Canada: The SME Growth Stock Plan

On April 21, 2005, the Minister of Finance, Michel Audet tabled the 2005-2006 Budget of the Québec Government.

To further promote the financing of businesses in the growth and expansion phases, the Budget announced the creation of a stock savings plan, called the SME Growth Stock Plan which will replace the former Quebec Stock Savings Plan (QSSP).

The SME Growth Stock Plan will consist of an arrangement concluded between an individual, other than a trust, and a broker or an investment fund, under the terms of which the individual will entrust such broker or investment fund, with the custody of his eligible shares, eligible securities and valid shares of an eligible corporation that will not be included in any other plan. The new plan will provide a minimum holding period of three years.

A single deduction rate, i.e. 100% of the adjusted cost of eligible shares will apply and the annual deduction cap will be 10% of the individual’s total income for a year.

The general rule under the new plan will be to the effect that any corporation issuing an eligible share must obtain a favorable advance ruling from Revenu Québec based on an application containing a prospectus.

In order to be an eligible issuing corporation and obtain a favorable advance ruling, the particular corporation must meet all of the following criteria on the date of receipt of the final prospectus:

1. It is a Canadian corporation with assets of less than $100 million;

   The assets referred to are those shown in the financial statements of the eligible issuing corporation for the taxation year preceding the one during which the eligible issuing corporation makes a public offering of shares under the new plan, and include the assets of any other corporation with which the eligible issuing corporation is associated (for tax purposes), on a worldwide basis, at any time during the twelve months preceding the time of the offering.

2. Its senior management is in Québec and more than half of the salaries paid to its employees during its last taxation year were paid to employees of an establishment located in Québec
3. Throughout the preceding 12 months, it carried on a business and had at least five full-time employees who are not insiders

   To determine if this criterion is satisfied, account is taken of certain corporate reorganizations such as mergers and winding-ups.

4. No more than 50% of the value of its property consists of investments other than eligible investments

All eligible issuing corporations must have a listing of their shares on a Canadian stock exchange. An eligible issuing corporation that makes an initial public offering of shares under the new plan will be required to take the necessary measures for its shares to be listed on a Canadian stock exchange no later than the sixtieth day following the date of the receipt for the final prospectus.

As mentioned earlier, in the context of an application for an advance ruling, the new plan will normally require the submission of a prospectus. However, the new plan will provide an exception to this general rule.

An investment fund offering shares under a prospectus pursuant to the new plan and which fund has been covered by a favorable advance ruling, may acquire for cash a share issued by an eligible corporation which would have been authorized to issue such a share to the fund pursuant to a prospectus exemption under section 51 of the Securities Act. However, such an eligible corporation must nonetheless obtain an advance ruling from Revenu Québec to the effect that it is an eligible issuing corporation and that the share issued in this offering is an eligible share, unless it has previously issued shares under a prospectus pursuant to the new plan.

Furthermore, an eligible issuing corporation that carries out such an offering of its shares under the new plan will have to provide Revenu Québec with a copy of the notice of private placement required by section 46 of the Securities Act.

Going forward, an eligible issuing corporation that has previously carried out a public offering of shares under the new plan pursuant to a prospectus will not thereafter be subject to the requirement of obtaining an advance ruling. If the issuing corporation has not made such an offering by prospectus, an advance ruling must be obtained at the time of each private placement.

For subsequent issuances under the new plan after a prospectus offering, an eligible issuing corporation may proceed by way of private placement and may only need to enclose with the private placement notice, an attestation by one of its directors to the effect that it is an eligible issuing corporation and that the share issued to the investment fund in the course of the private placement is an eligible share.

An investment fund under the new plan will consist of a mutual fund or open-end investment company that makes a public offering of securities and undertakes, in the final prospectus, to acquire, no later than December 31 of that year, securities eligible for the new plan with the proceeds of the public issue of securities. Furthermore, an investment fund will have to undertake to own, on December 31 of the year and each of the three subsequent years, securities qualifying under the new plan, whose adjusted cost is at least equal to the adjusted cost of the eligible securities issued by the investment fund during the year. Moreover, special rules to ease the undertakings of an investment fund may apply regarding an investment fund that is in its first public offering of eligible securities.

Moreover, an investment fund will have to be established in Québec and the trustee or manager, as the case may be, will have to reside in Canada and maintain an establishment in Québec.

Lastly, the rules pertaining to the almost permanent coverage, discussed below, will apply to investment funds.

Unlike the former QSSP, the new plan will not be open to securities other than an eligible share, an eligible security and, for coverage purposes only, a valid share. Accordingly, for the purposes of the new plan, the concept of eligible convertible security, i.e., in general, a debenture or non-guaranteed preferred share that its holder may convert into a common voting share, will not be carried over to the new plan.

An "eligible share" under the new plan will mean a common share with an unrestricted voting right, with respect to which the issuer has received a favorable advance ruling from Revenu Québec in relation to compliance with the objectives of the plan. The share must be acquired for cash in the course of a public share offering and be non-redeemable and with no fixed dividend.

The new rules will stipulate that a share may not be recognized as an eligible share if it is acquired in the course of an offering from which the proceeds are used to acquire shares or negotiable securities of another corporation. However, exceptions will be made regarding the acquisition of a controlled subsidiary.

In addition, a share may not be recognized as an eligible share when the use of the proceeds of the offering relates to activities to be carried out outside Québec and, in the view of Revenu Québec, such activities could have a tangible negative impact on the level of employment or the level of economic activity of the eligible issuing corporation, or its subsidiaries, in Québec.

A security acquired for cash by a first acquirer will constitute an eligible security under the new plan if it is issued under the new plan by an investment fund whose prospectus stipulates that it is covered by the new plan and provided that the fund has obtained an advance ruling by Revenu Québec.

According to the rules of the former QSSP, a QSSP investor could purchase a share on the secondary market to replace a qualifying share or security he disposed of. This operation was generally known as a "covering" operation and the replacement share that could be acquired to that end was called a "valid share".

Briefly, a valid share was a share included on a list drawn up to that effect by the Autorité des marchés financiers (AMF) and acquired in a stock transaction carried out on a stock exchange in Canada.

For the purposes of the new plan, the rules relating to a covering operation on the secondary market and the rules relating to the AMF list will also apply, with the necessary adaptations.

More specifically, the new AMF list will be extended to also include the name of a corporation that is not an eligible issuing corporation that carried out an offering of eligible shares, but could be such a corporation if it so applied and if a class of shares of its capital stock satisfies the definition of eligible shares.

For the purposes of the new plan, a public offering of shares will mean the placement of a share in accordance with a final prospectus receipt or, when the rules of the new plan relating to an investment fund apply, in accordance with a prospectus exemption stipulated in section 51 of the Securities Act, obtained from the AMF after April 21, 2005.

In addition to the concept of Eligible Issuing Corporation as defined earlier, the new plan will recognize in two specific cases, the possibility for a corporation to qualify as an eligible issuing corporation, despite it having failed to meet the four above-mentioned criteria.

The new plan will provide that certain holding companies may be recognized as an eligible issuing corporation.

A Canadian corporation whose head office or principal place of business is located in Québec and that makes a public offering of shares may qualify as an eligible issuing corporation if, on the date of the receipt of the final prospectus or prospectus exemption, almost all of its property consists of shares of the capital stock of one or more subsidiaries it controls or of loans or advances made to such subsidiaries, and if one of these subsidiaries satisfied each of the requirements mentioned above regarding a qualified issuing corporation.

Revenu Québec may grant the designation of eligible issuing corporation to a Capital Pool Company (CPC) that, on the date of the receipt of the final prospectus, satisfies the first and fourth criteria listed above (i.e. the assets criterion and that of 50% of the value of property), even though it does not meet the two other criteria (i.e. the Québec attachment criterion and the five employees/twelve months criterion).

Such a CPC may qualify as an eligible issuing corporation provided that most of the proceeds of the offering are used in the carrying out of a qualifying transaction whose objective consists, directly or indirectly, of the continuation of an existing business that, had it been carried on by the issuing corporation throughout the period of twelve months preceding that time, would have allowed the latter to satisfy the relevant criteria. In addition, Revenu Québec must be of the view that such offering satisfies the objectives of the new plan.

Rules will be put in place to ensure that the capital invested under the new plan remains fully invested in the small corporation market segment throughout the year, while allowing investors to actively manage their portfolio.

If an investor withdraws an amount from his plan and fails to cover this withdrawal within 21 days, this is deemed to be a withdrawal from the plan and this amount will not be allowed as a deduction in the calculation of the taxable income of the investor.

Pursuant to an informal discussion with the person in charge of applying the new plan at Revenu Québec, it was determined that in order to get an advance ruling, a company must submit the following:

• Its complete consolidated and non-consolidated financial statements
• A copy of the company’s certificate of incorporation
• A prospectus, if the offering is not under an exemption
• A check in the amount of $250
• Powers of Attorney authorizing the filer to make the application
• Any other document that Revenu Québec might judge to be pertinent

The cost of an advance ruling is $100 per hour of review time. The initial payment of $250 is designed to cover the first two and half hours of work for the basic assessment.

Revenu Québec estimates that once the file is complete, it will take between a month and two to issue the advance ruling.

As discussed above, the SME Growth Stock Plan will constitute an incentive for individuals investing on the public market, similar to the former QSSP, but better targeted in order to provide businesses with improved access to the public savings market.

Indeed, to ensure that investments are directed to the desired market segment, the SME Growth Stock Plan is geared to corporations of smaller size than the QSSP, i.e. corporations with assets under $100 million compared with $350 million under the QSSP. In addition, to simplify the administration of this plan, the SME Growth Stock Plan will be limited to the common shares of an eligible issuing corporation and will not be open to eligible convertible shares and share subscription rights. In the same vein, a single deduction rate, i.e. 100% of the adjusted cost of eligible shares, will apply.

Furthermore, to ensure that the capital invested in the desired market segment remains invested in this market segment throughout the life of the plan, and not just on a short-term basis at yearend, the SME Growth Stock Plan will impose an obligation of almost permanent coverage of eligible shares. Similarly, to increase the effects of this measure, the minimum holding period will be increased from two to three years.

The new plan will require that a corporation issuing an eligible share must usually obtain a favorable advance ruling from Revenu Québec based on an application which will normally contain a prospectus. However the plan will stipulate a prospectus exemption under the private placement in the context of shares acquired for cash by an investment fund.

The plan will also provide an exemption from the advance ruling requirement in the case of issuance of shares by a corporation that has previously carried out a public offering of shares under the new plan pursuant to a prospectus.

As with the former QSSP, the annual deduction under the SME Growth Stock Plan will be limited to a maximum of 10% of the individual’s total income of the year.

The new plan will have a limited lifespan. These new measures will apply beginning April 22, 2005, and will end on December 31, 2009.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.