4 April 2011 External T.I. 2010-0379141E5 - Capital Pool Companies

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: 1) Are general and administrative expenses incurred by a Capital Pool Company ("CPC") deductible before it has identified its 'qualifying transaction' ("QT")?
2) After the CPC has identified the QT, it makes a deposit but forfeits it on a later date. Is the expense deductible?

Position: 1) & 2) - It is a question of fact and further depends on whether such expenses are considered current or capital in nature.

Reasons: Depending on the nature of expense, they may be deductible.

XXXXXXXXXX
									2010-037914
									V. Srikanth

April 4, 2011							

Dear XXXXXXXXXX :

This is in response to your correspondence dated August 25, 2010, wherein you requested our views on the tax implications of the expenses incurred by a 'Capital Pool Company' (a "CPC"). Specifically, you wanted our views on the deductibility of expenses incurred prior to, and subsequent to, the identification of a 'qualifying transaction' ("QT").

Our Comments

Written confirmation of the tax implications inherent in actual proposed transactions is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, entitled Advance Income Tax Rulings. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on our website at http://www.cra-arc.gc.ca. If, however, the particular transactions are completed or partially completed, the enquiry should be addressed to the relevant Tax Services Office. Your request was not submitted in the format required for an advance income tax ruling request, however, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries which are not binding and we are prepared to provide you with the following comments.

It is our understanding (based on the 'TSX Venture Policy 2.4 - Capital Pool Companies') that the CPC program is a two-stage program that allows 3 or more individuals to come together to raise capital with no commercial operations, but with a two-year timeline in which to acquire a business or investment that meets listing criteria at the Toronto Stock Exchange ("TSX") Venture Exchange. It is our further understanding that the CPCs are formed with the intent of raising capital before the corporation has actually identified or commenced such business or investment. Briefly, phase 1 involves, inter alia, the raising of seed capital, incorporation of a company with the seed capital as the initial share capital and completing the listing procedures. In phase 2 of the program, the CPC, inter alia, identifies an appropriate business as its QT and enters into an agreement in principle to acquire the business.

With regards to the business activity of a CPC, the TSX Venture Exchange Policy 2.4 states:

"...The CPC program permits an IPO [(Initial Public Offering)] to be conducted and an Exchange listing to be achieved by a newly created company that has no assets, other than cash, and has not commenced commercial operations. The CPC then uses this pool of funds to identify and evaluate assets or businesses which, when acquired, qualify the CPC for listing as a regular Tier 1 or Tier 2 Issuer on the Exchange.

...The only business permitted to be undertaken by a CPC is the identification and evaluation of assets or businesses with a view to completing a Qualifying Transaction. Until the completion of the Qualifying Transaction, a CPC must not carry on any business other than the identification and evaluation of assets or businesses with a view to a potential Qualifying Transaction."

Further, it is also our understanding that a CPC has to comply with certain listing restrictions of the applicable stock exchange and, until the completion of a QT, there are restrictions on the usage of the funds at hand.

Before determining whether the expenses in phase 1 are deductible, it has to be established whether a CPC can be considered to have commenced its business, for tax purposes, at that time, i.e., before the QT has been identified. Regarding the issue of the commencement of business, CRA has published its general views in Interpretation Bulletin IT-364, entitled 'Commencement of Business Operations'. The courts have also had to consider this issue.

From paragraph 2 of IT-364, "Generally speaking, it is the Department's view that a business commences whenever some significant activity is undertaken that is a regular part of the income-earning process in that type of business or is an essential preliminary to normal operations. In order that there be a finding that a business has commenced, it is necessary that there be a fairly specific concept of the type of activity to be carried on and a sufficient organizational structure assembled to undertake at least the essential preliminaries...Where an activity consists merely of a review of various business possibilities in the expectation or hope that information will be obtained to justify going into a business of some kind, such an activity does not represent the commencement of a business." Based on these general comments, in considering the commencement of business issue for a CPC in phase 1, an entity which clearly has a 'sufficient organizational structure', we need to resolve whether the fact that the 'only business permitted to be undertaken by a CPC is the identification and evaluation of assets or businesses', is 'a regular part of the income-earning process in that type of business' and is 'a fairly specific concept of the type of activity to be carried on' or whether this is an activity that is 'merely a review of various business possibilities in the expectation or hope that information will be obtained to justify going into business of some kind.'

In Gartry v. The Queen, 94 DTC 1947 ("Gartry"), a taxpayer had started to operate his commercial fishing business when the boat he was in the process of buying for that purpose sank before he took ownership of it, and the taxpayer, thereafter, gave up on the business and sought to deduct the money he had spent on a number of things including intangibles such as legal and accounting fees, insurance and interest. Bowman C.J. made the following comments in determining whether the taxpayer was considered to have commenced his business:

"... In determining when a business has commenced, it is not realistic to fix the time either at the moment when money starts being earned from the trading or manufacturing operation or the provision of services or, at the other extreme, when the intention to start the business is first formed. Each case turns on its own facts, but where a taxpayer has taken significant and essential steps that are necessary to the carrying on of the business it is fair to conclude that the business has started. That is certainly the case here...In my view the business had been commenced and was well underway when the expenses in question were incurred."

Similar sentiments were expressed by Judge Bowman in his 1998 decision in Kaye v. The Queen, 98 DTC 1659 and his comments, as stated below, were quoted by Boyle J. in Spasic v The Queen 2009 TCC 193, wherein the issue was whether the taxpayer was considered to have carried on business during a certain period:

"... One must ask "Would a reasonable person, looking at a particular activity and applying ordinary standards of commercial common sense, say 'yes, this is a business'?" In answering this question the hypothetical reasonable person would look at such things as capitalization, knowledge of the participant and time spent. He or she would also consider whether the person claiming to be in business has gone about it in an orderly, businesslike way and in the way that a business person would normally be expected to do."

Considering the nature of the business activity of a CPC in relation to the general views of CRA from IT-364 and the observations made in jurisprudence, noted above, in our view, during phase 1 of its operations, for tax purposes, a CPC may be considered to have commenced its operations and may be eligible to deduct its general and administrative expenses incurred during that phase. Whether such expenses are capital or current in nature is a question of fact.

You further wanted our views on the tax consequences in a situation where a CPC makes a deposit to obtain mineral property options, after identifying the QT, and forfeits the deposit at a later date. 'After identifying the QT' puts the timing of the deposit into phase 2 where, in our view, there should be no issue concerning the commencement of a business. Accordingly, in our view, expenses incurred during this phase may be deductible; however, whether such expenses are current or capital in nature, as mentioned earlier, is a question of fact.

With respect to forfeited deposits, paragraph 3 of the Interpretation Bulletin (archived), IT-461, entitled 'Forfeited Deposits', states:

"Whether the rights under a contract are of an income or capital nature is a question of fact to be determined by the circumstances of each particular case. For example, if the property that was to have been acquired under the contract would have been a capital asset to the purchaser, the rights of the purchaser under the contract would generally be capital in nature; therefore, except in the case of personal-use property, the loss sustained on the disposition of those rights would be an allowable capital loss. On the other hand, if the property would have been inventory to the purchaser or the cost of the property would have been otherwise deductible from income, the loss incurred on cancellation of the contract would generally be a deductible business expense."

Please note that although IT-461 is archived, the above comments still reflect our views. Accordingly, in the given instance, where a CPC makes a deposit to obtain mineral property options and forfeits the deposit later, whether such expenditure is current or capital will depend on the nature of the business carried on by the CPC. Where such forfeiture arose in the course of its normal business activity, it may be deductible as a current expense pursuant to section 9 of the Income Tax Act; and, where such an expense is incurred in creating or adding to the business structure, it will be on account of capital. However, as stated in paragraph 31 of IT-143R3, entitled 'Meaning of Eligible Capital Expenditure', a forfeited deposit is not an eligible capital expenditure.

We trust that our comments will be of assistance.

Yours truly,

R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate