25 February 2000 Internal T.I. 1999-0015777 - QSBCS 50% AND 90% TESTS

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 comments made in our file E9610025 (letter dated June 25, 1996) still represent our views on the application of paragraph (d) of the definition of "qualified small business corporation share" ("QSBCS") in subsection 110.6(1).

Position TAKEN:

We confirm that the comments in file E9610025 still represent our views and are correct in law.

Reasons FOR POSITION TAKEN:

In the example in file E9610025, if we apply paragraph (d) of the definition of QSBCS, using Parentco as the "particular corporation", we find that all or substantially all of the FMV of Parentco's assets is attributable to a combination of assets described in subparagraph (c)(i) and shares or indebtedness of corporations described in clause (c)(ii)(B) of the definition of QSBCS. As Parentco (the "particular corporation") meets the "all of substantially all" test, paragraph (d) of the definition of QSBCS does not apply to require corporations connected with Parentco (i.e., Subco, in the example) to meet an all or substantially all test.

Subco does not satisfy the "all or substantially all" test; however, applying paragraph (d) of the definition of QSBCS, with Subco as the "particular corporation", could only require that corporations connected with Subco to meet the "all or substantially all" test. As there are no corporations connected with Subco, paragraph (d) is of no consequence in the above example.

            February 25, 2000

      Vancouver Island Tax Services HEADQUARTERS
      Verification and Enforcement Division     M. Azzi
            957-8972
      Attention: Paul Brown
            1999-001577

Qualified Small Business Corporation Share

This is in reply to your memo of December 17, 1999, wherein you requested that we confirm whether the comments made in our file E9610025 (letter dated June 25, 1996) still represent our views on the application of paragraph (d) of the definition of "qualified small business corporation share" ("QSBCS") in subsection 110.6(1) of the Income Tax Act (the "Act").

In one of the examples of the June 1996 letter, during the relevant period of time, the fair market value ("FMV") of the assets of the parent corporation ("Parentco") is comprised of active business assets (48%), indebtedness of its subsidiary ("Subco") (40%) and shares of Subco (12%), while the FMV of the assets of the Subco consists of active business assets (85%) and non-qualifying assets (15%) (and Subco is connected with Parentco within the meaning of paragraph (d) of the definition of QSBCS in subsection 110.6(1) of the Act). Based on your understanding of paragraph (d) of the definition of QSBCS, you state that, in your view, "where the corporation or another connected corporation does not have 90% or more of its assets in active business assets or in shares or debt of qualified small business corporations, then all connected corporations must use the 90% requirement in order to qualify as qualified small business corporations..." In your view, this would require both companies, in the example, to meet the 90% test (also referred to as the "all or substantially all" test). That is, in your view, since the FMV of the assets of one of Parentco or Subco does not meet the 90% test, paragraph (d) of the definition of QSBCS requires that all connected companies must be evaluated using the 90% test rather than the 50% test. As Subco does not meet the 90% test, it is therefore your view that the shares of Parentco do not meet the requirements of the definition of QSBCS. For purposes of this reply, as in our previous letter, it is assumed that at the "determination time", within the meaning of the definition of QSBCS in subsection 110.6(1) of the Act, Subco does not have any non-qualifying assets (such that Parentco can qualify as a "small business corporation" at that time).

Our Comments

We do not agree with your interpretation and, accordingly, confirm that the comments in file E9610025 still represent our views and are correct in law. Paragraph (d) of the definition of QSBCS in subsection 110.6(1) of the Act provides, in part, that "where...all or substantially all of the fair market value of the assets of a particular corporation...cannot be attributed to assets described in subparagraph (c)(i), shares or indebtedness of corporations described in clause (c)(ii)(B), or any combination thereof, the reference in clause (c)(ii)(B) to 'more than 50%' shall...be read as a reference to 'all or substantially all' in respect of each other corporation that was connected with the particular corporation". The "particular corporation" referred to, in paragraph (d) of the definition of QSBCS, is the corporation for which QSBCS status is being determined or a corporation connected with that corporation, and paragraph (d) defines "connected" for its purpose.

In the above example, if we apply paragraph (d) of the definition of QSBCS, using Parentco as the "particular corporation", we find that all or substantially all of the FMV of Parentco's assets is attributable to a combination of assets described in subparagraph (c)(i) and shares or indebtedness of corporations described in clause (c)(ii)(B) of the definition of QSBCS. As Parentco (the "particular corporation") meets the "all of substantially all" test, paragraph (d) of the definition of QSBCS does not apply to require corporations connected with Parentco (i.e., Subco) to meet an all or substantially all test.

We recognize that, in the above example, Subco does not satisfy the "all or substantially all" test; however, applying paragraph (d) of the definition of QSBCS, with Subco as the "particular corporation", could only require that corporations connected with Subco to meet the "all or substantially all" test. As there are no corporations connected with Subco, paragraph (d) is of no consequence in the above example. In this regard, we would note that it appears that, in your letter, part of the confusion may lie in the fact that you have misunderstood Parentco to be connected with Subco.

We have not been provided with sufficient information on the asset structure of the corporations which you are currently examining, in order to assess the impact of paragraph (d) of the definition of QSBCS on these corporations. However, we would note that in situations where there are more than two corporations in a chain, the general result of paragraph (d) of the definition of QSBCS in subsection 110.6(1) of the Act, is to allow for only one corporation in the chain to have less than 90% and more than 50% of the FMV of its assets in active business assets, or shares or debt of connected corporations. The major exception to this generality arises with corporations which meet the 90% test based on their own active business assets (i.e., assets described in subparagraph (c)(i) of the definition of QSBCS), thus avoiding the need to consider whether their subsidiaries meet an asset test.

We trust that these comments will be of assistance.

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

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