13 April 2004 External T.I. 2003-0051221E5 - Qualified Investment - CCPC Shares

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues:

Whether shares of a CCPC will remain a qualified investment if the corporation lends to a partnership the amount received on the issuance of shares to an RRSP trust?

Position:

If the shares were qualified investment at the time they were acquired, they will continue to be qualified investment.

Reasons:

As stated in paragraph 6 of interpretation bulletin IT-320R3, the condition that the corporation be a small business corporation must be satisfied only at the time the share of the corporation is acquired by the trust governed by an RRSP. Similarly, the condition that the annuitant is not a connected shareholder must be satisfied only at the time immediately after the share is acquired by the RRSP trust.

XXXXXXXXXX 								2003-005122
L. J. Roy, CGA
April 13, 2004

Dear XXXXXXXXXX:

Re: Registered Retirement Savings Plan - Qualified Investment

This is in reply to your letter of November 25, 2003, in which you requested an interpretation on whether shares would remain qualified investments for trusts governed by a registered retirement savings plans ("RRSP") in the following transactions.

Mr. A, Mr. B and Mr. C are partners in a partnership and are not related to each other. They transfer part of the partnership's operation to a newly incorporated corporation in which they would each own 100 common shares with an adjusted cost base and a paid up capital of $100. Thereafter, the trust governed by an RRSP of these three individuals would each acquire 100 preferred shares for an amount of $24,500. Sometime later, the corporation would lend to the partnership the amount received on the issuance of the preferred shares.

This Directorate can only provide written confirmation regarding the tax implications inherent in particular transactions where the transactions are proposed and are the subject matter of an advance income tax ruling request. You may refer to Information Circular 70-6R5 dated May 17, 2002 for more information concerning advance tax rulings. Copies of the information circular as well as all other Canada Revenue Agency ("CRA") publications are available at your local Tax Services Office or on the Internet at http://www.cra-arc.gc.ca/tax/technical/incometax/current-e.html. Where the particular transactions are completed, the enquiry should be addressed to the relevant Tax Services Office. The following comments are, therefore, of a general nature only and are not binding on the CRA.

The CRA's Interpretation Bulletin IT-320R3 Qualified Investments - Trusts Governed by Registered Retirement Savings Plans, Registered Education Savings Plans and Registered Retirement Income Funds, discusses the situations where shares of corporations will be qualified investments for trusts governed by registered plans. In this respect, paragraph 6 of IT-320R3 states that shares of small business corporations may be qualified investments for a trust governed by an RRSP where the conditions described in paragraph 4900(12)(a) of the Income Tax Regulations ("Regulations") are satisfied.

Under paragraph 4900(12)(a) of the Regulations, shares of a corporation (other than a cooperative corporation) that would, at the time of acquisition or at the end of the last taxation year of the corporation ending before that time, be a small business corporation, are qualified investments for a trust governed by an RRSP if, immediately after the time the shares were acquired by the trust, the annuitant under the plan was not a "connected shareholder" of the corporation. For this purpose, "small business corporation" has the meaning assigned by subsection 248(1) of the Income Tax Act ("Act") if the reference therein to "Canadian-controlled private corporation" is read as "Canadian corporation (other than a corporation controlled at that time, directly or indirectly in any manner whatever, by one or more non-resident persons)".

In addition, to qualify as a "small business corporation" all or substantially all (90% or more) of the fair market value of the corporation's assets must be attributable to assets that are:

a) used principally (50% of the time or more) in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it,

b) shares or indebtedness of one or more small business corporations that are connected with the particular corporation, or

c) assets described in (a) and (b) above.

For the purposes of these requirements, an "active business" is, in general, defined in subsection 248(1) of the Act as any business carried on by a taxpayer other than a "specified investment business" or a "personal services business". Please refer to the Interpretation Bulletin IT-73R5, The Small Business Deduction, for more information on "specified investment business" and "personal services business". Whether or not the corporation would be carrying on an active business is a question of fact. It is important to note that the shares of a small business corporation must qualify at the time they are acquired by a trust governed by an RRSP. Shares of a newly formed corporation generally will not qualify prior to the start of an active business.

Subsection 4901(2) of the Regulations provides that a connected shareholder of a corporation at any time is a person (other than an exempt person in respect of the corporation) who owns, directly or indirectly, at that time, 10% or more of the shares of any class of the capital stock of the corporation or of any other corporation that is related to the corporation.

An exempt person in respect of a corporation is a person who deals at arm's length with the corporation where the total of all amounts, each of which is the cost amount of all shares of the corporation or any other related corporation that the person owns, or is deemed to own, is less than $25,000

For a discussion of the criteria used to determine whether persons deal at arm's length with the corporation, refer to the Interpretation Bulletin IT-419R, Meaning of Arm's Length.

For purposes of the 10% and $25,000 tests, the rules in the definition of "specified shareholder" in subsection 248(1) of the Act apply with the result that certain shares will be deemed to be owned by the shareholder.

In addition, any share that the annuitant under a trust governed by an RRSP or a person not dealing at arm's length has a right to acquire is also included in the calculation of the percentage and cost amount of the shares held for purposes of the 10% and $25,000 tests pursuant to subsection 4901(2.2) of the Regulations.

The conditions respecting the "connected shareholder" test must be satisfied only at the time immediately after the shares are acquired by the trust governed by an RRSP.

In a situation where three unrelated shareholders each own one third of the shares of a small business corporation and use their own RRSP trusts to acquire some shares of the corporation, it is a question of fact whether the acquired shares will be qualified investments for each trust governed by an RRSP. The facts and circumstances that occur immediately after the acquisition must be examined in order to make this determination because, in order not to be a "connected shareholder" of the corporation, the annuitant under the trust governed by the RRSP has to deal at arm's length with the corporation immediately after the trust governed by the RRSP has acquired the shares. Where the voting power in a closely held corporation is equally divided between three shareholders who are not related persons, the corporation will generally be viewed as being controlled by the group consisting of the three shareholders, but not by either shareholder. Therefore, in these circumstances, it is possible for the annuitant under the trust governed by the RRSP to be dealing at arm's length with the corporation immediately after the acquisition of the shares. However, there may be other circumstances that indicate that such person did not deal at arm's length with the corporation. In the situation you described, the series of transactions seems to indicate that the shareholders could have common interests and would therefore not be dealing with the corporation at arm's length.

Also, having regard to the circumstances of the proposed transactions, we are of the view that consideration should be given to the possible application of subsection 15(2) of the Act to the loan that would be made by the corporation to the partnership.

When a person or a partnership connected to a shareholder of a corporation receives a loan or otherwise becomes indebted to the corporation, subsection 15(2) of the Act applies to include the amount of the loan or indebtedness in their income unless the loan comes within the exceptions discussed in the provisions of subsections 15(2.2) to (2.6) of the Act. By virtue of subsection 15(2.1) of the Act, a connected person with a shareholder of a particular corporation is, with two exceptions, all persons who do not deal at arm's length with the shareholder.

We are of the view that a partnership would be considered a person for purposes of subsection 15(2.1) of the Act and would be connected with a shareholder of a corporation where the partnership does not deal at arm's length with that shareholder. The determination as to whether a partnership deals at arms' length with a shareholder is a question of fact.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch