| 19(1) | 5-8939 |
| D. Yuen | |
| (613) 957-2111 |
December 5, 1989
Dear Sirs:
Re: Subsection 55(2) of the Income Tax Act (the "Act")
We are writing in reply to your letter of October 18, 1989 in which you requested our comments on the application of subsection 55(2) of the Act in the following hypothetical situation:
"A wholly-owned Canadian subsidiary of a Canadian parent transfers capital property to a second wholly-owned subsidiary of the parent. This transaction is effected under the provisions of subsection 85(1) of the Act in exchange for redeemable preference shares with a paid-up capital equal to the elected amount and a redemption amount equal to the fair market value of the property transferred. Subsidiary #2 sells the property to an arm's length person, realizing a capital gain, and then redeems the preference shares issued to Subsidiary #1. Presumably the redemption proceeds to Subsidiary #1 would be a deemed dividend under subsection 84(3) of the Act."
In the above situation the provisions of subsection 55(2) of the Act will apply to the deemed dividend resulting from the redemption of the preferred shares. The income earned or realized for purposes of subsection 55(2) of the Act ("safe income") attributable to the preference shares is nil since the entire inherent gain in those shares is attributable to the gain on the property transferred. Preferred shares are entitled to share in the safe income of the corporation during the holding period only to the extent of their dividend entitlements. It should be noted that the holding period does not include any time after the commencement of the series of transactions or events.
The opinions expressed are not rulings and are not considered binding on the Department as outlined in paragraph 24 of Information Circular 70-6R.
Yours truly,
for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch