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.