2000 Ruling 2000-0005843 - split-up butterfly

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: whether Parent can transfer shares of a specified class proportionally to children's corporations prior to a split-up butterfly reorganization

Position: No

Reasons: not a permitted exchange and 55(3.2)(c) deems parent not to be related to transferee

XXXXXXXXXX
XXXXXXXXXX 						2000-000584
XXXXXXXXXX 

Attention: XXXXXXXXXX

XXXXXXXXXX, 2000

Dear Sirs:

Re: XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayer. In your letters of XXXXXXXXXX you provided additional information in respect of, and amendments to, the facts and proposed transactions described in your original letter. We also acknowledge the information provided during our various telephone conversations.

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein:

(i) is in an earlier return of the taxpayer or a related person;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii) is under objection by the taxpayer or a related person;

(iv) is before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired; and

(v) is the subject of a ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise stated all statutory references herein are to the Income Tax Act (Canada), R.S.C. 1985 c.1 (5th Supp.), as amended, (the "Act").

In this letter, the following terms have the meanings specified:

(a) "adjusted cost base" ("ACB") has the meaning assigned to that term in section 54;

(b) "BCA" means the Business Corporations Act (XXXXXXXXXX) and, where applicable, its predecessor statutes;

(c) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7);

(d) "capital dividend account" has the meaning assigned to that term by subsection 89(1);

(e) "capital property" has the meaning assigned to that term in section 54;

(f) "cost amount" has the meaning assigned to that term by subsection 248(1);

(g) "depreciable property" has the meaning assigned to that term by subsection 13(21);

(h) "eligible capital property" has the meaning assigned to that term in section 54;

(i) "eligible property" has the meaning assigned to that term in subsection 85(1.1);

(j) "paid-up capital" ("PUC") has the meaning assigned to that term by subsection 89(1);

(k) "refundable dividend tax on hand" ("RDTOH") has the meaning assigned to that term by subsection 129(3);

(l) "specified class" has the meaning assigned to that term by subsection 55(1);

(m) "specified financial institution" ("SFI") has the meaning assigned to that term by subsection 248(1);

(n) "specified investment business" has the meaning assigned to that term by subsection 125(7);

(o) "taxable Canadian corporation" ("TCC") has the meaning assigned to that term by subsection 89(1);

(p) "taxable dividend" has the meaning assigned to that term by subsection 89(1); and

(q) "undepreciated capital cost" has the meaning assigned to that term by subsection 13(21).

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

FACTS

1. XXXXXXXXXX ("Opco") is a TCC and a CCPC which was incorporated under the BCA by Articles of Incorporation dated XXXXXXXXXX. The taxation year of Opco ends on XXXXXXXXXX of each year. Opco carries on a XXXXXXXXXX farming business.

2. The authorized share capital of Opco consists of

(i) an unlimited number of XXXXXXXXXX shares, each entitled to non-cumulative dividends of XXXXXXXXXX% and redeemable at a redemption price of $XXXXXXXXXX per share; and

(ii) an unlimited number of common shares.

3. The issued and outstanding shares of Opco are held as follows:

Class XXXXXXXXXX Common

XXXXXXXXXX ("Parent") XXXXXXXXXX
XXXXXXXXXX ("Child1") XXXXXXXXXX XXXXXXXXXX
XXXXXXXXXX ("Child2") XXXXXXXXXX XXXXXXXXXX
XXXXXXXXXX ("Child3") XXXXXXXXXX XXXXXXXXXX
XXXXXXXXXX ("Child4") XXXXXXXXXX XXXXXXXXXX
Total XXXXXXXXXX XXXXXXXXXX

The aggregate PUC of the XXXXXXXXXX shares of Opco is $XXXXXXXXXX while the aggregate PUC of the common shares is $XXXXXXXXXX. The XXXXXXXXXX shares of Opco are shares of a specified class. At the time of issue of each XXXXXXXXXX share, the cost of such share to its original owner was equal to the fair market value at that time of the consideration for which it was issued.

Child1, Child2, Child3 and Child4 are the children of Parent and each is older than 17 years of age. Each of Child1, Child2, Child3, Child4 and Parent is a resident of Canada.

The shares of Opco represent capital property to each of its shareholders. None of the shareholders of Opco has acquired any shares of Opco in contemplation of the proposed transactions described in this letter.

4. Opco owns and operates XXXXXXXXXX farms in XXXXXXXXXX. The assets of Opco include cash and accounts receivable, prepaid expenses, inventory, land, buildings, equipment and production quota. As at XXXXXXXXXX Opco had a NISA account which is recorded on its XXXXXXXXXX financial statements at the amount of $XXXXXXXXXX. Opco will liquidate its NISA account prior to the implementation of the proposed transactions described below.

The liabilities of Opco include current liabilities and long-term debt, including mortgages secured by its real property and equipment finance contracts.

5. As at XXXXXXXXXX Opco did not have any balance in either its RDTOH account or its capital dividend account. At the end of their taxation years in which the proposed transactions are implemented, none of Opco, Newco1, Newco2, Newco3 or Newco4 will have any RDTOH.

PROPOSED TRANSACTIONS

6. Prior to the implementation of the proposed transactions described below, Opco will redeem all of its issued and outstanding XXXXXXXXXX shares at their redemption price. As consideration, Opco will issue to each of Parent, Child1, Child2, Child3 and Child4 a non-interest bearing, demand promissory note having a principal amount and fair market value equal to the redemption price of the XXXXXXXXXX shares owned by such shareholder immediately before the share redemption described herein.

7. Each of Child1, Child2, Child3 and Child4 will incorporate a new corporation ("Newco1", "Newco2", "Newco3" and "Newco4", respectively) under the BCA. Each of Newco1, Newco2, Newco3 and Newco4 will be a TCC.

The authorized share capital of each of Newco1, Newco2, Newco3 and Newco4 will include:

(a) an unlimited number of common shares;

(b) an unlimited number of redeemable, retractable, non-voting XXXXXXXXXX shares with a redemption amount of $XXXXXXXXXX per share; and

(c) an unlimited number of redeemable, non-voting XXXXXXXXXX shares with a redemption amount of $XXXXXXXXXX per share.

At the time of incorporation, one (1) common share of Newco1, Newco2, Newco3 and Newco4 will be issued for nominal consideration to Child1, Child2, Child3 or Child4, as the case may be.

8. Each of Child1, Child2, Child3 and Child4 will transfer his or her common shares of Opco and the promissory note owing to such child by Opco to Newco1, Newco2, Newco3 or Newco4, as the case may be, in exchange for:

(a) a demand non-interest bearing promissory note issued by the transferee having a principal amount and fair market value equal to the principal amount and fair market value of the promissory note owing by Opco to such transferor; and

(b) XXXXXXXXXX shares of Newco1, Newco2, Newco3 or Newco4, as the case may be, having an aggregate fair market value and redemption amount equal to the fair market value of the common shares of Opco transferred to such Newco by the particular transferor.

Each of Child1 and Newco1, Child2 and Newco2, Child3 and Newco3 and Child4 and Newco4 will respectively elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of the common shares of Opco as described herein to each such Newco. The agreed amount specified in each election will be equal to the ACB to each of Child1, Child2, Child3 and Child4 of the transferred shares, which amount will be less than their fair market value at the time of transfer.

The amount to be added to the stated capital of the XXXXXXXXXX Shares of each Newco to be issued as described herein will not exceed the adjusted cost base, as determined pursuant to paragraph 84.1(2)(a.1), of the common shares of Opco to the particular transferor immediately before the transfer.

9. Immediately before the proposed transfers of property described in paragraph 11 below, the assets of Opco will be classified into three types of property for the purposes of the definition of "distribution" in subsection 55(1), as follows:

(a) cash or near cash property, comprising all of the current assets of Opco. This category will include cash, accounts receivable, rights arising from the prepayment of certain expenses ("prepaid expenses") and inventory;

(b) investment property, comprising all of the assets of Opco other than any cash or near cash property, any income from which would, for purposes of the Act, be income from property or from a specified investment business; and

(c) business property, comprising all of the assets of Opco other than any cash or near cash property, any income from which would, for purposes of the Act, be income from an active business carried on by Opco. This category will include land, buildings and equipment, as well as the production quota of Opco.

For greater certainty, any tax accounts, such as the balance of any non-capital losses, RDTOH or CDA of Opco, will not be considered property for purposes of the proposed transactions described herein.

It is not expected that Opco will own any investment property immediately before the proposed transfers of property.

10. In determining the net fair market value of each type of property owned by Opco immediately before the proposed transfers of property described in paragraph 11 below, the liabilities of Opco will be allocated to, and deducted in the calculation of, the net fair market value of each type of property of Opco as follows:

(a) current liabilities of Opco (including the current portion of any long-term debt and the notes payable to be issued by Opco as described in paragraph 6 above) will be allocated to the cash or near cash property (including any accounts receivable, inventory and prepaid expenses) of Opco in the proportion that the fair market value of each such property is of the fair market value of all cash or near cash property of Opco. The allocation of current liabilities of Opco as described herein will not exceed the aggregate fair market value of the cash or near cash property of Opco;

(b) liabilities of Opco, other than current liabilities, that relate to a particular property will then be allocated to the particular property (and effectively to the type to which the particular property belongs) to the extent of its fair market value. The liabilities that pertain to a type of property, but not to a particular property will then be allocated to that type of property, but not in excess of the net fair market value of such type of property after the allocation of liabilities to a particular property, as described herein;

(c) if any liabilities remain after the allocations described in steps (a) and (b) above are made ("excess unallocated liabilities"), such excess unallocated liabilities will then be allocated to the cash or near cash property, investment property and business property of Opco based on the relative net fair market value of each type of property prior to the allocation of such excess unallocated liabilities.

For the purpose of calculating the net fair market value of the types of property of Opco, deferred taxes, if any, will be ignored.

11. Opco will then transfer to each of Newco1, Newco2, Newco3 and Newco4 a portion of its business property and of its cash or near cash property and investment property, if any, such that the net fair market value of each type of property so transferred to each Newco (after allocating and deducting, in the manner described in paragraph 10 above, the liabilities of Opco which are to be assumed by each such Newco as described herein) will approximate that proportion of the net fair market value of all property of Opco of that type determined immediately before such transfer that

(a) the aggregate fair market value, immediately before the transfer, of all of the shares of the capital stock of Opco owned by the particular Newco, as the case may be, at that time

is of

(b) the aggregate fair market value, immediately before the transfer, of all of the issued and outstanding shares of the capital stock of Opco at that time.

For the purpose of this paragraph the expression "approximate that proportion" means that the discrepancy from that proportion, if any, would not exceed XXXXXXXXXX%, determined as a percentage of the net fair market value of each type of property which each Newco has received as compared to what each Newco would have received had it received its appropriate pro rata share of the net fair market value of that type of property. However, the aggregate net fair market value of all property of Opco transferred to each Newco as described herein will be equal to the proportion determined by (a) and (b) above of the aggregate net fair market value of all property of Opco immediately before the transfer.

As consideration for the property so transferred, each of Newco1, Newco2, Newco3 and Newco4 will:

(c) assume a portion of the liabilities of Opco (not to exceed the cost to the particular transferee, as determined under section 85, where relevant, of the property transferred to such transferee), such that the net fair market value of each type of property of Opco transferred to such transferee as described herein will approximate its proportionate share, as determined by the formula described in (a) and (b) above, of the total net fair market value of that type of property owned by Opco immediately before such transfers, and

(d) issue to Opco XXXXXXXXXX Shares of its capital stock having an aggregate fair market value and redemption amount equal to the amount by which the aggregate fair market value of the property transferred to the particular Newco, as the case may be, exceeds the amount of the liabilities assumed by each such transferee as described in (c) above.

Each of Newco1, Newco2, Newco3 and Newco4 will add to the stated capital account in respect of the XXXXXXXXXX Shares it issues an amount not exceeding the cost to such transferee (as determined under section 85, where relevant) of the property transferred to such transferee less any liabilities assumed by it.

12. In respect of the transfers described in paragraph 11 above, Opco and each of Newco1, Newco2, Newco3 and Newco4 will jointly elect pursuant to subsection 85(1), in prescribed form and within the time limits referred to in subsection 85(6), in respect of the transfer to each such transferee of each asset that is an eligible property. The amount agreed upon in each such election in respect of each of the eligible properties so transferred will not be less than:

(a) in the case of capital property (other than depreciable property of a prescribed class), an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii);

(b) in the case of depreciable property of a prescribed class, an amount equal to the least of the amounts described in subparagraphs 85(1)(e)(i), (ii) and (iii);

(c) in the case of eligible capital property, an amount equal to the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii); and

(d) in the case of inventory, the amount described in paragraph 85(1)(c.2).

In each case, the agreed amount will not exceed the fair market value of the respective property, nor will it be less than the amount of any liabilities assumed by the particular Newco as consideration for the transfer of such property.

For the purposes of the joint election described herein, the reference to "the undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition" found in paragraph 85(1)(e)(i) shall be interpreted to mean that proportion of the undepreciated capital cost to the taxpayer of all of the property of that class that the fair market value of the asset immediately before the disposition is of the fair market value of all property of that class immediately before the disposition.

The subsection 85(1) elections referred to herein will exclude any cash, accounts receivable and prepaid expenses.

13. Newco1, Newco2, Newco3 and Newco4 will each redeem all of its XXXXXXXXXX Shares held by Opco at their respective aggregate redemption amount and will pay the particular aggregate redemption amount by issuing to Opco a non-interest bearing promissory note payable on demand having a principal amount and fair market value equal to the respective redemption amount of its XXXXXXXXXX Shares so redeemed by it. Opco will accept the Newco1, Newco2, Newco3 and Newco4 promissory notes as full payment for the redemption amounts of the respective shares so redeemed.

Newco1, Newco2, Newco3 and Newco4 will, immediately before such share redemptions, be related to Opco within the meaning of subsection 251(2) and will be connected with Opco within the meaning assigned by subsections 186(2) and 186(4).

As a result of these share redemptions and pursuant to subsection 84(3), each of Newco1, Newco2, Newco3 and Newco4 will be deemed to have paid and Opco will be deemed to have received a taxable dividend equal to the amount by which the amount paid on each such share redemption exceeds the PUC of the particular shares so redeemed.

14. Following the redemption of the XXXXXXXXXX Shares as described in paragraph 13 above, the shareholders of Opco will, by special resolution, resolve to wind up and dissolve Opco under the applicable provisions of the BCA. No agreement or resolution relating to the winding up of Opco or the distribution of its property will provide for the cancellation of any shares of Opco. In connection with the winding-up of Opco, Opco will distribute to each of Newco1, Newco2, Newco3 and Newco4 the particular demand promissory note owing by it to Opco. As a result of the assignment and distribution of the aforesaid notes, the obligations under each of the notes will be cancelled.

All properties and liabilities of Opco will have been distributed or discharged, as the case may be. Articles of Dissolution will then be executed and filed with the appropriate Corporate Registry. Upon receipt of the Certificate of Dissolution, Opco will be dissolved.

As a result of the distribution of the promissory notes to each Newco as described herein, Opco will be deemed to have paid and each of Newco1, Newco2, Newco3 and Newco4 will be deemed to have received a taxable dividend equal to the amount determined under paragraph 88(2)(b).

ADDITIONAL INFORMATION

15. No assets have been or will be acquired by or disposed of by, and no liabilities have been or will be incurred by Opco in contemplation of and before the proposed transfers of property described in paragraph 11 above, except in the ordinary course of business or as described in this letter.

16. Except as described in this letter, Opco will not dispose of any of its assets as part of the proposed series of transactions, and none of Newco1, Newco2, Newco3 or Newco4 has any intention to dispose of any of its assets to an unrelated person subsequent to the proposed transactions.

17. None of the corporations referred to herein is, or will be at the time of the proposed transactions, an SFI.

18. None of the shares of Opco, Newco1, Newco2, Newco3 or Newco4 has been or will be, at any time during the implementation of the proposed transactions described herein:

(a) the subject of any undertaking or agreement that is referred to in subsection 112(2.2) as a "guarantee agreement";

(b) a share that is issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5); or

(c) the subject of a "dividend rental arrangement" as that term is defined in subsection 248(1).

19. Each of Opco, Newco1, Newco2, Newco3 and Newco4 will have the financial capacity to honour, upon presentation for payment, the amount payable under the promissory note issued by it as part of the proposed transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

20. The purpose of the proposed transactions is to distribute the property of Opco to corporations owned by each of Child1, Child2, Child3 and Child4 so that each of them will be able to own and operate their farms independent of his or her siblings.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Provided that as part of the series of transactions or events that includes the proposed transactions described herein, there is not:

(a) a disposition of property in the circumstances described in subparagraph 55(3.1)(b)(i);

(b) an acquisition of control in the circumstances described in subparagraph 55(3.1)(b)(ii);

(c) an acquisition of property in the circumstances described in paragraph 55(3.1)(c); or

(d) an acquisition of property in the circumstances described in paragraph 55(3.1)(d),

which has not been described herein, then by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends deemed to arise on:

(i) the redemption of the XXXXXXXXXX Shares of Newco1, Newco2, Newco3 and Newco4 held by Opco as described in paragraph 13 above; and

(ii) the distribution to each of Newco1, Newco2, Newco3 and Newco4 of the particular demand promissory note owing by it to Opco as described in paragraph 14 above.

For greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

B. The settlement of the promissory notes of Newco1, Newco2, Newco3 and Newco4 as described in paragraph 14 above will not give rise to a "forgiven amount" within the meaning of subsections 80(1) or 80.01.

C. The provisions of subsections 15(1), 56(2), and 246(1) will not apply to the proposed transactions described herein, in and by themselves.

D. As a result of the proposed transactions, in and by themselves, subsection 245(2) will not be applied to redetermine the tax consequences confirmed in the rulings given.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 and are binding provided that the proposed transactions are completed by XXXXXXXXXX.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

COMMENTS

Nothing in this ruling should be construed as implying that the Canada Customs and Revenue Agency has agreed to or reviewed:

(a) the determination of the fair market value or ACB of any particular asset or the PUC of any shares referred to herein; or

(b) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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