Principal Issues: [TaxInterpretations translation] Could an individual, who starts operating his business through a corporation, benefit from the capital gains deduction on QSBCSs if he disposed of his shares without having held them for at least 24 months? The taxpayer states that the individual could have benefited from the CGD for QSBCSs without meeting the 24-month holding requirement if he started his business operations and shortly thereafter transferred all of the assets used in an active business to a corporation in exchange for treasury shares of the corporation which he would subsequently dispose of.
Position: No.
Reasons: Statutory language. The tax intention underlying paragraph (b) of the definition of QSBCS in subsection 110.6(1) of the Act, in light of the clarifying provisions in paragraph 110.6(14)(f), is that treasury shares, in order to qualify as QSBCs, must be held for a period of not less than 24 months unless the situation meets one of the four exceptions set out in that paragraph of the Act.
XXXXXXXXXX 2004-007715
N. Deslandes, CGA
October 18, 2004
Dear Sir,
Subject: Capital gains deduction
This is in response to your fax of May 19, 2004, requesting our opinion on the above subject. We have not located the earlier request to which you refer.
You asked us about the potential for an individual to claim the capital gains deduction provided for in subsection 110.6(2.1) of the Income Tax Act (the "Act") upon the disposition of shares of a Canadian-controlled private corporation held for a period of less than 24 months.
The 24-month holding requirement to which you refer is set out in paragraph (b) of the definition of "qualified small business corporation share" in subsection 110.6(1).
You presented us with the situation of an individual who, shortly after the commencement of business, transfers to a corporation all of the assets used in an active business in exchange for treasury shares of the corporation. In such a case, the individual could benefit from the capital gains deduction provided for in subsection 110.6(2.1) if the individual disposes of those shares, even if the disposition occurs within a 24-month period, provided that all the other conditions of the Act are satisfied.
However, you point out that, if the same individual had started his business through the corporation and disposed of the shares without having held them for a period of at least 24 months, he would not be able to benefit from the capital gains deduction provided for in subsection 110.6(2.1). You consider this treatment to be unfair and would like our comments on this matter.
Our Comments:
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of our Directorate 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 which may not apply in full to the situation you have submitted to us.
To qualify for the capital gains deduction under subsection 110.6(2.1), an individual must dispose of a "qualified small business corporation share" ("QSBCS") as that term is defined in subsection 110.6(1).
This definition contains several conditions, including paragraph (b), which requires that, throughout the 24-month period preceding the time of disposition, the share must not be held by anyone other than the individual, or a person or a partnership related to the individual.
Subsection 110.6(14) provides clarification for the purposes of the definition of QSBCS. Among other things, paragraph 110.6(14)(f) provides that newly issued treasury shares of a corporation are deemed to have been owned, immediately before their issue, by a person who was not related to the original shareholder of those shares. The scope of this paragraph is important since it requires that a shareholder hold the new shares of a corporation for a minimum of 24 months before being able to claim the capital gains deduction provided for in subsection 110.6(2.1).
However, the legislature has provided four exceptions to this rule. One of those exceptions is set out in subparagraph 110.6(14)(f)(ii) and refers to situations where shares are issued as consideration for the transfer of all or substantially all of the assets used in an active business carried on by the transferor. In such a situation, the shares could qualify as QSBCSs and the holder of the shares could benefit from the capital gains deduction if they were disposed of within 24 months of their issue.
The other three exceptions in the Act are also set out in paragraph 110.6(14)(f) and deal with situations where shares are issued either as consideration for other shares, as consideration for the transfer of an interest in a partnership all or substantially all of the assets of which were used in an active business carried on by the members of the partnership, or as payment of a stock dividend.
The first situation presented in your letter is covered by the exception provided for in subparagraph 110.6(14)(f)(ii). The individual who holds such shares could therefore, as you indicated, benefit from the capital gains deduction since the shares could qualify as a QSBCSs, despite him having disposed of them without having held them for 24 months.
Note that subparagraph 110.6(14)(f)(ii) provides relief from the 24-month holding rule in paragraph (b) of the QSBCS definition, which is intended to allow an individual who has carried on business as a sole proprietor to benefit from the capital gains deduction on the sale of the individual’s business by first incorporating the business and then subsequently selling the shares of the corporation. However, there is no mechanism in this relief rule that combines the period during which the business was operated as a sole proprietor with the period during which the shares of the corporation were held to ensure that this period is at least 24 months. Such a mechanism exists, for example, in the case of relief for shares issued as consideration for other shares or as consideration for the payment of a stock dividend. (See paragraph (e) of the definition of QSBCS.)
The second situation described in your letter does not fall within one of the exceptions listed in paragraph 110.6(14)(f). The individual will therefore have to hold the shares for a period of at least 24 months in order for them to qualify as QSBCSs and to thus be able to benefit from the capital gains deduction on a future disposition.
As you can see, the wording of the Act is clear. Any change to the above rules would require an amendment to the provisions of the Act.
As you are aware, the mandate of the Canada Revenue Agency ("CRA") is to administer the Act while the responsibility for developing tax policy and amending the Act rests with the Department of Finance. If you wish to make representations concerning amendments to the Act, you may send your comments to the Department of Finance, Tax Policy Branch, Tax Legislation Division, L'Esplanade Laurier, 140 O'Connor Street, 17th Floor, East Tower, Ottawa, Ontario, K1A 0G5.
These comments are not advance income tax rulings and do not bind the CRA with respect to any particular factual situation.
We hope that these comments will be of assistance.
Best regards,
Ghislaine Landry, CGA
Manager
Individuals, Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate