3 May 1993 External T.I. 9236395 F - Safe Income and Part IV Tax

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

XXXXXXXXXX

Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Subsection 55(2) of the Income Tax Act (the "Act")

We are writing in response to your letter of December 4, 1992 wherein you requested our confirmation of the tax consequences of certain transactions described in your letter. The situation described in your letter involves a corporation ("Opco") 20% of the shares of which are owned by X. The safe income of Opco attributable to the shares owned by X is $100. The fair market value of these shares is $125. X will transfer all of his shares of Opco to a new corporation ("Newco") pursuant to subsection 85(1) of the Act in exchange for shares of Newco. Newco will ultimately be owned 50% by X and 50% by an arm's length person. Opco will then redeem all its shares held by Newco for $125, giving rise to a deemed dividend of $125 under subsection 84(3) of the Act. Opco will, pursuant to subparagraph 55(5)(f)(i) of the Act, designate $100 of the $125 taxable dividend to be a separate dividend. The remaining $25 will be deemed under subparagraph 55(5)(f)(ii) of the Act to be another separate dividend.

You requested our confirmation that

I.      the taxable dividend of $100 will be received tax free by Newco;

II.      Newco can elect to pay Part IV tax on the separate dividend of $25; and

III.      if Newco does so elect and neither Opco nor Newco claims a refund of the Part IV tax as part of the series of transactions or events that includes the redemption by Opco of its shares held by Newco, the deemed dividend of $125 will not be subject to the provisions of subsection 55(2) of the Act.

Our Comments:

The situation outlined in your letter appears to involve actual proposed transactions and identifiable taxpayers and, therefore, should be the subject of an advance income tax ruling. Confirmation as to the income tax consequences of proposed transactions will only be given in the context of an advance income tax ruling. The procedures for making a request for an advance income tax ruling are outlined in Information Circular 70-6R2, dated September 28, 1990, issued by Revenue Canada, Taxation and the related Special Release thereto. We can, however, offer the following general comments.

Unless a payer corporation which is connected, within the meaning of subsection 186(4) of the Act, with the particular corporation will receive a dividend refund within the meaning referred to in paragraph 129(1)(a) of the Act for its taxation year in which it pays the dividend, the particular corporation is not subject to tax under Part IV of the Act. There is no longer any provision in the Act to permit the particular corporation to elect to pay Part IV tax in any other circumstances.

With respect to the situation described in your letter, we are unable to agree with your conclusion that the $100 dividend which is designated to be a separate dividend will all be attributable to the safe income attributable to Newco's shares of Opco, with the result that subsection 55(2) will not apply to either of the two separate dividends.

For purposes of the following comments we have assumed that in the hypothetical situation described above, X has not realized any gain on the disposition of his shares of Opco to Newco. Otherwise, safe income allocable to the shares of Opco owned by Newco after the transfer would have been reduced.

It is our view that to the extent that a dividend refund arises in respect of tax paid on the investment income earned by a corporation which pays a dividend (the "payer corporation"), such income would, on an after tax basis, have been included in the calculation of the safe income of the payer corporation. Consequently, when a dividend that gives rise to the dividend refund is paid by the payer corporation, that portion of the dividend sufficient to give rise to the dividend refund would be considered to be paid out of safe income of the payer corporation.

In the hypothetical situation described above, if the amount of the $125 dividend which is subject to Part IV tax is $25, this portion of the dividend received by Newco and subject to tax under Part IV of the Act would be considered to be paid out of the safe income of Opco. Since an amount of $100 (including the $25 dividend subject to tax under Part IV of the Act), which is equal to the total safe income of Opco, is designated as a separate taxable dividend, subsection 55(2) will not apply to this dividend. However, subsection 55(2) will, in our view, apply to the other separate taxable dividend of $25.

The above comments only address the possible application of subsection 55(2) of the Act. Depending on the facts of a specific situation, other provisions, including subsections 112(2.1) to (2.4) and 186(1), sections 187.2 and 187.3, and subsection 191.1(1) of the Act, may also have application.

We trust that the above comments will be of assistance.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch