19 June 1989 Income Tax Severed Letter AC57673 - Calculation of Safe Income on Hand of Corporation Acquiring Scientific Research Tax Credit Property

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.

H.K. Tilak
19(1)                              613 957-2122

Dear Sirs:

Re: Subsection 55(2) of the Act

We are writing in response to your letter dated March 8, 1989 regarding several matters relating to the calculation of "income earned or realized", generally referred to as "safe income", for the purposes of subsection 55(2) of the Income Tax Act (the "Act"). The questions you have asked and the Department's position with respect thereto are set out below.

Scientific Research Tax Credit

You note that, typically, a corporate investor that acquires a property described in subparagraphs 127.3(2)(a)(iii) to (v) of the Act becomes entitled to a "scientific research and experimental development tax credit", within the meaning of paragraph 127.3(2)(a) of the Act, equal to 50% of the amount designated pursuant to subsection 194(4) of the Act by the issuer corporation and that, typically, the property is redeemed shortly thereafter for approximately 55-60% of the consideration paid by the corporate investor for the property.

You also note that safe income is reduced by income taxes paid or payable but that safe income is not reduced by amounts paid to acquire property. Accordingly, while it may be argued that, in the circumstances described above, the consideration paid by the corporate investor should be deducted in computing its safe income on the basis that such amounts were paid to obtain a reduction (through a tax credit) in an income tax liability of the corporate investor, you suggest that safe income need not be so reduced because the amounts expended were paid to acquire the property.

The Department's position with respect to tax credits generally is set out in a paper presented at the Fortieth Tax Conference of the Canadian Tax Foundation in Vancouver in November, 1988 ("Section 55: A Review of Current Issues" by R.J.L. Read) as follows:

"The effect that various tax credits will have on the safe income or safe income on hand of a corporation will depend on the nature of the particular credit involved, how it is claimed and the facts of a particular case. Depending on the circumstances, credits could have either a positive or negative effect on the safe income or safe income on hand calculation".

It is the Department's view that, in the circumstances described above, the safe income on hand of the corporate investor would be reduced at the time the property is acquired by the amount, if any, by which the aggregate of the amounts paid by the corporate investor to acquire the property exceed the cost of the property to the corporate investor determined pursuant to subsection 127.3(6) of the Act; any income or taxable capital gain realized at that time pursuant to paragraph 127.3(2)(b) of the Act or at any time thereafter in respect of the property by the corporate investor would, of course, increase the corporate investor's safe income at the time the income or taxable capital gain is realized.

A sample calculation of safe income on hand reflecting the Department's views expressed above is shown in an Exhibit attached to this letter.

Lease Inducement Payments

You note that certain lease inducement payments received by a corporation before May 23, 1985 may not be required to be included in computing the corporation's income for the purposes of the Act but that such non-taxable receipts would increase the corporation's retained earnings.

By analogy to the Department's position that non-deducible expenses made by a corporation to reduce the corporation's retained earnings and its safe income on hand, you have asked whether or not it is the Department's view that such non-taxable receipts would increase the corporation's safe income.

It is the Department's view that such non-taxable receipts would not increase the corporation's safe income because the amount of such receipts would not be included in the corporation's "income otherwise determined" and, hence, would not be included in the corporation's safe income as defined by subsection 55(5) of the Act. This treatment is analagous to that given to government grants that are capital in nature as described in subparagraph (XVII) on page 90 of the paper presented by J.R. Robertson at the 1981 Canadian Tax Foundation Conference. Nevertheless, it is the Department's view that non-deductible expenses should be deducted in computing the corporation's safe income on hand because, generally, amounts paid on account of such expenses cannot contribute to any unrealized gain on the shares of the corporation.

Non-Taxable Dividends

You note that some corporations have created two classes of common shares with one such class being entitled to taxable dividends for the purposes of the Act and the other being entitled to dividends that are not taxable dividends for the purposes of the Act. It is you understanding that, in the Department's view, the safe income of the corporation, before any dividends on any shares of thecorporation, is to be allocated between the two classes of common shares proportionately to the value of the interest in the company represented thereby and that the safe income so allocated to aparticular class of common shares is to be reduced by any taxable dividends paid on the shares of the particular class.

We do not confirm your understanding of the Department's views regarding the allocation of safe income to each class of shares in such circumstances. It is the Department's view that, generally, in the circumstances described, all dividends paid by the corporation on all of its shares are to be deducted in computing the safe income of the corporation and that the safe income of the corporation so determined is to be allocated to all of its shares proportionately to the value of the interest in the corporation represented by each such share.

The value of the interest in the corporation represented by any particular share is a question of fact that can only be determined by reference to the terms and conditions attaching to the particular share.

These comments represent our general views with respect to the subject matter of your letter. The facts of a particular situation may result in a different conclusion. The foregoing comments are not rulings and in accordance with the guidelines set out in Information Circular 70-6R dated December 18, 1978, are not binding on the Department.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch

                            EXHIBIT

                   Calculation of Safe Income
                  Where SRTC property acquired

Example

Corporate taxpayer that has operating income of $10,000,000 acquires an SRTC property described in subsection 127.3(2)(a)(iii) to (v) of the Act for consideration equal to $4,000,000 and becomes entitled to a tax credit, within the meaning of paragraph 127.3(2)(a) of the Act, equal to $2,000,000. The SRTC property is disposed of for $2,300,000 at some later time.

Operating Income                                    $10,000,000

   less - Tax @ 48%   $4,800,000
        - Tax Credit   2,000,000
        - Net Tax     $2,800,000                     (2,800,000)

less Net Outlay for SRTC property not deducted in computing operating income

        - Consideration Paid    $4,000,000
        - Cost (ss. 127.3(6))    2,000,000
        - Net Outlay            $2,000,000           (2,000,000)

Safe Income on Hand immediately 
after acquisition of SRTC property                   $5,200,000

Gain on Disposition of SRTC property

       - Non Taxable Gain (1/3) $100,000
       - Taxable Cap. Gain       200,000
       - less Tax @ 48%          (96,000)
       - Net increase in 
         Safe Income            $204,000                204,000

Safe Income on Hand immediately
after disposition of SRTC property                   $5,404,000