Principal Issues:
Are shares that are subject to an escrow agreement and that a corporation is obliged to hold in order to be able to carry on its business property used principally in the business that the corporation carries on?
Position:
Question of fact but possible.
Reasons:
The property must be actually used and risked in the business and the term risk must imply more than remote risk. The minimum requirements of the criterion are met as soon as the removal of the property would have a significantly negative effect on the corporation's operations.
XXXXXXXXXX 2006-020079 Nancy Turgeon, CGA July 9, 2007
Dear Madam,
Subject: Definition of “small business corporation”
This is further to your letter dated August 10, 2006, in which you asked whether shares of a public corporation held by a private corporation are property used principally in an active business carried on by the corporation if the shares are subject to an escrow agreement and the corporation is obliged to hold the shares and cannot dispose of them in order to be able to carry on its business under the public corporation's banner.
The situation you have indicated in your letter appears to relate to an actual situation involving a specific taxpayer. As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is our practice not to issue written opinions on proposed transactions otherwise than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
Whether property is used in an active business is a question of fact. However, we 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.
We cannot take a position on the situation in your letter other than in the context of a request for advance rulings, as this requires an examination of all the facts and the terms of the agreements between the parties.
However, in a situation where a franchisor and a franchisee are at arm's length, it appears to us that 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. Our interpretation might differ if the subscription to the shares was not a condition of membership and/or the shares were not pledged to the franchisor.
Best regards,
Louise J. Roy, CGA
Interim Manager
Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate.