Principal Issues: [TaxInterpretations translation] In the situation presented, is the disposition of the Subscribed Shares a qualifying disposition? Could the Subscribed Shares also be replacement shares?
Position: Questions of fact. In this case yes.
Reasons: Income Tax Act
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2010-038586
February 10, 2012
Dear Sir,
Subject: Section 44.1 and public share issuance
This is in response to your letter of November 3, 2010 in which you asked for our opinion on the application of section 44.1 of the Income Tax Act (the “Act") respecting an initial public offering ("IPO") by a corporation.
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
- A corporation ("Corporation") wishes to proceed with the issuance of common shares of its capital stock (the "Subscribed Shares") as part of an IPO and to list such shares on a designated stock exchange;
- On the closing date of the IPO (the "Closing Date"), the following transactions will take place sequentially in the following order:
- issuance and subscription of Subscribed Shares through a broker;
- listing the Subscribed Shares of the Corporation on a designated stock exchange;
- the opening of the markets on which the Corporation's shares are listed.
- On the Closing Date, the Corporation will satisfy the following criteria:
- the carrying value of its assets, and of corporations to which it is related, has never exceeded $50,000,000; and
- at the particular time, all or substantially all of the fair market value of its assets is attributable to assets used principally in an active business carried on principally in Canada by the Corporation, being an "eligible small business corporation", as that expression is defined in subsection 44.1(1).
- On the Closing Date, all of the issued and outstanding shares of the Corporation will be common shares;
- Prior to the listing of the Subscribed Shares of the Corporation on a designated stock exchange, the Corporation will qualify as a CCPC and for that purpose:
- if the Subscribed Shares and each share of the capital stock of the Corporation immediately before the issuance of and subscription for the Subscribed Shares were held by a person who is a non-resident, a public corporation (other than a prescribed venture capital corporation) or a corporation of which a class of shares of the capital stock is listed on a designated stock exchange, such person would not control the Corporation;
- no right referred to in paragraph 251(5)(b) is held by a non-resident, a public corporation (other than a prescribed venture capital corporation) or a corporation of which a class of shares of the capital stock is listed on a designated stock exchange, or controlled by one of those persons, except for the right to acquire the Subscribed Shares;
- no person or group of persons has any direct or indirect influence that, if exercised, would result in control in fact of the Corporation.
- At the time of the issuance of Subscribed Shares to an individual, the Corporation is a Canadian-controlled private corporation;
- At that time, the shares of the Corporation qualify as "eligible small business corporation shares", as that expression is defined in subsection 44.1(1);
- In particular, the Corporation meets the following requirements:
- the shares of its capital stock are common shares;
- the carrying value of its assets and of related corporations never exceeded $50,000,000; and
- at the time the Subscribed Shares are issued, all or substantially all of the fair market value of its assets is attributable to assets used principally in an active business carried on primarily in Canada by the Corporation, being a "qualified small business corporation” as that expression is defined in subsection 44.1(1).
In light of that scenario, you asked the following questions:
(1) Can the Subscribed Shares qualify as "replacement shares" for the purposes of section 44.1 for an individual in respect of a qualifying disposition by the individual?
(2) For an individual who holds Subscribed Shares, would the individual's disposition of the Subscribed Shares constitute a "qualifying disposition" on the assumption that:
- those shares belonged to the individual throughout a period of 185 days that ended immediately before the disposition; and
- throughout the period in which the individual was the owner, those shares were common shares of an "active business corporation"?
Our Comments
Your first question is whether the Subscribed Shares could be replacement shares for an individual, as that term is defined in subsection 44.1(1), in respect of a qualifying disposition.
A replacement share, for the purposes of section 44.1, must meet the following requirements:
- it is an eligible small business corporation share;
- it was acquired in the year of the qualifying disposition or within 120 days after the end of that year;
- it is designated by the individual in the individual’s return of income for the year of the qualifying disposition to be a replacement share in respect of the qualifying disposition.
An eligible small business corporation share of an individual is a common share issued by a corporation to the individual under the following requirements:
- at the time the share was issued to the individual, the corporation was an eligible small business corporation;
- immediately before and immediately after it was issued, the total carrying value of the assets of the corporation and corporations related to it did not exceed $50,000,000.
In this case, in the light of the facts you have provided, it is necessary to determine whether, at the time of the issuance of the share to the individual who wishes to designate the share as a replacement share, the corporation is an eligible small business corporation, as the requirements as to the carrying value of the assets are, in your opinion, satisfied. An eligible small business corporation is defined as a corporation that, at that time, is a Canadian-controlled private corporation ("CCPC") all or substantially all of the fair market value of the assets of which at that time is attributable to assets of the corporation that are
(a) assets used principally in an active business carried on primarily in Canada by the corporation or by an eligible small business corporation that is related to the corporation;
(b) shares issued by or debt owing by other eligible small business corporations that are related to the corporation; or
(c) a combination of assets described in paragraphs (a) and (b).
Thus, in the situation you described, it is necessary that the corporation issuing the Subscribed Shares to the individual who wishes to designate such shares as replacement shares be a CCPC at the time of their issuance to the individual. If that were the case, and to the extent that the Subscribed Shares were acquired within the time limits set out in the definition of "replacement share" in subsection 44.1(1) and the individual who acquired them designated them in proper form as replacement shares, we are of the view that the Subscribed Shares would represent replacement shares.
With respect to your second question, you wish to know whether the disposition of the Subscribed Shares may constitute a qualifying disposition.
As provided in subsection 44.1(1), a qualifying disposition of an individual is a disposition of shares of the capital stock of a corporation where each such share disposed of was:
- an eligible small business corporation share of the individual;
- throughout the period during which the individual owned the share, a common share of an active business corporation; and
- throughout the 185-day period that ended immediately before the disposition of the share, owned by the individual.
In this case, it is therefore necessary to determine whether the two following requirements are satisfied. First, the corporation that issued the Subscribed Shares to the individual must inter alia be a CCPC at the time of the issuance. Second, throughout the entire period during which the Subscribed Shares were owned by the individual, they must have been common shares of a corporation that is carrying on an active business. With respect to that latter requirement, we refer you to subsection 44.1(8) which provides that property is deemed, in certain circumstances, to be used or held by a corporation in the course of carrying on the active business of that corporation.
If both of the above requirements are satisfied, we would be of the view that the disposition of the Subscribed Shares would be a qualifying disposition to the extent, of course, that all other requirements under the Act are satisfied.
We hope that these comments will be of assistance.
Best regards,
François Bordeleau, Advocate
Manager
Business and Partnership Section
Income Tax Rulings Directorate