15 January 2007 External T.I. 2006-0208691E5 - Transfer of Property Prior to Share Sale

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.

Principal Issues: If real property that is owned by a shareholder of a corporation, but used by the corporation in its business, is transferred to the corporation prior to a sale of shares, will the capital gains exemption be available?

Position: No.

Reasons: Per paragraph 110.6(14)(f), the shares issued on transfer will be deemed to have been owned by a person not related to the shareholder and thus will not meet the definition of QSBC shares. Consistent with CRA position taken in response to 1988 Round Table question.

2006-020869
XXXXXXXXXX James Atkinson CGA
(519) 457-4832
January 15, 2007

Dear XXXXXXXXXX:

Re: Transfer of Property Prior to Sale of Shares - Paragraph 110.6(14)(f)

This is in response to your e-mail of September 29, 2006 inquiring about the application of paragraph 110.6(14)(f) of the Income Tax Act ("Act") where shares have been issued as consideration for property transferred, prior to a sale of those shares.

Our understanding of the facts is as follows:

1. Shareholders A and B are 50% common shareholders in a company ("OPCO") that carries on an active business. OPCO was incorporated in 1983 and continues to carry on the same business.

2. OPCO holds all operating assets of the business except for the land on which the business is situated.

3. Shareholder B personally owns the land on which OPCO's business is situated.

4. The shares of OPCO and the land on which its business is carried on are about to be sold to a third party by Shareholders A and B as applicable.

5. Prior to the sale of shares of OPCO, Shareholder B will transfer the land to OPCO in exchange for retractable preferred shares equal to the fair market value of the land.

6. The preferred shares issued in exchange for the land will have been held for less than 24 months by Shareholder B prior to the sale of all OPCO shares by Shareholders A and B to the third party.

Your question relates to whether subparagraph 110.6(14)(f)(ii) of the Act applies to the preferred shares issued by OPCO as a consequence of a transfer of the land to it by Shareholder B.

Our Comments:

The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. 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 ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

An individual who realizes a gain on the disposition of a qualified small business corporation (QSBC) share, as defined in subsection 110.6(1) of the Act, may be entitled to a deduction in calculating his or her taxable income according to subsection 110.6(2.1) of the Act. In order for a share to so qualify, the corporation must be a small business corporation, as defined in subsection 248(1) of the Act, and among other requirements the share must not have been owned by anyone other than the individual or a person or partnership related to the individual throughout the 24 months immediately preceding its disposition. 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. For those purposes, paragraph 110.6(14)(f) of the Act provides a deeming rule 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. Subparagraph 110.6(14)(f)(ii) provides in part that shares issued "as part of a transaction or series of transactions in which the person ..... disposed of property to the corporation that consisted of (A) all or substantially all the assets used in an active business carried on by that person...." are not subject to this deeming rule. Generally, where 90% or more of the assets of the business are disposed to a corporation, all or substantially all of the assets of such business will be considered disposed of to that corporation. In the situation that you describe, the mentioned deeming rule will not apply if the property disposed to OPCO represents all or substantially all of the assets of a separate active business of Shareholder B. Based on the facts, Shareholder B is not carrying on an active business by the mere ownership of land that is presumably rented to OPCO. As a result, the requirement in clause 110.6(14)(f)(ii)(A) is not met. Therefore, the preference shares issued by OPCO on the transfer of the property to it by Shareholder B will be deemed to have been owned by a person not related to the shareholder and will therefore not meet the definition of "qualified small business corporation share" in subsection 110.6(1).

We trust that these comments will be of assistance.

Yours truly,

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch