The partnership interest (in “SENC,” which holds all the shares of Subco, to which safe income is attributable) of an individual (X) was transferred under s. 85(1) at its adjusted cost base rather than its higher FMV to an unrelated holding corporation ("Holdco") in consideration for Class B preferred shares of Holdco. At the same time, X subscribed for Class A shares and an unrelated family trust subscribed for Class C (participating) shares, of Holdco. Should the safe income attributable to the Subco shares at time of transfer be considered in computing the safe income attributable to the Class B preferred shares in Holdco of X? CRA responded:
[I]t is possible that a portion of the safe income on hand generated by Subco prior to the transfer of the interest held in the partnership may be allocated to the preferred shares of the capital stock of Holdco on a reasonable basis. Furthermore, it is possible that the amount of safe income on hand generated by Subco allocated to the preferred shares of the capital stock of Holdco may vary over time and be replaced by an amount of income earned or realized by Holdco.
For example, the amount of safe income on hand generated by Subco that is allocated to the preferred shares of the capital stock of Holdco at the time of the transfer by the individual could decrease after the transfer if the partnership receives a dividend from Subco in respect of that portion of the safe income on hand generated by Subco or if the partnership realizes a capital gain on the sale of the shares it holds in the capital stock of Subco. On the other hand, Holdco will add its share of the dividend or capital gain to its income by virtue of paragraph 96(1)(f). This income of Holdco will form part of its safe income on hand. We are of the view that any increase in Holdco's safe income on hand resulting from such dividend or capital gain that would arise from Subco's income previously allocated to the preferred shares of the capital stock of Holdco should be considered to form part of the safe income on hand of such preferred shares and should not be added to the safe income on hand in respect of the common shares of the capital stock of Holdco. As such, there would be no duplication of safe income in respect of the same income.
Similarly, if Holdco were to sell its interest in the partnership, Holdco may realize a capital gain and that capital gain would be part of its safe income on hand. It would then be necessary to take into account that a portion of the safe income on hand generated by Holdco would reflect the safe income on hand generated by Subco allocated to the preferred shares of the capital stock of Holdco and to ensure that there is no increase in that portion when computing the safe income on hand in respect of the common shares of the capital stock of Holdco so as to avoid duplication.