12 September 1989 Income Tax Severed Letter AC74292 - Small Business Corporation - Interpretation Bulletins IT-486R and IT-268R3

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.

September 12, 1989

Legislative Affairs Directorate         Specialty Ruling
                                          Directorate
                                        S. Shinerock 
                                        957-2108
Roy C. Shultis
Director
Publications Division                   7-4292
 IT-486R IT-268R3

1. IT-486R , a revision of former IT-486 , was issued on December 31, 1987. IT-486R provides an interpretation of a number of sections (most of which have since been repealed) of the Income Tax Act (the "Act"), including the definition of a small business corporation ("SBC") within the meaning assigned under subsection 248(1) of the Act.

In order to qualify as a SBC, a corporation must be a Canadian-controlled private corporation (as defined under paragraph 125(7)(b) of the Act)... all or substantiallY all of the fair market value of the assets of which ... was attributable to assets that were

(a) used in an active business carried on primarily in Canada ..." Thus, there are two tests which must both be met before a corporation can meet the definition of a SBC, one being the "all or substantially all" test, and the other being the "primarily" test in respect of an active business carried on in Canada.

2. paragraph 5 of IT-486R , which is an expansion of paragraph 7 of former IT-486 , considers the meaning of the expression "all or substantially all of the assets of which were at that time used in an active business", and in particular the penultimate sentence thereof states:

Generally the Department considers that an asset is used in a business if its primary or principal use (i.e., more than 50% of its use) is in respect of that business.

Similar wording is contained in paragraph 29 of IT-268R3 for the purposes of paragraphs 70(10)(b) and 70(10)(c) of the Act with respect to the use of an asset in a farming business by a corporation or a partnership.

Paragraph 5 of IT-486R is also relevant to the interpretation of the definition of a qualified small business corporation share ("QSBCS"), as set out under subsection 110.6(1) of the Act, since paragraph (a) of that definition requires that it be a share of the capital stock of a SBC.

3. The expanded version of paragraph 7 of former IT-486 apparently has its source in the attachment to a memorandum dated May 30, 1986 from D.in. Joy to R.M. Beith (copies attached). This material suggests that the expanded version was only intended to establish cost as a basis for measurement in meeting the "all or substantially all" test. The penultimate sentence of this version appears to have been an afterthought. We note that the use of cost ceased to be an alternative with the amendment of the preamble to the SBC definition, which became effective on September 13, 1988.

We also attach a copy of a memorandum dated August 4, 1989 from Current Amendments & Regulations Division ("Current Amendments") to Section 32 of Rulings Directorate, on paragraph 5 of IT-486R . As you will note, Finance is concerned that the use of the "primary test" referred to in IT-486R could be overly generous when applied to certain assets in determining whether a share of a corporation held by an individual qualifies as a QSBCS.

4. It is our view that the practical application of the excerpt from IT-486R quoted in 2 above leads to unreasonable results. For example, if SIX of an asset, say a building, were used in an active business carried on primarily in Canada by a corporation, then the entire fair market value of the building (and the land subjacent to the building) would qualify for the purposes of determining whether the corporation was a SBC and also for the purposes of determining if a share of the corporation held by an individual was a QSBCS. However, if only 495 of the building were so used, then no portion of the building (or land) would qualify for the purposes referred to herein. We believe each of these results is inappropriate and that the provision can be more logically interpreted by RCT as requiring a pro-ration of the value of any asset of a corporation which is only partially used in an active business carried on primarily in Canada. Finance supports this interpretation as noted in 3 above.

5. We recommend that the second last sentence of paragraph 5 of IT-486R , as quoted in 2 above, be replaced with the following:

It is the Department's view that in determining whether all or substantially all of the assets of a corporation are used in a business, where a portion of an asset (e.g. 405 of the floor space of a building) is used in an active business carried on primarily in Canada and the other portion is used for some other purpose, the value of the asset (which, in the case of a building, would include the underlying land) must be pro-rated on the basis of the proportion of the asset that is used in that business and the proportion of the asset that is used for some other purpose. It is only the value of the part of the asset that is used in the business that will be considered to be a part of ,`... the fair market value of the assets which at that time was attributable to assets that were used in an active business for the purposes of determining whether the corporation is described in the definition of a small business corporation.

We also suggest that paragraph 29 of IT-268R3 be amended in a similar manner.

Please contact Stanley Shinerock or John Clark if you have questions concerning this matter.

M.A. Hiltz for Director General Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch