29 June 1990 Ministerial Letter 59648 F - Flow-through of Safe Income to Preferred Shares

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.

19(1)

June 29, 1990

Dear Sirs:

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

We are writing in response to your letter of February 19, 1990. You requested our comments regarding the application of subsection 55(2) of the Act in the following hypothetical circumstances.

(1)     Opco is a Canadian-controlled private corporation and  a taxable Canadian corporation within the meanings of paragraphs 125(7)(b) and 89(1)(i) of the Act, respectively.

(2)     The common shareholders of Opco are married individuals owning 65 per cent and 35 per cent of the issued shares respectively.

(3)     The corporation has a fair market value of $1,000,000 represented by $800,000 of active business assets and $200,000 cash.

(4)     The corporation has accumulated $500,000 in safe income for the purposes of subsection 55(2) of the Act.

(5)     The shareholders intend to sell 50 per cent of each of their shareholdings to an arm's length party for $500,000.

(6)     Before the intended sale, a new company ("Newco") is incorporated, and the spouses transfer one half of their respective shares of Opco to Newco pursuant to the provisions of subsection 85(1) of the Act and receive common shares of Newco as consideration.  The agreed amount under paragraph 85(1)(a) of the Act will equal the adjusted cost base, as defined under paragraph 54(a) of the Act, of the Opco shares.

(7)     The common shares of Opco owned by Newco are then exchanged, under the provisions of section 86 of the Act, for Voting, redeemable, retractable preference shares having an aggregate paid-up capital equal to the paid-up capital of the common shares exchanged.

(8)     The preference shares will be redeemable at an amount of $500,000 less any dividends paid on them before redemption.

(9)     Opco then declares a $200,000 dividend on the preferred shares.

We assume that the spouses acquired their respective shares at the same time and that the safe income is attributable to the inherent gain on those shares which accrued since that time.

Comments

The Opco shares transferred in (6) above will retain their proportionate share of the safe income of Opco.  The same share of safe income will flow through to the preference shares received upon the exchange described in (7) above.  The safe income attributed to the preference shares at that time will be $250,000 (i.e. $500,000 x 50%).

We assume that the payment of an initial $200,000 dividend will be followed by the redemption or retraction of the preference shares for $300,000. The entire $200,000 dividend would be paid out of the safe income attributable to those shares as we consider dividends to come first out of safe income.  Any subsequent deemed dividend on the redemption or retraction of the shares would be subject to the provisions of subsection 55(2) of the Act, however, the provisions of paragraph 55(5)(f) of the Act are available to Newco.

As the transactions described above fall within the provisions of subsection 55(2) of the Act, we would not expect that the provisions of subsection 56(2) or 245(2) of the Act would be applied.

The opinions expressed here are not rulings and are not considered binding on the Department as outlined in paragraph 24 of Information Circular 70-6R.

Yours truly,

for DirectorReorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and IntergovernmentalAffairs Branch