When does section 55(2) turn an intercorporate dividend into a capital gain, and how much does safe income protect?
For dividends received after April 20, 2015, section 55(2) recharacterizes a taxable intercorporate dividend as a capital gain, or as proceeds of disposition on a share redemption, when the dividend exceeds the safe income contributing to the share's gain and one of its purposes (for redemption dividends, its results) is a significant reduction in that gain.
When does section 55(2) turn a dividend into a capital gain?
Section 55(2) applies when all three conditions in subsection 55(2.1) are met, and no exception in 55(3) saves the dividend laws-lois.justice.gc.ca. Miss any one of the three and the dividend stays a dividend, deductible under section 112.
| Condition | What it asks | Provision |
|---|---|---|
| Recipient | A corporation resident in Canada that can deduct the dividend under 112(1), 112(2) or 138(6) | 55(2.1)(a) |
| Purpose or result | One purpose (for an 84(3) dividend, one result) is a significant reduction of the capital gain on any share; or, for a dividend on capital property other than a redemption, one purpose is a significant cut in a share's fair market value or a significant increase in the cost of property | 55(2.1)(b) |
| Amount | The dividend exceeds the income earned after 1971 that could reasonably be considered to contribute to the capital gain on the share | 55(2.1)(c) |
| Exception | No unrelated person event in the series (84(2) and 84(3) dividends only), or a permitted redemption in a reorganization | 55(3)(a), 55(3)(b) |
When it applies, the dividend is deemed not to be a dividend. A dividend from a redemption, acquisition or cancellation under 84(2) or 84(3) becomes proceeds of disposition of the share. Any other dividend becomes a capital gain of the recipient laws-lois.justice.gc.ca. Half of that gain is a taxable capital gain under paragraph 38(a)
laws-lois.justice.gc.ca, and the rate is still 50% for 2026 (see /tax/capital-gains-inclusion-rate-2026/).
Purpose test or result test: which one does your dividend face?
The test depends on how the dividend arises. A redemption dividend under 84(3) faces a result test, so your client's intentions don't help: if one result of the dividend is a significant cut in the capital gain on any share, the condition is met laws-lois.justice.gc.ca. Every other dividend faces a purpose test.
| Dividend | Test | What it targets |
|---|---|---|
| Redemption, acquisition or cancellation under 84(3) | Result | Significant reduction of a capital gain |
| Cash or in kind dividend on capital property | Purpose | Significant reduction of a capital gain, of a share's fair market value, or a significant increase in the cost of property |
| Stock dividend | Purpose | Same, with the amount set at the greater of the PUC increase and the fair market value of the new shares (55(2.2)) |
The Act never puts a number on "significant" laws-lois.justice.gc.ca. The cost increase test was added for planning such as a dividend paid in kind: Finance's notes describe a $1 million dividend of shares that lifts the total cost of the recipient's property from $1 million to $2 million
fin.canada.ca. Under 55(2.5), a dividend funded by borrowing counts in full: if Opco borrows $2 million to pay a dividend and its shares are still worth $0 afterward, the reduction is treated as $2 million
fin.canada.ca.
How does safe income shield the dividend?
Safe income is the income earned or realized by any corporation after 1971 and before the safe income determination time that could reasonably be considered to contribute to the capital gain on the share laws-lois.justice.gc.ca. The idea is that this income was already taxed at the corporate level, so moving it between corporations shouldn't be taxed again
fin.canada.ca.
The determination time is the earlier of two moments: right after the first unrelated person event in the series described in 55(3)(a), or right before the first dividend paid in the series laws-lois.justice.gc.ca. Income earned after that point doesn't count, even if it's earned before the dividend is paid.
For a private corporation, 55(5)(c) computes income as if section 113 deductions that went into the capital dividend account weren't included laws-lois.justice.gc.ca. The CRA then reduces safe income to what is on hand. Since February 15, 2008, its position is that expenses your client couldn't deduct must also come off safe income on hand, along with taxes and dividends already paid
canada.ca.
You don't elect into the split. Under 55(5)(f) the taxable dividend is automatically divided into one dividend equal to the lesser of the dividend and the safe income that contributes to the gain, and a second dividend for the excess laws-lois.justice.gc.ca. Only the second one is recharacterized.
How much of a $500,000 dividend does $300,000 of safe income protect?
Holdco owns all the shares of Opco, with an ACB of $100 and a fair market value of $1,000,000. Safe income on hand that contributes to the gain on those shares is $300,000. Opco pays Holdco a $500,000 cash dividend, then Holdco sells the Opco shares to an unrelated buyer for $500,000. One purpose of the dividend is to shrink the gain on the sale.
| Step | Amount |
|---|---|
| Dividend paid to Holdco | $500,000 |
| First separate dividend, up to safe income (deductible under s.112) | $300,000 |
| Second separate dividend, the excess | $200,000 |
| Capital gain deemed by 55(2) on the excess | $200,000 |
| Taxable capital gain at 50% | $100,000 |
| Gain on the share sale ($500,000 less $100 ACB) | $499,900 |
| Total capital gains for Holdco | $699,900 |
| Gain with no dividend at all ($1,000,000 less $100) | $999,900 |
The dividend reduced Holdco's gains by $300,000, exactly the safe income. The unrelated buyer also means 55(3)(a) is out, and it wouldn't apply anyway because this is not a redemption dividend. The untaxed half of the $200,000 gain still counts for Holdco's capital dividend account, because Folio S3-F2-C1 at ¶1.31.1 treats a gain deemed by 55(2)(c) as realized on a disposition of capital property when the dividend is paid canada.ca. More on that balance at /tax/capital-dividend-account/.
When does the related party exception still save a dividend?
Since 2015 the 55(3)(a) exception covers only dividends on a redemption, acquisition or cancellation under 84(2) or 84(3) laws-lois.justice.gc.ca. A regular cash dividend between related corporations gets no help from it. Finance said plainly that the exception is not meant to be used to create cost base
fin.canada.ca.
For a redemption dividend, the exception holds only if nothing in the series gives an unrelated person value. That means no disposition of property to an unrelated person (other than at fair market value), no significant increase in an unrelated person's interest in any corporation, and no disposition to an unrelated person of shares of the payer or of property more than 10% of whose value comes from the payer's shares or debt laws-lois.justice.gc.ca. The same 10% test applies to the recipient after the dividend.
Watch family files: for these tests, 55(5)(e) generally treats siblings as dealing at arm's length, so a redemption that moves value from one sibling's company to another's can fall outside the exception laws-lois.justice.gc.ca. The separate 55(3)(b) exception covers a permitted redemption in a reorganization where a distributing corporation transfers property to transferee corporations and is wound up or has its shares redeemed.
What changed in 2015, and is it law?
The current version applies to dividends received after April 20, 2015. It was enacted by the Budget Implementation Act, 2016, No. 1, which received assent on June 22, 2016 laws-lois.justice.gc.ca.
Three changes catch older files. The purpose test grew from capital gain reduction to also cover cuts in fair market value and increases in cost. The safe income test now asks whether income "contributes" to the gain, where it used to ask whether the gain was "attributable" to it. And the 55(5)(f) designation was replaced by the automatic split fin.canada.ca. As of October 2026, the consolidated Act on the Justice Laws site shows section 55 last amended by S.C. 2026, c. 3, so check the current text before you rely on an older memo
laws-lois.justice.gc.ca.
Sources
Does Part IV tax change how much of the dividend 55(2) reaches?
Yes. Section 55(2) doesn't touch the part of the dividend that is subject to Part IV tax that isn't refunded because of a dividend paid as part of the series laws-lois.justice.gc.ca. Part IV is 38 1/3% on dividends from a corporation that isn't connected, and a share of the payer's dividend refund for a connected one
laws-lois.justice.gc.ca. The full mechanics are at /tax/part-iv-tax/.
Does 55(2) apply to dividends paid to an individual shareholder?
No. The rule only reaches a dividend received by a corporation resident in Canada that can deduct it under 112(1), 112(2) or 138(6) laws-lois.justice.gc.ca. Section 112(1) gives that deduction for taxable dividends from a taxable Canadian corporation or from a resident corporation the recipient controls
laws-lois.justice.gc.ca. For the deduction itself, see /tax/intercorporate-dividends-section-112/.
Can a stock dividend trigger 55(2)?
Yes. For section 55 purposes its amount is the greater of the increase in paid up capital and the fair market value of the new shares, so a $1 PUC share worth $1 million counts as a $1 million dividend fin.canada.ca. Under 55(2.3), the part up to safe income is then deemed a separate taxable dividend
laws-lois.justice.gc.ca.
Is there a percentage that makes a reduction "significant"?
No. Section 55 doesn't define significant or give a threshold for it laws-lois.justice.gc.ca. The only numbers in the related party exception are the 10% tests on property derived from the payer's or recipient's shares or debt.
General information for the tax year shown, not advice for a specific client. Confirm the facts before you file or remit.