2002 Ruling 2002-0132903 - Split-up Butterfly

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Split up butterfly

Position: Standard butterfly

Reasons: N/A

XXXXXXXXXX 2002-013290

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX

Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX in which you requested advance income tax rulings on behalf of the above noted taxpayer and others identified herein. We also acknowledge your letter of XXXXXXXXXX and the additional information provided during our various telephone conversations in connection with your requests.

We understand that to the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

(i) dealt with in an earlier return of one of the taxpayers or a related person;

(ii) under objection by the above-noted taxpayer or others identified herein or a related person;

(iii) being considered by a Tax Services Office or taxation centre in connection with a tax return already filed of any one of the taxpayers or a related person;

(iv) the subject of a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

DEFINITIONS

Unless otherwise stated, all statutory references herein are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act").

In this letter, the following terms have the meanings specified:

(a) "adjusted cost base" ("ACB") has the meaning assigned to that term in section 54 and subsection 248(1);

(b) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7);

(c) "capital property" has the meaning assigned to that term in section 54;

(d) "cost amount" has the meaning assigned to that term by subsection 248(1);

(e) "DC" refers to XXXXXXXXXX (business number XXXXXXXXXX) which has a head office at XXXXXXXXXX and files its tax return at the XXXXXXXXXX tax services office;

(f) "depreciable property" has the meaning assigned by subsection 13(21);

(g) "dividend refund" has the meaning assigned to that term in subsection 129(1);

(h) "eligible property" has the meaning assigned to that term in subsection 85(1.1);

(i) "Mr. A." refers to XXXXXXXXXX (social insurance number is XXXXXXXXXX) who resides at XXXXXXXXXX and files his tax return at the XXXXXXXXXX tax services office;

(j) "Mr. B." refers to XXXXXXXXXX (social insurance number is XXXXXXXXXX) who resides at XXXXXXXXXX and files his tax return at the XXXXXXXXXX tax services office;

(k) "paid-up capital" ("PUC") has the meaning assigned to that term by subsection 89(1);

(l) "refundable dividend tax on hand" ("RDTOH") has the meaning assigned by subsection 129(3);

(m) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(n) "specified financial institution" ("SFI") has the meaning assigned to that term by subsection 248(1);

(o) "specified investment business" has the meaning assigned by subsection 125(7) and subsection 248(1);

(p) "taxable Canadian corporation" ("TCC") has the meaning assigned to that term by subsection 89(1); and

(q) "taxable dividend" has the meaning assigned to that term by subsection 89(1).

Our understanding of the facts, the proposed transactions and purpose of the proposed transactions is as set forth below:

FACTS

1. DC was incorporated under the laws of XXXXXXXXXX and is a TCC and a CCPC within the meaning of the Act.

2. DC operates a farming business in Canada with a XXXXXXXXXX division and a XXXXXXXXXX division and has a taxation year-end of XXXXXXXXXX.

3. DC computes its income in accordance with the method described in subsection 28(1) which is commonly referred to as the "cash basis".

4. DC's issued share capital is held as follows:

Class

Common
B Preferred

Mr. B

XXXXXX

XXXXXXXXXX

Mr. A

XXXXXX
XXXXXXXXXX

Mother of Mr. A and Mr. B

XXXXXX
XXXXXXXXXX

XXXXXX

XXXXXXXXXX

The Common shares are voting participating shares with an ACB to each holder thereof and a PUC of $XXXXXXXXXX each.

The Class B Preferred shares are non-voting redeemable/retractable preferred shares with an ACB to each holder thereof and a PUC of $XXXXXXXXXX each (redemption value of $XXXXXXXXXX each).

5. Mr. A and Mr. B are brothers and residents of Canada for the purposes of the Act. The mother of Mr. A and Mr. B, who is also a shareholder of DC, is also a resident of Canada for the purposes of the Act.

6. The shares of DC owned by each of Mr. A., Mr. B and their mother represent capital property to each of them.

None of the issued shares of DC was acquired by any of the shareholders in contemplation of the proposed transactions set forth below.

7. The assets of DC include cash, accounts receivable, prepaid expenses, inventory, capital property (including depreciable capital property) and eligible capital property (within the meaning of that term in section 54 and subsection 248(1)).

8 DC currently has no RDTOH and it will not have any RDTOH at the end of its taxation year in which the proposed transactions are implemented.

PROPOSED TRANSACTIONS

9. Mr. A will incorporate a new corporation ("Newco"), which will be a CCPC and a TCC within the meaning of the Act.

Mr. A will be the sole shareholder of Newco and the sole director thereof. The authorized share capital of Newco will include a class of voting common shares and several classes of redeemable retractable, non-cumulative preferred shares with a par value of $XXXXXXXXXX each, the redemption amount of which will be set by the Directors at the date of issuance. Upon incorporation, XXXXXXXXXX Class A voting common shares will be issued to Mr. A.

10. Following the incorporation of Newco, Mr. A will transfer to Newco all of the shares that he currently owns of DC, being XXXXXXXXXX DC Common shares and XXXXXXXXXX DC Class B Preferred share. For shares of each class that are transferred to Newco, Mr. A will receive from Newco Class G Preferred shares having an aggregate fair market value and redemption amount equal to the fair market value of the shares of the particular class transferred.

Although the Newco Class G preferred shares have a par value of $XXXXXXXXXX each the aggregate par value of the Newco Class G Preferred shares to be issued as consideration for the DC Common shares and the aggregate par value of the Newco Class G Preferred shares to be issued as consideration for the DC Class B Preferred share will not exceed the aggregate PUC of the DC shares of the particular class to Mr. A immediately before the transfer.

Mr. A and Newco will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the rules in 85(1) apply to the transfer of the DC Common shares, and to the transfer of the DC Class B Preferred share, to Newco. The amount agreed upon in each election will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

11. Immediately before the transfers of property described in paragraph 13 below, DC's properties will be classified into three types of property for the purposes of the definition of "distribution" in subsection 55(1) and paragraph 55(3)(b), as follows:

(a) cash or near cash property, being the current assets of DC including cash, accounts receivable, inventory and rights arising from the prepayment of certain expenses ("prepaid expenses");

(b) business property, being all of the assets of DC other than cash or near-cash property, the income from which would, for the purposes of the Act, be income from a business (other than a specified investment business); and

(c) investment property, being all of the assets of DC other than cash or near-cash property, any income from which would, for the purposes of the Act, be income from property or a specified investment business.

DC has an investment in XXXXXXXXXX and which will be categorized as a business asset of DC.

For greater certainty, any tax accounts of DC, such as the amount of RDTOH or any deferred income tax debit balance, will not be considered property for purposes of the classification described in this paragraph.

12. In determining the net fair market value of each type of property owned by DC immediately before the transfers of property described in paragraph 13 below, the liabilities of DC will be allocated to and be deducted in the calculation of the net fair market value of each type of property of DC as follows:

(a) Current liabilities (including the current portion of long-term debt) will be allocated to each cash or near-cash property in the proportion that the fair market value of each such property is of the fair market value of all cash or near-cash property. The allocation of current liabilities will not exceed the aggregate fair market value of all cash or near-cash property.

(b) Following the allocation of current liabilities to each cash or near-cash property in (a) above, any remaining net fair market value of any accounts receivable, inventories and prepaid expenses will be reclassified as business property and excluded from the cash or near-cash property, to the extent that such property will be collected, sold or used by DC or Newco in the ordinary course of the business to which such property relates.

(c) Liabilities (other than current liabilities) that relate to a particular property will be allocated to that particular property (and effectively to the type to which the particular property belongs) to the extent of the property's fair market value. Any excess of such liabilities over the fair market value of that property will be allocated to the type of property to which that property belongs. Liabilities that pertain to a type of property, but not to a particular property, will be then allocated to that type of property, but not in excess of the net fair market value of such type of property after the allocation of liabilities to a particular property.

(d) Any liabilities that remain after the allocations described in steps (a) and (c) above ("excess unallocated liabilities") will be then allocated to the cash or near-cash property, investment property and business property, if any, based on the relative remaining net fair market value of each type of property determined prior to the allocation of such excess unallocated liabilities.

For greater certainty, for the purposes of calculating the net fair market value of each type of property of DC, deferred taxes will be ignored.

13. Immediately following the determination of the net fair market value of its cash or near cash property, its business property and its investment property, if any, as described in paragraph 12 above, DC will sell at fair market value a portion of each type of property owned by it at that time to Newco such that immediately following the transfer, the net fair market value of each type of property so transferred by DC to Newco, determined in accordance with the guidelines described in paragraph 11 above, will approximate that proportion of the net fair market value of all property of DC of that type determined immediately before such transfer that:

(a) the aggregate fair market value, immediately before the transfer, of all of the shares of DC owned by Newco at that time;

is of

(b) the aggregate fair market value, immediately before the transfer, of all the issued and outstanding shares of DC at that time.

For the purposes of this paragraph and paragraph 16 below, the expression "approximate that proportion" means that the discrepancy from that proportion, if any, would not exceed XXXXXXXXXX%, determined as a percentage of the net fair market value of each type of property which Newco has received (or DC has retained) as compared to what Newco would have received (or DC would have retained) had it received (or retained) its appropriate pro rata share of the net fair market value of that type of property.

As consideration for the property so transferred, Newco will:

(c) assume a portion of the liabilities of DC such that the net fair market value of each type of property of DC transferred to Newco as described in this paragraph will approximate its proportionate share, as determined by the formula described in paragraphs (a) and (b) above, of the total net fair market value of that type of property owned by DC immediately before such transfers,

(d) issue a non-interest bearing promissory note (the "Newco Asset Purchase Note"), payable on demand, having a fair market value equal to its principal amount, neither of which exceeds the excess of the aggregate fair market value of the property transferred to Newco over the fair market value of the liabilities of DC assumed by Newco as described in paragraph (c) above, and

(e) issue Class H Preferred shares to DC having an aggregate fair market value and redemption amount equal to the amount by which the aggregate fair market value of the property transferred to Newco exceeds the aggregate of the fair market value of the liabilities assumed by Newco as described in paragraph (c) above and the fair market value and principal amount of the Newco Asset Purchase Note.

14. DC and Newco may enter into elections in accordance with the provisions of section 85 (in this paragraph 14, each election is an "Election") in respect of the disposition by DC to Newco of certain eligible properties (in this paragraph 14, each eligible property disposed of is an "Eligible Property"). Each Eligible Property will have a fair market value immediately before its disposition that exceeds its cost amount to DC at that time. The consideration received by DC for each Eligible Property will include Newco Class H Preferred shares. In addition, the aggregate fair market value of the consideration received by DC from Newco (including Newco Class H Preferred shares) for an Eligible Property will be equal to the fair market value of that Eligible Property. The Election will be made by DC and Newco, jointly, in the prescribed form and within the time limits referred to in subsection 85(6).

The amount agreed upon in an Election will not be less than:

(a) in the case of a capital property (other than depreciable property of a prescribed class) or inventory, an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii);

(b) in the case of a depreciable property of a prescribed class, an amount equal to the least of the amounts described in subparagraphs 85(1)(e)(i), (ii) and (iii); and

(c) in the case of an eligible capital property, an amount equal to the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii).

In addition, the agreed amount for each Eligible Property will not be less than the fair market value, at the time of the disposition, of the consideration therefore received by DC (other than Newco Class H Preferred shares) and the agreed amount will not be greater than the fair market value of the Eligible Property.

For the purposes of the Election, the reference in subparagraph 85(1)(e)(i) to "the undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition" shall be interpreted to mean that proportion of the undepreciated capital cost to DC of all of the property of that class immediately before the disposition that the fair market value at that time of the asset that is transferred is of the fair market value at that time of all property of that class.

In addition, the par value of the Newco Class H Preferred shares that will be issued as consideration for an Eligible Property will not exceed the cost of the Eligible Property to Newco (as determined by the provisions of section 85) less the aggregate of the fair market value of any liabilities of DC assumed by Newco as consideration for the Eligible Property and the fair market value of the portion of the Newco Asset Purchase Note allocated as consideration for the particular Eligible Property.

15. Immediately following the transfers of property described in paragraph 13 above, the following will take place:

a) DC will purchase for cancellation its XXXXXXXXXX Common shares owned by Newco for an amount equal to their fair market value and redeem its 1 Class B Preferred share owned by Newco at its redemption amount and fair market value. The consideration paid for the cancellation/redemption of the shares referred to will be the issuance by DC of a promissory note payable to Newco on demand without interest or fixed terms of repayment, having a principal amount and fair market value equal to the aggregate fair market value of the shares so purchased/redeemed (the "DC Repurchase Note"). Newco will accept the DC Repurchase Note in full payment of the purchase/redemption price of the shares.

b) Immediately after the cancellation/redemption of shares by DC previously described, Newco will redeem its Class H Preferred shares owned by DC at their aggregate redemption amount and fair market value. The consideration paid for the redemption of the Class H Preferred shares owned by DC will be the issuance by Newco of a promissory note payable to DC on demand without interest or fixed terms of repayment, having a principal amount and fair market value equal to the aggregate fair market value of the shares so redeemed (the "Newco Redemption Note"). DC will accept the Newco Redemption Note in full payment of the purchase price of the shares.

c) Following the cancellations/redemptions of shares described above, DC and Newco will set-off the principal amounts of the Newco Asset Purchase Note and the Newco Redemption Note against the DC Repurchase Note and each note will then be cancelled.

16. Immediately following the proposed transactions described above, the net fair market value of each type of property retained by DC, determined in the manner described in paragraphs 11 and 12 above, will approximate that proportion of the aggregate net fair market value of that type of property of DC determined immediately before the transfer described in paragraph 13 above that:

(a) the aggregate fair market value, immediately before the transfer of property described in paragraph 13 above, of the shares of DC owned by Mr. B and the mother of Mr. A. and Mr. B;

is of

(b) the aggregate fair market value, immediately before the transfers of property, of all the issued and outstanding shares of DC at that time.

PURPOSE OF PROPOSED TRANSACTIONS

17. Mr. A and Mr. B no longer agree on a business strategy for DC and have chosen to divide the assets of DC between themselves and operate independently.

Accordingly, it would be in the best interests of both parties to go their separate ways as soon as possible by carrying out a single-wing net asset butterfly.

ADDITIONAL INFORMATION

18. Except as described in this letter, no liabilities have been or will be incurred (other than in the ordinary course of business) by, and no assets have been or will be acquired or disposed of (other than in the ordinary course of business) by DC in contemplation of and before the proposed transfers of properties described in paragraph 13 above. No property of DC that is transferred pursuant to the proposed transactions described herein will be transferred to any other person as part of a series of transactions that includes the proposed transactions described herein.

19. Except as set out in this ruling request, no shareholder of DC is contemplating the sale of any shares of DC.

20. Neither Newco nor DC is, or will be at the time of the proposed transactions, a SFI and neither Newco nor DC is, or will be at the time of the proposed transactions, a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1).

21. None of the shares of DC or Newco has been or will be, at any time during the implementation of the proposed transactions described herein:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) as a "guarantee agreement";

(b) a share that is issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5); or

(c) the subject of a dividend rental arrangement as that term is defined in subsection 248(1).

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the proposed transactions, and purpose of the proposed transactions, and provided further that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Subject to the application of subsection 69(11), the provisions of subsection 85(1) will apply to:

(i) the transfer of each eligible property by DC to Newco which is the subject of an election under subsection 85(1) as described in paragraph 13 above, and to

(ii) the transfer of the common and preferred shares of DC held by Mr. A to Newco as described in paragraph 10 above,

such that the agreed amount in respect of each such transfer shall be deemed to be the transferor's proceeds of disposition and the transferee's cost thereof pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to herein.

B. On the redemption by Newco of its Class H preferred shares as described in paragraph 15(b) above and on the consequential purchase for cancellation/redemption of the common and preferred shares of DC as described in paragraph 15(a) above:

(a) by virtue of subsection 84(3):

(i) Newco will be deemed to have paid, and DC will be deemed to have received, a taxable dividend equal to the amount by which the amount paid in respect of the redemption of the Class H Preferred shares owned by DC exceeds the PUC thereof immediately before the redemption; and

(ii) DC will be deemed to have paid, and Newco will be deemed to have received taxable dividends equal to

(A) the amount by which the amount paid in respect of the purchase for cancellation of the Common shares of DC owned by Newco exceeds the PUC thereof immediately before the purchase for cancellation, and

(B) the amount by which the amount paid in respect of the redemption of the Class B Preferred Share owned by Newco exceeds the PUC thereof immediately before the redemption;

(b) the taxable dividends deemed to have been received by each of DC and Newco as described in paragraph (a) above will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient for the taxation year in which the dividend is deemed to have been received and such deduction will not be denied by any of subsections 112(2.1), (2.2), (2.3) and (2.4);

(c) the taxable dividends deemed to have been received by each of DC and Newco as described in paragraph (a) above will not be subject to tax under Part IV, except as provided in paragraph 186(1)(b), as:

(i) Newco will, immediately before the share redemptions described in paragraph 15(b) above, be related to DC within the meaning of subsection 251(2) and will be connected with DC within the meaning assigned by subsection 186(2) and 186(4); and

(ii) DC will, immediately before the share cancellation/redemption described in paragraph 15(a) above, be related to Newco within the meaning of subsection 251(2) and will be connected with Newco within the meaning assigned by subsections 186(2) and 186(4); and

(d) the taxable dividends deemed to have be paid

(i) by Newco to DC upon the redemption of the Newco Class H Preferred shares, as referred to in paragraph (a)(i) above, and

(ii) by DC to Newco upon the purchase for cancellation of the Common shares and the redemption of the Class B Preferred share of DC, as referred to in paragraph (a)(ii) above

will not be subject to tax under section 187.2 or section 191.1 by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1 and paragraph (a) of the definition of "excluded dividend" in subsection 191(1) because each dividend recipient will have a substantial interest, within the meaning assigned by subsection 191(2), in the dividend payer at the time of the dividend payment.

C. Provided that, as part of the series of transactions or events that includes the proposed transactions described herein, there is not:

(a) an acquisition of property otherwise than as a result of a disposition of property for cash consideration as described in clause 55(3.1)(a)(iv)(C);

(b) a disposition of property in the circumstances described in subparagraph 55(3.1)(b)(i);

(c) an acquisition of control in the circumstances described in subparagraph 55(3.1)(b)(ii);

(d) an acquisition of property in the circumstances described in paragraph 55(3.1)(c); or

(e) an acquisition of property in the circumstances described in paragraph 55(3.1)(d),

which has not been described herein, then by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends referred to in the rulings given in paragraph B(a) above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

E. The extinguishment of the Newco Asset Purchase Note, the Newco Redemption Note and the DC Repurchase Note, as described in paragraph 15(c) above will not, in and of itself, result in a forgiven amount within the meaning of either subsection 80(1) or subsection 80.01. In addition, neither DC nor Newco will otherwise realize any gain or loss as a result of the extinguishment.

F. The provisions of subsection 15(1), 56(2) and 246(1) will not apply to the proposed transactions described herein, in and by themselves.

G. As a result of the proposed transactions, in and by themselves, subsection 245(2) will not be applied to redetermine the tax consequences confirmed in the rulings given.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted, could affect the rulings provided herein.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued on May 17, 2002 and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

COMMENTS

Nothing in this letter should be construed as implying that the Canada Customs and Revenue Agency has reviewed, accepted or otherwise agreed to:

a. the determination of the ACB, the PUC or the fair market value of any shares referred to herein; or

b. any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch