22 July 1992 Income Tax Severed Letter 922056A - Prepaid Management Fees

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.

July 22, 1992

Tax Avoidance Business and
General
Halifax District Office Division
W.P. Guglich
(613) 957-2102
Attention: H. Dacey

922056

Prepaid Management Fees

This is in reply to fax memorandum dated July 6, 1992 concerning the treatment of prepaid management fees for purposes of the purification of a small business corporation.

You describe the following situation:

24(1)

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24(1)

You request our views respecting the following:

• 8. Is the prepayment of management fees sufficient to purify OPCO so that it would be considered a small business corporation?
• 9. Does the conversion of cash to prepaid management fees constitute conversion of redundant assets to assets used in an active business, for purposes of the enhanced capital gain exemption?

OUR VIEWS:

Both the definition of "qualified small business corporation share" in subsection 110.6(1) and "small business corporation" in subsection 248(1) of the Act make reference to "assets used principally in an active business carried on .....by the corporation"

A similar issue (whether property was used or held by a corporation in the course of carrying on a business) was considered by the Supreme Court in Ensite Limited v. The Queen, [[1986] 2 C.T.C. 459] (1986) CTC 459. In that case the court held that the holding or using of property must be linked to some definite obligation or liability of the business. A business purpose for the use of the property is not enough. The test was whether the property was used to fulfil a requirement which had to be met in order to do business. The threshold of the test was met when the withdrawal of the property would "have a decidedly destabilizing effect on the corporate operations themselves".

The same test could be applied in your present case. The part of the prepaid management fees that could be accrued under GAAP ($24(1)) may be able to meet the criteria in the above test, in that it could be considered a liability or obligation especially if the services have already been rendered for that period. As for the balance of the prepaid management fees, it can not be considered to be linked to any definite obligation or liability of OPCO. Furthermore the lack of such prepayment would not have any destabilizing effect on the operations of OPCO. Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

Consequently, in your present case; the prepayment of management fees does not necessarily purify OPCO, and the conversion of cash to prepaid management fees on the balance sheet does not in and by itself convert a non-qualifying asset into a qualifying asset, for purposes of the enhanced capital gain exemption.

We trust this will be of assistance to you.

E. Wheeler
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

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