CRA rules on a split-up butterfly between a divorced couple where excess debt is allocated to land rather than building to produce capital gains treatment

In order to accomplish a multi-wing split-up net asset butterfly of a private corporation (DC) owned by a divorced couple, they will transfer their common shares of DC to two new transferee corporations (TC1 and TC2), then DC will distribute each of the two rental properties, along with cash assets, to the respective TC in consideration for the assumption of liabilities (including shareholder advances and mortgage debt) and the issuance of TC preferred shares. Such preferred shares will then be redeemed for notes, and such notes will then be extinguished by operation of law on the winding-up of DC into TC1 and TC2 (but following the establishing of the first year ends of TC1 and TC2, to avoid Part IV tax circularity).

The DC debt likely exceeds the cost amounts of its assets. The sole consideration for the cash transfers will be debt assumptions, the buildings will be transferred on a full s. 85(1) rollover basis (i.e., debt assumed only up to their cost amounts, so that there is no recapture) and the balance of the assumed debt will be allocated to the transferred land so that the agreed amount therefor will produce (consistently with s. 85(1)(e.3)) the recognition of capital gains by DC (and resulting Part IV tax under s. 186(1)(b) to the TCs on the DC winding-up.)

Neal Armstrong. Summary of 2024 Ruling 2023-0998291R3 F under s. 55(1) – distribution.