Subsection 55(2)

Cases

Ottawa Air Cargo Centre Ltd. v. The Queen, 2007 DTC 661, 2007 TCC 193, aff'd 2008 DTC 6177, 2008 FCA 54

Lamarre J. rejected the taxpayer's submission that deemed dividends received by the taxpayer were "subject to" Part IV tax in the sense that the taxpayer could have remitted Part IV tax on those taxable dividends and thus would have been entitled to a refund of Part IV tax. The taxpayer, in fact, did not do this and instead applied non-capital losses against an assessment of Part IV tax when it was made by the Minister on the basis that s. 55(2) did not apply to the deemed dividends. Lamarre J. found (at para. 21) that "the requirement of an actual refund of Part IV is mandatory for the dividend to be re-characterized as a capital gain under subsection 55(2)".

Canada v. VIH Logging Ltd., 2005 DTC 5095, 2005 FCA 36

stub income included in SIOH/$45K out of $1.7M not significant

Cash dividends paid by a corporation ("Old VIH") to its parent (the taxpayer) in February 1993 came out of safe income of Old VIH given that the computation of Old VIH's safe income included significant income that it had earned after its last fiscal year end (March 31, 1992) and before the date of payment of the dividends. Sharlow J.A. stated (at p. 5101) that

"It does no violence to the language of subsection 55(2) to interpret the phrase 'before the commencement of the series of transactions' to mean 'immediately before the commencement of the series of transactions', rather than 'as of the end of the fiscal year ending before the commencement of the series of transactions', as the Crown contends."

In addition, it was open to the trial judge to find that a stock dividend paid shortly after the payment of the cash dividends, and which reduced the capital gain on a subsequent sale of the shares Old VIH by approximately $45,000, did not result in a significant reduction of the capital gain realized on such sale in the context of transactions which involve dividends totaling over $1.7 million.

Words and Phrases
before

Canada v. Canadian Utilities Ltd., 2004 DTC 6475, 2004 FCA 234

The two taxpayers, which were subject corporations, indirectly sold their investment in another public corporation ("ATCOR"). This was accomplished by their common shares of ATCOR being exchanged on the amalgamation of ATCOR with a newly incorporated subsidiary of a related corporation for Class A or B non-voting redeemable shares of the amalgamated corporation having a paid-up capital approximating the respective adjusted cost base of their ATCOR common shares, with the special shares then being redeemed. The Part IV tax payable on the deemed dividends arising on this redemption was refunded because of normal-course dividends paid by the taxpayers to their shareholders that year (and, in one case, the following year).

In finding that the subsequent normal course dividends were part of the same common law series of transactions as the amalgamation/redemption transactions, Rothstein, J.A. stated (at para. 67):

"the fact that CU COH intended to use both the ATCOR/Forest transactions and the normal course dividends to achieve their tax avoidance objective, that they had the ability to ensure that all the transactions would occur, and that all the transactions did indeed occur as intended are sufficient to constitute them all part of a common law series for the purposes of subsection 55(2). It is of no consequence that one or more of the transactions had an independent purpose and existence."

Lamont Management Ltd. v. The Queen, 2000 DTC 6256 (FCA)

safe income on non-FA included

Safe income attributable to shares of a Canadian corporation ("Canpac") that were purchased for cancellation in the hands of the taxpayer included safe income of a foreign corporation in which Canpac had an indirect equity interest of less than 10% and which did not qualify as a foreign affiliate of Canpac. There was no absurdity in safe income attributable to a foreign non-affiliate being calculated without reference to the specific rules applicable to other types of corporations under s. 55(5).

Words and Phrases
any

Canada v. Brelco Drilling Ltd., 99 DTC 5253 (FCA)

exempt deficits reduced safe income on hand

The U.S. subsidiary of the taxpayer, in turn, owned seven U.S. resident corporations five of whom had exempt deficits and two of whom had exempt surpluses. The trial judge found that the taxpayer was required to deduct the exempt deficits in computing its safe income for purposes of subsection 55(2). Before remitting the matter back to the Tax Court to hear evidence as to whether any factors reduced the safe income on hand, Linden J.A. stated (at p. 5260):

"The literature ... unanimously accepts that section 55(2) requires a calculation of safe income on hand, not exempt income generally ... . It is by definition a net calculation which begins with the deemed income in the section 55(5), but which does not end there." [See also Brelco Drilling Ltd. v. The Queen, 2000 DTC 1482 (TCC).]

The Queen v. Nassau Walnut Investments Inc., 97 DTC 5051 (FCA)

late s. 55(5)(f) designation available

Although it had been planned that the portion of deemed dividends received by the taxpayer (arising on the redemption of shares held by it) that did not come out of safe income would be subject to a designation under s. 55(5)(f), all of such amounts were reported by the taxpayer in its return as deemed dividends due to an error by a subsequently-appointed accounting firm. Before going on to find that a late designation under s. 55(5)(f) was available to the taxpayer (or, what might amount to the same thing, that there was a right of the taxpayer to amend its return to reflect the safe income on hand - and noting, at p. 5057, that "the Act itself implicitly recognizes that a designation and an election are not one and the same"), Robertson J.A. found that the assumption of the Minister that the safe income earned by the redeeming corporation should be allocated pro rata amongst all the shares in its capital (with the result that only a pro rata portion of the safe income was applicable to the shares that were redeemed in the hands of the taxpayer) was reasonable.

The Queen v. Placer Dome Inc., 96 DTC 6562 (FCA)

After the taxpayer solicited competing bids for the sale of a significant block of shares it held in another public company ("Falconbridge") both directly and through a holding company ("McIntyre"), it accepted an offer of Falconbridge that required Falconbridge to declare and pay a significant dividend on all the outstanding shares of Falconbridge, and (following the payment of a corresponding dividend by McIntyre) to purchase the shares of Falconbridge and McIntyre held by the taxpayer. The only purpose of the dividends was to permit Falconbridge to make an offer that effectively approximated 118% of the previous market price of the Falconbridge shares (and that exceeded the 115% of the market price which the other bidder could have paid without triggering the statutory requirement for a follow-up offer to the other Falconbridge shareholders). Accordingly, given that the purpose of the transactions was to be determined having regard to the actual state of mind of the taxpayer, rather than its purpose in some objective sense, s. 55(2) did not apply.

In the Tax Court, Bell TCJ. stated (96 DTC 1787 at 1794) that the taxpayer "had not participated in the creation and structure of the Falconbridge bid" and that "that finding alone renders it impossible to conclude that one of the purposes of the Appellant was to effect a significant reduction of the capital gain to be realized".

Words and Phrases
purpose

CPL Holdings Ltd. v. The Queen, 95 DTC 5253 (FCTD)

The two individual shareholders of a corporation operating a machine shop ("Clem Industrial") transferred all their shares of Clem Industrial to the taxpayer (which was a newly-incorporated holding company) in consideration for high-low shares of the taxpayer. They then caused Clem Industrial to pay a large dividend (virtually equal to the fair market value of its outstanding shares) to the taxpayer, which then lent the proceeds back to Clem Industrial in consideration for a demand debenture.

The taxpayer was able to establish that the purpose of these transactions was to make the taxpayer (and therefore, indirectly, its individual shareholders) secured creditors of Clem Industrial which, at the time, was named in a law suit. Accordingly, s. 55(2) did not apply notwithstanding that after the completion of the transactions, 49% of the shares of Clem Industrial were sold by the taxpayer for a nominal amount to an arm's length individual (the foreman of the machine shop).

Locations of other summaries Wordcount
Tax Topics - General Concepts - Onus 61

See Also

D & D Livestock Ltd. v. The Queen, 2013 DTC 1251 [at 1412], 2013 TCC 318

After a preliminary reorganization, all of the shares of the taxpayer (consisting of Class A common shares and Class D preference shares) were owned by another Canadian corporation ("HLL"), whose safe income on hand ("SIOH") respecting the taxpayer was $1.493M, comprised of safe income earned by the taxpayer of $0.976M and safe income of $0.517M in respect of the taxpayer's 50% shareholding of another Canadian corporation ("RTI"). Then:

  1. The taxpayer paid a stock dividend ("Stock Dividend 1") in the amount of $1.465M to HLL by issuing Class A shares to HLL with a stated capital of that amount in satisfaction of the dividend (thereby increasing the adjusted cost base ("ACB") of HLL's Class A shares of the taxpayer to $2.72M.)
  2. HLL transferred all its (Class A and D) shares of the taxpayer on a s. 85(1) rollover basis to a newly-incorporated subsidiary (Newco) in consideration for Class A common and Class D preference shares of Newco (so that under s. 85(1)(g) essentially all the ACB of the transferred shares, including the stepped-up ACB of the transferred Class A shares, was allocated to the cost to HLL of the Class D preference shares of Newco, which was $3.47M).
  3. HLL transferred it Newco Class D preference shares on a s. 85(1) rollover basis to a newly-incorporated subsidiary (Newco 2) in consideration for Class A common shares of Newco 2 ( having a deemed cost under s. 85(1)(h) of $3.47M.)
  4. Newco 2 satisfied a dividend of $3.47M to HLL by transferring its Class D preference shares of Newco to HLL.
  5. The taxpayer transferred its shares of RTI on a s. 85(1) rollover basis to a newly-incorporated subsidiary (Newco 3) in consideration for Class A common shares of Newco 3 (having a cost under s. 85(1)(h) of $0.50M.)
  6. Newco 3 paid a stock dividend ("Stock Dividend 2") in the amount of $0.52M to the taxpayer by issuing Class A shares to the taxpayer (and made s. 55(5)(f) designations for such dividend to be deemed to be 10 separate taxable dividends), thereby increasing the ACB of the taxpayer's Class A shares of Newco 3 to $1.02M.)
  7. Newco and the taxpayer were wound up.
  8. HLL transferred its Class A common shares of Newco 3 on a s. 85(1) rollover basis to Newco 2 in consideration for Class A common shares of Newco 2, thereby resulting in the ACB of HLL's Class A shares of Newco 2 being increased from $3.47M (see 3 above) to $4.49M under s. 85(1)(h) (see 6 above).
  9. Newco 3 was wound up.
  10. HLL transferred its Class A common shares of Newco 2 to a subsidiary (HLAL) on a s. 85(1) rollover basis in consideration for Class A common shares of HLAL.
  11. Newco 2's only asset was its 50% shareholding in RTI. HLAL sold its shares of Newco 2 to the other 50% shareholder of RTI for $7.05M, with a capital gain of $2.,566M being reported based on the $4.49M ACB in 8 above (i.e., such capital gain was reduced by the amount of both Stock Dividend 1 and 2).

The parties agreed that Stock Dividend 1 (see 1) reduced the SIOH of HLL in its shares of the taxpayer by $1.465M. At issue was whether Stock Dividend 1 also reduced the SIOH of the taxpayer on its shares of RTI, thereby reducing its SIOH in respect of the Newco 3 shares which were substituted therefor (see 5). CRA considered that such reduction occurred, so that virtually none of Stock Dividend 2 came out of SIOH of the taxpayer respecting its shares of Newco 3 (see 6). The capital gain reported by a successor of the taxpayer on a sale (see 11) of shares of a successor of Newco 3 (namely, shares of Newco 2) was reduced by the bump in the adjusted cost base of the shares of Newco 3 for the amount of Stock Dividend 2, as this bump carried over to the adjusted cost base of such shares of Newco 2– see 8). (The adjusted cost base of such shares of Newco 2 already effectively reflected the basis bump from Stock Dividend 1 as a result of the above series of transactions - see 2 and 3.) Accordingly, CRA had assessed the taxpayer on the basis that s. 55(2) applied to Stock Dividend 2.

In rejecting CRA's position, Graham J stated (at para. 31):

The shares in RTI had value because of the income earned by that company after 1971. That income had not been removed from RTI by way of dividend. The fact that a stock dividend (i.e. Stock Dividend 1) was declared by the [taxpayer] did nothing to change the fact that the shares in RTI obtained their value from the income earned by RTI after 1971.

729658 Alberta Ltd. v. The Queen, 2004 DTC 2909, 2004 TCC 474

transfer of safe income in a non-rollover transaction

Each of the two individual taxpayers, who owned one-half of the shares of a Canadian-controlled private corporation ("Comcare") having an accrued gain of approximately $12.4 million and safe income of approximately $1.9 million, transferred his shares of Comcare to his own newly-incorporated holding company ("Holdco") in consideration for a promissory note and common shares of Holdco, thereby realizing a deemed dividend of approximately $10.4 million. Comcare then paid taxable dividends of $1.9 million to the two Holdcos, and the two Holdcos each sold its shares of Comcare to a third-party purchaser for approximately $10.4 million.

Woods J. accepted the taxpayers position that all of the dividends paid by Comcare to the Holdcos should be considered to come out of safe income and rejected the position of the Minister that only one-sixth of the $1.9 million safe income had been inherited by the Holdco. Woods J. noted (at p. 2913) that "the accepted approach is that gain is first allocated to 'income earned or realized' and, only if dividends exceed this amount, is gain allocated to 'unrealized appreciation in the value of underlying assets'; and in these transactions no tax had been avoided as the individuals had received a deemed dividend equal to the accrued gain on the Comcare shares that was not represented by safe income.

Kruco Inc. v. The Queen, 2001 DTC 668 (TCC), aff'd 2003 FCA 284

phantom income position rejected

The safe income of a corporation ("Kruger") from which the taxpayer received a deemed dividend did not exclude income resulting from investment tax credits (which produced income inclusions under s. 12 (1)(t) or reduced capital cost allowance claims by virtue of ss.13(7.1)(e) and 13(21)(f)(vii)). With respect to the position of the Minister that amounts that do not constitute actual income earned ("phantom income") should not be considered as safe income, Dussault T.C.J. indicated that this position failed to reflect that income for tax purposes is not a logical and coherent concept that reflects reality and that the wording of s. 55(2) (and, in particular, s. 55(5)(c)) "does not permit any such orientation in the name of a perhaps desirable but non-existent realism" (p. 685). Furthermore, the approach of the Minister would result in double taxation (as a capital gain in the hands of the taxpayer) of amounts that had already been taxed to the corporation.

However, the safe income of the corporation was reduced by the excess of the $4 million purchase price for an SRTC debenture over the amount of the debenture. Dussault T.C.J. noted (at p. 686) that this excess was "the equivalent of a non-deductible expense and thus must logically be adjusted".

Granite Bay Charters Ltd. v. The Queen, 2001 DTC 615 (TCC)

After the individual shareholders ("Cox") of the taxpayer and a related corporation ("Greenstone") had entered into an agreement for the sale of Greenstone to a third party ("Dougan"), Greenstone transferred its non-logging assets to the taxpayer as redemption proceeds for shares of Greenstone held by the taxpayer. When the sale transaction with Dougan fell through, an agent, who for some time had been informally acting on behalf of Cox to find a buyer for Greenstone, identified another purchaser to whom the shares of Greenstone were sold some months later.

In finding that the deemed dividend arising on the share redemption occurred as part of the series of transactions resulting in the disposition of the Greenstone shares to the ultimate purchaser, Bowie J. stated (at pp. 620-1):

"... a change in the identity of the purchaser, where the intention to sell remained intact throughout and the hiatus is as short as this one, cannot divorce the share redemption from the subsequent sale of the Cox shares. .... To conclude that no nexus existed between the corporate reorganization and the redemption of the Greenstone shares in December or January and the sale of the Cox shares in February would be to ignore the obvious tax-avoidance purpose of subsection 55(2), as well as the words of subsection 248(10)."

Lamont Management Ltd. v. The Queen, 99 DTC 871 (TCC)

In light of the specific code provided in s. 55(5), it was found that the safe income attributable to shares redeemed in the hands of the taxpayer did not include safe income earned by a U.S. corporation in which the taxpayer was indirectly invested because that corporation was not a foreign affiliate. This was so notwithstanding that "the word 'any' is all-embracing and ... in its natural meaning it excludes limitations" (p. 877).

943963 Ontario Inc. v. The Queen, 99 DTC 802 (TCC)

Part IV tax dividend included safe income dividend

The taxpayer (a Canadian-controlled private corporation) received $1.2 million upon the purchase for cancellation of shares, having a paid-up capital of $732, of a connected corporation (HSP), thereby realizing a deemed dividend (before any application of s. 55(2)) of $1,199,268 (which it subdivided into 10 separate deemed dividends under s. 55(5)(f), the first eight of which totalled to the estimated applicable safe income on hand of $252,265, and the ninth of which was the $566,920 amount of the dividend subject to Part IV tax). In calculating the portion of the deemed dividend that, in turn, was deemed to be proceeds under s. 55(2), the Minister subtracted the Part IV tax dividend amount of $566,920 from $1,200,000 to arrive at $633,080, so that the taxpayer's capital gain was $303,378 based on its adjusted cost base of $329,702. The Minister (contrary to the taxpayer's approach) did not make a further deduction for the safe income amount as this was included in the dividend subject to Part IV tax.

In rejecting a submission (at para. 19) of the taxpayer "that a taxpayer has the right to designate which portion of a dividend that will or will not be subject to Part IV tax," and in confirming the Minister's calculation, Rip J stated (at para. 29) that "paragraph 55(5)(f) is silent with respect to any allocation of the Part IV tax among the designated dividends" and (at para. 31):

It is readily apparent that Part IV tax is exigible on receipt of the first dollar of dividend, on the facts at bar, on amounts first totalling $566,920. Safe income is not safe from Part IV tax.

Meager Creek Holdings Ltd. v. The Queen, 98 DTC 2073 (TCC)

Two Canadian corporations owned by the taxpayer paid significant dividends to the taxpayer shortly before the February 1990 federal Budget on the advice of their accountant who feared the introduction of a tax on intercorporate dividends. Six months later, discussions were held with respect to a potential sale of the corporations, and a sale of one-third of the shares occurred a few months later. In finding that the February 1990 dividends were not part of a series of transactions that included the sale, O'Connor TCJ. stated (at p. 2078) that he could not accept the Crown's submission "that any possible or future sale can suffice to bring subsection 55(2) into play".

Brelco Drilling Ltd. (Formerly Trimac) v. The Queen, 98 DTC 1422 (TCC)

The taxpayer, in computing the safe income attributable to its shares of another corporation ("Tricil") was not required to deduct the exempt deficits of various foreign affiliates of Tricil, and was entitled to include the exempt surpluses of other foreign affiliates of Tricil.

Les Placements E&R Simard Inc. v. The Queen, 97 DTC 1328 (TCC)

On September 10, 1988, the taxpayer transferred its assets to a subsidiary ("Alimentation 1988") in consideration for a demand promissory note and 506,125 Class B shares having a redemption value of $1 per share and nominal paid-up capital. 151,125 of the Class B shares were redeemed in the fiscal years of Alimentation 1988 ending on May 31, 1990, 1991 and 1992.

After finding that the redemption of the shares did not occur as part of the same series of transactions that included the September 10, 1988 sale transaction, Tardiff TCJ. found that there was no safe income attributable to the Class B shares because they had a fixed redemption amount, and, accordingly, could not participate in the earnings of Alimentation 1988.

Deuce Holdings Ltd. v. The Queen, 97 DTC 921 (TCC)

Bell TCJ. found that the safe income of the corporation in question should be computed on an after-tax basis, but should not be reduced by a retiring allowance whose payment had not been agreed to by the parties until after the period of time from which safe income was to be computed.

Gestion Jean-Paul Champagne Inc. v. MNR, 97 DTC 155 (TCC)

In connection with a buy-out of an individual's interest in a corporation ("Champagne") by his brother, the individual and his wife transferred their shares of Champagne to a newly-incorporated holding company, following which Champagne redeemed the transferred shares.

Lamarre Proulx TCJ. found that considering all the retained earnings of Champagne to be attributable to the redeemed shares ran counter to the corporate law principle of the equality of shares and the purposes of s. 55(2), and found that the safe income of Champagne should be prorated among the shareholdings.

454538 Ontario Ltd. v. MNR, 93 DTC 427 (TCC)

Two brothers (the "Mazzoccas"), who constituted two of the three equal shareholders of a corporation ("Tri-M"), transferred their shares of Tri-M on a partial rollover basis to two holding companies and caused the two holding companies to purchase the shareholding of the third shareholder ("Manley"). Immediately thereafter, an arm's length purchaser ("461") lent money to Tri-M sufficient for it to pay a dividend to the two holding companies equal to the estimated accounting retained earnings of Tri-M, following which 461 purchased the shares of Tri-M held by the two holding companies for a reduced purchase price.

In confirming reassessments by the Minister which included the amount of the dividends in the proceeds of disposition realized by the holding companies, Sarchuk J. rejected submissions inter alia:

  1. that the transactions were grandfathered on the basis that they occurred as part of a series of transactions or events which commenced prior to April 22, 1980 the evidence disclosed that "there was no serious intention on the part of the Mazzoccas to dispose of their interest in Tri-M prior to late summer and fall of 1980" (p. 431);
  2. that the reference to "income earned or realized" was ambiguous and therefore should be interpreted in the taxpayers' favour to refer to accounting retained earnings (it was clear in light of the wording of ss.55(5)(c) and in light of the decision in Mattabi Mines Ltd. v. MNR, [1988] 2 CTC 294, [1988] 2 S.C.R. 175 that "income" referred to income determined in accordance with the Part I of the Act); and
  3. that s. 55(2) was void for uncertainty (the problems in application of s. 55(2) were "not surprising given the complexity of the subject matter" and it could not be concluded that it was "couched in such vague or general language that it does not contain an intelligible standard" (p. 437)).

Administrative Policy

29 November 2016 CTF Roundtable Q. 4, 2016-0671491C6 - 55(2) and Part IV Tax

repeal of the s. 55(2) exemption, for dividends for which the Part IV tax is refunded on on-payment to an individual shareholder, busts integration

A dividend is received by Holdco from an Opco, which under the new s. 55(2) rules is no longer exempted from s. 55(2) even though the Part IV tax to which it was subjected is refunded on on-payment as a dividend to the individual shareholder. The high rate of resulting combined tax cannot be alleviated by treating such s. 55(2) application as permitting an election to treat the applicable portion of the individual shareholder’s dividend as a capital dividend. Instead, such capital gain only generates capital dividend account for use for future dividends.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 89 - Subsection 89(1) - Capital Dividend Account - Paragraph (a) s. 55(2) application to dividend as a result of a Pt IV tax refund does not generate CDA for on-payment of that dividend 269

9 October 2015 APFF Roundtable Q. 15, 2015-0595641C6 F - Surplus Stripping and GAAR

GAAR did not apply where a taxpayer deliberately triggered the application of s. 55(2)

Less overall tax is paid if, rather than Opco paying a taxable dividend to one of its shareholders (A, an individual), A rolls his shares into a new Holdco, Opco redeems the shares now held by Holdco (but without any s. 55(5)(f) designation being made by Holdco so that all of the redemption proceeds are subject to capital gains treatment under s. 55(2)), and then Holdco pays a capital dividend to A. CRA commented:

[T]he GAAR committee…recommended that the GAAR not be applied [in a similar file] having regard to the current state of the jurisprudence.

Nonetheless, the CRA is concerned by this type of tax planning, which in particular, is contrary to the integration principle. Accordingly, we have brought our concerns…to…Finance.

[See also 16 June 2014 STEP Roundtable Q. 7, 2014-0522991C6.]

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) GAAR did not apply where a taxpayer deliberately triggered the application of s. 55(2) 125

9 October 2015 APFF Roundtable Q. 12, 2015-0595601C6 F - Proposed legislation - subsection 55(2)

no relief under new rules where Part IV tax is refunded on payment of dividend to individual shareholder

Holdco holds shares of Opco with a nominal ACB and no safe income. In a corporate reorganization "aimed at protecting the assets of Opco, whose purpose is to reduce the fair market value (FMV) of Holdco’s shares in Opco," Holdco lends money to Opco equal to the accrued gain on the shares (of $1M), and receives that money back as an actual $1M dividend. It does not matter if this transaction has no capital gains avoidance purpose. CRA accepted that since the purpose of the creditor-proofing is to reduce the fair market value of the Opco shares, the full amount of the dividend is deemed to be a capital gain. Furthermore, there is no relief if the dividend from Opco is subject to Part IV tax, but this tax is refunded as a result of payment of an equivalent dividend to the individual shareholder of Opco. Under the new rules, it does not matter that the individual is not a corporation eligible for the s. 112(1) deduction, so that the dividend amount will still be deemed to be a capital gain.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) transaction targeted at reducing FMV of Opco shares for creditor-proofing was caught 245

14 May 2015 CLHIA Roundtable Q. 5, 2015-0573821C6 - Safe income

policy premiums reduce SIOH only if they do not increase CSV

Prior to a sale by Holdco of all the shares of Opco to an arm's length purchaser for $1,000,000, Opco will transfer its interest in the Policy on the life of Mr. X (the sole shareholder of Holdco) to Holdco as a dividend-in-kind. The Policy has a nil ACB, $200,000 FMV, $100,000 CSV and $1,000,000 death benefit. What will be the impact of the dividend-in-kind on the computation of safe income on hand?

Timing of addition to SIOH

After noting that Opco would be deemed by ss. 148(7) and (9) to receive proceeds of disposition equal to the Policy's CSV rather than FMV, CRA stated:

[T]he safe-income determination time for the Dividend-in-Kind… is the time that is immediately before the time that the Dividend-in-Kind is paid to Holdco. Because the income inclusion resulting from the disposition of Opco's interest in the Policy…will be added to Opco's safe income after the Dividend-in-Kind is paid to Holdco, it will not contribute to the capital gain that could be realized on a disposition at fair market value of an Opco share immediately before the time the Dividend-in-Kind is paid.

Effect of non-deductible policy premium on SIOH

After noting that "premiums payable by a taxpayer under a life insurance policy are generally considered to be on account of capital" and referencing "the payment of premiums on the Policy over the period throughout which Opco was a private corporation," CRA stated:

The portion of such premiums that contributes to the increase of the cash surrender value of the Policy would be considered to be on hand at the safe income determination time to the extent that it contributes to the accrued capital gain on a share of the capital stock of Opco at that time. … However, the portion of such premiums that does not contribute to the increase of the cash surrender value of the Policy at that time will not be on hand at the safe income determination time and would therefore reduce the amount of safe income that could reasonably be considered to contribute, immediately before the Dividend-in-Kind, to the accrued capital gain on the Opco shares on which that dividend is received.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 148 - Subsection 148(7) distribution to shareholder at CSV 141

10 October 2014 APFF Roundtable, 2014-0538061C6 F - Revenu protégé et fiducie

valid allocation of safe income dividend by discretionary trust to corporate beneficiary

A discretionary trust (the "Trust"), whose beneficiaries were A, A's spouse, their children and a corporation ("Holdco") all of whose participating and voting shares were held by A, received a dividend on its shareholding (being all the non-voting common shares) in Opco, and distributed that dividend to Holdco, making a s. 104(19) designation, and with Holdco claiming a s. 112(1) deduction for its income inclusion under s. 104(13). The Opco dividend amount equalled the safe income on hand respecting the Trust's shares, and no Part IV tax was payable (by virtue inter alia of A being the sole voting shareholder of Opco).

Should the dividend be recognized in the calculation of Holdco's safe income? After noting the availability and making of the s. 104(19) designation in respect of the dividend which was included in Holdco's income under s. 104(13), CRA stated (TaxInterpretations translation):

[I]t would be reasonable to consider that the amount of the dividend allocated to Holdco by virtue of subsection 104(19) which was included in the computation of its income, would increase its safe income by an equivalent amount.

27 June 2014 External T.I. 2013-0498191E5 F - Interaction entre 55(2) et l'impôt de partie IV

s. 55(2) tax on cross-redemption deemed dividends between connected CCPCs gave rise to circular Part IV tax

On a cross-share redemption between two connected Canadian-controlled private corporations, neither of which has a refundable dividend tax on hand account account immediately before the redemption, each corporation is deemed to receive a dividend from the other. Does the application of s. 55(2) to the deemed dividend received by each corporation, which generates an addition to its RDTOH account and, therefore, generates a dividend refund to it and associated Part IV tax on the deemed dividend paid by it to the other corporation, engage the exclusion from s. 55(2) for dividends which are subject to Part IV tax – or does the Part IV tax exclusion not apply so that s. 55(2) applies to the full amount of the deemed dividend received by each corporation? CRA stated (TaxInterpretations translation):

[I]n accordance with sections 129 and 186, it is provided that the dividend refund, the RDTOH account and thus the Part IV tax of a given corporation are calculated as a function of all relevant amounts in this regard for the whole taxation year.

Furthermore … in … 943963 Ontario Inc. … the parties … and the Court accepted that there was a given amount subject to Part IV tax by the appellant, the dividend recipient, notwithstanding that a part of the deemed dividend…was deemed to not be a dividend received, by virtue of subsection 55(2). In other words, the part of the dividend giving rise to a capital gain by virtue of subsection 55(2) did not affect the amount of the "assessable dividend" taken into account for calculating the Part IV tax payable… . The application of subsection 55(2) in that case did not engage any circular calculation. …

Moreover, the fact of calculating the RDTOH account at the end of a taxation year of each corporation in such a situation…involving cross redemptions and thus cross dividends, entails circular calculations by them of their respective RDTOH, dividend refunds and Part IV tax. In policy terms, it does not appear acceptable to us that circular calculations could result in a complete reimbursement of the total RDTOH of each corporation in such a situation.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 186 - Subsection 186(1) - Paragraph 186(1)(b) Part IV tax on cross-redemptions takes into account the Part I tax (and RDTOH addition) generated by s. 55(2) application thereto 340

16 June 2014 STEP Roundtable, 2014-0522991C6 - Safe Income

s. 55(5)(f) designation unnecessary

A corporation has insufficient safe income in respect of its shares and, rather than making a s. 55(5)(f) designation, self-assesses itself for a capital gain to the extent of the insufficient safe income on hand? Is it permissible for it to self-assess the dividend received by it as proceeds of disposition?

CRA referred to Nassau Walnut, which found that a s. 55(5)(f) designation is not an election (and "is, in some respects, no different than the deduction provided under subsection 112(1)") and, more generally, referred to Brelco, Lamont and Kruco for the principle "that the safe income of a corporation should not be subject to double taxation when distributed as a dividend to another corporation." CRA then stated:

CRA's long standing practice is to apply subsection 55(2) only to the excess of the taxable dividend paid on a share over the safe income on hand attributable to that share, when issuing an assessment based on subsection 55(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(5) - Paragraph 55(5)(f) s. 55(5)(f) designations are unnecessary 88

2012 Ruling 2011-0403291R3 - Treaty exempt sale

Treaty step-up to avoid the application of s. 55(2) to a spin-off made to effect an arm's length sale of the rump

Following a preliminary reorganization (including an amalgamation of predecessors of Amalco so as to "consolidate the tax attributes"), all the shares of Amalco are held by Foreignco3 (resident in the U.S.) which, in turn, is an indirect wholly-owned subsidiary of Foreign Parent, a listed company. Amalco has various direct or indirect (mostly Canadian) subsidiaries carrying on the XYZ Business and also holds the "Keep Assets," which mostly are non-resident or resident subsidiaries. The following transactions occur in order to accomplish an indirect sale of the XYZ Business by Foreignco3 to Buyer (an arm's length purchaser) after a spin-off of the other "Keep Assets" to a newly-incorporated Canadian spinco whose initial common share is held by Foreignco3 ("Canco"):

  1. On a s. 86 reorganization Foreignco3 will receive "Keep Shares" (non-voting redeemable retractable preferred shares) and New Common Shares in exchange for its old common shares of Amalco (which are taxable Canadian property).
  2. Foreignco3 will transfer the Keep Shares to Canco in exchange for additional Canco Shares, electing under s. 85(1) at fair market value.
  3. Amalco will transfer the Keep Assets to Canco in exchange for the Canco Note and the assumption of the Assumed Debts, with a net taxable capital gain resulting.
  4. Amalco will purchase the Keep Shares from Canco for cancellation (giving rise to an obligation, but with no note issued).
  5. The obligations arising in 3 and 4 and other obligations are set-off.
  6. Foreignco3 will sell the New Common Shares (which now derive their value from the XYZ Assets) to the Buyer for cash.

Rulings include:

  • the gain realized by Foreignco3 on the transfer of the Keep Shares to Canco in 2 and on the sale in 6 will be exempt from tax under Art. 13 of the Treaty.
  • 55(2) will not apply to the deemed dividends arising in 4.
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Disposition partnership distribution not disposition 64
Tax Topics - Treaties - Articles of Treaties - Article 13 Treaty step-up to avoid the application of s. 55(2) to a spin-off made to effect an arm's length sale of the rump 291

14 March 2014 Internal T.I. 2013-0499141I7 - IRC 338(h)(10), "earnings" and safe income

goodwill gains which accrued prior to purchase of FA and which were included under s. 55(5)(d) did not contributed to gain on Canco shares

An indirect wholly-owned foreign affiliate ("FA") of Canco made an arm's length purchase of all the shares of "US Holdco," whose wholly-owned subsidiaries ("US-Opcos") had accrued gains inherent in the appreciated assets of their active businesses including capital property, depreciable property and intangible property such as goodwill.

After noting (para. 33) that the income realized ("Intangible Property Safe Income") by the US-Opcos under former s. 55(5)(d) on the disposition of the intangible properties was in respect of gains that accrued on those intangible properties in the period before FA acquired the US Holdco shares (the "Pre-acquisition period") and that "the Intangible Property Safe Income was reflected in the purchase price and, therefore, the ACB, of the US Holdco shares that FA acquired," and before concluding (para. 36) that "the Intangible Property Safe Income did not contribute to the gains that accrued on FA's US Holdco shares in the Post-acquisition period and, therefore, did not contribute to the gains that accrued on PrivateCo's… Canco common shares immediately before their redemption," CRA stated (at para. 34):

[A]llocating the Intangible Property Safe Income to the gains that accrued on FA's US Holdco shares in the Post-acquisition period would offend the object and spirit of subsection 55(2) because such an allocation would result in "capital gains stripping" which is what subsection 55(2) is designed to prevent. This is because such an allocation would give rise to a "double counting" of FA's ACB of the US Holdco shares as safe income which could then be allocated to a gain that accrued on the US Holdco shares in the Post-acquisition period and that is attributable to the unrealized appreciation in the value of the underlying assets of the US-Opcos.

See also the summary under Reg. 5907(2)(f).

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Earnings "notional" deduction arising from Code s. 338(h)(10) step-up excluded 129
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(1) - Exempt Earnings no carve out for goodwill gains 132
Tax Topics - Income Tax Regulations - Regulation 5907 - Subsection 5907(2) - Paragraph 5907(2)(f) "notional" deduction arising from Code s. 338(h)(10) step-up of non-purchased goodwill reversed under Reg. 5907(2)(f) rather than (b) 433

14 February 2014 External T.I. 2012-0454481E5 F - Safe Income

not claiming s. 34.2(11) transitional reserve to increase SIOH

The only source of income of ABC, a CCPC, is its interest in a partnership (P) with a fiscal period end of XX. ABC has an income inclusion under s. 34.2(2) and claims a reserve under s. 34.2(11). May ABC choose not to claim the transitional reserve provided under s. 34.2(11) for a taxation year for the purposes of the computation of its safe income on hand? CRA stated (TaxInterpretations translation):

ABC may not claim an amount in respect of the transitional reserve under subsection 34.2(11) to establish its SIOH immediately before the "safe income determination time" respecting a particular transaction, so long as the corporation does not claim such reserve for the taxation year which includes the stub period… .

The principal reason for our position is the fact that the transitional reserve is temporary and that one could reasonably consider that, in general, the "qualifying transitional income" on which the transitional reserve is based results in an increase in the value of the shares… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 34.2 - Subsection 34.2(11) discretionary deduction 54

21 March 2014 External T.I. 2012-0471021E5 - Safe income and section 34.2

adjusted stub period accrual not "on hand"

The fiscal period of a partnership ends on June 30, 2013 but the taxation year-end of the private corporation which is a member is December 31, 2013, which is also its "safe-income determination time." Should a negative adjustment be made in computing the "safe income on hand" if the corporate partner has an income inclusion under s. 34.2(2) but there is a loss in the partnership for the stub period from July 1, 2013 to December 31, 2013?

After noting that "an adjustment to carve out from 'safe income' any amounts included in income under subsections 34.2(2) and (12) and any amounts claimed under subsections 34.2(4) and (11) would be contrary to the wording of [s. 55(5)(c)]," CRA went on to state that:

a negative adjustment in respect of the loss should be made in determining the "safe income on hand" of the corporation on the basis that the [s. 34.2(2)] amount would not be on hand to contribute to the fair market value or the gain inherent in the shares of the corporation.

11 October 2013 APFF Roundtable, 2013-0495851C6 F - Safe income adjustments

CRA post-closing adjustments of target income

Buyco acquired all the shares of Opco on 15 January 2010 from Sellco. A CRA audit resulted in a 2011 reassessment to increase Opco's income for its 2008 and 2009 years. CRA stated (TaxInterpretations translation):

[no price adjustment]

[W]here nothing in particular is provided in the purchase contract…respecting…[this situation] the additional income tax payable by Opco, in general, would reduce the safe income on hand attributable to the shares held by Sellco… . [T]he payment of the additional tax by Opco would have the effect of reducing the safe income on hand that can reasonably be considered to contribute to the gain on the shares of Opco held by Buyco [per the summary, "the gain inherent in the Opco's shares"].

[price adjustment to Buyco]

In the situation where the purchase contract…contains a price adjustment clause to the price for the shares payable by Buyco by reason of a new assessment sustained by Opco, the amount received by Buyco by reason of the price adjustment clause, in general, would reduce the acquisition cost of the shares of Opco. Furthermore, the amount of the additional tax payable by Opco by reason of the new assessment for a taxation year ending prior to the acqusisition of control would, in general, have the same effect as [above].

[price adjustment to Opco]

In the situation where the purchase contract…provides that Sellco is responsible for the amount of any new assessment for a taxation year subsequent to the acquisition of the shares and to the extent that Opco received…from Sellco an amount equivalent to the amount of additional tax arising under the new assessment, the calculation of the safe income on hand attributable to the Opco shares held by Buyco would need to take into account the application of ITA paragraph 12(1)(x) or ITA subsection 12(2.2) to the compensation received from Sellco.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 54 - Adjusted Cost Base CRA post-closing adjustments of target income 84

16 November 2011 External T.I. 2011-0423861E5 F - paragraph 53(1)b)

Holdco, whose common shares of Opco have a nominal adjusted cost base ("ACB") and paid-up capital ("PUC"), a fair market value ("FMV") of $2 million and safe income on hand ("SIOH") attributable to those shares of $900,000, increases the PUC of those shares by $1 million, and transfers those common shares (or to be more precise, new common shares issued in replacement therefor on the PUC increase) to Opco for cancellation in consideration for the issuance by Opco of (i) preference shares of Opco having an FMV, PUC and ACB (determined under s. 85(1)(g)) of $1 million; and (ii) common shares having a FMV of $1 million and nominal PUC and ACB.

If s. 55(2) did not apply to the s. 84(1) dividend, then the ACB of the common shares of Opco held by Holdco following that PUC increase would be determined under s. 53(1)(b) as the excess of the s. 84(1) deemed dividend of $1 million minus $100,000, being the portion of that dividend that did not come out of SIOH - i.e., $900,000.

On the other hand, if s. 55(2) applied to the s. 84(1) dividend, the ACB of those common shares would be the excess of the s. 84(1) deemed dividend received by Holdco (which, by virtue of s. 55(2) would be limited to the SIOH of $900,000) over the nil portion of that deemed dividend that did not come out of SIOH hand - i.e., also $900,000.

Accordingly, in both scenarios, Holdco would realize a $100,000 capital gain on the "dirty s. 85" transfer of the common shares, i.e., the excess of the agreed amount of $1 million over the ACB of $900,000. No amount would bee added to the proceeds of disposition of the common shares because of the exclusion under s. 55(2)(b); and CRA would not apply s. 55(2)(c).

12 December 2011 External T.I. 2011-0416801E5 F - Safe Income on Hand - Stub Period

respecting queries on how to calculate the safe income on hand ("SIOH") of a CCPC that recognized income on a lumpy basis when it made progress billings, CRA noted that the SIOH attributable to a particular share may be based on a holding period that contains two stub periods (the period from the date of acquisition of the share to the first year-end; and the period from the last year-end to the safe income determination time) and that "in general, SIOH is determined by allocating a pro rata share of the income for the full taxation year to the stub period."

6 December 2011 External T.I. 2011-0423181E5 F - Safe Income

200 Class A shares of Opco held by a shareholder had a safe income on hand ("SIOH") that was lower than their fmv, and 100 Class F shares had a SIOH which approximated their fmv. The 200 Clas A share are converted under s. 51 into 200 Class F shares.

All the Class F shares following the conversion including the newly issued ones will share proportionately is the SIOH formerly attributed to the exchanged shares.

Income Tax Technical News, No. 34, 27 April 2006 under "Safe Income Calculation"

The Kruco case.

3 June 2003 External T.I. 2003-001207 -

An amount designated by a personal trust in respect of its corporate beneficiary under s. 104(13.1) would not be included in determining the corporate beneficiary's safe income or safe income on hand.

14 December 2000 External T.I. 2000-003403 -

The safe income on hand of a corporation, is not reduced by non-capital losses of a corporation within the group that is acquired by it, although the amount paid to acquire such loss company will reduce the safe income on hand attributable to its shares as the shares of the loss company disappear on the subsequent amalgamation.

11 December 2000 External T.I. 2000-005316 -

If Holdco purchases Opco at a time when Opco has unrealized appreciation in certain assets such as inventory or capital property, gain from a subsequent sale of such asset will not increase the safe income attributable to the shares of Opco held by Holdco. However "notwithstanding the above, and as a practical matter, normally we do not require a detailed analysis of all the elements making up the capital gain on a share as long as safe income on hand is computed pursuant to our published guidelines".

2000 Ruling 2000-0003253 -

Where a share is exchanged for a second share on a rollover basis, the full safe income on hand attributable to the first share owned by the transferor immediately before the exchange will flow through to the second share on the exchange provided that the fair market value of the second share received on the exchange is not less than the fair market value of the transferred share immediately before the exchange.

13 April 2000 T.I. 2000 - 000792

Discussion of allocation of safe income when shares of a corporation are exchanged on a rollover basis for more than one class of shares.

1999 Ruling 3-991044 -

The safe income attributable to shares of a corporation that were sold to an arm's length purchaser included gain arising from an s. 111(4)(e) designation given that no election was made under s. 256(9).

1999 APFF Round Table, Q. 4 (No. 9M19190)

A loss that is denied under s. 40(2)(g)(ii) will be deducted when calculating safe income on hand.

29 June 1998 External T.I. 5-980210 -

Where a corporate shareholder transferred public company shares to a new holding company pursuant to s. 85(1), the safe income on hand of the shares of the new holding company would ordinarily include the safe income on hand attributable to the public corporation's shares even if no significant influence is exercised over the public corporation.

17 September 1997 T.I. 972141

The fact that a dividend refund has been received by the payor of a dividend is not normally relevant to consideration of the following expression: "that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series of transactions or events".

29 August 1997

Confirmation of policy expressed in the Read paper (1988 Conference Report) respecting the redemption of preferred shares which were received as a stock dividend.

26 August 1997 T.I. 971365

Where a wholly-owned subsidiary owns shares in the capital of its parent company, an allocation of safe income must be made to the shares of the parent corporation held by the subsidiary.

16 June 1997 External T.I. 5-971100 -

Any dividend paid by a payer corporation is considered to be paid first out of the safe income on hand attributable to the recipient corporation's shares of the payer corporation. Accordingly, the amount of the dividend to which s. 55(2) will not apply is the aggregate of the amount of the dividend subject to Part IV tax and the amount, if any, by which the amount of safe income on hand exceeds the amount of the income subject to Part IV tax. Conversely, the recipient corporation would not have to designate any amount under s. 55(5)(f) in any situation where the portion of the taxable dividend that is subject to Part IV tax exceeds the safe income on hand of the corporation.

17 March 1997 T.I. 963272

Discussion of the safe income entitlement of alphabet shares.

16 July 1996 External T.I. 5-960491 -

Where preferred shares issued by Newco on the roll-in to Newco of shares of Opco, have a dividend entitlement equal to dividends received by Newco on the shares of Opco, and to proceeds received by Newco on the sale of shares of Opco to the extent of the gain realized by Newco, but with the redemption amount of the shares being reduced on a dollar-for-dollar basis by the amount of the dividends paid out of such gain. RC will not consider the preferred shares to have a dividend entitlement in respect of the gain because of the corresponding reduction in redemption amount. Accordingly, the safe income attributable to the gain could not be attributed to the preference shares.

6 May 1996 T.I. 961124 (C.T.O. "Safe Income - Provision for Capital Item, Dividends")

A write- down in the carrying value of a capital asset to reflect an accrued loss inherent in the property, will not reduce safe income on hand because the write-down does not represent an amount of safe income that has been set aside to pay an amount not currently deductible for tax purposes.

Income Tax Technical News, No. 7, 21 February 1996

After referring to the Clem Industrial case, Mr. Hiltz stated:

"Ordinarily, if an arm's length sale of shares occurs within a short time after a dividend was received on the shares, we will consider this to be strongly indicative that one of the purposes of the dividend was to reduce the capital gain that would otherwise have been realized on the share sale."

1996 Ontario Tax Conference Round Table, "Purpose Test in Subsection 55(2)", 1997 Canadian Tax Journal, Vol. 45, No. 1, pp. 231-214

Discussion of CPL Holdings Ltd. v. The Queen, 95 DTC 5253 (FCTD).

5 July 1995 External T.I. 5-941606 -

Discussion of a situation where a Canadian-controlled private corporation ("Holdco") transfers an asset on a rollover basis to a newly-incorporated subsidiary ("Newco"), following which Newco sells the assets to an unrelated third party and pays the after-tax profit to Holdco giving rise to dividend refund to it and Part IV tax to Holdco, with Holdco paying corresponding taxable dividends to its shareholders that are not liable to Part IV tax.

10 April 1995 T.I. 950469 (C.T.O. "Same Income, Feb. 22, 1994 Election")

Discussion of proration formula for determining safe income where an individual realizes a capital gain of $100,000 in connection with bumping the ACB of her shares, then rolls her shares into a holding company in whose hands the shares are redeemed.

28 March 1995 T.I. 943095 (C.T.O. "Safe Income Stock Splits")

"Generally, when a portion of the capital gain inherent in the shares of a corporation is crystallized, the Department's approach ... is to apportion the safe income to which the entire gain is attributable proportionately to each part of the gain. A transferee's safe income attributable to the shares received would be computed by multiplying the safe income attributable to the transferred shares immediately before the transfer by the proportion that the transferee's potential gain (immediately after the transfer) is of the transferor's potential gain (immediately before the transfer)."

27 October 1994 T.I. 941436 (C.T.O. "Safe Income - Foreign Affiliates (H.A.A. 5102-3)")

When computing exempt or taxable surplus of a foreign affiliate for the purpose of determining safe income of a Canadian corporation with a wholly owned U.S. foreign affiliate, the relevant time is that at which the safe income is to be computed (i.e., immediately before the transaction or event, or the commencement of the series of transactions or events).

General discussion of computation of safe income in the context of a foreign affiliate.

20 July 1994 T.I. 940879

Safe income on hand will flow through on an s. 107(2) rollover in a similar manner to rollovers effected under ss.51, 85, 85.1, 86 and 87.

94 CPTJ - Q. 1

Because the Alberta royalty tax credit is not included in a corporation's net income for tax purposes, it would not be included in determining the corporation's safe income or safe income on hand.

3 May 1993 T.I. 923639 (C.T.O. "Safe Income and Part IV Tax")

Where X owns 20% of the shares of Opco having a safe income of $100 and a fair market value of $125, and transfers all of such shares to a new corporation ("Newco") on a rollover basis in exchange for shares of Newco, and Opco then redeems the shares held by Newco for $125 giving rise to a deemed dividend of $125, Newco will not be able to treat itself as having received a safe income dividend of $100 (assuming the appropriate designation under s. 55(5)(f)), and a further separate dividend of$25 subject to Part IV tax, if the payment of the deemed dividend by Opco triggers Part IV tax on $25 of that dividend deemed to be received by Newco:

"It is our view that to the extent that a dividend refund arises in respect of tax paid on the investment income earned by a corporation which pays a dividend (the "payer corporation"), such income would, on an after tax basis, have been included in the calculation of the safe income of the payer corporation. Consequently, when a dividend that gives rise to the dividend refund is paid by the payer corporation, that portion of the dividend [that is sufficient to give rise to the dividend refund would be considered to be paid out of the safe income of the payer corporation ... . Since an amount of $100 (including the $25 dividend subject to tax under Part IV of the Act) which is equal to the total safe income of Opco, is designated as a separate taxable dividend, subsection 55(2) will not apply to this dividend. However, subsection 55(2) will, in our view, apply to the other separate taxable dividend of $25."

20 July 1994 T.I. 940879 (C.T.O. "55(2)")

The rollover under s. 107(2) is accorded the same treatment for safe income purposes as the rollover under s. 85.

On a wind-up of one company into a second company, the safe income on hand of the second company will be reduced by the amount of the loss realized on the intercompany debt which is deemed to be paid in full by virtue of an s. 80(3) election. In addition, any other liabilities of the first company assumed by the second company that are in excess of the fair market value of the property of the first company distributed to the second company, will also reduce the safe income on hand of the second company.

Losses incurred in a taxation year that have not been deducted in computing income under s. 3 by the corporation, or by any corporation over which it has significant influence, will generally reduce safe income on hand of the corporation.

6 April 1994 T.I. 933171 (C.T.O. "Safe Income and SRED Expenditures")

Current SR & ED expenses must be deducted in computing the corporation's safe income on hand even if such expenses have not yet been deducted for tax purposes. However, SR & ED capital expenditures do not reduce the corporation's safe income on hand until the year that such amounts are claimed as a deduction for tax purposes.

93 C.R. - Q. 15

Safe income on hand will be reduced by large corporations tax.

93 C.R. - Q. 12

Discussion of distinction between "safe income" and "safe income on hand".

Calgary District Office Round Table, 3 May 1994, Q. 17

Because an Alberta royalty tax credit is not included in a corporation's income for tax purposes, it also is not included in its safe income or safe income on hand.

31 August 1993 Memorandum (Tax Window, No. 33, p. 4, ¶2639)

Impact of investment tax credits and share purchase tax credits on calculation of safe income.

2 February 1993 T.I. (Tax Window, No. 28, p. 5, ¶2414)

Amounts actually expended but not deductible for tax purposes (e.g., 20% of entertainment expenses), and amounts actually expended but deferred or capitalized for tax purposes (e.g., contributions of an employer to an employee benefit plan pursuant to s. 18(1)(o) or amounts capitalized under s. 18(2)) cannot be included in safe income on hand until such time, if any, as they are deducted for tax purposes.

Amounts not yet expended but deducted for accounting purposes but not for tax purposes (e.g., accrued compound interest, provisions for unfunded future employee pension obligations and provisions for future warranty obligations) reduce safe income on hand if safe income has been set aside to pay these amounts or if the future obligations have reduced a gain that would otherwise be realized on a disposition at fair market value of a share of any corporation.

20 October 1992 T.I. 910248 (September 1993 Access Letter, p. 413, ¶C38-174)

The deduction under s. 110(1)(k) has no effect on safe income.

92 C.R. - Q.35

RC response to suggestion that s. 55(2) does not apply to a taxable dividend arising out of transactions that were structured by the corporation rather than the vendor.

92 C.R. - Q.29

Where a deemed dividend arising on the redemption of a portion of the shares of Opco exceeds the safe income attributable to the redeemed shares and no designation under s. 55(5)(f) is made, the safe income that otherwise would be available will be permanently lost. The same result applies where there is a payment of an ordinary dividend.

28 July 1992 External T.I. 5-920803 -

Where A and B, who are two of the three individual shareholders of OPCO, transfer their common shares of OPCO to separate newly-incorporated holding companies and later, following a conversion of the common shares of OPCO held by the holding companies into preferred shares, have their holding companies receive redemption proceeds of the preference shares out of the capital dividend account of OPCO, the safe income attributable to the common shares of OPCO transferred to their holding companies cannot be attributed to the shares of OPCO held by the third shareholder, even though the subsequent deemed dividend paid out of the capital dividend account of OPCO does not affect its safe income.

Where an amount, otherwise deemed to be a dividend under s. 84(3), is deemed instead to be a capital gain under s. 55(2), it also will not reduce the safe income attributable to the other shares of the corporation.

10 January 1992 Memorandum (Tax Window, No. 17, p. 12, ¶1773)

The reduction in Part I tax caused by the application of available investment tax credits affects the corporation's safe income only in the years following the claim, for example, through a reduction of the amount of CCA or SR&ED expenditures available in those years.

10 January 1992 Memorandum (Tax Window, No. 17, p. 12, ¶1773)

The corporation to which assets are transferred in a butterfly may not be amalgamated with another corporation.

24 February 1992 Memorandum (Tax Window, No. 13, p. 13, ¶1630)

Re circumstances where RC is prepared to consider a reassessment of only the excess of deemed proceeds over safe income notwithstanding the failure to make a timely designation under s. 55(5)(f).

23 January 1992 T.I. (Tax Window, No. 12, p. 6, ¶1574)

Where a corporation pays a dividend in kind comprising part of its assets, its safe income must be pro-rated rather than being allocated fully to the dividend.

6 June 1991 T.I. (Tax Window, No. 4, p. 12, ¶1282)

Where shares of Opco are redeemed by Holdco giving rise to a deemed dividend of $2.2 million at a time that the safe income of Opco is $1.8 million, Holdco designates $1.8 million as a separate taxable dividend under s. 55(5)(f) and Opco receives a dividend refund of tax of $100,000, the $400,000 of income earned by Opco on which it paid refundable tax will be considered to be part of the safe income of Opco. Consequently, s. 55(2) will apply to the dividend of $400,000 because it would not be considered to have been paid out of safe income.

15 May 1991 T.I. (Tax Window, No. 3, p. 18, ¶1239)

S.55(2) generally will not apply to a deemed dividend which deliberately has been made subject to Part IV tax in order to avoid the application of s. 55(2).

13 March 1991 T.I. (Tax Window, No. 1, p. 20, ¶1140)

Crown royalties and other amounts representing cash outlays which are non-deductible under s. 18(1)(m) should be included in computing safe income. However, the resource allowance which does not represent an actual outlay, should be excluded.

26 November 1990 T.I. (Tax Window, Prelim. No. 2, p. 7, ¶1037)

Safe income effectively is transferred on an s. 85 rollover or an interspousal rollover under s. 73(1).

90 C.P.T.J. - Q.20

A corporation with safe income of $100 has one shareholder whose shares, all being of one class, have an accrued gain of $200. If the redemption of 1/2 of the shares results in a deemed dividend of $100, it will be unreasonable to conclude that the $100 gain inherent in the shares being redeemed is wholly attributable to the $100 of safe income and that the $100 gain inherent in the remaining shares is attributable to something other than the safe income.

29 June 1990 T.I. (November 1990 Access Letter, ¶1516)

Where the individual shareholders of Opco transfer their common shares of Opco to Holdco on a share-for-share exchange, the common shares held by Holdco are changed into preferred shares under an s. 86 reorganization and a dividend and deemed dividend are paid on the preferred shares held by Holdco, Holdco will receive only a proportionate share of the safe income of Opco. Holdco may avail itself of the election under s. 55(5)(f).

June 1990 Meeting of Alberta Institute of Chartered Accountants (November 1990 Access Letter, ¶1499, Q. 7)

Safe income is attributable to a particular class of shares in the same proportion in which each class of shares will be entitled to earnings of the corporation if they were distributed on a winding-up.

30 April 1990 T.I. (September 1990 Access Letter, ¶1415)

Employees of Opco, who own all its issued shares, transfer those shares to Newco in exchange for shares of Newco, thereby realizing a capital gain. Immediately thereafter, Opco pays a taxable dividend to Newco equal to the full amount of its safe income on hand prior to the share-for-share exchange. Assuming that the full amount of the unrealized gain on the shares of Opco is greater than Opco's safe income, and a portion of that gain is realized, then a proportionate part of this portion is attributable to safe income and the remaining part may be reasonably considered to be attributable to something else. Accordingly, a portion of the supposed safe income dividend also would be attributable to something other than safe income, and s. 55(2) will apply.

23 March 1990 T.I. (August 1990 Access Letter, ¶1376)

In response to a proposal that entailed purifying a corporation for purposes of the exemption for sales of qualified small business corporation shares by paying a large dividend on special shares which had been issued for a nominal amount, RC noted that the provisions of s. 55(2) are always of concern where a class of shares attracts an inordinately large dividend, whether that dividend is paid periodically or arises on the redemption of shares. Because s. 55(2) can apply where a large dividend of one class of shares reduces the accrued capital gain on another class of shares, no comfort can be drawn from the absence of any reduction of a capital gain on the special shares.

23 February 1990 T.I. (July 1990 Access Letter, ¶1322)

If it is known, at the beginning of a series of transactions, that there will be an acquisition of control of the corporation resulting in a deemed capital loss under s. 111(4), the deemed capital loss should be applied to reduce taxable capital gains realized prior to the commencement of the series for the purpose of computing the corporation's safe income.

12 January 1990 T.I. (June 1990 Access Letter, ¶1258)

A sale of an operating division by Opco followed by the payment of a dividend to Holdco equal to the net after tax proceeds of the sale likely would not be regarded as having been carried out for the prohibited purpose.

10 January 1990 T.I. (June 1990 Access Letter, ¶1259)

Where Opco pays a stock dividend of $500,000 in high-low preferred shares, only a pro-rata portion of its safe income is attributable to the preferred shares on the subsequent redemption thereof.

5 December 1989 T.I. (May 1990 Access Letter, ¶1216)

One corporation ("S1") transfers a capital property under s. 85(1) to a sister corporation ("S2") in consideration for redeemable preference shares which are then redeemed following the sale by S2 of the property to an arm's length purchaser. The safe income attributable to the preferred shares is nil because the entire gain on those shares is attributable to the capital gain on the transferred property, and no dividend entitlement accrued on the preferred shares prior to the commencement of the series of transactions.

15 November 89 T.I. (April 90 Access Letter, ¶1187)

A corporation ("Opco") is owned by siblings who wish to transfer their shares to their children. Each sibling would form a holding company into which he would transfer his common shares of Opco pursuant to s. 85(1) in exchange for preference shares having a redemption amount equal to the fair market value of the transferred common shares, and the children would receive common shares from treasury such that they would have an equity percentage equivalent to what the parents had. S.55(2) would apply on the redemption of the preferred shares. S.55(3)(a) would not apply because nephews and nieces do not deal at arm's length with their uncles and aunts.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) 98

89 C.R. - Q.12

The shares of Opco whose value essentially is represented by goodwill, are converted (or "frozen") into high-low preferred shares, which then are transferred to Holdco. Common shares of Opco are then sold to a third-party purchaser. Later, Opco sells the goodwill to an arm's length person and all the preferred shares of Opco are redeemed. The safe income of Opco earned subsequent to the freeze transaction is allocable to the preferred shares only to the extent of their dividend entitlement.

October 1989 Revenue Canada Round Table - Q.5 (Jan. 90 Access Letter, ¶1075)

Mr. A is not permitted to extract the safe income of a corporation prior to the sale of its shares, by having that corporation pay a stock dividend of preferred shares to a newly-incorporated holding company of Mr. A, followed by a redemption of those preferred shares. The principle is that the safe income of a corporation should be attributed to each share of its capital stock after payment of the stock dividend (i.e., safe income must also be allocated to the common shares), and safe income cannot be attributed to only one class of shares.

Read, "Section 55: A Review of Current Issues", 88 C.R., c. 18.

88 C.R. - F.Q.36

S.55(2) will apply if as part of the same series Opco transferred assets to Sisterco, for preference shares which were redeemed, and the shares of either Opco or Sisterco were sold to an arm's length purchaser.

80 C.R. - Q.4

General guidelines.

Articles

Bruce Ball, Ken Griffin, Rick McLean, Eric Xiao, "Subsection 55(2) material and Part IV", Submission of the Joint Committee, 13 October 2016

This letter attaches examples which the Committee had informally provided to Finance earlier in 2016. They illustrated concerns that the changes to the Part IV exception distorted the integration system, producing results that could be either more or less favourable than intended.

Scenario 1

Opco pays deemed dividend out of investment income on pref shares held by Holdco with no safe income and there is a resulting recovery of RDTOH when Holdco pays a full ineligible dividend to its individual shareholder (X), so that Holdco is subject to s. 55(2).

Result: Combined rate of tax of 59.4% (v. 51.6% if s. 55(2) did not apply), CDA is stranded in Holdco and Holdco lacks cash to pay its capital gains tax.

Scenario 1, Alt. 2

Opco pays a dividend to Holdco2, which is subject to s. 55(2) given a dividend refund on an on-dividend received by Holdco1 tax free. Holdco1 and Holdco2 amalgamate; Amalco pays capital dividend and smaller taxable dividend to X.

Result: Combined rate of 40.22%.

Scenario 2

Opco (which has RDTOH but also GRIP balance) pays deemed dividend to Holdco (subject to s. 55(2)), which pays an eligible and ineligible dividend to X generating a dividend refund – but application of s. 55(2) to Holdco permits substantial capital dividend election.

Result: Combined rate of 44.6%.

Further examples also provided.

There is also uncertainty regarding potential circularity arising in connection with late capital dividend elections.

Scenario 1, Alt.1

Same as Scenario 1 except that Holdco files a late CDA election (accommodated by it paying its dividend to X in 2 tranches).

Quaere: If a portion of the dividend is now a capital dividend, does that undo the s. 55(2) recharacterization in part?

Bruce Sinclair, "Current Topics in the Taxation of Real Estate Development", 2014 Conference Report, (Canadian Tax Foundation), 12:1-24.

Sale of Projectco before allocation to it by sub LP of condo sale profits (pp. 12:2-3)

Developers often undertake projects in a single-purpose entity ("Projectco") for commercial reasons.…A further level of liability protection can be provided if the project is held in a limited partnership…

[T]he developer will sell the shares of Projectco to another party that has the ability to reduce or shelter the income that will be allocated at the end of the fiscal period of the limited partnership following the sale of the Projectco shares. The sale will take place after the project has been completed and sold, but before profit has been allocated or distributed by the partnership. Typically, the profit will be held by the partnership in the form of cash or a loan to the developer or a related party….

[T]he purchase price for the Projectco shares will exceed the amount by which the value of the assets exceeds the liabilities and the full amount of the latent tax liability of Projectco….

Use of stock dividends to minimize gain to developer (p.12:3-4)

Whether this gain [on the sale of Projectco] is on income or capital account…the developer will seek to minimize [it]…by payment of one or more stock dividends by Projectco in an aggregate amount that will be equal to the purchase price of the Projectco shares less the adjusted cost base (ACB) of the shares, which is assumed to be minimal.

[T]he developer will take the position that the capital gain that would otherwise be realized on the sale of the shares of Projectco at fair market value is attributable to income earned prior to the "safe-income determination time"…

Sale of Projectco on capital account (p. 12:5)

[T]he principle established in the Fraser case [fn 5: Fraser v. Minister of National Revenue, 11964] SCR 657.] should not apply since the sale of the Projectco shares will not be a method of selling the underlying real property—which will already have been substantially or fully sold when the shares are sold under the transaction. For the shares to be considered to be held on income account, it would be necessary to find that the developer was trading or dealing in shares or that the acquisition of the Projectco shares was an adventure in the nature of trade….

VIH indicates Projectco shares are sold for more than FMV (p. 12:6)

[I]n the VIH Logging decision…the Federal Court of Appeal found as a fact based on expert evidence that the fair market value of the shares of the corporation was the fair market value of the assets of the corporation, principally cash, reduced by its liabilities—including the full liability for tax on income arising on the sale of the former assets of the corporation….

Projectco capital gain is attributable to Projectco pre-tax income (p. 12:7)

[W]hile the administrative position of the CRA is clear that the safe income should be reduced by the latent tax, there seems to be little doubt that no portion of the actual capital gain that would have been realized on the sale of the Projectco shares can be attributable to anything other than the pre-tax income of Projectco….

Dubious relevance of stub period accrual (pp. 12:7-8)

[A] typical partnership in which Projectco has an interest will not have reported any income in a prior fiscal period, so Projectco is not required to include a stub period accrual in its income for the taxation year ending on the acquisition of control of Projectco by the purchaser….

[T]he CRA stated in a technical interpretation issued in March 2014 [fn 10: … 2012-0471021E5…] that the amount of partnership safe income attributable to shares of a corporate partner to which the rules in section 34.2 apply should be the adjusted stub period accrual for the year. This is a substantial change from the CRA's former position that the safe income of a corporate partner should include the partner's share of the income of the partnership for the period ending at the safe-income determination time. [fn 11: … 2007-0243151C6…] While some may question whether this former position is supported by case law, [fn 12: See, for example, Canada v. Kruco Inc., 2003 FCA 284] it makes sense to the extent that the income of a partnership contributes to a gain arising on the sale of the shares of a corporate partner….

The CRA's March 2014 technical interpretation takes the position that the stub period accrual rules, where applicable, in effect constitute a code for the determination of income attributable to a corporate partner's interest in a partnership. The method for determining the adjusted stub period accrual is not based on income earned by the partnership for the portion of the fiscal period up to the safe-income determination time. Instead, it is based on income earned in a preceding fiscal period. While the rules in section 55 are somewhat artificial, it seems that an interpretation that achieves a result more in keeping with the economic situation of Projectco—that is, the accrual of income actually earned during the stub period—should be preferred….

[I]n VIH Logging… Woods J recognized that permitting the inclusion of stub period income is an unusual interpretation of paragraph 55(3)(c), which deems income earned and realized for a period to be the taxpayer's income as determined under the Act for the period; however, it was seen as "the only reasonable interpretation." It is equally reasonable to include stub period income earned or realized by a partnership of which a corporation is a partner in the corporate partner's safe income. One may reasonably ask whether this interpretation is in accordance with the provisions of paragraph 55(5)(a). That paragraph deems the portion of a capital gain attributable to income expected to be earned or realized to be a capital gain attributable to anything other than income, and consequently, deemed to be a capital gain under subsection 55(2)….[I]n a seminal 1981 paper, John Robertson noted that at least one of the purposes of the provision was to preclude an argument that a valuation based on a multiple of current income is based on income earned or realized.15 Such future earnings will not have been "earned or realized" in any normal sense. In the case of stub period income of a partnership, the income has been "earned or realized" but has not yet been allocated to a corporate partner.

[t]he amount of sale income of Projectco will include any income arising from the sale of units occurring before the payment of the stock dividend—which dividend will trigger the safe income determination time in respect of the transaction…the result of the application of subsection 52(3)—that is, the creation of" cost in the stock dividend shares—is not confined to subdivision c and will apply for all purposes of the Act…

Effect of latent tax liability on safe income and cost of stock dividends (pp. 12:10-11)

[T]he cost of the stock dividend shares is effectively limited to Projectco's safe income on hand. As discussed previously, the amount of safe income will be based on the taxable income of Projectco either with or without a reduction for the latent tax obligation.

If safe income is based on deducting the fall amount of the latent tax liability, the developer's tax basis in the stock dividend shares will depend on the fair market value of the Projectco shares. If, in turn, the determination of fair market value is based on the reasoning in VIH Logging, the portion of the dividend in excess of safe income will not be subject to the provisions of subsection 55(2), but the stock dividend shares will have no basis to the extent of the excess. If the fair market value is found to be the selling price, then the excess will be deemed to be a capital gain under subsection 55(2) and not a dividend. In this case, the excess will form part of the cost of the stock dividend shares. So in either case the developer will realize a capital gain on the amount of the excess, either as a result of the direct application of subsection 55(2) to the stock dividend or as a result of a reduction in ACB on the sale of the shares. However, there is a difference in circumstances in these two cases. In the former case, where the fair market value of the Projectco shares is based on VIH Logging, no capital dividend will arise on the sale of the stock dividend shares. Clause (a)(i)(A) of the definition of "capital dividend account" in subsection 89(1) provides that the amount of a capital gain for the purposes of computing the capital dividend account is to be determined without reference to subparagraph 52(3)(a)(ii), with the result that there is no increase in capital gain in computing the capital dividend account for tax-deductible stock dividends that are not attributed to safe income and would otherwise reduce ACB. In the latter case, the amount of the excess is deemed to be a capital gain under subsection 55(2) (and does not reduce ACB) because it is not deductible under subsection 112(1) and creates an addition to the capital dividend account.

…[I]f safe income is not based on the deduction of the full amount of the latent tax liability…the cost of the stock dividend shares will be different. If the fair market value of the Projectco shares is not based on VIH Logging, the developer should have full basis in the stock dividend shares because the full fair market value of the shares will be attributable to safe income . If the VIH Logging reasoning applies, the result is not clear. However, it might still be argued that the full amount of the dividend, including the excess over fair market value, is not subject to subsection 55(2) because it is attributable to safe income. The excess may not be subject to subsection 55(2) because it does not reduce the capital gain on a disposition at fair market value, but that does not mean that the excess is also not subject to subsection 55(2) because it is attributable to safe income….

K. A. Siobhan Monaghan, Taxation of Corporate Reorganizations, Chapter 8: Capital Gains Strips and Divisive Reorganizations," (2010, Carswell).

Rick McLean, Understanding Section 55 and Butterfly Reorganizations, 3rd Ed. (2010, CCH).

Matt MacInnis, "Pandora's Box Reopened", CA Magazine, September 2008, p. 48.

Steve Suarez, Firoz Ahmed, "Public Company Non-Butterfly Spinouts", 2003 Conference Report, c. 32.

F. Ahmed, "Allocation of Safe Income to Minority Shareholders", Canadian Current Tax, Vol. 9, No. 3, p. 24.

D. Ewens, "Planning for Safe Income Distribution", Corporate Structures and Groups, Vol. IV, No. 4, 1997, p. 228

Care must be taken when planning for providing a s. 88(1)(d) bump to a purchaser to ensure that safe income distributions are not counter productive.

"Subsection 55(2): Part 1", 1997 Canadian Tax Journal, Vol. 45, No. 2, p. 343.

Hiltz, "Income Earned or Realized: Some Reflections", 1991 Conference Report, c. 15.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 127 - Subsection 127(5) 0

Richter, "The Removal of Accrued Gains and Capital Stockholdings through the Use of 'Safe Income'", 1991 Canadian Tax Journal, p. 1349.

Paragraph 55(2)(b)

Administrative Policy

9 March 2016 External T.I. 2016-0630281E5 F - Redemption of shares and changes to 55(2)

demarcation between ss. 55(2)(b) and (c)

Does the designation by the corporate recipient of part of a dividend as a separate taxable dividend in respect of the portion of the dividend exceeding the safe income result in a capital gain corresponding to such separate taxable dividend in light of the amendment under the July 31, 2015 legislative proposals to the definition of "proceeds of disposition" in s. 54? CRA responded (TI translation):

If…the separate taxable dividend to which subsection 55(2) applies arises from the application of subsection 84(3) to the redemption of a share by the corporation…, the separate taxable dividend will be deemed to not be a dividend received by the recipient of the dividend and will be deemed, under paragraph 55(2)(b), to be included in the proceeds of the disposition of the redeemed share, except to the extent that the dividend is otherwise included in calculating those proceeds. The new definition of "proceeds of disposition"…provides that the dividend deemed to be received under subsection 84(3) will be reduced by the "proceeds of disposition" of the share except to the extent that the dividend is deemed by paragraph 55(2)(b) to be the proceeds of disposition of a share. This inclusion in the proceeds could result, in some circumstances, in an additional capital gain.

If subsection 55(2) applies, but paragraph 55(2)(b) does not apply, in a given situation, the dividend will be deemed, under paragraph 55(2)(c) to be a capital gain of the recipient of the dividend, for the year in which the dividend was received, from the disposition of a capital property. In such a case, it is not necessary to refer to the "proceeds of disposition" as defined in section 54 in respect of the separate taxable dividend.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) exemption of s. 84(3) deemed dividend not exceeding safe income 144
Tax Topics - Income Tax Act - Section 55 - Subsection 55(5) - Paragraph 55(5)(f) s. 55(2) application to separate dividend 103

Paragraph 55(2)(c)

Administrative Policy

31 August 2011 External T.I. 2011-0415891E5 F - Increase in stated capital, stock dividends -55(2)

CRA will construe paragraph 55(2)(c) so that the amount deemed not to be a dividend is not taxed as a capital gain twice. Paragraph 55(2)(c) will be applied in the year of the increase of the stated capital of the shares; when the shares are sold, the capital gain will be reduced by the amount already included in income pursuant to paragraph 55(2)(c).

Paragraph 55(5)(d)

Articles

Paul Dhesi, Korinna Fehrmann, "Integration Across Borders", Canadian Tax Journal, (2015) 63:4, 1049-72

Safe income of foreign affiliate (pp. 1069-1071)

Conceptually, the modified "tax-free surplus balance" definition in paragraph 55(5)(d) is the amount of tax-free surplus balance that could hypothetically be paid as a dividend by the foreign affiliate to the Canadian corporation free from Canadian tax, as if the shares of the foreign affiliate were directly owned by the Canadian corporation. [fn 50: Not including preacquisition surplus. The carve-out of regulation 5905(5.6) results in an effective "flattening" of a foreign affiliate structure for the purposes of the safe-income calculation, such that all foreign affiliates are treated as if they were direct subsidiaries of the relevant Canadian corporation.]...

The CRA has commented that it believes that

in general, in computing the safe income on hand attributable to the shares of the capital stock of a corporation, the losses of a subsidiary of the corporation must be taken into account when the loss results in a decrease in the FMV [fair market value] of the corporation's shares. [fn 54: ...2001-0093385.]

Nothing specific in the 2011 amendments to paragraph 55(5)(d) appears to directly address the exempt deficit issue in the computation of a foreign affiliate's safe income on hand.

...[S]ince safe income would generally be calculated in Canadian dollars, it is usually necessary to translate the tax-free surplus balance into Canadian dollars for the purposes of determining the amount of safe income in respect of a foreign affiliate. The CRA has stated that "[w]hen computing exempt or taxable surplus of a foreign affiliate at any particular time the exchange rate at that time should be used. [fn 57: ...9414365... .] In the context of foreign affiliate safe income, the CRA noted that the particular time would be the safe-income determination time.

[A] foreign affiliate's surplus balances are increased by the earnings of the foreign affiliate only at the end of the taxation year in which the earnings arise. [fn 60: The definition of "earnings" in regulation 5907(1) refers to the "earnings" of a foreign affiliate…for a taxation year."…] The CRA has provided administrative relief by indicating that this stub period income may be included in the calculation of safe income in respect of a foreign affiliate. [fn 61: ...9611945... .]

An election made under section 338(h)(10) of the US Internal Revenue Code by the purchaser and vendor in a share purchase permits the purchaser to treat the transaction as an asset purchase for US tax purposes, thereby achieving a step-up in US tax basis of the assets of the acquired corporation. The CRA has commented that tax depreciation in excess of amounts paid for assets would be added back in computing the safe income of a foreign affiliate in respect of which a Code section 338(h)(10) election has been made. [fn 63: ...2013-049914117... .]