1999 Ruling 9918653 - BUTTERFLY REOGANIZATION

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.

XXXXXXXXXX		991865

Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear Sirs:

Re: XXXXXXXXXX.("DC1") - XXXXXXXXXX
XXXXXXXXXX ("DC2") - XXXXXXXXXX
XXXXXXXXXX.("Opco") - XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We acknowledge receipt of your subsequent correspondence of XXXXXXXXXX and the information provided to us during our telephone conversations.

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 the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or a related person;

(iii) under objection by the taxpayers or a related person;

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

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

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

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

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

(c) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in their election under subsection 85(1) in respect of the property;

(d) "BCA" means the Business Corporations Act (XXXXXXXXXX);

(e) "CA" means the Company Act (XXXXXXXXXX);

(f) "Canadian-controlled private corporation" has the meaning assigned in subsection 127(5);

(g) "FMV" means fair market value;

(h) "financial intermediary corporation" means a corporation described in paragraphs (a) to (f) of the definition "financial intermediary corporation in subsection 191(1);

(i) "paid-up capital" has the meaning assigned in subsection 89(1);

(j) "private corporation" has the meaning assigned in subsection 89(1);

(k) "proceeds of disposition" has the meaning assigned in section 54;

(l) "RDTOH" means "refundable dividend tax on hand" as that expression is defined in subsection 129(3);

(m) "related" means persons related to each other within the meaning of subsection 251(2);

(n) "series of transactions or events" includes the transactions or events described in subsection 248(10);

(o) "significant influence" has the meaning assigned by section 3050 of the CICA Handbook and, for purposes of this letter, a corporation will be considered to have significant influence over a corporation if it has significant influence over that corporation or over any other corporation that has significant influence over that corporation;

(p) "specified financial institution" has the meaning assigned in subsection 248(1);

(q) "specified investment business" has the meaning assigned in subsection 125(7);

(r) "taxable Canadian corporation" has the meaning assigned in subsection 89(1);

(s) "taxable dividend" has the meaning assigned in subsection 89(1); and

(t) "taxable preferred share" has the meaning assigned by subsection 248(1).

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

Facts

1. Opco is a taxable Canadian corporation and a Canadian-controlled private corporation, incorporated under the BCA on XXXXXXXXXX. It is engaged in the business of XXXXXXXXXX. The authorized share capital of Opco includes an unlimited number of Class "A" Common shares without par value ("Opco Common Shares") and an unlimited number of Class "A" Preferred shares without par value. Opco has issued XXXXXXXXXX Opco Common Shares all of which are owned by DC2.

2. DC2 is a taxable Canadian corporation and a Canadian-controlled private corporation, incorporated under the CA on XXXXXXXXXX. DC2 owns all of the shares of Opco as well as real property which is leased to Opco and used by Opco as its head office and principal place of business. The rental income received by DC2 from Opco in respect of the real property is reported by DC2 as active business income pursuant to subsection 129(6).

The authorized and issued share capital of DC2 includes Class "A" voting, participating shares without par value ("DC2 Common Shares"). The holders of the DC2 Common Shares and the number of shares held are as follows:

Shareholder*
Number of
Shares Held

XXXXXXXXXX

DC2 has not issued any other shares other than as described above. DC1 is not related to any of the other shareholders of DC2.

*Some shareholders hold shares in self-administered RRSPs.

3. DC1 is a taxable Canadian corporation and a Canadian-controlled private corporation, incorporated under the CA on XXXXXXXXXX.

4. The fiscal year end for each of DC2 and Opco is XXXXXXXXXX.

Purpose of the Proposed Transactions

5. To give the shareholders of DC2, other than DC1, an increased interest in the future growth of Opco's business through an increased equity interest in the shares of Opco.

Proposed Transactions

6. The share capital of Opco will be reorganized such that each issued and outstanding Opco Common Share will be split, on a XXXXXXXXXX basis. The XXXXXXXXXX shares of Opco held by DC2 will therefore be split into XXXXXXXXXX Opco Common Shares.

7. A new corporation ("TC2") will be incorporated under the CA. TC2 will be a taxable Canadian corporation and a private corporation with an authorized capital of XXXXXXXXXX voting common shares ("TC2 Common Shares") without par value and XXXXXXXXXX redeemable, retractable preferred shares without par value ("TC2 Preferred Shares"). Prior to the transactions described below, TC2 will not, at any time, have had any assets, liabilities or outstanding shares. The TC2 Preferred Shares will have the following attributes:

(a) redeemable and retractable for a redemption amount equal to the FMV of the property received therefor at the time of issuance;

(b) entitled to a non-cumulative dividend at a rate to be fixed by the directors;

(c) entitled to a return of the redemption amount on a liquidation, dissolution, or winding-up of the corporation in preference to the TC2 Common Shares; and

(d) entitled to one vote per share at all meetings of the shareholders.

There will be a restriction on the payment of dividends on other classes of shares so that no dividends may be paid on the TC2 Common Shares which would have the effect of reducing the value of the TC2 Preferred Shares then outstanding.

8. All of the shareholders of DC2, with the exception of DC1, will transfer all of their DC2 Common Shares to TC2, in exchange for one TC2 Common Share for each DC2 Common Share so transferred. Each of the shareholders and TC2 will jointly elect, in prescribed form and within the time specified in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of the DC2 shares. The agreed amount in respect of the DC2 shares so transferred will, in each case, be equal to their adjusted cost base to the holder immediately before the transfer, which amount will not exceed the FMV of the shares.

TC2 will designate, pursuant to a special resolution, an amount in respect of the capital of the TC2 Common Shares which will not exceed the aggregate paid-up capital of the DC2 Common Shares acquired from the DC2 shareholders.

9. Immediately before the transfer described in paragraph 12, the property of DC2 will be determined on a consolidated basis by including the appropriate pro rata share of the assets of any corporation over which DC2 has the ability to exercise significant influence (the only corporation over which DC2 exercises significant influence is Opco - DC2 and Opco will hereinafter be referred to as the "DC2 Group") which assets will be classified into three types of property:

(a) cash or near cash property, comprising all of the current assets of the DC2 Group including any cash, marketable securities and similar instruments (other than marketable securities and similar investments held as portfolio investments), prepaid expenses, inventory and accounts receivable;

(b) business property, comprising all of the assets of the DC2 Group, other than cash or near cash property, any income from which would be income from a business (other than a specified investment business); and

(c) investment property, comprising all of the assets of the DC2 Group, other than cash or near cash property, any income from which would constitute income from property or from a specified investment business.

For greater certainty, the FMV of the shares of Opco and of any indebtedness receivable by DC2 from Opco will be allocated between the three types of property described above by multiplying the FMV of the Opco shares or the amount receivable from Opco, as the case may be, by the proportion that the net FMV of each type of property owned by Opco (as determined in accordance with the rules in paragraphs 10 and 11) is of the aggregate net FMV of all of the property owned by Opco.

10. In determining, on a consolidated basis, the net FMV of each type of property of DC2 immediately before the transfer described in paragraph 12, the liabilities of DC2 and Opco will be allocated to, and will be deducted in the calculation of, the net FMV of each type of property of such corporation in the following manner:

(a) in determining the net FMV of each type of property of Opco, immediately before the transfer described in paragraph 12, the liabilities of Opco (other than any liabilities owing to DC2) will be allocated to, and will be deducted in the calculation of, the net FMV of each type of property of Opco in the following manner:

(i) current liabilities of Opco will be allocated to the cash or near cash property (including any cash, accounts receivable, inventory and prepaid expenses) of Opco in the proportion that the FMV of each such property is of the FMV of all cash or near cash property owned by Opco. To the extent that the allocation of current liabilities as described herein exceeds the aggregate FMV of the cash or near cash property of Opco, Opco will be considered to have a negative amount of cash or near cash property;

(ii) any accounts receivable, inventory and prepaid expenses of Opco that are initially classified in accordance with (i) above as cash or near cash property, that will relate to a business that will be carried on by it and that will be collected, sold or consumed by Opco in the ordinary course of that business, will then be classified as business property and the net FMV thereof, determined after the allocation of current liabilities described in (i) above, will be included in the net FMV of business property and will not be included in the net FMV of cash or near cash property;

(iii) liabilities, other than current liabilities, of Opco that relate to a particular property, will then be allocated to the particular property (and effectively to the type to which the particular property belongs) to the extent of its FMV. Liabilities that pertain to a type of property but not to a particular property will then be allocated to that type of property. To the extent that the allocation of liabilities that pertain to a particular type of property as described herein exceeds the aggregate FMV of all that particular type of property of Opco, Opco will be considered to have a negative amount of that type of property;

(iv) any liabilities, other than current liabilities, of Opco which do not relate to a particular type of property will then be allocated to the cash or near cash property, business property and investment property, if any, of Opco based on the relative net FMV of each type of property prior to the allocation of such liabilities, but after the allocation of the liabilities described in subparagraphs (a)(i) and (a)(iii) above.

(b) in determining, on a consolidated basis, the net FMV of each type of property of DC2 immediately before the transfer of property described in paragraph 12, DC2 will include the appropriate pro rata share of the net FMV of each type of property of Opco, as determined in accordance with subparagraph (a) herein, and any liabilities of DC2 will then be allocated to, and be deducted in the calculation of, the net FMV of each type of property of DC2 in the following manner:

(i) current liabilities of DC2 will be allocated to the cash or near cash property (including any cash, accounts receivable, inventory and prepaid expenses) of DC2 in the proportion that the FMV of each such property is of the FMV of all cash or near cash property owned by it;

(ii) liabilities of DC2, other than current liabilities, that relate to a particular property will be allocated to the particular property (and effectively to the type to which the particular property belongs) to the extent of its FMV. The liabilities that pertain to a type of property, but not to a particular property, then will be allocated to that type of property, but not in excess of the net FMV of such type of property after the allocation of liabilities to a particular property as described herein; and

(iii) if any liabilities remain after the allocations described in steps (b)(i) and (b)(ii) are made ("excess unallocated liabilities"), such excess unallocated liabilities will then be allocated to the cash or near cash property, business property and investment property, if any, of DC2, based on the relative net FMV of each type of property prior to the allocation of such excess unallocated liabilities.

Any consulting fees payable by Opco at the time of the proposed transactions will only be treated as a liability of Opco for the purposes of this ruling to the extent such amounts are reasonable and the quantum of such fees is determined on a basis consistent with consulting fees paid in previous years.

It is anticipated that, in applying the consolidated look-through approach, DC2 will not have any net cash or near cash property or investment property.

11. For greater certainty, in determining the consolidated net FMV of each type of property of DC2, the following principles will apply:

(a) any tax-related accounts in any corporation (i.e. RDTOH, capital dividend account, deferred income taxes and inherent tax liabilities pertaining to unrealized income or capital gains) will be ignored;

(b) the amount of any liability will be the principal amount thereof;

(c) no amount will be considered to be a liability unless it represents a true legal liability which is capable of quantification; and

(d) the portion of any long-term debt due within one year will be treated as a current liability and the balance of any long-term debt will constitute a long-term liability;

12. DC2 will transfer to TC2 at FMV a portion of each type of property owned by it by transferring that number of Opco Common Shares to TC2, such that the net FMV of each type of property transferred to TC2, as described above, will approximate that proportion of the net FMV of all the property of DC2 of that type determined immediately before such transfer that:

(a) the aggregate FMV immediately before such transfer of all of the shares of DC2 owned by TC2,

is of

(b) the aggregate FMV immediately before such transfer of all of the issued and outstanding shares of DC2.

For the purpose of this paragraph, the expression "approximate that proportion" means that the discrepancy from the proportion, if any, would not exceed 1%, determined as a percentage of the FMV of each type of property which TC2 will receive (or DC2 will retain) as compared to what TC2 would have received (or DC2 would have retained) had it received (or retained) its pro rata share of the net FMV of that type of property. However, the aggregate net fair market value of all property of DC2 transferred to TC2 as described herein will be equal to the proportion determined by (a) and (b) above of the aggregate net fair market value of all property of DC2 immediately before the transfer.

13. In consideration for the Opco Common Shares, TC2 will issue XXXXXXXXXX TC2 Preferred Shares to DC2 having an aggregate redemption amount and FMV equal to the FMV of the Opco Common Shares. DC2 and TC2 will jointly elect, in prescribed form and within the time specified in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of the Opco Common Shares to TC2. The agreed amount in respect of the shares so transferred will be equal to their adjusted cost base to DC2 immediately before the transfer, which amount will not exceed the FMV of the shares.

TC2 will designate, pursuant to a special resolution, an amount in respect of the capital of the TC2 Common Shares an amount which will not exceed the aggregate cost (immediately after the transfer) of the Opco Common Shares transferred to TC2 by DC2.

For the purposes of subsection 191(4), the terms and conditions of the TC2 Preferred Shares will, at the time of their issue to DC2, specify an amount in respect of each share, including an amount for which the share is to be redeemed, acquired or cancelled. The amount to be specified in respect of each TC2 Preferred Share will be expressed as a dollar amount, will not be determined by a formula and will be equal to the FMV of the property received by TC2 as consideration for the share.

14. Immediately following the transfer described in paragraph 12:

(a) TC2 will be connected to DC2 on the basis that DC2 will own more than 10% but less than 50% of the issued share capital of TC2 having full voting rights under all circumstances and having a FMV which exceeds more than 10% of the FMV of all the issued shares of the capital stock of TC2; and

(b) DC2 will be connected to TC2 on the basis that TC2 will own more than 10% but less than 50% of the issued share capital of DC2 having full voting rights under all circumstances.

15. TC2 will redeem its TC2 Preferred Shares owned by DC2 and, in consideration therefor, will issue to DC2 a demand non-interest bearing promissory note (the "TC2 Note") having a principal amount and FMV equal to the FMV of the TC2 Preferred Shares so purchased. DC2 will accept the TC2 Note in full satisfaction of the purchase price of the TC2 Preferred Shares.

16. Concurrently with the redemption of the TC2 Preferred Shares described in paragraph 15, DC2 will purchase for cancellation its DC2 Common Shares owned by TC2 and, in consideration therefor, will issue to TC2 a demand non-interest bearing promissory note (the "DC2 Note") having a principal amount and FMV equal to the FMV of the DC2 Common Shares so purchased. TC2 will accept the DC2 Note in full satisfaction of the purchase price of the DC2 Common Shares.

17. The TC2 Note and the DC2 Note will be set-off and cancelled in full satisfaction of the obligations under each note. Immediately following the settlement of the notes, the net FMV of the cash or near cash property, business property and investment property retained by DC2 calculated in accordance with the rules in paragraphs 9 to 11, will approximate that proportion of the aggregate net FMV of that type of property of DC2, determined immediately before the transfer described in paragraph 12, that:

(a) the aggregate FMV (immediately before the transfer of property described in paragraph 12) of the DC2 Common Shares owned by DC1

is of

(b) the aggregate FMV (immediately before the transfer of property described in paragraph 12) of all of the issued and outstanding shares of DC2.

Additional Information

18. No property has or will become property of DC2 or Opco and no liabilities have been or will be incurred by either of DC2 or Opco in contemplation of and before the proposed transactions, except in the ordinary course of business.

19. Except as outlined herein, none of DC2, Opco, or TC2 have any intention of disposing of any assets to a partnership or to an unrelated person following the proposed transactions and no such corporation will dispose of any of its assets as part of the series of transactions or events which includes the proposed transactions, other than in the ordinary course of business.

20. The Opco Common Shares are not taxable preferred shares and will not become taxable preferred shares at any time before the completion of the proposed transactions.

21. None of the issued shares referred to herein (including the shares to be issued as part of the proposed transactions):

(a) is or will be subject to a guarantee agreement within the meaning referred to in subsection 112(2.2);

(b) is or will be part of a dividend rental arrangement within the meaning referred to in subsection 112(2.3); or

(c) has been or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5).

22. Neither of DC2 nor TC2 will be a specified financial institution or a financial intermediary corporation at any time before the completion of the proposed transactions.

23. No shares of DC2 were acquired in contemplation of the proposed transactions. All of the shareholders of DC2 hold their shares as capital property.

24. DC2 had no RDTOH at the end of its last taxation year. DC2 does not expect to have any RDTOH for its taxation year which includes the proposed transactions.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions, and provided that the proposed transactions are undertaken in the manner described above, our rulings are as set forth below.

A. The provisions of subsection 85(1) will apply to the transfer of the DC2 Common Shares by a particular shareholder of DC2 to TC2, as described in paragraph 8, in respect of which an election under subsection 85(1) is made by the particular shareholder and TC2, such that the agreed amount in respect of the transfer of such shares will be deemed to be the particular shareholder's proceeds of disposition and TC2's cost thereof pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

B. The provisions of subsection 85(1) will apply to the transfer of the Opco Common Shares to TC2 by DC2, as described in paragraphs 12 and 13, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of the transfer of such shares will be deemed to be DC2's proceeds of disposition and TC2's cost thereof pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfer.

C. Subsection 84(3) will apply:

(a) on the redemption, as described in paragraph 15, of the TC2 Preferred Shares owned by DC2, to deem TC2 to have paid and DC2 to have received; and

(b) on the purchase for cancellation as described in paragraph 16, of the DC2 Common Shares owned by TC2, to deem DC2 to have paid and TC2 to have received,

a taxable dividend on such shares equal to the amount, if any, by which the aggregate amount paid upon such purchase or redemption exceeds the aggregate paid-up capital in respect of such shares immediately before such purchase or redemption, and any such dividend,

(c) will be included, pursuant to subsection 82(1) and paragraph 12(1)(j), in computing the income of the corporation deemed to have received such dividend;

(d) will be deductible by the recipient pursuant to subsection 112(1) in computing its taxable income for the year in which such dividend is deemed to have been received, and such deduction will not be prohibited by any of subsections 112(2.1), (2.2), (2.3) or (2.4);

(e) will be excluded, pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54, in determining the proceeds of disposition to the recipient corporation of the shares so purchased or redeemed;

(f) will not be subject to tax under Part IV of the Act except as provided in paragraph 186(1)(b); and

(g) the provisions of subsection 112(3) will apply to reduce any loss which otherwise would be determined for the particular holder as a result of the redemption or purchase of shares described in the proposed transactions.

D. The dividends described in Ruling C:

(a) will not be subject to tax under Part IV.1 of the Act on the basis that each such dividend will be an excepted dividend by virtue of paragraph (c) of the definition of "excepted dividend" in section 187.1; and

(b) (i) provided that the amount paid on the redemption of the TC2 Preferred Shares is equal to the amount specified in respect of such shares as described in paragraph 13, the dividend described in Ruling C(a) will not be subject to tax under Part VI.1 on the basis that such dividend will be a dividend deemed by paragraph 191(4)(d) to be an "excluded dividend" as defined in subsection 191(1); and

(ii) the dividend described in Ruling C(b) will not be subject to tax under Part VI.1 of the Act on the basis that such dividend will be an excluded dividend by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

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

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

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

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

(d) 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 Ruling C and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption from subsection 55(2) provided by paragraph 55(3)(b).

F. The repayment of the TC2 Note held by DC2 and the DC2 Note held by TC2 as described in paragraph 17 will not, in and of itself, result in a forgiven amount within the meaning of either subsection 80(1) or section 80.01.

G. Provided that the cost to DC2 of the TC2 Note and the cost to TC2 of the DC2 Note will in each case, upon the issuance thereof, be equal to the principal amount of the particular note, no amount will be included in the income of DC2 or TC2 upon payment of the principal amount of the particular note.

H. The provisions of 15(1), 56(2), 69(4) and 246(1) will not apply as a result of the proposed transactions, in and by themselves.

I. Subsection 245(2) will not be applied, as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given above.

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 into law, could affect the rulings provided herein.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 and are binding on Revenue Canada Customs, Excise and Taxation provided that the proposed transactions are completed by XXXXXXXXXX.

Caveat

Nothing in this ruling should be construed as implying that Revenue Canada, Customs, Excise and Taxation has reviewed or made a determination in respect of:

(a) the cost, adjusted cost base or FMV of any particular asset;

(b) the paid-up capital of any shares referred to herein;

(c) the balance of RDTOH of any corporation; or

(d) 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 International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch