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Much has been written recently with respect to partnerships in light of the substantial changes resulting from the 2011 Federal Budget. In short, the Budget effectively imposes an anti-deferral mechanism in situations where a corporate partner is entitled to 10% (including interests held by related parties) or more of the partnership’s income and the partnership has a taxation year-end that varies from its corporate partner.
In short, the previous (up to 364 day) tax-deferral that was available to corporate partners on partnership income from a staggered year-end, will no longer be available. Transitional relief is available to ensure that the potential two-year’s taxable income that will result for certain corporate partners under the revised rules can be mitigated through a five-year reserve period. As a result of this, corporate partners will have a more substantial income tax liability over the upcoming five years and the reporting requirements could amount to a substantial head-ache for many business owners.
The question is: are partnerships still a viable business structure in Canada?
The answer is yes: and it depends on the circumstances.
Partnerships have been popular in the real-estate development industry for many years due to the high degree of flexibility offered to the partners but have also been equally appropriate for other industries.
First, a partnership itself is not a separate taxpayer and income (or loss) computed at the partnership level is allocated to the partners based on the partnership agreement. In industries where joint projects are common, this allows partners to utilize tax losses that more commonly arise in the early years of a business venture by deducting certain losses and costs against other income of the partner. The partnership allows for deduction of partnership losses and eliminates the potential for losses to become “trapped” in a corporation where they can only be used against future income earned within the company.
Partnerships also allow a business to have ease of access to ownership for future business partners. Where circumstances are such that partners are likely to come and go from the business over its lifetime, the partnership allows for entry of new partners and exit of old partners to occur without the need for more complicated corporate “estate-freezes” and without the need to continually re-value the partnership on every entry and exit. The partnership structure simply put, allows business and transactions to occur at an ownership level on commercially reasonable terms without the need for complex corporate planning and share transactions.
In addition, partnerships can still be utilized to complete transactions that are similarly available to corporations. Taxpayers are permitted to “roll” certain properties to partnerships on a tax-deferred basis. Partnerships can also conceptually be used to complete “estate freezes” or similar transactions that could convert equity and ownership from growth-valued units to fixed value units with a stated return. Although sometimes hotly contested by CRA, this allows for potential income splitting opportunities and ensures that the partnership vehicle is still viable for business transitions.
Also, partners don’t find themselves up against as many specific anti-avoidance rules as shareholders of similar projects. Notably, partners are not exposed to as many anti-income splitting “attribution” rules as shareholders and partners are not subject to the non-arm’s length anti-surplus stripping rules that sometimes apply to shares. Finally, partnerships as a business structure can, if effectively structured, be utilized to multiply a partner’s access to the small business with tiered corporate ownership which can give an ownership group powerful access to lower corporate “small business” tax rates crucial to growing businesses.
And despite the recent Federal Budget changes to the partnership anti-deferral tax rules, in situations where a partnership business is in growth-mode with increasing income, a deferral is still available because the new income accrual rules are always based on prior-year partnership results.
Although some of the strategies with respect to partnerships could be seen as aggressive in nature by the CRA, with the right intentions and advice they can be implemented while maintaining full compliance with the Income Tax Act. A business structure should never be created or structured for tax reasons alone, however, careful planning can ensure that taxpayers maintain full access to tax benefits that are available. Even in the face of new rules, partnerships continue to allow business owners to have access to significant commercial, business and tax-related benefits and deferrals that are not available with corporate vehicles alone.
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