Subsection 256(9) – Timing problem with capital gains deduction

A very common tax savings is the capital gains deduction that can, subject to various conditions, be utilized upon the realization of a capital gain on the disposition of qualified small business corporation shares. The deduction can shelter up to a lifetime maximum of $750,000 of capital gains. However, very careful planning must be done in most cases in order to ensure that the deduction can be utilized.

One trap is subsection 256(9) of the Income Tax Act. This short provision states that, for purposes of the Act, where control of a corporation is acquired by a person or group of persons at a particular time on a day, control of the corporation shall be deemed to have been acquired by the person or group of persons at the commencement of that day and not at the particular time unless the corporation elects in its tax return (for the applicable taxation year) for subsection 256(9) to not apply. This means, in plain English, that subsection 256(9) causes the acquisition of control on a disposition of shares of a private corporation to occur at the beginning of the day of the disposition. This can be problematic given that one of the conditions for the utilization of the capital gains deduction is that the shares at the particular time of disposition must be shares of a Canadian controlled private corporation. Given the timing clarification in subsection 256(9), the shares of the private corporation will not be considered to be Canadian controlled at the time of disposition to the extent that the shares are sold to a publicly traded corporation or to a non-resident person. The CRA agrees with this interpretation as stated in a couple of technical interpretations released by them in recent years. Accordingly, when selling shares of a Canadian controlled private corporation to a non-resident person or to a publicly traded corporation it will be critical to ensure that an election is made in the Canadian controlled private corporation’s tax return that subsection 256(9) will not apply. Making such an election will ensure that the corporation will be a Canadian controlled private corporation at the time of disposition and therefore the capital gains deduction will still be available.

While the CRA acknowledges that it appears that the legislative intent of subsection 256(9) was not to disturb the utilization of the capital gains deduction, the fact remains that it exists in the Income Tax Act and therefore must be complied with.