Principal Issues: [TaxInterpretations translation] (1) Will the immovable, following its transfer to the corporation, be an asset used primarily in the business carried on by the corporation?
(2) On the facts of this case, would the Canada Revenue Agency apply paragraph 110.6(7)(b) of the Income Tax Act to deny the capital gains exemption on the disposition of qualified small business corporation shares?
Position: (1) The property must be used principally in the operation of the corporation's business both at the time of the sale of the corporation's shares and during the 24-month period preceding the sale. Based on the facts of this case, and provided that this holding period is respected, we answer in the affirmative.
(2) No.
Reasons: Income tax law. Case law.
XXXXXXXXXX 2005-015203
July 11, 2006
Dear Sir,
Subject: Request for technical interpretation - Qualifying small business shares
This is further to your letter dated September 22, 2005, in which you requested a technical interpretation regarding the application of section 110.6 of the Income Tax Act (the "Act") to a capital gain arising on the potential disposition of shares of a private corporation. We apologize for the delay in responding to your question.
Relevant Facts
Your request for a technical interpretation states the following facts:
- The taxpayer carries on a business in XXXXXXXXXX through a Canadian-controlled private corporation;
- The taxpayer is the sole shareholder of the corporation;
- The taxpayer owns a building in undivided co-ownership with the taxpayer’s spouse;
- The taxpayer uses most of the building - 75% - to operate the taxpayer’s business;
- The remaining portion of the building is rented to tenants in order to generate income from property;
- The couple plans to transfer the building to the corporation on a rollover basis in exchange for preferred shares;
- At the time of transfer, the fair market value of the preferred shares will be equal to the fair market value of the immovable;
- The agreed amount on the rollover will be less than the fair market value of the property but will be equal to the UCC [undepreciated capital cost];
- The agreed amount is approximately 75% of the fair market value of the immovable;
- The couple plans to eventually dispose of the preferred shares of the corporation and, on the sale, to claim the capital gains exemption under section 110.6 of the Income Tax Act (the "Act").
Questions
In connection with the capital gains exemption available on the disposition of qualified small business corporation shares ("QSBCSs") under section 110.6, you asked the following two questions:
1. First, you wish to determine whether the immovable, following its transfer to the corporation, will be an asset used principally in the business carried on by the corporation;
2. Second, you wish to know whether the Canada Revenue Agency ("CRA") would apply paragraph 110.6(7)(b) to deny the couple the capital gains exemption regarding the disposition of QSBCSs.
Analysis
(1) Is the immovable an asset used principally in the business carried on by the corporation?
The capital gains exemption in section 110.6 is available where an individual disposes of any qualified small business corporation shares ("QSBCS") that are held by the individual, the individual's spouse or common-law partner or a partnership related to the individual.
In order to be a QSBCS, three requirements must be satisfied. Firstly, at the time of the sale of the share, it must be a share of a small business corporation. Second, the share must not have been owned, during the 24-month period preceding its sale, by a person or partnership that is not related to the individual. Third, throughout the 24-month period preceding the sale of the share, the corporation to which the share relates must have satisfied strict requirements regarding the use of its assets in an active business.
Through your question, you wish to know whether, subsequent to the rollover of the immovable to the corporation, the CRA will consider the immovable to be used principally in a business carried on by the corporation.
We confirm that our analysis will be limited to the nature of the use of the property in the corporation's business and that we will not comment on whether the corporation is using the specified proportion of the fair market value of its assets - both at the time of the sale of the shares and during the 24 months prior to that sale - in the course of its business.
A. Use of the immovable on the sale of the preferred shares
The definition of "small business corporation" ("SBC") in subsection 248(1) requires that all or substantially all of the assets of the corporation at that time of the sale of the shares be attributable to assets that are used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it, or shares of the capital stock or indebtedness of one or more corporations connected with the corporation, or a combination thereof.
The CRA has repeatedly interpreted the phrase "used principally in a business of the corporation" to mean more than 50%. We emphasize that this test must be applied to every asset of a corporation. In that regard, we refer you to Technical Interpretation 9716155 which confirms those positions. In this case, it is therefore necessary to determine whether, at the time of the eventual sale of the shares by the taxpayer and his spouse, all or substantially all of the corporation's assets - including the immovable - are attributable to items that are used principally in a business carried on by the corporation.
The question of whether an asset is principally used in a business carried on by a corporation was debated in Canada v. Ensite1.
In that case, the Supreme Court of Canada answered this question by stating that property is used principally in an active business if it is employed and risked in the business. Specifically,
The test is not whether the taxpayer was forced to use a particular property to do business; the test is whether the property was used to fulfil a requirement which had to be met in order to do business.
In Interpretation 9909845, the CRA stated that it considers that an asset is used principally in an active business if its primary or main use is in respect of that business.2
You will understand that the determination of the status of a small business corporation at the time of the sale of its shares is one of fact that can only be made in light of all the relevant elements. Nevertheless, in light of the circumstances of this case, we are of the view that the immovable - at the time of the eventual sale of the corporation's shares - would be used principally in the corporation's business. Of course, we assume that the use of the immovable at the time of the sale of the shares would be identical to the use currently being made of it.
In addition, throughout the 24-month period preceding the sale of the shares, more than 50% of the fair market value of the corporation's assets must be - for that entire 24-month period - attributable to assets used principally in an active business carried on by the corporation. Based on the facts you have provided and consistent with our conclusion above on the first part of the test - and provided the holding period is satisfied - we are of the view that the immovable would be an asset used principally in an active business carried on by the corporation.
The above conclusions should not be interpreted as confirmation that the shares of the taxpayer's corporation and of the spouse satisfy all the other conditions engaged in the concept of a qualifying small business corporation share.
(2) Application of paragraph 110.6(7)(b)
Paragraph 110.6(7)(b) reads as follows:
Notwithstanding subsections 110.6(2) and 110.6(2.1), where an individual has a capital gain for a taxation year from the disposition of property as part of a series of transactions or events
[...]
(b) in which any property is acquired by a corporation or partnership for consideration that is significantly less than the fair market value of the property at the time of acquisition (other than an acquisition as the result of an amalgamation or merger of corporations or the winding-up of a corporation or partnership or a distribution of property of a trust in satisfaction of all or part of a corporation’s capital interest in the trust),
no amount in respect of that capital gain shall be deducted under this section in computing the individual’s taxable income for the year.
Paragraph 110.6(7)(b) states that the capital gains exemption in subsections 110.6(2) and (2.1) is not available to an individual on the disposition of a property where
- a corporation or partnership acquires a property for consideration that is significantly less than its fair market value;
- the disposition of the property by the individual is part of the same series of events or transactions as the acquisition of the property by the corporation or partnership.
In this case, the taxpayer's corporation and spouse acquire the immovable in consideration for preferred shares. According to the information you have provided, the fair market value of those shares at the time of the transfer will be equal to the fair market value of the immovable. Consequently, since the first condition for the application of paragraph 110.6(7)(b) is not satisfied, the CRA is of the view that this provision cannot be used to prevent the taxpayer and spouse from claiming the capital gains exemption.
Best regards,
François D. Bordeleau, LL.B.
Individuals, Businesses and Partnerships Section
Income Tax Rulings Directorate
1 [1986] 2 S.C.R. 509
2 In English, the passage reads as follows: "[T]he Department considers that an asset is used principally in an active business if its primary or main use is in respect of that business".