Phantom deductions might increase safe income through offsetting phantom income or non-deductible cash outflows

CRA, departing from Kruco, is now considering that “phantom” income (i.e., income for ITA purposes not resulting in tangible cash inflows) should no longer be included in computing safe income. Although CRA has not publicly addressed the treatment of phantom deductions (i.e., deductions reducing net income but not corresponding to a cash outflow), the ARQ has indicated that no adjustment should be made in computing safe income by taking a phantom deduction into account.

However, it could be argued that a phantom deduction can offset an element that otherwise reduces safe income. For example, where a corporation had income of $1 million, phantom income of $60,000, and a phantom deduction of $80,000 (so that its net income was $980,000), it would seem unreasonable to exclude the $60,000 of phantom income from safe income without offsetting it by at least an equivalent portion of the phantom deduction ($60,000): all the net income of $980,000 can reasonably be regarded as contributing to the capital gain on the shares.

In a second example, where Opco has revenue of $1 million, tangible expenses of $200,000 and a phantom deduction of $150,000 so that its net income is $650,000, and it pays taxes of $150,000, one can consider that the phantom deduction offsets the taxes payable (which otherwise would reduce the safe income attributable to the shares), and that $650,000 ($650,000 net income + [$150,000 phantom deduction − $150,000 tax]) is the resulting safe income contributing to the capital gain on the shares.

Neal Armstrong. Summary of Marc-Antoine Mongrain and Jean-François Thuot, “Income, Phantom Income, and Phantom Deductions,” Canadian Tax Focus, Vol. 15, No. 1, February 2025, p. 2 under s. 55(2.1)(c).