Principal Issues: Whether premiums paid under a life insurance policy reduce the safe income on hand of a corporation?
Position: Yes. The amount of premiums paid under a life insurance policy that has not already been deducted in computing the corporation's net income for tax purposes and that is no longer on hand to contribute to the capital gain on a share of the capital stock of the corporation reduces the safe income on hand attributable to the particular share. However, the amount of the non deductible premiums paid that is reflected in the cash surrender value of the life insurance policy and that contributes to the capital gain on the particular share of the capital stock of the corporation does not reduce the safe income on hand attributable to the particular share.
Reasons: Previous positions and review of case law.
March 23, 2005
Ms. Marie-Claude Poitras Income Tax Rulings Directorate
Tax Avoidance Agent
Quebec Tax Services Office Guy Goulet, CA, M.Fisc.
Section 442-2-0 (613)-957-9768
2005-011393
Interpretation Request
Calculation of safe income
This is in response to your email of January 28, 2005 in which you requested our comments on the calculation of safe income on hand of a corporation in the Particular Situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation:
The Particular Situation as you have presented it to us is as follows:
1. A portfolio company (Holdco) that qualified as a "Canadian-controlled private corporation" as defined in subsection 125(7) has always held all of the issued and outstanding shares of the capital stock of an operating company (Opco).
2. Opco acquired in XXXXXXXXXX an interest in a life insurance policy (the Policy) to insure the life of a shareholder of Holdco. Opco was the owner of the Policy and the sum insured was payable to Opco.
3. From XXXXXXXXXX to XXXXXXXXXX, Opco paid a total of $XXXXXXXXXX as premiums in respect of the Policy.
Based on the documents reviewed, we understand that an amount of $XXXXXXXXXX was the savings component of the premiums paid during this period and that this savings component was reflected during this period in the cash surrender value of the Policy.
Finally, we understand that for accounting purposes, the entire amount paid of $XXXXXXXXXX was considered an operating expense and that no portion of this amount was capitalized to reflect the cash surrender value of the Policy on the Opco balance sheet. We also understand that none of this amount was taken into account in computing Opco's income determined in accordance with the Act for those years, i.e., it was added as non-deductible life insurance premiums to net income in the financial statements in the annual reconciliations of income for accounting purposes to net income for purposes of the Act.
4. On XXXXXXXXXX, the Policy had an "adjusted cost basis" of $XXXXXXXXXX and a "value" of $XXXXXXXXXX as defined in subsection 148(9).
5. On XXXXXXXXXX Opco carried out the following transactions:
a. Payment of a dividend in kind of $XXXXXXXXXX to Holdco. As part of this dividend, Opco transferred to Holdco the Policy and certain other property ("Other Property").
As a result of this dividend, Opco has included the following amounts in its income computation:
- XXXXXXXXXX under subsections 148(1) and 148(7), that is, the amount by which the value of its interest in the Policy ($XXXXXXXXXX) exceeded its adjusted cost basis ($XXXXXXXXXX);
- XXXXXXXXXX as a taxable capital gain from the disposition of the Other Property.
b. Increase in the paid-up capital in respect of the issued and outstanding shares of its capital stock by $XXXXXXXXXX. Subsection 84(1) applied to this increase such that Opco was deemed to have paid a dividend of $XXXXXXXXXX on those shares and Holdco was deemed to have received a dividend equal to that amount.
6. On XXXXXXXXXX, Holdco disposed of all of the issued and outstanding shares of the capital stock of Opco to an unrelated person for proceeds of disposition of $XXXXXXXXXX.
7. According to the representatives of Holdco, the total safe income of Opco was $XXXXXXXXXX at the time of the sale of Opco shares by Holdco on XXXXXXXXXX.
Your Questions
You wish to know what implications the above transactions have on the calculation of the safe income on hand of Opco for the period beginning XXXXXXXXXX and ending XXXXXXXXXX, specifically, with respect to the Policy.
Our Comments
Generally, 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, inter alia, subsection 112(1) as part of a series of transactions or events one of the purposes 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 of a share of the capital stock at FMV immediately before the dividend and that could reasonably be considered to be attributable to something other than safe income realized by a corporation after 1971 and before the "safe income determination time" for the series. In other words, subsection 55(2) will generally not apply to an inter-corporate dividend if that dividend is derived from safe income earned by the payor corporation after 1971 and before the "safe income determination time" for the series that is attributable to shares held by the dividend recipient.
The term "safe income determination time" is itself defined in subsection 55(1). This expression means, in short, in relation to a series of transactions or events, the earliest of the following times:
- the time after the first disposition or increase in interest, referred to in any of paragraphs 55(3)(a)(i) to (v), that resulted from the series;
- the time before the first payment of a dividend under the series.
Furthermore, "income earned or realized by a corporation after 1971" ("safe income") means the net income of the corporation, determined in accordance with the Act and adjusted by the application of paragraph 55(5)(b), (c) or (d), as the case may be. On the other hand, a corporation's "safe income on hand" is the adjusted "safe income" that could reasonably be considered to contribute to the capital gain that would have been realized on the disposition of a share of the corporation. To contribute to a gain on a share, the "safe income" must be on hand and available for distribution as a dividend. Our longstanding position with respect to the calculation of a corporation's safe income on hand is that any actual or potential disbursements arising in the relevant computation period should be deducted from safe income to the extent that such disbursements were not deducted in the calculation of the corporation's safe income and to the extent that such disbursements reduce the gain inherent in a particular share of the capital stock of the corporation.
Thus, any amounts paid by the corporation as premiums under a life insurance policy that have not been deducted in computing the corporation's net income pursuant to the Act must generally be deducted in computing the corporation's safe-income on hand. However, where the policy has a cash surrender value, it is possible that a portion of the premiums paid may contribute to the increase in the cash surrender value of the policy and to the gain inherent in a particular share of the corporation's capital stock. In general, in such a situation, we are of the view that such portion of the premiums paid, which has not been deducted in computing the corporation's net income in accordance with the Act, may not be deducted in computing a corporation's safe income on hand for a particular calculation period.
In this case, we are of the view that the "safe income determination time" is the time prior to the payment of the XXXXXXXXXX dividend in kind, which means that for purposes of calculating the safe income attributable to the shares held by Holdco immediately before the safe income determination time the $XXXXXXXXXX included in income under subsection 148(1) and the $XXXXXXXXXX taxable capital gain realized on the disposition of the Other Property as a result of the payment in kind of the dividend, pursuant to paragraph 55(5)(a), are to be ignored.
Furthermore, we are of the view that Opco must deduct in computing its safe income on hand attributable to the shares held by Holdco all amounts paid by it during the relevant calculation period as premiums under the Policy, i.e., a total amount of $XXXXXXXXXX. However, since the Policy has a cash surrender value, it is our view that the portion of the premiums paid that did not reduce the gain inherent in the shares of the capital stock of Opco held by Holdco, that was not deducted in computing the net income of Opco pursuant to the Act, and that contributed to the increase in the cash surrender value of the Policy, should not be deducted in computing the safe income on hand of Opco attributable to the shares held by Holdco in the relevant period. Based on the information you have provided to us, this amount is equal to $XXXXXXXXXX and is the ACB of the Policy. In this regard, we have assumed that the ACB of the Policy, although not capitalized to the assets of Opco, contributed to the value of the Opco shares. Since we have assumed that Holdco always held 100% of the shares of the capital stock of Opco during the relevant calculation period, we agree with you that a one-off global adjustment can be made at the end of the calculation period to the safe income on hand of Opco. On this basis, a net amount of $XXXXXXXXXX ($XXXXXXXXXX - $XXXXXXXXXX) could therefore be deducted in calculating the safe income on hand of Opco for the relevant period.
We hope that our comments are of assistance.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch