31 December 1992 Income Tax Severed Letter 9237660 - 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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Manitoba Bar
Association &
Institute of
Chartered
Accountants

Question 4 - Safe Income

The issued and outstanding shares of Canco, a taxable Canadian corporation, are held as to 50% each by two corporations, A Co. and B Co., both of which are resident in Canada. Each of A Co. and B Co. holds 1,000 preferred shares of Canco, and the issued common shares are held equally by A Co. and B Co. The aggregate paid-up capital of the preferred shares is $1, as is their adjusted cost base, and the same applies to the common shares. The fair market value of the preferred shares held by each of A Co. and B Co. is $1 million in each case, while the aggregate fair market value of the common shares held by each such shareholder is $1. Income earned or realized by Canco after 1971 that is available for distribution to A Co. and B Co. ("Safe Income") totals $2 million. Of this amount, $1.2 million of Safe Income is applicable to the common shares (i.e. $600,000 in respect of each of A Co. and B.Co.), while $800,000 of Safe Income is applicable to the preferred shares (i.e. $400,000 in respect of each of A Co. and B Co.). Canco does not have any capital dividend account.

• (a) If Canco is wound up pursuant to the provisions of subsection 88(2) of the Act, each of A Co. and B Co. will be deemed to have received a taxable dividend of $1 million in respect of the preferred shares held by each such shareholder, but no taxable dividend would be deemed to have been received in respect of the common shares held by each such shareholder.
• Assuming that no designation would be made pursuant to paragraph 55(5)(f) of the Act, would the Department apply the provisions of subsection 55(2) of the Act such that the dividend of $1 million deemed to have been received in respect of the preferred shares of Canco held by each of A Co. and B Co. would be deemed not to be a dividend but be deemed to be proceeds of disposition of the preferred shares, or would the Department permit the Safe Income attributable to the common shares of Canco held by A Co. and B Co. to be added to the Safe Income attributable to the preferred shares?
• (b) In a variation of the above scenario, assume that the facts are identical to those described above, except that all of the common shares of Canco held by B. Co. in part (a) are instead owned by the brother of the individual who owns all of the shares of B Co. It should also be assumed that the brother is not resident in Canada. In such a case, would the Department permit the Safe Income attributable to the common shares of Canco held by the brother to be added to the Safe Income attributable to the preferred shares of Canco held by B Co?

Department's Position

The factual situation posited in the above question does not explain why common shares having a fair market value of $2 are entitled to Safe Income of $1.2 million. Consequently, our response will be limited to setting out the basic principles of allocating Safe Income between different classes of shares.

In general, Safe Income of a corporation is attributable to a particular share of the corporation in accordance with the holding period of the share and its entitlement to participate in the income of the corporation. Thus, a preferred share would participate in Safe Income of a corporation in accordance with its dividend entitlement, which entitlement would be affected by the cumulative or non-cumulative nature of the preferred share. A common share would generally be entitled to participate in the Safe Income of a corporation pro rata with other common shares after the allocation of Safe Income to preferred shares. Consequently, there can be no shifting of Safe Income from one class of shares to another class, and Safe Income attributable to a particular class of shares that was not actually paid out in respect of that class would not be available to the other class. Under certain circumstances, such Safe Income could be lost.

Our response as set out herein would apply to both situation (a) and (b) above.

File No. 923766
Prepared by S.
Shinerock

December 31, 1992