CRA finds that a loan, that had funded a dividend creating a safe income deficit, reduced SIOH when repaid out of safe income earnings

In 2015, Opco, which had safe income of nil but an intangible asset worth $100,000, borrowed $100,000 to pay a dividend on its common shares to its sole shareholder (Mr. X). A Holdco ("Holdco Y") for an arm’s length (Mr. Y) then subscribed a nominal amount for common shares to become a 50% shareholder.

In 2018, after Opco had generated aggregate safe income of $200,000, Mr. X transferred his 50% shareholding to his wholly-owned Holdco ("Holdco X") on a s. 85(1) rollover basis at the shares’ nominal ACB. The $100,000 loan was repaid out of the $200,000 of retained earnings. The FMV of all the shares of Opco (which continued to hold the intangible worth $100,000) was $200,000.

CRA indicated that the safe income attributable to Mr. X’s 50% shareholding was effectively transferred to Holdco X on the s. 85(1) rollover. Regarding the safe income attributable to the shares at the conclusion of these transactions, it indicated that, since the loan was “was repaid out of the corporation's earned or realized income … that income cannot be viewed as contributing to the unrealized gain on the common shares of the capital stock of Opco” – so that the relevant safe income attributable to the 50% shareholding in Opco of each of the two Holdcos was $100,000 - $50,0000, or $50,000.

CRA did not discuss whether this same $100,000 reduction to the safe income of the two shareholdings for the $100,000 loan (or, looked at another way, for the $100,000 negative safe income resulting from the $100,000 dividend) would have also applied prior to the loan repayment.

Neal Armstrong. Summary of 7 October 2020 APFF Roundtable Q. 3, 2020-0852151C6 F under s. 55(2.1)(c).