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.
Dear Sirs:
Re: Small Business Corporation
This is in reply to your letter of February 25, 1991 and further to our telephone conversation (Thornley XXX of April 3, 1991 concerning the application of the definition of a "small business corporation" as defined in subsection 248(1) of the Income Tax Act (the "Act") to a hypothetical set of facts supplied by you.
The corporation in your example acquires vacant land, develops it, and subdivides the land into lots for future sale. Development expenses are capitalized with the cost of the land and written off proportionately when a developed lot is sold. Mortgages are take back as consideration for a sale. The fair market value of the assets of the corporation are largely made up of raw land, capitalized development costs and mortgages receivable. Income consists mainly of lot sales and mortgage interest. It is your understanding that the corporation in question is a "small business corporation" for purposes of the Act since it is a Canadian controlled private corporation where all or substantially all of the fair market value of its assets are attributable to assets that are used in an active business carried on primarily in Canada. You ask that we confirm your understanding.
Our Comments
As discussed during our second telephone conversation on April 3, 1991, it is our view that land inventory of a real estate developer would normally be considered used in an active business for purposes of the definition of small business corporation in subsection 248(1) of the Act.
It is our further view, however, that although a mortgage is an asset whose existence may be relevant to the equity of a corporation, it is not an asset used in an active business as the funds tied up in the mortgage are no longer available for the active business uses of the corporation. As discussed, the comments in paragraph 3 of Interpretation Bulletin IT-73R4 regarding interest arising from a mortgage on real property, the sale of which was categorized in a previous year as income from an active business, relate to the definition of "income of a corporation from an active business" in paragraph 125(7)(c) of the Act. This paragraph includes in the income of an active business any income pertaining to or incident to that business. However, the definition of "small business corporation" in subsection 248(1) of the Act requires that the assets be used in the active business. The fact that mortgage reserves and mortgage interest may be considered incident to or pertaining to the active business does not necessarily determine that the mortgages receivable are used in the active business. As indicated in IT-486R, it is a question of fact whether an asset is used in an active business.
In summary, mortgages are generally not considered to be assets used in an active business and where more than incidental to the business, the income earned therefrom is considered income from property and subject to the "specified investment business" rules in paragraph 125(7)(e) of the Act
We trust that our comments will be of assistance to you.
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