7 December 1988 Income Tax Severed Letter 5-6691 - Subsection 55(2) of the Income Tax Act (the "Act")

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.

XXXX

S. Shinerock (613) 957-2108

DEC 7 1988

Dear Sirs:

Re: Subsection 55(2) of the Income Tax Act (the "Act")

We refer to your letter of October 4, 1988, in which you set out certain facts pertaining to the ownership of shares of a taxable Canadian corporation, within the meaning of paragraph 89(1)(i) of the Act, and the transfer of certain of those shares to a Holdco immediately prior to their redemption. You are concerned about the allocation of "safe income" or... income earned or realized by any corporation after 1971... " as referred to in subsection 55(2) of the Act, with respect to two classes of common shares of the taxable Canadian corporation ("Opco"), and a class of preferred shares of Opco.

Your request appears to relate to a specific proposed transaction. Confirmation of the tax consequences of a specific proposed transaction will only be provided in response to a request for an advance income tax ruling. The procedures for requesting an advance ruling are set out in Information Circular 70-6R. Although we are unable to provide any opinion in response to the specific transactions described in your letter, we do provide the following general observations on the hypothetical situation set out below, which envisages circumstances similar to those described in your letter.

An Opco has issued share capital comprising two classes of common shares and one class of preferred shares. The common shares are equal with respect to their rights to receive dividends of Opco and to receive assets of Opco on the winding-up or liquidation of Opco. The preferred shares were issued as consideration for assets transferred to Opco pursuant to a joint election filed under subsection 85(1) of the Act. The preferred shares are entitled to a non-cumulative dividend, rank in priority to the common shares on a winding-up of Opco, and are redeemable at a redemption price which reflects the fair market value of the assets in consideration for which they were issued.

One of the shareholders of Opco, an individual who owns all of the shares of one class of common shares, transfers those shares to a Holdco as part of a series of transactions described in paragraph 55(3)(a) of the Act pursuant to which the shares are redeemed by Opco immediately after the transfer. The transfer is subject to a joint election filed under subsection 85(1) of the Act.

Opinion

All shares of a corporation will share pro rata in the safe income of that corporation in accordance with their entitlement to participate in the income of the corporation, which entitlement would, of course, depend upon the terms and conditions of a particular share, and the period during which a particular share would be held (the "holding period".)

Normally, safe income would be allocated pro-rata among typical common shares, regardless of their separate class, subject of course to their holding period. Preferred shares with a non-cumulative dividend entitlement could only have a safe income allocation in a case where dividends on those shares were declared but were unpaid at the time of their redemption.

If a corporation acquires a share of an Opco as a result of a section 85 rollover, and the purchaser corporation's adjusted cost base of the share is equal to the vendor's adjusted cost base, 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.

Additional information on the calculation of safe income as it would apply to common and preferred shares of a corporation can be found in a paper presented by J.R. Robertson at the Thirty-third Tax Conference held by the Canadian Tax Foundation in 1981. This paper was published in the Report of Proceedings of that conference.

Our comments above are expressions of opinion and are not rulings, as stated in paragraph 24 of Information Circular 70-6R.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch