In a recent decision, the Court of Appeal upheld the lower court’s decision in favour of Binscarth Holdings L.P. (the “Partnership”) and its general partner, Binscarth Holdings GP Inc. (“Binscarth Inc.”), rejecting the claims of the Applicants, who were limited partners in the Partnership.
The Applicants had sought a declaration that they were entitled to receive 100% of their proportionate share of the net income of the Partnership as annual cash distributions. Alternatively, they argued they should be entitled to 53.53% of their share of the net income, retroactive to January 1, 2016, in order to cover their tax obligations.
Background: Family Partnership Structure
The Partnership was created in December 2011 by Frank and Jine Anthony, with their children, the Applicants, as limited partners. The general partner of the Partnership, Binscarth Inc., was controlled by the Applicants’ brother, Grant Anthony. The Anthony Control Trust (the “Trust”) was the sole shareholder of Binscarth Inc., with the nine children of Frank and Jine Anthony being the beneficiaries of the Trust, and Grant as the trustee of the Trust. Frank and Jine were also trustees while they were living. The Partnership was formed to hold and acquire various properties, with the general partner holding discretion over the distribution of the Partnership’s net income.
The properties of the Partnership were previously held by a discretionary family trust. That trust was wound-up well before its 21-year deemed disposition date with the assets being distributed to the beneficiaries followed by a transfer from the beneficiaries to the Partnership in return for limited partnership units.
Since its formation, the Partnership did not pay out distributions directly to the limited partners, except for amounts needed to cover their tax liabilities. However, the Applicants argued that they were entitled to receive cash distributions of the full net income on an annual basis, asserting that the terms of the Limited Partnerships Act (the “Act”) required such distributions.
Interpretation of Section 11(1) of the Act
The primary issue at hand was the interpretation of section 11(1) of the Act, which governs the rights of limited partners in a limited partnership, and provides that a limited partner has a right to a share of the profits or other compensation by way of income. The Applicants argued that this section mandated that all profits of the Partnership be distributed to the limited partners annually in cash.
In response, Binscarth Inc. and the other Respondents contended that section 11(1) does not require the distribution of profits but instead entitles limited partners to a “share” of the profits, which may be credited to their capital accounts. They further asserted that the terms of the Limited Partnership Agreement (the “LPA”) gave the general partner sole discretion over the distribution of profits, and that the Applicants, by signing the LPA, had agreed to these terms and could not now challenge them.
The Court of Appeal agreed with the Respondents, clarifying that the “share” of profits referred to in section 11(1) did not mandate an annual distribution of profits. It clarified that the right to a “share” of the profits does not equate to an obligation for the general partner to make cash distributions to the limited partners. The Court further emphasized that section 24 of the Act, which governs the dissolution of a partnership and the distribution of capital, indicates that limited partners are entitled to distributions under specific circumstances, such as upon dissolution or in accordance with the terms defined in the Agreement. Additionally, the Court referred to section 11(2) of the Act, which specifically addresses the “payment” of profits and distinguishes it from the “share” referred to in section 11(1), suggesting that the legislature did not intend to require regular, annual distributions.
The Applicability of the Accumulations Act
The Applicants also argued that the provisions of the Accumulations Act, which governs the accumulation of income from the disposition of property, were being violated by the LPA’s indefinite accumulation of profits. The Court rejected this argument, explaining that the Accumulations Act applies to the disposition of property in the context of estate planning and testamentary trusts, not to commercial arrangements like limited partnerships. The Court emphasized that there was no precedent for applying the Accumulations Act in the context of a commercial partnership, and thus, the statute was inapplicable to the case at hand.
The Court further noted that the LPA was structured to give the general partner sole discretion over the distribution of profits, and the Applicants, by signing the LPA, had agreed to this framework. They could not now seek to invalidate this provision by invoking the Accumulations Act, as it was not intended to govern such commercial dealings.
Interpretation of Article 8.1(b) of the LPA
The Applicants also argued that Article 8.1(b) of the LPA required the general partner to distribute 53.53% of the Partnership’s income on an annual basis. The Court of Appeal disagreed, stating that the purpose of Article 8.1(b) was to ensure that the limited partners had sufficient funds to cover their tax obligations on allocated income, rather than to mandate a percentage-based cash distribution of the total net income. The provision aimed to address tax-related concerns, not to require regular distributions of profits.
Takeaways
The Court’s decision highlights the flexibility and control inherent in the Limited Partnership structure, especially in relation to succession planning and capital gains tax deferral. An important aspect of a Limited Partnership is that the partnership agreement can impose restrictions on the transfer of partnership units, limiting the ability of limited partners to transfer ownership freely upon death. This offers general partners more control over future ownership and distribution of units. However, it is crucial to ensure there is sufficient liquidity, such as through insurance or cash reserves, to cover capital gains taxes when a limited partner passes away as there will be a deemed disposition upon each partner’s death under Canadian income tax law.
When transferring property into a Limited Partnership, there can be a rollover so that accrued gains can be deferred – a process that is very similar to that of a rollover to a corporation. However, one needs to also look to other taxes that could apply to such a transfer such as land transfer tax.
A Limited Partnership also allows for the deferral of capital gains taxes through the use of inter vivos trusts or joint spousal trusts. These types of trusts can help delay taxes until after the settlor’s death, with the 21-year deemed disposition rule being the main limitation. While this can be advantageous, it’s important to note that transferring partnership units into a trust may trigger a deemed disposition at the time of transfer, which could result in tax consequences if there are accrued gains.
When establishing a Limited Partnership, it is beneficial for the general partner to be a corporation, as this provides limited liability protection for the shareholders of the general partner. This structure also offers flexibility in managing the partnership, particularly with regard to profit distributions, while ensuring that the shareholders are protected from personal liability. By carefully structuring the partnership and its agreements, the parties can ensure effective management and minimize risks associated with taxation and asset distribution.
Lastly, Binscarth serves as a good example of how the Limited Partnership structure can be used to maintain control. In this case, it appears that the parents wanted to ensure centralized control and decision making by having control of the Partnership vested in the general partner, which in turn was controlled by the Trust, with the trustees overseeing the Trust. This layered structure allowed the parents to retain authority over key decisions while ensuring control for future generations, demonstrating how Limited Partnerships can balance family governance with succession planning.