Principal Issues: Does the position set out in the Safe Income Paper regarding the allocation of safe income to preferred shares acquired as consideration for the transfer of property on a tax-deferred basis to the corporation apply where the preferred shares are acquired in exchange for common shares?
Position: No. The allocation of safe income to the preferred shares in such circumstances should follow the CRA’s long-standing position on the allocation of safe income to preferred shares acquired on a tax-deferred share exchange.
Reasons: The position set out in the Safe Income Paper is only applicable to, specifically, the transfer of property other than shares.
2024 CTF Annual Tax Conference
CRA Round Table
Question 1: Safe Income and Preferred Shares
The Canada Revenue Agency (CRA) has considered the allocation of safe income to preferred shares where a shareholder acquires preferred shares in a corporation as consideration for the transfer of a property (other than shares) on a tax-deferred basis to the corporation. As per the CRA Update on Subsection 55(2) and Safe Income, Where are we Now? (footnote 1) (the Safe Income Paper) that was presented at the 2023 CTF CRA Roundtable, we understand that it is now the CRA's view that, when the accrued gain is realized by the corporation, the gain would be seen as contributing to the gain on the preferred shares and would be included in the safe income of the preferred shares.
What is CRA's view on the allocation of safe income to preferred shares where the preferred shares are acquired in exchange for common shares? Do 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, assume that Holdco owns 100% of the common shares of Midco which in turn owns 100% of the common shares of Subco. The shares of each company have FMV of $1,000 and ACB of $1. Subco owns a capital property with FMV of $1,000 and ACB of $1. Holdco exchanges its common shares in Midco for preferred shares of Midco with FMV of $1,000 on a tax-deferred basis. When the gain on the property held by Subco is eventually realized, would that gain be seen as contributing to the gain on the preferred shares of Midco and would it be included in the safe income of the preferred shares of Midco?
CRA Response
As part of the Safe Income Paper, the CRA did state that where a shareholder acquires preferred shares of a corporation as consideration for a transfer of a property on a tax-deferred basis to the corporation, the accrued gain on the property at the time of the transfer and that would subsequently be realized by the corporation would indeed be viewed as contributing to the gain on the preferred shares and would be included in the safe income of the preferred shares. (footnote 2) However, the CRA stated that this position is only applicable to, specifically, the transfer of property other than shares. Accordingly, the position set out in the Safe Income Paper does not extend to the situation described in the question where shares of a corporation (the exchanged shares) are exchanged for preferred shares of the corporation on a tax-deferred basis.
Instead, the allocation of safe income to the preferred shares in such circumstances should follow the CRA’s long-standing position on the allocation of safe income to preferred shares acquired on a tax-deferred share exchange. Specifically, the portion of safe income of the corporation to which the exchanged shares would have been entitled immediately before the exchange would flow through to the preferred shares. (footnote 3) In relation to any safe income realized after the exchange, the preferred shares so acquired as a result of the exchange would generally participate in the safe income of the corporation in accordance with the shares’ dividend entitlement, which entitlement would be affected by the conditions of such shares as well as the cumulative or non-cumulative nature of the preferred shares. (footnote 4)
Laurence Gagné
2024-103818
December 3, 2024
FOOTNOTES
NOTE TO READER: BECAUSE OF OUR SYSTEM REQUIREMENTS, THE FOOTNOTES CONTAINED IN THE ORIGINAL DOCUMENT ARE SHOWN BELOW INSTEAD:
1 TON-THAT, M. “CRA UPDATE ON SUBSECTION 55(2) AND SAFE INCOME «WHERE ARE WE NOW?»”, 75TH ANNUAL TAX CONFERENCE, 2023.
2 IBID, AT PAGE 31.
3 JOHN R. ROBERTSON, “CAPITAL GAINS STRIPS: A REVENUE CANADA PERSPECTIVE ON THE PROVISIONS OF SECTION 55,” REPORT OF PROCEEDINGS OF THE THIRTY-THIRD TAX CONFERENCE, 1981 CONFERENCE REPORT (TORONTO: CANADIAN TAX FOUNDATION, 1982), 81-109, AT PAGE 85.
4 FOR INSTANCE, AS STATED IN DOCUMENTS 9632725 AND 9237660.