6 October 1998 External T.I. 9803205 - QUALIFIED SMALL BUSINESS CORPORATION SHARE

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, where paragraph 110.6(15)(b) applies, the value of the shares of the corporation that is the object of paragraph 110.6(15)(b) must be reduced by an amount equivalent to the reduction in the value of the assets of the corporation.

Position: No reduction should take place.

Reasons: Wording of paragraph 110.6(15)(b) is such that it does not require an equivalent reduction in the value of the assets.

XXXXXXXXXX 	5-980320
		Karen Power, C.A.
Attention:  XXXXXXXXXX 

October 6, 1998

Dear Sirs:

Re: “Qualified Small Business Corporation Share”

We are writing in response to your letter of February 4, 1998 wherein you requested our views on the application of paragraph 110.6(15)(b) of the Income Tax Act (the “Act”). We apologize for the delay in replying.

You have provided us with the following set of facts:

1. Mr. X is an individual resident in Canada and he owns all of the issued and outstanding shares of "X Co", a Canadian-controlled private corporation.

2. X Co owns two sets of assets: assets used in active business carried on in Canada having a fair market value of $800 and all the issued and outstanding shares of a second Canadian-controlled private corporation, "X Sub Co".

3. X Sub Co owns two sets of assets: $1 of cash and a loan of $99 to X Co which X Co uses to finance its business operations.

Our Comments

The particular circumstances in your letter on which you have asked for our views appears to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R3, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate district taxation office for their views. However, we are prepared to offer the following comments which may be of some assistance to you.

Where a corporation (X Co) is not using its assets in an active business, but holds shares or indebtedness in another corporation (X Sub Co), both of the corporations must qualify as a small business corporation (“SBC”) at the determination time in order for the shares of X Co to qualify as qualified small business corporation shares. Thus X Co would be a SBC only if X Sub Co were a SBC, but in order for X Sub Co to qualify as a SBC, X Sub Co must rely on its loan receivable from X Co as being a loan to a SBC which is connected with X Sub Co.

Paragraph 110.6(15)(b) of the Act was introduced to resolve the circularity problem which exists where one corporation must rely upon another corporation, which in turn must rely on the first mentioned corporation to qualify as a SBC or for the enhanced capital gains exemption. Paragraph 110.6(15)(b) reads as follows:

“For the purposes of the definitions “qualified small business corporation share” and “share of the capital stock of a family farm corporation” in subsection (1), the definition “share of the capital stock of a family farm corporation” in subsection 70(10) and the definition “small business corporation” in subsection 248(1),

(b) the fair market value of an asset of a particular corporation that is a share of the capital stock or indebtedness of another corporation with which the particular corporation is connected shall be deemed to be nil and, for the purpose of this paragraph, a particular corporation is connected with another corporation only where

(i) the particular corporation is connected (within the meaning assigned by paragraph (d) of the definition “qualified small business corporation share” in subsection (1)) with the other corporation, and

(ii) the other corporation is not connected (within the meaning of subsection 186(4) as determined without reference to subsection 186(2) and on the assumption that the other corporation is a payer corporation within the meaning of subsection 186(4)) with the particular corporation,

except that this paragraph applies only in determining whether a share of the capital stock of another corporation with which the particular corporation is connected is a qualified small business corporation share or a share of the capital stock of a family farm corporation and in determining whether the other corporation is a small business corporation.

In our view, nothing in the current wording of paragraph 110.6(15)(b) of the Act requires that the fair market value of the shares of the corporation that is the object of paragraph 110.6(15)(b) of the Act be readjusted. Thus, in your situation, nothing in the wording of paragraph 110.6(15)(b) would require that the value of the shares of X Sub Co be reduced to $1, and, as a result, the test set out in paragraph (a) of the definition of “qualified small business corporation shares” in section 110.6 of the Act would not be met. However, because of your views concerning the ‘policy result’ of this provision, we have brought your comments to the attention of the Department of Finance.

We trust our comments will be of assistance to you.

Roberta Albert, C.A.

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