Spin-off of real estate by Opco owned by 2 arm’s length shareholders does not comply with s. 55(3)(a) (p. 7)
Opco is owned on an 85-15 basis by two arm’s-length shareholders, Aco and Bco. Opco wishes to “spin out” the real property used in its active business, as part of the following steps:
- Aco and Bco transfer to Newco (newly-incorporated by them) a portion of their Opco shares equaling the value of such real property on an s. 85(1) rollover basis for Newco shares.
- Opco transfers the real property to Newco on an s. 85(1) rollover basis for Newco shares.
- The shareholdings between Newco and Opco are cross-redeemed, generating s. 84(3) dividends.
This spin-off would not satisfy the s. 55(3)(a) exception because Bco, which is not related to either Opco or Newco, has a significant increase in its interest in Newco contrary to s. 55(3)(a)(ii) and (v).
Cure through use of Middleco in reliance on s. 55(3.01)(g) (p. 8)
Instead suppose that the steps proceed as follows:
- Aco and Bco transfer their shares of Opco to newly-incorporated Middleco under s. 85 for Middleco shares.
- Middleco incorporates Newco and transfers to Newco a portion of its Opco shares equaling the value of the real property on an s. 85(1) rollover basis for Newco shares.
- Opco transfers the real property to Newco on an s. 85(1) rollover basis for Newco shares.
- The shareholdings between Newco and Opco are cross-redeemed, generating s. 84(3) dividends.
In this second scenario, s. 55(3)(a)(v) is not violated, since Bco does not obtain either a direct interest in Newco or in any other dividend payer.
Nonetheless, s. 55(3)(a)(ii) is violated for the same reason, and s. 55(3)(a)(i) is violated because Middleco is not related to Opco or Newco at the time it transfers Opco shares to Newco on a rollover basis.
However, s. 55(3.01)(g) would deem ss. 55(3)(a)(i) and (ii) not to have been violated, so that the s. 55(3)(a) exception can apply, since the tests in s. 55(3)(a)(i) to (v) would all be satisfied (see also 2015-0570021E5):
- The dividend payer and dividend recipient (Opco and Newco) are related immediately before the dividend is received and did not cease to be related as part of the series (ss. 55(3.01)(g)(i) and (ii)).
- The s. 55(3)(a)(i) disposition and s. 55(3)(a)(ii) increase occurred before the dividends were received: Bco’s significant increase in Middleco occurred before the butterfly dividends were received (s. 55(3.01)(g)(iii)).
- Such disposition or increase was the result of the disposition of shares to, or the acquisition of shares of, the particular corporation (Middleco) referenced in the s. 55(3)(a)(iii) test (here, Bco’s significant increase in its interest in Middleco is the result of an acquisition of shares of Middleco) (s. 55(3)(a)(iv).
- At the time the dividends were received, all of the shares of the dividend recipient and dividend payer were owned by the particular corporation (Middleco) (s. 55(3)(a)(v)).
Suppose that Opco is owned on an 85-15 basis by two arm’s-length shareholders, Aco and Bco. If Opco wishes to spin off the real property used in its active business to a Newco owned in the same proportions by Aco and Bco, the s. 55(3)(a) exception will not be available since Bco, which is not related to either Opco or Newco, has a significant increase in its interest in Newco occur contrary to s. 55(3)(a)(ii) and (v).
Instead suppose that there is a preliminary step under which Aco and Bco transfer their shares of Opco to newly-incorporated Middleco on an s. 85(1) rollover basis. Then, Opco spins off the real estate to a Newco incorporated by Middleco. Done this way, the spin-off would come within the s. 55(3)(a) exception given, inter alia, the relieving effect of the rule in s. 55(3.01)(g). See also 2015-0570021E5 F.
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