10 March 1999 External T.I. 9902555 - SMALL BUISNESS 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.

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

Principal Issues: A hypothetical situation has been provided in respect of which we have been asked whether a corporation can be considered to be carrying on business in Canada. Other issues were raised relating to the definitions of “qualifying small business corporation share” in subsection 110.6(1) of the Income Tax Act (the “Act”) and “small business corporation” in subsection 248(1) of the Act.

Position: General comments were provided

Reasons: Limited information was provided

XXXXXXXXXX 990255
M. Eisner
Attention: XXXXXXXXXX

March 10, 1999

Dear Sirs:

Re: The Capital Gains Deduction and the Small Businesses Deduction

This is in reply to your letter of January 27, 1999 concerning the above-noted subject.

You have outlined a hypothetical situation where a Canadian corporation (“Canco”) is the sole shareholder of its U.S. subsidiary (“USco”). All the outstanding shares of Canco are owned by residents of Canada. Canco created a financial product which USco is exploiting as a result of having entered into a licensing agreement with Canco. USco earns royalty income based on sales of the financial product by third party life insurance companies. Pursuant to the licensing agreement between Canco and USco, 95% of the royalty income earned by USco is being paid to Canco.

Employees of Canco, who developed the financial product, are employed in Canada. Although, Canco employees provide telephone support from Canada to the US customers who are using the financial product, the royalty payments are not linked to the telephone support provided by the Canco employees. Canco has more than 5 full-time employees.

With respect to the above circumstances, you have indicated that in order to qualify for the small business deduction under subsection 125(1) of the Income Tax Act (the “Act”), the income earned by the corporation must be “from an active business carried on in Canada”. The term “active business carried on by a corporation” is defined in subsection 125(7) of the Act as any business carried on by the corporation other than a “specified investment business” or a “personal services business”. These two latter terms are also defined in subsection 125(7) of the Act.

For the purposes of determining whether the corporation carries on business in Canada, you have referred to paragraph 26 of Interpretation Bulletin IT-270R2 “Foreign Tax Credit”. In general terms, that paragraph indicates that a business is considered to be carried on in the country where the operations in substance take place. More specifically, paragraph 26(c) indicates that trading in intangible property (i.e., the financial product in the above situation) takes place where the purchase or sale decisions are normally made and paragraph 26(g) indicates that a service business is considered to be carried on in the place where the services are performed. On the other hand, paragraph 32 of IT-270R2 indicates that royalty payments have their geographical source in the country in which the related right is used or exploited.

You have asked us for our comments on whether Canco carries on business in Canada for purposes of the small business deduction. Furthermore, for purposes of the definition of “qualified small business corporation share” in subsection 110.6(1) of the Act, you have asked whether the financial product would qualify as an asset used principally in an active business carried on primarily in Canada.

Our Comments

It appears that your situation relates to an actual fact situation. Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R3 dated December 30, 1996. Where the particular transactions are completed, the enquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments which are of a general nature and are not finding on the Department.

The comments in paragraphs 26 and 32 of IT-270 R2 have been made for the purposes of assisting taxpayers in determining the geographical source of income. As indicated in paragraph 26 of IT-270R2, the comments in paragraphs (a) to (g) thereof are to be regarded as being guidelines and that the determination of the place where a particular business (or a part thereof) is carried on necessarily depends upon consideration of all the relevant facts. We also note that the comments in paragraph 32 of IT-270R2 are not necessarily meant to preclude foreign source royalty payments from being regarded as having been earned in respect of a business carried on in Canada. We refer you to paragraph 24 of IT-270R2 which indicates that foreign-source income resulting from a business carried on in Canada can be included in the numerator of the fraction with respect to non-business income tax and sets out an example with respect to the net income derived from a loan made to a non-resident by a lending institution in the course of its business carried on in Canada.

Unfortunately, it is not possible to provide you with further comments on Canco’s eligibility for the small business deduction without more details with respect to the nature of the financial product and the operations of Canco. We also have not been provided with the relevant information to determine whether the financial product, in respect of Canco, qualifies as an asset “used principally in an active business carried on primarily in Canada” for the purposes of subparagraph (c) (i) of the definition of “qualified small business corporation share” in subsection 110.6(1) of the Act or paragraph (a) of the definition of “small business corporation” in subsection 248(1) of the Act. However, as a general observation, we would think that where a Canadian-controlled private corporation (“CCPC”), as defined in subsection 125(7) of the Act, has licensed its only asset to a wholly-owned U.S. subsidiary and the asset is used or exploited solely in the U.S., then that particular asset would generally not be considered to have been “used principally in an active business carried on primarily in Canada”. The use of a particular asset by the subsidiary of a CCPC has been anticipated in the above mentioned definitions. However, the subsidiary would still have to use the asset in an active business carried on primarily in Canada.

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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