Principal Issues: (a) In a given situation, is the asset test met where the corporation holds, for a brief moment, an amount of excess cash? (b) Does a dividend payable by the assumption of a debt is considered an asset for the purpose of the asset test?
Position: (a) Question of facts. (b) Yes
Reasons: a) It is the CRA long standing position that the expression “all or substantially all” generally means 90% or more. However, a threshold under 90% may be viewed as meeting the requirement of “all or substantially all”, depending on the facts and circumstances of each case. However, the asset tests provided under the definition of “qualified small business corporation share” in subparagraph 110.6(1) must be met at all time. b) Since the debt of the corporation is extinguished by the dividend payable by the assumption of such debt, the right to such dividend is considered an asset for the purpose of the definition of “qualified small business share”
FEDERAL TAX ROUNDTABLE, NOVEMBER 2, 2023
APFF CONFERENCE 2023
3. Qualified small business corporation share - all or substantially all
We wish to verify the interpretation of the concepts of "all or substantially all" in the context of a "qualified small business corporation share", more specifically, where a shareholder holds its equity interest in the capital stock of an operating corporation ("Opco") through a holding corporation ("Holdco").
A. The legislative basis and its administrative counterpart
The expression "all or substantially all" in the definition of "qualified small business corporation share" in subsection 110.6(1) generally means "90% or more", according to a longstanding CRA position (footnote 1). While a fixed number has been attached to the expression "all or substantially all", the CRA must consider each case in its particular context to determine whether, in a given situation, the "all or substantially all" test would be satisfied even though the actual proportion is less than 90% (footnote 2).
The expression "used principally" means "more than 50%" (footnote 3). In the context of the 50% for 24 months test provided for in paragraph 110.6(1)(c) of the definition of "qualified small business corporation share", the CRA does not provide any "administrative relief", and specifies that:
"[...] if at any time during the 24-month period preceding the disposition, even for a short period of time [emphasis added], the corporation does not meet the requirements of the test [...], the shares [...] could not be qualified small business corporation shares [...]" (footnote 4) (Our Emphasis).
Caution should therefore be exercised and all monthly bank statements and investment statements of the particular corporation for the 24-month period preceding the closing date should be reviewed.
B. The facts of the case
The typical structure we wish to analyze is one in which all of Opco's participating shares are held by a Holdco, while Holdco's participating shares are held by an individual or a trust. Holdco acts as a flow-through corporation only, so that the only permanent asset is the participating shares that Holdco holds in Opco. Contaminated assets pass through Holdco - i.e., they become part of Holdco's assets for a short time before being distributed to Holdco's shareholder in the form of a dividend.
C. Analysis
The legislative passage that causes the problem is this:
“where, for any particular period of time in the 24-month period ending at the determination time, all or substantially all [emphasis added] of the fair market value of the assets of a particular corporation that is the corporation or another corporation that was connected with the corporation cannot be attributed to assets described in subparagraph (i), shares or indebtedness of corporations described in clause (B), or any combination thereof, the reference in clause (B) to “more than 50%” shall, for the particular period of time, be read as a reference to “all or substantially all” […] (footnote 5)”. (S. 110.6(1), definition of "qualified small business corporation share", (d))". (Our Emphasis)
This passage should be interpreted as follows: Where the corporation to be qualified holds business assets with a FMV of less than 50% of the FMV of its total assets, but holds interests in connected corporations ("subsidiaries") whose FMV must be taken into account in reaching the 50% level of qualifying assets, then the subsidiaries to be qualified must satisfy the 90% additional asset test.
In other words, the 50-90 rule exists to prevent the dilution of non-qualifying assets that can be achieved by transferring qualifying and non-qualifying assets to one or more new subsidiaries.
A strictly textual application of the provision would produce absurd results. Consider the following situation:
- An individual holds participating shares of the capital stock of Holdco that have a FMV of $1,000,000, and an ACB and a paid-up capital ("PUC") of $100;
- Holdco holds participating shares in the capital stock of Opco with an FMV of $1,000,000, and an ACB and a PUC of $100.
- The assets of Holdco consist solely of its interest in Opco.
- The assets of Opco consist of the following:
A. Assets used principally in an active business carried on by Opco in Canada: $700,000;
B. Excess cash not considered to be used principally in an active business: $300,000.
We note that 100% of the assets of Holdco qualify - under subparagraph 110.6(1)(c)(ii) of the definition of "qualified small business corporation share", and that 70% of the assets of Opco qualify - under subparagraph 110.6(1)(c)(i) of the definition of "qualified small business corporation share".
Now assume that Opco proceeds with a partial purification of its assets by paying a dividend of $150,000 to Holdco. Holdco then immediately pays a dividend in the same amount to its shareholder. The situation looks like this after Opco has paid a dividend to Holdco but before Holdco pays a dividend to its shareholder:
- At that time, the FMV of the shares of the capital stock of Holdco is $1,000,000. However, Holdco's interest in Opco now represents 85% of its assets. More specifically, Holdco's assets consist of:
A. Surplus cash not considered to be used principally in an active business: $150,000;
B. Interest in Opco: $850,000.
- Also, at this time, the FMV of the shares of Opco's capital stock is $850,000. The assets that Opco uses principally in its Canadian active business now represent 82% of its assets. Specifically, Opco's assets consist of:
A. Assets used principally in an active business carried on by Opco in Canada: $700,000
B. Excess cash not considered to be used principally in an active business: $150,000.
We therefore note that at this particular point in time, the 50-90 test would not be satisfied and a new 24-month count would have to commence. If Opco had paid a dividend of less than $100,000 or more than $230,000, the 50-90 test would have been satisfied.
Questions to the CRA
(a) If Holdco holds $150,000 in cash for an instant, while it declares a dividend to its own shareholder and distributes the $150,000 to that shareholder, does this "contaminate" Holdco and force the commencement of a new 24-month period?
(b) Alternatively, if Holdco first declares a dividend of $150,000 to its shareholder, payable by the issuance of a note, and then Opco declares a dividend to Holdco, payable by the assumption of the note owed by Holdco to its shareholder, would your interpretation be the same? In this case, no new asset would have been recorded on Holdco's balance sheet and the purpose would be the same.
CRA Response to Question 3(a)
Since the requested question seeks comments on the concept of "all or substantially all" for the purposes of the definition of "qualified small business corporation share" ("QSBCS") in subsection 110.6(1), the CRA will not comment on the other conditions for a share of the capital stock of a corporation to qualify as a QSBCS in the situation described.
The concept of "all or substantially all" is found in paragraph (d) of the definition of QSBCS in subsection 110.6(1). The CRA's longstanding position is that the expression "all or substantially all" generally means 90% or more. However, the CRA recognizes that the "all or substantially all" test could be met even if the 90% threshold is not satisfied, depending on the circumstances and context. Where 90% or more of the FMV of a corporation's assets is not attributable to qualifying assets for purposes of the definition of QSBCS in subsection 110.6(1), the CRA must consider each case on its own merits and determine whether a threshold of less than 90% can be considered to satisfy the "all or substantially all" threshold. Consequently, the CRA cannot take a position on this issue with respect to a hypothetical situation.
That said, it is important to note that the asset tests described in the definition of QSBCS in subsection 110.6(1) (more than 50% or all or substantially all) must be satisfied at all times during the relevant period. Thus, as soon as one of those tests is not met during the relevant period, even for a short period, a share of the capital stock of a corporation will not qualify as a QSBCS.
CRA Response to Question 3(b)
The CRA understands from the scenario described in Question 3(b) that Opco effectively repays the note owed by Holdco to its shareholder that Opco assumed when declaring the dividend in favour of Holdco. Thus, the CRA understands that the dividend declared by Opco in favour of Holdco eliminates the debt owed by Holdco to its shareholder.
As previously stated, the asset tests described in paragraphs (c) and (d) of the definition of QSBCS in subsection 110.6(1) must be satisfied at all times by Holdco during the 24-month period preceding the particular time. The question is therefore whether the dividend declared in favour of Holdco constitutes an asset of Holdco, even if the amount of the dividend does not flow directly through Holdco.
The statement in this question indicates that the transactions described in Question 3(b) would not result in any new assets being recorded on Holdco's balance sheet. The CRA's longstanding position is that all assets of a corporation, whether or not recorded on a corporation's balance sheet, must be considered for purposes of applying the definition of QSBCS in subsection 110.6(1) I.T.A.
Since the term "asset" is not defined in the Income Tax Act, its ordinary meaning must be examined. The Petit Robert de la langue française defines the term "actif" [“asset”] as “l’ensemble des biens ou droits constituant le patrimoine “ ["all the property or rights constituting the patrimony"]. Black's Law Dictionary defines "assets" as follows: "An item that is owned and has value. The entries on a balance sheet."
The “Dictionnaire de la comptabilité et de la gestion financière” [The Dictionary of Accounting and Financial Management] provides a specialized definition of "actif" ["asset"] and "éléments d’actifs" ["asset items"] as follows:
"A component of the balance sheet that describes the economic resources over which entities have control as a result of past transactions or events, and which are expected to provide future economic benefits to the entity. Assets have three essential characteristics:
(1) they represent a future benefit in that they will be able, alone or with others, to contribute directly or indirectly to future cash flows;
(2) The entity is able to control (by virtue of an enforceable right or by any other means) access to that benefit;
(3) The transaction or event giving rise to the entity's right to, or control over, the benefit has already occurred."
[TaxInterpretations translation]
Some Canadian court decisions have examined the meaning of the term "assets" in different contexts. Generally, the scope of this term is quite broad and varies depending on the context in which it is used. For example, in a labour law case, King Seagrave Ltd v. Canada Permanent Trust Co.,[footnote: 1985 9 CCEL 31, 51 O.R. (2nd) 567.] it is stated:
"The word “assets” generally means everything available : see Black’s Legal Dictionary ... the search for its meaning must not end with a glance at the dictionary. I accept the submission that it should be given a purposive construction. Considered contextually I think the word “asset” was used in an all-embracing sense..."
In the scenario described in Question 3(b), the CRA is of the view that Holdco has an interest in the dividend declared by Opco and that the interest in such a dividend is an "asset" for the purposes of the definition of QSBCS, regardless of whether it is recorded on the corporation's balance sheet. In particular, Holdco benefits from the dividend declared by Opco even if the amount of the dividend does not pass through Holdco because it allows Holdco to have its liabilities reduced following the payment made by Opco.
Mathieu Martin-Monette
November 2, 2023
2023-098444
FOOTNOTES
Due to the requirements of our systems, the footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Technical Interpretation 9401125.
2 CANADA REVENUE AGENCY, Technical Interpretation 2007-0226261E5.
3 CANADA REVENUE AGENCY, Technical Interpretation 2005-0152031E5.
4 CANADA REVENUE AGENCY, Technical Interpretation 2003-0030045.
5 Subsection 110.6(1) "qualified small business corporation share", para. d) I.T.A.
6 1985 9 CCEL 31, 51 O.R. (2nd) 567.