The CRA "Update on Subsection 55(2) ..." (Full paper released on 22 December 2023) stated that, where a shareholder acquires preferred shares as consideration for the transfer of property on a tax deferred basis, the accrued gain on the property, when subsequently realized by the corporation, would be viewed as contributing to the gain on the preferred shares, and accordingly would be included in the preferred shares’ safe income. Does this position also apply where the preferred shares are acquired in exchange for common shares, so that the accrued gains on the underlying property held by the corporation and any of its subsidiaries at the time of the share exchange get allocated to the safe income of the preferred shares once realized? For example, if Holdco owns all the common shares of Midco with an FMV and ACB of $1,000 and $1, and MIdco owns all the common shares of Subco with an FMV and ACB of $1,000 and $1, and Holdco exchanges its Midco common shares for Midco preferred shares with a FMV of $1,000 on a tax-deferred basis, will the gain on the property held by Subco when eventually realized be included in the safe income of the Midco preferred shares?
CRA indicated that such extension of its position would not occur, and that the allocation of the safe income to the preferred shares would follow its longstanding position that a portion of the safe income to which the exchanged shares would have been entitled immediately before the exchange simply flows through to the preferred shares. Regarding the safe income realized after the exchange, the preferred shares would generally participate in the safe income of the corporation in accordance with the shares’ dividend entitlement only.