Dear Sirs:
Re: Qualified Small Business Corporation SherloCKS
This is in reply to your letter of September 24 1991 in which you ask that we confirm that, in the situation you describe, Opco and Holdco are small business corporations as defined in subsection 248(1) of the Income Tax Act (the 'Act'). The facts given are as follows:
1. Mr X intends to sell 250 class A shares of Opco and 50 class A shares of Holdco.
2. Mrs. X intends to sell 249 class A shares of Opco and 50 class A shares of Holdco.
3. No other shares of Holdco are issued. The other issued shares of Opco are 501 Class A shares owned by Holdco. These shares were purchased by Holdco in 1989 from an arm's length individual. All of the funds required for the purchase were borrowed by Holdco from Opco with the result that Holdco is indebted to Opco. The debt owing by Holdco to Opco will represent 25% of the fair market value of Opco's assets.
4. Holdco's only asset is the shares of Opco.
5. All assets of Opco, except for the debt owing to it by Holdco, are used by 0pco in the course of carrying on an active business in Canada.
In your view, the debt receivable is a note receivable from a "connected corporation" within the meaning of subsection 186(4) of the Act. You reason that since Opco has no other assets which would prevent it from not being considered a "small business corporation" as defined in subsection 248(1) of the Act, that Holdco would also be a "small business corporation."
Our Comments
In our view, the intercompany debt, in your example, owed by Holdco to Opco would prevent both Holdco and Opco from qualifying as a "small business corporation" as defined in subsection 248(1) of the Act. In our opinion, in order to qualify Opco, the note receivable must be used in an active business and this cannot be determined. Indeed, when we look at the business of Holdco, whether or not the asset is used in an active business cannot be determined till we look at Opco again.
Subparagraph (c)(ii) of the definition of "qualified small business corporation share' found in subsection 110.6(1) of the Act requires that a "bond, debenture, bill, note, mortgage, hypothec or similar obligation" be issued by a corporation connected (within the meaning of subsection 186(4) on the assumption that such corporation was at that time a payer corporation within the meaning of that subsection). In order for a loan owing to Opco to be a qualifying asset for purposes of subparagraph (c)(ii) it must be issued by a "payer corporation" as that term is described in subsection 186(4) of the Act i.e. a subsidiary. Therefore only downstream loans made by Opco would qualify under this subparagraph. Consequently, the intercompany debt owed by Holdco to Opco would not qualify under subparagraph (c)(ii) of the definition and would qualify under subparagraph (c)(i) only if Opco was in the business of lending money. As a result, the shares of Holdco would not qualify as "qualified small business corporation shares" as defined by subsection 110.6(1) of the Act. To read subparagraph (c)(ii) otherwise would lead to anomalous results. For example if we eliminate the active business assets from Opco's total assets, leaving only the intercompany debt, under your reasoning Holdco's shares could appear to qualify as "QSBCS's. (Holdco qualifies if Opco qualifies which qualifies if Holdco qualifies, etc.). This clearly was not intended. We therefore reiterate that only downstream loans made by Opco would qualify under subparagraph (c)(ii).
We trust this information will be of assistance to you.
Yours truly,
G. Thornley for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch