5-913476
Franklyn S. Gillman
24(1) (613) 957-8953
Attention: 19(1)
June 19, 1992
Dear Sirs:
Re: Subsection 96(2.5) of the Income Tax Act Exempt interest in a limited partnership
This is in reply to your letter dated December 11, 1991 wherein you requested the Department's opinion regarding the application of the above-mentioned subsection of the Act.
You were concerned with the result of certain transactions your clients have already undertaken. Opinions with regards to transactions that have already commenced, whether completed or not should be discussed with the District Office which services any of the taxpayers involved in the transaction.
While we are unable to provide confirmation of the tax effect with regards to situations such as the one you described, we offer the following general comments for your assistance.
The exempt interest rules under subsection 96(2.5) of the Act are worded to refer to activities of a partnership and not to its income or to any specific partner or taxpayer therein.
In our opinion, the purpose of subsection 96(2.5) of the Act is only to provide grandfathering protection for all functioning partnerships in existence that were actively carrying on business at the time the "at risk" rules contained in subsections 96(2.1) to (2.7) of the Act were introduced.
The tests to be met by a partnership are related to its size and level of activity at the time the legislation was introduced and that it was actively carrying on business in Canada or elsewhere. Therefore, it is our opinion, a taxpayer who acquires an interest after February 26, 1986
in a partnership actively carrying on business may acquire an "exempt interest", provided the partnership otherwise meets the criteria specified in subsection 96(2.5) of the Act. The requirement that a partnership was "actively carrying on a business" will generally be met as long as the partnership is carrying out activities which are necessary to or consistent with the business for which it was formed prior to February 26, 1986.
The grandfathering rules in the subsection are intended to limit the size of a business in a partnership to that which existed prior to February 26, 1986 and any expansion of the existing business following February 26, 1986 through a contribution of capital or an increase in the indebtedness of the partnership will take the partnership out of the application of subsection 96(2.5) of the Act.
In order for an interest in a partnership to continue to be an exempt interest, there must not be a substantial increase in the indebtedness in the partnership or a substantial contribution of capital to the partnership after February 26, 1986. In the determination of whether there has been a substantial increase in the capital or indebtedness after that date, it is our opinion that for the purposes of paragraph 96(2.5)(c) of the Act, there would be a significant expansion of a partnership's activity in a situation where for example a business was being set up before February 26, 1986, but was only completed after that date. As the setting up of the business commenced before February 26, 1986 but was only completed subsequent to that date (at which time the business was ready for operation), the exempting provision under paragraph 96(2.5)(c) of the Act would not be available to that partnership. This would not necessarily be the case if there was an indication from the facts of the particular case that the documents referred to in paragraphs 96(2.5)(a) or (b) of the Act had been entered into or filed respectively before February 26, 1986. Therefore, a substantial increase in the indebtedness or contribution of capital of the business after February 26, 1986 will exclude it from being an exempt interest unless an exemption under paragraphs 96(2.5)(a) or (b) of the Act is met. In that regard, generally, expenditures for assets being purchased pursuant to the terms of a written agreement entered into prior to February 26, 1986 will not be considered to be substantial.
In addition, any cash deficiency payments used to repay a loan referred to in paragraph 96(2.5)(a) of the Act, would not be considered to be a substantial increase in the indebtedness of the partnership. However, that paragraph would not apply to exempt an increase in capital contributions to or an increase in the indebtedness of the partnership that has been made by way of cash deficiency call payments for operating requirements.
We trust these comments will be of assistance.
Yours truly,
ChiefMerchandising, Manufacturing, Partnerships and Trusts SectionRulings Directorate