1 December 1992 External T.I. 9128655 F - 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.

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Attention:  19(1)

December 1, 1992

Dear Sirs:

Re:     Application of Subsection 55(2)

This letter is in response to your letter of October 10, 1991 in which you described the following fact situation:

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You then proceeded to discuss the Canadian income tax consequences of three alternative situations by which Holdco could dispose of its interest in Opco.

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You then requested our interpretation of the application of section 55 to the first and third situations described above.

Comments

It appears that the interpretation you seek refers to specific proposed transactions. Confirmation with respect to specific proposed transactions will only be provided in response to a request for an advance income tax ruling. If you wish to obtain an advance income tax ruling in respect of specific proposed transactions, a request can be submitted in accordance with Information Circular 70-6R2 dated September 28, 1990. We can, however, provide the following general comments.

In his article entitled "Section 55: A Review of Current Issues" (1988 Conference Report at 18:3 - 18:4), Robert Read states:

"Income earned or realized" or "safe income" with respect to a share of a corporation refers to the income earned by any corporation during the holding period of any particular share of a corporation that can reasonably be considered to be allocable to that share in the particular circumstances. "Safe income on hand" at a particular time with respect to a share of a corporation held by a particular shareholder is the portion of the income earned or realized by any corporation (safe income) during the relevant period of time that could reasonably be considered to attribute to the capital gain that would be realized on a disposition at fair market value at that time. A "safe dividend" is a dividend paid on a share that does not exceed the safe income on hand in respect of that share.

Therefore, it should be remembered that it is possible for a computation of safe income based only on income earned in the holding period to result in an amount that is greater than that which is "on hand" and that can be paid as a safe dividend. The entire amount of any dividend on a share, any portion of which exceeds the safe income on hand in respect of that share, may be subject to the application of subsection 55(2).

Applied to the present circumstances, before the dividends in situation 1 or situation 3 can be considered safe dividends, an examination must be made to determine whether the amount of the dividend could be considered to be derived from safe income on hand. It is usually not expected that the safe income on hand could be greater than the accrued gain since it should reflect the amount of the gain attributable to the safe income. If Opco had, during the period which Holdco held shares in Opco, incurred expenses which were not deductible for tax purposes, then Opco's safe income on hand may be lower than its safe income. This situation may account for some part of the difference between the amount of the safe income and the amount of the accrued gain on Holdco's shares of Opco. As a result, if non-deductible expenses incurred by Opco were to reduce Opco's safe income on hand in respect of the shares held by Holdco to an amount which is less than the amount of Holdco's accrued gain on the Opco shares ($60,000), then subsection 55(2) may apply to the dividends paid in situations 1 and 3.

Where, however, the safe income on hand with respect to the shares of Opco held by Holdco is at least equal to the amount of the accrued gain on the Opco shares held by Holdco, subsection 55(2) would not apply to the dividends paid in situations 1 and 3 and any capital losses arising in situations 1 and 3 (after the application of paragraph 54(h)(x) to the amount of the subsection 84(3) dividend in situation 1) would be deemed to be nil by the provisions of subsection 112(3).

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 and are not binding on Revenue Canada, Taxation.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch