Partnership Dissolutions: The Undivided Interest Condition

Subsection 98(3) is commonly relied on to provide a tax-deferred distribution of property (and, in certain cases, a cost bump) from a Canadian partnership to its partners on the dissolution of the partnership. However, structuring the dissolution to comply with that provision can be challenging, particularly because of the undivided interest condition in the preamble to subsection 98(3). The undivided interest condition requires that the partnership property be distributed to the partners such that immediately after the distribution each partner has an undivided interest in each partnership property that, when expressed as a percentage of all the undivided interests in that property, is equal to the partner’s undivided interest so expressed in each other partnership property.

The undivided interest condition poses a number of interpretive and practical questions for taxpayers.

  • What is an undivided interest? The term “undivided interest” is not defined in the Act; it is generally understood to refer to circumstances of co-ownership under the relevant common or civil law (see, for example, CRA document no. 2001-0072595, March 21, 2001, in the context of subsection 248(21)). In common-law jurisdictions, for example, a person who owns a parcel of land as a tenant in common with another person is generally considered to have an undivided percentage interest in the entire parcel, not an interest in half the parcel. The same principles of co-ownership should apply to identical properties, such as securities, held by the partnership (see, for example, “Revenue Canada Round Table” in the 1984 Conference Report, question 89).

  • Does the condition apply to all property of the partnership? On first reading, the condition appears to apply to any right or thing held by the partnership, because the term “property” is very broadly defined in subsection 248(1) to mean “property of any kind whatever . . . [and] unless a contrary intention is evident, money.” In my view, paragraph 98(3)(a) provides a “contrary intention”: it clearly distinguishes between money and “partnership property” distributed to the partners; therefore, money distributed by the partnership should not be subject to the undivided interest condition. Informal discussions with the CRA suggest that it may share this view.

  • In what proportions should the property be distributed to the partners? The Act does not provide specific guidance on this point. It is clear that each partner’s undivided percentage interest in a particular partnership property must be equal to the partner’s undivided percentage interest in every other partnership property; however, it is not clear what that percentage should be. Many tax practitioners accept that each partner’s percentage should be equal to its pro rata percentage interest in the partnership immediately before the dissolution of the partnership (although the calculation of such an interest is not always obvious, particularly when the partners have different classes of interests or priorities). The CRA stated in Interpretation Bulletin IT-471R, “Merger of Partnerships,” at paragraph 2, that the apportionment of the undivided percentage interests among the partners must merely be “reasonable in the circumstances.”

In my view, it is not entirely clear that subsection 98(3) contains an implicit requirement that the apportionment of undivided interests be pro rata or reasonable. That said, one might expect that arm’s-length partners would generally agree to a pro rata distribution and that such agreement would generally be considered reasonable. However, given that partnership property does not include money, subsection 98(3) may in fact be more flexible than some would initially expect—for example, it may be possible for a partner to receive a smaller undivided percentage interest in the non-money partnership property in favour of a larger distribution of money.

Kim Maguire
Borden Ladner Gervais LLP, Vancouver
kmaguire@blg.com

Canadian Tax Focus
Volume 4, Number 4, November 2014
©2014, Canadian Tax Foundation