10 June 1992 External T.I. 9132625 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.

June 10, 1992

Dear Sirs:

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

We refer to your letter of November 20, 1991, in which you requested a technical interpretation of the provisions of subsection 55(2) of the Act in connection with the payment of a dividend out of income earned or realized by a corporation after 1971 ("Safe Income"), as referred to in subsection 55(2) of the Act, in connection with the facts assumed in the hypothetical situations described below.

Application of Paragraph 40(2)(e) of the Act

Subco, a taxable Canadian corporation ("TCC"), within the meaning assigned by paragraph 89(1)(i) of the Act, disposes of all of the shares of its wholly-owned foreign affiliate ("F/A Co") to its parent corporation ("Parentco"), which is also a TCC.

Subco incurs a loss (within the meaning of paragraph 40(1)(b) of the Act) on the disposition, which loss is deemed to be nil by virtue of the operation of paragraph 40(2)(e) of the Act. In computing the adjusted cost base of the shares of F/A Co. to Parentco, the amount of the loss is added by Parentco to the cost of the shares of F/A Co pursuant to paragraph 53(1)(f.1) of the Act.

It is your view that the loss denied by paragraph 40(2)(e) of the Act need not be deducted in computing Safe Income of Subco at any particular time subsequent to the disposition of the shares of F/A Co, but instead reduces Safe Income of Parentco.

Alberta Royalty Tax Credits ("ARTCs")

Pursuant to the Alberta Corporate Tax Act, Part VI, Division 1, Sections 26, 26.1 and 26.2, taxpayers resident in Alberta are eligible for a cash provincial income tax credit based on a percentage of royalties paid by the taxpayer to the Government of Alberta ("Crown Royalties"). It is assumed for purposes of this letter that a corporate taxpayer that is a TCC has paid Crown Royalties for a number of years prior to the determination of its Safe Income, and has received refunds in respect of those royalties during those years from the Government of Alberta. It is further assumed that, by virtue of paragraph 18(1)(m) or paragraph 12(1)(o) of the Act, the Crown Royalties were either not deductible, or were includable in computing the income of the corporate taxpayer, and that the cash income tax credits received by the corporate taxpayer were not includable in computing its income under the Act.

It is your view that the receipt of the cash income tax credits may be included in computing the Safe Income of the corporate taxpayer.

Opinions

Application of paragraph 40(2)(e) of the Act

As explained by the Department on page 83 of the paper "Capital Gains Strips: A Revenue Canada Perspective on the Provisions of Section 55" that was published in the 1981 Conference Report (the "1981 Paper"), it is only that portion of the "income earned or realized" that remains on hand immediately before a dividend is paid that can contribute to a gain realized on the disposition of a share. In addition, we also took the position that undistributed retained taxed earnings only attribute to the value of a share of a corporation on a dollar for dollar basis, and that any balance of the gain is attributable to something other than "income earned or realized".

Thus, it is possible that a computation of Safe Income could result in an amount greater than that which could be paid as a safe dividend. For example, items that are non-deductible for income tax purposes (see page 104 of the 1981 Paper) will reduce the amount of post-1971 income to which a capital gain could be attributed, and this gives rise to the concept of "Safe Income on Hand", as referred to on page 18:4 of the Department's paper "Section 55: A Review of Current Issues", which has been published in the 1988 Conference Report.

It is therefore our view that the loss realized by Subco and which is denied by paragraph 40(2)(e) of the Act will have to be taken into account as a reduction in determining Safe Income on Hand of Subco, the corporation which incurs the loss, and this loss must also be taken into account in determining the Safe Income on Hand of Parentco on a consolidated basis.

ARTCs

In our view, an ARTC is equivalent to a government grant referred to on page 90 of the 1981 Paper, item (xvii). Accordingly, if an ARTC is  included in income under paragraph 12(1)(x) of the Act or under any other provision of the Act, then it would be included in determining the Safe Income of a corporation. However, if it is not so includable in income, then it is our view that an ARTC would be capital in nature, and could not be included in determining Safe Income, nor Safe Income on Hand.

We apologize for the delay in responding to your letter, which was due to the workload at this office.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch

21(1)(b)