Parent Co. owns 100 percent of the shares of Son Co. They have a fair market value of $950,000, and an adjusted cost base of $75,000. Son Co. has safe income of $60,000. In order to complete a sale of Son Co. to Unrelated Co., an arm's length corporation, Son Co. borrows $875,000 from a bank, and uses the funds to pay a dividend to Parent Co. As a result, the fair market value of the Son Co. shares drops to $75,000. At this point, the shares are sold to Unrelated Co. for $75,000. Under these circumstances, the tax consequences for Parent Co. are:

Question

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When Son Co. pays a dividend of $875,000 to Parent Co., the adjusted cost base of the Son Co. shares is reduced by the same amount, from $950,000 to $75,000. This means that when Parent Co. sells the Son Co. shares to Unrelated Co. for $75,000, they will realize a capital gain of $75,000 (fair market value of $75,000 minus adjusted cost base of $0). However, because Parent Co. received a dividend of $875,000, they will also be subject to dividend income tax on that amount.

The safe income of Son Co. is irrelevant for the tax consequences of Parent Co. in this scenario.

Parent Co Owns 100 Percent of the Shares of Son Co