In connection with the implementation of an earnout transaction for the purchase of Holdco common shares by a key employee, the equal unrelated (corporate) shareholders of Holdco (a Canadian-controlled private corporation holding Opco) first transfer a portion of their Holdco common shares to Opco in consideration for tracking preferred shares of Opco, with Opco immediately selling those shares on a five-year earnout basis to the key employee.
Before the implementation of the above transactions, Holdco and Opco adopted a policy of dividending out all of their operating earnings – but deferred paying any of these dividends until the rulings were granted. CRA ruled that the dividend determination time for the “Second Annual Dividends” (i.e., dividends payable based on the annual income for the Opco taxation year ending after the sale of the Holdco common shares by Opco to the key employee) is the time immediately before their payment rather than the time immediately before the payment of the previous dividends, so that the safe-income exception in s. 55(2.1)(c) could access the more recent earnings. The safe-income determination time for the dividends on the tracking preferred shares was the same time as the payment of the previous dividends.