments would be included in computing the capital gain by the former partner in respect of his or her interest in the partnership. However, the payments would also not be deductible in computing the income of the partnership or the other members.
On the other hand, it is a question of fact whether subsection 96(1.1) applies to a particular situation. A member who ceases to be a member of a partnership has an income interest in the partnership under subsection 96(1.1) if, inter alia, all the members agree to allocate a portion of the partnership's income to the member who has ceased to be a member of the partnership. Such an agreement could not be subsequently unilaterally altered by the withdrawing partner or by the remaining members of the partnership.
Where subsection 96(1.1) applies, the designated amount is income of the former member for the taxation year that includes the end of the fiscal period of the partnership in which the amount is designated.
Best regards,
François Bordeleau, Advocate
Manager
Business and Partnerships Section
Income Tax Rulings Directorate.