CRA indicates that a discretionary dividend will not reduce safe income attributable to the other class of discretionary dividend shares to the extent the dividend is taxable under s. 55(2)

Opco has safe income of $1M, an aggregate fair market value of $2M and two unrelated corporate shareholders holding equal numbers of Class A and B discretionary dividend common shares which they both had acquired on incorporation for nominal consideration. Rather than repurchasing the Class B shares of the second shareholder for $1M, Opco pays a dividend of $1M on the Class B shares and repurchases all those shares for nominal consideration.

Provided that the Class A shares continue to have a FMV of $1M and the FMV of the Class B shares was reduced by the $1M amount of the discretionary dividend, CRA would consider it to be reasonable to allocate $500,000 of the Opco safe income to the Class B shares, so that s. 55(2) would apply to $500,000 of the $1M dividend. CRA also stated:

The dividend of $1M would normally reduce the subsequent safe income on hand. However, we accept that the separate taxable dividend that was subject to subsection 55(2) did not reduce the safe income on hand of Opco.

Based on this administrative position, the safe income attributable to the Class A shares would be $500,000 (see also 2015 CTF Roundtable, Q. 6(c)).

CRA added the following gratuitous comment:

[T]he use of discretionary dividend shares could have an adverse effect if a butterfly transaction was contemplated in a particular situation. Indeed, given the uncertainty in the valuation of discretionary dividend shares, it could be more difficult to satisfy the conditions for there being a distribution, as defined in subsection 55(1)… .

Neal Armstrong. Summaries of 27 April 2016 T.I. 2016-0633101E5 Tr under s. 55(2.1)(c) and s. 55(1) – distribution.