Section 44.1

After February 27, 2000, but before October 18, 2000 (i.e., before the effective date of the introduction of s. 44(10)(d)), an individual sold eligible small business corporation shares and used the cash proceeds to subscribe for shares of a new corporation which used such proceeds almost entirely to purchase a piece of land for which, to date, a required zoning change has not yet been obtained. That corporation had no income in 2001 and 2002, and small income in 2003 from software development.

Before concluding that “the new corporation did not carry on a business at the time the shares were issued” so that “those shares were not shares of an eligible small business corporation,” CRA noted that there was no evidence that “a software development activity … [had] started at the time the taxpayer invested in the corporation,” and also stated:

[T]here may be arguments that the business was started at the time that steps to change the zoning were taken. However, simply sending in an application for a zoning change and waiting several years without any further activity does not lead us to conclude that a business was started.

In finding that shares issued from treasury of a corporation to a family trust, which later were distributed to a capital beneficiary, did not qualify as “eligible small business corporation shares” notwithstanding that, on their issuance, the corporation was an eligible small business corporation and the $50 million test was satisfied, CRA stated (TaxInterpretations translation):

A qualifying disposition of an individual (other than a trust) means a disposition of shares of the capital stock of a corporation where each share disposed of meets certain conditions in the definition of "qualifying disposition" in subsection 44.1(1). One of the conditions is that the share is an “eligible small business corporation share” of the individual.

In our view, the wording of the definitions of "qualifying disposition" and " eligible small business corporation share" in subsection 44.1(1) requires that the issuance of common shares be made to an individual who is eligible for purposes of a qualifying disposition. As a trust is excluded from the definition of "qualifying disposition", in our view, none of the shares described in your example could qualify as an “eligible small business corporation share” as defined in subsection 44.1(1).

Respecting the application of s. 44.1 to an initial public offering of common shares (“Subscribed Shares”) by a Canadian-controlled private corporation, CRA stated, respecting the application of the qualifying disposition definition, CRA stated:

First, the corporation that issued the Subscribed Shares to the individual must inter alia be a CCPC at the time of the issuance. Second, throughout the entire period during which the Subscribed Shares were owned by the individual, they must have been common shares of a corporation that is carrying on an active business. With respect to that latter requirement, we refer you to subsection 44.1(8) which provides that property is deemed, in certain circumstances, to be used or held by a corporation in the course of carrying on the active business of that corporation.

Respecting the application of s. 44.1 to an initial public offering of common shares (“Subscribed Shares”) by a Canadian-controlled private corporation, CRA stated, respecting the application of the replacement share definition:

it is necessary that the corporation issuing the Subscribed Shares to the individual who wishes to designate such shares as replacement shares be a CCPC at the time of their issuance to the individual. If that were the case, and to the extent that the Subscribed Shares were acquired within the time limits set out in the definition of "replacement share" in subsection 44.1(1) and the individual who acquired them designated them in proper form as replacement shares, we are of the view that the Subscribed Shares would represent replacement shares.

Must a "replacement share" continue to be a share of an eligible small business corporation after its issue in order for the capital gain deferral under s. 44.1 to continue to apply? CRA responded:

The definitions "qualifying disposition" and "replacement share" require, among other things, that each share that has been disposed of or acquired, as the case may be, is an "eligible small business corporation share". That expression provides, among other things, that "at the time the share was issued, the corporation was an eligible small business corporation”. The words in bold emphasize that the determination of a corporation's status is made at the time the shares are issued. Therefore, regardless of whether a corporation's status changed after the time of issuance of the eligible small business corporation share, the effect of subsection 44.1 remains.

… Thus, the deferred gain, which results in a reduction in the adjusted cost base, will be realized when the taxpayer sells the replacement shares, to the extent that the proceeds of disposition exceed the adjusted cost base.