Deborah Graystone
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2008
Tx 2 Module 7
Partnerships
The lecture for this lesson has been divided into the following parts:
Part 1: Topics 7.1 Definition, 7.2 Computation of Income, and 7.3
Computation of ACB of Partnership Interest, Topic 7.9 Information
Return
Part 2: Topic 7.4 Transfer of Property to Partnership and Admission of
New Partner
Part 3: Topics 7.5 Withdrawal of a Partner, Topic 7.6 Dissolution of a
Partnership
Part 4: Topic 7.8 Transfer of Property by a Partnership to a Corporation
Part 5: Topic 7.7 Limited Partnerships
Part 1: Definition, Computation of Income, ACB of Partnership Interest,
Information Return
Definition
•
What is a partnership? Not defined in ITA. Legal determination, generally
a relationship that exists between persons carrying on business in
common with a view to profit.
•
Is there a distinction between partnership, co-ownership, joint venture?
•
Tax purposes – partnership is not a person, but s. 96 provides that the
income of a member of a partnership is computed as if the partnership
were a separate person
•
See IT-90: What is a Partnership?
•
Partner may be an individual or a corporation or another partnership.
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Computation of Income
•
Basic concepts: S. 96(1): partnership computes its income as if it were a
person.
•
Requires computation of income at the partnership level – not at the level
of the individual partner. Most significant impact of this – CCA.
•
The income or loss calculated at the partnership level is then attributed to
the partners according to the partnership agreement. This may or may not
be equal to their interest in the partnership. Section 103 allows CRA to
challenge allocation.
•
The income or loss allocated to the partners retains its source, i.e. if it was
business income, investment income, capital gain, etc., to the partnership
it will be the same to the partner.
•
Partners file tax returns and pay tax on partnership income – not
partnership. Partnerships of more than 5 partners and limited
partnerships must file information returns (Topic 7.9)
•
Fiscal period - paragraph 249.1(1)(b), a partnership with an individual or
professional corporation as a member must have a December 31 yearend, unless alternate method elected. Other partnerships where no
members are individuals or professional corporations can maintain fiscal
periods which do not coincide with the calendar year. Partners must
include in their income their share of the partnership income or loss
earned during the fiscal period of the partnership ending in the fiscal
period of the partner (December 31, if individual). Example, corporate
partnership year-end October 31; corporate partner year-end September
30 – would include October 31, 2008 partnership income in taxable
income for year-ended September 30, 2009. Can achieve tax deferral
through selection of year-ends in non-individual/professional corporation
situations.
•
See lesson notes Topic 7.2 for more specific computation of partnership
income/loss issues
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Special rules in section 125 limit the small business deduction available to
corporations on their partnership income – specified partnership income.
Computation of the ACB of a Partnership Interest
•
A partner owns a capital property, i.e., a partnership interest. Disposition
of partnership interest – capital gain or loss.
•
Similar to shares, but as a partnership is not a legal person (unlike a
corporation) its interests cannot be separated from the partners' interests.
Therefore, a constant series of adjustments to the adjusted cost base
(ACB) of the partners' interests in the partnership is necessary.
•
Almost all the partner’s transactions with the partnership will involve ACB
adjustments.
•
Partnership interest ACB – important for determining tax consequences of
dissolution of a partnership, withdrawal of partner, disposition of a
partnership interest, or death of a partner.
•
Partnership interest ACB calculations – should be tracked annually for
each partner.
•
Partnership ACB adjustments are provided for in paragraphs 53(1)(e) and
53(2)(c).
•
Not the same thing as accounting for partner capital accounts.
•
See readings notes Topic 7.3 for a useful check list of ACB adjustments.
Starting point is capital contributions plus net income as calculated for tax
purposes, i.e. after adjustments for book amortization/CCA, nondeductible expenses, plus 100% of capital gains, less capital withdrawals
(draws), net loss for tax purposes, etc. etc. etc.
•
Negative ACB – usually because partner’s draws have exceeded income
allocation or allocation of partnership losses in excess of capital
contributions. Treated as a capital gain but usually only realized on
disposition of the partnership interest. Limited partnerships – immediate
capital gain.
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Part 2 – Transfer of Property to the Partnership and Admission of New
Partner
Transfer of Property:
•
May be done on formation of partnership or at any time
•
Transfer at FMV – disposition
•
Rollover available – subsection 97(2) – piggy-backs off S. 85.
•
Conditions for s. 97(2) rollover: Canadian partnership (all partners
resident in Canada), transferor must be a partner of the partnership
receiving the assets immediately after the transaction.
•
Consideration taken back – may include a partnership interest (doesn’t
have to, unlike S. 85 which required at least 1 share must be taken back)
•
If agreed amount > consideration received, excluding partnership interest,
difference is added to the ACB of the partner’s interest.
•
Form T2059 (similar to T2057 for S. 85). One partner files on behalf of the
other partners (first partner required to file tax return).
•
Superficial Loss (s. 40(2)(g)(i)) – when majority interest partner transfers
property to partnership and incurs capital loss, stop loss and added to
ACB of property acquired by partnership. Partner and partnership are
affiliated persons (s. 251.1(1)(f)) if partner holds majority interest
Admission of New Partner
•
Under partnership law, a partnership dissolves if there is any change in
the partners, unless the partnership agreement provides for the
continuation of the partnership. Provision for the continuation of the
partnership on the addition, withdrawal or death of a partner is standard in
most partnership agreements.
•
New partner could enter partnership by acquiring partnership interest from
one or more partners, contribute capital, or combination. If through
acquisition of partnership interest, existing partners dispose of portion of
interest with resulting capital gain or loss. No deemed disposition of
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partnership interest for existing partners if capital contribution and no ACB
adjustment.
Part 3: Withdrawal of Partner
•
Can be a difficult area
•
Many different ways for partner to withdraw: sale of partnership interest,
buy-back of interest by partnership (redemption), retention of residual or
income interest, or combination.
Consequences to Partnership:
•
S. 98(6): permits a full rollover if a Canadian partnership ceases to exist
and all of its property is transferred to another Canadian partnership
whose partners were all partners in the old partnership. The new
partnership is deemed to be a continuation of the old partnership. Applies
only if all of the property of the old partnership is transferred to the new
partnership.
Consequences to Withdrawing Partner:
•
Sale of interest- capital gain/loss on disposition
•
Buy-back of Interest by partnership - Where the partner withdraws but
retains for a period of time a right to receive property of the partnership in
satisfaction of his interest (residual interest). Para 98.1(1)(a) the
withdrawing partner is generally deemed not to have disposed of his
interest in the partnership. Withdrawing partner may recover amounts taxfree up to his partnership interest ACB – further recoveries are capital gain
as negative ACB taxed as capital gain in year it goes negative (not
deferred until interest paid-out in full). See example 7-14.
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Income Interest in Partnership:
•
Could be arrangement to allocate future partner income to retired or
deceased partner pursuant to partnership agreement (retirement income).
Common in professional partnerships.
•
Subsection 96(1.1) provides that this type of payment is to be treated as a
distribution of partnership profits for the purpose of subsection 96(1).
•
Retired partner deemed to continue to be member of partnership. Income
retains its source, i.e. business income
•
Certain conditions must be met - see readings
Dissolution of Partnership:
•
S. 98(2) - On dissolution, each property transferred to or taken by a
partner is deemed to be disposed of by the partnership at fair market
value. Tax implications: recapture of CCA, capital gains on the
disposition of partnership assets to the partners, ACB adjustments.
•
S. 98(3) Rollover: election to permit a tax-free rollover of partnership
property to the partners in certain circumstances – see lesson notes:
Canadian partnership ceased to exist, all property distributed to partners,
each person must have an undivided interest in each property distributed
(restrictive provision)
•
Joint election - form T2060
•
Partnership property deemed disposed of at cost amount – no gain or loss
on dissolution
•
Partner deemed to dispose of partnership interest at greater of ACB of
partnership interest or cash and % cost amount of property distributed. If
at ACB, then no gain or loss
•
See example 7-15 in readings for comprehensive example
Business Continued by One Partner:
•
Subsection 98(5) permits a tax-free rollover of assets from a discontinued
partnership to a proprietorship. The rollover applies where, within three
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months of the termination of a Canadian partnership, one of the former
partners commences to carry on the business of the previous partnership
as a sole proprietor. Partnership property is received by him as proceeds
of disposition of his partnership interest.
•
deems the member of the partnership who becomes the proprietor on a
disposition by the other partners to have acquired partnership interests
and not to have acquired partnership property.
•
Subsection 98(5) - not an elective provision - operates automatically when
conditions are met.
•
See example 7-16
Part 4: Transfer of Property by Partnership to a Corporation
•
Rollover for Incorporation of partnership – s. 85(2)
•
Election form - T2058
•
Subsection 85(3) – tax-free rollover where a partnership has transferred
property to a corporation under s. 85(2), and the partnership is wound up
within 60 days of the transfer, and the only assets of the partnership were
cash and property received from the corporation as consideration for the
disposition (shares)
•
In these circumstances subsection 85(3) provides a rollover treatment for
the transfer of the consideration received from the corporation (including
shares of the corporation) to the partners on the winding-up of the
partnership.
•
See example 7-18
Part 5: Limited Partnerships (LP)
•
Usually used to limit legal liability and limit risk to amount invested (capital
contribution), i.e. not jointly and severally liable for partnership’s acts, nor
are they liable to compensate for losses incurred by LP
•
Common in real estate, tax shelter investments
•
Limited Partner – S. 96(2.4) definition
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In many cases, it was not unusual for the limited partner to claim losses
which were in excess of his monetary liability to the partnership.
Considered to be abusive by tax authorities – introduced at-risk rules
•
subsections 96(2.1) to 96(2.7) limit the amount of losses which can be
deducted by a limited partner for tax purposes, to the at-risk amount less
certain deductions.
•
S. 96(2.2) - lengthy calculation of the at-risk amount. Essentially running
total of capital contributions (ACB of initial investment) less write-offs
allocated – see example 7-17
•
Negative ACB of LP – realized capital gain at end of fiscal period of
partnership in which ACB went negative