Limited Partnership Tax Shelters & At-Risk Rules
What are the At-Risk Rules?
The at-risk amount rules (at-risk rules) are used by Canada Revenue Agency (“CRA”) to counter the abusive deduction of partnership losses.
Limited partnerships are commonly utilized in tax shelter arrangements. This is primarily because the law has established that the income, gain and losses of partnerships “flow-through” the partnership to be taxed in the hands of the partners. Accordingly, “artificial” or legitimate business losses of the partnership can be claimed by the limited partners to reduce taxable income.
A limited partnership consists of a general partner and limited partners. According to sections 2, 7 and 9 of Ontario’s Limited Partnerships Act, RSO 1990, c L.16, the general partner is subject to full liability and limited partners are liable up to the amount of their cash and property contributions to the partnership or the amount the limited partner commits to contribute. The limited partner is a passive investor who does not provide services to the partnership. Each province has similar limited partnership legislation.
Partnership Interests
Subsection 237.1(1) of the Income Tax Act, RSC 1985, c 1 (5th Supp) defines a “tax shelter” component as an “an amount, or a loss in the case of a partnership interest, represented to be deductible in computing the person’s income for the particular year or any preceding taxation year…”. A “tax shelter investment”, defined in subsection 143.2(1) of the Income Tax Act, can include a “taxpayer’s interest in a partnership [that] entitles the taxpayer, directly or indirectly, to a share of the income or loss of a particular partnership…”.
Per subsection 143.2 (1), investing in a partnership that entitles a taxpayer to any business losses (that could be used to reduce your taxable income) may be deemed a tax shelter investment and therefore subject to scrutiny and CRA audit.
At-Risk Amount Rules
In an effort to curb the abuse of streaming losses through partnerships to reduce taxable income, the at-risk amount rules for limited partnerships were introduced to prevent the deduction of losses beyond the partner’s actual capital at risk of loss. At-Risk Amount is defined in subsection 96(2.2) of the Income Tax Act and the At-Risk Adjustment amount is defined at 143.2(2)).
If after calculating the at-risk amount there are losses in excess of the at-risk amount, that amount is deemed a limited partnership loss deductible in future years up to the respective at-risk amount, per paragraph 111(1)(e) of the Income Tax Act.
At-Risk Amount Calculation
The at-risk amount calculation is complicated but in general begins with the adjusted cost base of the limited partnership interest and then the addition of any income allocated from the partnership. This is followed by the addition of amounts related to Canadian resource property minus any amount the partner may owe the partnership plus any amount or benefit to the partner that may reduce the impact of any loss to the partnership interest (Income Tax Act paragraphs 96(2.2)(a), 96(2.2)(b), 96(2.2)(b.1), 96(2.2)(c), 96(2.2)(d), 96(2.2)(e)).
In simple terms, the at-risk amount legislation restricts a limited partner’s available loss for deduction, distributed from the partnership, to the capital that was genuinely at risk of loss due to the taxpayer’s investment in the partnership.
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