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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: (1) Whether a particular corporation meets the "more than 5 full-time employees" requirement in the definition of "specified investment business" in ss. 125(7) of the Act. (2) Whether the shares of the corporation may be considered "qualified small business corporation shares" under ss. 110.6(1) of the Act.
Position: (1) Question of fact, but likely no. (2) Question of fact, but likely no.
Reasons: (1) The corporation must employ in the business more than 5 full-time employees to avoid being considered a specified investment business. Although the corporation has more than 5 full-time employees on its payroll, it appears that the corporation is carrying on separate businesses, and in each business it does not employ more than 5 full-time employees throughout the year. (2) If the corporation does not carry on an active business, it cannot be considered a small business corporation.
XXXXXXXXXX 2002-017982
P. Massicotte, CA, M.Fisc.
May 15, 2003
Dear XXXXXXXXXX:
Re: Specified Investment Business
This is in response to your letter of December 5, 2002, requesting our comments in connection with the definition of "Specified Investment Business" in subsection 125(7) of the Income Tax Act (the "Act"), and the definition of "Qualified Small Business Corporation Share" in subsection 110.6(1) of the Act, in two specific situations.
The facts as we understand them are as follows:
Scenario 1
1. Six unrelated individuals each own an apartment building which they use to earn income in separate rental activities;
2. Each owner employs one full-time employee in connection with the rental of his or her apartment building;
3. The owners of the six apartment buildings create a new corporation ("Newco") and transfer the interest they have in their respective apartment building to Newco;
4. Each owner receives as consideration for the transfer a separate class of shares ("tracking shares") of Newco which has a "tracked" interest in the underlying apartment building transferred (tracking is based on the net income/loss of each respective property, as well as any capital gain/loss and recapture or terminal loss related to the property);
5. Each of the six full-time employees, although employed by Newco after the transfer of the apartment buildings, continues to work exclusively for the same apartment building he or she worked for prior to the transfer, and does not work on any other building held by Newco;
6. The only assets of Newco are the six apartment buildings transferred by its shareholders, as described in paragraph 3 above, and its only activities consist in the rental of the apartments;
7. Newco is not related nor associated with any other corporation.
Scenario 2
Same facts as in Scenario 1, except that the employees will work on any or all of the apartment buildings transferred to Newco after the transfer takes place. In the event that an employee works for more than one apartment building, the cost would be allocated between the buildings based on the employee's time spent.
You ask whether Newco would be considered to be carrying on a "Specified Investment Business", as defined in subsection 125(7) of the Act, and whether the shares of Newco could be considered "Qualified Small Business Corporation Shares", as defined in subsection 110.6(1) of the Act, under either or both scenarios above.
You are concerned that under Scenario 1 the corporation may be considered to carry on a specified investment business because of the issuance of "tracking shares" and the fact that, although Newco employs more than five full-time employees overall, each employee will work solely on a specific apartment building.
However, you suggest the situation in Scenario 2 would not result in Newco being considered to carry on a specified investment business as the employees work on all the apartment buildings. In your opinion, Newco would then be considered to carry on an active business, such that it would be eligible for the small business deduction, and its shares would potentially be considered "Qualified Small Business Corporation Shares", as defined in subsection 110.6(1) of the Act, where the other requirements of the definition are met.
The particular situation outlined in your letter appears to be a factual one, involving specific taxpayers. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. 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 for their views. However, we are prepared to provide you with the following general comments.
Subsection 110.6(1) of the Act defines "Qualified Small Business Corporation Share" and requires inter alia that it be a share of the capital stock of a small business corporation. Subsection 248(1) of the Act defines "Small Business Corporation" as: "...a particular corporation that is a Canadian-controlled private corporation all or substantially all of the fair market value of the assets of which at that time is attributable to assets that are:
(a) used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it,
(b) shares of the capital stock or indebtedness of one or more small business corporations that are at that time connected with the particular corporation ... or
(c) assets described in paragraphs (a) and (b)..."
Subsection 248(1) of the Act also defines "Active Business" as: "in relation to any business carried on by a taxpayer resident in Canada, means any business carried on by the taxpayer other than a specified investment business or a personal services business". The expression "specified investment business" is defined in subsection 125(7) of the Act, and means a business carried on by a corporation "... (other than...a business of leasing property other than real property) the principal purpose of which is to derive income (including interest, dividends, rents and royalties) from property but...does not include a business...where:
(a) the corporation employs in the business throughout the year more than 5 full-time employees, or
(b) any other corporation associated with the corporation provides...managerial... or other similar services to the corporation...and the corporation could reasonably be expected to require more than 5 full-time employees if those services had not been provided".
Accordingly, for shares of Newco to be considered at any time Qualified Small Business Corporation Shares under subsection 110.6(1) of the Act, it must be determined inter alia whether all or substantially all of the fair market value of its assets at that time is attributable to assets used principally in an active business it carries on. If all of Newco's activities fall within the definition of "Specified Investment Business", it cannot be considered to carry on an active business, and as a result cannot qualify for the small business deduction allowed under subsection 125(1) of the Act, nor the capital gains deduction in subsection 110.6(2.1) of the Act.
It is a question of fact whether a corporation carries on an active business or a specified investment business, which can only be determined after an examination of all relevant facts in a particular situation. Furthermore, it is possible for a corporation to carry on more than one business simultaneously. As mentioned in paragraph 2 of Interpretation Bulletin IT-206R, Separate Businesses, whether the carrying on of two or more simultaneous business operations by a taxpayer is the same business is dependent upon the degree of interconnection, interlacing or interdependence and the extent of the unity embracing the business operations. This test was set out in the English High Court decision in Scales v George Thompson & Company Limited (1927), 13 TC 83 and consistently accepted by Canadian courts (see DuPont Canada v. The Queen, 2001 DTC 5269 (FCA); Edgerton Fuels Limited v. MNR, 70 DTC 6158 (Ex.Ct.); H.A. Roberts Ltd v. MNR, 69 DTC 5249 (SCC); Utah Co. of the Americas v. MNR, 59 DTC 1275 (Ex. Ct.); Frankel Corporation Ltd v. MNR, 59 DTC 1161 (SCC)).
A wide range of factors have been considered by the courts when determining the degree of interconnection, interlacing or interdependence between simultaneous business operations, some of which are mentioned in paragraph 3 of IT-206R. The recent decision of the Federal Court of Appeal in the case of DuPont (above) referred to these factors as "substantial functional connections" between each business activity.
Although it may be relevant to consider the fact that employees of a corporation are shared between different business activities, as described in Scenario 2 above, this factor cannot in and of itself be determinative of the issue, particularly where the related expense is allocated and tracked as described above. While the determination of whether separate businesses are being carried on would require a review of all relevant facts, it would appear based on the limited facts provided that the issuance of shares such as those described above (commonly referred to as "tracking shares", "alphabet shares" or "targeted shares") would, in the above circumstances, entail the carrying on of separate businesses by the issuing corporation. We have not been provided with any information regarding the rights, privileges, restrictions or conditions attached to the different classes of shares issued in the present situation; however, it is our understanding that the dividend entitlement usually attached to a tracking share is fixed to the amount of profit realised by a particular business unit of the issuing corporation, and that these profits will never be paid out as dividends on any other class of shares of the corporation. Similarly, the liquidation entitlement attached to those shares is usually tied exclusively to the value of the particular business unit.
Where separate businesses are simultaneously carried on by a corporation, it must be determined whether each separate business is an active business or a specified investment business for the purposes of sections 110.6 and 125 of the Act. In that context, it our opinion that the requirements found in paragraph (a) of the definition of "Specified Investment Business", in subsection 125(7) of the Act, apply to each separate business. In other words, in order to be excluded from that definition, the corporation must employ in each separate business throughout the year more than 5 full-time employees. As stated in Question 30 of the 1981 Round Table of the Canadian Tax Foundation Conference, it is our opinion that a corporation may carry on more than one business, one of which may give rise to income from an active business and another which may give rise to income from a specified investment business. Again, based on the limited facts provided, it appears in the above scenarios that Newco would not employ more than 5 full-time employees throughout the year in any of its separate businesses.
Finally, we would also draw your attention to the fact that "tracking shares" to which are attached rights, privileges and conditions as described above may be regarded as taxable preferred shares as defined in subsection 248(1) of the Act.
We trust the above comments are of assistance to you.
Yours truly,
Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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