13 December 2001 External T.I. 2001-0081015 - CAPITAL GAINS DEFERRAL

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 CCRA.

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

Principal Issues: (1) Is the requirement that the share be issued from treasury to the person seeking deferral to be ignored ? (2) Will an active business be considered to arise when shares are first issued from treasury ? (3) Will initial shares issued to a lawyer on incorporation and then transferred to the current owner also disqualify the current owner from using the deferral ?

Position: (1) No. (2) Question of fact. (3) No, except in some cases.

Reasons: (1) Wording of the Act is clear and cannot be ignored. (2) Whether a corporation is carrying on a business is a question that can only be determined after reviewing all the relevant facts and information. (3) Position taken for purposes of section 110.6 of the Act could be extended to section 44.1 on the same basis.

XXXXXXXXXX 	2001-008101
		Patrick Massicotte
December 13, 2001

Dear XXXXXXXXXX:

Re: Capital Gains Deferral

We are writing in response to your letter of April 23, 2001, wherein you requested our comments regarding the interpretation of certain provisions of the small business share rollover rules in section 44.1 of the Income Tax Act (the "Act"). We apologize for the delay in responding to your letter.

More specifically, you request our views on the following matters, as they relate to section 44.1 of the Act:

1) Can a gain on the sale of a share acquired from purchase rather than from treasury qualify for deferral if other tests are met ? Is the requirement that the share be issued from treasury to the person seeking deferral to be ignored ?

2) Will an active business be considered to arise when shares are first issued from treasury even if there is a time delay before active business is commenced ?

3) Will initial shares issued to a lawyer on incorporation and then transferred to the current owner also disqualify the current owner from using the deferral ?

Our Comments

Written confirmation of the tax implications arising from particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request pursuant to Information Circular 70-6R4. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. However, we are prepared to provide you with some general comments which may be of assistance.

You ask whether an individual's gain realized on the disposition of a share which had been acquired by the individual from purchase, otherwise than in situations described in subsections 44.1(4) to (7) of the Act, rather than from treasury can be eligible for the deferral provided in section 44.1 of the Act. Under subsection 44.1(2) of the Act, the recognition of all or a portion of a capital gain from a qualifying disposition may be deferred. A "qualifying disposition", defined in subsection 44.1(1) of the Act, refers inter alia to the disposition of an "eligible small business corporation share" of an individual. This term is also defined in subsection 44.1(1) of the Act and refers specifically to a common share issued by a corporation to the individual, provided other requirements of the definition are met. These words are clear and unambiguous and cannot be ignored.

Moreover, these provisions are consistent with the intention of Parliament, as indicated in the Budget Plan of February 27, 2000. The purpose of these new measures was to promote innovation and growth by ensuring that businesses have access to the risk capital they need to expand and prosper. It proposed the deferral of tax on capital gains from eligible small business investments, to the extent the proceeds were reinvested in similar investments. "Eligible small business investments" were described inter alia as "newly issued shares in a small business corporation". It is therefore our view that shares acquired from purchase rather than from treasury cannot be considered eligible small business corporation shares for the purpose of section 44.1 of the Act.

Regarding the second issue raised in your request, please note that whether a business is actually carried on is a question that can only be determined after reviewing all the relevant facts and circumstances of each case. Paragraph 2 of Interpretation Bulletin IT-364, Commencement of Business Operations, provides general comments on when a contemplated business becomes an actual business. It states that "[w]here 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 business of some kind, such an activity does not represent the commencement of a business". It also states that it is the CCRA's general 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 a situation where, at the time a corporation issues shares to acquire money:

(a) the type of activity to be carried on by a corporation is known and a sufficient organizational structure is assembled to undertake at least the essential preliminaries;

(b) market surveys have been undertaken on a reasonably extensive basis for the purpose of establishing the most appropriate way or place to carry on the business;

(c) studies and representations have been made to regulatory authorities in order to obtain the required licenses, where applicable; and

(d) preliminary arrangements have been negotiated with respect to the premises required to operate the business we would generally accept, based upon the comments in paragraphs 2 to 5 of IT-364, that the business would have commenced at the time of issuance for the purposes of section 44.1 of the Act. However, the mere fact that shares have been issued from treasury will not, in and of itself, allow to conclude that a business is being carried on for the purposes of section 44.1 of the Act. Whether any business carried on is an active business must be determined according to the particular facts of each case in light of the applicable statutory provisions.

You also request our views on whether shares of a corporation owned by an individual may be considered to have been issued to that individual, for the purposes of the definition of "eligible small business corporation share" in subsection 44.1(1) of the Act, where they were actually received by the individual directly from the lawyer to whom the shares were originally issued upon incorporation, commonly referred to as shares of a shelf corporation. Notwithstanding the above comments, administratively, we would be prepared to ignore the ownership by the lawyer and consider the corporation to be newly incorporated, and the shares newly issued, on the date the incorporating lawyer transfers such shares to the individual, provided that the shares and assets of the corporation involved have always been nominal in value (not more than 3 shares and not more than $1 per share), as this would be consistent with the intent of the legislation.

In closing, please note that the role of the CCRA is to administer and enforce the Act as adopted by Parliament. In your letter, you raise a number of tax policy concerns and requests for amendments to the Act, which are the responsibility of the Department of Finance. Should you wish to pursue these concerns further, you may contact the Tax Policy Branch of the Department of Finance by writing to: L'Esplanade Laurier, 140 O'Connor Street, Ottawa, Ontario, K1A 0G5.

We trust the above comments are of assistance to you.

Yours truly,

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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