On January 1 of Year 1, Mr. A (the sole shareholder of Holdco) and Holdco subscribed, respectively, $100 and $900 for 100 Class A voting discretionary-dividend common shares and 900 Class B non-voting non-participating discretionary Preferred Shares on the incorporation of Opco. Only the Class A shares were entitled to participate on any winding-up. In its first five years of operation, Opco realized an annual after-tax profit of $200,000, all of which were annually paid to Holdco as dividends. At the beginning of Year 6, Mr. A sells his Opco shares to an arm’s length purchaser, when Opco’s fair market value is $500,000 (represented by the unrealized appreciation in Opco’s assets). Before this sale, Opco redeems the Class B preferred shares for their PUC of $900.
How should Opco’s safe income on hand be allocated between the two classes of shares? CRA responded:
[B]ased on … 2003-0006305 … and the rights, privileges, conditions and restrictions attaching to the Class B Opco shares (and taking into account in particular that the right to dividends of such Class B shares would be subject to the discretion of the board of directors and that such shares would not give rise to the right to share in the remainder of Opco's assets in the event of liquidation), it is possible that the safe income on hand realized by Opco from the time of the issuance of the Class B Opco shares may be fully allocated to the Class A shares of the capital stock of Opco. This is the position … in … 2002-0158885.