Public spin-off butterfly rulings contemplate no substantive changes to the new common shares issued on DC’s s. 86 reorg, treat replacement stock options as boot and treat effective splitting of DC management contract as no disposition

Some features of the most recent published ruling for the butterfly spin-off by a Canadian public corporation (DC) to Spinco:

• The assets (some held directly) of the two divisions to be spun-off are to be first rolled by DC into a Newco subsidiary before the transfer by DC of the Newco shares to Spinco – with Newco then being wound-up into DC at the completion of the butterfly reorg under s. 88(1). The stated reason of “simplification” may relate to Newco closing an arm’s length borrowing immediately before the spin-off and immediately paying off a note it issued to DC on the drop-down.
• In order that a disproportionate amount of the cumulative eligible capital of DC is not transferred to Newco on the drop-down, DC and Newco are permitted to pretend, in completing the s. 85(1) election form, that the CEC is a proportionate portion of the actual CEC amount (with “proportionate” defined in a somewhat circular manner).
• DC is managed by Manageco, whose long-term management contract is first to be redrafted to handle the split-up, e.g., splitting the compensation between management of the retained division, and the divisions to be spun-off, with this split to be effected based on the relative (post-drop-down) fair market value of the Newco shares. CRA ruled that these amendments would not cause a disposition of the contract. At the same time as the drop-down of the affected divisions to Newco, Manageco will then effect a s. 85(1) dropdown of its management business to two new subsidiaries.
• In order to comply with s. 7(1.4), there will be an exchange of pro rata portions (based on the relative FMV of the Newco shares) of each DC employee stock option to Spinco and DC in consideration for the issuance of replacement options. Such issuance by Spinco will be treated as non-share consideration for the butterfly transfer of Newco shares to Spinco (otherwise occurring in consideration only, or mostly, for the issuance of Spinco special shares).
• Before the butterfly spin-off, there is a s. 86 exchange of old comon shares for new common shares and for special shares of DC, with the stated capital of each old common share to be allocated to that of the two new replacement shares based on their relative FMV. The new common shares are identical to the old ones, except for their share provisions referring to the prior rights of the special shares (mainly, to receipt of any redemption amount). Thus, in order to get the s. 86 ruling, it was unnecessary to make any substantive changes to their listed rights.

Neal Armstrong. Summaries of 2015 Ruling 2014-0558831R3 under s. 55(1) – distribution, s. 7(1.4), s. 86(1), s. 85(1)(d) and s. 248(1) - disposition.