Issues: In a situation where a corporation sold its depreciable properties and its eligible capital property before the end of the taxation year of the corporation and where a dividend was paid by the corporation after the sale of these assets (and before the end of the taxation year), whether the amounts computed pursuant to subsections 13(1) and 14(1) at the end of the taxation year would be added to the safe-income before the safe-income determination time with respect to the dividend.
Position: We would accept to take the position that the safe-income immediately before the safe-income determination time would include the income computed pursuant to subsections 13(1) and 14(1) if the sale of the assets occurred before that safe-income determination time (even if we can reach another conclusion when considering only the wording of the provisions). However, we would also take the position that the income taxes payable with respect to those types of income would have to reduce this safe-income because they do not contribute to the capital gain on a share of the capital stock of the corporation.
Reasons: Textual, contextual and purposive approach. As the sale of assets occurred before the safe-income determination time, we can conclude that the income is earned or realized at the time of the sale.
XXXXXXXXXX 2016-063396
Sylvie Labarre, CPA, CA
April 20, 2016
Dear Sir,
Subject: Safe income – “stub period”
This is in response to your e-mail of February 18, 2016 in which you requested our position on the inclusion of certain income in the calculation of income earned or realized immediately before the safe-income determination time for purposes of subsection 55(2).
Unless otherwise stated, all statutory references herein are references to the provisions of the Income Tax Act (hereinafter, the "Act").
Hypothetical Situation
A corporation sells depreciable property and eligible capital property during a taxation year of the corporation.
Following the sale of these properties and before the end of the corporation’s taxation year it pays a dividend or redeems shares in its capital.
Question
You wish to know our position respecting the inclusion of income calculated under subsection 13(1) (recapture of depreciation) and subsection 14(1) (business income from the sale of eligible capital property) in the income earned or realized before the safe-income determination time when that determination time occurs before the end of the taxation year in which the sale of these assets occurred but after the asset sales giving rise to such income.
Our Comments
This technical interpretation provides general comments on the provisions contained in the Notice of Ways and Means Motion to implement certain provisions of the budget tabled in Parliament on March 22, 2016 and to implement other measures (hereinafter "Notice of Ways and Means”), the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of a particular transaction proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
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.
The safe-income determination time is defined in subsection 55(1). For example, if a payment of a dividend was being addressed, that time would be the time that is immediately before the earliest time that a dividend is paid as part of the transaction, event or series.
Under subsection 55(2) of the Act or paragraph 55(2.1)(c) found in subsection 5(1) of the Notice of Ways and Means, the income earned or realized by a corporation is determined for the period after 1971 and before the safe-income determination time. Therefore, in the described situation, the income earned or realized includes such income earned or realized before the time that is before the time of the dividend.
The Federal Court of Appeal, in The Queen v. VIH Logging Ltd., 2005 DTC 5095, confirmed that income earned or realized includes the income earned or realized for the period running from the first day of the taxation year ending after the dividend until the time of the dividend (hereinafter, the "stub" period). The Tax Court of Canada, in the same case (2004 DTC 2090), indicated that the taxpayer must calculate the income earned or realized as if a taxation year had ended at the time of the determination of safe-income.
Despite what the courts have indicated respecting income earned or realized during the "stub" period, there appears to be a technical difficulty arising under the wording of the legislative provisions respecting the time of calculation of safe-income in a situation where the issue is the inclusion of income under subsections 13(1) and 14(1). Indeed, even if a particular taxation year were considered as terminating at the safe-income determination time as contemplated by the Tax Court of Canada in the VIH Logging case, it would be at this point that such income would be included and not before the safe-income determination time as required by subsection 55(2) of the Act or paragraph 55(2.1)(c) found in subsection 5(1) of the Notice of Ways and Means. 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, given the context and purpose of computing income earned or realized, 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 given that they cannot be considered to contribute to the capital gain that would be realized on a share in the capital of the corporation.
On the other hand, the equivalent position will apply in respect of a terminal loss determined under subsection 20(16) from a sale of depreciable property occurring before the time of determination of safe-income. Thus, the terminal loss determined under subsection 20(16) must be deducted in computing the income earned or realized before the safe-income determination time so long as the sale of assets resulting in this loss occurred before the safe-income determination time and to the extent such loss reduces the hypothetical capital gain on the shares on which the dividend was paid (under the assumption of there being a sale at fair market value of the shares immediately before the dividend). A similar position would also be taken if the conditions of subsection 24(1) were satisfied before the safe-income determination time.
It is understood that if the asset sale occurred before the safe-income determination time and if the amounts were added to the safe-income for the "stub" period in accordance with the position indicated in the previous paragraphs, it would not be permissible to also include such amounts in the calculation of safe-income for a period subsequent to this "stub" period.
We hope that our comments will be helpful.
Stéphane Charette, CPA, CMA, MBA
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch