Chapter One – Lecture Notes
Chapter Thirteen Lecture Notes
The Capital Gain Exemption for “QSBC Shares”
David Christian Spring Term 2013
Thorsteinssons LLP UBC Faculty of Law
______________________________________________________________________________
Notes
Taxpayers rely heavily on whatever certainty and predictability can be gleaned from the Income Tax Act.
Iacobucci, J. (1998)
1. Choose a business.
• Name the company;
• Name the shareholder;
• Assume a five-year track record of success.
[pic]
2. X wants to sell. What is the tax result?
3. The capital gain on the shares:
Proceeds - cost (+selling costs) = gain
$700,000 - 15,000 (+ 5,000) = $680,000
Taxable capital gain (50%): = $340,000
Tax at 44% (top rate): = $149,600 in tax
4. End of story? No. Enter the “capital gain exemption” for “qualified small business corporation shares” (s.110.6(2.1)).
• The maximum deduction from taxable income is $375,000 - the taxable portion of capital gains. This translates an “exemption” for capital gains of up to $750,000.
This is only available if a resident individual has disposed of a qualified small business corporation share (“QSBC Share”).
5. “QSBC Share” is defined (s.110.6(1)).
6. There are three basic tests:
• 90% asset test;
• share ownership test; and
• 50% asset test.
[pic]
7. The 90% asset test is in paragraph (a) of the QSBC share definition, read with the definition “small business corporation” in s.248:
• a CCPC (Chapter 2);
• “all or substantially all” the value (gross value) of the assets of which is attributable to assets:
• used “principally” in an “active business” (Chapter 3 – s.248(1)) carried on “primarily” in Canada by the CCPC or a company “related” (Chapter 3) to it;
• shares or debt of a small business corporation “connected with” (Chapter 4) the CCPC; or
• a combination of these.
8. The government (CRA) considers “all or substantially all” to mean 90% or more. (It considers “primarily” and “principally” to be more than 50%.) This has become accepted practice. But this could be challenged. Consider some examples: 89%? A building that is less than 100% used in the business?
9. What does the definition of “small business corporation” contemplate schematically?
[pic]
10. The share ownership test: paragraph (b) of QSBC Share definition in s.110.6(1):
• throughout 24 months before sale, the share was NOT owned by anyone OTHER THAN the individual or a person related to the individual.
11. Notice the test is phrased in the negative. What about a treasury share issued by the CCPC last year? Is this okay? Test the negative, then:
• read s.110.6(14)(f): deemed to be owned by an unrelated person;
• unless the share is issued:
• as consideration for other shares; or
• as consideration for a transfer of assets of an active business.
12. Focus on the two exceptions in s.110.6(14)(f). Consider examples.
[pic]
Has the share ownership test been met for the Holdco shares if they are sold? Read s.110.6(14)(f), and paragraph (e)(i) of the definition of QSBC Share in s.110.6(1).
The shareholder acquired the Holdco share on the share exchange, and the Opco share met the 24 month share ownership test.
[pic]
Would Opco shares meet the share ownership test if they are sold? Read s.110.6(14)(f)(ii). Yes. It does not matter how long the active business was run as a proprietorship.
13. The 50% asset test. The 50% asset test is found in paragraph (c) of the QSBC Share definition in s.110.6(1). The requirements are that throughout the 24 months preceding the sale, the share was a share of:
• a CCPC (familiar);
• more than 50% of the value of the assets of which was attributable to:
• assets used principally in an active business carried on directly by the CCPC or a related company (i.e., a direct test);
• shares or debt of a CCPC connected with the top CCPC, and more than 50% of the connected CCPC’s assets were used in an active business, or were assets described here (i.e., itself had a connected CCPC); or
• a combination of (i) and (ii). Why so complicated?
14. Consider this 50% asset test further:
[pic]
15. Can you see a potential dilution? Assume one company, and in the 24-month period the assets are:
[pic]
Is the 50% asset test met? No. Less than 50% of the assets in Opco were used in the “active business”.
What if we had split the assets as follows?
[pic]
The “more than 50% asset test” would be met in each CCPC (i.e., Holdco and Opco).
16. Now read the “anti-dilution rule” in s.110.6(1), definition of QSBC Share, paragraph (d). If the value of Holdco’s “qualifying assets” (direct active business assets or qualifying CCPC shares/debt) is less than 90% of the total value of Holdco’s assets during the 24 month holding period, then Opco must meet a “90% asset test” for the 24 month holding period – i.e., 50% is not good enough in Opco. Test the above now:
[pic]
17. When is excess cash “used” in an active business? Recall Chapter 4.
• removal would “destabilize the business”;
• maybe some “deposit” requirement to do business (bond, certificate, etc.) so that it is “risked in the business”;
• maybe the business is “cyclical”, anticipated needs of the “heavy” season (i.e., holding cash in the “off-season” for the “heavy” season); or
• perhaps holding cash to ensure current liabilities are covered.
All of these should suffice, but holding cash to replace a capital asset may not be a qualifying asset.
18. Steps to consider before a sale?
• Use the capital dividend account to pay out excess cash (or “offside” assets) as a capital dividend tax free.
• Repay loans from the shareholder. Debts do not reduce the gross value of assets for the 90% test or the 50% test.
• The exemption is available to an individual. Consider more than one shareholder (spouses, kids, family trust).
• What if you want to “crystallize” now? Consider transfer to Holdco and electing under s.85(1) (Chapter 9). Consider share exchange in the same company and electing under s.85(1) (Chapter 10). However, be wary of section 84.1 trap (Chapter 14).
19. Review the time line again:
[pic]
Cross-examine the client and perform due diligence.
20. Consider 110.6(14)(a). What is the problem? Consider 110.6(14)(b). What is the problem?
21. Consider the decision in Hudon. When does an active business commence?
-----------------------
Value $700,000
Cost $15,000
Debt has
been paid off
Company
X
Investment
Assets
$100,000
Business Assets
$600,000
90%
asset
test
[time of Sale]
24 months preceding
time of sale
( The share ownership test
( The 50% asset test
Shareholder
CCPC
90% value (+) of assets used directly in an active business by CCPC or (related company).
(SBC)
Shareholder
SBC
CCPC
90%(+) value of assets = shares or debt of connected SBC (more than 10% votes/value, or control)
share
(SBC)
debt
(same test)
direct active business assets
Shareholder
SBC
CCPC
90%(+)
connected
(SBC)
Direct
Indirect
Combination
(same test)
Shareholder
Holdco
Opco
treasury shares issued on transfer (less than 2 years)
share held more than
two years
Share for Share
Proprietor
Opco
business
Shares issued on transfer (less than 2 years)
direct
interest
Business Assets for Shares
(connected)
Shareholder
CCPC
more than 50% assets used in active business
by the CCPC (or related company).
Shareholder
CCPC 2
CCPC
debt or shares value more than 50%
(same test)
indirect
direct
for the 24 months prior to sale …
Shareholder
Opco
$2,000
investment assets marketable securities)
(64.5%)
$1,100
active business assets
(35.5%)
for the 24 months prior to sale …
Shareholder
Holdco
Opco
share value $2,100 (67.7%)
$1,000 investment assets (32.3%)
$1,100 business
assets (52.4%)
$1,000 investment assets (47.6%)
for the 24 months prior to sale …
Holdco
Opco
Holdco does not meet
the “90% asset test”
$1,000
investment
assets
(47.6%)
$2,100
(67.72)
investment
assets
$1,000
(32.3%)
C
$1,100
active business
assets
(52.4%)
thus, Opco must meet a 90% asset test – it does not
for the 24 months prior to sale …
90%
asset
test
[time of Sale]
24 months preceding
time of sale
( The share ownership test
( The 50% asset test
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