Principal Issues: Whether our position to prorate the allocation of safe income on a partial crystallization of an accrued gain applies in the given fact situation.
Position: Yes
Reasons: Situation different from the one in 729658 Alberta Ltd.
XXXXXXXXXX 2005-011214
R. Gagnon
February 3, 2005
Dear Sir,
Subject: Safe income on hand
This is in response to your letter of January 19, 2005, in which you asked us what safe income on hand would be attributable to 100 common shares of Opco upon purchase of the common shares in the situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Facts
1. Opco is a "taxable Canadian corporation" as defined in subsection 89(1) and a "Canadian-controlled private corporation" as defined in subsection 125(7).
2. The issued and outstanding shares of the capital stock of Opco consist of 200 common shares.
The principal rights, privileges, conditions and restrictions for the common shares of the capital stock of Opco are as follows: No par value, voting, participating, entitled to receive dividends when declared by the board of directors. Upon liquidation or dissolution of the corporation, the holders of common shares are entitled to receive the remaining property of the corporation.
3. The paid-up capital, as defined in subsection 89(1), of the issued and outstanding common shares of the capital stock of Opco is $200. The fair market value of the 200 issued and outstanding common shares of the capital stock of Opco is $2 million.
4. Mr. A and Mr. B are resident in Canada for the purposes of the Act. Mr. A is the brother of Mr. B.
5. Mr. A and Mr. B each hold 100 common shares of the capital stock of Opco. The issued and outstanding shares of the capital stock of Opco are capital property within the meaning of the definition in section 54 to their holders. Mr. A and Mr. B have always been the sole shareholders of Opco.
6. The adjusted cost base, as defined in section 54, of the 100 common shares of Opco held by Mr. A is $100. The safe income on hand for the purposes of subsection 55(2) that is attributable to the 100 common shares of the capital stock of Opco held by Mr. A is $699,900.
7. Mr. A wishes to withdraw from being an Opco shareholder. The following transactions would be carried out by Mr. A and Opco in the order set out below.
8. A new corporation ("Holdco") would be formed. Holdco would be a "taxable Canadian corporation" as defined in subsection 89(1) and a "Canadian-controlled private corporation" as defined in subsection 125(7).
9. Mr. A would transfer to Holdco all of his 100 common shares of Opco, and would receive as consideration only common shares of the capital stock of Holdco.
Mr. A would make the subsection 85(1) election with Holdco, in the prescribed form and within the prescribed time set out in subsection 85(6), in respect of the 100 common shares of Opco. The agreed amount designated by Mr. A and Holdco would be $300,000.
Mr. A would then realize a capital gain of $299,900. Upon filing his income tax return, Mr. A would claim a capital gains deduction under subsection 110.6(2.1) in respect of his entire taxable capital gain.
10. Opco would purchase for cancellation the 100 common shares of its capital stock held by Holdco for a purchase price equal to their FMV at the time of purchase, i.e. $1 million. The purchase price would be paid by Opco in cash at the time of purchase of the 100 common shares. At the time of the purchase of the 100 common shares of its capital stock, Opco would be deemed by subsection 84(3) to have paid a taxable dividend (as defined in subsection 89(1)) of $999,900 on the 100 common shares held by Holdco.
Your Comments
In your view, the tax implications to Holdco of Opco's purchase of the 100 common shares of its capital stock would be as follows. Holdco would be deemed pursuant to subsection 84(3) to have received a dividend of $999,900 from Opco. However, $300,000 would be deemed pursuant to subsection 55(2) not to be a dividend received by Holdco and to be proceeds of disposition of the common shares. Holdco would not realize a capital gain on the purchase of the 100 common shares because the adjusted cost base of the shares would be $300,000.
In your view, your reasoning would be justified on the basis of 729658 Alberta Ltd. et al, 2004 DTC 2909 (T.C.C.).
Our Comments
It appears to us that the situation described in your letter could be an actual situation involving taxpayers. The Canada Revenue Agency does not generally provide a written opinion on proposed transactions otherwise than by way of an advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not apply in full to the situation presented.
We do not agree with your view of the tax implications in the situation described above. The situation described above is different from the situation considered in 729658 Alberta Ltd. et al, 2004 DTC 2909 (T.C.C.).
Safe income on hand at a particular time in respect of a share of a corporation held by a shareholder of the corporation is the portion of the safe income earned by the corporation that can reasonably be considered to contribute to the unrealized capital gain on the share in question. The determination of the amount of safe income on hand is a question of fact that can only be determined by taking into account all the facts and circumstances of each situation.
It appears to us that in a situation as described above, the safe income on hand attributable to the 100 common shares of Opco held by Holdco (after the transfer by Mr. A) should be approximately $489,900, because a portion of the unrealized capital gain on the 100 common shares of the capital stock of Opco was realized on the transfer of the shares to Holdco. The CRA's position with respect to this type of situation has not changed.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch