There is a concern that redeeming the preferred shares of a related individual at the commencement of a butterfly reorganization would oust the butterfly exception

Suppose that the distributing company (“DC”) has three shareholders: Dad owning frozen preferred shares; and his two sons, each owning 50% of the common shares. Dad’s shares are redeemed and the sons then butterfly the DC assets to their respective transferee companies (“TCs”).

There is a concern that the test in s. 55(3.1)(b)(i)(C) would not be met, so that s. 55(3.1)(b)(i) will applies to deny butterfly treatment. S. 55(3.1)(b)(i)(C) might apply on the basis that the redemption of Dad’s preferred shares constitutes an acquisition of property by a person (DC) who ceased to be related to the vendor (Dad) as part of the series (DC will be wound-up as part of the series and, therefore, will cease to be related to Dad). The particular issue is that it might be considered that this redemption entailed the acquisition of property by DC.

There is greater certainty if Dad instead transfers his DC preferred shares to each of the TCs in consideration for voting shares of the TCs, with the TCs then redeeming those preferred shares. In particular, this would appear to satisfy the technical requirements of ss. 55(3.1)(b)(i)(C), 55(3.1)(b)(iii)(A) and 55(3.2)(c).

Neal Armstrong. Summary of David Carolin, Manu Kakkar and Paola D’Agostino, “To Redeem or Not To Redeem a Specified Shareholder: That Is the 55(3)(b) Question,” Tax for the Owner-Manager, Vol. 23, No. 4, October 2023, p. 6 under s. 55(3.1)(b)(i)(C).