7 November 1990 Income Tax Severed Letter 136

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.

Dear Sirs:

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

This is in reply to your letter dated September 28, 1990. In that letter you requested our comments on the effect of the resource allowance, Alberta Royalty Tax Credits, inter-corporate dividends and dividend ordering, on the calculation of income earned or realized ("safe income on hand") for purposes of subsection 55(2) of the Act.

The Department's views on the calculation of safe income on hand were expressed in Mr. J.R. Robertson's address to the 1981 Canadian Tax Foundation. These views were subsequently updated by Mr. M.A. Hiltz at the 1984 Corporate Management Tax Conference and Mr. R.J.L. Read at the 1988 Canadian Tax Foundation Conference.

Generally, the Department is of the view that safe income during the holding period of a share is made up of taxable income plus certain adjustments, less the sum of losses incurred, dividends paid and provincial and federal income taxes paid or payable in respect of that income. The holding period is generally the time from the later of January 1, 1972 or the acquisition of the particular share to the time immediately before the transaction or event or the commencement of the series of transactions or events referred to in paragraph 55(3)(a) of the Act.

It should be noted that the amount of safe income must be on hand when a "safe dividend" is paid. As mentioned in Mr. Robertson's paper, there could be cases where a computation of safe income results in an amount greater than that which could be paid as a safe dividend. It is necessary, therefore, to calculate not only the amount of safe income, but also to determine the amount of "safe income on hand" out of which a safe dividend may be paid. A dividend paid which exceeds this latter amount may be subject to the provisions of subsection 55(2) of the Act, as the dividend would reduce the portion of the gain on the shares which is attributable to something other than safe income.

• 1. Resource Allowance

You state that, although the resource allowance results in a reduction of net income for tax purposes, it does not represent a cash outflow. Consequently you are unsure whether or not the resource allowance should be added back to net income for tax purposes in the calculation of safe income on hand.

It is Revenue Canada's position that resource allowances deducted pursuant to paragraph 20(1)(v.1) and section 65 of the Act (and related provisions of the Income Tax Regulations) should be added back to taxable income in the calculation of safe income on hand.

• 2. Alberta Royalty Tax Credits (ARTC)

You state that, "ARTC represent amounts refunded by the Government of Alberta based on a percentage of Alberta Crown Royalties paid. This income is non-taxable and accordingly is excluded from the computation of taxable income. Since these amounts result in a cash inflow to the recipient it is believed that such amounts should be included in safe income."

It is Revenue Canada's position that ARTC received or receivable are treated as a reduction of provincial taxes payable or a refund of such taxes and hence would increase safe income on hand of a resource corporation.

• 3. Inter-corporate dividends

You present a scenario where a wholly-owned subsidiary with $1 million of safe income pays a $1.2 million taxable dividend to its parent company. Assuming the parent had no safe income prior to the payment of the dividend, you conclude that subsequent to the payment of the dividend the safe income of the parent would be $1 million and the safe income of the subsidiary would be negative $200,000. Consequently you are uncertain how a computation of "consolidated safe income" could have decreased from $1 million prior to the payment of the dividend to $800,000 subsequent to the payment of the dividend.

Revenue Canada's current position with respect to the effect of inter-corporate dividends on safe income was outlined in Mr. R.J.L. Read's address to the 1988 Canadian Tax Foundation at page 18:5:

"In our view the phrase "income earned or realized by any corporation" contemplates the consolidation of safe income. Therefore, the safe income of the payer would have already been included in the consolidated safe income of the recipient, to the extent allowable to the recipient's shares of the payer, and this consolidated safe income of the recipient would not change on declaration or payment of the dividend by the payer".

This is consistent with Mr. J.R. Robertson's address to the 1981 Canadian Tax Foundation where at page 88 he states:

"Where the payment of a dividend would create a negative amount of safe income of the payor at a particular time, this negative amount will not be offset against other positive amounts on consideration because the dividend will not have been included in the safe income of the recipient."

• 4. Dividend Ordering

You requested our comments with respect to the ordering of dividends paid on safe income where the corporation has pre-1972 undistributed earnings on hand.

Mr. J.R. Robertson's address to the 1981 Canadian Tax Foundation states at page 88:

"Dividends paid in the period covered by the computation will be considered to first reduce the amount of the safe income even if such dividends were paid at a time in the period covered by the computation when such a dividend would not have been considered to be a safe dividend if subsection 55(2) applied to the transaction."

This continues to be Revenue Canada's position.

These comments represent our general views with respect to the subject matter of your letter. The facts of a particular situation may result in a different conclusion. The foregoing comments are not rulings and, in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990, are not binding on the Department.