2001 Ruling 2001-0074333 - 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: Standard Split-Up Butterfly Ruling.

Position: Favourable rulings provided.

Reasons: Complies with rules in section 55.

XXXXXXXXXX 2001-007433

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
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 taxpayers. We also acknowledge receipt of your correspondence dated XXXXXXXXXX and our telephone conversations in connection herewith.

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

(i) dealt with in an earlier return of one of the taxpayers or a related person;

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

(iii) under objection by one of the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired.

DEFINITIONS

In this letter, unless otherwise expressly stated:

(a) "Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, and unless otherwise stated, every reference herein to a section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "ACB" means "adjusted cost base" as that expression is defined in section 54 and subsection 248(1);

(c) "agreed amount" has the meaning assigned by subsection 85(1);

(d) "BCA" means the Business Corporations Act (XXXXXXXXXX);

(e) "capital property" has the meaning assigned by section 54;

(f) "CDA" means "capital dividend account" and has the meaning assigned by subsection 89(1);

(g) "cost amount" has the meaning assigned by subsection 248(1);

(h) "dividend refund" has the meaning assigned by subsection 129(1);

(i) "eligible property" has the meaning assigned by subsection 85(1.1);

(j) "guarantee agreement" has the meaning assigned by subsection 112(2.2);

(k) "Holdco" refers to XXXXXXXXXX;

(l) "Mr. A" refers to XXXXXXXXXX;

(m) "Mr. B" refers to XXXXXXXXXX;

(n) "Opco" refers to XXXXXXXXXX;

(o) "paid-up capital" (also referred to as "PUC") has the meaning assigned by subsection 89(1);

(p) "private corporation" has the meaning assigned by subsection 89(1);

(q) "proceeds of disposition" has the meaning assigned by section 54;

(r) "RDTOH" means "refundable dividend tax on hand" as that expression is defined in subsection 129(3);

(s) "restricted financial institution" has the meaning assigned by subsection 248(1);

(t) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(u) "significant influence" has the meaning assigned by section 3050 of the CICA Handbook;

(v) "specified financial institution" (also referred to as "SFI") has the meaning assigned by subsection 248(1);

(w) "specified investment business" ("SIB") has the meaning assigned by the definition in subsection 125(7) and subsection 248(1);

(x) "stated capital" has the meaning assigned by the BCA;

(y) "taxable Canadian corporation" has the meaning assigned by subsection 89(1); and

(z) "taxable dividend" has the meaning assigned by subsection 89(1).

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as set forth below.

Facts

1. Mr. A and Mr. B are each older than 17 years of age and are residents of Canada. Mr. B is the brother of Mr. A.

2. Holdco is a Canadian-controlled private corporation and a taxable Canadian corporation which was incorporated under the BCA. The authorized share capital of Holdco consists of:

(a) an unlimited number of Class A voting common shares;
(b) an unlimited number of Class B voting common shares;
(c) an unlimited number of Class C voting common shares;
(d) an unlimited number of Class D non-voting common shares;
(e) an unlimited number of Class E non-voting preferred shares;
(f) an unlimited number of Class F voting preferred shares;
(g) an unlimited number of Class G preferred shares;
(h) an unlimited number of Class H preferred shares; and
(i) an unlimited number of Class I preferred shares.

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

Shareholder Class A ACB Class E ACB

Mr. A XXXXXXXXXX

Mr. B XXXXXXXXXX

The aggregate PUC of the Class A common shares of Holdco is $XXXXXXXXXX, while the aggregate PUC of the Class E preferred shares is $XXXXXXXXXX. The shares of Holdco represent capital property to each of its shareholders. The Class A common shares have been held by the current holders thereof since XXXXXXXXXX and the Class E preferred shares since XXXXXXXXXX. The Class E shares of Holdco were issued as part of a transfer concluded under subsection 85(1).

4. Opco is a Canadian-controlled private Corporation and a taxable Canadian corporation and was incorporated under the laws of XXXXXXXXXX and was subsequently continued under the BCA. XXXXXXXXXX.

5. The authorized share capital of Opco consists of:

(a) XXXXXXXXXX Class A voting common shares;
(b) XXXXXXXXXX Class B voting common shares;
(c) XXXXXXXXXX Class C non-voting common shares;
(d) XXXXXXXXXX Class A preferred shares; and
(e) XXXXXXXXXX Class B preferred shares.

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

Shareholder Class ACB PUC

Holdco XXXXXXXXXX
Holdco XXXXXXXXXX
Holdco XXXXXXXXXX

All of the shares of Opco represent capital property to Holdco and were acquired by Holdco subsequent to 1971. None of the shares of Opco were acquired in contemplation of the proposed transactions set forth below.

7. The assets of Opco include accounts receivable, prepaid expenses, inventory, XXXXXXXXXX, buildings, equipment, XXXXXXXXXX and advances to a related corporation. As at XXXXXXXXXX the principal amount of these advances was $XXXXXXXXX . These advances carry no specific provision for interest or repayment. Holdco's only assets are the shares it holds in Opco and a minor amount of cash.

8. As at XXXXXXXXXX, Opco had a balance of $XXXXXXXXXX in its RDTOH account and did not have a balance in its CDA.

Proposed Transactions:

9. Opco will be amalgamated with Holdco in a short-form vertical amalgamation pursuant to the applicable provisions of the BCA. The resulting corporation will carry on business under the name of XXXXXXXXXX. (DC) having identical articles, bylaws and shareholders as Holdco. The ACB and PUC of the shares of DC will be identical to the ACB and PUC of the shares of Holdco.

10. Mr. B will incorporate a new corporation ("Transferee") under the BCA. Transferee will be a taxable Canadian corporation and a private corporation. Mr. B will be the first and sole director of Transferee. The authorized share capital of Transferee will include:

(a) an unlimited number of Class A voting common shares;
(b) an unlimited number of Class B voting common shares;
(c) an unlimited number of Class C non-voting common shares; and
(d) an unlimited number of Class D redeemable, non-voting preferred shares.

No shares of Transferee will be issued prior to the transactions described in paragraph 13 below.

11. Transferee will incorporate a new corporation ("Subco") under the BCA. Transferee will be a taxable Canadian corporation and a private corporation. Mr. B will be the first and sole director of Subco. The authorized share capital of Subco will include:

(a) an unlimited number of Class A voting common shares;
(b) an unlimited number of Class B voting common shares;
(c) an unlimited number of Class C non-voting common shares; and
(d) an unlimited number of Class D redeemable, non-voting preferred shares.

On incorporation, Transferee will subscribe for XXXXXXXXXX Class A common shares of Subco for cash consideration of $XXXXXXXXXX per share. Transferee will obtain a shareholder loan from Mr. B to finance the subscription.

12. Articles of amendment will be filed on behalf of Subco under the BCA to divide the Class "D" shares into an unlimited number of Class D Series I, redeemable, retractable, non-voting preferred shares (the "Preferred Shares") with a redemption and retraction amount of $XXXXXXXXXX per share. The Preferred Shares will entitle the holder thereof to non-cumulative dividends on the redemption amount at XXXXXXXXXX of the rate prescribed by Regulation 4301(c) of the Act.

13. Mr. B will transfer his Class A common shares and Class E preferred shares in DC to Transferee in exchange for Class A voting common shares of Transferee having an aggregate fair market value equal to the fair market value of the shares of DC transferred to Transferee.

Mr. B and Transferee will 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 DC shares as described herein to Transferee. The agreed amount specified in the election will be equal to the ACB of the transferred shares, which amount will be less than their fair market value at the time of the transfer.

The amount to be added to the stated capital of the Class A common shares of Transferee to be issued as described herein will not exceed the adjusted cost base of the shares of DC to Mr. B immediately before the transfer.

14. Immediately before the transfers of property described in paragraph 16 below, the property owned by DC will be classified into the following three different types of property for the purposes of the definition of "distribution" in subsection 55(1) and paragraph 55(3)(b):

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

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

(c) business property, comprising all of the assets of DC, other than cash or near-cash property, any income from which would, for the purposes of the Act, be income from a business (other than a SIB).

For the purpose of calculating the fair market value of each type of property, as described above, DC will not have significant influence over any corporation.

Any tax accounts of DC, such as the amount of refundable dividend tax on hand, the balance of any capital dividend account, or any deferred income tax debit balance will not be considered property for purposes of the classification described herein.

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

For the purposes of this distribution, the XXXXXXXXXX will be categorized as business property.

15. In determining the net fair market value of each type of property of DC immediately before the transfers of property described in paragraph 16 below, the liabilities of DC will then be allocated to, and deducted in the calculation of the net fair market value of each type of property of DC as follows:

(a) current liabilities of DC will be allocated to the cash or near-cash property of DC 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 owned by DC. The allocation of current liabilities as described herein will not, however, exceed the total fair market value of the cash or near-cash property of DC.

(b) any accounts receivable (this would not include the advances to related corporations), inventory, and prepaid expenses of DC, that are initially classified in accordance with paragraph (a) as cash or near-cash property, that will relate to a business that will be carried on by DC or Transferee and that will be collected, sold, or consumed by such corporation in the ordinary course of that business, will then be reclassified as business property and the net fair market value thereof, determined after the allocation of current liabilities as described in (a) herein, will be included in the net fair market value of business property and will not be included in the net fair market value of cash or near-cash property;

(c) liabilities, other than current liabilities, of DC that relate to a particular property will then be allocated to the particular property (and effectively to the type of property to which the property belongs) to the extent of its fair market value. The liabilities pertaining 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; and

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

16. Immediately following the determination of the net fair market value of its cash or near cash property, its business property and its investment property as described in paragraphs 14 and 15 above, DC will transfer at fair market value a portion of each type of property owned by it at that time to Subco such that immediately following the transfers, the net fair market value of each type of property so transferred by DC to Subco, determined in accordance with the guidelines described in paragraphs 14 and 15 above, will approximate that proportion of the net fair market value of all property of DC of that type determined immediately before such transfer that:

(a) the aggregate fair market value, immediately before the transfers, of all of the shares of DC owned by Transferee at that time

is of

(b) the aggregate fair market value, immediately before the transfers, of all the issued and outstanding shares of DC at that time.

For the purpose of this paragraph and paragraph 23 below, the expression "approximate that proportion" means that the discrepancy from that proportion, if any, would not exceed 1%, determined as a percentage of the net fair market value of each type of property which Subco has received (or DC has retained) as compared to what Subco would have received (or DC would have retained) had it received (or retained) 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 DC transferred to Subco as described herein will be equal to that proportion determined by (a) and (b) above of the aggregate net fair market value of all property of DC immediately before the transfers.

As consideration for the property so transferred, Subco will:

(c) assume a portion the liabilities of DC (not to exceed the cost to Subco, as determined under section 85, where relevant, of the property transferred to Subco) such that the net fair market value of each type of property of DC transferred to Subco 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 DC immediately before such transfers, and

(d) issue to DC Preferred 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 Subco exceeds the amount of the liabilities assumed by Subco as described in (c) above.

Subco will add to the stated capital account in respect of the Preferred Shares it issues an amount not exceeding the cost to Subco (as determined under section 85, where relevant) of the property transferred to it less any liabilities assumed by it.

17. In respect of the transfers described in paragraph 16 above, DC and Subco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of each property transferred by DC to Subco, as described in paragraph 16 above, that is an eligible property the fair market value of which at the time of the transfer exceeds or may exceed the cost amount thereof to DC. The agreed amount in each such election in respect of a particular eligible property 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 Subco 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.

18. Subco will then redeem the Preferred Shares held by DC at their aggregate redemption amount and fair market value and will pay the redemption amount by issuing to DC a demand promissory note (the "Subco Redemption Note") having a principal amount and fair market value equal to the redemption amount of the Preferred Shares. DC will accept the Subco Redemption Note as full payment for the redemption amount of the Preferred Shares so redeemed.

19. At the end of the day on which the Preferred Shares are redeemed as described in paragraph 18 above, Subco will cause its taxation year to end.

20. On the next business day DC will purchase for cancellation or redeem, at fair market value, all of the DC common and preferred shares of its capital stock owned by Transferee. DC will pay the purchase or redemption price for such shares by issuing to Transferee a demand promissory note (the "DC Note") having a principal amount and fair market value equal to the aggregate fair market value of the shares so purchased or redeemed. Transferee will accept the DC Note in full payment of the purchase price and the redemption price of the shares.

21. Subco will then be wound up into its parent, Transferee. As a result of the windup, all of the property of Subco will be distributed to Transferee and all of the liabilities of Subco will be assumed by Transferee.

22. DC and Transferee will then set-off the principal amount of their mutual debt obligations (i.e. the DC Note and the Subco Redemption Note) and each will then be cancelled.

23. Immediately following the proposed transactions described above, the net fair market value of each type of property retained by DC, determined in the manner described in paragraphs 14 and 15 above, will approximate that proportion of the aggregate net fair market value of that type of property of DC, determined immediately before the transfers described in paragraph 16 above, that:

(a) the aggregate fair market value, immediately before the transfers of property described in paragraph 16 above, of the shares of DC owned by Mr. A,

is of

(b) the aggregate fair market value, immediately before the transfers of property, of all of the issued and outstanding shares of DC.

Additional Information:

24. None of the transactions or events described in the facts of this letter occurred as part of the same series of transactions or events as the proposed transactions described in this letter.

25. No liabilities have been incurred by, and no assets have been acquired by or disposed of by DC or any predecessor thereof in contemplation of the proposed transactions described herein. Except as described in this letter, no liabilities will be incurred by, and no assets will be acquired by or disposed of by DC or any predecessor thereof in contemplation of the proposed transactions described herein. No property of DC that is transferred pursuant to the proposed transactions described herein will be transferred to any other person as part of a series of transactions that includes the proposed transactions described herein.

26. Neither DC nor Transferee will, at the time the proposed transactions described herein are implemented, be an SFI or a restricted financial institution.

27. Neither the shares of DC nor the shares of Transferee 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).

Purpose of Transactions:

28. The purpose of the proposed transactions is to distribute a proportionate share of the assets of Opco to a new corporation in order to separate the interests of the two directing minds of Opco. In essence the proposed transaction is a split up of the existing operations into two operations, one for each shareholder. The shareholders respective vision of the future direction of Opco differs. Accordingly, they wish to separate their respective interests in the operations and proceed independently of each other.

Rulings Requested and 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. Subject to the application of subsections 13(21.2) and 69(11), subsection 85(1) will apply to the transfer of each eligible property owned by DC to Subco, as described in paragraph 16 above, that is the object of an election as described in paragraph 17 above such that the agreed amount in respect of each such transfer shall be deemed to be the proceeds of disposition thereof to DC and the cost thereof to Subco pursuant to paragraph 85(1)(a).

B. On the redemption by Subco of the Preferred Shares issued by it, as described in paragraph 18 above, and on the purchase for cancellation or redemption of the all of the DC shares owned by Transferee, as described in paragraph 20 above:

(a) by virtue of paragraphs 84(3)(a) and 84(3)(b):

(i) Subco will be deemed to have paid, and DC will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid in respect of the redemption of the Preferred Shares exceeds the PUC of those shares immediately before the redemption;

(ii) DC be deemed to have paid, and Transferee will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid in respect of the purchase for cancellation or redemption of all of the DC shares owned by Transferee exceeds the PUC of those shares immediately before the purchase or redemptions as the case may be;

(b) the taxable dividends deemed to have been received by each of DC and Transferee as described in (a)(i) and (a)(ii) will

(i) be included in the recipient's income pursuant to section 82 and paragraph 12(1)(j);

(ii) pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient for the year in which the dividend is deemed to have been received and such deduction will not be denied by any of the provisions of subsections 112(2.1), (2.2), (2.3) or (2.4);

(c) the taxable deemed dividends referred to in (a) above will not be subject to tax under Parts IV.1 or VI.1 of the Act on the basis that each of the recipients will have a substantial interest, within the meaning assigned by paragraph 191(2)(a) of the Act, in the payer corporation at the time such taxable dividends are paid and, therefore, such dividends will be "excepted dividends" within the meaning of section 187.1 and "excluded dividends" within the meaning of subsection 191(1); and

(d) by virtue of subsection 186(2) and paragraph 186(4)(a), Transferee will be connected with DC and DC will be connected with Subco. Consequently,

(i) provided that Subco is not entitled to a dividend refund (within the meaning of subsection 129(1) of the Act) in respect of its taxation year in which it is deemed to pay the dividend referred to in (a)(i) above, DC will not be subject to Part IV tax in respect of such dividend, and

(ii) Subco shall, pursuant to paragraph 186(1)(b), be subject to Part IV tax in an amount equal to that proportion of the dividend refund to which DC will become entitled for its taxation year in which the dividend referred to in (a)(ii) above, is paid, that the amount of such dividend received by Subco is of the aggregate of all taxable dividends paid by DC in its taxation year in which such dividend is paid.

C. The extinguishment of the DC Note by DC and the Subco Redemption Note by Transferee as described in paragraph 22 above will not, in and of itself, result in a forgiven amount within the meaning of either subsection 80(1) or section 80.01. In addition, neither DC nor Transferee will otherwise realize any gain or incur any loss as a result thereof.

D. Provided that as part of the series of transactions or events that includes the proposed transactions, 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 referred to in Ruling B above, and for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

E. Pursuant to the application of clause 256(7)(a)(ii)(A), control of DC will be deemed not to have been acquired on the cancellation of the DC shares held by Transferee, as described in paragraph 20 above, for the purpose of the provisions enumerated in subsection 256(7).

F. The provisions of subsections 15(1), and 56(2) will not apply as a result of the proposed transactions described herein, in and by themselves.

G. As a result of the proposed transactions described herein, 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 70-6R4 dated January 29, 2001 and are binding on the Canada Customs and Revenue Agency 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 affect the rulings provided herein.

Comments

Nothing in this letter should be considered as confirmation of the income tax consequences of any of the transactions described in this letter other than as specifically described. In addition, nothing in this letter should be construed as confirmation, express or implied, of the fair market value or adjusted cost base of any property or the paid-up capital of any share.

As discussed, the provisions of paragraph 84.1(1)(a) may result in a reduction of the paid-up capital of the Class A common shares issued in respect of the transfer described in paragraph 13 above.

Yours truly,

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