21 November 2011 External T.I. 2011-0424331E5 - ITA 110.6(14)(f)

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: Whether the shares of a corporation qualify as qualified small business corporation shares.

Position: Possibly. It is a question of fact.

Reasons: The law.

XXXXXXXXXX 				2011-042433
					Linda Compton

November 21, 2011

Dear XXXXXXXXXX :

Re: Capital Gains Exemption and Paragraph 110.6(14)(f) of the Act

This is in response to your correspondence of October 17, 2011 requesting our views on the application of paragraph 110.6(14)(f) of the Income Tax Act ("Act").

Briefly, in your correspondence you describe a situation where an individual who carried on an unincorporated business transferred all of the assets that were owned by the individual and used in that business to a new corporation in exchange for shares of the new corporation. However, you indicate that the land and building that was used in that individual's business was owned by a related corporation prior to the transfer of the individual's business assets to the new corporation.

Your specific question concerns whether or not the shares that were issued to the individual on the transfer of the business assets to the new corporation, and which were not owned by the individual for at least 24 months immediately preceding the time of their disposition, would be eligible for the capital gains deduction provided in subsection 110.6(2.1) of the Act on the basis that paragraph 110.6(14)(f) of the Act applied to those shares.

Comments

An individual (other than a trust) who realizes a taxable capital gain on the disposition of a share that is a "qualified small business corporation share" ("QSBCS"), as defined in subsection 110.6(1) of the Act, may be entitled to a capital gains deduction under subsection 110.6(2.1) of the Act provided various conditions are met. Paragraph (b) of the definition of QSBCS describes a holding period requirement that provides that throughout a period of 24 months immediately preceding the determination time, the particular share (or shares) must not have been owned by any person or partnership other than the individual or a person or partnership that was related to the individual.

Paragraph 110.6(14)(f) of the Act provides a special rule which applies for the purposes of the definition of QSBCS. This special rule essentially deems shares issued by a corporation to a particular person or partnership as having been owned immediately before their issue to the particular person or partnership by a person who was not related to the person or partnership. The effect of this special rule is to require newly issued shares, other than those provided for in the exceptions in subparagraphs 110.6(14)(f)(i) and 110.6(14)(f)(ii), to be owned for the full 24 month holding period by the particular individual or by persons or partnerships related to the individual in order to qualify for the capital gains deduction. This special rule ensures that the 24 month holding period requirement in paragraph (b) of the QSBCS definition cannot be circumvented by the issue of shares of a corporation from treasury.

Subparagraph 110.6(14)(f)(i) provides that shares issued as consideration for other shares will not be subject to this special rule. In addition, subparagraph 110.6(14)(f)(ii) provides that shares issued as part of a transaction or series of transactions in which the person or partnership disposed of all or substantially all (generally considered to be 90% or more) of the assets used in an active business carried on by that person or the members of the partnership or disposed of an interest in a partnership where all or substantially all of the partnership's assets were used in an active business carried on by the members of that partnership are also not subject to this special rule.

Whether or not the conditions set out in subparagraph 110.6(14)(f)(ii) have been met in a particular fact situation can only be determined by a review of all the facts and circumstances surrounding that particular situation. Generally speaking, the fact that some of the assets used in a particular individual's unincorporated business may have been leased from another person would not necessarily preclude a finding of fact that the exception in subparagraph 110.6(14)(f)(ii) of the Act would not apply provided that the value of the individual's interest in such leased property (including any leasehold improvements) is taken into account in determining whether the "all or substantially all test" has been met.

In connection with the above, we would also like to refer you to the comments that appeared in the 1988 Canadian Tax Foundation Revenue Canada Roundtable at page 53:9 concerning a situation that involved the transfer of a building (representing 50% of the fair market value of all the business assets) that was owned and used by an individual in a sole proprietorship to a holding corporation ("Holdco") prior to a transfer of the remaining business assets to an operating corporation ("Opco"). The transfer of the building to Holdco had occurred in contemplation of a purchase and sale offer the individual received for all the proprietorship's business assets except for the building. In our response, we indicated that in that situation the exception in subparagraph 110.6(14)(f)(ii) of the Act would not apply to the sale of the shares of Opco as they were not issued as part of a transaction or series of transactions in which the individual disposed of all or substantially all of the assets used in an active business carried on by the individual to Opco.

We trust our comments will be of assistance to you.

Yours truly,

Michael Cooke
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch