28 July 1993 External T.I. 9308835 F - Safe Income on Hand

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:  XXXXXXXXXX

Dear Sirs:

RE:  Section 55 of the Income Tax Act (the "Act") XXXXXXXXXX

We are writing in response to your letter of March 25, 1993 wherein you requested clarification of certain comments made in our letter of February 2, 1993 which was written in response to your letter of October 21, 1992.

At issue are the following comments in Robert J.L. Read's paper titled "Section 55: A Review of Current Issues" at page 18:4 of the 1988 Conference Report of the Canadian Tax Foundation:

"'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 that could reasonably be considered to attribute to the capital gain that would be realized on a disposition at fair market value of the share at that time...

...If the income has been used or set aside by the corporation to pay amounts not currently deductible for tax purposes, it cannot contribute to the gain inherent in the issued shares of the corporation."

It is your view that safe income has not been set aside where

(a)     income has arisen for tax purposes;

(b)     that income for tax purposes has not been reduced by certain accounting provisions for future obligations (although those provisions have been deducted for accounting purposes); and

(c)     no related amount has been paid or expended (including expenditure by payment to a trustee or other custodian), such that the cash or other asset which will ultimately be paid or expended on account of such obligations remains an asset of the corporation and freely available for the use of the corporation.

It is also your view that future obligations which have reduced a gain that would otherwise be realized on a disposition at fair market value of a share of any corporation should not be a separate test in the determination of safe income on hand of a corporation. Rather, it is a conclusion which flows from the determination as to whether the safe income in question has been used or set aside.

Our Comments:

We regret that we are unable to concur with your views as described above.

What is meant by the expression "set aside" as used in the 1988 paper is not really conclusive to the issue under consideration. The statement that if "income has been used or set aside by the corporation to pay amounts not currently deductible for tax purposes, it cannot contribute to the gain inherent in the issued shares of the corporation" provides one example of a situation where income must be on hand to be reflected in a gain inherent in a share. It was never intended to suggest that this was the only situation where the corporation's "income earned or realized" had to be reduced. The above-referenced paper by Robert J.L. Read contains the following examples of income which has not been "used or set aside" but which reduce safe income on hand:

(a)     Under the heading "Lawsuits and Similar Contingent Liabilities" it is stated that "the safe income on hand will be reduced if the potential liability has reduced the gain that would otherwise be realized on a disposition at fair market value of the shares of the corporation."

(b)     Under the heading "Income Debenture" it is stated that "(i)f it is reasonable to expect that interest (on an income debenture) that has not been accrued in the corporation's records will later be accrued or become payable, then the safe income on hand should be reduced for the estimate of the payment that will be made."

In our view the principal criterion to be looked at in determining whether a particular item included in the computation of a corporation's safe income is relevant in determining "safe income on hand' is whether that income may reasonably be considered to contribute to the capital gain inherent in the shares of the corporation. Consequently, it remains our view, as stated in our letter of February 2, 1993, that amounts such as accrued compound interest and provisions for future warranty and pension obligations will reduce the safe income on hand of a corporation if such amounts have reduced the gain that would otherwise be realized on a disposition at fair market value of a share of the corporation.

We trust these comments clarify our views on this matter.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch