Canada: Budget 2018: A Blast From The Past – Tiered-Partnership Trap Reinstated

Budget 2018 proposes to tighten the so-called "at-risk" rules in the Income Tax Act (Canada) (the "Tax Act") to limit the losses that may flow through a tiered limited partnership structure.  The proposed amendments have been introduced to overrule recent case law, and to bring the law into line with the administrative practices of the Canada Revenue Agency (the "CRA") that prevailed prior to 2016.

Background

The "At-Risk" Rules

The "at-risk" rules effectively restrict the losses allocated by a partnership to a limited partner that may be deducted by the limited partner in computing its taxable income.  The Tax Act generally provides that a limited partner may not deduct losses allocated to it by a limited partnership to the extent that the losses exceed the amount that the limited partner has invested in the partnership.

Losses allocated by a limited partnership that may not be deducted by virtue of the "at-risk" rules are generally characterized as "limited partnership losses", which may subsequently be applied by the limited partner to offset income that is allocated by the particular limited partnership in the future. 

However, difficulties arise in applying the "at-risk" rules to a limited partner that is, itself, a partnership (an "Upper-Tier Partnership").  The CRA historically took the position that losses of a limited partnership (a "Lower-Tier Partnership") that were allocated to an Upper-Tier Partnership, but could not be deducted because the losses exceeded the Upper-Tier Partnership's "at-risk" amount in respect of the Lower-Tier Partnership, were also precluded from being able to be carried forward as a "limited partnership loss" and applied to offset income in future years.[1]  The CRA's position was predicated on the notion that, under Canadian law, partnerships are not separate juridical entities, but simply relationships that subsist between two or more persons carrying on business in common.  The Tax Act recognizes the unique character of a partnership and does not generally treat a partnership as a separate taxpayer.  The section of the Tax Act that governs the future application of limited partnership losses (paragraph 111(1)(e) of the Tax Act) provides that only a "taxpayer" may deduct limited partnership losses.  Accordingly, in the CRA's view, because an Upper-Tier Partnership is not a "taxpayer" for the purposes of section 111 of the Tax Act, neither an Upper-Tier Partnership, nor its partners, are permitted to utilize limited partnership losses in the future.

Recent jurisprudence overruled the CRA's long-standing administrative position on the application of the "at-risk" rules to Upper-Tier Partnerships.  In Green v.The Queen,[2] the Tax Court of Canada concluded that the "at-risk" rules do not preclude a loss allocated by a Lower-Tier Partnership from being deducted when computing the income of the Upper-Tier Partnership.  The Court undertook a textual, contextual and purposive analysis of the "at-risk" rules to conclude that Parliament did not intend for the "at-risk" rules to permanently preclude an Upper-Tier Partnership (and its partners) from being able to avail themselves of the benefit of a limited partnership loss in future taxation years.  The Federal Court of Appeal subsequently upheld the judgment of the Tax Court of Canada.  

In contesting the taxpayer's appeal in Green, the Government asserted that if an Upper-Tier Partnership was permitted to deduct partnership losses that exceeded its "at-risk" amount in respect of the Lower-Tier Partnership, the "at-risk" rules could effectively be circumvented.  In this regard, the Government expressed particular concern that taxpayers could form an Upper-Tier Partnership to hold limited partnership interests in several Lower-Tier Partnerships, and thereafter use the losses allocated from one Lower-Tier Partnership to offset income allocated from another Lower-Tier Partnership without regard to the amount "at risk" in any of the Lower-Tier Partnerships.  The Government further argued that the "at-risk" rules could be circumvented entirely if one were to establish a general partnership to serve as the limited partner of a Lower-Tier Partnership. 

Notwithstanding the potential validity of the foregoing concerns, the Federal Court of Appeal expressly concluded that such possibilities did not outweigh the negative ramifications of interpreting the "at-risk" rules in the manner advocated by the Government.  The Federal Court of Appeal instead held that Parliament could amend the Tax Act if it felt that changes were warranted.

Accepting the Court's Invitation

In Budget 2018, the Government responded to the Federal Court of Appeal's invitation in Green by proposing amendments that will effectively preclude an Upper-Tier Partnership (or its partners) from ever being able to utilize losses allocated by a Lower-Tier Partnership that exceed the Upper-Tier Partnership's relevant "at-risk" amount.  Under the proposed amendments, a loss precluded by the "at-risk" rules from being deducted in computing the income of an Upper-Tier Partnership will effectively be deemed never to have been incurred by the Upper-Tier Partnership.  Correspondingly, the proposed amendments confirm that the adjusted cost base of the Upper-Tier Partnership's interest in the Lower-Tier Partnership will not be reduced by the amount of the denied loss.  The Government asserted in Budget 2018 that the purported adjustment to the computation of the adjusted cost base of interests in Lower-Tier Partnerships will have the effect of reducing any capital gain arising on a subsequent disposition of interests in such Lower-Tier Partnerships (or increasing the loss that would be triggered on such dispositions), thereby yielding an appropriate result from a tax policy perspective.  However, despite the Government's assertions, the proposed amendments do not address the timing difference between being able to apply a limited partnership loss against future income allocated by a Lower-Tier Partnership and utilizing a loss that may only arise on the ultimate disposition of interests in the Lower-Tier Partnership.  Similarly, the proposed amendments fail to recognize the practical reality that non-capital losses allocated from a Lower-Tier Partnership may generally be applied against all forms of income of an Upper-Tier Partnership in contrast to the capital losses that would arise on a disposition of an interest in a Lower-Tier Partnership, which may only be applied to offset capital gains incurred by an Upper-Tier Partnership.

The proposed amendments also have a retrospective element.  Under the proposed amendments, any non-capital loss or limited partnership loss of a partner of an Upper-Tier Partnership attributable to prior allocations from a Lower-Tier Partnership will effectively be reversed to accord with the proposed amendments.  In effect, the proposed amendments will reinstate the Government's historical administrative position vis-à-vis the application of the "at-risk" rules in the context of tiered partnership structures.  However, the retrospective element of the proposed amendments will not affect the prior application of losses in respect of taxation years that ended prior to February 27, 2018.

The proposed amendments will re-establish a trap inherent in the "at-risk" rules as they apply to tiered-partnership structures.  While the proposed amendments address certain of the concerns raised by the Government in Green, the amendments extend further and effectively penalize partners of Upper-Tier Partnerships that would, in the absence of the Upper-Tier Partnership, have been permitted to apply limited partnership losses arising from allocations from a Lower-Tier Partnership against future income allocated by the Lower-Tier Partnership. 

Investors in tiered-partnership structures would be well advised to review the projected income and cash flow positions of all Lower-Tier Partnerships and take steps, including deferring any discretionary deductions, so as to minimize the allocation of losses through the structure that may be permanently denied under the proposed amendments.

The proposed amendments will apply, when enacted, to taxation years of a partner that end on or after February 27, 2018.

Footnotes

[1] See, for example, CRA Document No. 2004-0107981E5 (25 February 2005).

[2] 2016 DTC 1018 (TCC), aff'd 2017 DTC 5068 (FCA) ("Green").

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2018

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions