Principal Issues: [TaxInterpretations translation] ((1) Does the exception in subparagraph 110.6(14)(f)(i) of the Income Tax Act apply to shares issued by a corporation on a rollover pursuant to subsection 85(1)?
(2) If the replaced shares would otherwise be qualified small business corporation shares under that definition in subsection 110.6(1), will the replacement shares also be qualified small business corporation shares?
(3) Does the asset use test in paragraph 110.6(1)(e) of the definition of "qualified small business corporation share" take into account the more stringent test in paragraph (d) of that definition?
Position: (1) Yes.
(2) Yes.
(3) Yes.
Reasons: Interpretation of the Income Tax Act.
XXXXXXXXXX 2005-011779
November 8, 2005
Dear Sir,
Subject: Request for Technical Interpretation: Qualified Small Business Corporation Share ("QSBCS")
This is in response to your email dated February 22, 2005, requesting our opinion on the above subject. We apologize for the delay in responding to your question.
Facts
Your letter states the following:
- Mr. X holds all of the XXXXXXXXXX participating shares of Holdco, a CCPC (he also holds all of the shares of Holdco);
- The fair market value ("FMV") of those shares is valued at $XXXXXXXXXX;
- Holdco holds all of the shares of Opco, including all of the participating shares (XXXXXXXXXX) of Opco;
- The FMV of those shares is valuated at $XXXXXXXXXX;
- The only asset of Holdco is its investment in Opco;
- Mr. X has owned Holdco for more than 24 months and Holdco has owned Opco for more than 24 months;
- During the last 24 months, more than 50% but less than 90% of the FMV of Opco was at any time attributable to assets used principally in an active business that Opco was carrying on.
Within the framework of a restructuring of which it is unnecessary to repeat all the facts, Mr. X became the sole shareholder of Opco, holding one participating share and XXXXXXXXXX class D shares of the latter. Following that restructuring, Holdco became nothing more or less than an empty shell.
The Class D shares of Opco held by Mr. X were acquired by Mr. X as part of a rollover under subsection 85(1) of the Income Tax Act (the "Act"), whereby Mr. X transferred XXXXXXXXXX shares of Holdco to Opco.
Questions
Your email raises the following questions:
(1) In the event that Mr. X sells his Class D shares held in Opco prior to 24 months, would subparagraph 110.6(14)(f)(i) of the definition of QSBCS apply to deem the Class D shares, prior to their issuance, to be held by a related person?
(2) We believe that subparagraph 110.6(1)(e)(ii) of the definition of "QSBCS" will apply in respect of the Class D shares issued by Opco. Thus, if the asset utilization test is met on the predecessor shares (participating shares held in Holdco), the Class D shares would not lose their QSBC status for this reason even if a disposition of the new shares occurred prior to 24 months having passed. Can you confirm this position?
(3) Can you confirm that the asset utilization test referred to in subparagraph 110.6(1)(e)(ii) takes into account the more stringent test referred to in paragraph (d) of the QSBCS definition?
Analysis
Response to Question (1)
The capital gains exemption in section 110.6 is available where an individual disposes of one or more QSBCs. In order for shares to qualify as "qualified small business corporation shares", several criteria must be satisfied, including the requirement that the shares not be held by a person (or partnership) unrelated to the individual at any time during the 24-month period preceding the sale of the shares.
Paragraph 110.6(14)(f) creates a reversible presumption that shares issued by a corporation after June 13, 1988 are deemed to have been owned by a person (or partnership) unrelated to the individual and therefore subject to a new 24-month holding period. In the absence of this legislative provision, an individual could take advantage of the capital gains exemption in the case of shares issued from the capital stock of a corporation, held for a period of less than 24 months.
In answer to your question, based on the above facts, it is our opinion that the issuance of the XXXXXXXXXX Class D shares falls within the exception provided for in subparagraph 110.6(14)(f)(i). This conclusion reaffirms the position taken by the Canada Revenue Agency ("CRA") in Technical Interpretations E2003-0012695 and E9814245.
Response to Question (2)
In the case of substituted shares, the following rules apply. Under paragraph 110.6(1)(e), where one share is a substitute for another, the substituted share will be deemed to be a QSBCS only if the replaced share satisfies the criteria in the definition of QSBCS set out in paragraphs 110.6(1)(b) and (c) of that definition at the time of replacement.
As a supplement to this rule, and as noted above, paragraph 110.6(14)(f) creates a reversible presumption that shares issued by a corporation after June 13, 1988 are deemed to have been owned by a person (or partnership) unrelated to the individual. This presumption may be reversed if one of the exceptions in subparagraph 110.6(14)(f)(i), (ii) or (iii) applies. In the present case, it appears that the Class D shares of Opco fall within the scope of subparagraph 110.6(14)(f)(i) since they were issued as consideration for XXXXXXXXXX shares of Holdco. Thus, the Class D shares would not be deemed to be owned, prior to their issuance, by a person (or partnership) unrelated to Mr. X.
The effect of the combined application of paragraph 110.6(1)(e) of the definition of QSBCS and subparagraph 110.6(14)(f)(i) is to relieve Mr. X from the requirement to hold the Class D shares for a further 24 months following the rollover under subsection 85(1), provided that the XXXXXXXXXX shares of Holdco that were replaced satisfied the criteria set out in paragraphs 110.6(1)(b) and (c) of the definition of QSBCS at the time of the replacement.
Response to Question (3)
Paragraph 110.6(1)(e) of the definition of QSBCS applies where an individual holds a share of a corporation in substitution for another share during the 24-month holding period. The new share will be a QSBCS only to the extent that the replaced share was a QSBCS at the time of replacement. Thus, the replaced share must not have been held by a person (or partnership) who was not related to the individual during the 24-month period preceding the replacement time and must have been a share of a CCPC that satisfies the asset-use test under paragraph 110.6(1)(c).
In response to your question, it is our view that the asset use test in subparagraph 110.6(1)(e)(ii) takes into account the more stringent test in paragraph 110.6(1)(d).
Best regards,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate