In this post we will discuss what safe income is and how it is utilized. Essentially safe income refers to the income that has been earned, taxed and retained within the company. Safe income increases the value of the company’s shares. Since safe income contributes to the inherent gain on the shares, it can be subject to tax twice, once when earned and again through capital gains tax on a disposition of the shares. In order to prevent such double taxation, it is possible to extract or strip the safe income amount from a company in a tax efficient manner, reducing the gain inherent in the shares and thus reducing capital gains tax on a sale.

Subsection 55(2) of the Income Tax Act (the “ITA”) is an anti-avoidance provision. Its purpose is to prevent the extraction of value from a corporation by way of a tax-free dividend which is aimed to reduce the value of the corporation prior to its sale, thus reducing the amount of taxable capital gains payable on the sale. This is called “capital gains stripping”. The provision does, however, allow for capital gains stripping where the dividend paid can be attributed to the underlying previously taxed income of the corporation (otherwise known as “safe income”). The part of safe income that is available, that has not been previously distributed is called safe income on hand (“SIOH”).

A safe income strip is considered successful if it allows the shareholders of a corporation to reduce the accrued gain in the shares of a subsidiary corporation by extracting a tax-free dividend on the shares prior to their sale. However, any dividends received in excess of the SIOH will be re-characterized as proceeds of disposition under subsection 55(2) and will be subject to capital gains treatment.[1]

The calculation of safe income begins with reviewing the company’s corporate tax returns. The required adjustments are made to the company’s taxable income to arrive at the safe income. Safe income is cumulative and past years’ returns and financial statements are required to be reviewed and therefore it is essential for companies to retain such records.

A safe income strip in a share sale results in the reduction of capital gains through the payment of tax free dividends. Such dividends are generally used to effect a decrease in the fair market value (in the case of actual dividends) or an increase in the adjusted cost base (in the case of deemed dividends) of the sold shares. Conceptually, at a high level the “safe income” of a corporation generally represents its tax-paid retained earnings.[2]

Once the safe income has been calculated, It is then allocated to particular shares and shareholders. Following the allocation, the pre-sale transactions required to extract the safe income are implemented. The company’s share capital may be required to be re-organised, particularly in a scenario where the safe income planning is being combined with the capital gains exemption planning.

It is possible to isolate value in one class of shares to trigger a gain sufficient to use a capital gains exemption on the sale of those shares. To the extent that the safe income may be allocated to other classes, it may be extracted to reduce the gain on those shares. Individual shareholders commonly transfer the safe income shares to a connected holding company, after which the safe income is extracted by way of a tax-free inter-corporate dividend. The holding company may then sell its shares to the purchaser at a reduced gain, achieving a deferral of personal tax for as long as the value is retained in the holding company.

Safe income is an important tool to ensure a tax efficient sale of a business. The computation of safe income is quite complex, and there is a lot of uncertainty involved. Therefore, upfront planning and calculations are required to implement a successful sale.

Please do not hesitate to contact us with any questions or comments. Please note that the information on this blog post or in any other part of this site does not constitute legal advice to you for your specific circumstances. For actual legal advice, please be in touch and we will attempt to assist you or refer you to the appropriate advisor.

Authored by:

Ali Baniasadi


Ali is a partner at the law firm of Macdonald Sager Manis LLP,  full service business law firm located in the Toronto’s financial district. Ali’s practice focuses on corporate, tax and trademark law. Ali Baniasadi is the editor-in-chief of the and business law editor of the Toronto Lawyers Association Journal.

Hari is a corporate lawyer with experience in Information Technology, Renewable Energy and Nuclear Energy. He has worked in Canada, the US, Denmark, the UK, and India. in addition to his big-law experience, he was General Counsel at an US based IT Services company supervising internal and external counsel in jurisdictions across the world
Ruchika Shankar
IMG_9762 a
Ruchika is a lawyer with experience in General Corporate Law, Intellectual Property, Taxation and Consumer law.  She graduated from School of Law, Christ University in 2011. She was called to the Bar Council of New Delhi, India in 2012.

[1]Couzin Taylor Tax Counsel, [Court allows … transaction];

[2] Doron Barkai, Beau Young, Successful sale, CA Magazine, April 2012