Principal Issues: Whether an "active" limited partner may cease to qualify as a limited partner within the meaning of 40(3.14)(a) of the ITA and thus may not have to include in his income tax return a deemed capital gain for the year equal to the negative ACB of his interest in the partnership?
Position: Yes, provided that the partner is neither a limited partner under subsection 40(3.14) nor a specified member of the partnership as per the definition of the expression in subsection 248(1). A partner will not be considered as a limited partner under paragraph 40(3.14)(a) if his liability towards third parties is unlimited and if he is in fact liable for all obligations of the partnership under the law governing the partnership arrangement. The question of whether the liability of a partner is unlimited is a question of fact and law and can only be resolved after a full examination of all facts and circumstances surrounding the relevant situation.
Reasons: Application of the Act and previous technical interpretations.
FEDERAL INCOME TAX ROUNDTABLE 11 October 2013
2013 APFF CONFERENCE
Question 20
Limited Partner active in the management of a limited partnership
Articles 2236 to 2249 of the C.C.Q. provide for the rules applicable to limited partnerships. Specifically, Article 2238, paragraph 1 CCQ provides that general partners have the powers, rights and obligations of the partners of a general partnership but they are bound to render an account of their administration to the special partners. Article 2237, paragraph 2 C.C.Q. provides that a limited partner is a partner who undertakes to provide a contribution to the limited partnership.
Under tax law, subsection 40(3.1) provides for the inclusion in the income of a limited partner and /or a specified member of any capital gain resulting from the negative adjusted cost base of the partnership interest at the end of the partnership's fiscal year, while the general partner is not subjected to tax on any negative adjusted cost base.
In a particular situation, a partner who is designated in a limited partnership agreement as a limited partner plays an active role in the management of the limited partnership on a regular, continuous and substantial basis. According to the civil law, more specifically, Article 2244 CCQ, this limited partner loses the benefit of limited liability and may be liable in the same manner as a general partner for all the obligations of the partnership.
Question to the CRA
Can an active limited partner described in the preceding paragraph cease to qualify as a limited partner within the meaning of paragraph 40(3.14)(a), as the definition of "limited partner" provides that liability as a partner must be limited by the law governing the partnership agreement, so that the negative adjusted cost base of the limited partner is not required to be included in income?
CRA response
Under subsections 40(3.1) and (3.11), where in computing the adjusted cost base ("ACB") of a limited partner's or a specified member's interest in a partnership at the end in a given year, the amounts required to be deducted under subsection 53(2) exceed the total of the cost of the interest and the amounts to be added to cost under subsection 53(1), the excess is deemed to be a gain from the disposition, at the end of the fiscal year, of such interest of the partner.
For the purpose of subsection 40(3.1), a member of a partnership at a particular time is a limited partner of the partnership at that time if, at that time or within 3 years after that time, any of the facts set out in paragraphs 40(3.14)(a) to (d) applies. Paragraph 40(3.14)(a) provides in particular that the liability of the member as a member of the partnership is limited by operation of any law governing the partnership arrangement, excluding the partners of a limited liability partnership.
In the event that the partner not qualify as a limited partner within the meaning of subsection 40(3.14) or as a specified partner under the terms of subsection 248(1), we are of the view that the provisions of subsection 40(3.1) will not apply if, at the end of the fiscal period of the partnership, the amounts to be deducted under subsection 53(2) exceed the total cost of the partnership's interest in the partnership and amounts to be added by virtue of subsection 53(1).
In order not to qualify as a limited partner pursuant to paragraph 40(3.14)(a), it is understood that the partner's liability must be unlimited vis-à-vis third parties and that the partner must actually be liable for the obligations of the partnership within the meaning of the law governing the partnership agreement, in this case the C.C.Q. The question of whether the liability of a partner in a partnership is unlimited is a question of law and fact that can only be resolved after a full examination of all the facts, actions, circumstances and relevant documents surrounding the partnership in each situation.
A partner who is not a limited partner may still be subject to the rules set out in subsection 40(3.1) where the partner qualifies as a "specified member" within the meaning of subsection 248(1). Characterization as a specified member is also a question of fact and a review of all relevant facts, circumstances and documents surrounding the particular situation is required. We are of the view, however, that a partner generally will be actively engaged in the activities of a partnership under the definition of "specified partner" in subparagraph (b)(i) of subsection 248(1) when directly involved in the day-to-day management and /or in the daily activities of the business of the partnership, other than financing, and dedicates time, work and energy in the pursuit of the business on a regular, continuous and substantial basis.
In addition to the application of the provisions of subsection 40(3), we are of the view that the conversion of the limited partner's limited liability interest into an unlimited one could result in other tax consequences. For example, in certain circumstances, such a conversion could result in a disposition for tax purposes of the partner's interest in the partnership. It should be noted that this analysis has not performed in the context of this question.
Finally, it should be noted that any transaction or series of transactions designed to avoid the application of the rules set out in subsection 40(3.1) or those relating to at-risk amounts are carefully examined by the CRA.
Marie-Claude Routhier
2013-049586