Dear Sirs:
Re: Certified Production
This is in reply to your letter of February 22, 1991, wherein you requested our comments regarding the application of the Income Tax Act (the "Act") to the hypothetical situation described below.
Our understanding of the facts of the situation given to illustrate the issue is as follows:
1. A corporation (the "Corporation") and its wholly owned subsidiary (the "Subsidiary") formed a limited partnership (the "Limited Partnership") in Ontario, in which the Corporation is currently and always has been the sole limited partner and the Subsidiary is currently and always has been the sole general partner. Both the Corporation and the Subsidiary are a taxable Canadian corporation as defined in paragraph 89(1)(i) of the Income Tax Act (the "Act")
2. The Limited Partnership agreement provides that a) the Subsidiary shall have the sole and exclusive authority to administer the business and b) the allocation and distribution of profits and losses shall be in proportion to the respective contributions of the partners. Based on the Corporation's capital contributions to date, it is entitled to the majority of the profits and losses.
3. The Limited Partnership purchased five episodes of a Canadian produced television series (the "Episodes"). Each of the Episodes qualified as a "certified production" as defined in subsection 1104(2) of the Income Tax Regulations (the "Regulations") and as a class 10(w) property.
4. While none of the Episodes had been commercially used prior to the time of their acquisition by the Limited Partnership, each has been commercially used since that time.
5. Each of the Episodes is to be transferred from the Limited Partnership to the Corporation.
Your Questions
1. Will the Limited Partnership be treated as a person with whom the Corporation was not dealing at arm's length for the purposes of subsection 1102(4) of the Regulations?
2. Will the Episodes be eligible for inclusion in class 10(w) of the Corporation despite the fact that they have been acquired by the Corporation after the date of their first commercial use?
Your Opinion
1. A partnership would normally be considered a person for the purposes of applying subsection 1102(14) of the Regulations. The Corporation does not deal at arm's length with the Limited Partnership because it has effective control over the partnership, either in its capacity as the sole limited partner or through its ability to control the general partner.
2. Subsection 1102(14) of the Regulations takes priority over the definition of "certified production" with the result that a "certified production" may be transferred on a non-arm's length basis after its first commercial use to a transferee and remain in class 10(w) after the transfer.
Our Comments
While we are unable to provide confirmation of the income tax effects of the particular situation described in your letter, we can offer the following general comments related to a non-arm's length transfer of a certified production.
1. In our opinion, a partnership is considered to be a person for the purposes of subsection 1102(14) of the Regulations. Consequently, a non-arm's length transfer of depreciable property between a partnership and another entity would not fail to meet the requirements of that subsection solely on the basis that the transaction occurred between a partnership and another entity.
Where a corporation is a wholly owned subsidiary of another corporation, subparagraph 251(2)(b)(i) of the Act provides that these two corporations are persons related to each other. As a result, they are deemed not to deal at arm's length by virtue of paragraph 251(1)(a) of the Act. Whether a limited partnership and a) its sole general partner or b) its sole limited partner are not dealing at arm's length is a question of fact. Paragraphs 11 and 12 of Interpretation Bulletin IT-419 outline criteria used by the courts in making this determination. Two court cases dealing with this subject are Meritt Estate, 1969 DTC 5159 (Ex. Ct.) which discusses a "common mind" test and special Risks Holdings Inc., 1986 DTC 6035 (F.C.A.) which discusses the concept of a relationship of subordination. In addition, paragraph 15 of Interpretation Bulletin IT-419 indicates that "In situations where one partner is in a position to control a partnership, either through ownership of a controlling interest or through a mandate vested in him by his partners, the Department considers such person not to deal at arm's length with that partnership."
It is our opinion that in the situation where a limited partnership has only one general partner, that general partner will generally have control of the partnership's business and therefore, would not normally deal at arm's length with the limited partnership. Where such a general partner is a wholly owned subsidiary corporation of the sole limited partner of the partnership, it is possible for that limited partner to have `de facto' control over the limited partnership and exercise a common mind in directing the transactions of the partnership. As well, a relationship of subordination may exist between the limited partner and general partner. Therefore, depending on the facts of the situation, it is possible for a limited partner not to deal at arm's length with a partnership (unless subsection 1102(20) of the Regulations is applicable).
2. It is our opinion that where a partnership transfers a certified production in class(w) after the day of its first commercial use and in a separate class by virtue of subsection 1101(5)(k) of the Regulations to a corporation with whom the partnership was not dealing at arm's length such that subsection 1102(14) of the Regulations applies, that corporation will acquire class 10(w) property also in a separate class by virtue of subsection 1101(5)(k) of the Regulations upon the transfer. However, if a series of transactions is designed to obtain undue class 10(w) benefits, subsection 245(2) of the Act may be invoked by the Department to limit the capital cost allowance claimed with respect to that property.
These comments represent our opinion of the law as it applies generally. As indicated in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990, this opinion is not a ruling and accordingly, it is not binding on Revenue Canada Taxation.
We trust our comments will be of assistance to you.
Yours truly,
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch