6 December 2011 External T.I. 2011-0423181E5 F - Safe Income -- translation

Principal Issues: OPCO has one shareholder (hereinafter referred to as "SHAREHOLDER") which holds 200 Class "A" and 100 Class "F" shares of the capital stock of OPCO. The 200 Class "A" and 100 Class "F" shares of the capital stock of OPCO have a paid-up capital of, respectively $200 and $100, and a fair market value of, respectively $200,000 and $100,000. The adjusted cost base for SHAREHOLDER of the 200 Class "A" and 100 Class "F" shares of the capital stock of OPCO is, respectively $200 and $100. The safe income on hand (hereinafter "SIOH") attributable to the 200 Class "A" and 100 Class "F" shares of the capital stock of OPCO is respectively $80,000 and $100,000. If SHAREHOLDER acquires 200 Class "F" shares of the capital stock of OPCO in exchange for its 200 Class "A" shares of the capital stock of OPCO on a tax-deferred basis pursuant to subsection 51(1), whether the SIOH of the 300 Class "F" shares of the capital stock of OPCO held by SHAREHOLDER will amount to $180,000.

Position: Yes. The SIOH attributable to the Class "A" shares of the capital stock of OPCO would flow to the new Class "F" shares acquired by SHAREHOLDER under the circumstances. The SIOH would be allocated proportionally to each Class "F" shares of the capital stock of OPCO held by SHAREHOLDER.

Reasons: Question of fact and previous positions.

XXXXXXXXXX								2011-042318
									J. Lafrenière
									(613) 941-2956
December 6, 2011

Subject: Request for Technical Interpretation - Safe Income - Subsection 55(2)

Dear Madam,

This is in response to your October 3, 2011 e-mail inquiry asking for clarification regarding the calculation of safe income on hand for purposes of subsection 55(2) of the Income Tax Act (the "Act") in the context of a particular situation.

Unless otherwise indicated, all statutory are to provisions of the Act.

It appears to us that the situation described in your email and summarized below could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. However, we are able to offer the following general comments that may be helpful to you. It should be noted that the application of one or more provisions of the Act generally requires the analysis of all facts relating to a particular situation. Accordingly, and in light of the fact that your email only briefly describes a given hypothetical situation, the comments we make below may not be fully applicable in a particular situation.

Particular Situation

You presented the situation described below (the "Particular Situation") as part of your request for technical interpretation:

(a) A corporation ("Opco") has one shareholder ("Shareholder") holding shares of its capital stock having the following characteristics:

We find that, based on the information you have provided to us, the safe income attributable to each Class A and F share of the capital stock of Opco held by the Shareholder is $400 and $1,000, respectively.

b) The Shareholder acquires 200 Class F Shares of the capital stock of Opco in exchange for its 200 Class A Shares of the capital stock of Opco. Subsection 51(1) applies to this exchange of shares (the "Exchange"). The paid-up capital of Class F Shares of the capital stock of Opco is determined in accordance with the provisions of subsection 51(3).

Your questions respecting the Particular Situation

You asked us whether it should be considered that the safe income attributable to the 300 Class F shares of the capital stock of Opco held by the Shareholder is $180,000 (i.e. $600 per share). In such a case, you are of the opinion that there would be a dilution of the safe income.

You are asking us whether it should rather be considered that, on the one hand, the safe income attributable to the 100 Class F shares of the capital stock of Opco held by the Shareholder is $100,000 (as stated in paragraph (a) above) and that, on the other hand, the safe income attributable to the 200 Class F shares of the capital stock of Opco acquired by the Shareholder during the Exchange is $80,000.

Our Comments on the Particular Situation

Subsection 55(2) applies where a corporation resident in Canada has received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) as part of a transaction or event or a series of transactions or events, one of the purposes of which (or, in the case of a dividend under subsection 84(3), one of the results of which) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at FMV of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the safe-income determination time for the transaction, event or series.

Income earned or realized by any corporation after 1971 referred to in subsection 55(2), commonly referred to as "safe income", is net income computed for the purposes of the Act taking into account the adjustments referred to in paragraphs 55(5)(b) to (d). However, the "safe income" must be "on hand" ("SIOH") to be able to contribute to the unrealized capital gain on a share (footnote 1).

For example, if income has been used or earmarked to pay non-deductible expenses for the purposes of the Act, to pay dividends or to pay taxes, it can no longer be considered "on hand" to fund the payment of the dividend. (footnote 2)

The determination of the SIOH for shares of a particular corporation is based on the right of those shares to participate in the safe income of the corporation and generally depends on the "holding period" of the shares (footnote 3). Thus, the allocation or attribution of the SIOH between shares of various classes requires, in particular, an analysis of all the rights, privileges, conditions and restrictions attached to the classes of issued and outstanding shares, as well as an analysis of the relevant clauses of any unanimous shareholder agreement, and applicable corporate law.

Under the long-standing position of our Directorate, where there is a transfer of shares on a rollover basis, as provided for in sections 51, 85, 85.1, 86 and 87, the shares issued during the rollover participate proportionally in the SIOH attributable to the shares exchanged immediately before the transfer (footnote 4).

In light of the foregoing, the SIOH attributable to the 200 Class F shares of the capital stock of Opco acquired by the Shareholder in consideration for the exchange by the Shareholder of its 200 A Class shares of the capital stock of Opco shares should generally be equal to the SIOH attributable to the latter (i.e. $80,000).

However, since the unrealized capital gain on the 300 Class F shares of the capital stock of Opco held by the Shareholder (i.e. $299,700 (footnote 5)), proportionately relates to each of those shares (at $999 per share), the SIOH attributable to those shares (i.e., $180,000) can be considered to contribute to that unrealized capital gain and, consequently, should be allocated proportionally (at $600 per share) to all of the Class F shares of the capital stock of Opco held by the Shareholder.

In closing, we note that, in general, the capital gain that may be realized on a disposition at FMV of a share of the capital stock of a corporation is attributable in part to the SIOH and in part to something other than the SIOH. Thus, it is surprising that, in the Particular Situation, the SIOH attributable to the 100 Class F shares of the capital stock of Opco held by the Shareholder before the Exchange is greater than the unrealized capital gain on those shares. Nevertheless, that problem does not change the general comments set out above.

Please note that this opinion is not an advance ruling and does not bind the Canada Revenue Agency with respect to a particular factual situation.

We hope that these comments will be of assistance.

Best regards,

Maurice Bisson, CGA
Manager
Corporate Reorganizations and
Resource Industry Section
Corporate Reorganizations and
Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 John R. Robertson "Capital Gains Strips : A Revenue Canada Perspective on the Provisions of Section 55" in Conference 1981 (Toronto : Canadian Tax Foundation, 1982), pages 81-109, at page 84.
2 See in this regard Income Tax Technical News No. 37 of February 15, 2008.
3 John R. Robertson, supra footnote 1, at pages 84 and 85, guidelines (a) and (b).
4 Idem, pages 85 and 86, guidelines (c), (d) and (f).
5 That is, the excess of their FMV over their ACB, for the Shareholder (i.e. $300,000 - $300).