19(1) 5-7852
R.B. Day
(613)-957-2136We are writing in reply to your letter of April 10, 1989, wherein you requested our views regarding the interpretation of "qualified small business corporation share" with specific reference to paragraph 110.6(1)(d) of the Income Tax Act and also the application of the general anti-avoidance rule (GAAR) in section 245.
Our understanding of the two hypothetical situations set out in your letter, is as follows:
Case #1
1. Throughout the 24 month period prior to Repayment Day, Opco was a taxable Canadian-controlled private corporation with more than 90% of its asset used in an active business carried on in Canada.
2. Throughout the 24 month period prior to Repayment Day, Holdco was a taxable Canadian-controlled private corporation which held all the shares of Opco. The only other asset which Holdco held during this period was a debt obligation issued by Opco.
3. All of the shares of Holdco were held by Mr. X, an individual resident in Canada. The Holdco shares were held as capital property and had accrued gains in excess of $100,000. Mr. X acquired his Holdco shares more than 24 months before Repayment Day.
4. On Repayment Day Opco borrowed money from a bank used the money to repay its outstanding debt to Holdco. The repayment produced the following results:
(a) Opco, for brief moment in time, possessed cash with afair market value greater than 10% but less than 50% of the fair market value of its total assets.
(b) Holdco, for a brief moment in time, possessed cash with a fair market value greater than 10% but less than 50% of the fair market value of its total assets.
5. Immediately after the repayment, Holdco declared and paid a dividend to Mr. X equal to the amount of the debt described in paragraph 4. Case #2
1. Throughout the 24 month period prior to Redemption, Opco was a taxable Canadian-controlled private corporation with less than 90% but more than 50% of its assets used in an active business carried on in Canada. Opco's inactive asset was a surplus cash derived from its profitable business.
2. Throughout the 24 month period prior to Redemption Day, Holdco was a taxable Canadian-controlled private corporation which held all of the shares of Opco. Holdco held no other assets during this period.
3. All of the sabres of Holdco were held by Mr. X an individual resident in Canada. The Holdco shares were held as capital property and had accrued gains in excess of $100,000. Mr. X acquired his Holdco shares more than 24 months before Redemption Day.
4. On Redemption Day, Opco paid a sum of money to Holdco as consideration for the redemption for the redemption of some of its shares. The redemption produced the following results:
(a) Opco no longer had any inactive assets since all of its surplus cash was used to make the redemption payment.
(b) Holdco, for a brief moment in time, possessed an inactive asset (surplus cash) with a fair market value greater han 10% but less than 50% of the fair market value of its total assets.
5. Immediately after the redemption payment, Holdco declared and paid a dividend to Mr. X equal to the amount of surplus cash described in paragraph 4(b).
It is your view that where the 50% active asset requirement has been clearly met throughout the prescribed 24 month period, a Canadian-controlled private holding corporation share should not be disqualified by paragraph 110.6(1)(d) merely because it happened to drop below the 90% threshold for a brief moment in time. It is your view that paragraph 110.6(1)(d) in view of the hypothetical situations described above.
It is also your view that there is no express or implied provision in the Act which restricts a corporation's ability to redeem shares or repay debts. As a result, it is your view that, pursuant to subsection 245(4) GAAR should not apply to deny a deduction where payments or repayments are made in two or more stages for the purposes of ensuring that the 90% active asset requirement is not breached. You have requested that we confirm your understanding of GAAR in light of the two hypothetical situations described above assuming that the respective payments and repayments were made in multiple stages.
Our Comments
With respect to Paragraph 110.6(1)(d) we are unable to agree with your interpretation in this regard. Paragraph 110.6(1)(d) states in part that:
"where, for any period of time in the 24 month period ending at the determination time, all or substantially all of the fair market value of the assets of a corporation cannot be attributed to assets described in subparagraph (c)(i) or shares or obligation of corporations described in clause (c)(ii)(B), the reference in clause (c)(ii)(B) to "more than 50% shall, for that period of time, be read as a reference to or substantially all...".
This, in our view, means that where either Opco or Holdco fail tomeet the asset test "for any period of time in the 24 month period" regardless of the duration, the corporate shares would not be qualified as "qualified small business corporation shares". The use of the word "throughout" indicates, in our view, a test that does not permit an exception even for a brief period of time.
With respect to the application of section 245, it is our view that this provision would not, in the absence of other circumstances, apply to a series of payments or repayments made in the context of the two typical situations described in your letter. We would caution that the above comments reflect an expression of opinion only and as such, are not binding upon the Department.
Yours truly,
for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch