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What is Safe Income?

January 13, 2015

Tax Question:

What is safe income and what is it used for?

Facts:

Safe income is generally a corporation’s tax-paid retained earnings. A corporation’s safe income can be used to move excess cash out of one related company and into another related company before the company is sold. The cash is moved by issuing a tax-free inter-company dividend from the subsidiary up to the parent company.

Discussion:

When a corporation is sold, any excess cash on hand that is sold with the company would increase the sale price and increase the capital gain that the seller of the corporation has to report on their income taxes. In order to avoid inflating the capital gain for the excess cash, an inter-company dividend can be paid from the corporation that is for sale to its parent corporation. This effectively moves excess cash from one company to another. Since the corporations are related and the dividend consists of after-tax profits accumulated in corporation A, the related corporation or parent does not pay tax on the dividend. Instead, it would be combined with its retained earnings and could be paid out to the related corporation’s shareholders when it sees fit. In the example below, by paying a dividend to a related company to transfer the $300,000 of safe income, the gain on the sale of the company has been reduced by $300,000.

Before dividend of safe incomeAfter dividend of safe income
Company value$1,000,000$1,000,000
Excess cash$300,000
Share cost$(100,000)$(100,000)
Capital gGain$1,200,000$900,000

The calculation of a corporation’s safe income can be very complicated. If the dividend paid is greater than the corporation’s safe income, the difference will be treated as proceeds on the sale and increase the capital gain.

If you would like more information on this topic, please contact a member of the Empire CPA team by filling out the contact form below.

Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.

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