Subsection 55(2.1)

Paragraph 55(2.1)(b)

See Also

101139810 Saskatchewan Ltd. v. The Queen, 2017 TCC 3

s. 55(2) assessment of corporate tax on bad butterfly confirmed notwithstanding same accrued gain reported at individual shareholder level

Mr. Case (“Case”), held 34 of the 102 common shares of an operating corporation (“CSM”) through a personal holding company (“8231”), which also held $1.3 million in other assets. In order to accomplish a sale of his indirect CSM shareholding to the other unrelated indirect shareholders of CSM (Messrs. Melby and Rae, each also holding 34 common shares through a personal holding company), that shareholding was split between two new wholly-owned corporations of Case (“807” and “810”), essentially using butterfly mechanics, with Case then selling his shares of 807 and 810 to the personal holding companies of Melby and Rae, respectively. In somewhat greater (but still simplified) detail:

  1. Case transferred a portion of his shares (having a nominal adjusted cost base) of 8231 to each of the newly incorporated 807 and 810 on an s. 85(1) rollover basis in exchange for treasury shares;
  2. 8231 transferred 17 common shares of CSM to each of 807 and 810 on an s. 85(1) rollover basis in exchange for treasury shares;
  3. 807 and 8231 each redeemed the shares in its capital held by the other for a $1.3 million promissory note, and the set-off the two promissory notes; and similarly for 810 and 8231; and
  4. on the sale of 807 and 810 about three weeks later to the personal holding companies of Melby and Rae, respectively, Case realized capital gains of $2.6 million and, in his return, deducted the remaining amount of his capital gains deduction of $0.24 million.

Initially, CRA reassessed both 807 and 810, and 8231, under s. 55(2) respecting the s. 84(3) deemed dividends reported by them respecting the cross-redemptions in 3 above, but 15 months later, vacated the reassessment of 8231. Furthermore, each of 807 and 810 was allowed a safe income deduction of $564,246.

In dismissing the appeals of 807 and 810, Favreau J rejected their submission (at para. 22) that as the full “unrealized appreciation” in question had been realized by Case, it was contrary to s. 55(2) to also assess 807 and 810 for that gain, stating (at paras. 26, 76):

[I]t is clear from a plain and ordinary reading of subsection 55(2) that this provision is meant to apply to a corporation and not to an individual shareholder and thus, the capital gains realized by Mr. Case has no relevance in the analysis. Furthermore, I do not agree with the appellants’ proposed approach of looking at the transactions in their entirety in determining if the result of a deemed dividend was a reduction in capital gains as it goes beyond the wording of the provision. To accept the Appellants’ approach would be to ignore the reduction of the notional capital gain as a result of an 84(3) deemed dividend, which is contrary to the words of subsection 55(2). …

I am inclined to favour a narrow construction of double taxation such that it arises where the same amount is taxed in the hands of the same person. Mr. Case and the appellants are not the same persons.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(5) - Paragraph 55(5)(f) 55(5)(f) designation may be made after assessment under s. 55(2) 245
Tax Topics - Income Tax Act - Section 248 - Subsection 248(28) taxation of same appreciation at individual shareholder level and corporate level under s. 55(2) was not double taxation 270

Administrative Policy

5 October 2018 APFF Financial Strategies and Instruments Roundtable Q. 5, 2018-0761561C6 F - Rachat de parts en cas d’invalidité

purpose of dividend is determined based on facts respecting the series

Opco is held equally by two unrelated individuals directly and through their respective Holdcos and, on the disability of one, Opco receives disability insurance proceeds and pays them as a special dividend to the healthy shareholder’s Holdco to fund the purchase by it of the other’s Holdco. Finance stated:

[A]mounts received by a corporation that are not included in its income, such as the disability insurance proceeds received by the operating corporation, are not included in safe income. …

Where a corporation receives a dividend that is deductible in computing its taxable income and the dividend does not benefit from the safe income exception, the determination of whether the dividend will be recharacterized as a capital gain under subsection 55(2) and the purpose test should be consistent with the tax policy underlying section 55. The purpose of the payment or receipt of a dividend is determined according to the facts relating to the series of transactions or events of which the payment and receipt of the dividend is a part.

5 October 2018 APFF Roundtable Q. 5, 2018-0768761C6 F - Partage de la déduction accordée aux petites entreprises

dividend paid out of disability proceeds to fund purchase by survivor’s holdco might not have s. 55(2.1)(b) purpose

Messrs. A and B wholly-own Holdco A and B, respectively, each of which, in turn, holds half of the Class B shares of Opco having an FMV of $500,000. Messrs. A and B also each hold half of Opco’s Class A shares having in each case an FMV of $1,000,000. Opco holds an insurance policy that pays out in part in the event of disability. In the case of disability of either individual, Opco will receive the proceeds of the policy covering such event in order to then pay a special dividend of $1,000,000 to the Holdco of the active shareholder to fund the purchase by the latter of the shares held directly by the disabled individual – with Opco then redeeming shares held by the purchased Holdco of the disabled individual for $500,000.

After indicating that there was insufficient information to provide more than a general discussion of the purpose tests in ss. 55(2.1)(b)(i) and (ii), CRA noted that, in 2015-0613821C6, it indicated that it could issue a favourable advance ruling on a determination of purpose “where all manifestations of purpose and corroborating circumstances support the absence of one of the purposes described in subparagraph 55(2.1)(b)(ii) and (ii)” with such determination “conditional on the representation made by the taxpayer that the purposes for which the dividend was paid do not include one of the purposes described in proposed paragraph 55(2.1)(b)(i) and (ii) … .”

CRA then stated:

Although in certain circumstances the dividend paid by Opco to the holding corporation of the active shareholder may not be considered to have any of the purposes described in paragraph 55(2.1)(b), that determination can only be made after a review of all the facts of a particular situation.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 125 - Subsection 125(8) use of personal holding companies precluded assignment 287
Tax Topics - Income Tax Act - Section 125 - Subsection 125(7) - Designated Member - Paragraph (b) - Subparagraph (b)(i) Serviceco met the 3 conditions for being a designated member 209

2016 Ruling 2016-0652041R3 - Loss consolidation arrangement

s. 55(2) ruling re dividends on preferred shares used in loss shift

Respecting a triangular loss-shifting arrangement for the shift of non-capital losses by Parentco to its wholly-owned Profitco (with Profitco using the proceeds of an interest-bearing loan from Parentco to subscribed for preferred shares of a Newco subsidiary of Parentco, with dividends on such shares being funded with contributions of capital from Parentco), CRA ruled that s. 55(2) would not apply to the dividends paid by Newco to Profitco to fund the interest on the loan by Parentco to Profitco, based on a representation that:

The only purpose of both the payment and the receipt of the dividends on Newco’s Preferred Shares … is to provide a reasonable return on the Newco Preferred Shares issued by Newco to Profitco. More specifically, none of the purposes of the dividends is to reduce the fair market value or capital gain of any share, nor to increase the total cost amounts of properties of Profitco.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 111 - Subsection 111(1) - Paragraph 111(1)(a) standard triangular loss shift with annual funding of dividends and interest, cashless unwind with set-off and provincial GAAR and s. 55(2) rulings 228

21 November 2017 CTF Roundtable Q. 5, 2017-0726381C6 - 55(5)(f) and 55(2.3) with 55(2.1)

notwithstanding dividend bifurcation under s. 55(5)(f) (or 55(2.3), the s. 55(2.1)(b) purpose test is to be applied to the whole dividend

Opco pays a dividend of $1,000 to Holdco. Its shares had a pre-dividend fair market value of $1,500. As the safe income that can reasonably be viewed as contributing to gain on Opco shares was $900, does the s. 55(5)(f) deems two separate dividends of $900 and $100? Are both dividends separately tested under s. 55(2.1), so that the $900 is exempt as not exceeding safe income, and the $100 is exempt if its purpose is not to significantly reduce the gain or the value of the shares on which it is paid?

CRA indicated that under the old s. 55(2) regime, it was well understood that the purpose test applied to the whole dividend, so that the s. 55(5)(f) only required the inclusion under s. 55(2) of the portion of the dividend exceeding safe income. The new rules did not change this. The contrary interpretation would results in duplication of the safe income protection, and contrary to the s. 55(5)(f) purpose of bringing into income the amount by which the dividend exceeds safe income.

Under an appropriate purposive reading, the dividend referred to in:

  • the s. 55(2.1) preamble and in ss. 55(2.1)(a) and (b) is the whole $1000;
  • s. 55(2.1)(c) is the portion exceeding safe income ($100);
  • the s. 55(2) preamble is the whole $1000; and
  • the s. 55(2) preamble that is deemed not to be a dividend but to be a gain, is the s. 55(2.1)(c) amount ($100).
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.3) dividend bifurcation under s. 55(2.3) does not detract from s. 55(2.1) purpose tests being applied to whole dividend 156
Tax Topics - Income Tax Act - Section 55 - Subsection 55(5) - Paragraph 55(5)(f) bifurcated dividends are one dividend for s. 55(2.1)(b) purpose test but not under s. 55(2.1)(c) 100

21 November 2017 CTF Roundtable Q. 3, 2017-0724021C6 - Meaning of purpose

QSBC purification transaction must not have any bad purpose described in s. 55(2.1)(b), as determined objectively as per Ludco

2016-0658841E5 indicates that paying a dividend of surplus assets with the goal of purifying the corporation for “qualified small business corporation share” (QSBCS) purposes would be a relevant factor that should be taken into account, but that it should be ensured that the dividend has no other purpose described in paragraph 55(2.1)(b) so that, for example, if the dividend paid to the corporation exceeds the amount that would be required to transfer the surplus assets, this could be a sign that the dividend has another purpose.

Q.(a)

If the dividend’s only purpose is to maintain QSBCS status, the dividend should not have a purpose (but might have the result) of reducing the FMV or the gain on the shares. In this situation, would CRA agree that the purpose tests are not met?

CRA indicated that whether the payment of a dividend can be viewed as having only the purpose of maintaining QSBCS status, but has no purpose of reducing the value of the gain on the share or increasing the cost of property to the dividend-recipient, is a factual determination. It went on to indicate that where the dividend is paid with non-surplus assets, that may signify that it has a purpose referenced in s. 55(2.1)(b), and that another such sign could be where the removal of a surplus asset is made in contemplation of the disposition of the shares of a corporation.

CRA went on to question why on the facts there was not safe income corresponding to the surplus assets.

Q.(b)

Is the test under Ludco the right test to use to determine “purpose” as contrasted to that in Placer Dome? After quoting the statement in Ludco that “courts should objectively determine the nature of the purpose, guided by both subjective and objective manifestations of purpose,” CRA indicated that Ludco followed the purpose test in Symes, and the Symes/ Ludco test (consistently with many other decisions) constitutes the benchmark of purpose. In both Placer Dome, and McAllister Drilling referenced therein, the Court determined the purpose of the taxpayers by not only listening to their testimony, but also by examining all the facts, so that neither contradicts Ludco and Symes.

6 April 2017 External T.I. 2016-0658841E5 F - Purpose tests and Allocation of safe income

s. 55(2) did not apply to dividends paid only for asset protection and QSBC-status purposes

The participating and non-voting Class AA shares of Opco, which were held equally by two unrelated individuals (A and B), were worth $500,000 and had a safe income of $300,000 on January 1, 2016, and had a nominal paid-up capital and adjusted cost base. Nominal-value voting shares of Opco were held by Holdco, which was owned equally by A and B. On January 1, 2016, Holdco also subscribed $100 for 100 Class X shares of Opco, which were entitled to participate annually in Opco’s profits proportionately with the number of issued and outstanding AA and X shares and with the shares' redemption value reflecting the undistributed amount of such profits plus their initial subscription price.

On December 31, 2016, Opco had accumulated $100,000 in after-tax profits and safe income, and on January 1, 2017, Opco paid a dividend of $50,000 to Holdco pursuant to a strategy of eliminating excess liquidity in Opco in order to qualify the Class AA at all times for the capital gains deduction and also for asset protection purposes, thereby causing the Class X shares’ redemption value to decrease to $100.

Q.1:

Would the purpose of the transactions be to reduce a capital gain or reduce the market value of a share as described in s. 55(2.1)(b)? CRA responded:

[P]aying a dividend with the goal of [so] purifying the corporation…would certainly be a relevant factor that should be taken into account. However, it also should be ensured that the dividend has no other purpose described in paragraph 55(2.1)(b). For example, if the dividend paid to the corporation exceeds the amount that would be required to transfer the surplus assets, this could be a sign that the dividend has another purpose, which was one of those referred to in paragraph 55(2.1)(b).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) safe income was allocated between 2 classes of participating shares pro rata to their dividend entitlements 776

13 June 2017 STEP Roundtable Q. 6, 2017-0693411C6 - GAAR on share redemption-55(3)(a)

using s. 55(3)(a) to create a high-basis redemption note is abusive even if that high basis is not used right away

In 2015-0604521E5, a promissory note issued to Holdco on a share redemption was subsequently transferred to Newco as a capital contribution. Since the amount of the promissory note was higher than the ACB of the redeemed shares and increased Holdco’s ACB of the shares of Newco, CRA indicated that it would seek to apply GAAR to Holdco’s reliance on s. 55(3)(a).

Is a subsequent transaction to use the note (or other property, including cash, received as consideration for a share redemption), such as the above transfer of the note to Newco, a necessary trigger for GAAR to be so applied, i.e., could the receipt of a note with a high ACB in itself cause GAAR to apply?

CRA indicated that where a purpose is to increase the cost amount of property of the dividend recipient, GAAR would be triggered, and it is irrelevant whether the cost amount has been used in a series of transactions that includes the dividend.

13 June 2017 STEP Roundtable Q. 7, 2017-0693421C6 - 55(2) and pipeline planning

S. 55(2) does not apply to an estate pipeline transaction

On death, an estate receives shares of an investment holding company (H1), and then immediately structures a pipeline under which the H1 shares are transferred to H2 for a note - with the H1 shares of H2 then being redeemed. Could s. 55(2) apply? Would the starting safe income to the estate be nil?

CRA indicated that because there would be no capital gain if those shares were disposed of for fair market value proceeds immediately before the redemption, the redemption of shares of H1 would not result in a reduction of any gain. Also, the purpose test in s. 55(2.1)(b)(ii) does not apply to a dividend that is deemed to be received under s. 84(3). Here, the cost amount of the property is the same before and after the redemption, and the reduction of the fair market value of the shares being redeemed does not result in any deductible loss to H2. The CRA would not seek to apply GAAR in this situation.

Accordingly, the deemed dividend on the redemption would not be subject to s. 55(2) or the application of GAAR - and there is also no carry over of safe income, since the safe income has already been crystallized in the ACB of the shares.

29 November 2016 CTF Roundtable Q. 8, 2016-0671501C6 - 55(2) clause 55(2.1)(b)(ii)(B)

cash is property for 55(2.1)(b)(ii)(B) purposes

Is cash considered to be property for purposes of the application of s. 55(2.1)(b)(ii)(B)?

CRA indicated that it is contrary to the scheme of the Act to allow for a tax-free increase in costs, and that there is a lack of tax integration where a corporate shareholder receives property as a non-taxable whose cost exceeds the amount on which tax has been paid. After also noting that cash is property for (consistently with the s. 248(1) definition), CRA also noted that cash received on a dividend can be used to purchase any other property or even additional shares of the dividend payor, and this results in an increase in the cost amount of the shares of the dividend payor.

Accordingly, cash is property for this purpose.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Property cash is property in s. 55(2) 9

7 October 2016 APFF Roundtable Q. 14, 2016-0655921C6 F - Safe income on hand - Preferred shares

whether dividends paid on non-participating prefs engage s. 55(2) is a question of fact

Respecting the payment of a non-participating dividend to a holding company on preferred shares whose paid-up capital and ACB equals their redemption amount, CRA indicated that “the hypothetical capital gain that would have been realized on a FMV disposition of [the] preferred shares immediately before the dividend…would be nil,” so that the dividend would not be considered to come out of safe income on hand. Since the safe income harbour was not available, whether s. 55(2.1)(b) applied was a question of fact.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) fixed dividends on full-ACB prefs did not come out of SIOH 136

23 June 2016 External T.I. 2016-0627571E5 - Application of proposed amendments to section 55

low safe income is still too low even if it is the result of incentive tax deductions/preferred share dividends and redemptions

Divco, a Canadian-resident corporation with Canadian corporate shareholders, pays cash dividends from its excess cash-flow to its shareholders whose amount is determined in the Board’s discretion or which exceeds the reasonable dividend return that would be paid on a comparable listed share issued by a comparable corporation in the same industry and which, in either case, will significantly reduce Divco’s fair market value and are not paid out of safe income. Would the dividends’ purpose be as described in s. 55(2.1)(b)? CRA responded:

None of the factors listed [above] would, in and of themselves, be determinative of whether one of the purposes of the payment or receipt of a dividend is described in proposed paragraph 55(2.1)(b). …[T]he safe income of [Divco] would be less than its retained earnings… because [it] was entitled to tax benefits such as accelerated capital cost allowances that significantly reduced its income under the Act. … If corporate income has not previously been taxed, whether because the corporation was entitled to certain tax benefits under the Act or for any other reason, then a dividend paid by the corporation from such income should be subject to subsection 55(2) unless none of the purposes of the dividend is described in proposed paragraph 55(2.1)(b). The same comments would also apply in a situation where a corporation borrows money to pay a dividend or to redeem shares of its capital stock. ...

After also stating respecting dividends paid by Divco subsidiaries that “there is no consolidated approach in determining whether the purpose tests are met,” and that “year-end dividends that are only designed to offset intercorporate advances made under conventional cash pooling arrangements might not be considered to have [such] a purpose,” CRA was then asked about a scenario where Divco regularly or infrequently pays dividends on its non-cumulative preferred shares. CRA responded (before adding cautions):

[W]e assume that the redemption value of the preferred shares of Divco is equal to the fair market value of the consideration received by Divco upon the issuance of the shares. In addition, we assume that the dividend rate on the preferred shares reflects a reasonable dividend income return on equity on a comparable listed share issued by a comparable payer corporation in the same industry as Divco. In this context, it is our view that the terms and conditions of the preferred shares of Divco would generally be considered as an objective manifestation of the absence of purpose in proposed paragraph 55(2.1)(b).

Respecting a redemption of the preferred shares, CRA stated:

[W]e would normally not consider such redemption of shares that have no accrued gain to have such a purpose. Where there is an accrued gain on shares redeemed by a corporation, the absence of a reinvestment of the redemption proceeds in the corporation or of transfer of property to the corporation is not, by itself, conclusive in determining whether none of the purposes described in proposed paragraph 55(2.1)(b) exists.

2015 Ruling 2014-0552871R3 - Split-Up Butterfly

post-butterfly sale of distributed shares by one TC to the other

In connection with the butterfly split-up of DC equally between the family holding companies (Shareholder1 and Shareholder2) for two unrelated families, the shares of Subco2, which might be a significant subsidiary of DC, are split 50-50 between the two transferee corporations (TC1 and TC2) on the butterfly, then TC1 sells its shares of Subco2 to TC1 for FMV consideration.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution post-butterfly sale of distributed shares by TC1 to TC2/disproportionate split of CDA/assumption of prepaid rent (for which a 20(24) election) treated as boot 709
Tax Topics - Income Tax Act - Section 20 - Subsection 20(24) deferred revenue treated as boot 51

8 June 2016 CTF Technical Seminar: Update on s. 55(2)

integration principle/expanded scope/no contemplated sale required/no blanket exemptons/policy similar to boot rules

Comments of Yves Moreno and Annie Mailhot-Gamelin (both with the Income Tax Rulings Directorate) on the proposed s. 55(2) rules included:

  • The integration principle is key to CRA’s thinking about safe income and s. 55(2), (so that the role of s. 55(2) is “is to ensure that corporate tax is paid, but that at the same time that there is no duplication of corporate taxes”) and, conversely, “the concept of safe income is one of the pillars of integration.”
  • The changes to s. 55(2) were meant to address the type of planning raised by D & D Livestock, where ACB is created (without being caught by existing s. 55(2) because there was no gain on the shares in question). In particular, new s. 55(2) “now would address circumstances where the purpose of the dividend is to either reduce the value of a share…or to increase the cost of the property in the hands of the dividend recipient…” (with both elements being present in the D&D-style planning).
  • For the new rules top apply, there is no requirement that a sale occur as part of the same series of transactions. In this regard, the policy is similar to the boot rules, where excess boot will produce an immediate gain even if there is no plan to use the additional basis.
  • CRA previously provided comfort (in 2015-0613821C6) on the non-application of s. 55(2.1)(b) to dividends paid as part of a corporation’s standard practice of paying regular quarterly or annual dividends. CRA now indicated that the rationale is that “it is doubtful that the dividend would significantly reduce the fair market value or the gain on shares,” and that, in any event, “it is difficult to imagine that one of the purposes of the dividends would be to achieve that.” CRA rejected calling this position a “safe harbour,” stating that “the analysis of every dividend will involve its own set of facts and circumstances.” Similarly, there can be no automatic exemptions for other common dividend transactions such as funding general current expenses of a parent or settling intragroup debt resulting from cash pooling arrangements.
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) safe income appropriately reduced by incentive reductions 29
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution butterfly rulings may require amending discretionary shares 50
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.5) significant reduction in value of nominal value share 84

21 December 2015 External T.I. 2015-0617731E5 F - 55(2) and creditor proofing

Opco dividend to Holdco whose sole purpose is creditor-proofing is subject to s. 55(2)

Holdco holds all the shares of Opco, which have a fair market value (“FMV”) of $1M and an adjusted cost base (“ACB”) of $100. Opco (which carries on a construction business) has retained earnings of $1M and no safe income is attributable to Holdco’s shares of Opco.

“With the sole purpose of protecting its assets from the risks inherent in the construction sector,” Opco paid a $1M dividend to Holdco, which was not subject to Part IV tax and for which Holdco took a $1M s. 112(1) deduction, with Holdco lending the sum back to Opco. Holdco had no intention of selling the Opco shares, and the Opco shares were not redeemed etc. on the dividend payment.

Would s. 55(2) and draft s. 55(2.1)(b)(ii) apply to deem the dividend to be a gain from the disposition of capital property? CRA responded (TaxInterpretations translation):

It appears to us that one of the purposes of the payment of the dividend was to effect a significant reduction in the FMV of a share in the capital of the operating company when the purpose of the transaction was to shelter from creditors the assets of a corporation carrying on a business or to secure those assets by diminishing the total value of the operating corporation and augmenting the value of its shareholder (the holding company)… .

In the facts indicated by you, there was no safe income attributable to the shares in the capital of Opco, held by the holding company, even though the shares in the capital of Opco held by Holdco had an ACB of $100, an FMV of $1M and the retained earnings were $1M. We would have thought that on these assumptions, there would be an amount of safe income on hand which it was reasonable to consider as contributing to a capital gain which would have been realized on a disposition at FMV, made immediately before the dividend, of the shares held by Holdco on which the dividend was received.

However, on the assumption indicated by you respecting safe income, subsection 55(2) would apply to the amount of the dividend. This amount would be deemed not to be a dividend…[and] would be deemed to be a capital gain from the disposition of capital property by virtue of paragraph 55(2)(c).

3 December 2015 External T.I. 2015-0593941E5 F - Allocation of the safe income on hand

quaere whether 8% reduction is significant

CRA declined to express a view as to whether an $8,000 reduction in an accrued capital gain of $120,000 was significant.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) flexible allocation of SIOH where discretionary common shares 1215
Tax Topics - General Concepts - Fair Market Value - Shares FMV of discretionary share increased at moment of dividend declaration to exclusion of other discretionary shares 92

17 November 2015 Roundtable, 2015-0613821C6 - TEI question on section 55

regular dividends not in excess of return on comparable listed shares not included

TEI members remain concerned that, because all dividends result in a reduction of the fair-market value of shares held by the dividend payor and increase the cost of properties held by the dividend recipient, the CRA may try to reassess ordinary course dividends on the basis that a purpose of every dividend is a tainted purpose. Comments? CRA responded:

The "significant" aspect could be measured in terms of an absolute dollar amount or on a percentage basis.

…[A] dividend that is directly or indirectly instrumental in the creation of an accrued loss on any share that may be used, or has the potential to be used, to shelter a gain on some other property provides an indication that the FMV reduction purpose exists (for example, one might consider transferring a property with an accrued income or capital gain to the corporation that issued shares that have an accrued loss). Also, the use or possibility of using an increased cost amount of properties to shelter a gain is an indication that the purpose of the dividend is to increase cost.

Where a dividend is paid pursuant to a well-established policy of paying regular dividends and the amount of the dividend does not exceed the amount that one would normally expect to receive as a reasonable dividend income return on equity on a comparable listed share issued by a comparable payer corporation in the same industry, the CRA would consider that the purpose of the payment of such dividend is not described in proposed paragraph 55(2.1)(b).

24 November CTF Annual Roundtable, Q.10

application where no gain on shares/non-application to loss-shifting transactions

Points respecting proposed s. 55(2.1)(b)(ii) included:

  • The purpose test in s. 55(2.1)(b)(ii) could apply even if the dividend does not satisfy the purpose in proposed s. 55(2.1)(b)(i) (i.e., there is no gain on the shares)
  • “Whether a reduction of value is significant is a question of fact and could be measured in terms of an absolute dollar amount or on a percentage basis.”
  • “in-house loss consolidations that were only designed to move losses between related or affiliated corporations and on which we have ruled favourably in the past would not be considered to have a purpose described in proposed subsection 55(2.1). An indication that such purpose is absent in similar loss consolidations is that any ACB that is created in the loss consolidation is eliminated on the unwind of the loss consolidation structure."
  • Where a non-participating discretionary shares has no accrued gain, then a dividend paid thereon which violates the purpose test cannot benefit from safe income. However, where this occurs, CRA is prepared to accept that the safe income on the participating shares of the same corporation will not be affected.
  • CRA considers it to be offensive to redeem a share for a note in a s. 55(3)(a) reorganization, with the note being used to generates basis in excess of redeemed shares’ ACB.
  • Also offensive is "ACB streaming prior to a reorganization under 55(3)(a) or (b), where the redemption would be of low-ACB shares, while the high ACB shares would be preserved."
  • Creditor-proofing transactions apparently are considered to per se entail a purpose that engages s. 55(2.1)(b)(ii).

In related oral comments, CRA indicated that "normal course" dividends (albeit with a narrow description of the only clear safe harbour) should not be subject to the new rules and that it is willing to issue opinions (and presumably rulings, once the new rules are enacted) on the non-application of s. 55(2.1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(5) - Outstanding Debts to Specified Non-Residents foreign-currency debt to Canco translated at historical rate 34

2015 Ruling 2015-0604071R3 - Loss Consolidation Arrangement

loss shifting transaction not affected

Profitco is wholly-owned by Lossco, which is wholly owned by Parent. Profitco borrows from Profitco (at an interest rate reflecting the loan’s subordinated status) and subscribes for non-voting cumulative redeemable retractable preferred shares of Lossco. Parent will agree, in a support agreement with Lossco, to make capital contributions to fund Lossco’s payment of the dividends, which will occur on the unwinding of the transactions.

CRA provided an opinion that, after giving effect the July 31, 2015 draft amendments, s. 55(2) will not apply to this dividend.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 111 - Subsection 111(1) - Paragraph 111(1)(a) loss shift entailing Profitco subscribing for prefs of its Lossco parent, with dividends paid pursuant to support agreement/prefs redeemed wih note 202

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

transaction targeted at reducing FMV of Opco shares for creditor-proofing was caught

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 (targeted to be tax-free). 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.

Under a variation of the first alternative, the shares of Opco have full ACB (of $1M) and also safe income on hand of $1M. CRA indicated that this assumption that the safe income attributable to the shares of Opco held by Holdco was equal to the amouont of the dividend received was "surprising," stating "by way of example, the cost could reflect the accumulated safe income before an acquisition of shares by Holdco and, if Opco had not increased in value since that time, the safe income would be nil after such acquisition of shares by Holdco." However, accepting these assumptions, the dividend here as well of $1M would also be a capital gain, so that the ACB could only be utilized on a future disposition of the Opco shares.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2) no relief under new rules where Part IV tax is refunded on payment of dividend to individual shareholder 181

Articles

Doron Barkai, Alexander Demner, "Dealing with New Subsection 55(2): Issues and Strategies", 2016 Conference Report (Canadian Tax Foundation), 6:1–56

Possible need for a specific anti-avoidance purpose (p. 6-5)

[C]ertain practitioners have suggested that in the absence of a specific tax-avoidance motive behind a dividend, neither an FMV-reduction purpose nor a cost-increase purpose should be found to exist (fn 20: See Eoin Brady and Gwendolyn Watson, "The 'Purpose' of Subsection 55(2)," in 2015 Ontario Tax Conference (Toronto: Canadian Tax Foundation, 2015), 8:1-16]…

Creditor-proofing transaction: Opco pays dividend to Holdco who makes secured loan to Opco (pp. 6:15-16)

[I]n CPL Holdings…a dividend was paid followed by a loanback of the proceeds of the dividend to the operating corporation. The transactions had the effect of significantly reducing the capital gain that would have been realized on the disposition of shares. The court held that the purpose test in former subsection 55(2) was not satisfied. …

[T]he court did analyze the reduction in the FMV of the shares (which is essentially the new FMV-reduction purpose test) and concluded that such a reduction, in a creditor-proofing transaction, was one of the effects of the transaction, but not one of its purposes…

…However, the CRA could theoretically argue that the cost-increase purpose test is applicable with respect to creditor-proofing transactions. As a result of the creditor-proofing dividend, Holdco has realized a significant increase in the aggregate tax cost of all of its properties because of the secured loan… . However, the same analysis used by the court in CPL Holdings to determine that the FMV-reduction purpose test was not met is applicable in the context of the cost-increase purpose test….

[T]he CRA clearly stated [in 2015-0623551C6] that creditor-proofing transactions offend the new purpose tests… .

[T]he CRA's position that the FMV-reduction purpose test applies to creditor-proofing dividends by default can legitimately be questioned. A creditor-proofing dividend is typically paid solely to create (or enhance) internal security over Opco's assets….

CRA requirement for reversal of basis increase in loss-transfer transaction (p. 6:20)

[I]n a loss-consolidation transaction, the effect of the payment of a dividend on a share may be to increase the aggregate ACB of the dividend recipient's property; however, the CRA does not consider this to be a purpose of the payment or receipt of the dividend because any ACB created is eliminated in the unwinding of the transaction.

Purification of Opco for SBC purposes through dividending excess assets to Holdco: issues (p. 6:21)

[U]nder the current rules the safe income exception may not readily apply. A one-time purification dividend may be substantial and thus may exceed both the FMV and the accrued gain (if any) of the Opco shares held by Holdco. This may be especially problematic if Holdco owns only dividend-sprinkling shares that are redeemable for a nominal amount and have a limited liquidation entitlement (since the FMV of the shares may be nominal).

Furthermore, restructuring a purification dividend as a share redemption or repurchase to gain access to the related-party exception may not be possible. Distributing non-active business assets shortly before a divestiture would likely negate the application of the exception (given the risk of an unrelated party acquiring an interest in the dividend payer as part of the same series of transactions)….

In many circumstances, Holdco would likely be able to convincingly argue that the sole purpose of the purification dividend was to provide the individual shareholders access to their LCGE. and thus no offensive purpose existed….

Rick McLean, "Subsection 55(2): What Is the New Reality?", 2015 CTF Annual Conference paper

Example of planning engaging the introduction of the expanded s. 55(2.1)(b) test respecting increases in cost amount (pp. 22:9-12)

Holdco owns all of the shares of Opco that have an FMV of $10 with an ACB and a PUC if nil. The safe income attributable to the Opco shares held by Holdco is $1.

Opco pays a stock dividend of preferred shares on the common shares. The preferred shares have a redemption amount and an FMV of $1. ... The stated capital of the preferred shares is set at $1. ...

Under paragraph 52(3)(a), the ACB of the preferred shares is equal to $1. …[B]ecause the amount of the dividend does not exceed safe income, the ACB of the preferred shares is equal to the stated capital increase. ...

Holdco incorporates Newco and transfers the Opco preferred shares to Newco for common shares of Newco. At this point, Holdco and Newco could sell the shares of Opco and realize an aggregate capital gain of $9, which is an acceptable result.

Next, Newco declares a dividend of $1 payable to Holdco, which is satisfied by transferring the Opco preferred shares to Holdco. ...

Under the old rules…[t]he dividend reduced the Newco shares' FMV below their ACB, but it did not reduce a capital gain on the Newco shares. That is, the Newco shares had no accrued gain immediately before the dividend because the FMV was equal to the ACB. Accordingly, it cannot be said that the purpose of the dividend was to reduce a capital gain on the Newco shares. ...

Holdco transfers the Opco common shares (electing under subsection 85(1) at a nominal amount) and the Opco preferred shares to Newco for common shares of Newco. The FMV of the common shares of Newco is $10 with an ACB of $2. Holdco created ACB of $1 by capitalizing available safe income of $1 (which is acceptable) but then duplicated that ACB. Holdco can now sell the Newco shares and realize a capital gain of $8 instead of $9.

…[I]n the context of new subsection 55(2.1)…was the purpose of the dividend to increase the total cost amounts of property owned by Holdco? Yes.

Variant of 2015 Budget Paper example (p. 22:12-13)

  1. Holdco incorporates Subco and subscribes for one common share of Subco for $1.
  2. Subco pays a cash dividend of $1 to Holdco.
  3. Holdco transfers a property that has an accrued gain of $1 to Subco under subsection 85(1) in exchange for common shares of Subco.
  4. Holdco sells the Subco shares to Buyer.

Under the old rules, subsection 55(2) could not apply because the dividend paid by Subco did not reduce a gain on the Subco shares. New paragraph 55(2.1)(b) should cause subsection 55(2) to apply because one of the purposes of the dividend was to reduce the FMV of the Subco shares below ACB to create a loss share. It could also be said that one of the purposes of the dividend was to increase the total cost amounts of Holdco's property.

Non-application of GAAR to cash s. 55(3)(a) redemptions? (pp. 22:33-34)

[T]he two new purpose tests do not apply to a deemed dividend on a redemption, acquisition , or cancellation of shares under subsection 84(2) or 84(3).…CRA was asked [f.n. 61:…2015-0610681C6] whether share redemptions could be used as an alternative to regular dividends in order to avoid the application of the anti-avoidance rule in subsection 55(2).

…[T]he round-table question was addressing a situation in which a share is redeemed for cash consideration with the objective of using the paragraph 55(3)(a) exception. The CRA...did indicate that when a share is redeemed or cancelled, the ACB in the share is eliminated; therefore, redemption or cancellation would not normally be helpful in creating ACB or reducing FMV. This response appears to assume that the share was redeemed for cash and that there were no steps taken to isolate or preserve ACB. This could suggest that the CRA might not apply GAAR to transactions involving cash share redemptions that are intended to qualify under paragraph 55(3)(a). However, Finance's explanatory notes stated that paragraph 55(3)(a) was not intended to be used to accommodate the payment or receipt of dividends, which means that there is still uncertainty on this point.

Loss of safe-income exception if temporary decline in the FMV of shares (pp. 22:42)

  • In the past, Holdco acquired the shares of Opco for $1,000, which reflected the FMV of Opco's assets at that time.
  • Since Holdco acquired the shares, Opco has realized after-tax earnings of $10, represented by cash.
  • However, owing to market conditions, the FMV of Opco's assets has decreased to $800, resulting in a temporary decline to $810 (including the $10 of cash) in the FMV of the Opco shares. ...

If Opco pays a $10 cash dividend to Holdco, the safe-income exception does not apply even though that amount represents after-tax income earned by Opco. However, the FMV-reduction purpose test could apply. If the FMV of the Opco assets and shares subsequently recovers in value, such that the FMV of the Opco shares exceeds their cost base, then the safe-income exception can apply.

Subparagraph 55(2.1)(b)(i)

Administrative Policy

10 October 2014 APFF Roundtable Q. 20, 2014-0534671C6 F - D&D Livestock

CRA is concerned by planining that can result in an unjustified duplication of fiscal attributes including ACB

What is the CRA position on D & D Livestock? CRA stated (TaxInterpretations translation):

[S]ubsection 245(2) was not applied in this case. However, the CRA would not hesitate to invoke the GAAR in similar files. … The CRA considers among other things that transactions or series of transactions permitting the double utilization of the same amount of safe income in order to reduce a capital gain realized on an ultimate disposition of shares of a corporation are abusive and go against the object of subsection 55(2). Moreover, Justice Graham emphasized at paragraphs 27 and 28 of the decision… that the transactions in the case resulted in stripping of capital gains.

Furthermore, the CRA is also concerned by planning which can result in an unjustified duplication of fiscal attributes, for example, the duplication of the adjusted cost base of a share, regardless of the fact the that adjusted cost base exists by reason of safe income of a corporation. Similar transaction will be contested by the CRA, as appropriate.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) unjustified duplication of fiscal attributes is abusive 163

Subparagraph 55(2.1)(b)(ii)

Administrative Policy

12 May 2017 External T.I. 2017-0683511E5 F - Purpose tests of a dividend or repurchase of share

redeeming common shares otherwise than out of safe income may be GAARable

Holdco holds 100% of Opco’s participating shares, which have a value of $100,000, paid-up capital and adjusted cost base of $1 and safe income attributable thereto of nil. Opco has a cash balance of $100,000, which it would dividend to Holdco to acquire an immovable for leasing to Opco for use in Opco’s business. Would one of the purposes of the dividend be described in s. 55(2.1)(b)(ii)? Alternatively, in order to avoid the potential application of s. 55(2) to the payment of an actual dividend, could Opco purchase for cancellation 99.99% of the participating shares held by Holdco for $99,999?

Respecting the first situation, in the course of noting that determining the purpose of the dividend was a question of fact, as to which CRA noted factors for assessing the motivation behind the purpose, CRA stated:

[T]he payment of a dividend for the purpose of acquiring an immovable must be assessed taking into account that the property could have been purchased by Opco instead of Holdco. There could therefore be a purpose similar to that of protecting the assets from risk inherent in the carrying on of the Opco business, a purpose that we have already characterized as the purpose of reducing the value of shares.

Respecting the second situation, CRA stated:

[T]he utilization of paragraph 55(3)(a)…in order to replace a dividend not coming out of safe income, could be determined to be offensive.

[S.] 55(3)(a) is intended to facilitate corporate reorganizations made in good faith by related persons but is not intended to accommodate the payment or receipt of dividends or transactions or events which seek to increase, manipulate or manufacture tax basis.

Thus, the application of the general anti-avoidance rule in subsection 245(2) should be queried, considering that the money given to Holdco would not come from the income that had already been taxed in Opco and that the adjusted cost base of participating shares in the capital stock of Opco would be nominal.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3) - Paragraph 55(3)(a) using s. 55(3)(a) to distribute cash otherwise than from safe income likely abusive 181
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) use of s. 55(3)(a) redemption exception to circumvent safe income limitation could be offensive 52

Paragraph 55(2.1)(c)

See Also

626468 New Brunswick Inc. v. The Queen, 2018 TCC 100

safe income was reduced by corporate income taxes that would be computed on that income

Before agreeing to sell an apartment building (the property) owned by him to a third party, Mr. Gillis transferred the property on a s. 85(1) rollover basis to a newly-incorporated corporation (“Tri-Holdings”) in consideration for the assumption of a portion of the mortgage on the property and for the issuance of four common shares (representing all the Tri-Holdings’ shares) with a nominal paid-up capital (“PUC”). Mr. Gillis then transferred those shares on a s. 85(1) rollover basis to a newly-incorporated holding company (“468”) in consideration for shares of 468 with a nominal PUC. Tri-Holdings sold the property to the third party, realizing a capital gain and recapture of capital cost allowance. Tri-Holdings then effected successive increases in the PUC of its shares, thereby resulting in successive s. 84(1) deemed dividends to 468 (one of which was a capital dividend), which thereby increased the adjusted cost base of 468”s shares of Tri-Holdings. 468 sold all its shares in Tri-Holdings to an unrelated corporation for a price based on the cash of Tri-Holdings.

At issue was whether the safe income attributable to 468’s shares of Tri-Holdings was reduced by the corporate income tax borne by Tri-Holdings on the income arising from the sale of the property. After quoting at length from Deuce Holdings. D’Auray J stated (at para. 29):

Justice Noël … in … Kruco agreed that the words “earned or realized” in subsection 55(2) refer to income after taxes. …

In rejecting the 468’s further submission that “that taxes have to be calculated at the end of the year and that at the end of the year Tri-Holdings did not owe any income tax” (para. 30) D’Auray J stated (at paras. 31, 33):

As stated by Justice Sharlow in VIH Logging Ltd., supra, the phrase “income for the year” is not used in subsection 55(2) of the Act. …

[T]he safe income of Tri-Holdings had to be determined immediately before December 13, 2006, namely before the first deemed dividend was generated. This is what the Minister did … .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(5) - Paragraph 55(5)(b) safe income reduced by corporate income taxes 185

Administrative Policy

27 November 2018 CTF Roundtable Q. 1, 2018-0780061C6 - Allocation of safe income

rulings on safe income allocation to discretionary dividend shares

At the 2016 CTF Annual Conference, the CRA indicated that it was conducting a study in connection with the proper allocation of safe income in circumstances involving a corporation that has issued shares that are entitled to discretionary dividends. What did CRA conclude? CRA indicated that:

  • It stands by all positions on this matter that it has expressed since the 2015 CTF Annual Conference.
  • On a going-forward basis the CRA is willing to provide assurance on the tax treatment of the discretionary dividend shares, but only in the context of a ruling request – and thus will no longer express its views on this matter in Technical Interpretations or Roundtable responses.

29 May 2018 STEP Roundtable Q. 4, 2018-0743951C6 - Safe income and estate

safe income flow through on a s. 70(6), but not s. 70(5), transfer

In 2017 STEP Roundtable Q.7, 2017-0693421C6, CRA stated that safe income of a corporation owned by the deceased did not flow through to his estate. Would this apply if the shares transferred on a rollover basis under s. 70(6)?

CRA indicated that the basis for the referenced position was that the safe income was crystalized in the ACB of the shares that were now held by the estate. However, where the shares were disposed of at their adjusted cost base because of the s. 70(6) rollover, the safe income that could reasonably be considered to contribute to the accrued gain on those shares would flow through to the estate.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 70 - Subsection 70(6) safe income flow through on a spousal rollover of shares on death 63

2015 Ruling 2015-0589471R3 - Earnout

utilization of safe income as earned through a contemplated succession of dividends of all the annual earnings

In connection with the implementation of an earnout transaction for the purchase of Holdco common shares by a key employee, the (corporate) shareholders of Holdco (a Canadian-controlled private corporation holding Opco) first transfer a portion of their Holdco common shares to Opco in consideration for tracking preferred shares of Opco, with Opco immediately selling those shares on a five-year earnout basis to the key employee.

Before the implementation of the above transactions, Holdco and Opco adopted a policy of dividending out all of their operating earnings – but deferred paying any of these dividends until the rulings were granted. CRA ruled that the dividend determination time for the “Second Annual Dividends” (i.e., dividends payable based on the annual income for the Opco taxation year ending after the sale of the Holdco common shares by Opco to the key employee) is the time immediately before their payment rather than the time immediately before the payment of the previous dividends, so that the safe-income exception in s. 55(2.1)(c) could access the more recent earnings.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 12 - Subsection 12(1) - Paragraph 12(1)(g) 5-year earnings based earnout for sale of Holdco common shares by Opco to key employee 794
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Safe Income Determination Time safe income determination time for a subsequent contemplated dividend was immediately before that dividend 512
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1) s. 85(1) rollover available on dirty s. 85 exchange 90
Tax Topics - Income Tax Act - Section 7 - Subsection 7(1) - Paragraph 7(1)(a) transactions for using s. 7 rules on sale of non-treasury shares 200

6 June 2017 External T.I. 2016-0658351E5 - Stock dividends and safe income

safe income crystallized in basis when preferred share stock dividend paid

CRA provided an example illustrating the operation of s. 55(2.3), which streams safe income to stock dividend shares and away from the shares upon which the stock dividend is paid, where the dividend recipient is a corporation..

Opco’s two shareholders (Holdco and Ms. X) each own a bloc of 50 common shares with an ACB, FMV and safe income on hand of $5,000, $500,000 and $450,000, respectively. Opco pays a $700,000 stock dividend consisting of preferred shares with an aggregate redemption amount and PUC of $700,000 and $1, respectively.

Because the amount of the stock dividend is deemed to be $350,000 for s. 55(2) purposes, Opco’s safe income that contributes to gain on the 50 Opco common shares of Holdco is deemed to be reduced by $350,000. Holdco now owns half the preferred shares with an ACB pursuant to s. 52(3)(a) of $350,000, and 50 common shares with a FMV of $150,000 and an ACB of $5,000, resulting in an inherent capital gain of $145,000. Thus, Opco has $100,000 of safe income that contributes to the inherent capital gain on Holdco’s original 50 common shares and the other $350,000 of safe income is now reflected in the ACB of Holdco’s preferred shares of Opco.

As for Ms. X, Opco’s safe income of $450,000 that contributes to the gain on her 50 common shares is not reduced by the stock dividend paid, and this safe income of $450,000 will be apportioned between her preferred shares received as a stock dividend, and her original 50 common shares, based on their respective accrued gains, as determined after the payment of the stock dividend.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.3) illustration of safe income streamed to preferred share stock dividend 369

6 April 2017 External T.I. 2016-0658841E5 F - Purpose tests and Allocation of safe income

safe income was allocated between 2 classes of participating shares pro rata to their dividend entitlements

The participating and non-voting Class AA shares of Opco, which were held equally by two unrelated individuals (A and B), were worth $500,000 and had a safe income of $300,000 on January 1, 2016, and had a nominal paid-up capital and adjusted cost base. The voting shares of Opco, having an aggregate redemption value of $100, were held by Holdco, which was owned equally by A and B. On January 1, 2016, Holdco also subscribed $100 for 100 Class X shares of Opco, which were entitled to participate annually in Opco’s profits proportionately with the number of issued and outstanding AA and X shares, so that their holders were entitled (and only entitled) to dividends equal to the cumulative earnings from the time of their issuance and the redemption value of the shares (which otherwise would equal such proportionate accumulated profits plus the issue price) was reduced by the dividends paid.

On December 31, 2016, Opco had accumulated $100,000 in after-tax profits and safe income, As there were 200 outstanding AA and X shares, the X class shares had a redemption value on January 1, 2017 of $50,100 (($100,000 x 100/200) + $100 of PUC) On January 1, 2017, Opco paid a dividend of $50,000 to Holdco.

Q.2:

Would the dividend be excluded under s. 55(2.1)(c)? After noting the Robertson rule that “income will be attributable to a particular class of shares in the same ratio in which each class would be entitled if all earnings of the corporation, but not share capital, were to be distributed,” CRA stated:

[G]iven that…the Class X and AA shares were entitled to an equal share of Opco’s profits following the issuance of the Class X shares and that the value of the shares of each class would increase due to this share of profits, … the safe income earned or realized annually following the issuance of the Class X Shares could be proportionately allocated based on the number of shares of each class. Accordingly, based on…the share of Opco’s safe income contributing to the hypothetical capital gain on the Class X shares would be $50,000…and no part of the $50,000 dividend would be subject to subsection 55(2).

Q.3:

Alternatively, although the after-tax net profits remained at $100,000, the cumulative safe income in the year was only $90,000, with safe income attributable to the Class X shares of $45,000, and the $50,000 dividend was paid in two tranches of $45,000 and $5,000. CRA indicated that “it would be reasonable to consider that half of the safe income earned during the year would contribute to the hypothetical capital gain on the Class X Shares and half of the safe income would contribute to the hypothetical capital gain on the Class AA Shares if a dividend was paid on those shares,” so that the first dividend, but not the second, would enjoy the safe income exclusion.

Q.4:

As a further alternative, the 2016 profits instead were $200,000, the cumulative safe income in that year was $190,000, and the total market value of all the shares of Opco was $800,000 as a result of such profits and an increase in the value of intangibles. Class X shares had a redemption value of $100,100 (50% of the profits plus the paid-up capital). On January 1, 2017, OPCO paid a dividend of $95,000, followed by a second of $5,000, to Holdco.

CRA stated:

it would still be reasonable to conclude that half of the safe income would contribute to the hypothetical capital gain on the Class X shares. The increase in the value of the Class AA Shares would result from an unrealized capital gain for tax purposes and therefore would not be included in the safe income for the year. Consequently, the dividend of $95,000 would not be greater than the amount of safe income on hand and, therefore. would not come within subsection 55(2).

Q.5:

Under a further variation, an amount representing 50% of OPCO’s safe income would be allocated to the Class X shares and the balance of the accounting profits would be allocated to the Class AA shares. Assuming an aggregate safe income since the Class X share issuance and accounting profits of $100,000, if there were a distribution of all the accounting profits, the Class X and AA shares would receive $45,000 and $55,000, respectively. CRA stated:

[T]he increase in the corporation's safe income (during the holding of the Class X shares) for that year should be allocated based on the amounts to which each Class would be entitled. For example, 45/100 of $90,000 (i.e., the total safe income during the holding of the Class X shares) would be allocated to the Class X shares, or $40,500.

Therefore, it is not be possible to isolate the safe income of the corporation or a portion thereof in a particular class of shares if the corporation's safe income was less than the accounting profits

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) s. 55(2) did not apply to dividends paid only for asset protection and QSBC-status purposes 282

13 June 2017 STEP Roundtable, Q.5

CRA is still studying the allocation of SIOH to discretionary dividend shares

At the 2016 CTF Annual Conference, CRA indicated that it was conducting a study of how safe income on hand should be allocated for corporations that have issued shares that are entitled to discretionary dividends, and when a dividend disproportionate to the respective pro rata interest is declared on such shares. What is the status of this study?

CRA indicated that this review has not been completed, and reiterated that its previous comments on the allocation of safe income should not be taken as implying that CRA does not have any concerns about safe income being allocated to discretionary dividends shares.

15 November 2016 Roundtable, 2016-0672321C6 - Guidance on determination of safe income

annually recurring dividends are not a series of transactions for safe-income determination purposes/CRA provision of old returns/safe income reduced by contingent amounts

a. Given the historical records required to prepare safe income calculations, what type of practical approaches and assumptions are accepted by CRA?

b. Could CRA provide copies of previous tax returns and (re)assessments dating back to the incorporation of the entities required to compute safe income?

c. What type of audit practices can taxpayers expect in respect of supporting documentation used to calculate safe income that contributes to the capital gain on a share?

d. Given that the safe-income determination time is no later than the time immediately before the earliest dividend paid as part of a series, how is this applied where a company pays a regular (e.g., quarterly or annual) dividend?

e. Do contingent liabilities and reserves, such as for pensions obligations reduce the safe income that can reasonably be considered to contribute to the capital gain on a share given that Kruco held that safe income should be reduced by cash outflows?

CRA responded:

a. … The onus is on the taxpayer to provide support for the calculation of safe income that can reasonably be viewed as contributing to the capital gain on a share. The CRA expects the supporting documentation to be organized as an accumulation of year-by-year computations. …

…[W]here…the taxpayer offers an alternative proxy such as the accounting retained earnings or adjusted retained earnings balance…the CRA auditor might conclude that retained earnings is a fair proxy for safe income on hand but only after a very stringent validation process.

…[A]n incorrect claim could be subject to the application of subsections 152(4), 163(2) or 239(1), depending on the circumstances.

b. …[W]hen a taxpayer makes a request to the CRA to obtain a copy of income tax returns and/or notices of assessment, the CRA will attempt, in regards to available resources, to provide the requested documentation. However…it is not in a position to provide assurances that these requests will be actioned in all cases.

c. The audit practices…include…a verification of the portion of the safe income that can reasonably be considered to contribute to the capital gain on each share of the corporation in any given year. This typically involves a validation that a detailed analysis was done using share registers and minute books provided by the taxpayer. The analysis should be carried out for each year and the adjustments should take into consideration any changes in the shareholdings.

d. In a recent ruling, the CRA took the view that regular, recurring annual dividends would not, in the circumstances of the ruling request, be part of a series of transactions. Accordingly, a ruling confirmed that the safe income determination time in respect of the first and second annual dividends will be immediately before each such dividend.

CRA went on to discuss 2016-0633961E5 (respecting recapture of depreciation realized on sale before safe-income determination time being included in safe income.)

e. As discussed in ITTN-37…Kruco requires a second stage inquiry in respect of the calculation of a corporation's safe income to determine whether the income earned or realized was kept on hand (i.e., whether such income can reasonably be viewed as contributing to the capital gain on a share). The decision supports the notion that the safe income should be reduced by actual or potential cash outflows such as non-deductible expenses, contingent liabilities and accounting reserves in the determination of the amount of safe income that can be viewed as contributing to the capital gain on a share.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Safe Income Determination Time safe income determination time does not commence at beginning of series of regular annual dividends 119

7 October 2016 APFF Roundtable Q. 13, 2016-0652981C6 F - Allocation of the safe income on hand

business income earned by a corporation following a subscription for a separate class of discretionary dividend shares could be allocated to those shares

On the incorporation of Opco in Year 1, two unrelated Holdcos (HC and HB) each subscribed $100 for 100 Class C or Class B voting common shares. In Year 8, HA (also unrelated) subscribed $50,000 for 100 Class A voting common shares of Opco at a time that Opco's aggregate safe income was $70,000 and the FMV of its shares was $100,000 (or $150,000 after the subscription). In Year 10, at a time that the aggregate safe income of Opco was $90,000 and the FMV of its shares was $170,300, a $35,000 dividend was paid on the Class A shares of HA. How should the global safe income be allocated among the different classes given their different holding periods?

CRA indicated that if the $20,000 of safe income generated in the two years up to the dividend payment was business income (rather than, for instance, being from the realization of gains that had already accrued at the time of HA’s share subscription), and making some surmises on the contribution of this safe income to the accrued capital gain on the shares of HA, “the amount of $20,000 would represent a separate taxable dividend pursuant to paragraph 55(5)(f) and would not be subject to subsection 55(2),” whereas if the purpose test in s. 55(2.1)(b) was satisfied, the balance of the dividend could be subject to s. 55(2).

Before referring to various conferral-of-benefit provisions, GAAR and the difficulties posed by discretionary dividend shares in a butterfly, CRA stated that it was “not intended to give our general approval for the use of discretionary dividend shares.”

7 October 2016 APFF Roundtable Q. 14, 2016-0655921C6 F - Safe income on hand - Preferred shares

fixed dividends on full-ACB prefs did not come out of SIOH

Holdco holds 100 common shares of Opco and 100 non-participating preferred shares which are redeemable for, and have a PUC and ACB of, $100. Opco has some safe income. Would the payment of a dividend on the pref shares trigger the application of s. 55(2)?

After noting that “the hypothetical capital gain that would have been realized on a FMV disposition of class "B" preferred shares immediately before the dividend…would be nil,” so that the dividend would not be considered to come out of safe income on hand, CRA stated that if s. 55(2.1)(c) thus applied then (subject to the Part IV tax exclusion) “subsection 55(2) would apply in the present situation if all the conditions of paragraphs 55 (2.1)(a) to (c) were established.” If it so applied, “the amount of the dividend would not reduce the SIOH of the corporation.”

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) whether dividends paid on non-participating prefs engage s. 55(2) is a question of fact 83

7 October 2016 APFF Roundtable Q. 15, 2016-0652991C6 F - Application of subsection 55(2) - holding period

stock dividend of nominal value discretionary shares to shift value to an affiliate

X (an individual) holds 799,000 Class A common shares of Opco having a safe income on hand (“SIOH”) of $1M and a FMV of $1.8M. Opco pays a stock dividend of Class B shares which are voting, participating, bear discretionary dividends and are redeemable by Opco for $1, which is their PUC. X incorporates Holdco and transfers the Class B shares to Holdco under s. 85(1). Opco then pays a $1M dividend to Holdco. Does s. 55(2) apply? What if instead there is a $1M s. 84(1) dividend?

After noting that there was no transfer of safe income to the Class B share in light of its nominal value and taking into account CRA’s “long-standing position on the transfer of safe income on a stock dividend – “and no SIOH would contribute to the hypothetical capital gain on the class "B" share in the capital stock of Opco held by Holdco,” CRA noted that accordingly:

If all other conditions were satisfied, subsection 55(2) would apply in respect of the dividend of $1 million. …

If Opco proceeded with an increase in PUC rather than a cash dividend…the CRA would have the same answer… .

7 October 2016 APFF Roundtable Q. 16, 2016-0653001C6 F - Safe income and freeze preferred shares

application of safe income on hand to dividends paid on estate freeze prefs

Holdco A holds 100 voting common shares of Opco with a paid-up capital and adjusted cost base of $100, as well as 100 estate freeze non-participating, non-voting preferred shares bearing a pre-determined dividend of 8% on their redemption amount of $1,000,000, having an ACB of $100 and having safe income of $700,000 traceable to the shares for which they had been exchanged. The shares of Opco have an aggregate fair market value of $2,500,000 and its global safe income is $1,700,000. (a) If Opco generates safe income in the year of $150,000 and declares a dividend of $80,000 on its preferred shares, what portion of the dividend will be covered by the global safe income and, following the dividend’s payment, what will be the preferred shares’ safe income? (b) What if Opco did not generate any safe income in the year before that dividend was declared?

CRA responded:

If the dividend of $80,000 was not greater than the SIOH of the corporation which contributed to the hypothetical capital gain on frozen preferred shares (the amount of $700,000 transferred at the time of the freeze could have been reduced due to previous dividends as well as SIOH that accumulated since the freeze if it contributed to the hypothetical capital gain on preferred shares), paragraph 55(2.1)(c) and subsection 55(2) would not apply. The dividend of $80,000 would firstly reduce the SIOH of the corporation from the time of the freeze if it contributed to the hypothetical capital gain on the freeze preferred shares and up to the lesser of safe income that contributed to the hypothetical capital gain on the freeze preferred shares and the dividend amount. Any difference between the amount of the dividend and this reduction in the post-freeze SIOH of the corporation would reduce the SIOH of $700,000 that is specifically attached to the freeze preferred shares freeze (less any prior reduction).

Depending on circumstances, it may be that the only SIOH contributing to the hypothetical capital gain on the frozen preferred shares was the amount of $700,000 less any previous reduction of such safe income. If the dividend amount of $80,000 was not greater than such SIOH, paragraph 55(2.1)(c) and subsection 55(2) would not apply. In such case, the SIOH of $700,000 (less any previous reduction) would be reduced by the amount of the dividend.

8 June 2016 CTF Technical Seminar: Update on s. 55(2)

safe income appropriately reduced by incentive reductions

CRA considers it to be appropriate from a policy perspective for safe income to be correspondingly lower where incentive deductions have lowered a corporation’s income for ITA purposes.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) integration principle/expanded scope/no contemplated sale required/no blanket exemptons/policy similar to boot rules 348
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution butterfly rulings may require amending discretionary shares 50
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.5) significant reduction in value of nominal value share 84

20 April 2016 External T.I. 2016-0633961E5 F - Computation of safe income - stub period

recapture/eligible capital amount realized on sale before safe-income determination time included in safe income

Following the sale of depreciable properties and eligible capital properties and before the end of its taxation year, a corporation pays a dividend or redeems shares in its capital. Would the income arising from such sales be considered to be earned or realized before the safe-income determination time? CRA responded (TI translation):

It is only at the end of the taxation year of the corporation that income determined in accordance with subsection 13(1) (resulting from the sale of depreciable property of the corporation) or subsection 14(1) (resulting from the sale of eligible capital) is included in the income of the corporation.

...Thus, based only on the wording of the legislation, the income computed under subsections 13(1) and 14(1) would not technically be part of the safe income in this situation.

However…we will accept that income determined under subsections 13(1) and 14(1) will be included in computing the income earned or realized before the safe-income determination time so long as the sale of assets that gave rise to such income had occurred before the safe-income determination time and to the extent that this income contributes to the hypothetical capital gain on the shares on which the dividend was received (under the assumption that there is a disposition at fair market value of the shares immediately before the dividend). Moreover, in such a case, we also will take the position that the taxes payable on these earnings must be deducted from that safe-income… .

[T]he equivalent position will apply in respect of a terminal loss… .

27 April 2016 External T.I. 2016-0633101E5 F - Attribution of safe income

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

Opco has a fair market value of $2M and its safe income is $1M. Its issued share capital consists of 1,000 Class A common shares and 1,000 Class B common shares held by two unrelated holdcos (Holdco1 and Holdco 2), who had subscribed for their shares on incorporation for nominal consideration. Opco repurchases all the Class B shares for $1M (Alternative 1) or Opco pays a discretionary dividend of $1M to Holdco 2 and the repurchases the Class B shares for nominal consideration, with the FMV of the Class A shares remaining at $1M, and the FMV of the Class B shares reduced by the dividend amount (Alternative 2). How is the safe income of Opco attributed to the Class A and B shares?

Respecting Alternative 1, CRA stated (TI translation):

[I]t is reasonable to conclude that the income earned or realized that contributes to the capital gain for each class is equal for each class ($500,000 per class under the above assumptions) given their value and nominal adjusted cost base.

Accordingly, s. 55(2) would apply to the excess of the deemed dividend over $500,000.

Respecting Alternative 2, CRA stated:

Under this alternative, it may be that we could conclude that the Class B shares had a value equal to the total of the discretionary dividend and the redemption value of $1 and that the Class A shares retained their value of $1M. …

If this were the case…it would be reasonable to consider in this hypothetical alternative that the income earned or realized that contributed to the hypothetical capital gain on the class B shares was equal to half of the Opco safe income [thereby producing the same result as in Alternative 1]. …

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

In light of this policy, the safe income attributable to the Class A shares would be $500,000.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution discretionary dividend shares may not satisfy the distribution definition 72

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

exemption of s. 84(3) deemed dividend not exceeding safe income

Were ss 55(2) and 55(2.1) as set out in the July 31, 2015 Legislative Proposals intended to exempt, from capital gains treatment, a s. 84(3) dividend resulting from a redemption of shares whose amount does not exceed the safe income and which would be deductible under s. 112(1) or 112(2) by a Canadian recipient corporation?

After paraphrasing s. 55(2.1)(c), and before referring to the Part IV tax and s. 55(3)(a) exception, CRA stated (TI translation):

Therefore, if this [s. 55(2.1)(c)] condition is not satisfied, subsection 55(2) will not apply. We would consider that a deemed dividend arising on the redemption of shares that is equal to or lower than the safe income on hand respecting the redeemed shares does not have a purpose of effecting a significant reduction of the capital gain. In this regard, paragraphs 55(5)(b) to (d) are the rules for calculating the income earned or realized by a corporation.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(5) - Paragraph 55(5)(f) s. 55(2) application to separate dividend 103
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2) - Paragraph 55(2)(b) demarcation between ss. 55(2)(b) and (c) 278

3 December 2015 External T.I. 2015-0593941E5 F - Allocation of the safe income on hand

flexible allocation of SIOH where discretionary common shares

1st situation. Three unrelated Holdcos (A, B and C) each hold all the 100 voting participating shares of a separate class of discretionary dividend shares of Opco, which has safe income on hand of $90,000, whose shares collectively are worth $120,000, and with the three share classes sharing equally on liquidation and having a nominal adjusted cost base (“ACB”). The directors declare a $35,000 dividend on the Class OA shares held by Holdco A only.

2nd situation. The same as the 1st except that the shares are non-voting and non-participating [i.e., are non-cumulative preferred shares] and that other voting and participating shares were issued by Opco to the three Holdcos.

3rd situation. Two unrelated individuals (A and B) each held 39 Class A shares of Opco and their respective Holdcos (Holdco A and B) each held 11 Class B or 11 C shares, respectively. All three classes are voting, participating and discretionary-dividend shares and their collective safe income on hand is $100,000, their collective fair market value (“FMV”) is $120,100 and their ACB is $1 per share. Holdco A and B each receive a $50,000 dividend.

4th situation. Two brothers (A and B) each held 49 Class A shares of Opco and their respective Holdcos (Holdco A and B) each held 1 Class B or 1 C shares, respectively. The Class A shares are voting, participating and discretionary-dividend shares, the Class B and C shares are voting, non-participating and discretionary-dividend shares and the collective safe income on hand is $100,000. Holdco A and B each receive a $50,000 dividend.

5th situation. Mr and Ms A hold 99 Class A and 1 Class B voting, participating and discretionary-dividend shares of Opco which they had acquired at the same time, having an aggregate FMV now of $120,100, and an ACB of $1 per share and CRA also assumed safe income on hand for Opco of $100,000. A separation agreement provides that Ms A will transfer her Class B share to a newly-incorporated holdco (HoldcoMsA) under s. 85(1), Opco will pay a dividend equal to 90% of its NAV on the Class B share and then repurchase that share for $1.

Question. What is the treatment of the dividends (and, in the first two situations, the impact on safe income on hand) in these transactions?

1st situation. CRA stated (TaxInterpretations translation):

The question is whether… it is reasonable to consider that an amount of safe income on hand equal to the dividend contributed to the capital gain which would be realized on a disposition at FMV, immediately before the dividend, of a share on which the dividend was received (the “hypothetical capital gain”). The amount of the hypothetical capital gain would be a function of the FMV which could be attributed to the share on which the dividend was declared, such FMV being measured immediately before the dividend payment but keeping in mind that such share would have a right to an additional amount equal to the dividend declared thereon.

…Taking into account [such] an additional value of $35,000 for the Class OA shares…the $35,000 dividend would not be greater than the safe income on hand which it would be reasonable to consider as contributing to the hypothetical capital gain.

Following the dividend…the safe income on hand of Opco would be reduced to $55,000.

If no other dividend was declared, and Opco was liquidated and the residue of its property paid in equal parts to each class of participating shares, the capital gain which would be realized on the shares of each class, if there was a disposition at FMV immediately before the dividend…would be $28,333. In such a case,…the safe income on hand which it would be reasonable to consider as contributing to the capital gain on the shares of each class would be $18,333 ($55,000/3).

2nd situation. After again referencing that the shares would have a right to an additional amount immediately before the payment time equal to the declared dividend, CRA stated:

It could be…that there would be no hypothetical capital gain if the FMV of the non-participating and non-voting shares was equal to their ACB. For example, this could occur if the unpaid dividends represented distinct rights from the shares to which they related.

In such a case, the condition in paragraph 55(2.1)(c)…would be satisfied. If no capital gain arises on a disposition at FMV of shares on which the dividend is paid, there indeed is no safe income on hand which contributes to the hypothetical capital gain.

…[Respecting] paragraphs 55(2.1)(a) and (b)…the dividend…would reduce the… capital gain which could be realized on a disposition at FMV of the common shares. … With a dividend in the order of magnitude of $35,000…we could conclude that the reduction is significant or the increase in cost is significant.

…If one of the purposes of the payment or receipt of a dividend is as stated in subparagraphs 55(2.1)(b)(i) and (ii), subsection 55(2) could apply to the $35,000 dividend if the other conditions were satisfied. In such a case, the CRA would accept that the amount of the dividend does not reduce the safe income on hand of the corporation. If instead, subsection 55(2) did not apply to the dividend on the preferred shares, the amount of the dividend would reduce the safe income on hand of the corporation.

…[I]f the amount of the hypothetical capital gain for the non-voting and non-participating shares was equal to $35,000, it might be that we would consider that the $35,000 dividend was not greater than the safe income on hand which it was reasonable to consider as contributing the hypothetical capital gain. If so, subsection 55(2) would not apply. In that case, the safe income on hand of the corporation would be reduced by the amount of the dividend.

3rd situation. CRA noted that this was similar to Situation 1, repeated essentially the same analysis, and concluded:

…Taking into account [such] an additional value of $50,000 equal to the amount the dividend which would be paid on the shares…of Class B and C…each dividend of $50,000 would not be greater than the safe income on hand which it would be reasonable to consider as contributing to the hypothetical capital gain on each of Classes B and C. Consequently, subsection 55(2) would not apply… ..

The dividends which were not subject to subsection 55(2) would reduce the safe income on hand for the shares of Opco.

4th situation. CRA noted that this was similar to Situation 2, and provided the same analysis but adding that subsection 55(2) would not apply if Part IV tax applied to the dividends and was not refund by reason of a payment of a dividend by the Holdco.

5th situation. After noting that the analysis was similar to the 1st situation, CRA stated:

[]I]t is necessary to compare the dividend paid by HoldcoMsA, being 90% of $120,000 ($108,000) to the safe income on hand of Opco ($100,000).

...[T]he dividend is greater than the safe income on hand of such share by $8,000. The question is whether the dividend of $108,000 would significantly reduce the FMV of the "A" shares in the capital stock of Opco. If this were the case and one of the purposes was such reduction, the conditions for the application of subsection 55(2.1) would be satisfied. Subsection 55(2) would apply respecting the dividend (subject to the application of paragraph 55(5)(f)) received by HoldcoMsA, unless Part IV tax applied and the tax was not refunded by the payment of a dividend by HoldcoMsA.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Fair Market Value - Shares FMV of discretionary share increased at moment of dividend declaration to exclusion of other discretionary shares 92
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) quaere whether 8% reduction is significant 19

10 October 2014 APFF Roundtable Q. 19, 2014-0538041C6 F - 2014 APFF Roundtable, Q. 19 - Stock dividend

SI apportionment to stock dividend prefs

Mr. X holds all 100 of Opco's Class A shares with a fair market value of $1,000,000 and nominal ACB and PUC. Opco pays a stock dividend comprising Class B shares which have a retraction right for $900,000; the 100 Class shares are exchanged for estate freeze Class C preferred shares; and the family trust subscribes for Class A shares for $10. What would be the safe income attributable to the Class B shares issued as the stock dividend? CRA responded (Tax Interpretations translation):

When there is a stock dividend of a class having a redemption amount higher than its nominal paid-up capital, it will be necessary to apportion the safe income and the safe income on hand which is attributable to the shares on which the dividend was paid, being the Class A shares, between such shares and the shares received as a stock dividend, being the Class B shares. The apportionment of this safe income and safe income on hand which will thereupon be attributable to the Class B shares will be effected in accordance with the proportion of the gain inherent in the Class B shares as compared to the gain inherent in the Class A shares prior to the stock dividend. The amount of safe income and safe income on hand which would be attributable to the Class B shares would reduce the safe income and safe income on hand which was attributable to the Class A shares prior to the payment of the stock dividend.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1.1) not engaged if stock dividend is proportional 203
Tax Topics - Income Tax Act - Section 74.4 - Subsection 74.4(2) non-application to stock dividend, cf. s. 86 reorg 243
Tax Topics - Income Tax Regulations - Regulation 6205 - Subsection 6205(2) purpose test in Reg. 6205(2)(a) is not necessarily accomplished by all estate freezes/"arrangement" broad 403

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 first stated (TaxInterpretations translation):

[T]he CRA expects that, in general, a corporation's income will not be artificially inflated by failing to claim capital cost allowance or a usually claimed reserve.

In general, it is acceptable to allocate the income calculated for a taxation year of a corporation or partnership, on a pro rata basis, to determine the income attributable to a corporation’s stub period if such allocation is reasonable in the circumstances. ...

...[I]n the calculation of safe income on hand, a downward adjustment cannot be made to remove or modify the [adjusted stub perod accrual] included in computing a corporation's income for a particular taxation year under subsection 34.2(2) on the basis that the ASPA represents an approximate amount based on a partnership's past year's income.

Similarly, an upward adjustment cannot be made to ignore the Transitional Reserve deducted by virtue of subsection 34.2(11).

Such adjustments would have the effect of directly conflicting with the wording of paragraph 55(5)(c) and of subtracting or adding amounts that are part of taxable income determined as the basis for taxation for purposes of subsection 55(2).

In response to the specific question, CRA stated:

BC may not claim an amount in respect of the Transitional Reserve under subsection 34.2(11) to determine its SIOH immediately before the "safe income determination time" respecting a particular transaction, insofar as the corporation does not claim such reserve for the taxation year which includes the stub period, if any.

The principal reason for our position is the fact that the Transitional Reserve is temporary and that it could reasonably be considered that, in general, the "qualifying transitional income" on which the Transitional Reserve is based results in an increase in the value of the shares of the capital stock of the corporation.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 34.2 - Subsection 34.2(11) transitional reserve deduction is in taxpayer's discretion 53
Tax Topics - Income Tax Act - Section 55 - Subsection 55(5) - Paragraph 55(5)(c) no departures permitted from s. 34.2 adjustments 180

11 October 2013 APFF Roundtable Q. 18, 2013-0495851C6 F - Safe income adjustments

CRA post-closing reassessment of Target's pre-closing income changes its SIOH

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 agreement of purchase and sale for the shares of the capital stock of Opco respecting the amount of additional income tax payable by Opco, the amount of additional tax paid by Opco, in general, would reduce the safe income on hand attributable to the shares held by Sellco for the purposes of subsection 55(2). In such a situation, it appears to us that the 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 the capital stock 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 agreement of purchase and sale contains an adjustment clause to the price for the shares payable by Buyco by reason of a reassessment 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 reassessment for a taxation year ending prior to the acquisition of control would, in general, have the same effect on Opco’s safe income on hand as ... above.

[price adjustment to Opco]

In the situation where the agreement of purchase and sale for the shares of the capital stock of Opco provides that Sellco is responsible for the amount of any reassessment for a taxation year prior to the acquisition of the shares and to the extent that Opco received or is considered to have received from Sellco an amount equivalent to the amount of additional tax arising under the reassessment, 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 paragraph 12(1)(x) or 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 downward adjustment under price adjustment clause reduces shares' ACB 85

Articles

Henry Shew, "Safe Income May Vary Within Shares of the Same Class", Canadian Tax Focus, Vol. 8, No. 3, August 2018, p. 3

Illustration of the implications of safe income differing where shares of the same class held for different periods (p. 3)

Assume that Holdco purchases 100 shares of Opco for $10 (“the old shares”). Tthese shares can earn $1 per share of safe income per year. Therefore, at the end of year 1, Holdco has $100 of safe income on hand. At the beginning of year 2, Holdco purchases another 100 shares of Opco (“the new shares”) for $10. These shares also earn $1 per share of safe income per year. Therefore, at the end of year 2, Holdco should have $300 of safe income on hand in total ($100 of safe income earned in year 1 plus $200 of safe income earned in year 2).

Opco then proceeds to pay an intercorporate dividend of $1.25 per share for a total dividend of $250 (200 x $1.25). It might seem that subsection 55(2) will not apply because the dividends are less than the safe income ($250 < $300), but this is not the case. For the old shares, Holdco has $200 of safe income (100 x ($1 + $1)) and $125 of dividends (100 x $1.25). On the new shares, however, Holdco has the same $125 (100 x $1.25) of dividends, but only $100 of safe income (100 x $1). Therefore, subsection 55(2) applies to recharacterize $25 of the dividends on the new shares.

Where insufficient safe income (p. 3)

…[O]ne [might] still escape the application of subsection 55(2) by relying on the “reasonable regular dividends” exemption rule (…2015-061382C6…) [or] ensur[in] that the intercorporate dividends do not reduce the value of any share or increase the cost base of properties….

Doron Barkai, Alexander Demner, "Dealing with New Subsection 55(2): Issues and Strategies", 2016 Conference Report (Canadian Tax Foundation), 6:1–56

Risk of CRA calculating safe income where taxpayer has applied s. 55(2) (pp. 6:13-14)

If a taxpayer has not calculated its safe income on hand and accepts the application of subsection 55(2) to an intercorporate dividend, query whether the CRA would go to the effort of calculating safe income for the taxpayer to ensure that the safe-income dividend is not recharacterized to be a capital gain. When a dividend is recharacterized as a capital gain and it is later determined that all or a portion of the recharacterized dividend is considered to be paid out of safe income, the recharacterized capital gain would revert to being a dividend. As a result, practitioners should take care when distributing capital dividends arising from subsection 55(2) gains because they could be retroactively determined to be taxable dividends and result in the payment of excessive capital dividends.

Potential unavailability of the safe-income exception for normal-course dividends (pp. 6:18-19)

Dividends are … frequently paid to finance or support a corporation's parent company or a larger corporate group. Examples include dividends paid

  • pursuant to an internal policy of cash pooling—for example, when cash is centralized for lender security, administration, or credit-rating purposes;
  • for internal redistribution—for example, when payment is made to a moneylending corporation that lends the receipted funds to another entity within the same corporate group; or
  • to cover general corporate expenses. …

[T]he safe-income exception may not be available for several reasons, including …:

  1. the safe income is less than the profits distributed (for example, as a result of accelerated CCA claims or accrued but unpaid dividends associated with other shares);
  2. there is no inherent gain in the shares of Opco on which the dividend is paid (as a result of an unrelated decline in the aggregate value of Opco's assets, for example); or
  3. in the case of periodic dividends, the safe-income determination time concept is strictly applied (although, as discussed above, this should not be the case).

These issues are exacerbated if a chain of corporations exists. For example, suppose Parentco owns Subco 1, which owns both Subco 2 and Subco 3. Although a dividend from Subco 2 to Subco 1 might be covered by the safe-income exception, any further dividend paid from Subco 1 to Parentco might not be so protected. This would be the case, for example, if there is a decline in the value of Subco 3 and therefore there is no accrued gain inherent in the shares of Subco 1, even if the Subco 2 shares are in a gain position.

Safe-income planning on sale produces only a deferral (p. 6:35)

[B]efore the sale, a safe-income dividend was paid (or deemed to be paid), thus reducing the gain on the subsequent sale. This planning could result in a significant deferral of tax on the portion of the value related to the safe-income dividend, provided that this portion of the value was retained in a corporation. The benefit of this planning is effectively unwound when the safe income is ultimately distributed as a dividend to the shareholders. Given current tax rates, this planning is generally beneficial only in situations in which the plan is to defer the dividend distribution for a significant period because the current tax rate on dividends paid on the distribution to individuals significantly exceeds the rate of tax that would be paid on the realization of a capital gain….

Streaming of safe income where discretionary common shares (pp. 6:37-38)

[T]he CRA has suggested recently that all income earned or realized by a corporation during the holding period may reasonably contribute to the gain on the class of discretionary common shares on which a discretionary dividend is paid (to the exclusion of other participating share classes). [fn 102: 2015-0593941E5] This global approach to safe income seems to result in the ability to stream safe income to specific shareholders receiving dividends first. Safe income effectively becomes a pool that can be allocated to any participating shareholder by virtue of receiving a discretionary dividend before other shareholders. This approach appears to represent a marked departure from the CRA's historical position regarding the allocation of safe income. Our understanding is that the CRA may have purposefully adopted a more lenient approach toward safe income to balance the perceived inequities associated with the amendments to section 55. This approach also potentially results in the allocation of safe income to more than one person when considering the consolidated lookthrough approach whereby the safe income on a share of a particular corporation can include income earned or realized by any corporation with which the corporation has a direct or indirect interest….