11 January 2002 External T.I. 2001-0086895 - CAPITAL GAINS EXEMPTION

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) Whether shares must be held for a minimum period of time to be considered QSBCS under ss. 110.6(1). (2) Whether such period begins at the time the corporation is created or at the time an active business commences. (3) When is a corporation considered to be carrying on a business. (4) Where overburden is sold in order to access gravel deposits as part of preparing a site for production, would the proceeds be considered on account of income or capital. (5) If on account of capital, can the proceeds be applied to reduce the cost of the property.

Position: (1) Yes. (2) Period is throughout the 24 months immediately preceding the determination time. (3) Question of fact. (4) Question of fact (5) No.

Reasons: (1) The intention of par. (b) of the definition of QSBCS in ss. 110.6(1), in light of par. 110.6(14)(f), is to ensure that treasury shares issued for cash are held for a period of at least 24 months before being sold. (2) Par. (b) of the definition of QSBCS in ss. 110.6(1) requires only ownership throughout the 24 months immediately preceding the determination time, whether a business is carried on by the corporation is not relevant for those purposes. (3) IT-364 provides the CCRA's position based on relevant case law. (4) Whether sale on account of income or capital is a question of fact, as outlined in IT-423. (5) Subsection 43(1) of the Act would apply to the computation of the gain or loss, allowing a reasonable allocation of the ACB.

XXXXXXXXXX 	2001-008689
		Patrick Massicotte
January 11, 2002

Dear XXXXXXXXXX:

Re: Capital Gains Exemption

We are writing in response to your letter of May 28, 2001, wherein you requested our comments regarding the interpretation of certain provisions of the Income Tax Act (the "Act"). We apologize for the delay in responding to your letter.

In the context where shares of a corporation are proposed to be sold, you inquire whether a minimum holding period applies in determining whether the shares can be considered qualified small business corporation shares pursuant to subsection 110.6(1) of the Act. If so, you inquire if this period begins at the time the corporation is created, the date the corporation acquires assets to be used in an active business or at the time the corporation actually begins to carry on the active business. With respect to the latter issue, you ask what activities can be considered business operations where a newly created corporation does not begin to carry on an active business immediately upon its incorporation.

Finally, where the corporation acquires a parcel of land with the intention of starting a gravel pit operation, you ask whether the sale of the trees and overburden (topsoil) in order to access the gravel deposits, as part of the preparation of the land for the purpose of active business operations, would constitute income or capital and whether, in the latter case, the amounts received could be applied against the adjusted cost base of the property. We note that you indicate the corporation intended to start a gravel pit operation, however, it is unclear whether the gravel pit ever operated.

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. For purposes of this reply we have assumed that the land is capital property. Whether land is capital or inventory, or whether there has been a conversion from capital to inventory, is a question of fact. The factors which may generally be considered relevant for such a determination are outlined in Interpretation Bulletin IT-218R, Profit, Capital Gains and Losses from the Sale of Real Estate, Including Farmland and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and Vice Versa.

Subsection 110.6(1) of the Act provides a definition of the term "qualified small business corporation share" ("QSBCS") of an individual at any time (the "determination time"). Paragraph (b) of that definition provides that throughout the 24 months immediately preceding the determination time, the share must not be owned by anyone other than the individual or a person or partnership related to the individual. This ownership test does not require the individual to actually hold the shares for 24 months, merely that no unrelated person or partnership hold the shares during that period. However, for those purposes, paragraph 110.6(14)(f) of the Act provides that shares issued by a corporation after June 13, 1988 are deemed to have been owned immediately before their issue by a person not related to the person or partnership to whom the shares were issued, unless the shares were issued in specific circumstances described therein (which would not be applicable in the case submitted).

These rules are intended to ensure that, for instance, treasury shares issued for cash are held for a period of at least 24 months before being eligible for a capital gains deduction. As provided by paragraph (b) of the definition of QSBCS in subsection 110.6(1) of the Act, this period begins at the determination time and runs throughout the 24 months immediately preceding that time. The issue of whether the corporation was carrying on a business during that period of time is not relevant for those purposes, although it would generally be relevant for the purposes of the other requirements of the definition, such as paragraph (a) and (c) of that definition.

In that context, what is considered business operations is a question of fact. As mentioned in paragraph 2 of Interpretation Bulletin IT-364, Commencement of business operations, it is not possible to be specific about the point in time when a contemplated business becomes an actual business. Generally speaking, it is the CCRA's 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 order that there be a finding that a business has commenced, it is necessary that there be a fairly specific concept of the type of activity to be carried on and a sufficient organizational structure assembled to undertake at least the essential preliminaries. This requirement is applicable whether the projected business is intended to be a continuing one or is to be a single transaction in the form of an adventure in the nature of trade. Where 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 a business of some kind, such an activity does not represent the commencement of a business. A business would be reviewed as being merely contemplated for the future if no serious or reasonably continuous efforts are being made to begin normal business operations. The issue of whether a business has commenced is best resolved by officials of your local Tax Services Office, as they are in a better position to appreciate all the facts of each case.

Finally, whether the sale of trees and overburden (topsoil) is on account of income or capital in a specific situation depends on a review of all the relevant facts and circumstances. As mentioned in Interpretation Bulletin IT-423, Sale of sand, gravel or topsoil, generally the sale of earth substances is considered to be income of a taxpayer where: (a) paragraph 12(1)(g) of the Act is applicable, because amounts received are considered to be dependent upon the use of or production from property when they are contingent on the quantity of material taken and the application to that of some rate or standard (such as price per ton or per cubic yard), or (b) the sale constitutes business income.

For a sale to be treated as income it is only necessary to establish that one of the above-mentioned criteria apply, although in many cases both of them will apply. We note that paragraph 9 of IT-423 states that generally the sale of topsoil removed from land owned by a taxpayer who is in the business of developing the land is a sale from that business, notwithstanding the fact inter alia that it was not the intention of the taxpayer at the time of purchase of the land to sell the topsoil, or that the sale is an isolated transaction. Also, as noted in paragraph 5 of IT-423, factors that may indicate that a taxpayer is in a business may include the fact that the taxpayer is involved in the removal of the substances or that the transaction is similar to other activities that the taxpayer has entered into, although not sufficient in themselves for such a conclusion. However, as provided in paragraph 12 of Interpretation Bulletin IT-373R2 (Consolidated), Woodlots, an amount received for allowing someone to cut and remove timber from his or her woodlot may be considered to be on account of capital in certain specific circumstances. Again, such issues are generally best resolved by officials of your local Tax Services Office, as they are in a better position to appreciate all the facts of each case.

Where the amounts received from the sale of such part of the property can be considered on account of capital, the proceeds should be included in the computation of the gain or loss resulting from such a disposition, pursuant to subsection 40(1) of the Act. For those purposes, subsection 43(1) of the Act provides that the adjusted cost base of that part of a property is the portion of the adjusted cost base of the whole property that can reasonably be regarded as attributable to that part.

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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