7 June 1999 Internal T.I. 9907157 - SAFE INCOME ON HAND

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: several issues relating to the claculation of safe income

Position: see response

Reasons: see response

		June 7, 1999

	Toronto East Tax Services Office	Reorganizations and
		International Section
T. Harris
	Attention: S. Bossin	957-2114
		Tax Avoidance
		Section 444-1-4
			7-990715

XXXXXXXXXX - Safe Income Calculation

This is in response to your memorandum of March 15, 1999 wherein you requested our opinion with respect to several issues which were encountered during your review of the safe income calculation of XXXXXXXXXX.

FACTS

Our understanding of the facts is as set out below:

XXXXXXXXXX

ISSUES

You have requested our comments with respect to the following issues which have arisen as a result of your review of the safe income on hand of XXXXXXXXXX:

1. In calculating its safe income on hand, XXXXXXXXXX did not deduct the pre-acquisition non capital losses of XXXXXXXXXX has relied on the statement by J.R. Robertson in his paper presented to the 1981 annual conference of the Canadian Tax Foundation which states that “a gain cannot arise before the acquisition of an asset. Therefore, the computation of safe income with respect to a particular share is generally confined to the holding period. (Any surpluses realized or otherwise on hand at the time of acquisition should be reflected in the adjusted cost base of the shares).”

2. In calculating its safe income on hand, XXXXXXXXXX did not deduct the Part 1.3 taxes paid, the amount of investment taxes claimed to reduce its Part I taxes or the amount of provincial capital taxes paid by it.

3. Included in XXXXXXXXXX calculation of safe income on hand at XXXXXXXXXX is income from a partnership having a fiscal period ending on XXXXXXXXXX. The calculation includes income for the year ended XXXXXXXXXX as well as income for the stub period from XXXXXXXXXX.

4. In calculating its safe income on hand, XXXXXXXXXX did not deduct amounts in respect of non-deductible expenses, such as meals, entertainment, and interest and penalties on income taxes.

YOUR POSITION

1. It is your view that XXXXXXXXXX should reduce its safe income on hand by the amount of XXXXXXXXXX non-capital losses. In this regard, you note that in his paper presented to the 1981 annual conference of the Canadian Tax Foundation, J.R. Robertson stated that “where safe income of one corporation in a group is negative, such a negative amount cannot be eliminated simply by transferring the shares of that corporation from one corporation to another in the group.” These comments were reiterated in a paper presented by Carole Gouin-Toussaint, then Director of the Bilingual Services and Resources Industries Division, in a speech on June 3, 1991 on the subject of Safe Income. You, therefore, believe that the quotation referred to by XXXXXXXXXX is not applicable in this case since the shares were acquired from a sister company.

2. The guidelines for computing safe income on hand state that “all federal and provincial taxes” must be deducted in arriving at the proper amount. You are unsure as to whether taxes under Part 1.3 and provincial capital taxes are included in the description of “all federal and provincial taxes”. You are also not sure whether the deduction for federal income taxes is the gross amount or the net amount actually paid by XXXXXXXXXX after applying the investment tax credits.

3. In his 1988 paper titled “Section 55: A Review of Current Issues”, Robert J.L. Read stated “The computation of safe income on hand of a corporation during the holding period would include safe income arising in these stub periods and, if the corporation is a member of a partnership, would also include any accrued income or loss of the partnership referable to the stub period that is not otherwise included in the safe income of the corporation.” You question whether this still represents the Department’s position.

4. You believe that the non-deductible expenses must be deducted in computing safe income on hand.

OUR COMMENTS

Subsection 55(2) of the Act applies to a dividend received by a corporation resident in Canada that is deductible under subsection 112(1) where one of the purposes of the dividend was to significantly reduce the portion of a capital gain that would have been realized on a fair market value disposition of the share and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971. The expression “income earned or realized” is deemed to be the amount determined under paragraph 55(5)(b), (c) or (d), as the case may be. Consequently, the income earned or realized by a corporation after 1971 refers to the corporation’s net income, as determined for the purposes of the Act, as adjusted by paragraph 55(5)(b), (c) or (d) that is attributable to the particular share during the relevant holding period.

It is, however, the Department’s position that income earned or realized by a corporation can only contribute to a gain on a share to the extent that it is on hand and available for distribution to the shareholder as a dividend. Since income earned or realized is computed on the basis of net income as determined for purposes of the Act, in computing the portion of the gain on a share which is attributable to such amount it is necessary to adjust this amount by any disbursements which do not reduce the corporation’s net income for tax purposes. Such disbursements will generally include amounts paid as dividends, income taxes, charitable donations and any other amount which is not deductible in computing the corporation’s net income.

With respect to the specific items referred to in your memorandum, our comments are as follows:

1. As discussed during our telephone conversations, the impact that the deduction of pre-acquisition non capital losses incurred by a loss corporation following its acquisition by another member of the related corporate group should have on the loss corporation’s safe income on hand is currently under review. You have, therefore, requested that pending completion of our review, we provide you with our comments relating to the other issues which you have raised.

2. In our view amounts paid by XXXXXXXXXX on account of its taxes under Part 1.3 should be deducted in computing its safe income on hand. The rationale for this view is that like most other federal and provincial taxes, it represents a disbursement of funds which is not deductible in computing the corporation’s net income for tax purposes (see, for example, paragraph 20(1)(t) of the Act) and which is not available to contribute to the gain on the share. The large corporation tax is no different from amounts paid as income taxes which the courts have recognized as reducing safe income on hand. In this regard, Bell J. made the following comments in Deuce Holdings Limited v. The Queen 97 DTC 921 (T.C.C.) at page 932:

“...It is logical that subsection 55(2) take into account the fact that proceeds that would, but for a dividend, have been realized on a disposition at fair market value of any share immediately before the dividend, would have been computed after tax. ...No purchaser would rationally pay a price for a share of the capital stock of a corporation without taking into account tax paid or payable on that corporation’s income”.

With respect to provincial capital taxes, it is our understanding that such amounts are normally deductible in computing a corporation’s net income for tax purposes. As such, it would not be necessary to deduct them a second time in computing the corporation’s safe income on hand.

In a paper presented by Mr. M. Hiltz of this Directorate at the 43rd Tax Conference of the Canadian Tax Foundation held in Toronto in November 1991, the Department explained its position regarding the effects of investment tax credits on the calculation of safe income on hand. In the comments and examples included in pages 15:15 to 15:24 of that paper, the Department indicated that the amount of income taxes payable which reduce a corporation's safe income on hand is the amount of such taxes payable for the year without taking into account any ITC which might be used to reduce the amount of such taxes. The ITC will only be brought into safe income in a subsequent year as the amount of the ITC is reflected in the corporation's net income pursuant to a specific provision of the Act, such as one of paragraphs 12(1)(t), 13(7.1)(e), 37(1)(e) or "L" in the definition of cumulative Canadian exploration expense in subsection 66.1(6).

3. The Department’s position with respect to the inclusion of income relating to a stub period remains as set out on pages 18:5 and 18:6 of the paper titled “Section 55: A Review of Current Issues” which was presented by Robert J.L. Read at the 1988 annual conference of the Canadian Tax Foundation. Consequently, we agree that XXXXXXXXXX safe income on hand as at XXXXXXXXXX would include its share of any income for the stub period from XXXXXXXXXX. The allocation of income to the stub period should be reasonable in the circumstances. It may be appropriate to take business cycles into account. Proration of such income on a daily basis is often, but not always, a reasonable basis for proration.

4. The Department’s position with respect to non-deductible expenses remains as set out on page 90 of the paper titled “Capital Gains Strips: A Revenue Canada Perspective On the Provisions of Section 55” which was presented by J.R. Robertson at the 1981 annual conference of the Canadian Tax Foundation where it was stated that:

“xviii) A deduction for any expense incurred or disbursement made in the period that was not allowed or not claimed as a deduction in computing income will reduce safe income. However, there will be no deduction for an expense incurred or disbursement made in respect of the acquisition of property, an eligible capital expenditure, or a repayment on account of the principal amount of a loan.”

Consequently, we agree with your view that XXXXXXXXXX safe income on hand as at XXXXXXXXXX should be reduced by amounts in respect of non-deductible expenses, such as meals, entertainment, and interest and penalties on income taxes. Our rationale being that these amounts represent funds which have been disbursed and which have not been deducted in computing the corporation’s net income for tax purposes and which are not available to contribute to the gain on the shares.

The Department’s approach to the computation of safe income on hand has recently been supported by the majority decision of the Federal Court of Appeal in the case of Her Majesty the Queen v. Brelco Drilling Ltd. (formerly Trimac Limited). In this as yet unreported decision which was handed down on May 11, 1999, Linden, J. made the following comments on this subject:

“I consider that the operation of subsection 55(2) has been settled. As noted above, in two recent decisions, unanimous panels of this Court have accepted that “safe income” means “safe income on hand”. Those panels declared that safe income was a net calculation. In one of those cases, Walnut Investment, supra, a unanimous panel of this Court expressly accepted that so long as the approach taken by the Minister in allocating safe income is reasonable, subsection 55(2) should apply. There is no reason why this Court should depart from its jurisprudence. The reasoning of the Tax Court Judge, that there is no legal basis for requiring exempt deficits - or any other cost which reduces the safe income on hand - to be taken into account in determining “income earned or realized”, is therefore flawed......

I am bolstered in these conclusions by the literature, which unanimously accepts that section 55(2) requires a calculation of safe income on hand, not exempt income generally. “Safe income on hand” refers to that portion of safe income of a share which can reasonably be considered to contribute to the capital gain on that share. It is by definition a net calculation which begins with the deemed income in section 55(5), but which does not end there....”

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department’s mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.

We trust that our comments will be of assistance.

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch