2014-0522991C6 Safe Income

Principal Issues: Can a recipient of a dividend, which exceeds the amount of safe income on hand, self-assess the dividend as proceeds of disposition?

Position: Question of fact. See below.

Reasons: CRA's long standing practice is to apply subsection 55(2) only to the excess of the taxable dividend paid on a share over the safe income on hand attributable to that share. In a situation where a recipient corporation self-assesses the entire amount of a dividend received on a share as a gain under paragraph 55(2)(c) or as proceeds of disposition under paragraph 55(2)(b), CRA could reassess the recipient corporation and reduce the amount of the gain subject to paragraph 55(2)(c) by applying the purpose test provided under subsection 55(2) or, in other circumstances involving a surplus stripping scheme, by applying the GAAR.

Author: Bordeleau, François
Section: 55(2); 55(5)(f); 55(2)(b); 55(2)(c); 112(1); 245(1)

STEP CRA Roundtable – June 2014

Question 7 – Safe Income

Under the provisions of subsection 55(2), an intercorporate dividend can be re-characterized as proceeds of disposition to the extent that the amount of the dividend is attributable to anything other than income earned or realized (usually referred to as “safe income on hand”). 

Suppose that the conditions for the rule in subsection 55(2) are met, and a dividend exceeds the amount of safe income on hand. The dividend would then be deemed to be proceeds of disposition or a gain, in its entirety (if no designation is made under paragraph 55(5)(f) for the dividend to constitute a series of separate dividends). 

In this circumstance, is it permissible for the recipient of the dividend to self-assess the dividend as proceeds of disposition? It would appear that the structure of the Income Tax Act requires this. Does CRA accept such a result, or would CRA attempt to apply the general anti-avoidance rule where it was clear that the arrangement was structured for tax planning reasons, to result in a capital gain?

CRA response

In the case of The Queen v. Nassau Walnut Investments Inc., 97 DTC 5051 (FCA), in interpreting subsection 55(2) and paragraph 55(5)(f) of the Act, the Court found that:

-     Subsection 55(2) of the Act applies if a dividend effects a significant reduction in a capital gain that could reasonably be considered to be attributable to anything other than safe income.
-     Paragraph 55(5)(f) of the Act is not an elective provision.
-     The designation requirement of paragraph 55(5)(f) of the Act is, in some respects, no different than the deduction provided under subsection 112(1) of the Act.
-     The purpose of paragraph 55(5)(f) of the Act is to prevent the conversion by subsection 55(2) of the Act of an entire dividend into taxable capital gain where a portion of that dividend might be attributable to safe income.

In that case, the Court concluded, among other things, that Nassau was obligated at the time of filing its income tax return for the taxation year in question to make a designation pursuant to paragraph 55(5)(f) of the Act.

Moreover, courts have consistently held, in interpreting subsection 55(2) of the Act, that the safe income of a corporation should not be subject to double taxation when distributed as a dividend to another corporation. In that regard, we refer you to The Queen v. Kruco Inc., 2003 FCA 284, Lamont Management Ltd. v. The Queen, [2000] 3 FC 508 (FCA) and The Queen v. Brelco Drilling Ltd., [1999] 4 FC 35 (FCA).

CRA’s long standing practice is to apply subsection 55(2) of the Act only to the excess of the taxable dividend paid on a share over the safe income on hand attributable to that share, when issuing an assessment based on subsection 55(2) of the Act.

In a situation where a recipient corporation self-assesses the entire amount of a dividend received on a share as a gain under paragraph 55(2)(c) of the Act or as proceeds of disposition under paragraph 55(2)(b) of the Act, regardless of the safe income on hand attributable to the share, CRA could reassess the recipient corporation and reduce the amount of the gain subject to paragraph 55(2)(c) of the Act by applying the purpose test provided under subsection 55(2) of the Act, or, in other circumstances involving a surplus stripping scheme, by applying the general anti-avoidance rule provided under subsection 245(2) of the Act.  

François Bordeleau
June 16, 2014
2014-052299

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