tax planning using partnerships - canadian bar association · topics for discussion •why use a...

Tax Planning

Using Partnerships

Robin MacKnight

Wilson Vukelich LLP

Thought for the Day

• Anything you can do with a

corporation, I can do better with a

partnership!

May 27, 2010 2010 Tax Law for Lawyers 2

Topics for Discussion

• Why use a partnership?

• Trends in the cases and practice

• Partnership basics and tax fictions

• Section 103 – the allocation issue

• Limited partnerships

• Tax shelters and tax shelter investments

• Estate planning with partnerships

• Reading tax opinions


Why Use a Partnership?

• It’s not a corporation!!

• No statutory rules

• No statutory protections

• Flexibility – in governance and

changing member rights and

interests

• Conduit for tax purposes


Advantages to a Partnership

• Rollovers:

• Real estate (Loyens)

• Allocate inherent tax liability to contributing partner

• Governance:

• No statutory minority protection

• Matter of contract

• Anonymity – minimal filing and disclosure requirement


Advantages

• Compensation:

• Avoids employment issues

• Allows “self correction” based on

performance


Advantages

• Flexibility:

• Easier to trace performance of

business units

• No solvency tests

• Allows “self correction” of relative

ownership to protect the business


Disadvantages

• CRA skeptical of partnerships –

perceived to be a tax avoidance vehicle

• Skepticism based on application of

section 103

• Notwithstanding, there is increasing use

of partnerships and conduit vehicles


What is a Partnership?

• Common law test

• Two or more persons

• Carrying on business

• In common

• With a view to profit

• Codified in provincial Partnership Act

• Artificial statutory creatures – limited

partnership, limited liability partnership


The Concept of Business

• “Adventure in the nature of trade” is a business for tax purposes

• Does mere common ownership suffice?

• What commercial activity is required to meet the business threshold?

• Can you demonstrate a “common intention” among the purported partners?


Common Law Tests

• “in common” – requires intention of the

parties to create a partnership

• Critical difference between partnership

and other vehicles

• CRA’s recent basis for attack –

177795 Canada Inc. 2007 TCC 569;

2009 FCA 19; leave to appeal to SCC

dismissed


Common Law Tests

• Note that tax motivation is not a

common law test – but query whether

it could demonstrate intention?

• Tax motivation does not expressly

disqualify a partnership under either

partnership or tax rules


Common Law Tests

• No requirement that partnership

agreement be in writing or be registered

• Consequently, many unwritten

commercial arrangements may

constitute a partnership under common

law

• Note that a limited partnership does not

exist until notice is registered


May 27, 2010 Osgoode Hall Law School 2006 LLM 14

Trends in the Cases

• CCRA initially challenged existence of

partnership on basis no business

existed

• Recent cases demonstrate low

threshold for “business”

• New CCRA challenge – is business

carried on “in common”?


Trends in the Cases

• Low threshold for demonstrating a business

• Continental Bank Leasing

• Gagnon

• Quaidoo

• But still distinct from hobbies or personal use

• Dahl

• Johnson

Tax Fictions of a Partnership

• Paragraph 96(1)(a) – partnership is a separate person

• (b) – separate fiscal year

• (c ) - each partnership activity is a separate source carried on by a separate person

• (d) – deductions claimable by partnership

• (f) – nature of the source of income flows through to partners


Computation and Allocation of

Income

• Income computed as if partnership

were a separate person from partners

• Income/gain/loss computed by source

• Income allocation generally set out in

partnership agreement

• Partners recognize income for their tax

year in which partnership tax year ends

• Note 249.1 for partnership fiscal year


Subsection 103(1)

“ Where the members of a partnership have

agreed to share, in a specified proportion, any

income or loss of the partnership from any

source … or any other amount in respect of

any activity of the partnership that is relevant to

the computation of income or taxable income

of any of the members thereof, and the

principal reason for the agreement may

reasonably be considered to be the reduction

or postponement of the tax that might

otherwise have been or become payable…


“… the share of each member of the

partnership… is the amount that is

reasonable in the circumstances

including the proportions in which the

members have agreed to share profits

and losses of the partnership from other

sources or from sources in other places.”


Subsection 103(1.1)

“Where two or more members of a

partnership who are not dealing with each

other at arm’s length agree to share any

income or loss of the partnership… and

the share of any such member … is not

reasonable in the circumstances having

regard to the capital invested or work

performed for the partnership by the

members thereof or such other factors as

may be relevant …


“… that share shall, notwithstanding

any agreement, be deemed to be the

amount that is reasonable in the

circumstances.”


Recent Cases

• XCO Investments 2005 TCC 655; aff’d

FCA 2007 FCA 53

• PennWest Petroleum 2007 TCC 190

• Krauss 2009 TCC 597


Commercial Issues

Formation of limited partnership

• LP formed when a declaration filed

• Must there first be a valid partnership?

• Not a legal entity

• No restriction on business activities

(except LLPs – only professions can

use them)


Commercial Issues

Liability Issues:

• No limits on liability of general partner

• Limited partner liable only

• in respect of the value of money and

other property the limited partner

contributes, or

• agrees to contribute

• as stated in the record of limited

partners


Commercial Issues

Restrictions on Limited Partners:

• Cannot have limited partner’s name in firm name

• Cannot contribute services – only money and property

• Limited partner must be a passive investor and cannot participate in the control of the business


Commercial Issues

What constitutes control on the part of a

limited partner?

• Haughton Graphics Ltd.v.Zivot and

Marshall

• Nordile Holdings Ltd.v. Breckenridge


Limited Liability Partnerships• Recent amendments in Ontario havel

created “full shield” LLPs

• Problem – partners will have limited

liability – so notwithstanding they are

active in the business, they will be

subject to all the limited partnership rules

• Note 40(3.14) – prevents capital gain

when negative ACB arises? (see comfort

letter)


Limited Partnership Losses

• Concept – losses deductible by a limited

partner in respect of a taxation year

cannot exceed the partner’s “at risk

amount” at the end of that year

• Such “excess” losses are limited

partnership losses


Who is a Limited Partner?

Act deems a partner to be a limited

partner if:

• Liability is limited by operation of law

• Member is entitled to specified

benefit

• Certain agreements relevant

• 3 year rule (see Brown)


Timing Issues

Deduction of losses restricted if

member is a limited partner “at

any time in the taxation year”



Losses which exceed the limited

partner’s at-risk amount are:

• Not deductible in computing taxable

income for the year; and

• Not included in computing the limited

partner’s non-capital losses for the

year



Excess losses of limited partners

are:

• Eligible for indefinite carry-forward

• Deductible if there is future income

or future additional capital

contributions are made


The ITA Regime

• “at risk amount” – ss. 96(2.2)

• “tax shelter” – s. 237.1

• “tax shelter investment” – ss. 143.2(1)

• “limited recourse amount” – ss. 143.2(1)

• “at risk adjustment” – ss. 143.2(2)


Calculating the At-risk Amount

• Ss. 96(2.2):

• defines at-risk amount “at any

particular time”

• starting point is A.C.B. – 96(2.2)(a)

• add share of current year income

allocated to partner – 96(2.2)(b)


Adjustments to At-risk Amount

Decrease by:

• Amounts owing by partner to

partnership – 96(2.2)(c) (but

excluding any 143.2 adjustments)

• “Amount” or “benefit” to which

partner may be entitled – 96(2.2)(d)


Tax Shelters

• Concept – no deductions allowed in

respect of a “Tax Shelter” unless the

shelter is registered

• Statute-barred rules do not apply

• Originally, registration was virtually

automatic

• Now see 4 page application for

registration number (form T5001) plus

11 page guide to completing it


Tax Shelters

• Expansive definition in ss. 237.1(1)

• Not restricted to partnership interests

– catches direct investments as well


Tax Shelters

Rules applicable when:

• Losses or amounts “represented to

be deductible”

• equal or exceed cost of the

investment, less related prescribed

benefits


Statements and Representations

• Maege 2006 TCC 117

• Baxter 2006 TCC 230, rev’d 2007

FCA 172

• Makuz et al 2006 TCC 263


Tax Shelter Mechanics

• “Promoter” must apply for registration

• Broad definition of “promoter”

• Includes:

• “advisers” in respect of the sale or issuance, and

• Anyone who accepts consideration in respect of the tax shelter


Tax Shelter Investment

• Multi-part definition in ss. 143.2(1)

• Property that is a tax shelter under 237.1

• Taxpayer’s interest in a partnership

where

• an interest in the taxpayer

• Is a tax shelter investment and

• The taxpayer’s partnership interest

would be a tax shelter investment (!!)




Limited Partnership

Limited PartnersGeneral

Partner

Asset or Expenditure Q – tax shelter investment?

Q – tax shelter?

Or Tax shelter investment?


• Note that a LP unit can be a “tax shelter” under 237.1

• This would mean that all LPs holding similar units would hold tax shelter investments under para (a) of TSI definition

• But if the LP units are not generically tax shelters, one individual LP might hold his/her unit as a TSI under (b)



• If LP unit is not generically a TSI, how

could it become TSI in the hands of a

particular LP?

• Statements or representations

made to that particular LP

• Limited recourse financing of that

LPs interest


Consequences of TSI status

• If the interest of any investor is a tax

shelter investment, then the interests of

all other investors become TSI also –

see subpara. (b)(ii) of definition of TSI


Indirect TSI

• Consider situation where partnership

units are not themselves “tax shelters”

under 237.1

• However, partnership acquires property

or incurs an expense with a “limited

recourse debt” per 143.2(7)

• Limited recourse amount becomes a

“prescribed benefit” under Reg. 231(6.1)

• So underlying asset or expenditure

becomes a tax shelter under 237.1May 27, 2010 2010 Tax Law for Lawyers 46

Tax Shelter Cost Reduction

Cost of property/amount of expenditure

reduced by:

• All “limited-recourse amounts” of the

taxpayer reasonably related to the

expenditure, plus

• The taxpayer’s “at-risk adjustment” in

respect of the expenditure


At-Risk Adjustment

• any amount or benefit

• taxpayer may receive or obtain

• at any time

• to reduce any loss in respect of the

expenditure or property


Limited Recourse Amount

• 143.2(1) definition – recourse for any

unpaid principal amount is limited,

either immediately or in the future,

either absolutely or contingently


Limited Recourse Amounts

• 143.2(7) extends definition to include

unpaid principal amounts unless

• Bona fide arrangements made at

time debt arose for repayment of

principal and interest “within a

reasonable period not exceeding

10 years” and

• Interest paid annually > prescribed

rate at time debt incurred


Limited Recourse Amount

• 143.2(8) further extends definition –unpaid amount of debt deemed to be LRA where the taxpayer is a partnership and recourse against any member of the partnership in respect of the debt is limited

• So any debt of a limited partnership (or LLP!) becomes a limited recourse debt (including bank operating lines, mortgages, lines of credit, accounts payable)


Limited Recourse Amounts

• Unpaid principal of limited recourse debt

• Any debt of a limited partnership

• Debt repayable in more than 10 years

• Compound interest debt

• Debt with balloon interest payments

• Debt with no fixed payment terms – eg.

inter-corporate accounts


Consequences of LRA• Cost of property or amount of

expenditure reduced under 143.2(6)

• If the units of the LP are tax shelters in

their own right, any expenditure of the

LP incurred with debt is reduced by the

amount of the LRA

• So unless LP pays cash up front to its

suppliers, it can’t recognize the

expense!!!


Examples of Unexpected

Application of these Rules

• Inter-corporate debt

• Line of credit

• Employee share purchase plan with

downside protection

• Long term financing of revenue

producing asset


Planning with Limited

Partnerships

• Any “at risk” adjustments under 96(2.2)?

• Any “tax shelter” issues under 237.1?

• Any “limited recourse adjustments” under

143.2?


Estate Planning with

Partnerships

• Krauss – no impediment in ITA to using

partnership as estate planning vehicle

• Same problem as corporation –

ensuring no transfer of value to other

members of the partnership

• Converting a family trust into a limited

partnership can solve timing issues in

succession planning


Tax Shelter Opinions• Check the scope of the opinion – what

assumptions have been made? Have the critical issues been assumed away?

• Have the facts been independently verified, or is opinion based strictly on information presented by promoter? How?

• Does opinion reflect the transactions described in the securities offering document?

• Reality check = does OM reflect every transaction in the series?


tax planning using partnerships - canadian bar association · topics for discussion •why use a...

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