10 September 1996 External T.I. 9628355 - RRSP INVESTMENT IN SMALL BUSINESS

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: How can RRSP invest in small business.

Position: Routine reply sent to taxpayer as requested.

Reasons: Routine

XXXXXXXXXX						5-962835

September 10, 1996

Dear Sir:

Re: Qualifying Investments for RRSPs

This is in reply to your letter of August 5, 1996, addressed to the Calgary Tax Services Office, in which you requested clarification of when RRSPs may invest in shares of a small business. In reply we are providing the following general comments on investments that may be held by an RRSP in the form of shares, debt and mortgages. Since you are considering a corporation that will be holding real estate as its principal investment, you should note in particular the comments on "qualifying active business" and "active business". Generally, these provisions will restrict an RRSP from investing in such corporations.

1.Shares of a Corporation

Generally an RRSP can invest in shares of a corporation if the shares are listed on a prescribed stock exchange in Canada or in a country other than Canada, or if the corporation is a "public corporation" as defined in the Act - see the current version of Interpretation Bulletin IT-391 for more information on public corporation status. It should be noted that for purposes of the Act, life insurance corporations are considered to be public corporations.

When the shares of a corporation do not qualify as investments for an RRSP as noted above, they may qualify if they are shares of a Canadian-controlled private corporation (CCPC) which is an "eligible corporation" and the annuitant of the RRSP is not a "designated shareholder" of that company. These latter two terms are defined and the relevant provisions are contained in sections 4900 through 5103 of the Regulations.

In brief, an "eligible corporation" is generally a taxable Canadian corporation which uses substantially all (90% or more) of its property in a "qualifying active business". Specifically excluded from this definition are securities dealers, financial institutions, corporations whose principal business is the lending of money or the purchasing of debt, and non-resident controlled corporations.

A "qualifying active business" is also a defined term which generally includes any business which is carried on in Canada except one where the principal purpose is to earn income from property in the form of interest, dividends, rent, royalties or gains from dispositions of property. A qualifying business may, however, include a business of leasing property other than real property, and a retail or wholesale business. A corporation's business will be considered to have been carried on in Canada if at least 50% of its employees are engaged in the business in Canada or at least 50% of its salaries or wages are paid for services provided in Canada in respect of the business. If the corporation is part of a group of related corporations, the combined services of their employees and the combined salaries and wages paid must be considered in making this determination.

With respect to property acquired by the RRSP after November 29, 1994, a "designated shareholder" of a corporation is any RRSP annuitant who at the time:

(a)is, or is related to, a "specified shareholder" (generally, a person who directly or indirectly holds 10% or more of the shares of any class of shares of the corporation or of any corporations related to the corporation), unless the cost amount of all the shares is, in total, less than $25,000. For this purpose, an annuitant of an RRSP is deemed to own the shares owned by the RRSP (see definition of "specified shareholder" in paragraph 248(1)(b) of the Act), and any share that the RRSP annuitant or a related person has a right to acquire is included for purposes of the 10% and $25,000 tests (see subsection 4901(2.3) of the Regulations);

(b)is or is related to a member of a partnership that controls the corporation in any manner;

(c)is or is related to a beneficiary under a trust that controls the corporation in any manner;

(d)is or is related to an employee of the corporation where the employees control the corporation, except where the corporation is controlled by one person or a related group of persons; or

(e)does not deal at arm's length with the corporation.

Note that the conditions respecting both the "eligible corporation" and the "designated shareholder" must be satisfied at the time the RRSP acquires the shares and thereafter. Should the annuitant become a "designated shareholder" of the corporation or the corporation fails to be an "eligible corporation" at a later date, the shares will become non-qualified investments for the RRSP.

Subsection 4900(12) of the Regulations (applicable after December 2, 1992) was introduced to allow a share of the capital stock of a "small business corporation" to be a qualified investment for an RRSP, provided that the RRSP annuitant is not a "connected shareholder" of the corporation immediately after the acquisition of the share. The corporation must be a "small business corporation" at the time the share is acquired by the RRSP or at the end of the taxation year of the corporation ending before the time the share is acquired. For this purpose, a "small business corporation" is a Canadian corporation that is not directly or indirectly controlled by one or more non-residents. In addition, to qualify as a "small business corporation" all or substantially all (90% or more) of the fair market value of the corporation's assets must be attributable to assets that were:

(a)used principally (50% of the time or more) in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it,

(b)shares or indebtedness of other small business corporations which were connected with the particular corporation, or

(c)assets described in a and b above.

For the purposes of these requirements, an "active business" is, in general, defined as any business carried on by a taxpayer other than a "specified investment business" or a "personal services business". A "specified investment business" is defined as a business the principal purpose of which is to derive income from property including such income as interest, dividends rent and royalties. Gains from the disposition of real property may or may not be from an active business. Please refer to IT-73R4 available from your local Tax Services office for a discussion of these terms.

With respect to property acquired by an RRSP after November 29, 1994, a "connected shareholder" of a corporation is a "specified shareholder" as defined in subsection 248(1) of the Act (generally, a person who directly or indirectly holds 10% or more of the shares of any class of shares of the corporation or of any corporations related to the corporation). However, an annuitant who is a "specified shareholder" of the corporation will not be a "connected shareholder" if he or she deals at arm's length with the corporation and the cost amount of all the shares is, in total, less than $25,000. For this purpose, an annuitant of an RRSP is deemed to own the shares owned by the RRSP (see definition of "specified shareholder" in paragraph 248(1)(b) of the Act) and any share that the RRSP annuitant or a related person has a right to acquire is included for purposes of the 10% and $25,000 tests (see subsection 4901(2.2) of the Regulations).

Note that the conditions respecting the "small business corporation" must be satisfied only once, that being at the time the shares are acquired by the RRSP or at the end of the taxation year of the corporation ending before the time the share is acquired. Similarly, the conditions respecting the "connected shareholder" must be satisfied only once, that being at the time immediately after the shares are acquired by the RRSP.

Should the corporation fail to remain a "small business corporation" or the annuitant become a "connected shareholder" at a later time the shares will not consequently become non-qualified investments for the RRSP. In accordance with subsection 4900(13) of the Regulations a share of a "small business corporation" will become non-qualified, however, if:

i.an individual provides services to or for, acquires goods from, or is provided services by, the issuer of the share or a person related to the issuer;

ii.an amount is received by the RRSP in respect of the share; and

iii. the amount can reasonably be considered to be

(A) on account of or in lieu or in satisfaction of, payment for the services to or for the issuer or the person related to the issuer, or

(B) in respect of the acquisition of the goods from, or services provided by, the issuer or the person related to the issuer.

2.Debt of a Corporation.

Generally speaking, a debt owing by a corporation to a trust governed by an RRSP would represent a qualified investment of the RRSP only if the debt is:

(a)a bond, debenture, note, or similar obligation of a corporation the shares of which are listed on a prescribed stock exchange in Canada;

(b)a bond, debenture, note, or similar obligation of a public corporation (defined in subsection 89(1) of the Act) other than a mortgage investment corporation;

(c)a bond, debenture, note, or similar obligation of a Canadian corporation which is guaranteed by a corporation or a mutual fund trust whose shares or units are listed on a prescribed stock exchange in Canada;

(d)a bond, debenture, note, or similar obligation of a Canadian corporation which is controlled directly or indirectly by one or more corporations or mutual fund trusts whose shares or units are listed on a prescribed stock exchange in Canada;

(e)a bond, debenture, note, or similar obligation of a Canadian corporation where the conditions described in subparagraph 4900(1)(i)(iii) of the Regulations are met which, in part and in general terms, require the corporation to have share equity of at least twenty five million dollars or be controlled by such a corporation and have issued and outstanding debt of at least ten million dollars;

(f)a security of a Canadian corporation

i. that was issued pursuant to The Community Bonds Act S.S. 90, c. C-16.1, The Rural Development Bonds Act S.M. 91-92, c. 47, the Community Economic Development Act 1993 S.O. 93, c. 26, or the New Brunswick Community Development Bond Program through which financial assistance is provided under the Economic Development Act N.B. 75, c. E-1.11, and

ii. the payment of the principal amount of which is guaranteed by Her Majesty in Right of a province;

(g)indebtedness of a Canadian corporation (other than a corporation that does not deal at arm's length with a person who is an annuitant under the RRSP trust) represented by a bankers' acceptance;

(h)a bond, debenture, note, or similar obligation of a corporation the shares of which are listed on a stock exchange referred to in section 3201 (i.e., prescribed stock exchanges outside Canada); or

(i) a bond, debenture, note, mortgage, or similar obligation as described in paragraph (b) of the definition of "qualified investment" in section 204 of the Act, namely bonds, debentures, notes, mortgages, or similar obligations of or guaranteed by the Government of Canada, of the government of a province or an agent thereof, of a Canadian municipality or municipal or public body performing a function of government in Canada, of a body 90% or more of which is owned by a province or Canadian municipality or of a wholly-owned subsidiary of such a body, or of an educational institution or hospital if repayment of principal and payment of interest is to be made, or is guaranteed, assured, or otherwise specifically provided for or secured, by a province.

There are other provisions which also allow RRSP's to hold debt of Canadian corporations. However, these are directed to particular types of corporations such as credit unions or cooperative corporations.

3.Mortgages.

A mortgage secured by real property situated in Canada owned by a corporation can be held by an RRSP. This is discussed in paragraph 9 of the Department"s Interpretation Bulletin IT-320R2 available from your local Tax Services Office. As discussed in the Bulletin a mortgage may qualify as a qualified investment under paragraph 4900(1)(j) or subsection 4900(4) of the Income Tax Regulations (the "Regulations") depending upon the relationship between the mortgagor and the annuitant.

Pursuant to subsection 4900(4) of the Regulations, a mortgage secured by real property situated in Canada or an interest therein, is a qualified investment for an RRSP unless the mortgagor is the annuitant of the RRSP, or is a person with whom the annuitant does not deal at arm's length. Arm's length is defined in subsection 251(1) of the Income Tax Act (the "Act") and paragraph (a) therein deems related persons to not deal at arm's length. Please refer to Interpretation Bulletin IT-419 for a discussion of this topic.

For purposes of the Act, subparagraph 251(1)(b) defines related persons to include a corporation and

(i) a person who controls the corporation, if it is controlled by one person,

(ii) a person who is a member of a related group that controls the corporation, or

(iii)any person related to a person described in (i) or (ii).

Accordingly a mortgage secured by real property in Canada would not be a qualified investment for an RRSP in accordance with subsection 4900(4) of the Regulations if the mortgagor is a corporation and the annuitant is related to that corporation either as a shareholder or as a spouse of a shareholder.

If a mortgage is not qualified under subsection 4900(4) of the Regulations it may qualify under paragraph 4900(1)(j) of the Regulations provided it satisfies all of the following conditions:

(a)the mortgage is in respect of real property situated in Canada;

(b)the mortgage is administered by an approved lender under the National Housing Act;

(c)the mortgage is insured under the National Housing Act or by a corporation offering its services to the public in Canada as an insurer of mortgages;

(d)the rate of interest on the mortgage and other terms reflect normal commercial practice; and

(e)the mortgage is administered as if it were a mortgage on a property owned by a stranger.

5.Other Investment Vehicles.

Indirect investments in corporations may also be made by virtue of paragraph 4900(6) of the Regulations through the use of a Small Business Limited Trust or a Small Business Investment Limited Partnership. These are defined in Part LI of the Regulations.

6.Non-Qualified Investments.

In summary, it should be noted that the Act does not prevent an RRSP from holding non-qualified investments but applies certain income inclusions and taxes in respect of such investments.

The above comments are an expression of opinion only and do not bind the Department. We trust, however, that they will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch