Principal Issues: Whether subsection 98(3) would apply to the dissolution of a partnership.
Position: Depends on the particular facts and circumstances.
Reasons: See below.
FEDERAL TAX ROUNDTABLE, OCTOBER 7, 2021
APFF CONFERENCE 2021
Question 11
Application of subsection 98(3)
Mr. A and Mr. B have been carrying on the business AB S.E.N.C. ("AB") for several years. AB's assets consist of cash, accounts receivable, prepaid expenses and a very large amount of goodwill developed internally over the years. The FMV of the goodwill constitutes more than 85% of the FMV of AB.
Mr. B wishes to sell his shareholding in AB to Mr. A, who intends to continue carrying on the business.
It is intended that section 98(3) will apply so that Mr. A and Mr. B will each end up with their share of the assets of AB.
A Inc. would be incorporated and Mr. A would be its sole shareholder.
Mr. A would transfer his share of AB's assets to A Inc. pursuant to subsection 85(1) in exchange for shares of the capital stock of A Inc.
A Inc. would purchase Mr. B's share of AB's assets and he would realize a capital gain on his disposition of such share.
Questions to the CRA
a) Does subsection 98(3) apply in such a situation since there is a continuity of AB's operations through A Inc., a corporation controlled by Mr. A?
b) Should subsection 98(5) have precedence since Mr. A indirectly continues AB's operations with A Inc.?
c) Can subsection 98(5) really be applied in this case since goodwill is difficult to partition unless the concept of a share of an asset as found in subsection 98(3) is applied?
d) Could the CRA nevertheless accept the application of subsection 98(5)?
CRA Response
Generally, subsection 98(3) generally applies where a Canadian partnership has ceased to exist and all the partnership property has been distributed to persons who were members of the partnership immediately before that time so that immediately after that time each such person has, in each such property, an undivided interest, or for civil law an undivided right that is equal to the person’s undivided interest or right, when so expressed, in each other such property, if each such person has jointly so elected in respect of the property in prescribed form and within the time referred to in subsection 96(4).
By virtue of subsection 98(4), subsection 98(3) does not apply where subsection 98(5) applies.
Subsection 98(5) is a self-executing provision and generally applies where a Canadian partnership has ceased to exist and within 3 months after the particular time one, but not more than one, of the persons who were, immediately before the particular time, members of the partnership (the “proprietor”) carries on alone the business that was the business of the partnership and continues to use, in the course of the business, any property that was, immediately before the particular time, partnership property and that was received by the proprietor as proceeds of disposition of the proprietor’s interest in the partnership
Thus, in order for subsection 98(5) to apply, it is necessary, inter alia, that the person carrying on the business of the partnership was a member of the partnership immediately before the time at which the partnership ceases to exist and that person continues to use, in the course of the business, property that was owned by the partnership immediately before that time.
The facts of the particular situation do not mention when AB would cease to exist. Whether a partnership ceases to exist is a question of law and fact. One must rely on the partnership agreement and the applicable private law to determine whether and when a partnership ceases to exist.
In the situation where A Inc. would not be a partner of AB immediately before the time at which AB would cease to exist, we are of the view that subsection 98(5) could not apply.
Alternatively, the provisions of subsection 98(3) could apply in the hypothetical situation described above with respect to the allocation to Mr. A and Mr. B of an undivided interest in each of AB's properties, provided that the conditions set out therein are satisfied.
In conclusion, although the wording of this question does not allow us to reach a definitive conclusion, the application of the provisions of paragraph 13(7)(e) should be considered in relation to Mr. B's disposition of his undivided interest in each of AB's former assets to A Inc.
Nancy Charlebois
(514) 496-8591
October 7, 2021
2021-090101