Partnership
Reorganizations
May 18, 2011
2011 Tax Law For Lawyers
1
Topics
•
•
•
•
•
Transfer of assets into/out of a partnership
Consequences of changes in partners
Dissolution of a partnership
Incorporating a partnership
Partnership mergers
May 18, 2011
2011 Tax Law For Lawyers
2
Transfers Into Partnerships
• General rule – ss. 97(1) - disposition and
acquisition at FMV (subject to possible
application of stop loss rules)
• Possible rollover – ss.97(2) – election to avoid
FMV transfer
• Adopts rules from ss. 85(1) with change from
“share” to “partnership interest”
• No restriction on real estate inventory – but
note GAAR IC 88-2
May 18, 2011
2011 Tax Law For Lawyers
3
Transfers Into Partnerships
• All members of partnership must join in
election under ss. 96(4) – T-2059
• Election only available where transferee is a
“Canadian partnership” after the transfer
• Section 102 – determine status as Canadian
partnership “at any time in respect of which
the expression is relevant”
• Stacked partnerships – a partnership is a
person for purposes of these rules – ss.
102(2) and IT-413R
May 18, 2011
2011 Tax Law For Lawyers
4
Partnership Rollovers
• Loyens – original personal real estate gains
offset by corporate losses
• Case describes how to effect partnership
transfer and incorporation
• GAAR analysis
• Obiter comments on waivers
May 18, 2011
2011 Tax Law For Lawyers
5
The First Rollover
William
Harry
Varna Partnership
Harrison Property
May 18, 2011
One document for transfers of
two part interests
2011 Tax Law For Lawyers
6
The Second Rollovers
William
Harry
Separate documents for transfers
of separate interests
Lossco
Varna Partnership
Harrison property
May 18, 2011
2011 Tax Law For Lawyers
7
Critical Points
• Income recognized on transfer into
partnership due to assumption of debt
• Capital gain recognized on transfer of
partnership interests to Lossco due to
negative ACB in partnership interests
• Both partnership and Lossco existed and
carried on business
May 18, 2011
2011 Tax Law For Lawyers
8
Transfers Out Of Partnership
• General rule – ss. 98(2)
• Any property distributed to partner results in
a disposition at FMV of that property to the
partnership and a corresponding acquisition
at FMV by the partner
• Consequent recapture/gain in partnership
(usually allocated to partner receiving
distribution under the partnership agreement)
• Stop loss rules may apply to defer loss
May 18, 2011
2011 Tax Law For Lawyers
9
Changing Partners
• Does change in membership of partnership
cause it to cease to exist?
• At common law, a change of partners
constituted an event of dissolution unless
partnership agreement provided otherwise
• Note presumptions in Partnership Act s. 27 for
continuance
• Presumption appears to have been disregarded
in recent cases
May 18, 2011
2011 Tax Law For Lawyers
10
Changing Partners
• Change of status (general to LLP) does not
constitute dissolution – PA ss. 44.1(2)
• CCRA- if change in status results in significant
changes to rights/obligations of the partners,
there may be a disposition of interest – 1990
Roundtable; 1992 CMTC
May 18, 2011
2011 Tax Law For Lawyers
11
Admission of New Partners
• Is admission of new partners really a
disguised sale by prior partners?
• Stursberg 93 DTC 5271 (FCA) – transfer of
property followed by cash withdrawals,
creating negative ACB
• MNR and court – partial disposition of
property, proceeds equal to cash plus
negative ACB
• Note ss. 40(3.1) now addresses this
May 18, 2011
2011 Tax Law For Lawyers
12
Admission of New Partners:
Disguised Sale
See also:
• Haro Pacific 90 DTC 6583 (FCTD)
• Pinot Holdings 96 DTC 1277 (TCC)
• MDS Health Group 97 DTC 5009 (FCA)
May 18, 2011
2011 Tax Law For Lawyers
13
Admission of New Partners
• If genuine expansion of continuing
partnership, no disposition by continuing
partners
• Capital contributed by new partner forms
original ACB of partnership interest
• See IT-338R2
May 18, 2011
2011 Tax Law For Lawyers
14
Retirement of Partners
• Retired partner has “residual interest” in
partnership until all claims to income and
capital paid off
• Income paid to retired partner considered
income from partnership business – 96(1)(b)
• Retired partner not considered a partner for
purposes of ss. 102 (1) – see preamble to ss.
96(1.1)
May 18, 2011
2011 Tax Law For Lawyers
15
Impact of Change in Partners
• If partnership ceases to exist due to change in
partners, ss. 98(1) and (2) apply on the
dissolution of the partnership
• Exceptions:
• Continuance for tax purposes – ss. 98(6)
• Rollout of property to partners – ss. 98(3)
May 18, 2011
2011 Tax Law For Lawyers
16
Dissolution of Partnership
• Usually involves distribution of property, so
98(2) may apply
• No deemed realization under 98(2) if:
• 98(3) – pro rata distribution of assets
to all partners
• 98(5) – distribution of assets to one
partner to create proprietorship
• 98(6) – continuation of partnership by
remaining partners
May 18, 2011
2011 Tax Law For Lawyers
17
Dissolution of Partnership
• Para 98(1)(a) – until all partnership
property has been distributed to partners:
• Partnership deemed not to have
ceased to exist; and
• Partners deemed not to have ceased
to be partners
May 18, 2011
2011 Tax Law For Lawyers
18
Partnership Rollouts
May 18, 2011
2011 Tax Law For Lawyers
19
Partnership Rollouts - ss. 98(3)
• Canadian partnership must cease to exist
• All partnership property must be distributed to
persons who were members of partnership
immediately before it ceased to exist
• Immediately after the distribution, each partner
must hold a pro rata interest in each property
distributed
• All partners must jointly elect – form T-2060
May 18, 2011
2011 Tax Law For Lawyers
20
Partnership Rollouts
• If four conditions satisfied:
• 98(3)(a) - Proceeds of disposition of a
partnership interest is deemed to be an
amount equal to the greater of:
– its ACB immediately before final
distribution (the “particular time”); and
– the amount of money plus the cost
amount of property (immediately
before distribution) received on
dissolution
May 18, 2011
2011 Tax Law For Lawyers
21
Partnership Rollouts
• If conditions satisfied:
• 98(3)(b) - Cost to former partner of
property received deemed to be:
– pro rata share of cost amount of each
property
– pro rata share of 4/3 of CEC
– potential “bump” on non-depreciable
capital assets
May 18, 2011
2011 Tax Law For Lawyers
22
Partnership Rollouts
• If conditions satisfied:
• 98(3)(f) - Partnership deemed to have
disposed of each property for
proceeds equal to the cost amount of
that property immediately before
distribution
May 18, 2011
2011 Tax Law For Lawyers
23
Partnership Rollouts
• Notwithstanding intention for rollover,
partner will realize a capital gain where ACB
of partnership interest is less than the pro
rata share of the tax cost of assets received
on distribution
• Partner cannot realize a capital loss –
minimum proceeds deemed to equal ACB
May 18, 2011
2011 Tax Law For Lawyers
24
Partnership Rollouts
• 98(3) does not refer to liabilities assumed
by partner
• CCRA practice is to consider liabilities
assumed to be equivalent of a capital
contribution – IT-471R
• 98(3) does not refer to reserves claimed
by partnership
May 18, 2011
2011 Tax Law For Lawyers
25
Continuing the Partnership
• Unlike 98(3), 98(6) applies automatically
(no election) where:
• old partnership ceases to exist
• all property of the old partnership is
transferred to a new Canadian
partnership
• all members of the new partnership
were members of the old one
May 18, 2011
2011 Tax Law For Lawyers
26
Continuing the Partnership
• 98(6) ensures that property transferred
rolls over at tax cost, with no deemed
disposition under 98(2)
• Partners’ interest deemed not disposed of
– so old partner could roll negative ACB to
new interest
May 18, 2011
2011 Tax Law For Lawyers
27
Continuing Partnerships
• Problem with 98(6) – all property of old
partnership must be transferred to new. So
how do you deal with property distributed to
retiring partners?
• CCRA – so long as retiring partner gets only
cash, and all other assets roll over, it will
consider 98(6) to apply
May 18, 2011
2011 Tax Law For Lawyers
28
Incorporating Partnerships
• Two methods:
• Incorporate partnership assets and
liquidate partnership – ss. 85(2) and
(3)
• Transfer partnership interests to
corporation – ss. 85(1)
• See Loyens 2003 TCC 214; 2003
DTC 355; [2003] 3 CTC 2381
May 18, 2011
2011 Tax Law For Lawyers
29
Incorporating Partnerships
• Under 85(2) and (3) rollover:
• Transferor partnership need not be a
Canadian partnership
• cannot elect in respect of RE inventory
• All partners and corporation must elect –
T-2058
May 18, 2011
2011 Tax Law For Lawyers
30
Incorporating Partnerships
• Partnership transfers assets to Newco
under 85(2) – same issues as “normal”
rollover under 85(1)
• 85(3) applies automatically where:
• Assets transferred under 85(2);
• Partnership wound up within 60 days;
• Only assets of partnership distributed
to partners are $ and Newco shares
May 18, 2011
2011 Tax Law For Lawyers
31
Consequences
• If partnership distributes non-share
consideration, cost to partner is its FMV, which
reduces the ACB of partner’s interest;
• Newco shares have ACB equal to ACB of
interest less boot received;
• Partnership deemed to have disposed of
Newco shares at cost amount, so no gain inside
partnership;
• No gain to partner so long as ACB of
partnership interest > value of boot received
May 18, 2011
2011 Tax Law For Lawyers
32
Incorporating Partnerships
• Other approach is to roll over partnership
interests under 85(1)
• Rely on operation of law to collapse
partnership;and
• Rely on 98(5) rollout to proprietorship to
move tax cost of assets into Newco
May 18, 2011
2011 Tax Law For Lawyers
33
Partnership Mergers
• No single rollover provision like section 87
• Must use combination of 97(2) and 98(3)
• Only available for Canadian partnerships
May 18, 2011
2011 Tax Law For Lawyers
34
Partnership Mergers
• Generally use one of two methods:
• 98(3) rollout to partners, followed by
97(2) roll-in; or
• 97(2) rollover into new partnership,
followed by 98(3) rollout of new
partnership interests
May 18, 2011
2011 Tax Law For Lawyers
35
Consequences of Methods
• First method clean and easy
• Second method presents technical issues but
solution may exist
May 18, 2011
2011 Tax Law For Lawyers
36
Problem with Method 2
• For 98(3) rollout, each partner must receive a
pro rata interest in every other partners’
interest
• To “consolidate” individual interests, each
partner must sell a portion of interest immediate capital gain?
• May be able to solve cross-ownership issue
by using partition rules in ss.248(20) and (21)
• No rollover of negative ACB of prior interest
May 18, 2011
2011 Tax Law For Lawyers
37
Section 103
May 18, 2011
2011 Tax Law For Lawyers
38
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…
May 18, 2011
2011 Tax Law For Lawyers
39
“… 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.”
May 18, 2011
2011 Tax Law For Lawyers
40
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 …
May 18, 2011
2011 Tax Law For Lawyers
41
“… that share shall, notwithstanding any
agreement, be deemed to be the amount
that is reasonable in the circumstances.”
May 18, 2011
2011 Tax Law For Lawyers
42
Recent Cases
• XCO Investments 2005 TCC 655; aff’d
FCA 2007 FCA 53
• PennWest Petroleums 2007 TCC 190
• Krauss 2009 TCC 597
• Stow 2010 TCC 406
May 18, 2011
2011 Tax Law For Lawyers
43
Recent Cases (Cont’d)
May 18, 2011
2011 Tax Law For Lawyers
44