26 February 1982 Income Tax Severed Letter 5-2917 - [820226]

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.

FEB 26, 1982 E. Mikhail (613) 995-1787

XXXX

Dear Sirs:

This is in reply to your letter of July 9, 1981 in which you enquired about the anti-capital gains stripping provisions of subsections 55(2) to (5) of the Income Tax Act.

We concur with your conclusions on the application of subsection 55(2) as described by you in the last two paragraphs of page 2 and the first paragraph of page 3 of your letter. As a matter of clarification, however, we would like to add a couple of points. We refer to the qualifying post-1971 income as "safe income", i.e. income that may, in your set of circumstances, be paid out as a subsection 84(3) dividend and not be caught by subsection 55(2). Firstly, generally, a safe dividend can be paid to the extent that there is safe income on hand immediately before the dividend is paid. However, since each share is entitled only to its proportionate share of the safe income of the corporation during the relevant holding period of that share, a safe dividend on that share cannot exceed its proportionate share of safe income. Secondly, where a corporation acquires a share as a result of a section 85 rollover such a transferred share will retain its share of safe income that could have been paid as a safe dividend immediately before the transfer. In effect, the transferee's holding period in respect of such a transferred share includes the transferor's holding period.. Thirdly, it may be of interest to note in connection with your conclusions that if a subsection 84(3) dividend is caught by subsection 55(2), the whole amount is caught and not just the portion of the gain attributable to something other than income earned or realized before 1972. The risks that this provision creates may be reduced by paying a series of dividends instead of one large one.

With regard to your question concerning the meaning of safe income, we have the following comments to make. These comments are not all- inclusive but cover the usual type of situation.

The computation of safe income during the holding period with respect to a particular share: Generally, for a company other than a foreign affiliate, the Department's view of Safe Income during the holding period is made up of taxable income reported plus deductions for inventory allowance (20(1)(gg)) and scientific research (37.1) less the sum of losses incurred, dividends paid and income taxes (including provincial income taxes) paid or payable in respect of the income for that same period. A corporation that is not a private corporation will also include half of the excess of its capital gains over its capital losses and the excess of its eligible capital amounts over the sum of its cumulative eligible capital at the commencement of the period and one-half of its eligible capital expenditures in the period. If it is reasonable to consider that a dividend received by a corporation came out of safe income of the payor it will be added to safe income in the recipient. 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. All dividends paid in the holding period on all classes of shares are a deduction in the computation of safe income with respect to a particular share. When a corporation acquires a share as the result of a section 85 rollover such a transferred share will retain its share of safe income that could have been paid as a safe dividend immediately before the transfer. In effect the transferee's holding period in respect of such a transferred share includes the transferor's holding period.

The Department's views on the application of section 55 were presented in a paper entitled "Capital Gains Strips: A Revenue Canada prospective on the provisions of section 55" in November, 1981 at the Canadian Tax Foundation Conference in Vancouver. Needless to say, our comments are based on the law as it presently stands and do not take into account changes that may be forthcoming as a result of the November 12, 1981 Budget.

Yours truly, ORIGINAL SIGNED 8y ORIGINAL SIGNÉ PAR D. B. MORPHY

for Director Corporate Rulings Division Legislation Branch