14 December 2000 Internal T.I. 2000-0034037 - safe income

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Calculation of safe income

Position: Pre-acquisition losses did not reduce the safe income of the corporation acquiring the shares of the loss corporation

Reasons:     See below
		December 14, 2000

	Toronto East Tax Services Office	Reorganizations and 	Tax Avoidance Section	 International Section
D. Boychuk
(613) 957-2123
	Attention: L. Patrick
	 	Section 444-1-4
		2000-003403

XXXXXXXXXX - Safe Income Calculation

We are writing further to your memorandum of March 15, 1999 seeking our views on the safe income ("SI") calculation in respect of the shares of the above-noted corporation.¹ We initially responded to your queries in our memorandum of June 7, 1999, however, at that time, we advised you that we were currently reviewing the impact on SI of various loss utilization transactions within affiliated groups. We have now completed our review.

The facts are fully set out in our previous memorandum and are not repeated here. All terms defined in our previous memorandum have the same meaning herein.

Analysis

In our view, the SI attributable to the shares of XXXXXXXXXX owned by XXXXXXXXXX was not reduced by the non-capital losses of XXXXXXXXXX. Since the shares of XXXXXXXXXX were acquired for fair market value, the losses were reflected in the adjusted cost base of those shares to XXXXXXXXXX. This is consistent with our position that a loss reduces SI in respect of a corporation's shares at the time it is incurred, not at the time it is deducted.² In addition, the acquisition only reduced XXXXXXXXXX safe income on hand ("SIOH") by the amount paid to acquire the shares and debt of XXXXXXXXXX XXXXXXXXXX As a result, the SIOH of XXXXXXXXXX immediately before the acquisition of the shares of XXXXXXXXXX by XXXXXXXXXX was not materially affected by the transactions.

In the circumstances, we do not believe the result is inappropriate. The sale of shares of a loss corporation within a corporate group may have the effect of increasing the consolidated SI in the group. However, such transactions should not result in an increase in consolidated SIOH.

The following example more fully illustrates the calculation of SI and SIOH in affiliated group transactions:

Assume that Parentco has two wholly-owned subsidiaries, Subco1 and Subco2. Subco1 owns all of the shares of Opco which it acquired for $100. Since the acquisition, Opco incurred non-capital losses of $100 (the "Losses"). The net fair market value of Opco's assets (other than its tax losses) is nil. The adjusted cost base of the shares of Opco to Subco1 is $100 and the adjusted cost base of the shares of Subco1 to Parentco is also $100.

The shares of Subco2 held by Parentco have an inherent capital gain of $100. The gain is attributable to $100 of SI in Subco2, all of which is on hand.

On a consolidated basis, Parentco has SI and SIOH of nil.³

Subco1 sells the shares of Opco to Subco2 for $20, an amount equal to the present value of Opco's losses, and incurs a capital loss which is denied by subsection 40(3.4). Subco2 finances the purchase from its SIOH. Opco is then amalgamated with Subco2 to form Amalco. In the year following the amalgamation, Amalco earns $100 which is offset by the use of the Losses.

Following the sale of the shares of Opco, the Losses are no longer relevant in the computation of the SI of Subco1. However, the denied capital loss incurred by Subco1 on the sale of the shares of Opco represents an amount which is no longer on hand and, therefore, it must be deducted in computing the SIOH of Subco1.⁴

Since Subco2 acquires the shares of Opco at their fair market value, the Losses are not relevant in computing the SI attributable to Subco2's shares. However, the$20 paid by Subco2 to Subco1 in consideration for the shares of Opco is deducted in determining the SIOH attributable to the shares of Subco2.⁵

Note that while the consolidated SI of Parentco increased by the amount of the Losses, its consolidated SIOH was unaffected.⁶

Following the use of the Losses, Amalco will have SI of $200 and SIOH of $180. This is the correct result since any dividend paid by Amalco to Parentco which is equal to or less than $180 will not reduce any portion of the gain on the shares of Amalco which is attributable to something other than SIOH.

Summary

XXXXXXXXXX SI and SIOH relating to its shares of XXXXXXXXXX (formerly XXXXXXXXXX) were not reduced by XXXXXXXXXX pre-acquisition losses.

If you have any questions or comments, please contact Daryl Boychuk at (613) 957-2123.

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTES

¹ Safe income is a substitute for "income earned or realized" which is calculated pursuant to the rules set out in subsection 55(5). In The Queen v. Brelco Drilling Ltd., 99 DTC 5253, the Federal Court of Appeal confirmed that safe income must be on hand. Generally speaking, safe income on hand begins with a calculation of safe income and is then reduced by any outlays which are not deducted in computing safe income (e.g. income taxes).

2 Robertson, 1981 Tax Conference Report, p.84. A loss is considered to reduce the SI of the corporation at the time it is incurred because the assets used to fund the loss are no longer on hand and thus can no longer contribute to the value of the corporation's shares.

³ The SI and SIOH attaching to the shares of Parentco is nil even though Parentco is in a position to receive a $100 safe dividend from Subco2. In this example, the SI in Subco2 is offset by the Losses and, therefore, it does not contribute to any gain on the shares of Parentco.

⁴ The denied loss is also deducted in computing the consolidated SIOH in respect of the shares of Parentco.

⁵ The $20 is deducted in computing the SIOH of Subco2 (subsequently, Amalco) as it was used to acquire the shares of Opco which disappear on the amalgamation of Subco2 and Opco. Therefore, Amalco does not have this amount on hand.

⁶ In computing the consolidated SIOH of Parentco, the denied loss ($80) and the outlay to acquire the shares of Opco ($20) are deducted, thus fully offsetting the $100 increase in SI.

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