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) Possible error in purchase and sale agreement. 2) Would the disposition of shares qualify for the capital gains exemption.
Position: 1) Reference to ITTN#22. 2) General comments.
Reasons: 1) See policy above. 2) Question of fact.
Michael Cooke, C.A.
December 7, 2010
Dear XXXXXXXXXX :
Re: Sale of Shares of a Small Business Corporation
We are writing in reply to your letter of September 20, 2010, wherein you requested our views on the income tax implications under the Income Tax Act (the "Act") pertaining to a sale of shares of a corporation by its sole shareholder. In particular, you wanted to know whether the corporation was a small business corporation at the time of the share sale, which is one of the requirements for determining whether the capital gains exemption under subsection 110.6(2.1) of the Act was available on the sale of the shares.
Based on the facts in your letter and from our discussion with you (Cooke/XXXXXXXXXX ) on November 22, 2010, we understand that there might have been an error in the purchase and sale agreement pertaining to the effective date of the sale of the shares of the particular corporation ("Xco") by its sole shareholder ("Individual A") to the arm's-length purchaser corporation ("Zco). You indicated that the parties actually considered the effective date of the share sale as being XXXXXXXXXX , but that the purchase and sale agreement (and presumably the share register of Xco) indicates that the effective date of the share sale was XXXXXXXXXX . You indicate that this is a concern because as part of the terms of the sale of the Xco shares to Zco, certain properties owned by Xco (i.e., land and a building used in Xco's business) were sold to Individual A before the Xco shares were sold to Zco. The land and buildings are currently being rented by Individual A to Zco.
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.
Correction of Error
There is no provision in the Act that specifically deals with dating or amending documents retroactively. To determine the date a transaction takes place under the Act, reliance is generally placed on the legal documents and the legal rights they create. While "backdating" or altering documents and records is clearly not permitted under any provision of the Act, there have been situations where courts have issued rectification orders to reflect the true intention of parties versus the legal effect created by the original documentation. In such cases, the tax implications may alter significantly what the result would have been if the original documentation were used [see Juliar v. Canada, 2000 DTC 6589 (ON C.A.)].
Therefore, as a general rule, the CRA cannot ignore legally valid documents entered into by parties to a transaction and the legal rights that they create in order to assess the tax consequences of such transactions. However, where the documents do not reflect the true intentions of the parties, the parties may be able to apply to the courts for a rectification order as discussed in Income Tax Technical News ITTN-22. Any request to vary the income tax consequences of transactions that have already taken place will only be considered if such variance would amount to a rectification of an error and only if there is unequivocal evidence substantiating the fact that an error was made.
Capital Gains Exemption
In order for a share of a corporation to meet the definition of a "qualified small business corporation share" ("QSBCS"), as that term is defined in subsection 110.6(1) of the Act, each of the three tests must be satisfied: (1) the small business corporation test; (2) the 24-month holding period test; and (3) the asset use test. If any one of these three tests is not satisfied, the particular share will not meet the definition of QSBCS and it will not be possible for the individual disposing of such a share to claim the capital gains exemption under subsection 110.6(2.1) of the Act. In the situation described above, it appears that your only concern is whether the test in (1) has been met at the time of the sale of the shares of Xco. As such, we will not discuss the tests in (2) or (3) in this response.
The test in (1) is that the corporation must be a "small business corporation" ("SBC"), as that term is defined in subsection 248(1) of the Act, at the particular time of the disposition of the share or shares of the particular corporation. It is the CRA's view that the "particular time" referred to in the definition of SBC and the "determination time" provided for in paragraph (a) of the definition of QSBCS in subsection 110.6(1) of the Act is the time when the share is actually disposed of, absent the possible application of paragraph 110(14)(g) of the Act where the disposition of the share occurs due to the death of the individual. Based on the facts, Xco would only qualify as a SBC if all or substantially all (i.e., at least 90%) of the fair market value of its assets were used principally (i.e., more than 50%) in an active business carried on primarily in Canada at the time of the disposition of the shares of Xco to Zco.
Since Xco has disposed of some of its assets (i.e., land and building) before Individual A disposed of the Xco shares, the determination of whether the SBC test in (1) has been met at the time of the disposition of the shares would depend on the type and use of the consideration, if any, that Xco received from Individual A for the land and building. Whether or not such consideration is used by Xco in an active business is a question of fact. General comments relating to the meanings of "active business" and "specified investment business" can be found in Interpretation Bulletin IT-73R6, The Small Business Deduction.
We trust that these comments will be of assistance.
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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