The relevant statutory regime

Transcription

1 2017 Issue No June 2017 Tax Alert Canada FCA affirms release of trapped limited partnership losses in multi-tiered partnerships EY Tax Alerts cover significant tax news, developments and changes in legislation that affect Canadian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor or EY Law advisor. On May 19, 2017, the Federal Court of Appeal (FCA) released its decision in Green et al. v. The Queen (2017 FCA 107), rejecting the Crown s appeal of the Tax Court of Canada (TCC) decision (2016 TCC 10). The issue in this case relates to the applicability of the at-risk rules in subsection 96(2.1) of the Income Tax Act (Canada )(the Act) to losses allocated by a lower-tier limited partnership to a partner that is itself a limited partnership (a top-tier partnership) and the question of whether losses in excess of such a top-tier partnership s at-risk amount are, by virtue of the application and interpretation of subsections 111(e) and 102(2) of the Act, perpetually trapped in the top-tier partnership, or whether they are to be characterized as business losses and allocated to the partners of the top-tier partnership. The issue addressed in this case challenges long-standing published administrative views of the Canada Revenue Agency (CRA). 1 Facts Throughout the 1996 to 2009 taxation years, the taxpayers, each an individual, were limited partners in a master limited partnership (MLP). MLP was a limited partner in 31 different limited partnerships (each, PSLP). In every one of the 1996 to 2009 fiscal years, each PSLP incurred business losses, which were allocated to MLP and, in turn, allocated by MLP to its limited partners, which included the taxpayers. Throughout the 1996 to 2008 fiscal years, MLP s at-risk amount for the purposes of subsection 96(2.1) of the Act in each of the PSLPs was nil. Each of the taxpayers at-risk amounts in MLP in those years was also nil. The losses allocated by MLP to each of the taxpayers over the relevant years were added to the taxpayers limited partnership losses balance. 1 Examples of the CRA s administrative position include CRA Document Number E5 and E5.

2 In the 2009 fiscal year, a capital gain was allocated by MLP to its limited partners, increasing each of the taxpayers at-risk amounts in MLP and thereby allowing the limited partnership losses accumulating since 2006 to be deducted by each of the taxpayers. The CRA reassessed each of the taxpayers to deny the deduction of these limited partnerships losses. The relevant statutory regime Generally, partnerships, including limited partnerships, are neither persons nor taxpayers for the purposes of the Act; however, subsection 102(2) provides that a reference to a person or taxpayer who is a member of a partnership shall include a reference to another partnership that is a member of a particular partnership. The deeming rule in subsection 102(2), which allows a partnership to be treated as a person, only applies for the purposes of sections 96 to 103 inclusive. 2 Section 96 governs the computation of a partnership s income, as if it were a separate person, for the purposes of allocating the amount of loss or income of the partnership to the partners. The provisions of section 96 also provide that the source of income or loss is maintained in the hands of the partners when such amounts are allocated to them. Where a taxpayer is a member of a limited partnership, the at-risk rules in subsection 96(2.1) of the Act restrict a partner s ability to deduct losses. Losses in excess of the taxpayer s at-risk amount as determined by paragraph 96(2.1)(b) are, pursuant to the following paragraphs of 96(2.1): (c) not deductible by the taxpayer in the current year; (d) not included in computing the taxpayer s non-capital loss for the year; and (e) deemed to be the taxpayer s limited partnership loss for the year in respect of the partnership. Paragraph 111(1)(e) of the Act generally provides an indefinite carryforward of limited partnership losses and permits such losses to be deducted in future years either against income from the partnership that generated the losses or, where the taxpayer's at-risk amount in respect of the partnership has increased, against income from other sources. Crown s position The Crown argued that since MLP is, as a result of subsection 102(2), considered a taxpayer for the purposes of subsection 96(2.1) of the Act, the losses allocated to it by the PSLPs are deemed, by paragraph 96(2.1)(e), to be limited partnership losses of MLP and therefore cease to be business losses. Moreover, since MLP is not a taxpayer for the purposes of subsection 111(1), as the rule in subsection 102(2) does not apply for the purposes of section 111 of the Act, paragraph 111(1)(e) does not apply, and, thus, MLP is not entitled to a deduction of the limited partnership losses in a future taxation year. The Crown also argued that section 96 of the Act does not contemplate the allocation by a partnership of limited partnership losses. 3 The TCC decision The TCC applied a textual, contextual and purposive analysis of the relevant provisions to reject the Crown s arguments. A textual, or literal, interpretation of subsection 96(2.1) of the Act supports the view that business losses of a lower-tier partnership (e.g., PSLP) in excess of a top-tier partnership s (e.g., 2 Subdivision j of Division B of Part I of the Act. 3 Subsection 96(1) only refers to the allocation of a partnership s income, non-capital loss, restricted farm loss and farm loss to its members. FCA affirms release of trapped limited partnership losses in multi-tiered partnerships 2

3 MLP s) at-risk amount in the lower-tier limited partnership do not cease to be business losses and therefore are available to be allocated to the partners of the top-tier partnership. The TCC found contextual support for this interpretation in subparagraph 53(2) (c) (i) of the Act, which reduces the adjusted cost base of a partnership interest by the taxpayer's share of any loss of the partnership from any source for that fiscal period, except to the extent that all or a portion of such a loss may reasonably be considered to have been included in the taxpayer's limited partnership loss in respect of the partnership for the taxpayer's taxation year. The TCC held that if a limited partnership loss did not also retain its character as a business loss, this exception in subparagraph 53(2) (c)(i) of the Act would not be necessary. When considering the purpose of subsection 96(2.1), the TCC accepted that the purpose of the at-risk rules is to limit the extent to which a limited partner may deduct partnership losses from business or property against income from other sources to the capital risked in the partnership (i.e., the partner's atrisk amount). A partnership s business or property losses in excess of the limited partner's at-risk amount may be carried forward and deducted in future years. On this basis, the TCC held that it was clear that the purpose of subsection 96(2.1) of the Act is not to deny absolutely the losses in excess of a limited partner's at-risk amount but, rather, to defer deduction of the excess until a time when the partnership has generated income or the partner's at-risk amount has increased for some other reason. On this basis, the TCC held that the purposive analysis did not support the Crown s assertion. The TCC held in favour of the taxpayers. FCA decision The FCA began by acknowledging that the TCC was correct to apply a textual, contextual and purposive analysis of the relevant provisions. However, the FCA considered subsection 96(2.1) of the Act in the context and purpose of subsection 96(1), section 3 and section 111 of the Act. After stressing the fact that a partnership does not pay tax, the FCA commenced its analysis by noting that the purpose of subsection 96(1) is not to determine the amount of tax that is payable by the partnership, but, rather, to ensure that the income or loss of the partnership is allocated to its partners and that the source of such income or loss is maintained for the purposes of section 3 of the Act. Moreover, the FCA noted that section 3, the general rule for computing income of a taxpayer for a year, does not apply to a partnership, because it is not a taxpayer. Similarly, section 111 does not apply to a partnership, and therefore a partnership that is a member of another partnership would not have a non-capital loss, as defined in subsection 111(8), to compute. On this basis, the FCA is of the view that paragraphs 96(2.1)(c) and (d) of the Act, the provisions that direct that a loss in excess of at-risk is not deductible by the taxpayer in the current year and is not included in computing the taxpayer s non-capital loss for the year, are only intended to apply to taxpayers that are required to compute these amounts for the purposes of sections 3 and 111 of the Act. Since partnerships are not taxpayers, these provisions do not apply to them and, thus, these amounts are not required to be computed by them. Moreover, the FCA noted that since paragraph 111(1)(e), which provides for the carry forward of limited partnerships losses, does not apply to partnerships, Parliament could not have intended for the restrictions on partnership losses in paragraph 96(2.1)(e) of the Act to apply to a partnership such as MLP, while denying the benefit of a future deduction as provided for in paragraph 111(1)(e) of the Act. On this basis, the FCA held that paragraph 96(2.1)(e) does not apply to a partnership that is a member of a limited partnership and rejected the Crown s argument that losses allocated by MLP to its partners ceased to be business losses by virtue of the application of paragraph 96(2.1)(e). The balance of the FCA s decision addressed, with use of numerical examples, why the Crown s position was not supportable when considered in the context of the purpose of section 3 and subsections 96(1) FCA affirms release of trapped limited partnership losses in multi-tiered partnerships 3

4 and (2.1) of the Act. The FCA reiterated its view that Parliament did not intend for a partnership that is member of another partnership to compute income. Rather, Parliament intended for the sources of income (or loss) to be kept separate and retain their identity as income (or loss) from a particular source as they are allocated from one partnership to another partnership and then to the partners of that second partnership (and so on, as the case may be). 4 On this basis, the FCA rejected the Crown s appeal and concluded that business losses of the PSLPs would be business losses in MLP and then, subsequently, business losses to the taxpayers when allocated to them by MLP. Lessons learned The FCA decision is arguably a significant setback for the CRA on this issue. As noted by the Crown in the decision itself, the FCA s judgment may allow the at-risk rules to be avoided altogether if the top-tier partnership is a general partnership. Moreover, the preservation of the character of business losses through tiered partnerships permits taxpayers to use business losses allocated to them from one limited partnership to offset income allocated to them from other limited partnerships. While the FCA acknowledged the Crown s concerns, they did not outweigh the concerns the FCA had with the Crown s interpretation. Nevertheless, the FCA alluded to the possibility that Parliament could amend the provisions of the Act to address such specific concerns. Interestingly, the FCA also referred to the possibility that the CRA may, depending on the circumstances, seek to apply the general-anti avoidance rule in section 245 of the Act, but acknowledged that such application could only be considered in the context of particular facts. Notwithstanding such possibilities, there is little doubt, in the meantime, that the decision in Green raises some practical questions with respect to how tiered-partnership structures should track and allocate business and property losses in excess of at-risk amounts that are no longer considered limited partnership losses. Learn more For more information, please contact your EY or EY Law advisor or one of the following professionals: Toronto Steve Landau steve.landau@ca.ey.com Craig Roskos craig.m.roskos@ca.ey.com Andy Tse andy.tse@ca.ey.com Eric Xiao eric.c.xiao@ca.ey.com 4 This view has been previously expressed by the TCC in Devon Canada Corporation v. The Queen, 2013 TCC 415 and Fredette v. The Queen, [2001 DTC 621]. FCA affirms release of trapped limited partnership losses in multi-tiered partnerships 4

5 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY s Tax Services EY s tax professionals across Canada provide you with deep technical knowledge, both global and local, combined with practical, commercial and industry experience. We offer a range of tax-saving services backed by in-depth industry knowledge. Our talented people, consistent methodologies and unwavering commitment to quality service help you build the strong compliance and reporting foundations and sustainable tax strategies that help your business achieve its potential. It s how we make a difference. For more information, visit ey.com/ca/tax. About EY Law LLP EY Law LLP is a national law firm affiliated with EY in Canada, specializing in tax law services, business immigration services and business law services. For more information, visit eylaw.ca. About EY Law s Tax Law Services EY Law has one of the largest practices dedicated to tax planning and tax controversy in the country. EY Law has experience in all areas of tax, including corporate tax, human capital, international tax, transaction tax, sales tax, customs and excise. For more information, visit eylaw.ca/taxlaw Ernst & Young LLP. All Rights Reserved. A member firm of Ernst & Young Global Limited. This publication contains information in summary form, current as of the date of publication, and is intended for general guidance only. It should not be regarded as comprehensive or a substitute for professional advice. Before taking any particular course of action, contact EY or another professional advisor to discuss these matters in the context of your particular circumstances. We accept no responsibility for any loss or damage occasioned by your reliance on information contained in this publication. Quebec and Atlantic Canada Alain Leonard alain.leonard@ca.ey.com Christian Desjardins christian.desjardins@ca.ey.com Prairies Warren Pashkowich warren.w.pashkowich@ca.ey.com Doron Barkai doron.barkai@ca.ey.com Vancouver Janette Pantry janette.pantry@ca.ey.com EY Law LLP Daniel Sandler daniel.sandler@ca.ey.com Allison Blackler allison.blackler@ca.ey.com David Robertson david.d.robertson@ca.ey.com Manjit Singh manjit.singh@ca.ey.com Louis Tassé louis.tasse@ca.ey.com Roger Taylor roger.taylor@ca.ey.com Document ID: EY TA ey.com/ca