Income Tax Folio S4-F16-C1, What is a Partnership?

Series 4: Businesses

Folio 16: Partnerships

Chapter 1: What is a Partnership?

Summary

The Act does not define a partnership but it recognizes the existence of partnerships and sets out the income tax consequences of transactions involving partnerships and their members.  Section 96 provides that the income of a member of a partnership is computed as if the partnership were a separate person resident in Canada. The purpose of this Chapter is to outline the factors that are relevant to determining whether a partnership exists.

Although the Act sets out a number of rules that apply to limited partnerships, which are a special type of partnership provided for under provincial law, this Chapter does not discuss the factors related to determining whether a limited partnership exists. Nonetheless, the discussion in this Chapter is relevant to limited partnerships insofar as a limited partnership cannot be established unless a partnership exists.

This Chapter also discusses some of the factors that indicate the existence of a joint venture, which is an arrangement that has attributes similar to a partnership.

The Canada Revenue Agency (CRA) issues income tax folios to provide technical interpretations and positions regarding certain provisions contained in income tax law. Due to their technical nature, folios are used primarily by tax specialists and other individuals who have an interest in tax matters. While the comments in a particular paragraph in a folio may relate to provisions of the law in force at the time they were made, such comments are not a substitute for the law. The reader should, therefore, consider such comments in light of the relevant provisions of the law in force for the particular tax year being considered.

Table of contents

• Discussion and interpretation
  • Provincial definition of a partnership
  • Common law jurisdictions
  • Determining the existence of a partnership
  • Characteristics of a partner
  • Quebec partnerships
  • Joint ventures
• Application
• Reference

Discussion and interpretation

Provincial definition of a partnership

1.1 Each of the common law provinces or territories has a partnership statute that defines the term partnership.  Similarly, the Civil Code of Quebec defines a contract of partnership.

1.2 In Continental Bank Leasing Corp. v. Canada, [1998] 2 SCR 298, 98 DTC 6505, and later in Backman v. Canada , [2001] 1 SCR 367, 2001 DTC 5149, and Spire Freezers Ltd. v. Canada , [2001] 1 SCR 391, 2001 DTC 5158, the Supreme Court of Canada confirmed that for purposes of the Act the existence of a partnership must be determined by reference to the partnership law of the relevant province or territory, and this is the case even when dealing with a partnership established in a jurisdiction outside Canada.

1.3 In the case of a foreign entity or arrangement, the CRA takes the following two-step approach to determine whether such entity or arrangement should be treated as a partnership for Canadian tax purposes:

i. Determine the characteristics of the foreign business entity or arrangement by reference to any relevant foreign law and the terms of any relevant agreements relating to the entity or arrangement; and

ii. Compare the characteristics of the foreign business entity or arrangement to the characteristics of business entities or arrangements under Canadian law in order to see which Canadian entity or arrangement it most fundamentally resembles.

If the foreign entity or arrangement more fundamentally resembles a partnership arrangement under Canadian law than a corporation, trust or co-ownership, it will be treated as a partnership for Canadian tax purposes.

Common law jurisdictions

1.4 Under Canadian provincial and territorial common law statutes, a partnership is defined as the relation (or relationship) that subsists (or exists) between persons carrying on a business in common with a view to profit.

1.5 These statutes generally also provide that:

• an incorporated company or association is not a partnership;
• a joint tenancy, tenancy in common, joint property, common property or part ownership does not, by itself, create a partnership as to anything so held or owned, whether the tenants or owners do or do not share any profits made by the use thereof; and
• the sharing of gross returns does not by itself create a partnership, whether the persons sharing such returns have or have not a joint or common right or interest in any property from which or from the use of which the returns are derived.

Determining the existence of a partnership

1.6  Whether a partnership exists is a mixed question of fact and law. The fact that a partnership is formally registered does not necessarily mean that a partnership actually exists. In partnership law, a declaration of this type does not prevail over the actual facts of a situation (see ¶1.10).

1.7 In Continental Bank, Backman and Spire Freezers, the Supreme Court of Canada used the provincial and territorial partnership statutes to identify three fundamental criteria for determining whether a partnership exists in the common law provinces. To conclude that a partnership exists in the common law provinces, the Court affirmed that one must demonstrate that two or more persons are:

• carrying on business;
• in common;
• with a view to profit.

Carrying on business

1.8  The determination of whether persons are carrying on business for purposes of the definition of a partnership is a question of fact and law. This issue was critical in the Supreme Court of Canada’s decisions in Spire Freezers and Backman. In Backman, the Supreme Court of Canada held that there was no partnership since there was no business carried on.  This same court decided in Spire Freezers that there was a partnership. The facts in that case were distinguished from those in Backman in terms of the degree of effort required of the appellants and expended by them in the management of the partnership.

In common

1.9  In Backman, the Supreme Court of Canada held that the common purpose required for establishing a partnership will usually exist where the parties have entered into a valid partnership agreement setting out their respective rights and obligations as partners. However, even if a partnership agreement and other documentation indicate an intention to form a partnership, the fundamental criteria of a valid partnership must still be met in order to conclude that one exists.

1.10 In determining whether a business was carried on in common, the Supreme Court of Canada held in Continental Bank and Backman that the authority of any partner to bind the partnership is a relevant factor. However, the fact that the management of a partnership rests with a single partner does not mandate the conclusion that the business was not carried on in common. This differs from the fundamental requirements of a joint venture. As noted in ¶1.20(b), parties to a joint venture must have a right of mutual control and management.

A view to profit

1.11 In Backman, the Supreme Court of Canada held that determining whether a view to profit exists requires an enquiry into the intentions of the parties entering into the particular arrangement.

Elements of a partnership

1.12 In Continental Bank, the Supreme Court of Canada listed some of the elements of a partnership in the common law jurisdictions which included:

• 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;
• joint bank accounts; and
• correspondence with third parties.

Overall approach

1.13 In Continental Bank, the Supreme Court of Canada held that the existence of a partnership depends on the true contract and intention of the parties as determined by examining all of the facts of the case. In Backman, the Supreme Court of Canada confirmed this principle stating that an enquiry must be made into whether the objective, documentary evidence and the surrounding facts, including what the parties actually did, are consistent with a subjective intention to carry on business in common with a view to profit.

1.14 In Backman, the Supreme Court of Canada recommended a practical approach in determining whether a partnership exists. The court stated that whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances.

Characteristics of a partner

1.15 Except in certain cases, such as limited partnerships and limited liability partnerships, common law partners are generally jointly and severally liable for any debts that arise while carrying out the business of the partnership. Where the participants in a business arrangement are not jointly and severally liable for the debts of the business, it generally indicates that a partnership does not exist.

1.16 The type and extent of a person's involvement in the business is generally relevant in determining whether that person is a partner. Limited partners in a limited partnership are an exception to this rule.

1.17 In Backman and Spire Freezers, the Supreme Court of Canada held that in order for a person to become a new partner of a valid and pre-existing partnership, that person and the existing members of the partnership must satisfy the essential elements of a valid partnership at the time of the entry of the new partner. That is, the new partners along with the partners of the pre-existing partnership must be carrying on business in common with a view to profit.

Quebec partnerships

1.18 Article 2186 of the Civil Code of Québec defines a contract of partnership to be “a contract by which two or more parties, in a spirit of cooperation, agree to carry on an activity, including the operation of an enterprise, to contribute thereto by combining property, knowledge or activities and to share among themselves any resulting pecuniary profits.”

Joint ventures

1.19 As with partnerships, the term joint venture is not defined in the Act. Whether a joint venture exists is a mixed question of fact and law which must be determined by reference to the law of the particular province or territory.

1.20 In Woodlin Developments Ltd. v. MNR, [1986] 1 C.T.C. 2188 (TCC), 86 DTC 1116, the Tax Court of Canada identified three distinctive requirements to conclude that a joint venture exists. There must be:

a) a joint property interest in the subject matter of the venture;
b) a right of mutual control and management of the enterprise; and
c) a limitation of the objective of the business to a single undertaking or a limited number of undertakings.

1.21 Since a joint venture is not recognized as a taxpayer under the Act, a joint venture cannot have its own fiscal period or claim capital cost allowance, among other things.

1.22 A joint venture agreement, whereby two or more persons agree that each provides their own property, performs a specific task and receives a specific division of profits from such a task, may be considered a partnership as regards such profits. However, if the property is not held under joint tenancy or tenancy in common, it is not considered to be partnership property. This means that the capital cost allowance provisions relating to partnership property would not apply.

Application

This updated Chapter, which may be referenced as S4-F16-C1, is effective November 26, 2015.

When it was first published on May 5, 2015, it replaced and cancelled Interpretation Bulletin IT-90, What is a Partnership?

Any technical updates from the cancelled interpretation bulletin can be viewed in the Chapter History page.

Except as otherwise noted, all statutory references herein are references to the provisions of the Income Tax Act, R.S.C., 1985, c.1 (5th Supp.), as amended and all references to a Regulation are to the Income Tax Regulations, C.R.C., c. 945, as amended.
 
Links to jurisprudence are provided through CanLII.

Income tax folios are available in electronic format only.

Reference

Section 96