21 March 2014 External T.I. 2012-0471021E5 - Safe income and section 34.2

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.

Principal Issues: 1- Should an adjustment be made to carve out from "safe income" any amounts included in income under subsections 34.2(2) and (12) and any amounts claimed under subsections 34.2(4) and (11)? 2- Should a negative adjustment be made in computing the "safe income on hand" if the corporate partner has an income inclusion under subsection 34.2(2) but there is a loss in the partnership for the stub period?

Position: 1- No. 2- Yes.

Reasons: 1- Based on the jurisprudence, "safe income" must be computed in accordance with the deeming provisions under paragraphs 55(5)(b), (c) and (d). More specifically, in the case of a private corporation, by virtue of paragraph 55(5)(c), the computation of "safe income" must conform to the computation of income under the Income Tax Act, disregarding two specific statutory deductions mentioned in that paragraph. Therefore, an adjustment to carve out from "safe income" any amounts included in income under subsections 34.2(2) and (12) and any amounts claimed under subsections 34.2(4) and (11) would be contrary to the wording of that provision. 2- Once the "safe income" is computed in accordance with the applicable deeming provision under subsection 55(5), the next step is to determine the "safe income on hand" which is a factual determination. Based on the jurisprudence, and consistent with the CRA's position on the treatment of non-deductible expenses, a negative adjustment should be made in respect of the loss on the basis that the amount would not be on hand to contribute to the fair market value or the gain inherent in the shares of the corporation.

XXXXXXXXXX
2012-047102
Chrys Tzortzis, CPA, CA

March 21, 2014

Dear XXXXXXXXXX:

Subject: Safe Income and Section 34.2

This is in response to your email of November 26, 2012, concerning the computation of "safe income" where a corporation is subject to section 34.2 of the Income Tax Act. We apologize for the delay in responding.

In particular, for the purposes of subsection 55(2) of the Act, you wonder whether or not an adjustment should be made to carve out from "safe income" any amounts included in income under subsections 34.2(2) and (12) of the Act and any amounts claimed under subsections 34.2(4) and (11) of the Act. In addition, you ask whether a negative adjustment should be made in computing the "safe income on hand" of a corporation if the corporation has an income inclusion under subsection 34.2(2) but there is a loss in the partnership for the stub period. To illustrate, the fiscal period of the partnership ends on June 30, 2013 but the taxation year-end of the corporation is December 31, 2013 and the stub period of concern is the period from July 1, 2013 to December 31, 2013. As indicated in your email, we will assume that the "safe-income determination time", as defined in subsection 55(1) of the Act, coincides with the corporation's regular taxation year-end. We will also assume that the corporation is a private corporation.

This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, Advance Income Tax Rulings.

Our Comments

The term "safe income" is generally used to describe the concept of "income earned or realized" by a corporation which is relevant for the purposes of subsection 55(2).

In accordance with the Federal Court of Appeal decision in The Queen v. Kruco Inc., 2003 DTC 5506, "safe income" must be computed in accordance with the deeming provisions under paragraphs 55(5)(b), (c) and (d) of the Act. More specifically, in the case of a private corporation, by virtue of paragraph 55(5)(c), the computation of "safe income" must conform to the computation of income under the Act, disregarding two specific statutory deductions mentioned in that paragraph. Therefore, an adjustment to carve out from "safe income" any amounts included in income under subsections 34.2(2) and (12) and any amounts claimed under subsections 34.2(4) and (11) would be contrary to the wording of that provision.

In your correspondence, you refer to document 2007-0243151C6 and the position stated therein that if the corporation is a member of a partnership during the holding period, the "safe income on hand" of this corporation during the holding period should normally take into account the corporation's share of the income (or loss) of the partnership that is attributable to an interim or "stub" period, to the extent, of course, that this income (or loss) is not otherwise included in the computation of the "safe income on hand" of the corporation. You wonder if this position still applies where the corporation is under the new 34.2 regime and has an income inclusion under subsection 34.2(2). With reference to the stub period noted in the illustrative example above (i.e. July 1, 2013 to December 31, 2013) and based on the foregoing, in our view, the above-noted position would not apply in such a situation since the rules under section 34.2 would apply to determine the partnership income attributable to the stub period.

Once the "safe income" is computed in accordance with the applicable deeming provision under subsection 55(5), the next step is to determine the "safe income on hand" which is a factual determination that basically calls for an inquiry as to whether the "safe income" was kept on hand or remained disposable to fund the payment of the dividend. Thus, in the situation described above where the corporation has an income inclusion under subsection 34.2(2) but there is a loss in the partnership for the stub period, it is our general view, consistent with our position on the treatment of non-deductible expenses, that a negative adjustment in respect of the loss should be made in determining the "safe income on hand" of the corporation on the basis that the amount would not be on hand to contribute to the fair market value or the gain inherent in the shares of the corporation.

We trust the above comments will be of assistance.

Yours truly,

G. Moore
for Director
Partnerships and Corporate Financing Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch