Principal Issues: [TaxInterpretations translation] Do the shares of Realtyco constitute qualified small business corporation shares as defined in section 110.6 of the Income Tax Act?
Position: No. The debt owed by Opco would not be a debt of a small business corporation that is connected to Realtyco. Opco would not be a SBC because only about 44% of the fair market value of Opco's assets would be attributable to assets that meet the definition of a SBC.
Reasons: Income Tax Act.
FEDERAL TAX ROUNDTABLE
APFF CONFERENCE 2005
QUESTION
10. QUALIFIED SMALL BUSINESS CORPORATION SHARES
Mr. A and Ms. B are and have always been residents of Canada for the purposes of the Act. They deal with each other at arm's length. Mr. A and Ms. B have each held 50% of all the issued and outstanding shares of Opco and Realtyco, both taxable Canadian corporations, for more than 24 months. All of the property of Opco is used in a manufacturing business carried on exclusively in Canada. Realtyco owns two properties, an immovable that is fully leased to Opco and a debt obligation of which Opco is the debtor. The immovable has a fair market value of $100,000. The debt owed by Opco to Realtyco is $125,000 and Opco is solvent. This debt comes from surplus cash invested by Realtyco in Opco. Realtyco has no debt.
It appears that the shares of Realtyco held by Mr. A and Ms. B are not qualified small business corporation shares ("QSBCS") within the meaning of subsection 110.6(1) because the debt held by Realtyco results in it not qualifying as a small business corporation within the meaning of subsection 248(1). Indeed, Opco and Realtyco do not appear to be connected for the purposes of the Act. In addition, the 50% test found in paragraph (c) of the definition of QSBCS in subsection 110.6(1) does not appear to be satisfied for the same reason. A pre-sale reorganization of the Realtyco shares could not solve this problem given the 24-month time limit.
Does the CRA come to the same conclusions?
RESPONSE
The capital gains exemption in section 110.6 is available in respect of any qualified small business corporation share ("QSBCS") that is held by an 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. First, the share must be a share of a small business corporation ("SBC") as defined in subsection 248(1). Second, the share must not be held, during the 24-month period preceding its sale, by a person or partnership that is not related to the individual. Third, the corporation to which the share relates must meet strict requirements regarding the use of its assets in an active business carried on primarily in Canada by the corporation.
The definition of SBC in subsection 248(1) requires that all or substantially all of the assets of the corporation be assets that are used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it, or consist of shares of the capital stock or indebtedness of one or more corporations that are connected with the corporation.
In this case, the immovable held by Realtyco would be an asset used principally in an active business carried on in Canada by Opco, a corporation related to Realtyco, for the purposes of paragraph (a) of the definition of SBC in subsection 248(1).
On the other hand, the 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, as you state, 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.
We also agree with you that 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 in subsection 110. 6(1) which would have to be satisfied before Mr. A and Ms. B could potentially qualify for a capital gains deduction under subsection 110.6(2.1) on the disposition of their Realtyco shares.
François Bordeleau
952-1506
October 7, 2005
2005-014102