14 November 1985 Income Tax Severed Letter 5-8077 - [Section 55 of the Income Tax Act]

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.

XXXX D. Holtz (613) 993-6201

November 14, 1985

Dear Sirs:

Re: Section 55 of the Income Tax Act

This is in reply to your letter of October 10, 1985 wherein you requested confirmation of your understanding of the computation of "income earned or realized . . . after 1971" for the purposes of subsection 55(2) of the Act. To illustrate your understanding, you presented the following hypothetical example:

Taxable income                                                      $ X

Less non-deductible items: 
   Crown royalties - S.18(1)(m)                     $ X 
   Mineral Taxes - S.18(1)(m)                         X 
   Crown lease rentals - S.18(1)(m)                   X 
   Phantom income - S.69(6) tax   and (7)             X 
   Petroleum and gas revenue tax                      X 
   Incremental oil revenue disallowed                 X 
   Interest and penalties                             X 
   Political donations                           
    -S.18(1)(l)                                       X
   Other non-deductible expenses                      X               X
                                                     --              --
                                                                      X
Less current income taxes: 
   Federal (net of investment tax credit)             X     
   Provincial (after provincial credits and      
    rebates, including Alberta royalty tax 
    deduction and Alberta royalty tax credit)         X               X
                                                     --              --
                                                                      X             
Less dividends paid                                                   X
                                                                     --  
                                                                      X 
Add: 
   Half of capital gains (net of capital losses)      X 
   Dividends received                                 X
   Taxable incremental oil revenue -S.81(1)(r)        X     
   Resource allowance -S.20(1)(v.l)                   X 
   Depletion Allowance -S.65                          X               X
                                                     --              -- 
Post-1971 income earned or realized                                 $ X
reasonably attributable to capital gain                             === 

The Department's views on the principles employed in the calculation of income earned or realized after 1971 ("safe income") were stated at the 1981 Canadian Tax Foundation and are published in the 1981 Conference Report. The position was subsequently updated at the 1984 Corporate Management Tax Conference.

With respect to the example contained in your letter, we cannot offer confirmation of your calculation as there may be other items of which we are not aware. However, viewing your example in isolation, we agree with the results of your calculation subject to the following:

- losses incurred after 1971 would be deducted in determining the amount of a gain attributable to "safe income"

- dividends received will be included in the "safe income" of the recipient if received out of the "safe income" of a subsidiary.

- the addition of one half of the difference between capital gains and capital losses is made for resident corporations which are not private.

It should be noted that the amount of "safe income" calculated must be on hand when a "safe dividend" is paid. As mentioned at the 1981 Canadian Tax Foundation there could be cases where a computation of "safe income" results in an amount greater than that which could be paid as a "safe dividend". Subsection 55(2) addresses the payment of a dividend which would result in a reduction in the portion of the capital gain attributable to something other than income earned or realized after 1971. Consequently, to ensure that adverse income tax consequences do not arise on the payment of a dividend, it is first necessary to analyze the Potential gain referred to in the preamble to subsection 55(2). If any part of the gain is attributable to anything other than income earned or realized (i.e. appreciation in the value of assets, goodwill, etc.) then any dividend which reduces that portion of the gain may be subject to the provisions of subsection 55(2).

We trust that the foregoing will be of assistance.

Yours truly,

Chief Corporate Reorganizations Section Reorganization and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch