14 May 2015 CLHIA Roundtable Q. 5, 2015-0573821C6 - 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.

Principal Issues: Opco transfers an interest in a life insurance policy to its parent, Holdco. (1) Incidence of the Dividend-in-Kind on Opco's safe-income for the purposes of determining the portion of the Dividend-in-Kind that would be subject to the application of subsection 55(2). (2) Incidence of the payment of insurance premiums on Opco's safe income on hand for the purposes of determining the portion of the Dividend-in-Kind that would be subject to the application of subsection 55(2).

Position: (1) The resulting income inclusion would not be part of the safe income at the safe income determination time. (2) The portion of the premiums that does not contribute to the increase of the cash surrender value would generally reduce the safe income on hand at the safe income determination time.

Reasons: 1) The safe income determination time precedes the moment of the transfer. (2) The safe income on hand would be reduced by the amount of the premiums that are not allocated to the cash surrender value.

2015 CLHIA - CRA Round Table -- May 14, 2015

Question 5:

Hypothetical scenario:

• Mr. X owns 100% of the shares in Holdco, which owns 100% of the shares in Opco.
• Each of Opco and Holdco is a Canadian-controlled private corporation.
• Opco has subscribed for and paid all the premiums in respect of an insurance policy on the life of Mr. X ("Policy").
• The terms and the conditions of the Policy are as follows:
  • Adjusted cost basis: nil
  • Fair market value ("FMV"): $200,000.
  • Cash surrender value: $100,000.
  • Death benefit: $1,000,000.
• Holdco intends to sell all the shares that it owns in Opco to an arm's length purchaser ("Purchaseco") for $1,000,000 ("Sale").
• Prior to the Sale, Opco will transfer its interest in the Policy to Holdco by way of a dividend-in-kind ("Dividend-in-Kind").

Question

What will be the impact of Opco's Dividend-in-Kind to Holdco on the computation of its safe income and safe income on hand?

Response

The applicable legislative and administrative framework

Budget 2015 introduced amendments to subsection 55(2) which apply to dividends received by a corporation on or after April 21, 2015. This answer is based on the amended wording of subsection 55(2) as it reads in the Notice of Ways and Means Motion to amend the Income Tax Act and Other Tax Legislation that is found in Annex 5 to the Budget.

Subsection 55(2) may apply to Opco's payment of the Dividend-in-Kind to Holdco if one of the purposes of the Dividend-in-Kind was to: (i) significantly reduce the amount of the capital gain that, but for the Dividend-in-Kind, would have been realized on a disposition at fair market value of any share; (ii) significantly reduce the fair market value of any share; or (iii) significantly increase the cost of property such that the amount that is the total cost amounts of all properties of Holdco immediately after the payment of the Dividend-in-Kind is significantly greater than the amount that is the total cost amounts of all properties of Holdco immediately before the payment of the Dividend-in-Kind.

According to paragraph 55(2.1)(c), subsection 55(2) will only apply if the amount of the Dividend-in-Kind exceeds the amount of income earned or realized by Opco after 1971 and before the safe-income determination time that can reasonably be considered to contribute to the capital gain that could be realized on a disposition at fair market value of the Opco share on which the Dividend-in-Kind is received ("safe income").

Paragraph 55(5)(c) provides that Opco's safe income for a period throughout which it was a private corporation refers to the net income for tax purposes earned by Opco for the period throughout which it was a private corporation, subject to the adjustments found in that provision. Moreover, it has been CRA's long-standing position that safe income can only contribute to a gain on shares if it is on hand ("safe income on hand") in accordance with the guidelines stated in Income Tax Technical News No. 37 dated February 15, 2008.

Incidence of the Dividend-in-Kind on Opco's safe-income for the purposes of determining the portion of the Dividend-in-Kind that would be subject to the application of subsection 55(2)

The disposition of Opco's interest in the Policy to Holdco by way of the Dividend-in-Kind will result in an income inclusion for Opco pursuant to subsection 148(1), which is equal to the amount by which the proceeds of the disposition of Opco's interest in the Policy exceed the adjusted cost basis to Opco of that interest in the Policy. According to subsection 148(7), a corporation that holds an interest in a life insurance policy is deemed to have become entitled to receive proceeds of the disposition equal to the "value" of the interest where it disposes of such interest by way of a distribution to a person with whom it does not deal at arm's length. Where the interest in a life insurance policy includes an interest in the cash surrender value of the policy, subsection 148(9) provides that its "value" is equal to the amount that the holder of the interest would be entitled to receive if the policy were surrendered at that time.

For the purposes of subsection 55(2), however, the safe-income determination time for the Dividend-in-Kind or the series of transactions that include the Dividend-in-Kind is the time that is immediately before the time that the Dividend-in-Kind is paid to Holdco. Because the income inclusion resulting from the disposition of Opco's interest in the Policy pursuant to subsection 148(1) will be added to Opco's safe income after the Dividend-in-Kind is paid to Holdco, it will not contribute to the capital gain that could be realized on a disposition at fair market value of an Opco share immediately before the time the Dividend-in-Kind is paid. However, such an income inclusion will be reflected in Opco's safe income after the Dividend-in-Kind is paid.

Incidence of the payment of insurance premiums on Opco's safe income and safe income on hand for the purposes of determining the portion of the Dividend-in-Kind that would be subject to the application of subsection 55(2)

Except where paragraph 20(1)(e.2) applies, premiums payable by a taxpayer under a life insurance policy are generally considered to be on account of capital, and therefore are not deductible under paragraph 18(1)(b).

Despite the fact that the premiums paid by Opco do not enter into the computation of its safe income for the period throughout which it was a private corporation until the safe income determination time on the Policy, the amount of safe income at the safe income determination time might be reduced on account of the portion that is not on hand at that time due to the payment of premiums on the Policy over the period throughout which Opco was a private corporation.

The portion of such premiums that contributes to the increase of the cash surrender value of the Policy would be considered to be on hand at the safe income determination time to the extent that it contributes to the accrued capital gain on a share of the capital stock of Opco at that time. That portion will not result in an adjustment to the amount of safe income in order to determine the amount of safe income that is on hand at the safe income determination time. However, the portion of such premiums that does not contribute to the increase of the cash surrender value of the Policy at that time will not be on hand at the safe income determination time and would therefore reduce the amount of safe income that could reasonably be considered to contribute, immediately before the Dividend-in-Kind, to the accrued capital gain on the Opco shares on which that dividend is received.

Yves Moreno / François Mathieu
2015-057382