When Holdco was incorporated and capitalized with $500,000 of share capital, it incorporated Opco 1 and 2 and subscribed $100 and $499,900 for shares of Opco 1 and 2, respectively. Opco 1 realized $900,000 in safe income and its shares now have a fair market value (FMV) of $1,000,000. Opco 2 realized operating losses of $2,000,000 in building up an intangible asset. As it financed the losses in part with third-party debt of $1,500,100, the shares of Opco have an FMV of $499,900.
Should the safe income attributable to the shares of Holdco be reduced by negative safe income given that the latter does not reduce the accrued capital gain in the shares – or is such amount $900,000?
After noting that (based on Brelco) “the losses of an affiliate can reduce a parent corporation's safe income on hand even if the parent corporation has not directly or indirectly guaranteed the affiliate's losses.” CRA stated:
[T]he fact that Opco 2's trading losses ultimately did not have the net effect of reducing the fair market value of the Holdco shares, and assuming that no entity in the Holdco Group had guaranteed or financed the debt of Opco 2, the CRA is of the view that Opco 2's trading losses should not reduce the consolidated safe income attributable to the shares of the capital stock of Holdco. Indeed, it is our understanding that Opco 2's operating losses were funded by debt from an entity unrelated to Holdco and by the investment of Holdco in Opco 2. Furthermore, those losses are now reflected in the value of the intangible asset created and held by Opco 2. Consequently, the losses of Opco 2 ultimately had no effect on the fair market value of the Holdco Shares. It would therefore be reasonable to consider that the safe income attributable to the shares of the capital stock of Holdco should be $900,000, which is the safe income attributable to the shares of the capital stock of Opco 1 held by Holdco.