This is a follow-up to the first blog I wrote about the 50% asset test rule that dentists must follow to qualify for the lifetime capital gains exemption (“LCGE“). In this blog, I’m going to talk about the 90 % asset test.
On the day of the sale, “all or substantially all” of the fair market value of the assets (which the CRA has interpreted to mean 90%) are “used principally in an active business carried on primarily in Canada“. And if you would like to know more about terms like “used”, “principally”, “active business”, “carried on”, “primarily in Canada”, you can read my previous blog.
Now, you’ll notice that this test is virtually identical to the 50% test except for two fundamental differences: (1) it deals with the day of the sale (instead of the 24 month preceding the sale and (2) it’s a much higher threshold than 50 % (it’s all or substantially all, which the CRA has interpreted to mean at least 90 %).
The Courts Question the 90 % Rule
And although the CRA has stated that it believes 90 % is the correct percentage (and if you’re conservative, you’ll follow that), the Courts have cast some doubt on that interpretation.
In Wood v. M.N.R.  1 C.T.C. 2391, the Tax Court of Canada had to determine the meaning of the phrase “substantially all”. In that case, the taxpayer was a non resident and had earned taxable income in Canada. The taxpayer was trying to qualify for a personal exemption on the grounds that “all or substantially all” of his income had been included in computing his taxable income earned in Canada. The CRA disagreed on the basis that, to qualify for the personal exemption, a non-resident taxpayer’s income earned in Canada had to represent at least 90 % of his total income. The Court disagreed and sided with the taxpayer. The Court held at paragraph 5:
5 The Minister’s rule (from I.T.-171 (supra)) is that the Canadian income should be at least 90 per cent of total income — the “90 per cent rule”. Obviously that is just a departmental assessing policy, and while arbitrary is undoubtedly a useful and functional mechanism in dealing with a difficult section of the Act. I would think the Minister might be hard-pressed to refuse a claim where the percentage was 89 per cent, maybe even 85 per cent or 80 per cent or lower — and that brings up this taxpayer’s position which ends up to be about 70 per cent. ($30,000 out of $42,500). Clearly the term “substantially all” does not lend itself to a simple mathematical formula. Further it would seem to me that any particular definition of “substantially” would be only valid with reference to the specific context in which it is found. Clearly the term “substantially all” does not lend itself to a simple mathematical formula. Further it would seem to me that any particular definition of “substantially” would be only valid with reference to the specific context in which it is found.”
The Wood decision was followed in the the case of Balz (F.) Estate v. Minister of National Revenue,  1 C.T.C. 2332, Fournier c. R., [2004 T.C.C. 786, Imapro Corp. v. Canada,  2 C.T.C. 298, and Ilott v. R.,  T.C.J. No. 675. In the latter case, the Tax Court of Canada had to determine whether “all or substantially all” of some trucks had been used by the corporation for business purposes (as opposed to being personal vehicles). The Tax Court followed the Wood decision and held the following at paragraph 88:
88 The Court is satisfied that even though the departmental assessing policy may be the “90 per cent rule” the cases make it clear that something less than that might be sufficient to meet the Appellants’ needs here. Further, the Court is satisfied that no specific quantitative figure can be used in the determination. The Court must look at the use of the trucks in the context of the facts of each individual case and the Court accepts the statements of Taylor J. in Wood, supra, that clearly the term “all or substantially all” does not lend itself to a simple mathematical formula. Further, it would seem to the Court that any particular definition of “substantially” would be only valid with reference to the specific context in which it is found.
The Court’s reasoning in the Ilott case has been upheld in Keefe v. R.  1 C.T.C. 3028, where the Tax Court found that 81% of the distance driven in the course of employment could be considered “all or substantially all” of the distance traveled in the course of employment for the purposes of the Income Tax Act.
In Ruhl v. R.,  T.C.J. No. 1365, the Tax Court of Canada had to determine whether a pick up truck used in a farming business was used “substantially all” for transporting goods or equipment. The CRA used a 90 per cent as a rule of thumb, although there was not statutory basis for this percentage. In response, the Court noted the following at paragraphs 9 :
9 The terms “substantial” or “substantially all” are expressions of some elasticity. It has been said that they are an unsatisfactory medium for carrying the idea of some ascertainable proportion of the whole. They do not require a strictly proportional or quantitative determination.
In that particular case, the Court found that mileage totaling business use “80 per cent is in my view substantially all of the time”.
In McDonald v. R.,  4 C.T.C. 2569, the Tax Court of Canada had to determine whether an employee had traveled for work purposes “substantially all” of the time. The Court followed the decision in Ruhl, and held the following at paragraph 22:
22 These dictionary definitions confirm that the word “substantially”, as Bowman, J.T.C.C. remarked in Ruhl v. R., is elastic and an unsatisfactory medium for conveying the concept of an ascertainable proportion of the whole. The words “substantially all” in the context of paragraph 6(2)(d) need not be interpreted as 90% or more but may be a lesser proportion of the whole depending on the facts. In the case at bar, at least 85% of the distance traveled was in connection with Mr. McDonald’s employment and in my view that is substantially all of the distance traveled by the automobile in the total days it was available to Mr. McDonald [emphasis added].
In Watts v. R.,  T.C.C. 535, Justice Bowman decided that an amount varying from 76% to 81% of the taxpayer’s income that was taxable in Canada over a three-year period could qualify as “all or substantially all”.
Other cases which have followed the Court’s interpretations cited above include: Seto v. R., 2007 T.C.C. 489 [Informal Procedure], Thibault c. R., [2008 T.C.C. 16], and Reluxicorp inc. c. R.  T.C.C. 336.
So as you can see, the Courts have – albeit in contexts different than the LCGE – accepted something below the 90 % arbitrary threshold set by the CRA (for exaple, 80% has been accepted in McKay v. R.,  G.S.T.C. 93 Informal Procedure and Ruhl v. R.). And just keep in mind that the Courts have the final say on how the Income Tax Act is interpreted (not the CRA). That said, if you’d like to avoid a challenge by the CRA and not have to deal with lawyers, courtrooms, the CRA, and judges (and the emotional, financial and intellectual toll it brings), then you might want to plan ahead to meet a 90 % threshold on the day of the sale!
Death and the 90 % Asset Test
A word on death. Sometimes, it’s unannounced. And if a dentist hasn’t properly purified their dentistry professional corporation, their estate won’t be able to take advantage of the LCGE. Thankfully, the Income Tax Act provides some relief. Section 110.6(14)(g) says that shares can still qualify for the LCGE even if the 90 % test isn’t met at the time of the shareholder’s test SO LONG AS the corporation met that 90 % test at any time in the 12 month period immediately preceding the shareholder’s death. Just keep in mind that the other tests – namely, the 24 month share ownership / holding rule and the 50 % asset test – must also be met for the dentist to qualify for the LCGE; and, with respect to the 24 month share ownership / holding rule (unless the exception applies), this test must be satisfied at the chosen time AND at the time of death.