CRA considers that a momentary right to discharge a dividend payable constitutes a non-active business asset for QSBCS purposes

An individual holds the common shares of Holdco having an FMV of $1 million, and Holdco’s only asset is the common shares of Opco, also with an FMV of $1 million. $700,000 of Opco’s assets are used principally in its active business carried on primarily in Canada and $300,000 are excess cash. Stopping there, the para. (d) tainting rule in the qualified small business corporation share (QSBCS) definition would not be engaged because 100% of Holdco’s assets were qualified assets, being shares of Opco which satisfied the 24-month 50% asset test in para. (c).

Suppose, however, that, under a “purification” transaction, Opco pays a cash dividend of $150,000 to Holdco, which immediately pays a dividend in the same amount to the individual. At the instant in time in which Holdco held such cash, more than 10% of its assets would not be the qualifying assets listed in para. (d), which would apparently mean that Opco at the relevant times would now be required to satisfy a "substantially all" rather than 50% asset test, which perhaps would not be met because its excess cash assets were $150,000/$850,000, or 18%.

If such holding of the $150,000 in cash by Holdco for an instant in time would “contaminate” it under para. (d), would this problem be solved if instead Holdco declared and paid a $150,000 dividend, payable to its shareholder by a note, and then Opco declared a dividend payable through discharging the note?

CRA indicated that Holdco would be tainted if it did not satisfy the “all or substantially all” test in para. (d) “even for a short period” – but “recognize[d] that the ‘all or substantially all’ test could be met even if the 90% threshold is not satisfied, depending on the circumstances and context.” In indicating that, if the “all or substantially all” test was violated for a short period by the above transaction, the problem would not be solved through the payment-in-kind proposal, CRA stated:

Holdco has an interest in the dividend declared by Opco and … the interest in such a dividend is an "asset" for the purposes of the definition of QSBCS, regardless of whether it is recorded on the corporation's balance sheet. In particular, Holdco benefits from the dividend declared by Opco even if the amount of the dividend does not pass through Holdco because it allows Holdco to have its liabilities reduced following the payment made by Opco.

Neal Armstrong. Summary of 2 November 2023 APFF Roundtable, Q.3 under s. 110.6(1) – qualified small business corporation share – (d).