Principal Issues: Whether shares are qualified small business corporation shares in a particular situation involving substitution of shares by way of a rollover pursuant to subsection 85(1) and an amalgamation.
Position: No definitive conclusion with regards to the particular described situation.
Reasons: General comments on subparagraph 110.6(14)(f)(i) and on the subsection 110.6(1) definition of qualified small business corporation share.
XXXXXXXXXX 2015-060753 Rachel Jacques-Mignault
January 4, 2022
Dear Madam,
Subject: Qualified small business corporation shares
This is in response to your inquiry regarding the definition of qualified small business corporation shares ("QSBCS") in subsection 110.6(1) of the Income Tax Act. Specifically, you wish to know whether some of the conditions provided under that definition are satisfied in the following hypothetical situation.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Hypothetical Situation
1. On January 1, Year 1, the common shares of the capital stock of Opco were exchanged for rollover preferred shares as follows:
a. Mr. X: 10 common shares for 100 Class F shares;
b. Mr. Y: 90 common shares for 900 Class F shares.
2. On January 1, Year 1, the following shareholders subscribed for shares of the capital stock of Opco for their nominal values:
a. Mr. X: 10 participating shares and 10 voting shares;
b. Mr. Y: 90 participating shares and 90 voting shares.
3. On December 31, Year 2, a holding company ("Holdco") was incorporated. Mr. X transferred his participating shares and Class F shares of the capital stock of Opco to Holdco and elected to have subsection 85(1) apply to the transfer. Mr. X received, in consideration for the transferred shares, common shares of the capital stock of Holdco. The agreed amount was equal to the adjusted cost base of the transferred shares. The shares of the capital stock of Opco were the only asset of Holdco.
4. On November 1, Year 3, Holdco and Opco considered an amalgamation as third parties wished to acquire Opco and would require that there be only one entity, Opco. The corporation resulting from the amalgamation ("Amalco") would only issue shares of its capital stock in exchange for the shares of the capital stock of Opco or Holdco (the predecessor corporations).
Questions
If the transaction contemplated in Step 4 did not occur, you wish to know our position on whether the common shares of the capital stock of Holdco received by Mr. X in the transaction contemplated in Step 3 would qualify as QSBCSs, assuming that the tests as to the fair market value ("FMV") of the assets were satisfied.
Alternatively, you wish to know whether the shares issued by Amalco would qualify as QSBCSs, making the same assumption as in the previous question.
Our Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R11, Advance Income Tax Rulings and Technical Interpretations.
In order for a share of the capital stock of a corporation to qualify as a QSBCS under the definition of QSBCS in subsection 110.6(1) of the Act, it must satisfy three requirements set out in paragraphs (a) to (c) of that definition, which are summarized as follows:
i. It must, at the determination time, be a share of a small business corporation ("SBC"), as defined in subsection 248(1), owned by the individual, the individual's spouse or common-law partner, or a partnership related to the individual;
ii. Throughout the 24-month period immediately preceding the determination time of the share, the share must not be owned by anyone other than the individual or a person or partnership related to the individual;
iii. Throughout the part of the 24-month period immediately preceding the determination time of the share while the share is owned by the individual or a person or partnership related to the individual, the share must be a share of the capital stock of a "Canadian-controlled private corporation", as defined in subsection 125(7) of the Act, and more than 50% of the fair market value of the assets of that corporation must be attributable to items described in subparagraph 110. 6(1)(c)(i) or (ii); that is, respectively, assets used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it, or shares of the capital stock or indebtedness of one or more other corporations that were connected with the corporation, subject to certain conditions being met.
You asked us to assume that the FMV tests are satisfied. In the context of the definition of QSBCS, such tests are generally used to determine whether:
- a corporation is a SBC, which is one of the requirements set out in paragraph (a) of the definition of QSBCS in subsection 110.6(1);
- the condition in paragraph 110.6(1)(c) of the definition of QSBCS that more than 50% of the fair market value of the assets of that corporation be attributable to items described in subparagraph (i) or (ii) (110.6(1)(c)) is met.
Consequently, we have assumed that you have been able to reach your own conclusions as to the foregoing and that, under the hypothetical scenario described above, the principal issue to be resolved in determining whether the shares in question are QSBCSs is whether the condition in paragraph 110. 6(1)(b) is satisfied, which requires that throughout the 24-month period immediately preceding the time of its determination, the share is not owned by anyone other than the individual or a person or partnership related to the individual.
In answering this question, it is necessary to consider paragraphs 110.6(14)(f) and 110.6(1)(e), which may have application here. Paragraph 110.6(14)(f) provides, for the purposes of the definition of QSBCS in subsection 110.6(1), shares issued after June 13, 1988 by a corporation to a particular person or partnership are deemed to have been owned, immediately before their issue, by a person who was not related to the particular person or partnership. Exceptions to this deeming rule are provided for in subparagraphs 110.6(14)(f)(i), (ii) and (iii). In the hypothetical scenario described above, subparagraph 110.6(14)(f)(i) should be considered since it provides an exception that deems the shares not to be owned prior to their issuance by an unrelated person or partnership if they are issued as consideration for other shares.
In addition, paragraph 110.6(1)(e) also applies where, at any time in the 24-month period ending at the determination time, the share was substituted for another share. In this regard, subparagraph 110.6(1)(e)(i) requires that throughout the period beginning 24 months before the determination time (the time of the disposition) and ending at the time of the substitution, the original share (or the substituted share) must not have been owned by a person or partnership other than a person or partnership described in paragraph 110.6(1)(b). In addition, the original share must be a share of the capital stock of a corporation described in paragraph 110.6(1)(c) throughout the portion of the period referred to in subparagraph 110.6(1)(e)(i) during which such share is owned by a person or partnership described in paragraph 110.6(1)(b).
Disposition of Common Shares in the Capital Stock of Holdco
In the hypothetical scenario described above, Holdco would issue its common shares to Mr. X in exchange for shares of the capital stock of Opco held by Mr. X. Consequently, the common shares of the capital stock of Holdco held by Mr. X would not be deemed to have been owned by an unrelated person prior to their issuance, in accordance with subparagraph 110.6(14)(f)(i).
Thus, if Mr. X wished to sell his shares of the capital stock of Holdco to the third-party purchaser on November 1 of Year 3, the condition of paragraph 110.6(1)(b) of the definition of QSBCS would be satisfied in respect of those shares, taking into account subparagraph (e)(i) of that definition. Indeed, the shares of the capital stock of Holdco that Mr. X would like to sell would not have been owned by anyone other than Mr. X. Similarly, throughout the period beginning 24 months before the disposition and ending at the time of the transfer to Holdco in Step 3, the shares of the capital stock of Opco that were replaced by the common shares of the capital stock of Holdco would not have been owned by anyone other than Mr. X.
Subparagraph 110.6(1)(e)(ii) would also have to be considered for the purpose of determining whether the condition in paragraph 110.6(1)(c) was satisfied in the situation where the common shares of the capital stock of Holdco were sold. Thus, in this situation, it would not be sufficient to determine whether Holdco was a corporation described in paragraph (c) of the definition of QSBCS from the time of the issuance of the shares of its capital stock held by Mr. X; as it would also be necessary for Opco to satisfy that same definition throughout the 24-month period preceding the sale until the time of the transfer provided for in Step 3.
Disposition of the shares of the capital stock of the amalgamated corporation
In Step 4 of this hypothetical situation, Amalco would issue the shares of its capital stock in consideration for the shares of capital stock of Opco (to Mr. X and Mr. Y) and of the capital stock of Holdco (to Mr. X). Consequently, the shares of the capital stock of Amalco held by Mr. X and Mr. Y would not be deemed to have been owned by an unrelated person prior to their issuance in accordance with subparagraph 110.6(14)(f)(i).
In addition, if Mr. Y wished to sell his shares of the capital stock of Amalco to the third-party purchaser on November 1, Year 3, the condition in paragraph 110.6(1)(b) of the definition of QSBCS would be satisfied in respect of those shares, taking into account subparagraph 110.6(1)(e)(i) of that definition. In particular, the shares of the capital stock of Amalco that Mr. Y wished to sell would not have been owned by anyone other than Mr. Y. Similarly, throughout the period beginning 24 months before the disposition and ending at the time of the amalgamation in Step 4, the shares of the capital stock of Opco that were replaced by the shares of the capital stock of Amalco would not have been owned by anyone other than Mr. Y.
Furthermore, subparagraph 110.6(1)(e)(ii) of the definition of QSBCS would also have to be considered in determining whether the condition in paragraph 110.6(1)(c) of that definition was satisfied respecting the shares of the capital stock of Amalco held by Mr. Y. However, in the hypothetical scenario, it would not be sufficient to determine whether or not Amalco was a corporation described in paragraph 110.6(1)(c) of the definition of QSBCS from the time of the issuance of the shares of its capital stock held by Mr. Y. It would also be necessary to ensure that Opco also came within that provision of the Act throughout the 24-month period preceding the sale until the time of the amalgamation provided for in Step 4.
Similarly, if Mr. X wished to sell, on November 1 of Year 3, his shares of the capital stock of Amalco to the third-party purchaser, the condition of paragraph 110.6(1)(b) of the definition of QSBCS would be satisfied in respect of those shares, taking into account subparagraph 110.6(1)(e)(i) of that same definition. It is our position that paragraph 110.6(1)(e) can apply respecting multiple substitutions.
Thus, the shares of the capital stock of Amalco that were substituted for the common shares of the capital stock of Holdco held by Mr. X would not have been owned by anyone other than Mr. X since subparagraph 110.6(14)(f)(i) applied respecting those shares. Similarly, the common shares of the capital stock of Holdco, which were held by Mr. X, would not have been owned by anyone other than Mr. X, again since subparagraph 110.6(14)(f)(i) would have applied. Finally, prior to being replaced on the Step 3 transfer but within the 24-month period preceding the disposition to the third-party purchaser, the shares of the capital stock of Opco that were held by Mr. X prior to their replacement would not have been owned by anyone other than Mr. X.
Subparagraph 110.6(1)(e)(ii) of the definition of QSBCS should also be considered in determining whether the condition set out in paragraph 110.6(1)(c) of the definition of QSBCS was satisfied respecting the shares of the capital stock of Amalco held by Mr. X. As stated in the previous paragraph, our position is that paragraph 110.6(1)(e) may apply in respect of multiple substitutions. Consequently, regarding the shares of the capital stock of Amalco that replaced the common shares of the capital stock of Holdco, it would not be sufficient to determine whether Amalco was a corporation described in paragraph 110. 6(1)(c) from the time of the issuance of the shares of its capital stock held by Mr. X; it would also be necessary for Holdco to come within that same provision of the Act for the period beginning with the Step 3 transfer and ending with the amalgamation, and for Opco to come within paragraph 110.6(1)(c) of the definition of QSBCS throughout the 24-month period preceding the sale until the Step 3 transfer.
These comments do not constitute an advance income tax ruling and are not binding on the Canada Revenue Agency in respect of any particular factual situation. We hope you find them of assistance.
Nancy Deslandes, CPA, CGA, D. Fisc.
Manager
Business and Employment Income Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch