3 December 2015 External T.I. 2015-0593941E5 F - Allocation of the safe income on hand -- summary under Paragraph 55(2.1)(c)

1^st situation. Three unrelated Holdcos (A, B and C) each hold all the 100 voting participating shares of a separate class of discretionary dividend shares of Opco, which has safe income on hand of $90,000, whose shares collectively are worth $120,000, and with the three share classes sharing equally on liquidation and having a nominal adjusted cost base (“ACB”). The directors declare a $35,000 dividend on the Class OA shares held by Holdco A only.

2^nd situation. The same as the 1^st except that the shares are non-voting and non-participating [i.e., are non-cumulative preferred shares] and that other voting and participating shares were issued by Opco to the three Holdcos.

3^rd situation. Two unrelated individuals (A and B) each held 39 Class A shares of Opco and their respective Holdcos (Holdco A and B) each held 11 Class B or 11 C shares, respectively. All three classes are voting, participating and discretionary-dividend shares and their collective safe income on hand is $100,000, their collective fair market value (“FMV”) is $120,100 and their ACB is $1 per share. Holdco A and B each receive a $50,000 dividend.

4^th situation. Two brothers (A and B) each held 49 Class A shares of Opco and their respective Holdcos (Holdco A and B) each held 1 Class B or 1 C shares, respectively. The Class A shares are voting, participating and discretionary-dividend shares, the Class B and C shares are voting, non-participating and discretionary-dividend shares and the collective safe income on hand is $100,000. Holdco A and B each receive a $50,000 dividend.

5^th situation. Mr and Ms A hold 99 Class A and 1 Class B voting, participating and discretionary-dividend shares of Opco which they had acquired at the same time, having an aggregate FMV now of $120,100, and an ACB of $1 per share and CRA also assumed safe income on hand for Opco of $100,000. A separation agreement provides that Ms A will transfer her Class B share to a newly-incorporated holdco (HoldcoMsA) under s. 85(1), Opco will pay a dividend equal to 90% of its NAV on the Class B share and then repurchase that share for $1.

Question. What is the treatment of the dividends (and, in the first two situations, the impact on safe income on hand) in these transactions?

1^st situation. CRA stated (TaxInterpretations translation):

The question is whether… it is reasonable to consider that an amount of safe income on hand equal to the dividend contributed to the capital gain which would be realized on a disposition at FMV, immediately before the dividend, of a share on which the dividend was received (the “hypothetical capital gain”). The amount of the hypothetical capital gain would be a function of the FMV which could be attributed to the share on which the dividend was declared, such FMV being measured immediately before the dividend payment but keeping in mind that such share would have a right to an additional amount equal to the dividend declared thereon.

…Taking into account [such] an additional value of $35,000 for the Class OA shares…the $35,000 dividend would not be greater than the safe income on hand which it would be reasonable to consider as contributing to the hypothetical capital gain.

Following the dividend…the safe income on hand of Opco would be reduced to $55,000.

If no other dividend was declared, and Opco was liquidated and the residue of its property paid in equal parts to each class of participating shares, the capital gain which would be realized on the shares of each class, if there was a disposition at FMV immediately before the dividend…would be $28,333. In such a case,…the safe income on hand which it would be reasonable to consider as contributing to the capital gain on the shares of each class would be $18,333 ($55,000/3).

2^nd situation. After again referencing that the shares would have a right to an additional amount immediately before the payment time equal to the declared dividend, CRA stated:

It could be…that there would be no hypothetical capital gain if the FMV of the non-participating and non-voting shares was equal to their ACB. For example, this could occur if the unpaid dividends represented distinct rights from the shares to which they related.

In such a case, the condition in paragraph 55(2.1)(c)…would be satisfied. If no capital gain arises on a disposition at FMV of shares on which the dividend is paid, there indeed is no safe income on hand which contributes to the hypothetical capital gain.

…[Respecting] paragraphs 55(2.1)(a) and (b)…the dividend…would reduce the… capital gain which could be realized on a disposition at FMV of the common shares. … With a dividend in the order of magnitude of $35,000…we could conclude that the reduction is significant or the increase in cost is significant.

…If one of the purposes of the payment or receipt of a dividend is as stated in subparagraphs 55(2.1)(b)(i) and (ii), subsection 55(2) could apply to the $35,000 dividend if the other conditions were satisfied. In such a case, the CRA would accept that the amount of the dividend does not reduce the safe income on hand of the corporation. If instead, subsection 55(2) did not apply to the dividend on the preferred shares, the amount of the dividend would reduce the safe income on hand of the corporation.

…[I]f the amount of the hypothetical capital gain for the non-voting and non-participating shares was equal to $35,000, it might be that we would consider that the $35,000 dividend was not greater than the safe income on hand which it was reasonable to consider as contributing the hypothetical capital gain. If so, subsection 55(2) would not apply. In that case, the safe income on hand of the corporation would be reduced by the amount of the dividend.

3^rd situation. CRA noted that this was similar to Situation 1, repeated essentially the same analysis, and concluded:

…Taking into account [such] an additional value of $50,000 equal to the amount the dividend which would be paid on the shares…of Class B and C…each dividend of $50,000 would not be greater than the safe income on hand which it would be reasonable to consider as contributing to the hypothetical capital gain on each of Classes B and C. Consequently, subsection 55(2) would not apply… ..

The dividends which were not subject to subsection 55(2) would reduce the safe income on hand for the shares of Opco.

4^th situation. CRA noted that this was similar to Situation 2, and provided the same analysis but adding that subsection 55(2) would not apply if Part IV tax applied to the dividends and was not refund by reason of a payment of a dividend by the Holdco.

5^th situation. After noting that the analysis was similar to the 1^st situation, CRA stated:

[]I]t is necessary to compare the dividend paid by HoldcoMsA, being 90% of $120,000 ($108,000) to the safe income on hand of Opco ($100,000).

...[T]he dividend is greater than the safe income on hand of such share by $8,000. The question is whether the dividend of $108,000 would significantly reduce the FMV of the "A" shares in the capital stock of Opco. If this were the case and one of the purposes was such reduction, the conditions for the application of subsection 55(2.1) would be satisfied. Subsection 55(2) would apply respecting the dividend (subject to the application of paragraph 55(5)(f)) received by HoldcoMsA, unless Part IV tax applied and the tax was not refunded by the payment of a dividend by HoldcoMsA.