19 September 1989 External T.I. 58425 F - Capital Gains Deduction for Qualified Small Business Corporation Shares

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.

September 19, 1989

We are writing in reply to your letter of July 20, 1989, wherein you requested our views as to whether the shares of a particular corporation would be qualified small business corporation shares, as defined in subsection 110.6(1) of the Income Tax Act for purposes of the enhanced capital gains deduction in subsection 110.6(2.1).

Our understanding of the situation set out in your letter, and your analysis of the income tax implications, is as follows:

A Canadian controlled private corporation ("CCPC") owns assets consisting only of land and building which are leased to a related corporation, and a loan receivable from the same related corporation.

The related corporation is a small business corporation which carries on an active business in Canada, and is.not connected with the particular corporation for purposes of subsection 186(4).

In order for an individual to claim the deduction permitted by subsection 110.6(2.1), the shares of the CCPC must fulfil the requirements or the definition in subsection 110. 0(1) of a "qualified small business corporation share" "(QSBCS") as follows:

•     the corporation must be a small business corporation ("SBC") at the time of disposition,

•      during the 24 month qualifying holding period, shares must have been owned by the disposing shareholder or person(s) related to him, and

•      throughout the 24 month qualifying holding period, greater than 50% of the fair market value ("FMV") of the corporation's assets must have been used in an active business carried on by it or a related corporation primarily in Canada.

In order to be a SBC, as defined in subsection 248(1), at the time of disposition, the corporation must be a CCPC, all or substantially all of the FMV of the assets of which at that time were attributable to assets that were:

(a)      used 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 of one or more small business corporations that were at that time connected with the particular corporation (within the meaning of subsection 186(4) on the assumption that such small business corporation was at that time, a "payer corporation" within the meaning of that subsection) or a bond, debenture, bill, note, mortgage, hypothec or similar obligation issued by such a connected corporation, or

(c)      assets described in (a) and (b),

     and for the purposes of paragraph 39(1)(c), includes a corporation that was at any time in the 11 months preceding that time a small business corporation.

The land and building qualify under paragraph (a) above.  However, your question relates to whether or not the loan receivable from the related corporation qualifies under (a) or must qualify under (b).  Paragraph (a) discusses an active business carried on by a "related" corporation. Paragraph (b) discusses obligations of a "connected" corporation.

In your view, the loan receivable qualifies under paragraph (a), and that paragraph (b) would be inapplicable.  You have requested clarification that where there is a loan receivable from another corporation, there is no need that the corporation be connected if paragraph (a) is met.

Is is also your view that the corporation meets the requirements of subsection 110.6(1) QSBCS and 248(1) SBC in order for subsection 110.6(2.1) to apply, provided the loan receivable from the related corporation which carries on an active business in Canada qualifies as an asset used in an active business carried on primarily in Canada for purposes of the definition of a SBC.

Our Comments

On the assumption that the related company used all or substantially all of the FMV of the land and building leased to it in an active business carried on in Canada, we would agree that these assets would be described in paragraph (a) of the definition of a SBC and in subparagraph (c)(i) of the definition of QSBCS.

With respect to the loan receivable, if the particular corporation's ordinary business activity does not include the lending of money, the loan receivable from the related company would not be an asset used in an active business carried on in Canada by the particular corporation. With respect to the inter-company loan, it is our opinion, that such a loan should bear interest at a fair market rate in order to be used in an active business of making loans.  In our view, if the ordinary business of the corporation does not include the making of loans, a loan receivable must qualify under paragraph (b) of the definition of SBC in subsection 248(1).

We hope these comments are of assistance to you.

Yours truly,

for DirectorSmall Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch