10 July 1998 External T.I. 9802365 - QUALIFYING SMALL BUSINESS CORPORATION SHARES

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 land and building “used principally” in an active business in relation to the definition of qualifying small business corporation share and small business corporation.

Position:

Law generally explained

Reasons:

Specific facts and documentation not available

XXXXXXXXXX 980236
M. Eisner
Attention: XXXXXXXXXX

July 10, 1998

Dear Sirs:

Re: Capital Gains Deduction

This is in reply to your letter of January 15, 1998, concerning the above-noted subject. We apologize for the delay in replying.

You have outlined a situation where the assets of a corporation (“Parentco”) that is a “Canadian-controlled private corporation” (“CCPC”), as defined in subsection 125(7) of the Income Tax Act (the “Act”), consist of land and building and shares of its subsidiary (“Subco”). Two thirds of the area in the building is leased to Subco with whom Parentco is related, as that term is defined in subsection 251(2) of the Act, and the remaining area of the building is leased to corporations that deal at arm’s length with Parentco. Subco uses the leased space in connection with its business which qualifies as an “active business”, as defined in subsection 248(1) of the Act. Parentco receives 60% of the gross rents in respect of the building from Subco.

With respect to the above circumstances, the definition of “small business corporation” (“SBC”) in subsection 248(1) of the Act refers to “all or substantially all of the fair market value of the assets ... is attributable to assets that are used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it.” Paragraph (a) of the definition of “qualifying small business corporation share” (“QSBCS”) in subsection 110.6(1) of the Act refers to “more than 50% of the fair market value of the assets of which is attributable to assets used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it.”

You have asked us to confirm your view that an asset cannot be used partly in an “active business” and partly in some other manner for purposes of the “used principally” test in the SBC and QSBCS definitions.

You have also asked us for our views on how the word “principally’ is to be interpreted and have referred to an example where Subco could be regarded as having used more than 50% of the physical space of the building in an active business, but that the prime space with a higher rental value, which is leased by Parentco to arm’s length tenants, accounts for more than 50% of the total rent received.

Our Comments

Written confirmation of the tax consequences inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R3 dated December 30, 1996. However, we are prepared to provide the following comments which are of a general nature and are not binding on the Department.

We note that in your incoming letter you indicate that Parentco and Subco are associated corporations. You have also made reference to subsection 129(6) of the Act. For purposes of the SBC and QSBCS definitions, the test, among other criteria, will be whether the land and building were “used principally in an active business” carried on by either Parentco or Subco. Such definitions, as highlighted above, already provide that the asset in question can be used in an active business carried on primarily in Canada “by the corporation or a corporation related to it”. Subsection 129(6) of the Act is not relevant in this regard.

The term “principally” is not a defined term. An asset which is used more than 50% in an active business is “used principally in an active business” and the entire value of such an asset may be used for the purposes of the “all or substantially all” requirement.

Whether an asset is used in an active business is a question of fact. Generally, the Department considers that an asset is used principally in an active business if its primary or main use is in respect of that business. The “used principally” test is applied on a property by property basis.

The fact that more than 50% of the space of a building is used in an active business by a CCPC (or a related corporation) is generally a strong indication that the building is used principally in an active business. In the Canada Trust Company decision (85 DTC 322), the Tax Court of Canada accepted the square footage use of a building as a factor to be given significant weight in the determination of the particular use to which a building is put. This factor along with the factor that more than 50% of the total rent would be received by Parentco from Subco, as you have indicated in your letter, would seem to present a reasonable argument that the asset is used principally in an active business of Subco. However, as mentioned above, the determination of “used principally in” is a question of fact and there are no set guidelines as to which factors to use in different situations.

You have stated that the total rent received from Subco by Parentco is greater than 50% of the total rent received, however, you have asked us for our comments where the rent received by Parentco from Subco amounted to less than 50%. We can not provide a definitive comment without the opportunity to review all the relevant facts. Generally, if the fair rental value of the rented space to arm’s length tenants is greater than the fair rental value of the space used in an active business, this may indicate that the building is not used principally in an active business. Whether such a factor would be decisive in relation to the square footage test would have to be determined on a case by case basis.

While it would be necessary to consider the relevant facts and documentation of your situation before a determination could be made, we would be pleased to consider it should you wish to request an advance income tax ruling.

We trust that our comments will be of assistance to you.

Yours truly,

Jim Wilson
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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