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: In a situation where a small business corporation raises funds in an IPO to expand its business operations, the funds raised unconditionally belong to the corporation during a period of a few days (3 to 10 days) between the date of closing of the prospectus and the day the shares are approved for unqualified listing on the stock exchange, and such funds account for more than 10% of the assets of the corporation, is the ITA 48.1(1) election still available, considering that such election requires ownership of the shares of a SBC immediately before the SBC ceases to be such by virtue of its shares being listed on the exchange?
Position: General comments only.
Reasons: Resolution depends on the facts.
XXXXXXXXXX 2000-005710
S. Parnanzone
May 7, 2001
Dear XXXXXXXXXX:
Re: Section 48.1 Election – Technical Interpretation
We are replying to your letter of November 14, 2000, concerning the election under section 48.1 of the Income Tax Act (the “Act”).
You described a situation where a corporation that qualifies as a “small business corporation” (SBC), as this term is defined in subsection 248(1) of the Act, raises funds through an initial public offering (IPO) intending to use the funds to expand its business through the acquisition of either other businesses or additional capital assets. You indicated that while on the closing date of the prospectus all the funds raised in the IPO unconditionally belong to the corporation because the Securities Commission approved the prospectus, in your situation the corporation’s shares are not listed for trading until 3 to 14 days later (the “waiting period”) because of the time required to supply documents to the stock exchange and for the stock exchange to review such documents prior to giving its final approval for unqualified listing of the shares. You are concerned that the corporation will not qualify as a SBC during the waiting period because “(t)he funds raised from the IPO can cause the company to have more than 10% of the fair market value of its assets to be assets that are not used in active business, especially where the cash is intended to acquire other businesses.” As a result, you suggest that an individual may fail to meet one of the conditions for the election in section 48.1 of the Act that requires an individual to own at any time in a taxation year shares of a corporation that at that time is a SBC and “immediately after that time” ceases to be a SBC because a class of its shares (or another corporation’s shares, under proposed legislation) is listed on a prescribed stock exchange.
You would like to interpret the expression “immediately after that time” in subparagraph 48.1(1)(a)(ii) of the Act so that the corporation is not disqualified as a SBC by virtue of holding cash during the waiting period. To this end, you would like the Canada Customs and Revenue Agency (CCRA) to interpret the reference to “immediately after that time” to include “the sequence of events that a corporation must complete in order to have its shares listed.” In support of a broader interpretation, you referred to the Macklin case (92 DTC 6595).
The particular circumstances in your letter on which you have asked for our views appear to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R4, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. However, we are prepared to offer the following general comments, which may be of assistance.
The election under section 48.1 of the Act is in respect of shares of a SBC. As defined in subsection 248(1), a SBC, at any particular time, generally means a particular corporation that is a Canadian-controlled private corporation (“CCPC”) all or substantially all of the fair market value of the assets of which at that time is attributable to either (or a combination of) assets that are used principally in an active business carried on primarily in Canada by the particular corporation (or a corporation related to it) or shares or indebtedness of any SBC connected with the particular corporation. In our view, “all or substantially all” means at least 90% of the fair market value of the assets must be attributable to assets used in the active business. Thus, if more than 10% of the assets are not used in the business, the corporation is not a SBC.
In our view, there are three main issues involved in your enquiry with respect to the election in subsection 48.1(1). The first concerns the time at which the corporation ceases to be a SBC for purposes of subsection 48.1(1) of the Act. That is, the issue is whether the wording of this provision can be interpreted such that the provision would apply to a corporation that was a SBC closely or proximately in time before the shares are listed on the exchange.
In our view, the wording of subsection 48.1(1) of the Act clearly suggests that the corporation must be a SBC at the point in time immediately before the shares are listed. It is also our view that the Macklin case does not necessarily support a broader interpretation since this case dealt with an altogether different set of tax provisions (section 44) and circumstances. While it is a question of fact as to when shares are listed on a stock exchange, the CCRA’s position is set out in our file # 962766, to which you made reference in your letter. That is, with respect to when shares are listed on an exchange, it is the CCRA’s view that shares will be regarded as being listed on a stock exchange so long as a full listing (i.e. an unqualified listing) of the shares exists. Accordingly the CCRA takes the view that shares that are conditionally listed will not be listed for the purposes of the Act until the time at which all of the conditions for their listing have been satisfied. However, the CCRA is prepared to accept that shares are listed on an exchange if the exchange considers them to have an unqualified listing prior to the date set for the shares to be called for trading.
The second issue involved in your enquiry concerns whether the funds raised in the IPO would be considered, during the waiting period, to be assets used principally in an active business. If the funds are so used, the corporation will not be disqualified as a SBC solely because it holds the IPO funds during the waiting period so that, for the purposes of the election under subsection 48.1(1), the corporation that is a SBC will cease to be such because its shares are listed on an exchange. For your guidance, the CCRA’s general views concerning when cash held by a corporation will be considered to be used in an active business are as follows:
- Whether a particular asset is used principally in an active business is a question of fact, which must be determined with reference to the circumstances of the case under review. The relevant circumstances include the actual use to which the cash is put in the course of the business, the nature of the business and the practice in the particular business.
- Cash is considered to be used principally in the business if its withdrawal would destabilize the business.
- Cash that is temporarily surplus to the needs of the business and is invested in short-term income producing investments will be considered to be used in the business.
- Cash that is accumulated and is then depleted in accordance with the annual seasonal fluctuations of an ongoing business will generally be considered to be used in the business; however, a permanent balance in excess of the company's reasonable working capital needs will generally not be considered to be so used.
- The accumulation of funds over an extended period of time in anticipation of the replacement or purchase of capital assets or the repayment of a long-term debt will not generally qualify the funds as being used in the business.
- Cash is considered to be used principally in the business if its retention fulfils a requirement that has to be met in order to do business, such as certificates of deposit required to be maintained by a supplier.
- Cash and near cash assets held to offset the non-current portion of long-term liabilities will generally not be considered to be used in the business.
- The CCRA recognises that prudent financial management requires businesses to maintain current assets (including inventories and accounts receivable, as well as cash and near cash properties) in excess of current liabilities and will consider this requirement in assessing whether cash or near cash assets are used principally in a business.
While these guidelines are necessarily general in nature, we would mention that whether cash and near cash will be considered to be used in the course of an active business can only be determined after an examination, on a retrospective basis, of all the relevant facts in the particular situation.
The third issue that arises in your enquiry concerns who controls the corporation during the waiting period. Since you have indicated that the funds raised in the IPO unconditionally belong to the corporation on the closing date of the prospectus, the subscribers of the IPO shares may acquire certain rights in the process. It would appear that, depending on the facts, a corporation may cease to be a SBC because it ceases to qualify as a CCPC by virtue of a change in control as a result of the rights referred to in paragraph 251(5)(b) of the Act being acquired by the subscribers of the IPO shares (as opposed to the corporation ceasing to be a CCPC, and as a consequence a SBC, by virtue of the listing of shares on the exchange). Whether paragraph 251(5)(b) is applicable would depend on the facts and whether paragraph 110.6(14)(b) applies in the particular case.
We trust that the foregoing comments are of assistance.
Yours truly,
Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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