Canada: Dissolution Of A Partnership – Income Tax Consequences – Toronto Tax Lawyer Analysis

Last Updated: October 4 2018
Article by David Rotfleisch

Introduction – Dissolution of a Partnership

Businesses can take many different forms under Canadian law. Sole proprietorships, corporations, partnerships, and trusts are among the most common types of legal forms for Canadian Businesses. Some businesses have a legal structure which is a combination of the above mentioned forms. The choice of legal form has significant tax and non-tax consequences for the business and its investors. In particular, the legal form chosen for a business will affect the tax consequences for investors when that business is shutdown. The focus of this article is on the tax consequences that arise when businesses structured as partnerships shut down.

A partnership is the relationship which subsists between persons carrying on a business in common with a view to profit. As such, a partnership is not treated by the law as a separate entity existing apart from its partners in the way that corporations are separate from their investors. While the partnership exists, its profits and losses are attributed to its partners for Canadian income tax purposes. The partnership itself does not pay Canadian income tax directly. When the partners cease to be carrying on a business in common with a view to profit, the partnership will have ceased to exist for most legal purposes. When the property of a dissolved partnership is distributed to the partners, it is treated as having been disposed of for fair market value at the time of the distribution, which can result in tax owing by the partners. If certain specific conditions are met, property can be distributed by a dissolved partnership on a tax deferred basis.

Dissolution of a Partnership – Deemed Existence of the Partnership

The law of partnerships falls under provincial jurisdiction, although the requirements to set up a partnership are similar in all of the common law provinces. When the factual conditions that give rise to a partnership, namely that persons are carrying on a business in common for a view to profit, cease to obtain, the partnership no longer exists for the purposes of provincial commercial law. These factual conditions can cease to exist before the partnership is fully wound up. For example, the business can stop operating before the remaining partnership property is distributed.

Subsection 98(1) of the Canadian Income Tax Act addresses this issue by deeming the partnership to continue to exist until all of the partnership's property has been distributed to those legally entitled to receive it. Similarly, the persons who were partners at the time the partnership ceased to exist are deemed to continue to be partners and to own an interest in the partnership. This means that partners continue to recognize their share of the partnership's income or loss for its fiscal period in the period after the partnership ceases to exist but before it is fully wound up. Additionally, the partnership is deemed to have a fiscal period which ends immediately before the partnership ceases to exist for the purposes of provincial law, though a partner who is an individual can elect under subsection 99(2) of the Canadian Income Tax Act to compute his or her income as if the partnership's fiscal period was unaffected by dissolution.

Dissolution of a Partnership – Tax Consequences of Distributing Partnership Property

When a partnership distributes partnership property to a person who was a partner immediately before the time of the distribution, the partnership is deemed to have disposed of the property at fair market value. The person receiving property from the partnership is deemed to have acquired the property at fair market value. This means that, subject to the special rules discussed below, the partnership will realize gains (or losses) on any property it distributes during the process of winding up. Since the partners at the time the partnership ceased to exist are deemed to remain partners until the process of winding up is complete, the income (or losses) associated with these distributions will be allocated to the partners and will be taxable in their hands.

Tax Deferred Distribution of Property on Dissolution – Conversion to Co-Ownership

In some situations it is possible for the property of a dissolved partnership to be distributed on a tax deferred basis. One such situation is where all the partners jointly elect to convert a Canadian partnership to co-ownership. A partnership is categorized as a Canadian partnership by the Canadian Income Tax Act at a particular time if at the particular time every member of the partnership is resident in Canada. If this is done, the partners must agree on a reasonable ownership percentage for each partner. Then all of the property is distributed to all the partners such that each partner is a co-owner of each property with a fractional interest in each property equal to their ownership percentage. The partnership is then deemed to have disposed of each property it held for proceeds of disposition equal to its cost amount, which means it will not realize any gains or losses to allocate to the partners. Each partner is deemed to have disposed of their interest in the partnership for proceeds of distribution equal to the greater of the two amounts:

  • The partner's adjusted cost base of the partnership interest; and
  • The partner's percentage share of the total combined cost amounts of all of the partnership's property.

This means that the partners cannot realize a loss on this disposition, and that they will realize a gain only if their percentage share of the partnership's combined cost amounts exceeds their adjusted cost base for their partnership interest. Even if a gain is realized, it is typically smaller than the gain that would realized if the partnership were treated as disposing of its property at fair market value. The partners are then deemed have cost amounts for each co-ownership interest equal to their ownership percentage multiplied by the partnership's cost amount for that property. If a partner realized a gain on the disposition of its interest in the partnership, then it may increase the cost amounts of any co-ownership interest in non-depreciable capital property it received to the extent of that gain as it designates, subject to the constraint that it cannot increase the cost amount of any particular co-ownership interest above that interest's fair market value.

Tax Deferred Distribution of Property on Dissolution – Conversion to Sole Proprietorship

When one, but not more than one, of the partners carries on the business of a Canadian partnership alone (referred to as the proprietor) within three months of the partnership ceasing to exist, then the distribution of the partnership's property to the proprietor is eligible for a tax deferred treatment similar to the one discussed above. Unlike when a partnership is converted into co-ownership, no election is required provided that the conditions described above are met.

The proprietor is deemed to have disposed of its interest in the partnership for proceeds of distribution equal to the greater of:

  • The total combined adjusted cost base of each interest in the partnership held by the proprietor; and
  • The total combined cost amounts to the partnership of all the property received by the proprietor plus any additional proceeds received by the proprietor on the cessation of the partnership.

The partnership is deemed to have disposed of each of its properties for proceeds of disposition equal to their respective cost amounts. This means that the partnership will not realize a gain and that the proprietor will not realize a gain so long as the second of the two amounts described above does not exceed the first of the two amounts described above. The proprietor inherits the partnership's cost amounts for all of the property it receives from the partnership. If the proprietor realized a gain on the disposition of its interest in the partnership, then it may increase the cost amounts of any non-depreciable capital property it received to the extent of that gain as it designates, subject to the constraint that it cannot increase the cost amount of any particular property above that property's fair market value.

Dissolution of a Partnership – Tax Deferred Distribution of Property on Dissolution – Incorporation of the Partnership

The legal form of a business can be changed from a partnership to Canadian corporation on a tax deferred basis. A corporation that is a tax resident of Canada and was incorporated in Canada is a Canadian corporation. Note that the partnership need not be a Canadian partnership for this treatment to be available and that requirements for a Canadian corporation are more flexible than those for a Canadian partnership. Subsection 85(2) of th e Canadian Income Tax Act allows for property to be transferred into a Canadian corporation in exchange for consideration that includes shares of that corporation on a tax deferred basis. If the partnership transfers its property to a Canadian corporation in exchange for consideration which includes shares of that corporation and winds up within sixty days of the transfer to the corporation, then it can distribute the consideration it received from the corporation to the partners on a tax deferred basis.

When the partnership distributes the property it received as consideration from the corporation to the partners, each partner's cost amount for any non-share consideration (typically cash or debt of the corporation) is equal to the fair market value of that property. The aggregate cost amount for the share consideration received by each partner is equal to the cost amount of that partner's partnership interest minus the fair market value of the non-share consideration they received (though no less than zero). Each partner is then deemed to have disposed of their interest in the partnership for an amount equal to the combined cost amount of the property they received from the partnership. This means that unless the partner received non-share property with a fair market value greater than the cost amount of their partnership interest, they will not realize a gain. The partnership is deemed to have disposed of the consideration which it received from the corporation for proceeds of disposition equal to its cost amount for the consideration, so it does not realize a gain or loss.

Tax Deferred Distribution of Property on Dissolution – Continuation of the Partnership

In most provinces, in the absence of a partnership agreement with a provision that explicitly provides otherwise, the death or insolvency of any partner causes the partnership to cease to exist. This could result in a constructive distribution of partnership assets to the partners with attendant tax consequences, even if the remaining partners continue the business of the partnership. The Canadian Income Tax Act has partially addressed these issues by allowing automatic tax deferred transfers of partnership property from a predecessor partnership to a successor partnership in certain circumstances.

For tax deferred treatment to apply, both the predecessor partnership and the successor partnership must be Canadian partnerships. The predecessor partnership must also transfer all of its property to the successor partnership before or at the time the predecessor partnership ceases to exist. The successor partnership cannot have any members who were not members of the predecessor partnership. If all of these conditions are met, the successor partnership is deemed to be a continuation of the predecessor partnership, and the partnership interests of members of the successor partnership are deemed to be continuations of their partnership interests in the predecessor partnership.

Dissolution of a Partnership - Tax Tips

The rules governing the tax consequences of the dissolution of partnerships are complex. The account given above is a simplified summary and does not cover all the details that need to be considered when a partnership is dissolved. If you had an interest in a partnership that has dissolved or if you are contemplating a reorganization which could involve the dissolution of a partnership, it is essential to consult an experienced Toronto tax lawyer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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
Similar Articles
Relevancy Powered by MondaqAI
Miller Thomson LLP
Collins Barrow National Incorporated
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Miller Thomson LLP
Collins Barrow National Incorporated
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