12 October 1990 Ruling 59571 F - Capital Gains Exemption on 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.

October 12, 1990

Dear Sirs:

Re:  Technical Interpretations - Clause 110.6(14)(f)(ii)(A) and paragraph 20(1)(c) of the Income Tax Act (the "Act")

This is in reply to your letter, dated February 5, 1990, whereby you requested a technical interpretation concerning the above-captioned provisions of the Act in the following hypothetical circumstances.

Situation 1

A joint venturer in an active business concern transfers 100% of his interest in such concern to a corporation in consideration for shares of such corporation.

You requested our opinion as to whether clause 110.6(14)(f)(ii)(A) of the Act would apply so that the shares so issued would not be considered to have been owned, prior to their issuance, by an unrelated person.

Clause 110.6(14)(f)(ii)(A) of the Act provides that, for the purposes of the definition of "qualified small business corporation share" in subsection 110.6(1) of the Act:

     "shares issued after June 13, 1988 by a corporation to a particular person (...) shall be deemed to have been owned immediately before their issue by a person who was not related to the particular person (...) unless the shares were issued (...)

     (ii) as part of a transaction or series of transactions in which the person (...) disposed of property to the corporation that consisted of

     (A)  all or substantially all of the assets used in an active business carried on by that person (...)".

The term "joint venture" is not defined in the Act, nor does it have a clearly established legal or commercial meaning. Accordingly, whether or not paragraph 110.6(14)(f) applied to a transfer such as the one described above would have to be determined having regard to the nature of a particular business arrangement. However, it is our view that the requirements of clause 110.6(14)(f)(ii)(A) would ordinarily be satisfied where a joint venturer, whose contribution to the undertaking of the joint venture is such that he can be said to be carrying on an active business, transfers to a corporation all of his interests in the assets used in such business.

Situation 2

You further requested our opinion regarding the deductibility of interest expense incurred on monies borrowed to fund an acquisition of shares of a small business corporation the following circumstances.

The arm's-length purchaser of the shares of a small business corporation ("OPCO") has incorporated a holding corporation ("Holdco") to undertake the purchase, with the intent of amalgamating Holdco and Opco (to form "Amalco") after the acquisition of the shares. You have presented us with the following two scenarios:

(a)     Holdco is the primary debtor to a third-party financial institution which has lent funds to acquire shares of Opco. Typically, the lender in this case requires an escrow closing where funds are advanced on condition that Opco guarantee Holdco's debt (and encumber its assets to secure such guarantee) and, frequently, on condition that the amalgamation occur on closing so that the lender's security interests against the property of Opco can be registered simultaneously with the release of funds by Holdco to the vendors; or

(b)     Opco is the primary debtor to the third-party financial institution and Holdco borrows funds from Opco to finance the purchase. In this example, the acquisition by Holdco during the escrow period is followed by a direct loan from the third-party lender to Opco on the security of its assets so that the lender's security interests can be registered prior to the amalgamation, namely, at the time of the loan. The next step, within the closing escrow period, is an advance by Opco to Holdco, on arm's-length terms at a rate of interest exceeding that charged by the third-party lender. Such funds borrowed by Holdco are then released to the vendor in consideration of the share purchase. Holdco and Opco amalgamate to cause the intercorporate debt to disappear.

You requested that we confirm that our administrative practice is to permit, in either case (a) or (b) above, Amalco to claim the interest deduction on interest paid to the third-party lender provided that the assets acquired in the course of the amalgamation continue to be used by Amalco for the purpose of gaining or producing income from a business or property to the extent that the income is not exempt.

Following the decision of the Supreme Court of Canada in Her Majesty The Queen v. Phyllis Barbara Bronfman Trust in January, 1987, The Department of Finance issued a release, on June 2, 1987, to clarify the government's position regarding the impact of the decision on certain commercial transactions such as corporate borrowing to purchase shares. Mr. Elmer Mackay, then Minister of National Revenue, indicated that Revenue Canada's administrative practice concerning the deductibility of interest expenses, as set out in interpretation bulletins, would be maintained. Representatives of Revenue Canada confirmed at the 1987 Corporate Management Tax Conference of the Canadian Tax Foundation, that the Department would maintain its administrative practice as set out in its Interpretation Bulletin IT-315 "Interest Expense Incurred for the Purpose of Winding-up or Amalgamation", dated May 10, 1976.

IT-315 expresses the administrative position of the Department regarding the deductibility of interest when loans are incurred by a taxpayer which is a Canadian corporation for the purpose of acquiring shares of a corporation which is subsequently amalgamated with the acquiring corporation.

We are of the opinion that the administrative position of the Department set out in IT-315 would apply to circumstances such as those outlined in example (a) above.

However, we are of the opinion that the interest paid by Amalco under the circumstances described in example (b) would not be deductible under paragraph 20(1)(c) of the Act, since the loan incurred by Holdco to acquire Opco no long exists after the amalgamation. Furthermore, since in example (b) the funds borrowed by Opco were not used by that corporation to acquire shares, the requirements for the application of the administrative position set out in IT-315 would not be satisfied.

The comments in this letter represent opinions and not rulings. Accordingly, these opinions are not binding on Revenue Canada, Taxation, as indicated in paragraph 24 of Information Circular 70-6R dated December 18, 1978.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch