920507
J.D. Brooks
24(1) (613) 957-2103
Attention: 19(1)
July 28, 1992
Dear Sirs:
Re: Qualified Small Business Corporation Shares
This is in reply to your letter of February 18, 1992 in which you requested our opinion as to whether certain shares in four hypothetical cases you described would be qualified small business corporation shares ("QSBCS"s) within the meaning of subsection 110.6(1) of the Income Tax Act (the "Act").
A common element in three of your four hypothetical cases is the existence of a loan from an operating corporation up to a shareholder corporation. Accordingly, our reply focuses on this element.
Our Comments
In order for the shares of a corporation to qualify as QSBCSs, the corporation must be a small business corporation ("SBC") at the determination time and this necessitates, inter alia, the corporation meeting a test (the "90% test") regarding the current use of its assets. In order to pass this test, the corporation's assets which represent all or substantially all of the fair market value of the corporation's assets must be either (1) assets which are used principally in an active business carried on primarily in Canada by the corporation (or by a corporation related to it), or (2) shares or indebtedness of one or more SBCs that are connected (within the meaning of subsection 186(4) of the Act on the assumption that the SBCs are "payer corporations") with the corporation (i.e. those corporations use their own assets principally in active businesses carried on primarily in Canada, or they invest in shares or indebtedness of other connected corporations which qualify as SBCs).
Where a corporation (Holdco) is not using its assets in an active business sufficient to enable it to qualify on its own merits as an SBC but holds shares or indebtedness in another corporation (Opco) which is connected with Holdco, both of the corporations must qualify as SBCs at the determination time in order for the shares of Holdco to qualify as QSBCSs. Let us first consider whether a loan receivable by Opco from Holdco would constitute indebtedness of a corporation connected with Opco. We assume, in this example, that Individual owns all of the shares of Holdco and therefore controls Holdco. Provided that Holdco controlled Opco, Individual would indirectly control Opco (since Individual controls Holdco) and would be deemed by subparagraph 251(2)(b)(i) of the Act to be related to Opco. According to paragraph 251(1)(a), Individual would not deal at arm's length with Opco. Therefore, since more than 50% of Holdco's shares would be owned by a person, being Individual, who does not deal at arm's length with Opco, Holdco would be deemed by subsection 186(2) of the Act to be controlled by Opco. Thus Opco's loan would be receivable from a corporation which is connected with Opco.
Let us now consider the use of the corporations' assets. Each corporation must meet the 90% test regarding the current use of its assets. Holdco would be an SBC only if Opco were an SBC, but in order for Opco to qualify as an SBC, Opco must rely on its loan receivable from Holdco as being a loan to an SBC which is connected with Opco. To restate the dilemma, Holdco cannot demonstrate that it is an SBC since it needs to rely on Opco itself being an SBC, and Opco cannot demonstrate that it is an SBC since it needs to rely on Holdco being an SBC. It is our opinion that neither Holdco nor Opco would be an SBC.
Since the resolution of this circularity problem requires a legislative amendment, we have referred the matter to the Department of Finance.
These comments represent an expression of opinion and, as stated in Information Circular 70-6R dated September 28, 1990, are not binding on the Department.
Yours truly,
E. WheelerBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch