9 February 1993 Income Tax Severed Letter 9301993 - Qualified Small Business Corporation

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

XXXXXXXXXX 930199
Glen Thornley

Attention: XXXXXXXXXX (613) 957-2101

February 9, 1993

Dear Sirs:

Re: Advance Ruling Request

This is in reply to your letter of January 7, 1993 requesting an advance income tax ruling on behalf of

XXXXXXXXXX

As discussed over the telephone on January 27, 1993, an advance ruling is a written statement given by the Department to a taxpayer stating how it will interpret specific provisions of existing Canadian income tax law in its application to a definite, proposed transaction or transactions which the taxpayer is contemplating. Full disclosure is required and where the transaction is to be completed at some indefinite future time or where satisfactory evidence is lacking that a proposed transaction is being seriously contemplated the request for an advance ruling may be refused. Additionally, where a matter on which a determination is requested is primarily one of fact (i.e., is a corporation a small business corporation?) and the circumstances are such that all the pertinent facts cannot be established at the time of the request for the advance ruling an advance ruling will not be granted.

As it was unlikely that an advance ruling could be issued or that if one could be issued, it would probably be a negative ruling, you agreed to withdraw your ruling request. We acknowledge receipt of the February 9, 1993 withdrawal and have closed our file in this matter. A refund of your deposit will follow shortly.

In the event that you should later decide to re-submit a ruling request in this matter or a similar matter, we suggest in addition to the above requirements that the relevant documents and other information referred to in paragraphs 15(a) to (j) of Information Circular 70-6R2 be submitted with your request. A copy of I.C. 70-6R2 is enclosed for your files.

Although an advance income tax ruling will not be issued in this matter, we provide the following general comments with respect to the definition of a "qualified small business corporation share" ("QSBCS") in subsection 110.6(1) of the Income Tax Act (the "Act").

Our Comments

One of the initial requirements of a QSBCS is that at the "determination time" it be a small business corporation. A small business corporation is defined in subsection 248(1) of the Act at any particular time to mean a Canadian- controlled private corporation all or substantially all of the assets of which were at that time used in an active business. In our view all or substantially all means at least 90% of the assets must be used in the active business of the corporation. Thus if more than 10% of the assets are non-active, that is, not used (in the normal sense of that word) in the business, the corporation is not a small business corporation.

From the information obtained during our telephone conversation, it appears that you may have a least 3 problem areas. They are as follows:

• 1) MORTGAGES, although a mortgage is an asset whose existence may be relevant to the equity of a corporation, it is not generally an asset used in an active business as the funds tied up in the mortgage are no longer available for the active business uses of the corporation. The comments in paragraph 3 of Interpretation Bulletin IT-73R4 regarding interest arising from a mortgage on real property, the sale of which was categorized in a previous year as income from an active business, relate to the definition of "income of a corporation from an active business" in paragraph 125(7)(c) of the Act. This paragraph includes in the income of an active business any income pertaining to or incident to that business. However, the definition of "small business corporation" in subsection 248(1) of the Act requires that the assets be used in the active business. The fact that mortgage reserves and mortgage interest may be considered incident to or pertaining to the active business does not necessarily determine that the mortgages receivable are used in the active business. As indicated in IT-486R, it is a question of fact whether an asset is used in an active business. For example, mortgages taken back by a developer in order to facilitate sales may initially appear to be assets used in an active business, but if such mortgages are retained for more than a short period, they appear to have become more in the nature of investments.

In summary, mortgages having normal commercial terms
and conditions and held as investments are not
considered to be assets used in an active business and
where more than incidental to the business, the income
earned therefrom is considered income from property and
subject to the "specified investment business" rules in
paragraph 125(7)(e) of the Act.

• 2) TERM DEPOSITS, as indicated above whether assets are used in an active business is a question of fact. In order to make such a determination, it is necessary to have knowledge of all the facts surrounding a particular situation, however, it is our view that where cash is temporarily surplus to the needs of a business and is invested in short-term income-producing investments, those investments may be considered to be used in the business. On the other hand, where substantial amounts of cash and deposits - in excess of that required for use in the business, are retained in the corporation on a permanent basis, they would not be considered to be funds used in the business. Such funds would be considered to be permanently set aside for investment or uses other than in an active business. This position is consistent with comments in paragraph 8 of IT-73R4, paragraph 29 of IT-268R3 and paragraph 5 of IT-468R. Generally cyclical cash and short-term investments upon which interest income earned is treated as active business income, may, depending on all of the circumstances, be considered to be used in an active business for purposes of the definition of "small business corporation" in the Income Tax Act.
• 3) NOTE RECEIVABLE FROM SON, it is the Department's view that, unless the corporation's business includes the lending of money, a loan receivable by a corporation would not constitute an asset "used principally in an active business" for purposes of subparagraph (c)(i) of the definition of qualified small business corporation share in subsection 110.6(1) of the Act. Similarly, an amount receivable which arises on the disposition of an asset would not be an asset used principally in an active business, regardless of whether the asset disposed of had been used in an active business. The only receivables that may be considered to be assets used in an active business of a corporation are trade accounts receivable that arise from sales by the corporation pursuant to its active business.

It would appear that if more than 10% of the corporation's assets at the "determination time" are comprised of any or all of the above noted assets, it will fail to qualify as a small business corporation for purposes of the QSBCS definition in subsection 110.6(1) of the Act. If this is the case a gain on the disposition of the corporation's shares will not qualify for the enhanced capital gains deduction.

We trust our comments will be of assistance to you.

Yours truly,

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