Private company split-up butterfly raises Part IV tax/dividend refund circularity issue

A CCPC (DC) whose only significant asset is a shareholding (not exempt from Part IV tax) in a Canadian public company (Pubco) is butterflying that asset out to its numerous CCPC shareholders (TCs), who are owned by 3rd or 4th generation family members and to which it is not connected for Part IV tax exemption purposes.  As both the deemed dividends arising on the redemption of the preferred shares issued by the TCs to DC on the butterfly, and the deemed dividends arising on the winding-up of DC (on which the promissory notes received by DC on the redemption of the TC preferred shares are distributed to the TCs) are subject to Part IV tax and generate a dividend refund, there is a classic circularity problem.

The ruling letter does not address this issue directly, but indicates that the stated capital of the TC preferred shares is nominal, and the stated capital of DC's shares is reduced to a nominal amount before its winding-up, in order "to ensure that each of the TCs and DC’s respective dividend refund ... and respective Part IV tax liabilities ... will approximately be equal to each other."

Neal Armstrong.  Summary of 2012 Ruling 2011-0416001R3 under s. 55(1) - distribution.