Principal Issues: Whether the "safe-income determination time" will be triggered for the selling company by the inception of a new corporation by the buyer to buy the assets of the selling company.
Position: Question of fact.
FEDERAL TAX ROUNDTABLE, OCTOBER 7, 2022
APFF CONFERENCE 2022
14. Application du paragraphe 55(2) L.I.R.
Background:
On March 15, 20XX, a purchaser incorporates a corporation for the purpose of eventually purchasing the assets of another corporation (the vendor corporation). Upon the incorporation of the purchasing corporation, the computation of the safe income of the vendor corporation stops (the "safe income determination time"), as this is one of the triggers for subsection 55(3), because this incorporation is the first step in a series of transactions.
On April 4, 20XX, the vendor corporation sells its assets for their FMV to the new purchasing corporation, necessarily after its incorporation, i.e., after the safe income computation has stopped. As a result, its taxable income from the sale will not be included in computing safe income because of the timing of the stop to the computation. To the extent that the vendor corporation pays a dividend to its corporate shareholder, the dividend paid as a result of the asset sale would be recharacterized as a capital gain because of the lack of safe income. However, the asset sale has already been fully taxed.
Questions to the CRA
(a) Is this how the CRA interprets the Income Tax Act in a situation such as the one described above?
(b) Is the safe income from the sale of the assets lost or will it be considered in a future computation of safe income?
CRA Response to Question 14(a)
The question considers that the incorporation of the corporation by the purchaser is part of the same series of transactions that includes the payment of the dividend by the vendor corporation and thus creates a triggering event described in subparagraph 55(3)(a)(ii), which constitutes the "safe-income determination time", as defined in subsection 55(1), for the vendor. This time would therefore be before the sale of assets. However, this determination remains a question of fact.
Assuming that the incorporation of the corporation is part of the same series of transactions that may create an increase in the total direct interest in a corporation of an unrelated person, we agree that the "safe-income determination time" defined in subsection 55(1) could be the time after that first increase in interest.
However, practical solutions to these types of technical issues exist and therefore the CRA does not consider that a flexible approach is necessary in the circumstances described in the question.
CRA Response to Question 14(b)
If the safe income from the sale of the assets is not included in safe income for the purposes of the dividend paid following the sale, this safe income is generally not lost and may be used in the subsequent payment of dividends to the extent that such subsequent dividends are not part of the same series of transactions as the sale of the assets.
In addition, it should be noted that, depending on the facts and circumstances of a particular situation, for example in situations of a total sale of assets of a corporation followed by a winding-up dividend pursuant to subsection 88(2), the CRA would be prepared to consider, after a detailed analysis of a file, that the subject matter of the dividend would not fall within paragraph 55(2.1)(b).
Marc Séguin
October 7, 2022
2022-094219