| 5-920803 | |
| 24(1) | Charles Thériault |
| (613) 957-8953 |
Attention: 19(1)
July 28, 1992
Dear Sirs:
This letter is in reply to yours dated March 13, 1992 wherein you requested our interpretation regarding the calculation and allocation of safe income between preferred and common shares of a corporation for the purpose of subsection 55(2) of the Income Tax Act (the "Act") in relation to the following hypothetical situation.
Three individuals, A, B and C, own all the common shares of Opco. A and B transfer their shares of Opco to Holdco A and Holdco B respectively. The transfers are made pursuant to subsection 85(1) of the Act and the agreed amounts are equal to A and B's respective adjusted cost base of the shares transferred. Immediately before the transfer, $2,500 of safe income is attributable to each common share of Opco.
Immediately after, Opco reorganizes its share capital (presumably pursuant to subsection 86(1) of the Act and Holdco A, Holdco B and C are issued preferred shares in exchange for their common shares. The preferred shares have a nominal paid-up capital, and their redemption value is equal to the fair market value of the common shares exchanged, $3,000 each. Holdco A, Holdco B, C and a new investor, Holdco D, subscribe to new common shares of Opco. In a separate series of transactions, Opco redeems the preferred shares that Holdco A and Holdco B own using its capital dividend account.
Question
You want to know if the safe income that was attributable to the preferred shares of Opco immediately before they were redeemed by Opco could be attributed to the other shares of Opco.
Unrelated to the above situation, you also want to know if a deemed dividend pursuant to subsection 84(3) of the Act that is deemed to be a capital gain for the recipient pursuant to subsection 55(2) of the Act will reduce the safe income attributable to the other shares of the company.
Our comments
The Department's views on the computation of safe income were expressed in Mr. Robertson's address to the 1981 Conference of the Canadian Tax Foundation. These views were subsequently updated by Mr. Mike Hiltz at the 1984 Corporate Management Tax Conference, as well as by Mr. R.J.L. Read at the 1988 Conference of the Canadian Tax Foundation. Regarding your first question, Mr. Robertson made the following comment at page 85 of the Report of the Proceedings of the Thirty-third Tax Conference:
"c) Where a share (the exchange share) is exchanged for shares (the new shares) on a rollover basis the portion of the safe income of the corporation to which the exchanged share would have been entitled immediately before the exchange will flow through to the new share. Other shares in the corporation issuing the new shares should not share in the particular exchanged share's flow through of safe income.... It is not possible to acquire safe income by purchase or otherwise and it is not reasonable to claim that a gain on a share is attributable to income earned in respect of some other share other than a share for which it was exchanged on a rollover basis.
All shares of the corporation in which the new shares have been issued will share pro rata in the safe income of that corporation from the time of the exchange. This is a reasonable approach to take and would cover rollovers such as those provided by sections 51, 85, 85.1, 86, and 87." (Our underlining)
Mr. Robertson also stated the following at page 89:
"xi) Capital dividends and other nontaxable dividends, the balance of a capital dividend account, etc., are ignored in computation of the amount of the safe income."
These Robertson comments are still valid in our view in the above situation. The safe income that was attributable to the common shares of Opco immediately before A and B transferred them to Holdco A and Holdco B respectively ($2,500 per share) cannot be attributed to the other shares of Opco, even though the capital dividend did not affect the safe income of Opco.
Regarding your other question, Mr. Robertson made the following comment at page 89:
"vi) When a dividend has been treated in the hands of the recipient as a gain (pursuant to paragraph 55(2)(c)) it will not be deducted in the computation of safe income. In this way there will be no duplication of amounts taxed as gains pursuant to paragraph 55(2)(c) and of amounts treated as proceeds of disposition pursuant to paragraph 55(2)(b) when the shares are eventually disposed of."
This is still the Department's position.
Our above comments are not rulings and are provided in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990.
Yours truly,
for DirectorReorganization and Foreign divisionRulings DirectorateLegislation and Intergovernmental Affairs Branch9207000 - 9207999