19 May 1989 Income Tax Severed Letter 5-7700 - [Qualified Small Business Corporation Share*]

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.

Small Business and General Division R. Langevin (613) 957-2138

MAY 19 1989

Dear Sirs:

This is in reply to your fax dated March 16, 1989, requesting our technical interpretation of the definition of a "qualified small business corporation share" ("QSBCS") in subsection 110.6(1) of the Income Tax Act (the "Act") in the following circumstances:

(1) Mr. A owns 100% of A Corp, a Canadian-controlled private corporation (CCPC).

(2) A Corp owns 100% of B Corp, a second CCPC.

(3) B Corp owns 100% of C Corp, a third CCPC.

(4) The above ownership have remained unchanged for over 24 months.

(5) C Corp has carried on an active business in Canada for longer than the last 24 months. C Corp has, for this entire period, employed greater than 50% but less than 90% of its assets when valued at fair market value (FMV) in its active business carried on in Canada.

(6) B Corp's only asset during the past 24 months has been its shares in C Corp.

(7) A Corp has held two assets during the past 24 months whose values at FMV were:

Shares of B Corp $1,000,000 (67%)

Marketable securities (inactive) $ 500,000 (33%)

Your Question

Would shares of A Corp be qualified small business corporation shares if sold at a time immediately after the end of the above 24 month period, provided A Corp, B Corp and C Corp qualified at that time as "Small Business Corporations" (SBC) within the definition of subsection 248(1) of the Act?

Our Comments

To qualify as a QSBCS, a share must be one of a SBC as defined in subsection 248(1) of the Act. In addition, the share must satisfy a holding period requirement as provided by paragraph (b) of the QSBCS definition in subsection 110.6(1) of the Act. Moreover, the share must be a share of a corporation that meets an active business asset test as required by paragraph (c) of the definition of a QSBCS. For the purposes of this discussion, we will assume that the holding period requirement is met.

The definition of a QSBCS requires that at the "determination time" the share must be one of a SBC. For the purposes of the scenario being considered A Corp must be a SBC at the determination time. In addition, paragraph (c) of the QSBCS definition requires that the shares Mr. A holds in A Corp must be shares of the capital stock of a CCPC more than 50% of the fair market value of the assets of which was attributable to assets used in an active business directly by A Corp or shares, inter alia, of the capital stock issued by one or more corporations that were connected with A Corp (within the meaning of subsection 186(4) of the Act). Clause (c)(ii)(B) of the QSBCS definition requires that, throughout that part of the 24 months immediately preceding the determination time while the subject shares were owned by A Corp, such shares must have been shares of CCPC's more than 50% of the fair market value of the assets of which was attributable to assets described above.

There is a proviso, however, in paragraph (d) of the QSBCS definition which is central to the issue raised. Paragraph (d) provides that where for any period of time in the 24 month period ending at the determination time, all or substantially all of the fair market value of the assets of A Corp cannot be attributed to assets which are used directly in an active business or the shares of a connected corporation(s) which meet the test imposed by clause (c)(ii)(B) of the QSBCS definition, then the reference in clause (c)(ii)(B) to "more than 50%" shall for that period of time be read as "all or substantially all" in respect of those other corporations connected with A Corp. Therefore, where all or substantially all of the fair market value of the assets of A Corp, or any other subsidiary intermediate holding corporation in the stacking situation (other than the operating company at the bottom of the chain), are not of the type described in (c)(i) and (c)(ii)(B) of the QSBCS definition as required, paragraph (d) of that definition imposes the higher active business asset test on all those "other corporations" further down the chain, including the operating corporation at the bottom of the chain.

Accordingly, in the scenario under consideration both B Corp and C Corp are connected with A Corp. However, A Corp does not meet the "all or substantially all" test as provided by paragraph (d) of the QSBCS definition with the result that paragraph (d) requires that both of the connected corporations B Corp and C Corp must meet the higher active business asset test imposed by paragraph (d) of the definition. Inasmuch, as C Corp does not meet the higher test, the requirements in paragraph (d) of the QSBCS definition have not been met, with the result that the subject shares Mr. A holds in A. Corp would not qualify as QSBCS's.

This result would not be altered if Y Corp and X Corp are inserted into the scenario as you have described it.

We trust our comments are of some assistance.

Yours truly,

for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch