Main rules governing the taxation of Canadian partnerships

Partnership not a person

The Act imposes a tax on “persons”. A partnership is not a person, nor is it deemed to be one for purposes of the Act generally.

Computation of partnership income

The basic regime requires computation of income (or loss) at the partnership level and an allocation of the income (or loss) to the members of the partnership. The primary basis for the allocation is the partnership agreement, subject to any express limitations imposed by the Act, and the application of specific or general anti-avoidance rules.

Although a partnership is not a person for purposes of the Act generally, the Act requires a computation of the income (or loss) of the partnership from each source,12 and from sources in a particular place, as if the partnership were a separate person in order to determine each partner’s income (or loss) from those sources. A computation is also required of taxable capital gains and allowable capital losses from the disposition of partnership property.

Income (or loss) from various sources computed at the partnership level is allocated to the partners. Each partner reports his or her share of the partnership income (or loss) in his or her return for the partner’s taxation year in which the fiscal period of the partnership ends, and pays tax accordingly. If a partnership loss that is allocated to a partner in a particular taxation year cannot be deducted by the partner in the current year, the loss may be carried forward or back in accordance with the normal rules that apply to losses, unless restrictions apply (as in the case of limited partnership losses).

Special rules apply to certain types of partnership expenditures that give rise to incentive tax deductions, such as resource expenditures, scientific research and experimental development (SR&ED) expenditures and expenditures qualifying for investment tax credits.  The application of these rules to partnerships, and in particular to limited partnerships, is complex and beyond the scope of this article.

Partnership’s fiscal period

Generally, a partnership any of whose members is an individual must use the calendar year as its fiscal period. A partnership that has only corporations (other than professional corporations) as members may still choose any fiscal period (not longer than 53 weeks).

Adjusted cost base (ACB) of a partnership interest

The ACB of a partner’s partnership interest is relevant in determining the capital gain or capital loss on the disposition of the partnership interest.14 The taxpayer’s ACB of an interest in a partnership of which the taxpayer is, or is deemed to be, a limited partner is also relevant in computing the partner’s “at-risk amount” in respect of the partnership under the at-risk rules discussed below.

If the partner contributes cash or transfers assets to the partnership in return for a partnership interest, the cost of that interest will normally be the cash contributed or, in the case of a transfer of other property, the net fair market value (FMV) of the transferred property.15 The cost to a taxpayer of a partnership interest acquired from another person will normally be the purchase price paid for that interest.

The cost of the partnership interest, otherwise determined, is subject to various positive and negative adjustments provided in Sec. 53 to arrive at the ACB. The overall purpose of the adjustments is to preserve the“conduit” nature of the partnership for tax purposes and eliminate the double-counting of income and loss items that would otherwise result.

The following are some of the key additions to the ACB of a partnership interest at a particular time:

(1) The partner’s share of the partnership income from all sources for each completed fiscal period of the partnership that ended before the particular time, including the full amount of the partner’s share of any capital gains of the partnership.

(2) Any contribution of capital made to the partnership before the particular time otherwise than by loan. (3) The partner’s share of certain items that, if received directly by the partner, would be non-taxable, such as life insurance proceeds and “capital dividends”.

Some of the key deductions in computing the ACB at a particular time are:

(a) The partner’s share of the partnership losses from all sources for each completed fiscal period of the partnership that ended before the particular time, including the full amount of any capital losses.
(b) Any amount received before the particular time as a distribution of partnership profits or partnership capital.
(c) The partner’s share of any “limited partnership loss” to the extent such loss was deducted in computing the partner’s income.
(d) In certain cases, the unpaid principal amount of any indebtedness of the partner for which recourse is limited and which is related to acquiring the partnership interest.
(e) The partner’s share of the partnership’s resource expenditures.18
(f) The partner’s share of charitable and political donations made by the partnership.
(g) Any amount deducted by the partner as investment tax credits allocated to the partner by the partnership. These lists are not exhaustive; they include the most common adjustments.

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Shared from:  Bulletin for International Taxation

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