10 May 2013 External T.I. 2013-0483891E5 - Qualified small business corporation - connected

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 a corporation qualifies for the capital gains exemption under various scenarios.

Position: Question of fact

Reasons: See analysis below.

XXXXXXXXXX 2013-048389
K. Robinson
May 10, 2013

Dear XXXXXXXXXX:

Re: Qualified Small Business Corporation Shares ("QSBCS")

We are writing in response to your email of April 3, 2013, wherein you asked whether shares of the capital stock of a particular corporation qualify as QSBCS as that term is defined in subsection 110.6(1) of the Income Tax Act ("Act").

Our Comments

Written confirmations of the tax implications inherent in particular transactions are provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, "Advance Income Tax Rulings", dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html. Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required. Such review would normally be conducted by the applicable Tax Services Office during the course of an income tax audit which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year. Notwithstanding the foregoing, we are prepared to provide the following comments that may be of assistance.

If an individual (other than a trust) is resident in Canada throughout the year and realizes a taxable capital gain on the disposition of QSBCS in that year, that individual may be entitled to a capital gains deduction in calculating his or her taxable income pursuant to subsection 110.6(2.1) of the Act. The definition of QSBCS in subsection 110.6(1) of the Act incorporates, inter alia, three main tests, as briefly discussed below, that must be met in order for the individual's shares to be considered as QSBCS for these purposes.

1) Small Business Corporation ("SBC") Test

The first test, in paragraph (a) of the QSBCS definition, examines the use of the particular corporation's assets at the time the shares are sold (i.e., the "determination time") and requires that the shares must be the shares of a SBC at the determination time.

Under the definition of SBC in subsection 248(1) of the Act, a corporation will, inter alia, be a SBC at any particular time where, subject to subsection 110.6(15) of the Act, the particular corporation is a Canadian-controlled private corporation ("CCPC") and all or substantially all (i.e., generally 90% or more) of the fair market value ("FMV") of its assets at that time is attributable to assets that are

(a) used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it,

(b) shares of the capital stock or indebtedness of one or more SBCs that are at that time connected with the particular corporation (within the meaning of subsection 186(4) on the assumption that the SBC is at that time a "payer corporation" within the meaning of that subsection) (footnote 1) , or

(c) described in paragraphs (a) and (b).

2) Holding Period Ownership Test

The second test, in paragraph (b) of the QSBCS definition, requires an examination of the continuity of ownership of the particular shares during the 24 month period immediately before the sale. This test requires 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.

3) Holding Period Asset Use Test

The third test, in paragraph (c) of the QSBCS definition, requires an examination of the use of the corporation's assets throughout the 24 month period immediately preceding the sale of the shares of the particular corporation. This test requires that the corporation must be a CCPC during that time and more than 50% of the FMV assets of the corporation must be attributable to "eligible assets". Eligible assets would consist of:

(i) assets used principally in an active business carried on primarily in Canada by the corporation or by a related corporation; and/or

(ii) shares or indebtedness of connected corporations where such corporations are CCPCs that also meet the 50% Holding Period Asset Use Test.

If the particular corporation itself has sufficient eligible assets described in (i) above to meet the 50% Holding Period Asset Use Test in paragraph (c), then the more stringent 90% Holding Period Asset Use Test described in paragraph (d) of the definition of QSBCS would not have to be considered.

As noted above, the determination as to whether the particular corporation's shares would meet all the conditions set out in the definition of QSBCS would require a complete review of the relevant facts and circumstances.

We trust that these comments will be of assistance.

Yours truly,

Michael Cooke, C.P.A., C.A.
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Further information on the meaning of connected corporations can be found in IT-269R4, "Part IV Tax on Taxable Dividends Received by a Private Corporation or a Subject Corporation".