ARCHIVED - Merger of Partnerships

What the "Archived Content" notice means for interpretation bulletins

NO: IT-471R

DATE: May 17, 1991

SUBJECT: INCOME TAX ACT
Merger of Partnerships

REFERENCE: Subsections 97(2) and 98(3) (also section 22, subsection 97(1) and the definition of "cost amount" in subsection 248(1), paragraphs 34(1)(a) and 102(a) and subparagraphs 14(5)(a)(iv) and 53(1)(e)(iv))

Application

This bulletin cancels and replaces Interpretation Bulletin IT-471 dated February 16, 1981. Current revisions are indicated by vertical lines.

Summary

This bulletin deals with two provisions of the Income Tax Act that may be used to merge two or more partnerships. It also deals with the tax treatment of goodwill, accounts receivable and work in progress when partnerships are merged.

Discussion and Interpretation

1. The Act does not specifically provide for the merger or amalgamation of partnerships. However, two or more partnerships may effectively achieve a form of merger if each partnership distributes all of its property to its partners in accordance with subsection 98(3) and each partner subsequently contributes this property to the new partnership in accordance with subsection 97(2). The application of subsections 98(3) and 97(2) is available only to "Canadian Partnerships" as defined in paragraph 102(a).

Distribution Pursuant to Subsection 98(3)

2. The rules provided by subsection 98(3) apply if a partnership ceases to exist and all of the partnership property is distributed to the partners. Each partner must have an undivided interest in each such property that is proportionately equal to the partner's undivided interest in each other property and the partners must jointly elect on form T2060. The Department will accept the apportionment of the undivided interest mentioned above among the partners on any basis determined by the partners provided that it is reasonable in the circumstances.

3. On the distribution of the partnership assets to the partners, the interest in the partnership of each partner is disposed of for proceeds deemed, by virtue of paragraph 98(3)(a), to be the greater of

(a) the adjusted cost base of the partner's interest in the partnership immediately before the distribution, and

(b) the money received by the partner plus the partner's proportion of the cost amount, as defined in subsection 248(1), to the partnership, immediately before the distribution, of all other property distributed.

The adjusted cost base of each partner's interest in the partnership as referred to in (a) above will include pursuant to subparagraph 53(1)(e)(iv) the partner's proportion of the partnership liabilities assumed by the partners on the dissolution of the partnership. Under paragraph 98(3)(f), the partnership will be deemed to have disposed of the property for proceeds equal to the cost amount of the property to the partnership immediately before its distribution.

4. The effect of 3 above is that a capital loss will never be incurred on the disposition of a partner's interest in the partnership pursuant to subsection 98(3), but a capital gain will be realized when the amount described in 3(b) above exceeds the amount described in 3(a) above. Where the amount described in 3(a) above exceeds the amount described in 3(b) above, this excess (hereinafter referred to as "the excess") may be allocated to the cost of the undivided interest in certain properties distributed to the partner pursuant to paragraphs 98(3)(c) and (d) as described in 5 and 6 below. This has the effect of deferring any capital loss until the partnership property is disposed of by the partner. Paragraph 98(3)(d) is repealed with respect to property described in 7 below received by a partner from a partnership.

5. The cost of the undivided interest to each partner in each partnership property that is a non-depreciable capital property is deemed by paragraph 98(3)(b) to be the partner's percentage of the cost amount to the partnership of that property plus the portion of "the excess", if any, that the partner allocates to that property. The amount of "the excess" allocated to any particular property cannot be such that the resulting cost will exceed the partner's percentage of the fair market value of the property immediately after its distribution.

6. Where paragraph 98(3)(d) continues to apply (see 7 below for a description of property precluded from the application thereof), the cost of the undivided interest to each partner in each partnership property that is a depreciable property or a non-capital property is deemed to be the partner's percentage of the cost amount to the partnership of that property plus that portion of "the excess", if any, that the partner chooses to allocate to that property.

The total amount that may be allocated to these properties is equal to the specified portion (see 8 below) of "the excess" that has not been allocated to non-depreciable capital properties as described in 5 above. Also, the amount allocated to a depreciable or non-capital property must be such that the resulting cost will not exceed the partner's percentage of the fair market value of the particular property immediately after its distribution.

7. An allocation under 98(3)(d) described in 6 above cannot be made where

(a) the property was acquired by the partnership after December 4, 1985 unless the property was acquired pursuant to an agreement in writing entered into before December 4, 1985,

(b) the property is received by a partner in satisfaction of an interest in the partnership acquired by the partner after December 4, 1985 unless the partnership interest was acquired

(i) pursuant to an agreement in writing entered into on or before December 4, 1985, or

(ii) from a person with whom the partner was not dealing at arm's length, where the interest in the partnership has not been acquired in an arm's length transaction after December 4, 1985, otherwise than pursuant to an agreement in writing entered into on or before December 4, 1985, or

(c) the property is received by a corporate partner in satisfaction of an interest in the partnership that was owned at a time when control of the corporation was acquired (otherwise than by virtue of an acquisition described in paragraph 256(7)(a)) after December 4, 1985 unless control was acquired pursuant to an agreement in writing entered into on or before December 4, 1985.

For purposes of (b) above, "arm's length" is to be determined without reference to paragraph 251(5)(b).

8. Where an allocation, under paragraph 98(3)(d), of "the excess" to a depreciable property or a non-capital property is not precluded by 7 above, the reference to "specified portion" in 6 above and 12 below is "one-half" for taxation years and fiscal periods ending prior to 1988 and "three-quarters" for taxation years and fiscal periods ending after 1987 except where the partner is

(a) an individual, in which case the reference is "two-thirds" for taxation years and fiscal periods ending after 1987 and before 1990,

(b) a Canadian-controlled private corporation throughout its taxation year, for taxation years ending after 1987 and commencing before 1990, the reference is the aggregate of

(i) that proportion of 1/2 that the number of days in the year that are before 1988 is of the number of days in the year,

(ii) that proportion of 2/3 that the number of days in the year that are after 1987 and before 1990 is of the number of days in the year, and

(iii)that proportion of 3/4 that the number of days in the year that are after 1989 is of the number of days in the year, or

(c) a corporation that was not a Canadian-controlled private corporation throughout its taxation year, for taxation years ending after 1987 and commencing before 1990, the reference is the aggregate of

(i) that proportion of 1/2 that the number of days in the year that are before July, 1988 is of the number of days in the year,

(ii) that proportion of 2/3 that the number of days in the year that are after June, 1988 and before 1990 is of the number of days in the year, and

(iii)that proportion of 3/4 that the number of days in the year that are after 1989 is of the number of days in the year.

9. Where a partner's percentage of the capital cost to the partnership of depreciable property of a prescribed class is greater than the deemed cost as described in 6 above, paragraph 98(3)(e) provides that the former amount is deemed to be the capital cost to the partner of the property and the difference is deemed to have been allowed to the partner as capital cost allowance in respect of the property.

10. A partner's "excess" need not be allocated to that partner's interests in the assets in the same manner as the other partners. Provided the requirements described in 5 and 6 above are met, the excess of each partner may be allocated in the most advantageous manner to each partner.

Contribution Pursuant to Subsection 97(2)

11. Where all of the partners of the new partnership jointly elect under subsection 97(2) on form T2059 in accordance with the rules in subsection 96(3), each may complete the rollover by contributing any capital property, a Canadian resource property, a foreign resource property, an eligible capital property or an inventory to which subsection 98(3) applied to the new partnership at the amounts determined under subsection 98(3). If the property is so contributed and each partner receives no consideration other than the partner's interest in the new partnership, the cost of that interest and the proceeds of disposition of the property contributed will be equal to the aggregate of the amounts determined under subsection 98(3) and no capital gain will result. If the liabilities of the original partnership which were assumed by a partner are transferred to the new partnership, the amount of those liabilities will be a reduction from the cost of the partner's interest in the new partnership. The property contributed to a partnership by a partner that cannot be or is not transferred under subsection 97(2) is deemed by subsection 97(1) to have been disposed of for proceeds equal to the fair market value of the property at the time of contribution and a gain or loss may result.

Goodwill and Eligible Capital Expenditure

12. Where paragraph 98(3)(d) applies (see 7 above), amounts may be allocated to goodwill, but the amount allocable forms part of the total amount that may be allocated as described in 6 above. Therefore, on the contribution of the goodwill to the new partnership at the amounts determined under subsection 98(3), pursuant to subsection 97(2), the new partnership will have an eligible capital expenditure which would not exceed the cost amount of the goodwill to the old partnership plus the specified portion (see 8 above) of the sum of "the excesses" allocated by the individual partners. The cumulative eligible capital of the new partnership will be equal to three-quarters of this eligible capital expenditure if the transfer is made after the commencement of the partnership's first fiscal period commencing after 1987 and one-half of the eligible capital expenditure if the transfer is made before that time.

13. Under paragraph 98(3)(f), eligible capital property is deemed to have been disposed of at its cost amount to the partnership. Under subsection 248(1), the cost amount of eligible capital property is the balance in the cumulative eligible capital account. However, pursuant to subparagraph 14(5)(a)(iv), the partnership will be deemed to have received only a portion of that amount in computing its cumulative eligible capital. Accordingly, the partnership will have an immediate write-off of the remaining portion of the cumulative eligible capital account by virtue of subsection 24(1) on ceasing to carry on business.

Accounts Receivable

14. When accounts receivable, other than loans or lending assets, are distributed to the partners under subsection 98(3), the distribution would take place at the cost amount of the amounts receivable to the partnership. This is defined in subsection 248(1) to be their face amount. Consequently, no reserve for doubtful accounts could be claimed by the partnership in the year of disposition. However, when these accounts receivable are contributed to the new partnership under subsection 97(2), the elected amount for the transfer can not exceed the fair market value of the accounts receivable. The fair market value would be limited to the face amount of the accounts receivable less an appropriate discount to reflect their collectibility. To resolve this problem, the Department will accept a sale from each merging partnership to the new partnership of its accounts receivable. The selling price should be face value of the accounts less a reasonable reserve for doubtful accounts, and an election under section 22 should be filed (see the current version of IT-188). The merging partnerships would each take back a note receivable from the new partnership for the elected amount and these notes would then be distributed to the partners under subsection 98(3), with each partner then contributing the partner's undivided interest in each note to the new partnership under subsection 97(2).

Work in Progress

15. When partnerships carrying on a business that is the professional practice of an accountant, dentist, lawyer (including a notary in the province of Quebec), medical doctor, veterinarian or chiropractor merge in the manner set out in 1 above and work in progress had been excluded from their incomes by virtue of 34(1)(a), the cost amount to the partnership of that work in progress immediately before its distribution to the partners will be "nil". The cost of each partner's undivided interest in the work in progress is, therefore, "nil" plus the amount of the excess allocated to it by the partner as described in 6 above. The resulting amount may then be contributed to the new partnership pursuant to 97(2) and expensed in its first taxation year whether or not the election provided by paragraph 34(1)(a) is made by the new partnership.

General

16. Partnerships may contribute property to a new partnership and make the election provided by subsection 97(2). (See the current version of IT-413.) Two or more partnerships may, therefore, effectively merge to form a new partnership if they jointly elect on form T2059 pursuant to subsection 97(2). In this situation, the interests of the partners of the original partnerships would be represented by their particular partnership's interest in the new partnership to which its property has been contributed.