23 November 2000 External T.I. 1999-0006705 - qsbcs - beneficial owneership

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether the 24-month ownership holding period test in the definition of "qualified small business corporation share" in subsection 110.6(1) of the Act is met where a taxpayer enters into an agreement before the 24-month holding period is over to sell shares of a small business corporation to a non-related employee of the corporation but does not transfer legal title to the shares and maintains beneficial ownership of the shares until after the 24-month holding period is over?

Position:

Yes.

Reasons:

A buy-sell agreement to sell the shares at a later date for a fixed price does not, in and by itself, mean that there is a change in beneficial ownership of the shares at the time the buy-sell agreement was entered into.

XXXXXXXXXX 1999-000670
G. Moore
November 23, 2000

Dear XXXXXXXXXX:

Re: Qualified Small Business Corporation Shares

We are replying to your letter of November 17, 1999, regarding the definition of "qualified small business corporation share" as defined in subsection 110.6(1) of the Income Tax Act (the "Act"). We apologise for the delay in responding.

You describe a situation where Mr. A incorporates an entity on January 1, 19X1, subscribing for shares from treasury. Mr. A commences to operate a new business in this corporation. Mr. B is an employee of the new corporation. He is not related to Mr. A. On November 1, 19X1, Mr. A and Mr. B reach an agreement whereby Mr. A will sell to Mr. B one-third of the outstanding shares for the fair market value on November 1, 19X1. The shares of the corporation are shares of a small business corporation eligible for the $500,000 exemption in all respects except that Mr. A has not owned the shares for at least 24 months. Mr. A does not sell the shares to Mr. B at this time. Instead, the agreement is structured so that Mr. A will sell the shares to Mr. B in January 19X3, for their fair market value on November 1, 19X1. Mr. A will retain legal and beneficial ownership of these shares until January 1, 19X3. When the shares are transferred in January 19X3, they will meet the criteria of a "qualified small business corporation share" for purposes of the $500,000 exemption. You are asking whether Mr. A will be entitled to claim the capital gains exemption in 19X3 on the sale of shares. Mr. A and Mr. B are both Canadian residents.

Our Comments

It appears that the transaction described in your letter relates to an actual transaction. Written confirmation of the consequences inherent in particular transactions are given by this directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. Where the particular transactions are partially completed or completed, the enquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments which are of a general nature.

The determination of whether a particular share meets the definition of "qualified small business corporation share" in subsection 110.6(1) of the Act is a question of fact which can only be established after a review of all the relevant facts of each particular case. In addition to the fact that you have not requested an advance income tax ruling, there is insufficient information to enable us to comment on whether the shares meet, at a particular time, the definition of "qualified small business corporation share".

As you know, with respect to the definition of "qualified small business corporation share", there is a 24-month ownership holding period test that must be met at the determination time. It is a question of fact whether Mr. A would be considered to have maintained ownership of the shares throughout the 24 month period. Generally the Canada Customs & Revenue Agency ("Agency") would require the taxpayer to have maintained beneficial ownership of the shares throughout the 24 month period. The fact that Mr. A and Mr. B have entered into a buy-sell agreement on November 1, 19X1 for the shares to be sold in January 19X3 for a predetermined price (i.e. the fair market value of the shares on November 1, 19X1) does not, in and by itself, mean that there has been a change in beneficial ownership of the shares at November 1, 19X1. Other factors would also be taken into consideration by the Agency in making this determination. For example, in the context of shares, the right to vote and the right to receive dividends are significant factors to consider with respect to the determination of who holds beneficial ownership of a share at any particular time.

You have indicated that Mr. A will retain all the attributes of beneficial ownership of the shares until January 19X3, at which time he will have "owned" the shares for a 24-month period. As long as Mr. A retains legal and beneficial ownership of the shares until January 19X3, then it appears that the 24-month ownership holding period test in the definition of "qualified small business corporation share" would be met.

The above comments are not an advance income tax ruling and are not binding on the Agency. We trust our comments will be of assistance to you.

Yours truly,

J. Wilson.

for Director
Business and Publications Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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