April 24, 1991
Dear Sirs:
Re: Paragraph 110.6(1)(c) and 110.6(1)(d) of the Income Tax Act (the "Act")
This is in reply to your letter of February 26, 1991 requesting our views on the application of paragraphs 110.6(1)(c) and 110.6(1)(d) in the following hypothetical situations.
| Example 1: | ||
| Parent: | $51000 | 51% |
| Active business assets | 38000 | 38 |
| Shares of subsidiary | 11000 | 11 |
| Investments | $100000 | 100% |
| Subsidiary: | ||
| Investments | $38000 | 100% |
In your view the parent would meet the test in paragraph 110.6(1) of the Act because more than 50% of its assets are active business assets. Therefore the shares of the subsidiary and the subsidiary asset mix would be irrelevant because the test in paragraph 110.6(1)(c) of the Act would be met with the active business assets. Paragraph 110.6(1)(d) of the Act would be irrelevant because the shares of the subsidiary are not required to meet the 50% test.
| Example 2 | ||
| Parent | $45000 | 45% |
| Active business assets | 44000 | 44 |
| Shares of subsidiary 1 | 11000 | 11 |
| Investments | $100000 | 100% |
| Subsidiary: | ||
| Active business assets | $31000 | 59% |
| Shares of subsidiary 2 | 14000 | 29 |
| Investments | 6000 | 12 |
| 51000 | 100% |
In your view, the parent company would meet the test in paragraph 110.6(1)(c)(iii) of the Act because more than 50% of the fair market value of the assets are used in combination of active business assets and shares of a subsidiary (meet the holding period test and the 50% test). However, because all or substantially all of the assets are not used in an active business, paragraph 110.6(1)(d) of the Act would apply. Therefore in order for the parent shares to meet the paragraph 110.6(1)(c) test all or substantially all of the assets of the subsidiary would have to be used in an active business for 24 months. Because this is not the case the parent company shares would not meet the test in paragraph 110.6(1)(c) of the Act.
You request us to confirm this understanding.
Our Comments
Briefly, to qualify as a qualified small business corporation share ("QSBC share") at the determination time, a share must be one of a small business corporation as defined in subsection 248(1) of the Act. The share must also satisfy a holding period requirement as provided by paragraph (b) of the QSBC share definition in subsection 110.6(1) of the Act. In addition, the share or the shares of a connected corporation, must be a share of a corporation that meets an active business test as required by paragraph (c) of the QSBC share definition in subsection 110.6(1) of the Act. Furthermore, a more rigid active test, provided in paragraph (d) of the QSBC share definition in subsection 110.6(1) of the Act will apply with respect to certain corporations connected with the corporation under certain conditions. Throughout the 24 month period preceding the disposition, the shares or obligations held in the connected corporations must not have been held by anyone other than the holding corporation or a person or partnership related to it. Shares or debt held during this period must be shares or debt of a Canadian-controlled private corporation more than 50% of the fair market value of the assets or shares or debt of which was attributable to an active business. It should be noted that while liabilities of a corporation are not relevant, if they are liabilities of a subsidiary they have an impact on the fair market value of the shares aud thus on the small business corporation status.
Accordingly as you stated if more than 50% of the fair market value of the corporation's assets are active business assets, the corporation would meet the 50% test in paragraph 110.6(1)(c) of the Act and it would be irrelevant if the corporation also held shares or indebtedness issued by one or more connected corporations. Accordingly, in your example 1, since the corporation can meet the 50% assets used in active business test by itself there is no need to look at the test in paragraph 110.6(1)(d) of the Act.
In Example 2, in view of the above and on the assumption that, at the determination time, the Parent would otherwise qualify as a small business corporation, the Parent would be subjected to the more rigid active business asset test, provided in paragraph (d) of the QSBC share definition in subsection 110.6(1) of the Act. Generally, a Parent or several Holdcos in vertical direct ownership requires the application of the test provided in paragraph (c) of the QSBC share definition in subsection 110.6(1) of the Act. If any corporation in the chain cannot meet the test, then all or substantially all of the assets of the connected corporation must be used in an active business carried on in Canada throughout a 24 month period ending at the determination time. Accordingly, in the case at hand, paragraph (d) of the definition imposing a 90% test on the Subsidiary during the holding period in place of the otherwise 50% test in paragraph (c) of the QSBC share definition in subsection 110.6(1) of the Act. Since the subsidiary does not satisfy the "all or substantially all" requirement, it is our view that a share of the Parent would not be a QSBC share at the determination time.
We trust our comments are of assistance.
Yours truly,
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch