18 December 1989 Income Tax Severed Letter 5-9140 - [891218]

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. Leung (613) 957-2116

XXXX

DEC 18 1989

Dear Sirs:

Re: Subsections 55(5) and 127(5) of the Income Tax Act (the "Act")

We are writing in response to your letter of November 22, 1989 wherein you requested our comments on the effect of investment tax credits on the calculation of income earned or realized ("safe income on hand") for purposes of subsection 55(2) of the Act.

The Department's views on the calculation of safe income on hand were expressed in Mr. J.R. Robertson's address to the 1981 Canadian Tax Foundation. These views were subsequently updated by Mr. M.A. Hiltz at the 1984 Corporate Management Tax Conference and Mr. R.J.L. Read at the 1988 Canadian Tax Foundation annual conference.

Generally, safe income on hand is made up of taxable income plus certain adjustments, less the aggregate of losses incurred, dividends paid and income taxes paid or payable. The effect that various tax credits will have on the safe income on hand of a corporation will depend on the nature of the credit involved, how it is claimed and the facts of the case. Depending on the circumstances, credits could have either a positive or negative effect on the safe income on hand calculation.

For example, assume that in Year 1 a taxpayer has claimed an investment tax credit of $350, which is included in his income in Year 2 pursuant to paragraph 12(1)(t) of the Act.

Year 1 
  Taxable income                               $3,000
  Tax 40%                        $1,200 
  Less: ITC                         350           850
                                 ------        ------
  Safe income on hand                           2,150
                                               ======

Year 2 
  Taxable income before 12(1)(t)               $4,000
  Add: 12(1)(t) inclusion                         350
                                               ------ 
                                                4,350
  Less: Tax 40%                                 1,740
                                               ------ 
                                                2,610
  Less: ITC "Phantom" Income                      350
                                               ------
  Safe income on hand                          $2,260
                                               ======
Total safe income on hand at end of Year 2     $4,410
                                               ======

In Year 2, the taxpayer's taxable income would be increased by $350 pursuant to paragraph 12(1)(t) of the Act. In the calculation of safe income on hand, this $350 "phantom" inclusion would be deducted, resulting in a net inclusion of nil.

This result is consistent with the guidelines established in Mr. Robertson's paper. While the calculation of safe income on hand would reflect the taxed retained earnings of the taxpayer, paragraph (xx) of the guidelines provided for a reduction of amounts which represent "phantom" income.

An investment tax credit refund will not generally constitute "phantom" income. Consequently, the refund may increase safe income on hand to the extent the refund exceeds any tax payable, in the current or subsequent years, as a result of including the refund in income pursuant to paragraph 12(1)(t) of the Act. Due to this tax liability, the gain inherent in the shares may not reflect the full value of the refund, and consequently may not be reflected in safe income on hand.

Our comments represent our interpretation of the guidelines outlined in Mr. Robertson's paper as they apply to the above example. The facts of each case are unique and the principle applied in this example may not be appropriate in every case.

Yours truly,

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