2016-0672321C6 indicated that that safe income on hand should be reduced by accounting contingencies, reserves and allowances because of their effect on the value of a share. Suppose that the FMV of Holdco’s shares of Opco (having a nil PUC and ACB) is $1,000,000, consisting of shareholder’s equity (i.e., share capital and retained earnings) of $800,000, unrealized gains of $500,000 and contingent liabilities and accounting provisions valued at $300,000, and suppose further that such retained earnings correspond to the safe income earned attributable to the Opco shares of Holdco.
In determining safe income on hand, should safe income be reduced by accounting contingencies and reserves? It was suggested that it was more appropriate that such amounts should instead be applied first to the unrealized gains. CRA stated:
The CRA is maintaining its longstanding position that to the extent that contingencies and accounting reserves have the effect of reducing the inherent gain on a corporation's share, such amounts should reduce the corporation's safe income on hand.
Consequently, safe income on hand of a corporation must generally be reduced by actual or potential cash outflows, such as non-deductible expenses, contingencies and accounting reserves, in determining the amount of safe income that can be considered to contribute to the gain on a share.
The CRA would, however, be prepared to consider more specific situations in the context of a request for advance rulings so as to make a safe income determination based on all the facts of a case.