24 June 2010 External T.I. 2010-0367031E5 - QSBCS - 24 Month Holding Period

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: Do shares issued from treasury have to be held 24 months preceding the time of disposition to otherwise be considered QSBC shares eligible for the capital gains deduction?

Position: Yes unless the conditions of subparagraphs 110.6(14)(f)(i) or (ii) are met which provide exceptions to the holding period requirement.

Reasons: The law.

XXXXXXXXXX
									2010-036703
									James Atkinson CGA
									(519) 457-4832
June 24, 2010

Dear XXXXXXXXXX :

Re: Capital Gains Deduction - QSBC Shares

This is in response to your letter dated May 5, 2010, concerning the capital gains deduction provided for under section 110.6 of the Income Tax Act ("Act"). Your question concerns whether or not shares that were not owned by an individual for a minimum 24 month period immediately preceding the time of disposition may be considered eligible for the capital gains deduction provided in subsection 110.6(2.1) in respect of a "qualified small business corporation share" ("QSBCS"), as defined in subsection 110.6(1)..

In your correspondence, you describe an individual ("Mr. A") who disposed of XXXXXXXXXX shares of a corporation ("Aco") in 2009. Mr. A acquired, in 2006, XXXXXXXXXX shares of the XXXXXXXXXX Aco shares. These XXXXXXXXXX Aco shares were held by Mr. A in excess of 24 months preceding the disposition of all his Aco shares. The other XXXXXXXXXX shares, forming the balance of shares that were disposed of by Mr. A, were acquired in 2007 and 2008. The Aco shares acquired in 2007 and 2008 were held for less than 24 months preceding their disposition. All Aco shares acquired by Mr. A in 2006, 2007 and 2008 were issued from treasury. All of the Aco shares meet the conditions of paragraph (a) and (c) of the definition of QSBCS. The only issue relates to the application of paragraph (b) of the definition of QSBCS.

The agreement that governed the sale of Aco shares by Mr. A contains an earnout clause. The earnout clause provides for additional proceeds to Mr. A if certain Aco performance expectations are exceeded.

Since not all of the XXXXXXXXXX Aco shares meet the 24 month holding period requirement described in paragraph (b) of the definition of QSBCS, you question whether Mr. A is precluded from claiming the capital gains deduction in respect of the capital gain realized from any of the XXXXXXXXXX Aco shares or whether Mr. A is entitled to a deduction in respect of only XXXXXXXXXX of the Aco shares.

Our Comments:

The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

An individual who realizes a taxable capital gain on the disposition of a share that is a "qualified small business corporation share" ("QSBCS"), as defined in subsection 110.6(1) of the Act, may be entitled to a capital gains deduction in calculating taxable income pursuant to subsection 110.6(2.1) of the Act.

Paragraph (b) of the definition of QSBCS describes a holding period requirement that provides that throughout a period of 24 months immediately preceding the determination time, the share must not have been owned by any person or partnership other than the individual or a person or partnership that was related to the individual.

Paragraph 110.6(14)(f) provides a special rule which applies for the purposes of the definition of QSBCS and treats shares issued by a corporation to a particular person or partnership except in certain circumstances, as having been owned, immediately before their issue to the particular person or partnership by a person who was not related to the person or partnership. Subparagraph 110.6(14)(f)(i) provides that shares issued as consideration for other shares will not be subject to this rule. In addition, subparagraph 110.6(14)(f)(ii) provides that shares issued as part of a transaction or series of transactions in which the person or partnership disposed of all or substantially all of the assets used in an active business carried on by that person or the members of the partnership or disposed of an interest in a partnership where all or substantially all of the partnership's assets were used in an active business carried on by the members of that partnership are not subject to this rule.

The effect of the rule in paragraph 110.6(14)(f) is to require shares issued in circumstances, other than those provided for in the exceptions in subparagraphs (i) and (ii), to be owned for the full 24 month holding period by the taxpayer or persons or partnerships related to the taxpayer in order to qualify for capital gains deduction. This rule ensures that the holding period requirement in the QSBCS definition cannot be circumvented through the issue of shares of a corporation from treasury.

Paragraph 110.6(14)(a) of the Act provides an ordering rule for the disposition of shares that are identical properties for the purposes of determining whether a share is a QSBCS. Where a taxpayer disposes of shares only some of which meet the holding requirements of subsection 110.6(1) for QSBCSs, paragraph 110.6(14)(a) deems the taxpayer to have disposed of the shares in the order in which he acquired them.

Based on the facts provided, XXXXXXXXXX shares of Aco disposed of by Mr. A were held for less than 24 months before their disposition. Those shares will not meet the requirement found in paragraph (b) of the definition of a QSBCS unless one of the two exceptions provided for in subparagraphs (i) and (ii) of paragraph 110.6(14)(f) is met. Whether or not such conditions are met is a question of fact.

As regards the XXXXXXXXXX Aco shares that meet the 24 month holding period, a capital gains deduction pursuant to subsection 110.6(2.1) of the Act may be claimed, providing the other requirements for such deduction are otherwise met.

With respect to the tax treatment of additional proceeds received pursuant to the share earnout clause, pertinent information can be found in IT-426R - Shares Sold Subject to an Earnout Agreement, September 28, 2004, and IT-462 - Payments Based on Production or Use, October 27, 1980, available from the CRA website.

We trust that these comments will be of assistance.

Yours truly,

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch