29 August 1990 Administrative Letter 901806 F - Associated Corporations

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.

August 29, 1990

Dear Sirs:

Re:  Section 256 of the Income Tax Act (the "Act")

We refer to your letter of July 19, 1990, in which you requested a technical interpretation of the provisions of certain subsections of section 256 of the Act as they would pertain to the investment in equity shares issued to a corporation governed by the Small Business Equity Corporation Act of Alberta (the "SBEC Act"), which was proclaimed in force on July 20, 1984.  For the purpose of this letter:

(i)     a "Small Business Equity Corporation" ("SBEC") is a corporation registered as such under the SBEC Act;

(ii)     an "equity share" has the meaning assigned under paragraph 1(g) of the SBEC Act, and basically, is a share of a class of shares of a corporation carrying voting rights under all circumstances;

(iii)     an "eligible investment" is defined in subsection 11(2) of the SBEC Act, and basically, is an investment in the equity shares of a small business defined under subsection 11(1) of the SBEC Act.  Paragraph 11(2)(d) of the SBEC Act places an upper limit of 49% in respect of the equity share investment of one or more SBEC's in a small business.

Under the SBEC program the Government of Alberta provides a grant to non-corporate investors, or a tax credit to corporate investors, equal to 30, of the amount invested in a qualifying small business (an "investee").

You have given us to understand that an SBEC may invest in equity shares containing fractional votes (e.g. 1/10 of a vote per share) of an investee. Accordingly, SBEC's could invest in equity shares of an investee having an aggregate of less than 49% of the votes thereof, but nevertheless own in the aggregate more than 49% of the fair market value of the issued equity shares.

In a telephone conversation 19(1) Shinerock) in which, clarification of paragraph 6 of your letter under reference was sought, you indicated that an SBEC could acquire 401 of the issued common shares of an eligible investment and one preference share having only 1/10 of a vote.  The value of the preference share would be such that the aggregate fair market value of the common shares and the preference share would be in excess of 49% of the fair market value of the investee.

You have informed us that an SBEC need not be a Canadian-controlled private corporation ("CCPC") as defined under paragraph 125(7)(b) of the Act, and also need not be a private corporation, as defined under paragraph 89(1)(f) of the Act, by virtue of being controlled by a public corporation.

You have drawn the following conclusions relative to certain provisions of the Act as they would apply to the above described situation:

(1)     Shares that have a fractional vote attached to them should be considered, for the purposes of the definition of "specified class" set out under subsection 256(1.1) of the Act, and for the purposes of paragraph 256(1.2)(c) of the Act as non-voting shares, especially where in the aggregate, the holder of the shares does not own enough  fractional votes to register a "whole" vote.

(2) (a)     If the shares containing fractional votes are not considered to be shares of a specified class, with the result that an SBEC could become associated with each of  two investee corporations, and those corporations would therefore be deemed to be associated with each other pursuant to subsection 256(2) of the Act, then on the assumption that the SBEC is a CCPC, it may elect, in prescribed form, not to be associated with either investee in respect of a particular taxation year of the SBEC in which it would otherwise be deemed to be  associated.  Accordingly, each investee would not then be required to allocate the $200,000 annual business limit as provided in subsection 125(3) of the Act by reason only of being deemed to be associated with the SBEC pursuant to subsection 256(2) of the Act.

    (b)     For the purposes of determining an investee's addition to its investment tax credit, as set out in paragraph (e) of the definition of "investment tax credit" in subsection 127(9) and in subsection 127(10.1) of the Act, subsection 127(10.2) of the Act shall, subject to subsection 127(10.3) thereof, apply  to the investee where it is deemed to be associated with another investee in the manner described in (a) herein.  Consequently, each such investee may, pursuant to subsection 127(10.3) of the Act, allocate between them the expenditure limit referred to in subsection 127(10.2) of the Act.

(3)     Where at least one of two or more corporations that would otherwise be associated under subsection 256(1) of the Act has a 1989 taxation year that commenced before 1989, subsections 256(1.2) and 256(1) would not have effect until the 1990 taxation year of such corporation.

Our Comments

As mentioned in your letter, our comments are made on the assumption that the provisions of subsection 256(5.1) have no application to the situation described above.

1.     Since the definition of an equity share is central to the interpretation you have requested on subsection 256(1.1) of the Act we spoke with 19(1) as to whether a preference share having a fractional vote would be considered to be an "equity share"  within the meaning of paragraph 1(g) of the SBEC Act. Without being specific on the matter, indicated that  this would depend on the incorporating articles of the issuing corporation, and the spirit and intent of the SBEC Act.  Since it would seem to be rather pointless in giving a share a fractional vote if it could not be exercised under certain conditions or circumstances (e.g. the acquisition of  ten shares each having 1/10 of a vote would give the right to one whole vote), we are unable to agree with you that such a share should be considered to be a non-voting share for the purposes of paragraph 256(1.1)(b) of the Act.

     For the purposes of determining whether an (investee) corporation would be deemed to be controlled by another corporation, a person or a group of persons, as described in  paragraph 256(1.2)(c) of the Act, we would point out that subparagraph (c)(i) thereof contemplates that "deemed control" would exist where such other corporation, a person or group of persons owned shares of an (investee) corporation  having a fair market value of more than 50% of the fair      market value of all the issued and outstanding shares of the capital stock thereof.  Thus, it is not necessary that any common shares of such a corporation be held in order to come within this "deemed control" rule.  Consequently, it is our view that if a SBEC held only preference shares, each of which had a fractional vote, in two or more investees, and if such preference shares fell within the 50% plus test of subparagraph 256(1.2)(c)(i) of the Act, then, such investees would be     associated with one another pursuant to paragraph 256(1)(b) of the Act regardless of whether the fractional votes added  up to one whole vote.  We would be of the same view even though the preference shares were non-voting.

2(a)     We agree that an investee would not be subject to the provisions of subsections 125(2) and (3) of the Act provided  that an SBEC that is a CCPC made a valid election referred to in subsection 256(2) of the Act.

   (b)     We agree that each investee referred to in (a) herein will be  subject to the associated corporation rules in subsections 127(10.2) and (10.3) of the Act notwithstanding that an SBEC  makes a valid election under subsection 256(2) of the Act, since such election is effective only for the purposes of section 125 of the Act, and not also for the purposes of section 127 of the Act.

3.     Provided that the 1989 taxation year of at least one corporation referred to in 3 above commenced before 1989, and  further provided that none of subparagraphs (a)(ii) to (iv)  of the transitional rule set out in section 192(6), Chapter 55, 1988, would have application, we agree that such corporation would not be associated with another corporation by virtue of the application of subsections 256(1.2) and 256(1) of the Act until the 1990 taxation year of such corporation.

As stated in paragraph 24 of Information Circular 70-6R dated December 18, 1978, the opinions expressed in this letter are not rulings and are consequently not binding on the Department.

Yours truly,

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