CRA indicates that a disproportionate allocation of DSI on a purchase spin-off can avoid the application of s. 55(2)
In Example 17 of CRA’s 2023 Safe Income Paper, the entire direct safe income (“DSI”) of a transferor corporation (“Opco”) was allocated to a transferee corporation (“Newco”) on an s. 55(3)(a) spin-out. Specifically, Opco (wholly-owned by Holdco) had DSI of $1,000 and two assets (Asset 1 with a nil ACB and $1,000 FMV, and Asset 2 with an ACB and FMV of $1,000). The DSI of Opco was reflected in Asset 2’s ACB.
Opco spun off, under s. 55(3)(a), Asset 2 to Newco (wholly-owned by Holdco). As part of the spin-out, Holdco transferred Opco shares with a nil ACB and $1,000 FMV to Newco for shares of Newco with a nil PUC and ACB, and $1,000 FMV. Opco then transferred Asset 2 to Newco in consideration for Newco shares with an ACB, PUC and FMV of $1,000. The cross-shareholdings were then redeemed for notes and the notes cross-cancelled, thereby generating a taxable dividend of $1,000 to Newco. CRA concluded that the entire $1,000 DSI of Opco was transferred to the shares of Newco held by Holdco.
Now, in a variant of Example 17, as part of the series the Opco shares were subsequently sold to an unrelated person so that (pursuant to s. 55(3.1)(b)) the s. 55(3)(a) exception would be unavailable.
CRA indicated that the entire $1,000 of DSI of Opco would continue to shift to such Newco shares of Holdco. The same analysis applied here as for Example 17: since the $1,000 of DSI of Opco was reflected in the ACB of Asset 2, which was transferred to Newco, it was reasonable to conclude that, after the spin-out, the $1,000 of DSI of Opco contributed solely to the gain on the shares of Newco held by Holdco. Accordingly, immediately prior to the redemption of Newco’s shares of Opco, the $1,000 in DSI of Opco reasonably contributed to the accrued gain on the shares of Opco held by Newco, so that s. 55(2) should not apply to that deemed dividend.
Neal Armstrong. Summary of 17 June 2025 STEP Roundtable, Q.12 under s. 55(2.1)(c).