By Grant Gilmour
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 intercompany dividend from the subsidiary up to the parent company.
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 intercompany 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 income After dividend of safe income
Company value $1,000,000 $1,000,000
Excess Cash $ 300,000
Share cost $ (100,000) $ (100,000)
Capital Gain $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 to discuss safe income and how it affects you, please contact Gilmour Knotts Chartered Accountants.
Grant Gilmour B.SC. MBA, CPA, CA is the International Tax Partner of Gilmour Knotts Chartered Accountant. To connect with Grant visit: www.gilmour.ca