| 19(1) | 5-9140 |
| S. Leung | |
| (613) 957-2116 | |
| December 18, 1989 |
Dear Sirs:
Re: Subsections 55(5) and 127(5) of the Income Tax Act (the "Act")
We are writhing in response to your letter of November 22, 1989 wherein you requested our comments on the effect of investment tax credits on the calculation of income earned or realized ("safe income on hand") for purposes of subsection 55(2) of the Act.
The Department's views on the calculation of safe income on hand were expressed in Mr. J.R. Robertson's address to the 1981 Canadian Tax Foundation. These views were subsequently updated by M.A. Hiltz at the 1984 Corporation Management Tax Conference and Mr. R.J.L. Read at the Canadian Tax Foundation annual conference.
Generally, safe income on hand is made up of taxable income plus certain adjustments, less the aggregate of losses incurred, dividends paid and income taxes paid or payable. The effect that various tax credits will have on the safe income on of a corporation will depend on the nature of the credit involved, how it is claimed and the facts of the case. Depending on the circumstances, credits could have either a positive or negative effect on safe income on hand calculation.
For example, assume that in Year 1 a taxpayer has claimed an investment tax credit of $350, which is included in his income in Year 2 pursuant to paragraph 12(1)(t) of the Act.
| Year 1 | |||
| Taxable income | $3,000 | ||
| Tax 40% | $1,200 | ||
| Less: ITC | 350 | 850 | |
| Safe income on hand | 2,150 | ||
| Year 2 | |||
| Taxable income before 12(1)(t) | $4,000 | ||
| Add: 12(1)(t) inclusion | 350 | ||
| 4,350 | |||
| Less: Tax 40% | 1,740 | ||
| 2,610 | |||
| Less: ITC "Phantom" Income | 350 | ||
| Safe income on hand | 2,260 | ||
| Total safe income on hand at end of Year 2 | $4,410 |
In Year 2, the taxpayer's taxable income would be increased by $350 pursuant to paragraph 12(1)(t) of the Act. In the calculation of safe income on hand, this $350 "phantom" inclusion would be deducted, resulting in a net inclusion of nil.
This result is consistent with the guidelines established in Mr. Robertson's paper. While the calculation of safe income on hand would reflect the taxed retained earnings of the taxpayer paragraph (xx) of the guidelines provided for a reduction of amounts which represent "Phantom" income.
An investment tax credit refund will not generally constitute "Phantom" income. Consequently, the refund may increase safe income on hand to the extent the refund exceeds any tax payable, in the current or subsequent years, as a result of including the refund in income pursuant to paragraph 12(1)(t) of the Act. Due to this tax liability, the gain inherent in the shares may not reflect the full value of the refund, and consequently may not be reflected in safe income on hand.
Our comments represent our interpretation of the guidelines outlined in Mr. Robertson's paper as they apply to the above example. The facts of each case are unique and the principle applied in this example may not be appropriate in every case.
Yours truly,
for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch