20 February 1990 Ministerial Letter 59328 F - Capital Gains Exemption for 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.

February 20, 1990

Dear Sirs:

Re:  Qualified Small Business Corporation Share

We are writing in response to your letter dated December 10, 1989, wherein you requested our opinion regarding the provisions of subsection  110.6(1) of the Income Tax Act (the "Act") in the hypothetical situation described hereunder.

In particular, you request our opinion as to whether the shares of Holdco, at the determination time, would be qualified small business corporation shares.  The expressions "Qualified small business corporation shares" (QSBC shares) and "determination time" as referred to above and subsequently have the meaning assigned in subsection 110.6(1) of the Act under the definition of "QSBC shares".

Facts

1.     Holdco, a Canadian-controlled private corporation, is wholly owned by Mr. A.  The expression "Canadian-controlled private corporation" as referred to above and subsequently has the meaning assigned in paragraph 125(7)(b) of the Act.

2.     Opco, a Canadian-controlled private corporation, is wholly owned by Holdco.

3.     The above outlined corporate share ownership has remained unchanged for over 24 months.

4.     A new taxable Canadian corporation ("Newco") is created.  Mr. will transfer all the shares of Holdco to Newco, for proceeds of disposition equal to the fair market value of the Holdco shares resulting in a taxable gain against which Mr. A proposes to apply a capital gains deduction for QSBC shares as provided in subsection 110.6(2.1) of the Act.

5.     The fair market value of Holdco's assets, at the determination time, and for the 24 months immediately preceding that time were in the following proportions:

6.     The intercompany receivable from Opco, as indicated in paragraph 5 above, was not related to any intercompany sales and was not made in the ordinary course of Holdco's business.  In addition, this receivable which has been outstanding for several years is not evidenced in writing, is interest free and there are no formal arrangements for it's repayment.

7.     The fair market value of Opco's assets, immediately before the determination time, and for the 24 months immediately preceding that time were in the following proportions:

8.     Immediately before the determination time, the cash or near cash investments described in paragraph 7 above will be removed.

Upon reviewing the above summarized transactions you are concerned that the intercompany receivable, as described in paragraphs 5 and 6 above, would not be considered as an asset attributable to a "similar obligation" issued by Opco, as that expression is used in subparagraph (c)(ii) of the QSBC share definition in subsection 110.6(1) and paragraph (b) of the "small business corporation" definition in subsection 248(1) of the Act. As such, Holdco would not meet the "all or substantially all" threshold provided in the small business corporation definition in subsection 248(1) of the Act, with the result that the shares held by Mr. A in Holdco would not qualify as QSBC shares. 

In particular you ask;

1.     "Provided the excess cash in Opco was removed, would the shares held by the individual shareholder qualify as qualified small business corporation shares?"

2.     "If the shares do not qualify as shares of a qualified small business corporation, could the intercompany receivable be replaced with a note receivable and this test be met after a 24 month waiting period?"

Our Comments

Briefly, to qualify as a QSBC share, at the determination time, a share must be one of a small business corporation as defined in subsection 248(1) of the Act.  The share must also satisfy a holding period requirement as.provided by paragraph (b) of the QSBC share definition in subsection 110.6(1) of the Act.  In addition, the share or the shares of a connected corporation, must be a share of a corporation that meets an active business asset test as required by paragraph (c) of the QSBC share definition in subsection 110.6(1) of the Act.  Furthermore, a more rigid active business asset test, provided in paragraph (d) of the QSBC share definition in subsection 110.6(1) of the Act, will apply with respect to certain corporations connected with the corporation under certain conditions.

With regards to the intercompany receivable, as described in paragraphs 5 and 6 above, it is our view that, the phrase "similar obligation" must be interpreted with reference to the words "a bond, debenture, bill, note, mortgage, hypothec" which immediately precede it in the relevant definitions.  Each of the debt instruments referred to above is one which is evidenced in writing and thus an "intercompany" receivable, as described above, would not be a "similar obligation" for purposes of subparagraph (c)(ii) of the definition of a QSBC share or paragraph (b) of the definition of small business corporation.

In view of the above and on the assumption that, at the determination time, Holdco would otherwise qualify as a small business corporation, it is our view that Opco would be subjected to the more rigid active - business asset test, provided in paragraph (d) of the QSBC share definition in subsection 110.6(1) of the Act.

With regard to your first question, as cited earlier, concerning the possibility of Holdco shares held by Mr. A qualifying as QSBC shares upon the removal of the excess cash, it is our view that where either Opco fails to meet the higher active business asset test as provided in paragraph (d) of the QSBC share definition in subsection 110.6(1) of the Act, "for any period of time in the 24 month period" regardless of the duration, the Holdco shares would not be QSBC shares.  The use of the word "throughout" in clause (c)(ii)(B) of the QSBC share definition in subsection 110.6(1) of the Act, indicates, in our view, a test that does not permit an exception even for a brief period of time.

With regard to your second question, as cited earlier, concerning the replacement of the "intercompany" receivable with a "note" receivable, it is our view that if the "intercompany" receivable were subsequently evidenced in writing before the determination time, within the meaning of the definition of QSBC share, it would be a note or a similar obligation as described in paragraph (c)(ii) of the definition of QSBC share and paragraph (b) of the definition of small business corporation from the time it is evidenced in writing. It would not, however, be a "similar obligation" before that time for purposes of determining whether the test found in subparagraph (c)(ii) of the definition has been met.

In formulating our reply as outlined above, consideration was not given to the application of other provisions of the Act, such as section 84.1 to the transaction described in paragraph 4 above or subsection 55(2) to the transaction described in paragraph 8 above, which apply in a specific situation involving the disposition of shares.

We trust that the above comments will be of assistance.

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch