CRA comments favourably on a safe income strip using a preferred share stock dividend

Opco pays a stock dividend on its common shares (having a nominal paid-up capital and adjusted cost base) held by Holdco. The stock dividend is comprised of preferred shares with a nominal paid-up capital and a redemption amount equal to Opco’s safe income of $700,000. Opco then redeems the preferred shares for $700,000 and Holdco sells its Opco common shares to a third party for proceeds that reflect the $700,000 strip.

CRA indicated that s. 55(2) would apply to the preferred share redemption if the Part IV tax exception did not apply. However, given that the amount of the preceding stock dividend would be deemed by 55(2.2) for various s. 55(2) purposes to be $700,000, that amount would come out of the safe income of Opco under s. 55(2.3)(b) which, in turn, would mean that the cost of the preferred shares to Holdco would be deemed by s. 52(3)(a)(ii) also to be $700,000.

Accordingly, the application of s. 55(2) to convert the deemed dividend arising on the preferred shares redemption into proceeds of disposition would not result in any capital gain, given the stepped-up tax basis in the redeemed shares.

Neal Armstrong. Summary of 12 December 2016 External T.I. 2016-0668341E5 Tr under s. 55(2.3)(b).