11 October 1995 External T.I. 9424895 - QSBCS - CIRCULARITY

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.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

- Whether the fair market value of cross shareholdings between two corporations would be deemed to be nil under paragraph 110.6(15)(b).

Position TAKEN:

- No

Reasons FOR POSITION TAKEN:

- The corporations are not connected under the meaning provided in paragraph 110.6(15)(b).

		942489

XXXXXXXXXX B. Kerr

Attention: XXXXXXXXXX

October 11, 1995

Dear Sirs:

Re: Qualified Small Business Corporation Shares

This is in reply to your letter of September 14, 1994, wherein you requested a technical interpretation as to whether the shares of two corporations would qualify as "qualified small business corporation shares" within the meaning assigned by subsection 110.6(1) of the Income Tax Act (the "Act"). We apologize for the delay in responding.

The situation described in your letter involves two corporations that are connected under subsection 186(4) of the Act. The common shares of each corporation are owned by the same group of unrelated individuals. Each corporation owns 8% non-cumulative voting non-prescribed shares of the other corporation. However, no dividends have been paid on these non-prescribed shares.

You have asked us whether the non-prescribed shares held by each corporation would qualify as small business corporation shares, whether the failure to pay dividends on these non-prescribed shares would cause the provisions of subsection 110.6(8) of the Act to apply to the common shareholders of each corporation or in the event of an amalgamation of the two corporations the common shareholders of Amalco on the disposition of such shares, and whether the amalgamation would cause the provisions of subsection 55(2) of the Act to apply to the cancellation of the cross shareholdings of the two corporations.

Our Comments

The situation outlined in your letter involves an actual fact situation. To the extent that it relates to a past transaction you should contact the appropriate Tax Services Office, since the review of such transactions falls within their responsibility and it is the practice of this Department not to comment on such transactions when the identities of the taxpayers are not known. If it relates to a proposed transaction, assurance as to the tax consequences of actual proposed transactions will only be given in the context of an advance income tax ruling. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R2 dated September 28, 1990, and the Special Release thereto dated September 30, 1992, issued by Revenue Canada, Taxation. However, we can offer the following general comments.

The term "small business corporation" is defined in subsection 248(1) of the Act. This definition, inter alia, is subject to subsection 110.6(15) and provides asset qualifying tests for the particular corporation. One of the types of qualifying assets are shares of the capital stock or indebtedness of one or more small business corporations that are at that time connected with the particular corporation (within the meaning of subsection 186(4) on the assumption that the small business corporation is at that time a "payer corporation" within the meaning of that subsection). However, subsection 110.6(15)(b) provides a different meaning of the term connected. In this situation, we agree that the provisions of subsection 110.6(15)(b) would not apply to deem the fair market value of the shares to be nil for this purpose since the two corporations are not connected within the meaning provided in paragraph 110.6(15)(b). Accordingly, it may be that neither corporation qualifies as a small business corporation. We have informed the Department of Finance ("Finance") of this circularity problem, however, should you wish to pursue this matter we would suggest that you write to Finance at the following address:

Tax Policy & Legislation Branch
Department of Finance
140 O'Connor Street
L'Esplanade Laurier
17th Floor, East Tower
Ottawa, Ontario
K1A 0G5

In general subsection 110.6(8) of the Act is an anti-avoidance rule enacted to prevent the conversion of dividend income into exempt capital gains. Subsection 110.6(8) of the Act will apply if it may reasonably be concluded, having regard to all the circumstances, that a significant part of a capital gain is attributable to the fact that dividends were not paid on a share (other than a prescribed share) of a corporation. In interpreting the phrase "a significant part of the capital gain" it is our view that the determination of what constitutes a significant part of the capital gain is a question of fact which must be decided in each particular case having regard, as the subsection states, to all the circumstances. Accordingly, the Department has not developed detailed or specific guidelines in respect of this issue. While we are of the view that in many cases this question is appropriately answered by ascertaining the proportion or percentage of the capital gain that is attributable to the non-payment of adequate dividends, we are also of the view that there may be circumstances where it is appropriate to consider the amount or magnitude, expressed in dollars, of the capital gain that is so attributable.

The amalgamation of two predecessor corporations does not cause subsection 110.6(8) to be inapplicable to the amalgamated corporation. This is so irregardless of whether under corporate law or the Act the amalgamated corporation is considered to be a continuance of and the same as the predecessor corporation or a new corporation, or whether the shares of the amalgamated corporation are considered to be the same as the shares of the predecessor corporation or are new shares. The provisions of subsection 110.6(8) apply to dispositions after November 21, 1985. Nevertheless, to determine whether it applies, consideration must be given to the fact that dividends were not paid on shares of "a corporation" in preceding taxation years, other than prescribed shares. It is necessary to consider whether the share that is no longer issued and outstanding, in respect of which dividends were not paid, would have been prescribed under section 6205 of the Income Tax Regulations (the "Regulations"). In our view if the provisions of subsection 110.6(8) would have applied to the shares of a predecessor corporation then the provisions of subsection 110.6(8) may apply to the shares of the amalgamated corporation. This view can also be supported by virtue of the provisions of paragraph 6205(4)(c) of the Regulations.

We would, however, also like to point out that, as reflected in the answer to Question 51 at the Round Table on Federal Taxation held at the 1994 annual meeting of the Association De Planification Fiscale Et Financière, if the prescribed and non-prescribed shares are divided among a number of individuals, the Department, in its advance tax rulings, has taken into account the fiscal policy on capital gains deduction contemplated for qualified shares in small businesses and the 110.6(8) anti-avoidance provision when assessing the facts of a given situation. Thus, in some cases, the department has considered that subsection 110.6(8) of the Act did not apply to disallow any capital gains deduction with regard to a capital gain made by disposing of prescribed shares, even if the increase in value of the prescribed shares may be due to the absence of dividends on other non-prescribed shares in circulation.

Under the corporate law of most jurisdictions in Canada, where shares of one of the predecessor corporations are held by another of the predecessor corporations, such shares are normally cancelled on the amalgamation without any repayment of capital in respect thereof (see for example, subsection 182(2) of the Canada Business Corporations Act.) Since no amount has been paid to the shareholder on the cancellation of such shares, no dividend would be deemed to have been received under subsection 84(3) of the Act to which subsection 55(2) could apply.

We trust that these comments will be of assistance.

Yours truly,

R. Albert
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch