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EXCERPT #1
Tax Planning for Small Business Guide
Excerpt: [¶1104] Assets used in an active business
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TAX PLANNING FOR SMALL BUSINESS GUIDE
The capital gains exemption on the sale of shares of a Canadian controlled private
corporation is a widely-known concept. However, like most corporate tax concepts,
there are a number of technical issues surrounding the availability of this exemption
that need to be analyzed. By searching the Tax Planning for Small Business Guide you
will be able to properly advise your clients as to their eligibility for the capital gains
exemption, in addition to a variety of other issues.
[¶1104] ASSETS USED IN AN ACTIVE BUSINESS
A key requirement in respect of the capital gains
exemption is that the asset must be used in an active
business. Issues arise (for example) where assets which
might otherwise relate to active business are dormant.
The following are some assets on which the
CRA has commented:
• Cash – Technical Interpretation No. 9514695 states
the following:
Cash or near cash property is considered to be used
principally in the business if its withdrawal would
destabilize the business. The test is not whether the taxpayer was forced to use the property to do business; the test
is whether the property was used to fulfil a requirement
which had to be met in order to do business.
Cash which is temporarily surplus to the needs of the
business and is invested in short-term income producing
investments could be considered to be used in the
business.
Cash balances which accumulate and are depleted in
accordance with the annual seasonal fluctuations of an
ongoing business will generally be considered to be
used in the business but a permanent balance in excess
of the company's reasonable working capital needs will
generally not be considered to be so used. The accumulation of funds in anticipation of the replacement or
purchase of capital assets or the repayment of a longterm debt will not generally in itself qualify the funds as
being used in the business.
Cash or near cash property is considered to be used
principally in the business if its retention fulfils a requirement which had to be met in order to do business, such
as certificates of deposits required to be maintained by a
supplier.
The Department recognizes that prudent financial management requires businesses to maintain current assets (including
inventories and accounts receivables, as well as cash and
near cash properties) in excess of current liabilities and will
consider this requirement in assessing whether cash or
near cash assets are used principally in a business. In the
Department's view, cash and near cash assets held to
offset the non-current portion of long term liabilities will not
generally be considered to be used in the business.
In Skidmore v. The Queen, 2000 DTC 6186 (F.C.A),
the taxpayer was denied the exemption because of
the excessive amount of term deposits held in the
company, notwithstanding rainy day arguments –
that these cash reserves were a necessary asset in
its tree growing business due to the fact they would
be required in the event the company experienced
certain misfortunes in its business operations, such
as a crop failure. It was held that the cash reserves
were not an integral aspect of the business operations
nor was there a relationship of significant financial
dependence between the business and the amounts
in question.
• Loans to Employees – Loans described under
subparagraphs 15(2)(a)(ii), (iii) and (iv) (to enable
employees to acquire dwellings for their habitation,
to acquire shares of the corporation or to acquire
automobiles to be used in the performance of their duties,
respectively) would not qualify as assets used in an active
business.
• Interest in a Partnership – The CRA has stated on
a number of occasions that a partnership interest and
a loan to a partnership would both be considered to be
assets used in an active business carried on by the
corporation where all or substantially all of the assets
3
of the partnership were used in an active business
carried on by the partnership. In a number of Technical
Interpretations, the CRA has stated that a corporation's
interest in a limited partnership would also qualify,
provided that all or substantially all of the assets of
the limited partnership are used in an active business.
• Assets for Future Use – Real estate developers may,
in certain circumstances, bank land inventory where
it is not profitable to immediately develop it. In such
cases, there is a concern as to whether such assets are
used in an active business. The CRA has stated that it
will consider plots of land that are land inventory to be
used in an active business provided that it is obvious
that these plots have been acquired and are held for
the purpose of being sold, or developed and sold
in the course of the business. Where a corporation
acquires property for the purposes of developing
a facility for use in its own business (i.e., a new
manufacturing facility), the CRA has stated that the
property will generally be considered an asset used
in the active business of the company from the date
of acquisition so long as the new facility was in fact
used in the active business within a reasonable time
after completion and not for any other purpose.
(See 1990 CRA Round Table, Q. 18)
• Land – Generally, the CRA is of the view that, in order
for land to be considered used in an active business,
it must be subjacent to any building or structure affixed
to the land or immediately contiguous land used as
a parking area, driveway, yard, garden or similar land
that is necessary for the use of the building (paragraph
18(3)(a)). Undeveloped land, the carrying costs of which
would have to be capitalized pursuant to subsection
18(2), would not be considered to be used in an active
business. (See Technical Interpretation No. 9231655,
February 3, 1993.) However, the CRA has not been
unfavourable to situations where taxpayers are
required to acquire more land than is actually
used in the business. (See Technical Interpretation
No. 9606355, March 16, 1998)
• Single Venture (adventure in the nature of trade) –
Another common issue is whether an asset held as
an adventure in the nature of trade is used in an
active business. An example might be the case
where a corporation holds a parcel of land with a
view to flipping the property for a quick gain. An
issue is whether the activity is significant enough
that business is being carried on by the corporation.
In “Capital Gains Exemption Refresher” (Hermann,
C., 2000 Conference Reports, p 29:7) , the following
is stated:
The concern stems from cases such as Tara Exploration
and Development Company Limited v. M.N.R., 70 DTC 6370
(Ex. Ct.), where the engagement in an adventure, or
concern in the nature of trade, was not considered to be
carrying on an active business, which is required if an asset
used therein is to be regarded as a good asset. CRA has
commented that it is a question of fact that will determine
how this issue is to be resolved. [See Interpretation Bulletin
IT-459, paragraph 3.] However, they have commented that
inventory, including land inventory of a real estate corporation, would normally be considered used in an active
business (CRA Document No. AC59482, March 13, 1990).
One would therefore expect that an isolated land flip by a
corporation might not be accorded such treatment.
• Mortgages Receivable – Mortgages having normal
commercial terms and conditions and held as investments are not considered to be assets used in an active
business. As well, the income earned from the mortgages
is considered income from property and subject to the
specified investment business rules in paragraph
125(7)(e). Mortgages taken back by a developer in order
to facilitate sales may initially be assets used in an active
business, but if such mortgages are retained for more
than a short period, they may become investments. (See
Technical Interpretation No. 9301993, February 9, 1993.)
• Amounts received from the sale of assets – The
CRA is of the view that an amount receivable which
arises on the disposition of an asset would not be an asset
used principally in an active business, regardless of
whether the asset disposed of had been used in an
active business. The only receivables that may be
considered to be assets used in an active business of
a corporation are trade accounts receivable that arise from
sales by the corporation in the course of its active business.
(See Technical Interpretation No. 9301993, February 9,1993,
as well as Technical Interpretation No. 9501105,
March 31, 1995.)
• Share investment as part of active business – In
Technical Interpretation No. 9235675, April 28, 1993,
based on the Ensite case, the CRA was favourable
toward shares of an investee company which was a
4
long-established sales and distribution co-operative doing
all of the marketing and distribution for all companies
involved in the corporation's particular type of business.
• Non-arm's length receivables – The CRA
has indicated that, in a non-arm's length situation,
two factors which could indicate that the assets
(receivables) are not used in the business would
be where the receivables remain outstanding for
an extended period of time or are converted into
inter-corporate advances on a regular basis. (See
Technical Interpretation No. 9729115, March 26, 1998.)
Qualico Developments Ltd. v. The Queen, 84 DTC 6119
(F.C.A.). In that case, he suggested that unsold inventory
was not used in the business and that it is only used
when it is employed in the business in some way. The
majority decision in that case offered a more liberal
approach to the concept of using property in
a business.
The “all or substantially all” requirement is, in a very real
sense, antithetical to the policy implicit in the small
business deduction itself, since the latter encourages
reinvestment at the corporate level. In fact, the very
situations in which the enhanced exemption may become
• Pension surpluses – The CRA has indicated that a
critical will typically involve successful businesses which have
pension surplus is an inactive asset if the company
cannot withdraw the excess from the plan and use
the funds in its active business. (See Technical Interpretation
No. 9829955, December 2, 1998.)
built up surplus assets. Additionally, it will be more difficult
for such businesses to qualify for the “all or substantially
all” requirement as the corporate tax rate decreases, which
would result in the tendency to retain surpluses at the
corporate level.
• Replacement insurance proceeds – Insurance
proceeds used to replace the destroyed/insured asset
that had been used in the business will be considered
an active business asset, even if the insurance proceeds
result in significant short-term cash reserves in the
corporation. (See Technical Interpretation No. 9416755,
October 13, 1994.)
• Assets required as security for loan – Technical
Interpretation No. 9514695 states:
Where a financing arrangement that is fundamental to
the business operations requires certain security to be
maintained and it is reasonable to conclude from the
facts that the security is employed and at risk in the
business, the security may be considered to be used in
the business. In order to draw this conclusion in a factual
situation, there would have to be a financial relationship of
dependence of some substance between the security and
the business. If there is no real expectation that the
security will be resorted to, one could conclude that the
security was not used in the business. In our view, the
employment of marketable securities merely as collateral
is not generally sufficient to enable it to be considered to
be used in a business.
In all cases, it is a question of fact as to whether an
asset is used in an active business. The CRA has stated
that it is not the intention to adopt a restrictive view
of the term “used”. A very restrictive interpretation of the
word used was suggested by Hugessen, J., in the case
As a result, it is typically necessary to undergo structural
reorganizations in order to allow the purification of a
corporation's assets. It should be noted, however, that
some purification reorganizations (i.e., tax-deferred
spinoffs of corporate assets to a transferee corporation)
generally cannot be successfully effected in contemplation
of a sale to an arm's-length third party. If such a sale is
contemplated, the flexibility to jettison corporate assets
is greatly restricted. Generally speaking, purification
in these situations will involve taxable dispositions by the
corporation of assets which are being stripped; in addition,
the ability to jettison assets to other corporations on a tax-free
dividend basis will generally be dependent upon the safe
income (i.e., for the purposes of subsection 55(2)) attaching
to shares on which the dividends are received. The bottom
line is that, unless purification methods are used in
advance of a contemplated disposition, the alternatives
become limited: meeting the “all or substantially all”
test may be difficult or impossible without incurring a
substantial tax liability.
The commentary on this topic is current as of
January 2nd, 2005.
Note: For a list of selected Technical Interpretations
pertaining to active business assets, reference should
be made to Appendix B of “The Capital Gains
Deduction – a Checklist Approach”, Len Vandenberg,
2000 British Columbia Tax Conference (Vancouver.
Canadian Tax Foundation 2000) p 8:1-64.
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TAX PLANNING FOR SMALL BUSINESS GUIDE
See inside for excerpt: [¶1104] Assets used in an active business.
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