30 May 2001 External T.I. 2001-0072375 - safe income distribution

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:

1) Whether subsection 55(2) of the Act would apply to the full amount of the deemed dividend or only the amount, if any, that is in excess of the safe income on hand that is otherwise attributable to the shares owned by the shareholder.

2) Whether the payment of a safe dividend by way of a transfer of property affects the application of subsection 55(2) where such payment does not result in an equal "distribution" of each type of property owned by Opco immediately before the payment.

Position:

1) Full amount unless paragraph 55(5)(f) designation is made.

2) Possibly depending on facts.

Reasons: The Law.

XXXXXXXXXX 2001-007237

May 30, 2001

Dear XXXXXXXXXX:

Re: Safe Income Distribution

We are writing in reply to your letter of February 21, 2001 wherein you requested our opinion regarding the application of subsection 55(2) of the Income Tax Act (the "Act") in a situation where the common shares of an operating corporation ("Opco") are purchased for cancellation.

You are aware that subsection 55(2) will apply to the above transaction to the extent that the accrued gain that otherwise would have been realized on a fair market value disposition of the Opco shares is not fully attributable to the particular corporate shareholder's share of Opco's safe income on hand. However, you asked whether subsection 55(2) of the Act would apply to the full amount of the deemed dividend (under subsection 84(3)) or only the amount that is in excess of the portion of the notional gain that is attributable to Opco's safe income on hand. You also want us to confirm that the transfer of investment property by Opco to the corporate shareholder as consideration for the cancellation of its common shares will not affect the application of subsection 55(2) in your situation.

Your request appears to relate to a proposed transaction involving specific taxpayers. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R4 ("IC-70-6R4") dated January 29, 2001. However, if the situation relates to a completed transaction a request for the Canada Customs and Revenue Agency's views must be made to your local Tax Services Office. We can, however, provide the following general comments.

Subsection 55(2) of the Act is an anti-avoidance provision that applies, inter alia, where a corporation resident in Canada receives a taxable dividend that was deductible under subsection 112(1) or (2) and one of the purposes of which (or, in the case of a dividend under subsection 84(3) one of the results of which) was to effect a significant reduction in the portion of a capital gain that, but for the dividend, would have been realized on a fair market value disposition of the share immediately before the dividend and that could reasonably be considered to be attributable to anything other than "income earned or realized by any corporation after 1971" (i.e., "safe income") and before the safe income determination time.

Where subsection 55(2) is found to apply, it will apply to the entire amount of the taxable dividend received by a corporation (except the portion, if any, that is subject to Part IV tax that is not refunded as part of the series). While paragraph 55(5)(f) of the Act may provide relief, the corporation receiving the dividend must actually make a designation in accordance with the requirements of that paragraph in order that a portion of the dividend otherwise subject to subsection 55(2) (i.e., not exceeding the amount of safe income on hand attributable to the particular corporate shareholder's shares) will be deemed to be a separate taxable dividend (the resulting dividend is referred to as a "safe dividend").

For your information, the safe income of a corporation is based on the corporation's net income determined pursuant to the provisions of division B of Part I of the Act, as adjusted by paragraph 55(5)(b), (c) or (d), as the case may be, and that is attributable to the particular share during the relevant holding period. Moreover, in order for safe income to be able to contribute to a capital gain on a share such income must actually be on hand and otherwise be available for distribution to the shareholder at that time as a dividend (i.e., this is what we refer to as "safe income on hand"). This is why it is our position that safe income must further be reduced by the amount of any actual or potential disbursement or outlay arising in the safe income holding period that has not otherwise been deducted by the corporation and which would reduce the capital gain otherwise inherent in the particular shares of the corporation.

Generally, the fact that a taxable dividend may be paid by a corporation distributing property (other than cash) to a corporate shareholder would not, by itself, affect whether the corporate shareholder could designate the dividend as a safe dividend. However, where such a dividend is paid in contemplation of a butterfly reorganization pursuant to paragraph 55(3)(b) of the Act, or as part of a series of transactions or events that includes a butterfly reorganization, such payment should be taken into account in determining whether each shareholder of the distributing corporation has received its proportionate share of each type of property owned by the distributing corporation immediately before that time.

Our comments are provided in accordance with the practice outlined in paragraph 22 of IC-70-6R4.

Yours truly,

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