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.
Principal Issues: 1) Can a corporation be purified by simply netting excess cash (i.e., a non-active business asset) against current liabilities owing by the corporation? 2) Can a corporation be purified by "removing" non-active business assets solely by making one or more accounting journal entries?
Position: 1) No. 2) No.
Reasons: 1 and 2 - The law.
XXXXXXXXXX 2011-041516
Michael Cooke, C.A.
August 22, 2011
Dear XXXXXXXXXX :
Re: Purification of a Corporation
We are writing in reply to your email correspondence of July 25, 2011, wherein you requested our views on the income tax implications under the Income Tax Act (the "Act") pertaining to certain purification transactions to be undertaken prior to the sale of shares of a corporation by its sole shareholder.
In particular, your first question is whether the Canada Revenue Agency ("CRA") would accept that a corporation can be purified by simply netting its excess cash (i.e., a non-active business asset) against current liabilities owing by it. Your second question is whether the CRA would accept that a corporation can be purified by "removing" non-active business assets solely by way of making one or more accounting journal entries.
Our Comments:
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed the inquiry should be addressed to the relevant Tax Services Office (the "TSO"). We are, however, prepared to offer the following comments, which may be of assistance.
The definition of "small business corporation" ("SBC") in subsection 248(1) of the Act requires that at the particular time all or substantially all (i.e., at least 90%) of the fair market value of the particular corporation's assets must, inter alia, be attributable to assets that are used principally (i.e., more than 50%) in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it. The particular corporation must also be a "Canadian-controlled private corporation" at that time as that term is defined in subsection 125(7) of the Act. Since this active business asset test only contemplates looking to the fair market value of the particular corporation's total assets (including intangibles) there is no legislative basis for netting the amount or value of the corporation's liabilities against its assets for this purpose. Accordingly, in response to your first question, it is not possible to "purify" a corporation by netting the particular corporation's liabilities against its non-active business assets.
In response to your second question, it is our view that it is also not possible to "purify" a corporation simply by making one or more accounting journal entries (that are intended to remove or eliminate non-active business assets). Any purification transactions entered into by the particular corporation, such as the transfer of property to another person or the payment or settlement of inter-company indebtedness (by way of a dividend or other method) must be bona fide and legally effective. Please refer to the comments in Income Tax Technical News #14, paragraph 15(b) of Interpretation Bulletin IT-109R2; paragraphs 25 and 26 of Interpretation Bulletin IT-119R4; and paragraph 10 of Interpretation Bulletin IT-362R for some general guidance on this issue.
We trust that these comments will be of assistance.
Yours truly,
Sandy Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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