Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: In a husband and wife equal-sharing partnership, the husband received a "salary" even though the partnership incurred a loss for the fiscal period before and after allowing the payment to the member. The wife earned other income from what appeared to be full employment outside the partnership. (1) Should the loss be allocated to the members after deducting the amount of the salary? (2) Is subsection 103(1.1) applicable?
Position: (1) No. (2) subsection 103(1.1) appears to be applicable.
Reasons: The "salary" is not a deductible expense and the loss (subject to the application of subsection 103(1.1)) should be allocated between the members before any deduction of the payment. The payment would be a distribution representing the member's share of income of the partnership if there is sufficient income earned by the partnership. If there is no income, the payment is a withdrawal of capital of the partnership. Paragraphs 96(1)(f) and (g) provide that the income or loss, respectively, of a partnership from a particular source or sources from a particular place be the income or loss of the member from that source or place, to the extent of the member's share thereof.
Notwithstanding the equal-sharing provision of any partnership agreement, the members being husband and wife are not dealing at arm's length. Secondly, if the equal profit/loss division is not otherwise based on a greater investment input of capital by the wife, such division would be unreasonable pursuant to subsection 103(1.1) based on the apparent lack of work performed by her in the partnership.
May 23, 2002
XXXXXXXXXX TAXATION SERVICES HEADQUARTERS
OFFICE Denise Dalphy, LL.B.
Director (613)-941-1722
Attention: XXXXXXXXXX
Technical Advisor
2002-013279
"Salaries" Received by a Member of a Partnership
This is in reply to your e-mail transmission of April 3, 2002 involving a particular situation concerning the above-captioned subject.
Our understanding of the situation is as follows:
1. A husband and wife are the only members of a farming partnership. The husband works full-time on the farm while the wife earns off-farm employment income ("other income") of $30,000 annually in respect of which she works 10 hours a day. The partnership agreement provides that the husband receives a "salary" of $20,000 annually.
2. After deduction of the husband's "salary" of $20,000, the partnership incurs a loss of $50,000 for the year, which is allocated equally between the husband and wife. In this case, the wife claims a reduction of her other income of $30,000 by her share of the partnership loss of $25,000 while the husband claims a $5,000 loss ($25,000 loss less $20,000 "salary") to report for income tax purposes.
3. You request our views regarding the use of subsection 103(1.1) or 96(1) of the Income Tax Act for the appropriate assessing action to deny the deduction of the "salary" of $20,000 in computing the income of the partnership.
(I) It is presumed that the particular partnership is a general partnership.
(II) Where an amount has been distributed to a partner in any form, the amount can only be paid as the partner's share of the partnership's income or as a withdrawal from the partnership's capital, and not as a deductible business expense, regardless of whether the partnership agreement described it as "salary" (see, for example, Understanding the Taxation of Partnerships by Peter McQuillan). Accordingly, where a distribution made to a partner exceeds the partner's share of the allocable partnership income, the excess would be considered to be a withdrawal from capital.
(III) With regard to the particular situation that you described, the loss of the partnership for the particular fiscal period is $30,000, not $50,000. The full payment of the $20,000 "salaries" made to the husband would amount to a withdrawal from capital, since there was no partnership income to be allocated for the year. Subject to our comments in paragraph (IV) below, the partnership loss of $30,000 would be allocated $15,000 to the husband and $15,000 to the wife which amounts would reduce the ACB of their partnership interests under subparagraph 53(2)(c)(i) of the Act. The $20,000 payment out of capital would also reduce the ACB of the husband's partnership interest under subparagraph 53(2)(c)(v) of the Act.
(IV) Notwithstanding that the partnership agreement provides for equal division of the partnership's income or loss between the husband and wife, it appears that such equal division may not be reasonable in the circumstances and that subsection 103(1.1) of the Act would apply to reallocate any such equal allocation of income or loss (unless, for example, it was determined that the equal allocation of income or loss was based on a greater investment of capital by the wife in the partnership). Subsection 103(1.1) of the Act may apply for the following reasons:
(a) the husband and wife, as members of the partnership, are acting at non-arm's length, and
(b) with the wife spending 10 hours daily on outside employment, the facts would not seem to support the proposition that she spends an equal amount of time, or performs equal work, in the partnership as the husband.
(V) For greater certainty, it should be noted that, in the case of a general partnership, a member's share of the losses, withdrawals and other distributions from the partnership may be subject to a capital gain as a result of a negative ACB of the member's partnership interest, at the point when (i) the partnership would be regarded as having ceased to exist pursuant to subsection 98(1) of the Act or (ii) the member holds a residual interest (if the member has otherwise ceased to be a member) in the partnership under subsection 98.1(1) of the Act.
We hope our comments will be helpful to you.
Steve Tevlin
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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