Principal Issues: Does subsection 96(1.1) apply in a situation where dividend income is allocated to a retired partner?
Position: General comments provided.
Reasons: The determination of whether a person has ceased to be a partner is a question of fact and law that can only be resolved after a complete examination of all of the provisions of a particular document, letter or agreement.
9 OCTOBER 2015 FEDERAL TAX ROUNDTABLE
2015 APFF CONFERENCE
Question 17
Withdrawal of a partner - allowance under subsection 96(1.1)
Practice
A partnership carries on a professional services business in Canada. In addition to carrying on the business, the partnership holds a 70% interest in a corporation carrying on a business (hereinafter "Opco").
Under an agreement with a retiring partner, the parties intend to provide that the partner will dispose of his interest in the partnership, but will preserve a right in accordance with specified guidelines to a portion of the dividends that may eventually be paid to the partnership by Opco.
Questions to the CRA
(a) Can subsection 96(1.1) apply to this agreement to the extent that the partner and the partnership sign an election to that effect? Would dividends that could potentially be received by the partnership and allocated to the former partner under this agreement preserve their nature and thus be taxable as dividends from Canadian corporations?
(b) Where upon his departure, and after taking into account the amounts received, his partnership interest has an ACB, will the partner be able to claim a capital loss in that the only amounts that he can receive from the partnership in the future will represent the dividends received from Opco by the partnership and allocated in accordance with the retirement agreement?
CRA response to Q. 17(a)
It is the terms of an agreement between a person who ceases to be a partner of a partnership and the other partners, whose object is to provide for the payment of a sum by the partnership in favour of the former partner, which determine which of subsection 96(1.1) or subsection 98.1(1) is applicable. We note that these provisions have automatic application and no choice is available to the taxpayer.
Your question describes only briefly the given hypothetical situation. In the absence of an analysis of the terms of the agreement between the retiring partner and the remaining partners and of all facts and circumstances relating to the particular given situation, it is not possible for us to comment more precisely on the potential application of these provisions.
Furthermore, it is necessary to verify that the recipient of the payment has genuinely withdrawn from the partnership and thus ceased to be a partner. If this is not the case, it will instead be the terms of subsection 96(1) whose application it would be necessary to consider.
However, we would note that in the event that the substance of the agreement was to share in the income of the partnership and not to settle the rights referred to in subsection 98.1(1), we would consider utilizing the specific anti-avoidance rules in section 103 if we thought that the sharing of the income among the former partner and the remaining partners was not reasonable. The presumptions in subsection 96(1), in particular, those respecting the nature of items of income, should apply respecting the portion of the income shared by each partner of the partnership, including the departing partner. Such portion will be considered to be the amount which is reasonable in light of the circumstances.
CRA response to Q. 17(b)
A partner withdrawing from a partnership must generally recognize a capital gain or capital loss (subject to any application of the loss limitation rules) by reason of his disposition of an interest in the partnership. The fact that he preserves an interest in the income as provided under subsection 96(1.1) does not alter this conclusion. The deemed disposition provided by subsection 98.1(1) could also have the effect of deferring the taxation of a capital gain or the recognition of a capital loss.
Sylvain Grégoire
2015-059581