Tax II Chapter 13
Spring 2013
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.
X
Value $700,000
Cost $15,000
Debt has
been paid off
Company
Investment
Assets
$100,000
Business
Assets
$600,000
2.
X wants to sell. What is the tax result?
3.
The capital gain on the shares:
Proceeds
$700,000
-
cost (+selling costs)
15,000 (+ 5,000)
Taxable capital gain (50%):
= gain
= $680,000
= $340,000
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Tax at 44% (top rate):
4.
= $149,600 in tax
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.
[time of Sale]
24 months preceding
time of sale
 The share ownership test
 The 50% asset test
7.
90%
asset
test
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:
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
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?
Direct
Indirect
Shareholder
(SBC)
CCPC
90% value (+) of
assets used directly
in an active
business by CCPC
or (related
company).
Shareholder
(SBC)
debt
Shareholder
CCPC
share
CCPC
90%(+) value of
assets = shares or
debt of connected
SBC (more than
10% votes/value, or
control)
direct active
business assets
(SBC)
connected
90%(+)
SBC
SBC
(same test)
10.
Combination
(same test)
The share ownership test: paragraph (b) of QSBC Share definition in
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s.110.6(1):

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:


12.
throughout 24 months before sale, the share was NOT owned by
anyone OTHER THAN the individual or a person related to the
individual.
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.
Focus on the two exceptions in s.110.6(14)(f). Consider examples.
Share for Share
Shareholder
share held
more than
two years
treasury shares issued
on transfer (less than 2
years)
Holdco
Opco
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.
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Business Assets for Shares
Shares issued on transfer
(less than 2 years)
Proprietor
Opco
direct
interest
business
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.
14.
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?
Consider this 50% asset test further:
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for the 24 months prior to sale …
direct
indirect
Shareholder
Shareholder
CCPC
CCPC
debt or shares
value more than
50%
more than 50%
assets used in active
business
by the CCPC (or
related company).
(connected)
CCPC 2
(same test)
15.
Can you see a potential dilution? Assume one company, and in the 24-month period the
assets are:
for the 24 months prior to sale …
Shareholder
Opco
$2,000
investment assets
marketable securities)
(64.5%)
$1,100
active business
assets
(35.5%)
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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?
for the 24 months prior to sale …
Shareholder
Holdco
$1,000
investment
assets (32.3%)
$1,000
investment
assets (47.6%)
share value
$2,100 (67.7%)
Opco
$1,100
business
assets (52.4%)
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:
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for the 24 months prior to sale …
C
Holdco
investment
assets
$1,000
(32.3%)
$1,000
investment
assets
(47.6%)
17.
$2,100
(67.72)
Holdco does not meet
the “90% asset test”
Opco
$1,100
active business
assets
(52.4%)
thus, Opco must
meet a 90% asset
test – it does not
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?
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19.

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).
Review the time line again:
[time of Sale]
24 months preceding
time of sale
 The share ownership test
 The 50% asset test
90%
asset
test
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.
commence?
When does an active business
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