2015-0610661C6 2015 CTF Q.6(c), Safe Income

Principal Issues: What is the impact of dividends paid on discretionary dividend shares on the safe income attributable to other classes of shares issued by the corporation?

Position: 1) Whether the discretionary dividend shares have a value immediately before a dividend payment is a valuation issue. 2) If the non-participating discretionary shares have no accrued gain, no safe income could reasonably be considered to contribute to the capital gain on such shares. Dividends on such shares are subject to proposed subsection 55(2.1). 3) A dividend on non-participating discretionary shares results in a reduction of safe income that could reasonably be considered to contribute to the capital gain on the participating shares. However, the CRA is prepared to accept that such safe income is not affected by the dividend if the dividend was subject to the application of subsection 55(2)

Reasons: See below.

Author: Ton-That, Marc
Section: 55(2), 55(2.1)

2015 CTF Annual Conference
CRA Roundtable

Question 6(c): Calculating Safe Income Attributable to a Share

Under the new rules, a dividend will not be subject to subsection 55(2) if the dividend does not exceed the safe income that can reasonably be considered to contribute to the capital gain that could be realized on a disposition at FMV, immediately before the dividend, of the share on which the dividend is received.  Many corporations have fairly complex share structures and the existing CRA administrative positions will not cover safe income allocation issues which will emerge in future safe income calculations under the proposed rules.

For example, assume that a corporation has issued shares that are non-participating and non-voting but do allow for discretionary dividends. In addition, the corporation has issued common shares and conventional estate freeze preferred shares. As there was safe income on hand at the time of the freeze, the safe income on the original common shares is now attributable to the preferred shares and additional safe income was earned after the freeze which is attributable to the common shares.

As the discretionary dividends shares likely have nominal value, there would be no capital gain and no safe income could attribute to those shares.  So, if a dividend is actually paid on the discretionary dividend shares, how would this impact the allocation of safe income attributable to the other two classes of shares issued by the corporation?

CRA Response:

Whether participating or non-participating shares that are entitled to discretionary dividends have a value immediately before a dividend is paid is a valuation issue.

Where non-participating discretionary shares have no accrued gain, no safe income could reasonably be considered to contribute to the capital gain that could be realized immediately before the dividend since no such capital gain exists.  As such, the dividend would be subject to the purpose test in proposed subsection 55(2.1), i.e., whether a purpose of the payment of such dividend is to significantly reduce the value or the capital gain of the other shares of the payer corporation or to significantly increase the cost of properties held by the dividend recipient.  As explained earlier in the response to part (a) of the question, the purpose can only be determined by a review of all the facts.

The dividend on the non-participating discretionary shares results in a reduction of the safe income that could reasonably be considered to contribute to the capital gain on the participating shares since the capital gain has been reduced by the dividend and the portion of the income that was paid out as a dividend is no longer available to support such capital gain.

However, where the dividend on the non-participating shares is found to be subject to the application of subsection 55(2), we are prepared to accept that the safe income on the participating shares is not affected by the dividend.

Where dividends are paid on participating or non-participating discretionary shares that have an accrued gain, the dividends could be considered to be safe income dividends to the extent of the safe income that could reasonably be considered to contribute to the capital gain on such shares.

Marc Ton-That
2015-061066
November 24, 2015

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