30 November 1997 Ruling 9816533 - BUTTERFLY REORGANIZATION

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 Department.

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

Principal Issues: Butterfly "split-up"

Position: see issue sheet

Reasons: see issue sheet

XXXXXXXXXX
XXXXXXXXXX 3-981653
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX in which you requested advance income tax rulings on behalf of the above-noted taxpayers. We also acknowledge your letter of XXXXXXXXXX and our telephone conversations in connection herewith.

To the best of your knowledge, and that of the taxpayers named herein, none of the issues involved in this advance income tax ruling request is under objection or appeal or is being considered by any tax services office or taxation centre of Revenue Canada in connection with any income tax return already filed.

Definitions

In this letter unless otherwise expressly stated:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof, and unless otherwise stated, every reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "ACB" means "adjusted cost base" which has the meaning assigned by section 54;

(c) "CBCA" means Canada Business Corporations Act;

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

(d) "capital dividend account" has the meaning assigned by subsection 89(1);

(e) "capital property" has the meaning assigned by section 54;

(f) "cost amount" has the meaning assigned under subsection 248(1);

(g) "excluded dividend" has the meaning assigned by subsection 191(1);

(h) "excepted dividend" has the meaning assigned under section 187.1;

(i) "FMV" means "fair market value" and is the highest price available in an open and unrestricted market between informed prudent parties acting at arm's length and under no compulsion to act;

(j) "PUC" means "paid-up capital" which has the meaning assigned by subsection 89(1);

(k) "RDTOH" means the expression "refundable dividend tax on hand" as defined in subsection 129(3);

(l) "series of transactions or events" has the meaning assigned by subsection 248(10);

(m) "taxable Canadian corporation" has the meaning assigned by subsection 89(1); and

(n) "taxable dividend" has the meaning assigned by subsection 89(1).

FACTS

1. XXXXXXXXXX is a corporation incorporated under the CBCA and is a Canadian-controlled private corporation and a taxable Canadian corporation. The tax affairs of XXXXXXXXXX are administered by the XXXXXXXXXX Tax Services Office and its income tax returns are filed with the XXXXXXXXXX Taxation Centre.

2. The issued share capital of XXXXXXXXXX consists of XXXXXXXXXX common shares, which are held as follows:

		Shareholders		Number of Shares

			XXXXXXXXXX
			XXXXXXXXXX
			XXXXXXXXXX 

The paid-up capital of the XXXXXXXXXX common shares is $XXXXXXXXXX and the ACB to each of XXXXXXXXXX common shares is $XXXXXXXXXX per share. The XXXXXXXXXX common shares are capital property to XXXXXXXXXX.

3. XXXXXXXXXX are residents of Canada for purposes of the Act.

4. On the death of XXXXXXXXXX, a testamentary spousal trust (the "Estate Late XXXXXXXXXX") was created pursuant to his last Will and Testament signed before witnesses on XXXXXXXXXX as well as his first Codicil thereto signed before witnesses on XXXXXXXXXX which were probated by judgement of the Superior Court of the District of XXXXXXXXXX. The income beneficiary during her life was XXXXXXXXXX spouse, XXXXXXXXXX became income beneficiaries. Upon their eventual deaths, the children of XXXXXXXXXX who are also the grandchildren of the XXXXXXXXXX would become capital beneficiaries.

The year-end of the Estate XXXXXXXXXX.

5. Upon the death of their mother, XXXXXXXXXX became income beneficiaries of the Estate XXXXXXXXXX. In the course of winding-up the estate of their mother, XXXXXXXXXX, determined that there was no reason to continue the existence of the Estate XXXXXXXXXX. As a result, XXXXXXXXXX renounced, for no consideration, in notarial form on XXXXXXXXXX respectively, any interest they may have had in the Estate XXXXXXXXXX. This had the effect of leaving the grandchildren as the income and capital beneficiaries.

6. The Estate XXXXXXXXXX held XXXXXXXXXX Class A Preferred shares of XXXXXXXXXX, with a redemption price of $XXXXXXXXXX and a nominal ACB and paid-up capital. These shares were voting, redeemable and retractable preference shares. The Estate XXXXXXXXXX realized a substantial capital gain when it was deemed by virtue of subparagraph 104(4)(a)(i.1) to have disposed of such shares at their fair market value of $XXXXXXXXXX when XXXXXXXXXX and income beneficiary, died on XXXXXXXXXX. Pursuant to subsection 104(5), it was deemed to have reacquired such shares at a capital cost equal to such fair market value of $XXXXXXXXXX.

7. Following the renunciation by XXXXXXXXXX of their respective interest in the Estate XXXXXXXXXX Class A Preferred shares of XXXXXXXXXX were redeemed on XXXXXXXXXX for an amount of $XXXXXXXXXX payable in the form of a promissory note. The redemption of the XXXXXXXXXX Class A Preferred shares resulted in a deemed dividend of an amount equal to the amount by which the payment exceeded the paid-up capital of such shares pursuant to subsection 84(3). By virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54, a capital loss was realized by the Estate XXXXXXXXXX in an amount equal to the amount by which the ACB of the XXXXXXXXXX Class A Preferred shares exceeded the proceeds of disposition.

The dividend deemed to have been received by the Estate XXXXXXXXXX was then distributed to the children of XXXXXXXXXX in proportion to their respective entitlement in the Estate XXXXXXXXXX in the form of promissory notes.

8. XXXXXXXXXX is a holding company with cash and capital property made up of publicly traded portfolio securities.

9. As at XXXXXXXXXX had a balance of approximately $XXXXXXXXXX in its capital dividend account and no RDTOH.

On XXXXXXXXXX paid a dividend of $XXXXXXXXXX to its shareholders electing under subsection 83(2) that such dividend be paid out of its capital dividend account.

It is estimated that XXXXXXXXXX will have approximately $XXXXXXXXXX in its capital dividend account and RDTOH of approximately $XXXXXXXXXX at the time of the transfer of property described in paragraph 20 below (the "Butterfly Transfer").

10. Immediately before the Butterfly Transfer, the property of XXXXXXXXXX will be classified into two types of property for the purposes of a distribution, as follows:

(a) cash or near cash property, comprising all of the current assets of XXXXXXXXXX, including any cash, deposits, marketable securities, accounts receivable, inventory and rights arising from prepaid expenses (hereinafter referred to as "prepaid expenses"); and

(b) investment property, comprising all of the assets of XXXXXXXXXX, 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.

For the purpose of determining the types of property, a right to receive an amount as its dividend refund for the year by XXXXXXXXXX will be classified as cash or near cash property.

11. XXXXXXXXXX incorporated a new corporation ("Newco") under the CBCA on XXXXXXXXXX. Newco is a private corporation and a taxable Canadian corporation.

Newco's authorized share capital includes voting common shares ("Newco Common Shares"), three classes (Class A, Class B and Class C) of non-voting (except for the Class C) redeemable and retractable preference shares (collectively, the "Newco Preference Shares"). XXXXXXXXXX subscribed for XXXXXXXXXX Newco Common Shares for the sum of $XXXXXXXXXX at the time of incorporation.

12. No property has or will become property of, and no liabilities have been or will be incurred by, XXXXXXXXXX in contemplation of and before the Butterfly Transfer, except as described herein.

13. Neither Newco nor XXXXXXXXXX will dispose of any of the assets owned by XXXXXXXXXX, immediately before the Butterfly Transfer, following the Proposed Transactions as part of the same series of transactions or events, other than in the ordinary course of business.

14. There are not, and will not be at any time prior to the completion of the Proposed Transactions, any guarantee agreements in respect of any of the shares of Newco or XXXXXXXXXX.

15. None of the shares of Newco or XXXXXXXXXX will be issued or acquired as part of a series of transactions described in subsection 112(2.5).

PROPOSED TRANSACTION

16. Prior to the Butterfly Transfer, the issued and outstanding shares of XXXXXXXXXX will be split XXXXXXXXXX shares for each XXXXXXXXXX common share issued and outstanding. There will be no change in the total capital represented by the issue, or in the interest or rights of any shareholder as a result of the stock split. The purpose of the stock split is to allow for the redemption of a certain number of XXXXXXXXXX common shares that will result in the transfer of a proportionate amount of XXXXXXXXXX capital dividend account to a shareholder without the use of a fraction of a share.

17. Newco will incorporate a new corporation ("Subco") under the CBCA. Subco will be a taxable Canadian corporation and a private corporation.

The authorized share capital of Subco will consist of an unlimited number of voting participating common shares and an unlimited number of non-voting redeemable and retractable preference shares (the "Subco Preference shares"). The Subco Preference share will be redeemable and retractable at an amount equal to the fair market value of the properties of XXXXXXXXXX transferred to Subco less any liabilities assumed.

Newco will subscribe for XXXXXXXXXX Subco common shares for the sum of $XXXXXXXXXX each at the time of its incorporation.

18. XXXXXXXXXX will sell, at fair market value, all the shares that she holds in XXXXXXXXXX to Newco. As sole consideration for such transfer, Newco will issue to XXXXXXXXXX Class A Preference shares that are redeemable and retractable in the aggregate at an amount equal to the fair market value of the common shares of XXXXXXXXXX transferred to Newco.

Newco will add to the stated capital account maintained for its Class A Preference shares an amount not to exceed the paid-up capital of the common shares of XXXXXXXXXX.

The paid-up capital of each share of XXXXXXXXXX transferred to Newco will not exceed the cost amount of such share to XXXXXXXXXX.

19. XXXXXXXXXX and Newco will jointly elect in prescribed form within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the shares so transferred will be equal to the cost amount to XXXXXXXXXX, immediately before the transfer, which amount will be equal to or less than the fair market value of such shares.

20. XXXXXXXXXX will sell, at fair market value, to Subco XXXXXXXXXX % of its cash and near-cash property and investment property. As a result of such transfers, the fair market value of the cash and near-cash property and investment property received by Subco will be equal to the proportion of the fair market value of all of the cash and near-cash property and investment property, respectively, owned by XXXXXXXXXX immediately before the transfer, that:

(a) the fair market value, immediately before the transfer, of all the shares of the capital stock of XXXXXXXXXX owned by Newco at that time

is of

(b) the fair market value, immediately before the transfer, of all the issued shares of the capital stock of XXXXXXXXXX at that time.

In consideration for such transfers, Subco will assume a proportion of the liabilities of XXXXXXXXXX and will issue Subco Preference Shares to XXXXXXXXXX.

Subco will add to the stated capital maintained for its Subco Preference Shares an amount equal to the aggregate of the cost amounts of the properties transferred less the amount of the liabilities assumed by Subco.

21. XXXXXXXXXX and Subco will jointly elect in prescribed form within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each property of XXXXXXXXXX that is an eligible property transferred to Subco. The agreed amount in respect of such property so transferred will be an amount equal to the cost amount of the property at the time of the transfer. The agreed amount will not exceed the fair market value of the property at the time of the transfer.

22. Immediately after the transfer of the assets to Subco, Subco will redeem its preference shares owned by XXXXXXXXXX and will issue to XXXXXXXXXX a non-interest-bearing demand promissory note (the "Subco Note") having a principal amount and fair market value equal to the redemption price of the Subco Preference Shares.

23. Subco will then be wound up into its parent, Newco. As a result of the wind-up, the Subco Note will become a liability of Newco.

24. Following the wind-up of Subco as described in paragraph 23 above, XXXXXXXXXX will purchase for cancellation, at fair market value, its common shares held by Newco in two stages:

(a) in the first stage, XXXXXXXXXX will purchase a sufficient number of common shares or part thereof which will result in a deemed dividend, pursuant to the provisions of subsection 84(3), equal to one half of XXXXXXXXXX capital dividend account immediately before that time, which XXXXXXXXXX will elect, pursuant to subsection 83(2), to have been paid from its capital dividend account; and

(b) in the second stage, XXXXXXXXXX will purchase the balance of its common shares held by Newco.

XXXXXXXXXX will issue to Newco as consideration for the purchase of its common shares a non-interest-bearing demand promissory note having a principal amount equal to the fair market value of the shares purchased ("XXXXXXXXXX Note").

25. The Subco Note will be set off against the XXXXXXXXXX Note and they will be cancelled.

PURPOSE OF THE PROPOSED TRANSACTIONS

26. The purpose of the proposed transactions is to allow XXXXXXXXXX to divide the assets of XXXXXXXXXX so that each may be able to pursue their separate and different investment and estate planning objectives independently of each other.

RULINGS

Provided that the above statements are accurate and constitute complete disclosure of all of the relevant facts, proposed transactions and the purposes of the proposed transactions, we confirm the following:

A. The split of the XXXXXXXXXX common shares, in and by itself, as described in paragraph 16 above will not result in a disposition of the XXXXXXXXXX shares held by XXXXXXXXXX.

B. The provisions of subsection 85(1) will apply to the transfer:

(i) by XXXXXXXXXX of the shares of XXXXXXXXXX to Newco described in paragraph 18 above; and

(ii) by XXXXXXXXXX of its properties that are eligible properties to Subco described in paragraph 20 above

such that the agreed amount in respect of each transfer of eligible property will 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.

C. On the redemption of the Subco Preference Shares held by XXXXXXXXXX, as described in paragraph 22 above, and the purchase for cancellation of the common shares of XXXXXXXXXX, as described in paragraph 24 above, the amount if any, by which the amount paid to redeem or purchase the particular shares, as the case may be, exceeds the paid-up capital of the particular shares immediately before the redemption or the purchase for cancellation:

(i) will be deemed pursuant to paragraph 84(3)(a) to be a dividend paid by the issuer of such shares;

(ii) will be deemed pursuant to paragraph 84(3)(b) to be a dividend received by the holder of such shares;

(iii) to the extent that a dividend described in (ii) above is a taxable dividend, such dividend will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient for the year in which the dividend is deemed to have been received; and

(iv) by virtue of the application of paragraph (j) of the definition "proceeds of disposition" in section 54, the amount of a deemed dividend described in (ii) above will be excluded from the proceeds of disposition of the share, and any loss arising from the disposition of the share will be reduced by the amount of such dividends pursuant to subsection 112(3).

D. No taxes under Part IV of the Act will be payable in respect of a dividend described in Ruling C above except as provided in paragraph 186(1)(b).

E. Part IV.1 of the Act will not apply to the deemed dividends described in Ruling C above because the dividends will be excepted dividends pursuant to paragraph (b) of the definition of "excepted dividend" in section 187.1.

F. Part VI.1 of the Act will not apply to the deemed dividends described in Ruling C above because the dividends will be excluded dividends pursuant to paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

G. The application of subsection 84.1(1) to the transfer of the XXXXXXXXXX common shares by XXXXXXXXXX to Newco described in paragraph 18 above will not result in a reduction of the paid-up capital of the Newco Class A Preference shares pursuant to the provisions of paragraph 84.1(1)(a).

H. The provisions of subsection 85(2.1) will not apply to reduce the paid-up capital of the Subco Preference Shares issued by Subco to XXXXXXXXXX described in paragraph 20 above.

I. By virtue of the provisions of paragraph 55(3)(b), the provisions of subsection 55(2) will not apply to the deemed dividends described in Ruling C above, provided that, as part of the series of transactions that includes the proposed transactions described herein, there is no:

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

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

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

(iv) acquisition of property in the circumstances described in paragraph 55(3.1)(d)

which has not been described herein.

J. Provided that XXXXXXXXXX elects pursuant to subsection 83(2), a dividend described in Ruling C above, arising as a result of the purchase for cancellation of the common shares of XXXXXXXXXX described in subparagraphs 24(a) above, will be deemed to be a capital dividend to the extent that the dividend does not exceed XXXXXXXXXX capital dividend account immediately before the time the dividend becomes payable.

K. The provisions of section 80 will not apply to the settlement by way of set off of the Subco Note and XXXXXXXXXX Note described in paragraph 25 above.

L. The provisions of subsection 88(1) will apply to the winding-up of Subco into Newco described in paragraph 23 above.

M. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 issued by Revenue Canada and are binding provided that the proposed transactions are completed before XXXXXXXXXX.

These rulings are based on the Act as it currently reads and do not take into account any future amendments, whether currently proposed or not, to the Act.

COMMENTS

Nothing in this letter should be construed as implying that Revenue Canada has agreed to or accepted:

(a) the determination of the fair market value or adjusted cost base of any property referred to herein, or the paid-up capital of any shares, or

(b) any tax consequences arising from the facts or proposed transactions described above other than those specifically confirmed in the rulings given.

Yours truly,

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

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