Recent CRA Challenges
Involving Partnerships
CPTS Luncheon Series
May 15, 2013
Robert Kopstein and Carrie Aiken
1
Overview
• General Legal Principles
• CRA Challenges and Assessments
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2
Formation / Validity of Partnerships
Character Conversion Transactions
Issues under Successor Rules in subs. 66.7
Deduction of Partnership Expenses at Partner Level
General Legal Principles
• Under the Partnership Act (Alberta) (“APA”), a
partnership means:
“The relationship that subsists between persons
carrying on a business
in common with a view to profit”
• Formation of a partnership is determined under common
law and provincial statute
• “Partnership” is not defined in ITA
3
General Legal Principles
• A partnership is not an entity distinct from its partners - it
is a relationship between the partners
• No distinction between limited and general partnerships
in this regard (except that a limited partnership must be
registered)
• A partnership acts through its partners in a relationship
of mutual agency – one partner’s actions bind the other
partners (APA, s. 6-10)
• At common law, each partner is viewed as carrying on
the business of the partnership (see Robinson, 98 DTC
6232 (FCA) and s. 253.1)
4
General Legal Principles
• An aggregation of partners who own the property that is
used to carry on the partnership’s business
• Property of the partnership is held and applied by the
partners exclusively for the purposes of the partnership
and in accordance with the partnership agreement (APA,
s. 23)
• Madsen v. The Queen, 2001 DTC 5093 (FCA) –
ownership of property does not vest in the partnership;
the acquisition of partnership property takes place
between the partners on behalf of the partnership
5
Interaction of Partnership and ITA
• Partnership is not a taxpayer under ITA – income
is computed at the partnership level “as if” the
partnership were a separate person
• ITA does not deal with partnerships consistently
or comprehensively
– Some provisions recognize the partnership interest as
a property distinct from the underlying assets
– Some deem the partnership to be a separate person
– Others preserve the nature of the income or loss of
the partnership in the hands of the partners
6
Interaction of Partnership
and the ITA
Examples:
• S 96 deems the partnership to be a person for the
purpose of computing income but does not address the
issue of ownership of assets
• Elections under subs 85(3) and 97(2) treat members of
the partnership as the operative parties and not the
partnership itself
• S 116 looks through the partnership to require any nonresident person who is a member to file the requisite
notifications
7
Formation of Partnerships
• Leading cases on legal requirements for the
formation of a partnership:
– Continental Bank of Canada v. The Queen, 98 DTC 6505 (SCC)
– Spire Freezers Ltd. V. The Queen, 2001 DTC 5158 (SCC)
– Backman v. The Queen, 2001 DTC 5149 (SCC)
See Appendix for case summaries
• Three essential ingredients to form a
partnership: (1) a business (2) carried on in
common (3) with a view to profit
8
Formation of Partnerships
• Objective determination of whether the
documentary evidence and the surrounding
facts (including what the parties actually did)
was consistent with the subjective intention to
carry on business in common with a view to
profit
(See Backman)
9
(1) A Business
• Partnership can exist even if partners do not
carry on business for tax purposes
– Common law definition of “business” is relevant
– Not the definition of “business” under the ITA
• At common law, a business is “anything which
occupies the time and attention and labour of a
man for the purpose of profit”
• Relatively low threshold – generally any
commercial activity, including a mere investment
in property, can be a business
10
(1) A Business
• No need for sustained activity – can be formed
for a single transaction or short period of time
• There is no minimum time frame over which the
partnership must exist – 1 day, 2 months, 1
year? (Hickman Motors)
• Examine what happened after closing – did the
business continue to be carried on? (Spire
Freezers)
• Period of inactivity is not fatal
11
(1) A Business
• Sufficient to continue an existing business into
the partnership
• May include passive activities (e.g., receipt of
rent) and investment in other partnerships
• Existence of a business is not dependent upon a
reasonable expectation of profit or positive
revenue stream
– This is particularly acute in the oil and gas industry
where there is often a time lag between the start of a
project and associated revenue streams
12
(2) Carried On In Common
• Question of the intent of the partners
• Management can rest with a single partner
• Contracting out under a services agreement
should be no different than delegating to a
managing partner
13
(2) Carried On In Common
Continental Bank (at para 34):
“… I am satisfied that the business that was carried on was carried on by the
partners in common. Under the Partnership Agreement, the Partners "delegate
to the Managing Partner full power and authority to manage, control, administer
and operate the business and affairs of the Partnership and to represent and
enter into transactions which bind the Partnership" (Art. 4.01). The fact that the
management of the Partnership was given to the Managing Partner does not
mandate a conclusion that the business was not carried on in common. Nor
does the fact that Central, acting alone, was negotiating transactions relating to
the lease portfolios prior to December 29, 1986. The respondent argues that
the exclusion of Leasing and the Bank from any of those activities negates any
claim that the Central entities and the Continental entities were actually
carrying on business in common during that period. As Lindley & Banks on
Partnership, supra, point out, at p. 9, one or more parties may in fact run the
business on behalf of themselves and the others without jeopardizing the legal
status of the arrangement.”
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(2) Carried On In Common
• Evidence consistent with an intention to carry on
business in common may include:
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–
–
–
Contribution of time, skill, cash or assets
Joint property interest in subject-matter of the adventure
Sharing of profits and losses
Filing of tax returns as a partnership and, where applicable, financial statements,
joint bank accounts and correspondence with third parties
• These evidentiary factors have been developed through
long line of case law and there is no hierarchy or need to
demonstrate all factors
• For example, the SCC noted in Continental Bank that
holding oneself out as a partner does not “alone have
the effect of validating the partnership”, but
rather evidences the partners’ intentions
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(3) With a View to Profit
•
•
•
•
Intention of the parties is relevant
Profit making purpose may be ancillary
Amount of profit is not determinative
Do not need a net gain over a specific time
frame
• A tax-motivation for the formation of the
partnership may exist – need to distinguish
between motivation and intention
16
(3) With a View to Profit
• Backman (at para 24):
In determining whether there is a view to profit courts should not adopt or
employ a purely quantitative analysis. The amount of the expected profit is only
one of several factors to consider. The law of partnership does not require a net
gain over a determined period in order to establish that an activity is with a view
to profit. For example, a partnership may incur initial losses during the start up
phase of its enterprise. That does not mean that the relationship is not one of
partnership, so long as the enterprise is carried on with a view to profit in the
future. Therefore, where a partnership is formed with the predominant motive of
acquiring a tax loss, it is not necessary to show an intention to profit by the
amount necessary to recoup the acquired losses or produce a net gain.
17
Challenges from the CRA
• Two streams of challenges
– Partnership is not validly created and does not meet
requirements under common law and applicable statute; or
– the benefits associated with the use of the partnership should be
denied under the GAAR
• Seeing challenges in several contexts
– Contribution of asset to a partnership under subs 97(2) followed
by sale of partnership interest to third party or investment by third
party in partnership (e.g., capital carry arrangements)
– Package and bump transactions (e.g., Oxford Properties) –
transfer assets (that would otherwise be ineligible for 88(1)(d)
bump) to partnership under subs 97(2) so that on change of
control, partnership interest can be bumped
under 88(1)(d)
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CRA Arguments on Valid Formation
of Partnerships
• “Business” for purposes of determining whether
a partnership exists is the more restrictive
definition in the ITA and not under common law
• Requires an active business (activities must
occur on regular or continuous basis)
• No revenue streams possible or expected
• Intention to form a partnership solely attributable
to tax motivation
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CRA Arguments on Valid Formation
of Partnerships
• Insufficient levels of activity
– Partner undertook activities / incurred expenses
directly
– Partners and partnership’s participation in business
removed because of services agreement
• Insufficient assumption of risks / responsibilities
by partnership
• Duration of partnership (e.g., only in place for
short period of time before transaction)
20
CRA Arguments on Valid Formation
of Partnerships
• Partners did not sufficiently hold themselves out
as partners
• In some cases, CRA is alleging the partnership
is a sham (particularly where partnership not
publicized in annual reports, etc.)
– High threshold for establishing sham
– Requires an element of deceit
– Is there an element of deceit in circumstances where
disclosure is not required (e.g., consolidated financial
statements)?
21
CRA Arguments on Character
Conversion Transactions
• The partnership does not exist (see above)
• If a person transfers assets to a partnership in
anticipation of a sale, the partnership interest is
akin to a trading asset
• Under the GAAR on the basis that there is an
abuse of the ITA where a person converts an
income gain into a capital gain through the use
of a partnership (e.g., a person should directly
sell assets instead of a partnership interest)
22
Character Conversion Transactions
• Point in time test – did the taxpayer hold capital
property at the time of the disposition?
• Question of whether something is income or
capital for tax purposes is the underlying legal
question and is not mandated by a specific
provision or scheme in the ITA
23
Character Conversion Transactions
• Partnership Interest held on capital account
– SCC commentary in procedural appeal relating to Continental
Bank, 98 DTC 6501 (at para 16)
“Assuming that the Bank transferred its partnership interest to 693396 Ontario Limited
("693396") and 693397 Ontario Limited ("693397"), I agree with Bastarache J. that the transfer
should be construed as a capital transaction and not an adventure in the nature of trade, making
the alternative assessment untenable. None of the circumstances indicate that the Bank's
acquisition and subsequent disposition of Leasing's partnership interest was a speculative
trading venture…”
– Walchuk v. The Queen, 2004 DTC 2184 (TCC)
– Cardella v. The Queen, 2001 DTC 5451 (FCA); 99 DTC 631
(TCC)
24
Character Conversion Transactions
Walchuk v. The Queen, 2004 DTC 2184 (TCC) at para 14-15:
“A partner, by nature, carries on business with a view to profit, not from resale, but from
the ongoing business. That is the nature of a partnership interest. For income tax
purposes the partnership interest is treated as capital property, separate from the assets
of the partnership…
The partnership unit may have some similar characteristics to a share in that it too
constitutes something which, by its nature is an investment, and not itself, an ordinary
transferable widget. However, to overcome the normal status of a partnership unit as
capital property is a more onerous task than doing likewise for shares, simply due to the
nature of the structure. There are ready markets for shares. The owner of the share is not
coincidentally the owner of the business' underlying assets. The partner, however, is both
the owner of the capital property, the partnership interest, and the owner of the underlying
assets, the business itself. This is only to indicate that to claim there are two businesses
there must be compelling, convincing evidence that the dealing with the one - the
partnership unit - is distinct and separate from the dealing with the other.”
25
Character Conversion Transactions
• A note on GAAR - there will be a finding of abusive tax
avoidance where the taxpayer is in compliance with the
wording of the provision, but the transaction:
– Achieves an outcome that the statutory provision was intended
to prevent;
– Defeats the underlying rationale of the provision; or
– Circumvents the provision in a manner that frustrates or defeats
its object, spirit or purpose
(See: Canada Trustco & Copthorne)
• Minister has obligation to prove the underlying policy that
it asserts is being abused in a GAAR challenge
26
Character Conversion Transactions
• As noted by the SCC in Canada Trustco:
– “Despite Parliament's intention to address abusive tax
avoidance by enacting the GAAR, Parliament
nonetheless intended to preserve predictability,
certainty and fairness in Canadian tax law. Parliament
intends taxpayers to take full advantage of the
provisions of the Income Tax Act that confer tax
benefits. Indeed, achieving the various policies that
the Income Tax Act seeks to promote is dependent on
taxpayers doing so.” (at para 31)
27
Character Conversion Transactions
• ITA provides for carrying on business through
corporation, partnership, trust, proprietorship
• Taxpayers are entitled to choose the appropriate vehicle
based on their circumstances
• Specific rules governing dispositions into and out of
corporations, partnerships, trusts
• No rules on when a taxpayer can or cannot use a
particular vehicle (other than subs 69(11)) or how long
the vehicle must be in place
• Anti-stuffing provisions in the bump rules (e.g., when
purchaser adds property following acquisition
or new para 88(1)(d)(ii.1), 88(1)(e) and 97(3))
28
Oxford Properties
• Oxford was a large commercial real estate firm that owned and
managed office, industrial and retail property that was listed on TSX
• BPC was a Canadian corporation formed to make takeover bid for
Oxford
• Prior to the takeover Oxford transferred certain real properties to
newly formed limited partnerships under subs 97(2) (“Tier1 LPs”)
• Oxford was purchased by a subsidiary of BPC (in 2001) and then
amalgamated to obtain a tax-bump to the partnership interest and
other non-depreciable properties owned by Oxford (in 2002)
• In 2002, Tier1 LPs formed limited partnerships (“Tier2 LPs”) and
transferred properties to them under subs 97(2). Tier1 LPs wound-up
under subs 98(3) and ACB of Tier2 LPs was bumped under para
98(3)(b) and (c)
• In 2006, Oxford sold 3 of the Tier2 LPs to tax-exempts
29
Oxford Properties
First Bump Transaction:
BPC
BPC
Vertical
Amalgamation,
subs. 87(11),
bumping ACB of
Tier1LP and
other property
held by Oxford
under 88(1)(d)
Tier1
LPs
Tier2
LPs
Assets
30
Assets
Oxford sells Tier2 LPs to
tax-exempts
Oxford
Amalco
151
Tier1
LPs
Third Transaction:
Acquire
Co
Acquire
Co
Oxford
Second Bump Transaction:
Step 2: Tier1 LPs
wind-up under
98(3) and ACB of
Tier2 LPs
bumped
Step 1: Tier1
LPs transfer
assets to Tier2
LPs under 97(2)
Oxford Properties
• Minister reassessed Oxford under the GAAR seeking to deny the
bumps and apply subs 100(1)
• Tax benefits identified by the Minister (and agreed to by the Appellant)
were:
– (1) deferral of tax on capital gains and recapture by virtue of subs 97(2);
– (2) increase in the ACB of the interest in the Tier1 LPs and Tier2 LPs by virtue of
subs 88(1) and 98(3); and
– (3) the reduction of income tax payable by the Appellant on the sale of its
partnership interests to the tax-exempts.
• One of the arguments of the Appellant under the GAAR is that the first
set of transactions (up to the creation of the Tier2 LPs) were “primarily
tax motivated solely on the part of BPC, but not on the part of the
Appellant as they can reasonably be considered to have been
undertaken or arranged for bona fide purposes other than to obtain a
tax benefit.”
31
Successor Rules
• Rules in s 66.7 limit the deduction of resource expenses
following direct or indirect transfers of Canadian
resource properties (“CRP”)
• General rule is that resource expenses may only be
deducted by the corporation that incurred them
• Direct or indirect purchaser of CRP may be entitled to
deduct resource expenses incurred by the original owner
of the CRP in limited circumstances
• Rules also apply on an acquisition of control to deem a
corporation to be a successor to itself
• Overriding purpose of 66.7 is to provide a tracing
mechanism
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Successor Rules
• Application of 66.7 to a partnership has been a source of significant
uncertainty, particularly in light of the assessing practices of the CRA
• Where CRP is owned by a partnership at the time of an acquisition
of control of a corporation that is a member of the partnership, para
66.7(10)(j) provides the necessary link between any successored
resource tax pools (which are at the partner level) and the CRP
(which is owned by the partnership) at the time of the acquisition
• Para 66.7(10)(j) addresses concept of “ownership” and deems a
corporation to own the applicable proportionate interest in the CRP
owned by the partnership and, thus, permits the corporation to
deduct income and proceeds allocated by the partnership from
those CRP against the corporation's successored resource pools
• CRA’s view is that para 66.7(10)(j) does not look
through multiple tiers of partnerships
(2012-0432931E5)
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Successor Rules
Devon v. The Queen
• Successor rules were triggered as a result of acquisition of control of
Anderson Exploration Ltd., parent to Home Oil Company (now
Devon)
• Prior to acquisition, Home Oil owned CRP through a partnership
• Following acquisition, the partnership transferred its CRP to a
subsidiary partnership
• CRA reassessed denying Devon’s claim for successor deductions
attributable to the CRP on the grounds that para 66.7(10)(j) ceased
to apply on the drop down of the CRP to the second level
partnership
• Recently won a Rule 58 motion for the determination of a question
34 of law before a hearing
Successor Rules
• CRA has taken the view that there is no “successoring transaction”
when a partnership distributes CRP to a partner on a tax-deferred
partnership wind-up and, therefore, subs 66.7(16) applies:
“Where at any time a Canadian resource property or a foreign resource
property is acquired by a person in circumstances in which none of …
subsections (1) to (5) apply, every person who was an original owner or
predecessor owner of the property by reason of having disposed of the
property before that time shall, for the purpose of applying those
subsections to or in respect of the person or any other person who after
that time acquires the property, be deemed after that time not to be an
original owner or predecessor owner of the property by reason of
having disposed of the property before that time.”
35
Successor Rules
• The CRA has generally taken the position that a partnership is not a
"person" for purposes of the ITA so that no successor election can
be made by a partnership and a partner for purposes of 66.7(7)
• Effect of CRA’s position is that the link between successored
resource pools at the partner level and the CRP distributed by the
partnership to the partner is eliminated and the successored
resource pools are stranded
• Thus, because the successor rules do not, according to the CRA,
apply, subsection 66.7(16) kicks in to deem there never to have
been an original owner in respect of the transferred property
36
Successor Rules
• Ultimately a question of statutory interpretation
“In order to determine whether a transaction is an abuse or misuse of the Act, a
court must first determine the "object, spirit or purpose of the provisions"... The
object, spirit or purpose can be identified by applying the same interpretive
approach employed by this Court in all questions of statutory interpretation—a
"unified textual, contextual and purposive approach"… While the approach is
the same as in all statutory interpretation, the analysis seeks to determine a
different aspect of the statute than in other cases. In a traditional statutory
interpretation approach the court applies the textual, contextual and purposive
analysis to determine what the words of the statute mean. In a GAAR analysis
the textual, contextual and purposive analysis is employed to determine the
object, spirit or purpose of a provision.” Copthorne (at para 69-70)
37
Successor Rules
• The purpose of para 66.7(10)(j) is to provide the
necessary tracing to the “owner” of the CRP (which is
the corporation itself)
• No language under successor rules or supporting
technical notes which provide that subs 66.7(16) should
override the specific deeming rules in subs 66.7(10)(j)
• To read in an override in subs 66.7(16) would remove all
meaning from the specific relieving rule in subs
66.7(10)(j) enacted to address partners and partnerships
under the successor rules
38
Successor Rules
• Subs 66.7(16) was enacted as a specific anti-avoidance
provision
• If a corporation is deemed to be the “owner” of a
property under para 66(10)(j) and the partnership is
wound-up, the corporation is still the owner following the
wind-up
• CRA positions on para 66.7(10)(j) and 66.7(16) are
inconsistent with the scheme, object and purpose of the
successor rules or the ITA generally
39
Deduction of Expenses
• Expenses incurred at partner level instead of at the
partnership level
• Partner is considered to be carrying on the business of
the partnership; therefore, under general principles,
expenses incurred in the course of the business are
deductible
“First, a taxpayer who complies with the provisions of the Act should not be
denied the benefit of such provision simply because the transaction was
motivated for tax planning purposes. Second, in the absence of evidence that
the transaction was a sham or abuse […] and where the words of the act are
clear, it is not the role of the Court to decide […] whether the taxpayer is
deserving of the deduction. Third, it is an error for the Court to ignore the legal
and commercial reality of a transaction.”
(Continental Bank)
40
Deduction of Expenses
• CRA has argued that the deduction should have been at
the partnership level and denied it at the partner level
• Accounting principles requiring “matching” of expenses
to revenues are not law and need not be followed for the
purposes of calculating income under the ITA, provided
that an alternative method presents an accurate picture
of income (Canderel)
41