Principal Issues: [TaxInterpretations translation] Should the replaced shares be owned for a period of 24 months prior to their replacement, so that the replacement shares (which were owned less than 24 months before the time of disposition) can qualify as qualified small business corporation shares as defined in subsection 110.6(1) of the Income Tax Act (the "Act"), if all the other conditions of that definition are otherwise satisfied?
Position: No. The tests provided for in subparagraphs 110.6(1)(e)(i) and (ii) of the Act must be satisfied for the portion of the period beginning 24 months before the time of disposition and ending at the time of replacement.
Reasons: May 1991 Explanatory Notes re the test provided for in paragraph 110.6(1)(e) respecting the replaced shares.
XXXXXXXXXX 2011-042182 Lucie Allaire, LL.B, CGA February 23, 2012
Dear Sir,
Subject: Paragraph 110.6(1)(e) of the definition of qualified small business corporation shares ("QSBCS")
This is in response to your e-mail dated September 21, 2011 in which you requested our comments regarding the application of paragraph 110.6(1)(e) of the definition of QSBCS in the Income Tax Act (the “Act”).
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
Particular Situation
You referred to an individual, Mr. X, who acquired the shares of Holdco on January 1, 2010, while Holdco only held, as its sole asset, the shares of Opco. You suggested that from January 1, 2010, between 50% and 90% of the fair market value ("FMV") of Opco was attributable to the elements referred to in subparagraph 110.6(1)(c)(i) of the definition of QSBCS.
On September 1, 2011, Mr. X transferred his shares of Holdco to Opco in exchange for Class D shares of Opco. Subsequently, on January 2, 2012, Mr. X disposed of his Class D shares of the capital stock of Opco and you submitted that at that time that more than 90% of Opco's FMV was attributable to elements referred to in subparagraph 110.6(1)(c)(i) of the definition of QSBCS.
You are of the view that the replacement shares, being the Holdco shares, qualify as QSBCS if they satisfy the criteria of paragraphs 110.6(1)(b) and (c) of the definition of QSBCS for the period beginning 24 months before the particular time (January 2, 2012) and ending at the time of replacement (September 1, 2011). You concluded that the effect of the combined application of paragraph 110.6(1)(e) and subparagraph 110.6(14)(f)(i) is that the Opco Class D Shares held by Mr. X constitute QSBCS. For example, you stated that under subparagraph 110.6(14)(f)(i), Opco Class D shares were not deemed to have been owned, immediately before their issue on September 1, 2011, by a person who was not related to Mr. X.
Your Question
You wish to confirm that the Class D shares of Opco were QSBCS on January 2, 2012.
Our Comments
An individual who realizes a gain on the sale of a QSBCS, as defined in subsection 110.6(1), may claim a capital gains deduction in computing the individual’s taxable income pursuant to subsection 110.6(2.1). For a share to qualify as a QSBCS, it must, among other things, be a share of a small business corporation within the meaning of subsection 248(1) at the particular time, being the time of disposition.
In addition, paragraph 110.6(14)(f) provides a presumption that shares issued after June 13, 1988 by a corporation to a particular person or partnership are deemed to have been owned immediately before their issue by a person who was not related to the particular person or partnership. However, that presumption may be rebutted if any of the exceptions in 110.6(14)(f)(i), (ii) or (iii) apply. In that regard, the exception in subparagraph 110.6(14)(f)(i) provides that the shares were deemed to have been owned immediately before their issue by a person who was not related to the particular person or partnership unless the shares were issued as consideration for other shares,
Furthermore, paragraph 110.6(1)(e) of the definition of QSBCS applies where, at any time in the 24-month period ending at the determination time, the share was substituted for another share (the original or replacement share).
According to the May 1991 Explanatory Notes of the Department of Finance Canada, paragraph 110.6(1)(e) of the definition of QSBCS provides that the original share must, throughout the part of the 24-month period preceding the determination time that is before the time of substitution (referred to as “the holding period”), not have been owned by a person or partnership other than a person or partnership described in paragraph 110.6(1)(b) of the definition. In addition, the original share must be a share of a corporation that meets an active business asset test throughout the holding period during which the share was owned by a person or partnership described in paragraph 110.6(1)(b) of the definition.
In light of the above, we share your interpretation of the period of application of paragraph 110.6(1)(e) of the definition of QSBCS. Consequently, in the event that Opco's Class D Shares otherwise satisfy the conditions of the QSBCS definition and subparagraph 110.6(14)(f)(i) applies, we are of the view that they may qualify as QSBCS if, throughout the 24-month period beginning before January 2, 2012 and ending on September 1, 2011, the original or replacement shares, being the shares of Holdco, satisfy the tests prescribed in subparagraphs 110.6(1)(e)(i) and (ii), which describe the conditions set out in paragraphs 110.6(1)(b) and (c) of the definition.
We point out that this opinion is not an advance ruling and does not bind the Canada Revenue Agency with respect to a particular factual situation.
We hope that these comments will be of assistance.
François Bordeleau, Advocate
Manager
Business and Trusts Section
Business and Trusts Division
Income Tax Rulings Directorate