Small Business Corporation

CCRA indicated that a future income tax asset (including one not recognized on the balance sheet) must be taken into account for QSBCS and SBC purposes, but such an asset is not considered to be used in the business of the corporation because it is not employed or risked in that business.

An individual owned an interest-bearing debt of a wholly-owned corporation operating a restaurant which in 20X1 sued the franchisor at the same time as closing the restaurant. If, notwithstanding good prospects of success in the action, it is dismissed by the court in 20X6, can a business investment loss (“BIL”) then be claimed?

CRA noted that, if the capital loss was triggered under s. 50(1), the recognition of a BIL would require that the corporation qualify as a small business corporation (an “SBC”) - which would entail a requirement for instance that it have been carrying on a Canadian active business at some point within the preceding 12 months. CRA then stated:

Following [Poulin], we accept … that an amount for damages may be deducted in a year in which a taxpayer no longer carries on business, since the taxpayer is presumed not to have ceased carrying on business for as long as the taxpayer is engaged in carrying through on acts committed to by the taxpayer in the course of the business, even if, at the time the amount is deducted, the taxpayer is no longer transacting and can no longer attend to the taxpayer’s customers.

CRA set out general guidelines on when cash held by a corporation would be considered to be used in an active business carried on by it for purposes of the “specified small business corporation” definition in Reg. 4901(2) (respecting qualification of its shares for RRSPs). The listed factors (which are similar to those applied by CRA in other contexts) included:

• Cash or near cash property is considered to be used principally in the business if its withdrawal would destabilize the business.
• Cash which is only temporarily surplus to the business needs may qualify.
• Cash balances which accumulate only to be depleted in accordance with the annual seasonal fluctuations of the business will generally qualify – but a permanent balance in excess of the company's reasonable working capital needs will generally not qualify.
• Funds will not qualify by virtue only of being accumulated to purchase capital assets or repay long-term debt.

S. 110.6(15)(a) provides that a shareholder’s shares are to be valued for various listed purposes including the “small business corporation” definition on the basis that a life insurance policy owned by the corporation on the shareholder’s life is to be valued at its cash surrender value. CRA has confirmed that 110.6(15)(a) applies even where the corporate policy covers lives other than that of the shareholder, e.g., the payout occurs on the death of both the shareholder and a key employee, or on the survivor of the shareholder and his spouse.

Is the asset recorded in the financial statements as a capital lease considered as an asset used in an active business for purposes of the definitions of a qualified small business corporation share or of a small business corporation? CRA responded:

[T]hese accounting entries should not be taken into account in determining whether a share is a QSBCS or whether a corporation is an SBC.

However…account must be taken of the FMV of the rights in the lease in determining whether a share is a QSBCS or whether a corporation is an SBC.

To determine whether or not the rights in a lease are an asset used principally in an active business carried on by the corporation, the use of the property which is the subject of the lease must be considered.

Before going on to indicate that internally generated goodwill is considered in determining whether shares of a foreign affiliate of a corporation resident in Canada qualify as "excluded property" of another foreign affiliate of the corporation, CRA stated:

[T]he "all or substantially all" test will normally be satisfied if assets representing at least 90 percent of the fair market value of the assets of the corporation are used in an active business carried on by it. The assets of the corporation include goodwill, whether or not such goodwill has been purchased.

See summary under s. 95(1) – excluded property.

Is a future income tax asset an asset used in an active business for the purposes of the definition of qualified small business corporation share in s. 110.6(1) and of small business corporation in s. 248(1)? CRA responded (reversing 2000-001582 and 2008-028530):

[A[ future income tax asset is not an asset for the purposes of the definition of QSBCS and the definition of SBC. …

Furthermore, where a future income tax asset becomes a tax receivable, this tax must be considered as an asset in determining whether a share is a QSBCS or if a corporation is a SBC. The tax receivable may be an asset used in the active carrying on of a business for [such] purposes … . For example … tax receivable due to the carryback of a loss from an active business is an asset used primarily in the business that the corporation is actively carrying on for purposes of both definitions. …

The same interpretation applies to deferred tax assets.

Must the 90% level always be attained before the "substantially all" test is satisfied? CRA stated:

According to the jurisprudence, the interpretation of the term "all or substantially all" ... depends on the relevant legislative provision and the facts of each case. ...

...[T]he CRA ... usually consider[s] that the "all or substantially all" test is satisfied when a level of 90% or more is reached.

However, the test of "all or substantially all" could, depending on the circumstances and the context, be satisfied even if the 90% level is not reached. Where the 90% level is not attained, the CRA must consider each case in its particular context to determine if a threshold lower than 90% could satisfy the "all or substantially all" test.

Is a future income tax asset an asset that is used principally in an active business carried on in Canada for purposes of the "qualified small business corporation share" ("QSBCS") and "small business corporation" ("SBC") definitions?

After indicating that there was "no significant difference" between the terms "future income tax assets" and "deferred tax assets" used in Chapter 3465 of Part II of the CICA Handbook, and in IAS 12, respectively, CRA stated (TaxInterpretations translation):

[A] future income tax asset is not an asset for purposes of the definition of QSBCS and of SBC. … However, when a future income tax asset becomes a tax receivable, such tax receivable must be considered as an asset for determining if a share is a QSBCS or a corporation is a SBC. The tax receivable can constitute an asset used in carrying on an active business…if it arises from the active carrying on of the business. For example … a tax receivable resulting from the carryback of a loss from an active business is an asset used primarily in the business carried on by the corporation... .

A corporation is the holder of a life insurance policy on its shareholder (Mr. X, who has an incurable illness) with a nil cost, a cash surrender value of $50,000 and a fair market value of $500,000. CRA indicated that, based on s. 110.6(15)(a)(i), the calculation of the fair market value of the assets of the corporation for purposes of determining whether it was a small business corporation should be done on the basis that those assets included the policy valued at its cash surrender value. Under s. 110.6(15)(a)(ii) the proceeds of the policy also would be ignored for such purposes except to the extent of the cash surrender value, provided that the proceeds were applied within 24 months to redeem shares.

The query referred to Ville de Laval c. Polyclinique médicale Fabreville, s.e.c., 2007 QCCA 426 and Ferme CGR enr., s.e.n.c. (Syndic de), 2010 QCCA 719, where the Quebec Court of Appeal indicated that a partnership possessed a patrimony separate from its partners, and asked whether this altered the position in 9636835 that a corporation holding a partnership interest in a partnership carrying on an active business was in the same position as if it carried on the business directly. CRA stated (TaxInterpretations translation) that

[T]he concept of an autonomous patrimony of a partnership and its application to federal taxation is one which raises numerous questions. Accordingly, the CRA will continue monitoring the evolution of this issue.

Despite these developments, the CRA considers it preferable for the time being to continue applying the position stated in Technical Interpretation 9636835 in determining if the conditions contemplated in the definition of "small business corporation" are satisfied.

In order to qualify as a SBC, Opco issued cheques to various suppliers. Do the issued and outstanding cheques, that have not yet been cashed, reduce the excess cash on hand of Opco? CRA responded:

Under the civil law in force in Quebec, the delivery of an outstanding cheque does not constitute payment … [and] the date of payment of a debt settled by cheque is considered to be the date on which the cheque is honored or paid by the bank … .

[Here] the cheques in circulation and not yet cashed do not constitute payments of the amounts due to Opco's suppliers and … consequently, there can be no reduction in the amount of the cash of Opco as long as the bank does not honor or pay such cheques.

Cheques issued by Opco but not yet cashed would not reduce its cash on hand given that under the applicable law (the Quebec Civil Code), the issuance of a cheque does not constitute payment, so that the debt is not settled until the cheque is honoured.

The deeming under s. 129(6) of property income to be active business income does not apply for purposes of the small business corporation definition, so that a Canadian-controlled private corporation which rents a substantial property to an associated CCPC will not qualify as a small business corporation even where the associated corporation carries on a Canadian active business.

A couple will transfer a co-owned building – that is used 75% in the operation of an active business of a corporation owned by one of them and 25% for rental to third parties – to the corporation on a rollover basis in consideration for shares with a FMV equaling that of the building.

CRA indicated that it would regard the building as being “an asset used principally in an active business carried on by the corporation” following the rollover transaction.

Mr. A and Ms. B, who deal with each other at arm's length, have held 50% each of the shares of Opco and of Realtyco for over 24 months. All of the property of Opco is used in its Canadian manufacturing business and Realtyco owns an immovable with an FMV that is fully leased to Opco and a debt owing by Opco of $125,000. In finding that the Realtyco shares were not qualified small business corporation shares ("QSBCS"), CRA stated:

[T]he debt owed by Opco would not constitute a debt of a small business corporation that is connected with Opco for the purposes of paragraph (b) of the definition of SBC in subsection 248(1). Indeed … Opco is not connected with Realtyco within the meaning of subsection 186(4).

Consequently, Realtyco would not be a SBC within the meaning of subsection 248(1), since only about 44% ($100,000 out of $225,000) of the fair market value of its assets would be attributable to items falling within that definition of SBC.

… [A] prior reorganization of Realtyco could not resolve these difficulties because of the "more than 50%" test for the fair market value of the asset during the 24-month holding period in paragraph (c) of the definition of QSBCS … .

Regarding whether a corporation engaged in a business of trading listed shares qualified as an SBC, CCRA stated:

[T]he holding or use of an asset must be linked to a defined responsibility or obligation of the business, and the mere fact that the use of the asset has a commercial purpose is not sufficient. The asset must be used or risked in the business and satisfy a requirement necessary for the operation of the business. In this context, "risked" means more than being exposed to a remote risk. If no longer having the asset would destabilize the corporation's operations, the asset would generally be considered to be used in the course of a corporation's operations. … [The] corporation's assets, particularly cash and longer-term investments, would require that type of analysis.

44% of the floor area of a building owned by Holdco is used in the grocery operations of its wholly-owned subsidiary (Opco) and the balance is rented for residential purposes; however the rents received by it for the commercial portion represent 68% of its total revenues. As a condition to Opco being a franchisee of a third-party franchisor, Holdco was required to lease the commercial portion to the franchisor, which subleased it to Opco, and Opco was required to subscribe for shares of the franchisor.

CCRA was inclined to doubt that the building was used principally in the active business of Opco, noting that Canada Trust (85 DTC 322) indicated “that the physical space used (in terms of square feet) was a factor to which significant weight should be given.“ However, it considered that the interposition of the franchisor in the lease structure would not by itself preclude the commercial portion from being regarded as used principally in the active business of Opco, and that the shares of the franchisor held by Opco could be considered to be an active business asset given that their holding was a requirement of the franchise.

The fact that an asset is a trade receivable does not, by itself, indicate that it is used principally in an active business. Although trade receivables generally are considered to be used in an active business because they are held to meet current cash flow or current working capital requirements, they were not so used where they remained outstanding for an extended period of time.

Where a portion of a lot is more than physically necessary to carry on a business and cannot be disposed because of zoning restrictions or because it is not suitable for any economic use, RC will not seek to deny that the lot is not being used principally in an active business.

Where a marina having foreshore water leases is required under the terms of the lease to own land contiguous with the foreshore lease, such land would be considered to be used in an active business because it is a condition precedent to the operation of the Marina.

In response to a question, respecting a corporation which holds only an interest in a partnership, whether the shares of such corporation can qualify as qualified small business corporation shares, the Directorate indicated that (as stated in the summary) where

a corporation has a partnership interest as one of its assets, it is the underlying partnership's assets (to the extent of the corporation's interest therein) that are used in determining whether all or substantially all of the corporation's assets are used in an active business for the purpose of the definition of small business corporation under subsection 248(1) of the Act and for the purpose of the definition of QSBCS under subsection 110.6(1) of the Act. Provided that these assets are used in an active business carried on primarily in Canada by the partnership, they will qualify as being used by the partner in an active business carried on primarily in Canada by the corporation.

"... It is still Revenue Canada's view that a Canadian-controlled private corporation whose only asset is an interest in a partnership, where or substantially all of the partnerships assets are used to carry on an active business in Canada, would be considered to be a small business corporation"

"Where a financing arrangement that is fundamental to the business operations requires certain security to be maintained and it is reasonable to conclude from the facts that the security is employed and at risk in the business, the security may be considered to be used in the business... . If there is no real expectation that the security will be resorted to, one could conclude that the security was not used in the business. In our view, the employment of marketable securities merely as collateral is not generally sufficient to enable it to be considered to be used in a business"

"... Although a mortgage is an asset whose existence may be relevant to the equity of a corporation, it is not generally 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. However, mortgages taken back by a developer in order to facilitate sales may initially appear to be assets used in an active business, but if such mortgages are retained for more than a short period, they appear to have become more in the nature of investments".

"It is our opinion that normally a full-service motel operation would be providing a sufficient level of services such that it would not be considered to constitute a business whose principal purpose is to derive income from property. With respect to the campsites for trailers and campers, we have previously taken the position with respect to a corporation having less than six full-time employees, operating a trailer court and offering no more than normal services such as grounds maintenance and snow removal, that it would be considered to be conducting a specified investment business"

Under a co-ownership arrangement, each co-tenant has a right to occupy the property in respect of all its areas and neither party can point to a particular part which represents its share of all areas. Accordingly, where substantially all the value of a corporation's property is represented by its 50% co-tenancy interest in a building, and it uses over 50% of its proportionate interest in the building in an active business with the other co-tenant being at arm's length, the corporation will not qualify as a small business corporation if less than 50% of the building's total value is being used in an active business carried on by the corporation.

The policy that where a corporation has a partnership interest, it is the underlying partnership assets (to the extent of the corporation's interest therein) that are used in determining whether all or substantially all of the corporation's assets are used in an active business, applies even if another partner of the partnership is a public corporation.

A private-company franchisee is required to hold shares of a public corporation under an escrow agreement under which it is prohibited from disposing of them, in order to be permitted to carry on its business under the public corporation's banner. Are such shares property used principally in an active business carried on by the corporation? CRA responded:

[W]e generally consider property to be used in a business if it is used principally in respect of that business, and is actually employed and risked in the business, which implies more than remote risk and more than the use of the asset for business purposes.

… [W]here a franchisor and a franchisee are at arm's length … the shares of the franchisor held by a franchisee could be considered to be used in the business operated by the franchisee, to the extent that the subscription is a condition of membership under the banner, and the shares are pledged as security to the franchisor to secure the obligations of the franchisee.

Intercorporate accounts receivable arising as a result of the leasing of equipment and the provision of administrative services by one corporation to an associated corporation, in RC's view would probably not be used in the business of the first corporation because the receivables generally would remain outstanding for extended periods of time and apparently would be converted into intercorporate advances on a regular basis.

Re wether a corporation that provides management services to a related professional practice is carrying on a business.

Assets used principally in the active business of a limited partnership will be considered to be used in an active business by the corporate general partner of the limited partnership to the extent of its interest therein.

In applying the look-through approach to a partnership interest, it is the fair market value of the proportionate interest in the assets of the partnership which is considered to be the fair market value of the assets of the corporate partner, rather than the fair market value of the partnership interest.

A partner's advance to a partnership is generally not an asset used in an active business unless the partner is in the business of advancing funds.

"As a general rule a business that involves the sale or leasing of goods is usually carried on in the country where the corporation is resident, unless the business (or a part of it) is conducted by a virtually autonomous branch operation outside of Canada. Where a corporation's business involves the rendering of services, that business is carried on in Canada only to the extent that services are rendered in Canada, necessitating an apportionment of net business income on a reasonable basis"

Shares which a franchisee is required to purchase in the franchisor in order to provide security in respect of trade payables which it owes to the franchisor will be considered to be used in an active business.

Mortgages taken back by a developer in order to facilitate sales may initially be assets used in an active business, but will become investments if retained for more than a short period.

Substantial amounts of cash and deposits in excess of those required for use of the business and that are retained on a permanent basis, will not be considered to be funds used in the business.

The only receivables considered to be assets used in an active business are trade accounts receivable that arise from sales in the course of the corporation's active business.

In order for land to be considered to be used in an active business, it generally must be subjacent to any building or structure affixed to the land or immediately contiguous land used as a parking area, driveway, yard, garden or similar land that is necessary for the use of the building. However, where zoning restrictions require that a larger parcel of land be acquired, the entire parcel could be considered to be an active business asset.

Where one of the assets of a corporation is a partnership interest, the corporation's proportionate share of the fair market value of the partnership assets will be considered for purposes of applying the requirement that 90% of the fair market value of the corporation's assets be used in an active business.

If more than 50% of an asset is used in an active business, the asset will be considered to be used principally in an active business.

Assets leased by a partnership for use in its active business will be considered to be used in an active business carried on by the corporate partner to the extent of the partner's interest in the partnership. However, for the partnership business to be carried on by the corporate partner, there must be no legal impediment to the corporation's involvement in the business as may be the case with the limited partnership interest.

An unsecured non-interest bearing loan with no specific terms of repayment would qualify under the concept of "indebtedness" introduced by S.C. 1991, c. 49.

Where a corporation earns interest income from cyclical cash and short-term investments and the interest is included in its active business income, then depending on the circumstances those assets would be considered to be used in an active business.

Where the only assets of Holdco are shares of its wholly-owned subsidiary which carries on an active business in Canada and more than 10% of whose property is represented by an intercompany debt owing by Holdco, Holdco will not qualify as a small business corporation because more than 10% of the subsidiary's assets are represented by the debt of a corporation (Holdco) which is not connected to it.

Where a corporation sells its business for cash, it has ceased to carry on an active business as of the date of the sale even if the cash proceeds are held for the purpose of acquiring another business similar to the one sold and the company is actively seeking out acquisition opportunities.

Where a corporation sells land and building used in a division of its active business and takes back a mortgage from the purchaser, the mortgage will not be used in an active business.

An Opco whose shares, being common shares, are equally owned by two individuals (A and B) engages in a purification transaction (to qualify as a small business corporation) pursuant to which they transfer a portion of their common shares on a s. 85(1) rollover basis to their respective new Holdcos, whose Opco common shares are exchanged under s. 51 for redeemable preferred shares. To extract Opco excess cash, the stated capital of the preferred shares (producing s. 84(1) deemed dividends and ACB increases) and the resulting PUC is distributed in cash.

After commenting on safe income issues, CCRA indicated that SBC “purification” transactions are not contrary to the spirit of the Act.

Where Opco and Realco are connected CCPCs and the real estate assets of Realco are leased to Opco, the shares of Realco and of Opco will constitute qualified small business corporation shares regardless whether the real property owned by Realco is financed by a mortgage from third parties, or by a non-interest bearing promissory note owing by it to Opco.

Where the proceeds of a life insurance policy held by a corporation on the life of its shareholder will be distributed by the corporation as a dividend or will be used to fund the acquisition of the shares of the deceased shareholder, such proceeds will not normally be considered to be used in an active business carried on by the corporation.

In the situation where a building was held in joint tenancy by an individual and a corporation owned by him, because no more than 50% of the building was used in the active business of the corporation no part of the value of the corporation's interest in the property would be a qualified use, notwithstanding that the corporation and the individual had a written agreement under which the corporation was entitled to the sole exclusive use and occupation of the portion of the property used in its business.

Where Mr. A and Mr. B conduct an active business through a partnership and Mr. A rolls his interest in the partnership into Holdco, which has no assets other than its interest in the partnership, then it is Holdco's proportionate share of the assets of the partnership that is used to determine whether Holdco is a small business corporation.

A corporation whose only assets are an interest in a limited partnership carrying on an active business and a loan to the partnership, qualifies.

88 C.R. - "Small Business Corporation Shares" - "Background": The "all or substantially all" test will normally be satisfied if assets (including unpurchased goodwill and underlying partnership assets) representing at least 90% of the fair market value of the assets of the corporation (including life insurance proceeds) are used in an active business carried on by it.