The participating and non-voting Class AA shares of Opco, which were held equally by two unrelated individuals (A and B), were worth $500,000 and had a safe income of $300,000 on January 1, 2016, and had a nominal paid-up capital and adjusted cost base. The voting shares of Opco, having an aggregate redemption value of $100, were held by Holdco, which was owned equally by A and B. On January 1, 2016, Holdco also subscribed $100 for 100 Class X shares of Opco, which were entitled to participate annually in Opco’s profits proportionately with the number of issued and outstanding AA and X shares, so that their holders were entitled (and only entitled) to dividends equal to the cumulative earnings from the time of their issuance and the redemption value of the shares (which otherwise would equal such proportionate accumulated profits plus the issue price) was reduced by the dividends paid.
On December 31, 2016, Opco had accumulated $100,000 in after-tax profits and safe income, As there were 200 outstanding AA and X shares, the X class shares had a redemption value on January 1, 2017 of $50,100 (($100,000 x 100/200) + $100 of PUC) On January 1, 2017, Opco paid a dividend of $50,000 to Holdco.
Q.2:
Would the dividend be excluded under s. 55(2.1)(c)? After noting the Robertson rule that “income will be attributable to a particular class of shares in the same ratio in which each class would be entitled if all earnings of the corporation, but not share capital, were to be distributed,” CRA stated:
[G]iven that…the Class X and AA shares were entitled to an equal share of Opco’s profits following the issuance of the Class X shares and that the value of the shares of each class would increase due to this share of profits, … the safe income earned or realized annually following the issuance of the Class X Shares could be proportionately allocated based on the number of shares of each class. Accordingly, based on…the share of Opco’s safe income contributing to the hypothetical capital gain on the Class X shares would be $50,000…and no part of the $50,000 dividend would be subject to subsection 55(2).
Q.3:
Alternatively, although the after-tax net profits remained at $100,000, the cumulative safe income in the year was only $90,000, with safe income attributable to the Class X shares of $45,000, and the $50,000 dividend was paid in two tranches of $45,000 and $5,000. CRA indicated that “it would be reasonable to consider that half of the safe income earned during the year would contribute to the hypothetical capital gain on the Class X Shares and half of the safe income would contribute to the hypothetical capital gain on the Class AA Shares if a dividend was paid on those shares,” so that the first dividend, but not the second, would enjoy the safe income exclusion.
Q.4:
As a further alternative, the 2016 profits instead were $200,000, the cumulative safe income in that year was $190,000, and the total market value of all the shares of Opco was $800,000 as a result of such profits and an increase in the value of intangibles. Class X shares had a redemption value of $100,100 (50% of the profits plus the paid-up capital). On January 1, 2017, OPCO paid a dividend of $95,000, followed by a second of $5,000, to Holdco.
CRA stated:
it would still be reasonable to conclude that half of the safe income would contribute to the hypothetical capital gain on the Class X shares. The increase in the value of the Class AA Shares would result from an unrealized capital gain for tax purposes and therefore would not be included in the safe income for the year. Consequently, the dividend of $95,000 would not be greater than the amount of safe income on hand and, therefore. would not come within subsection 55(2).
Q.5:
Under a further variation, an amount representing 50% of OPCO’s safe income would be allocated to the Class X shares and the balance of the accounting profits would be allocated to the Class AA shares. Assuming an aggregate safe income since the Class X share issuance and accounting profits of $100,000, if there were a distribution of all the accounting profits, the Class X and AA shares would receive $45,000 and $55,000, respectively. CRA stated:
[T]he increase in the corporation's safe income (during the holding of the Class X shares) for that year should be allocated based on the amounts to which each Class would be entitled. For example, 45/100 of $90,000 (i.e., the total safe income during the holding of the Class X shares) would be allocated to the Class X shares, or $40,500.
Therefore, it is not be possible to isolate the safe income of the corporation or a portion thereof in a particular class of shares if the corporation's safe income was less than the accounting profits