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.