16 July 1996 External T.I. 9604915 - 55(2)-NOT APPLY WHERE SALE & REDMPTION DIFFERENT SERIES.

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.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

i) Whether "income earned or realized", by a transferee on the disposition of a property ("Property") acquired on a section 85 rollover for consideration that included preferred shares, inter alia, with the following features:

i) a dividend entitlement requiring the payment of the proceeds from the sale of the Property up to a maximum amount equal to the ultimate gain realized by the transferee on the sale to an unrelated third party of the Property; and

ii) redeemable for an amount equal to the fair market value of the shares of Opco at the time of the transfer but will be reduced a dollar for every dollar of dividend described in (i) above paid on the shares

and that do not form part of a series of transactions to which subsection 55(2) may apply, could be attributable in its entirety to the preferred shares of the transferee held by the transferor.

ii) Whether subsection 55(2) would apply to a deemed dividend, pursuant to subsection 84(3), received as part of a series of transactions that is not otherwise an excepted transaction and where the corporation receiving the dividend (which is subject to Part IV tax) does not, as part of the same series of transactions that includes the deemed dividend, pay any taxable dividends entitling it to a refund of RDTOH that is attributable to its Part IV tax liability in respect of the deemed dividend received.

Position TAKEN:

i) No. "Income earned or realized" before the commencement of the series of transactions to which subsection 55(2) may apply, with respect to a share, generally constitutes safe income attributable to a preferred share to the extent permitted by the dividend entitlement. However, it would not seem possible generally to increase the safe income attributable to a share based on that share's dividend entitlement if that entitlement is accompanied by a reduced redemption value. To accept that safe income could be attributed to a share on this basis would be tantamount to accepting that the unrealized gain attributable to something other than safe income attributed to a preference share on a rollover could be reduced by a dividend subject to 55(2) by reason of safe income and this simply does not appear possible.

ii) No. 55(2) would not apply where the payment of the dividend triggering the dividend refund is not part of the series of transactions which includes the deemed dividend received. Income of a corporation can be attributed to the extent of that share's dividend entitlement.

Reasons FOR POSITION TAKEN:

i) The Department's published view is that "safe income" with respect to a share of a corporation refers to the income earned by any corporation during the holding period of a particular share of the corporation. The holding period is generally the time from the later of January 1, 1972 or the acquisition of the particular share to the time immediately before the commencement of the series of transactions or events referred to in paragraph 55(3)(a).

ii) Subsection 55(2) does not apply to the portion of a dividend received by a corporation that is subject to tax under Part IV and where:

the Part IV tax is not refunded as a consequence of payment of a dividend to a corporation, and

the payment of the dividend is not part of the series of transactions which includes the dividend received.

									5-960491
XXXXXXXXXX							P. Diguer

Attention: XXXXXXXXXX

July 16, 1996

Dear Sirs:

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

This is in reply to your letter dated February 5, 1996 in which you requested our opinion concerning a situation which we summarize hereunder.

Situation

Mr. X owns all the shares of Holdco, which is a minority shareholder of another corporation ("Opco"). A new corporation ("Newco") is created and is controlled by Mr. X through multiple voting shares. Holdco transfers the shares of Opco to Newco on a tax-deferred basis pursuant to subsection 85(1) of the Income Tax Act (Canada) (the "Act") and receives as consideration redeemable retractible preference shares (the "Shares") carrying, inter alia, a right to cumulative dividends equal to the dividends received by Newco on the shares of Opco (the "Dividend entitlement"). The aggregate redemption amount of the Shares is equal to the fair market value of the shares of Opco at the time of transfer.

There is an inherent gain in respect of the shares of Opco and there is no safe income attributable to the shares of Opco at the time of the transfer. At the time of the transfer of the shares of Opco, the adult child of Mr. X subscribes for common shares of Newco for fair market value which is a nominal amount.

The shares of Opco are sold by Newco to an arm's length person for fair market value thereby resulting in a capital gain. Newco does not have any losses. A portion of the capital gain will be added to Newco's "capital dividend account" by virtue of subsection 89(1) of the Act. Newco will also have a "refundable dividend tax on hand" as a result of the capital gain by virtue of subsection 129(3) of the Act.

The Shares are redeemed on two occasions resulting in two deemed dividends. A capital dividend election is made in respect of the first deemed dividend pursuant to subsection 83(2) of the Act. As a consequence of the second deemed dividend (a taxable dividend), Newco is entitled to a dividend refund pursuant to subsection 129(1) of the Act and Holdco will have a Part IV tax liability.

Following a review of certain technical interpretations, #5-7578, #5-8939 and #920102 (the "Interpretations"), you have concluded that it is the Department's view that none of the "income earned or realized" for purposes of subsection 55(2) of the Act ("safe income") resulting from the capital gain would be attributable to the Shares. Nevertheless, in your view, it is reasonable to attribute the income arising on the sale of the shares of Opco to an arm's length person as safe income to the Shares (up to the fair market value of the shares of Opco at the time of transfer to Newco) because only the preference shareholder (Mr. X) is entitled to these funds. The common shareholder has no prospect whatsoever of receiving those funds.

Opinion requested

You ask the following two questions:

a) Would the Department attribute safe income to the Shares if the shares of Opco had a dividend entitlement equal to (i) dividends received by Newco on the shares of Opco and (ii) the proceeds from the sale of the shares of Opco up to a maximum amount of the gain realized by Newco on the sale of the shares of Opco and the shares were redeemable for an amount equal to the fair market value of the shares of Opco at the time of the transfer but will be reduced a dollar for every dollar of dividend described in (ii) above paid on the shares.

In your view, the attribution of the safe income to the Shares with the Dividend entitlement would be in accordance with the Technical interpretations referred to above.

b) Subsection 55(2) does not apply in any event to the portion of the dividend subject to tax under Part IV that is not refunded as a consequence of the payment of a dividend to the corporation where the payment is part of the series of transactions or events described in the provision. Assuming that Holdco does not pay any taxable dividends entitling it to a refund of RDTOH that is attributable to its Part IV tax liability in respect of the deemed dividend as part of the series, would the Department consider that subsection 55(2) will not apply to the second deemed dividend.

Our comments

The situation outlined in your letter appears to relate to a specific taxpayer and involve actual contemplated transactions. As explained in Information Circular 70-6R2 dated September 28, 1990 ("IC-70-6R2"), assurance as to the tax consequences of contemplated transactions can only be obtained in the context of an advance income tax ruling. The procedures for requesting an advance ruling are outlined in IC-70-6R2. Nevertheless, we can offer the following general comments.

a) Safe income

Safe income can accrue to a share of a corporation in one of two ways:

i) the safe income of a corporation can be attributed to a share of a corporation to the extent of that share's dividend entitlement during the holding period up to the commencement of a series of transactions involving a 55(3)(a) event.

ii) on a rollover - the safe income attributable to a rolled over common share of a corporation can be attributed on a pro-rata basis to the share issued as a consequence of the roll over.

Our reply herein is premised on the understanding that the sale of the Opco shares and the redemption of the preferred shares by Newco are not part of the same series of transactions or events. In a situation such as the one described above, which we shall use for illustrative purposes, the shares rolled over have no safe income. Therefore the preference shares issued at the time of the rollover will also have no safe income immediately after the rollover. The sale of the Opco shares will give rise to safe income for Newco that could be attributed to the preference shares of Newco on the basis of their dividend entitlement.

In response to your first question, we would like to mention that while our general position is that safe income can accrue to a share to the extent of its dividend entitlement, we would not regard the amount described in (a)(ii) of your question above as a dividend entitlement, since it is accompanied by a reduction in the redemption amount. In effect, what you have described as a dividend entitlement there is simply another way of paying the redemption amount.

b) Part IV tax

Subsection 55(2) does not apply to the portion of a dividend received by a corporation that is subject to tax under Part IV where:

. the Part IV tax is not refunded as a consequence of the payment of a dividend to a corporation, or

. where the payment of a dividend triggers a refund of Part IV tax and the refund is not part of the series of transactions which includes the dividend received.

If Holdco is subject to Part IV tax on the dividend, the dividend will not be subject to subsection 55(2) unless Holdco also becomes entitled to a dividend refund as part of the same series.

Furthermore, where the Part IV Tax is refunded, the question of whether the refund occurs as part of the series of transactions or events is a question of fact upon which it is not possible to offer an opinion of a general nature.

c) Notice of Way and Means Motion

On June 20, 1996 the Honourable Paul Martin, Minister of Finance tabled a Notice of Ways and Means Motion in the House of Commons (the "Notice") that, inter alia, as set out in section 26 of the Notice, proposed changes to section 55 of the Act (the "Proposed amendments"). Included in the Proposed amendments, is a new (later) cut-off point for the period for determining safe income (the "safe-income determination time").

The new term "safe-income determination time" is added by subclause 26(2) of the Notice, and states the following:

(2) Subsection 55(1) of the Act is amended by adding the following in alphabetical order:

"safe-income determination time" for a transaction or event or a series of transactions or events means the time that is the earlier of

(a) the time that is immediately after the earliest disposition or increase in interest described in any of subparagraphs 3(a)(i) to (v) that resulted from the transaction, event or series, and

(b) the time that is immediately before the earliest time that a dividend is paid as part of the transaction, event or series.

Thus, the "safe income" attributable to a preferred share of Newco held by Holdco would, for purposes of the Proposed amendment, include its proportion of the income earned or realized by Newco, to the extent of its dividend entitlement, as computed at the "safe-income determination time".

The foregoing represents our general views with respect to the subject matter of your letter. The foregoing opinions are not rulings and in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990 and the Special Release dated September 30, 1992 are not binding on Revenue Canada, Customs, Excise and Taxation.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch