Subject: Safe Income Calculation Investment Tax Credits
This is in reply to your memorandum of December 24, 1990 regarding the effects of investment tax credits ("ITC") on the calculation of income earned or realized by a corporation after 1971 (hereinafter referred to as ("Safe Income)
You concur that the amount of any ITC claimed as a result of the acquisition of qualified property would reduce the amount of income tax otherwise payable, thereby resulting in an increase in Safe Income. Pursuant to the provisions of subsection 13(7.1) of the Income Tax Act (Canada) (the "Act"), the amount of ITC's claimed would also reduce the capital cost and the undepreciated capital cost of depreciable property of a prescribed class resulting in a lesser amount of capital cost allowance than would otherwise be deductible in computing taxable income. Consequently, the Safe Income would again increase. Therefore, it is appropriate to reduce the Safe Income by the amount of any phantom income caused by the reduction in the undepreciated capital cost of the qualified property.
21(1)(b)
As an anti-avoidance provision, subsection 55(2) of the Act was enacted to ensure that the realized proceeds on a variety of arm's length intercorporate share sales would not be treated as tax-free intercorporate dividends, but instead as capital gains. The provisions were designed to allow the tax-free transfers of Safe Income between corporations since the Safe income has been taxed at the corporate level. 21(1)(b)
21(1)(b)
The gain on a share can be attributable to two separate and distinct factors, the Safe Income that remains on hand within the corporation and the value attributable to something other than the Safe Income that remains on hand within the corporation (i.e. generally unrealized gains). Phantom income does not result in an inflow of funds to the corporation and, as such, would not be included in the computation of Safe Income that remains on hand. In addition, due to the nature of phantom income it is unlikely that such phantom income would increase the value of a share of the corporation and thereby contribute to a gain attributable to something other than the Safe Income that remains on hand. Accordingly, we do not share your view that such phantom income is being taxed twice, once as income under Part 1 and secondly as a capital gain.
The comments set out above represent our interpretation of the relevant provisions of the legislation. We recognize, however, that the decision of whether or not to issue a reassessment can only be made following a review of all of the relevant factors pertaining to a given situation.
DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch