Partnerships and Tax Law
A Combination of Legislation and Common Law
As outlined in the decision of the Supreme Court of Canada (SCC) in Continental Bank Leasing Corp. v. Canada, 1998 CanLII 794 (SCC), [1998] 2 SCR 298, the law relevant to the taxation of partnerships is drawn from multiple sources including provincial legislation and case law.
Ontario’s Partnerships Act, RSO 1990, c P.5 defines a partnership, at section 2, as:
the relation that subsists between persons carrying on a business in common with a view to profit, but the relation between the members of a company or association that is incorporated by or under the authority of any special or general Act in force in Ontario or elsewhere, or registered as a corporation under any such Act, is not a partnership within the meaning of this Act.
Limited Partnership
Per Ontario’s Limited Partnerships Act, RSO 1990, c L.16, a limited partnership consists of a general partner and limited partners. The general partner is subject to full liability and limited partners are liable up to the amount of their cash and property contributions or the amount the limited partner commits to contribute. The limited partner is a passive investor who does not provide services to the partnership.
A Partnership is Not a Distinct Legal Entity and not a Taxpayer
For tax purposes, a partnership is not a distinct legal entity and not a taxpayer. However, for the purpose of the income, gain and loss calculations of the Income Tax Act, RSC 1985, c 1 (5th Supp), it is treated as a separate person and once determined, the income, gain and losses are distributed to the partners to be assessed in their hands.
The majority of legislation related to the taxation of the income of partnerships can be found in Subdivision J of Division B, “Computation of Income”. “Subdivision J “Partnerships and their Members” comprises sections 96 to 103. A partnership is considered a flow-through entity as the tax consequences flow through to the partners.
Tiered or Stacked Partnership
A tiered or stacked partnership is defined at subsection 102(2) of the Income Tax Act and refers to when a partnership owns a partnership interest in another partnership:
for the purposes of subdivision j of Division B of Part I of the Act (relating to partnerships and their members), ““a reference to a person or a taxpayer who is a member of a particular partnership shall include a reference to another partnership that is a member of the particular partnership.””
The Common Law Test - Continental Bank Leasing Corp. v. Canada, 1998 CanLII 794 (SCC), [1998] 2 SCR 298
As outlined in the decision of the Supreme Court of Canada (SCC) in Continental Bank Leasing Corp. v. Canada, 1998 CanLII 794 (SCC), [1998] 2 SCR 298, the law relevant to the taxation of partnerships is drawn from multiple sources including provincial legislation and case law.
The facts in Continental regarded transactions related to the winding up of the Continental Bank of Canada and a subsidiary Continental Leasing. At the centre of the transaction was a partnership. The SCC was tasked with deciding if the partnership was valid and therefore a favourable rollover was valid.
The analysis began with a consideration as to whether the respective transactions were a sham. The Tax Court of Canada and Federal Court of Appeal both held that the related transactions did not amount to a sham, partially defined in Stubart Investments Ltd. v. The Queen, 1984 CanLII 20 (SCC), [1984] 1 S.C.R. 536 as “a transaction conducted with an element of deceit so as to create an illusion calculated to lead the tax collector away from the taxpayer or the true nature of the transaction…”. Following, it was necessary to examine the documents establishing the legal framework and determine their legitimacy.
Also, according to the SCC at paragraph 21 of Continental, the:
indicia of a partnership include the contribution by the parties of money, property, effort, knowledge, skill or other assets to a common undertaking, a joint property interest in the subject-matter of the adventure, the sharing of profits and losses, a mutual right of control or management of the enterprise, the filing of income tax returns as a partnership and joint bank accounts…The remaining question to answer was whether there was a business carried on in common with a view to a profit.
The Partnership Act, section 1, defines business as including “every trade, occupation and profession.” In Continental, the SCC determined that the activities of the Appellant constituted a business. Even though the Respondent argued that during the period at issue business activity did not take place, the SCC found that a business was established in general. There was evidence that business activity existed prior and the existence of a valid partnership did not depend on the creation of a new business.
The “in common” component meant that more than one person must have carried on the business. The SCC looked to the respective agreement which demonstrated participation by multiple persons. This was most evident in the fact that multiple persons were bound by the agreement with the power to bind the firm. In addition, the facts established that the persons “held themselves out as partners.”
Upon concluding that the business was carried on with a view to a profit, the SCC also referred to the partnership agreement which “provided for the distribution of the profits from the leasing business”. The SCC found that contradictory evidence was lacking and even if profit-making was an “ancillary objective” it was still relevant.
Continental Bank Leasing Corp. v. Canada, 1998 CanLII 794 (SCC), [1998] 2 SCR 298
Stubart Investments Ltd. v. The Queen, 1984 CanLII 20 (SCC), [1984] 1 S.C.R. 536
SpenceDrake Tax Law