2001 Ruling 2001-0087753 - 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 CCRA.

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

Principal Issues: Split-up butterfly of a investment holding company

Position: Meets the butterfly exemption except that we do not confirm that a disposition by the transferee corporations would be in the ordinary course of business for purposes of paragraph 55(3.1)(c) or would not be part of the series of transactions that includes the reorganization.

Reasons: The transferee corporations are not in the business of trading investments.

XXXXXXXXXX 							2001-008775

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

RE: XXXXXXXXXX ("DC")
XXXXXXXXXX ("Sib1")
XXXXXXXXXX ("Sib2")
XXXXXXXXXX ("Sib3")

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers.

You confirm that to the best of each taxpayer's and your own knowledge, none of the issues contained herein:

- is in an earlier return of the taxpayer or a related person;

- is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or a related person;

- is before under objection by the taxpayer or a related person;

- is before the courts; or

- is the subject of a ruling previously considered by the Directorate.

DEFINITIONS

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

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

(b) "adjusted cost base" has the meaning assigned by section 54;

(c) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in their election under subsection 85(1) in respect of the property;

(d) "affiliated person" has the meaning assigned by subsection 251.1(1);

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

(f) "capital dividend" has the meaning assigned by subsection 83(2);

(g) "capital dividend account" (also referred to as "CDA") has the meaning assigned by subsection 89(1);

(h) "capital loss" has the meaning assigned by paragraph 39(1) (b);

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

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

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

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

(m) "identical properties" or "properties identical thereto" includes a property described in subsections 40(3.5) and 248(12);

(n) "paid-up capital" (also referred to as "PUC") has the meaningassigned by subsection 89(1);

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

(p) "private holding corporation" has the meaning assigned by subsection 191(1);

(q) "refundable dividend tax on hand" (also referred to as "RDTOH") has the meaning assigned by subsection 129(3);

(r) "related" has the meaning assigned by subsection 251(2);

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

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

(u) specified financial institution" has the meaning assigned by subsection 248(1);

(v) "specified investment business" has the meaning assigned by subsection 125(7);

(w) "stated capital" has the meaning assigned by the XXXXXXXXXX;

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

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

(z) taxable preferred share" has the meaning assigned by subsection 248(1).

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

FACTS

1. Sib1, Sib2 and Sib3 are siblings.

2. DC is a taxable Canadian corporation and a Canadian-controlled private corporation. DC was incorporated on XXXXXXXXXX under the provisions of the Business Corporations Act XXXXXXXXXX DC's only undertaking is the investment of its funds. Its activities are a specified investment business.

3. The authorized share capital of DC includes:

- an unlimited number of voting common shares,

- XXXXXXXXXX class A special shares,

- an unlimited number of class B special shares,

- an unlimited number of class C special voting shares and

- an unlimited number of class D special shares.

The class A special shares are non-voting, redeemable and retractable at $XXXXXXXXXX per share. The class B special shares are non-voting, redeemable and retractable at $XXXXXXXXXX per share. The class C special shares are voting, redeemable and retractable at $XXXXXXXXXX per share. The class D special shares are voting, redeemable and retractable at $XXXXXXXXXX per share.

The issued share capital of DC as of XXXXXXXXXX consisted of XXXXXXXXXX common shares with an aggregate PUC $XXXXXXXXXX and XXXXXXXXXX class D shares with an aggregate PUC of $XXXXXXXXXX. The ownership of the shares is divided as follows:

			Common		Class D

Sib1	    			XXXXXXXXXX
Sib2		    		XXXXXXXXXX
Sib3		            	XXXXXXXXXX 

In XXXXXXXXXX Class D shares were redeemed. In addition, approximately XXXXXXXXXX shares were redeemed in XXXXXXXXXX as part of a plan to redeem shares quarterly.

4. The class D shares and promissory notes of $XXXXXXXXXX (issued by DC) were owned by the XXXXXXXXXX. The income beneficiary of the Trust was XXXXXXXXXX. The capital beneficiaries

were her three children, Sib1, Sib2 and Sib3. XXXXXXXXXX died on XXXXXXXXXX, and the trust commenced winding-up after that time. The class D shares and promissory notes were distributed from the Trust to the three capital beneficiaries.

All of the common shares were owned by the above three individuals since incorporation.

Since the distribution of class D shares from the XXXXXXXXXX , approximately XXXXXXXXXX class D shares have been redeemed on a XXXXXXXXXX basis.

5. None of the DC shares owned by the shareholders were acquired in contemplation of the proposed transactions described below.

6. DC primarily owns marketable securities consisting of publicly traded Canadian and U.S. stocks, bonds and other financial instruments and cash. DC's cash at any point in time represents the proceeds of dividends and interest received or the proceeds from the sale of securities, which are continually being reinvested in new securities. The income of DC is reported as income from a specified investment business.

7. The marketable securities described in paragraph 6 are capital property to DC.

8. DC also holds shares in a wholly-owned subsidiary, XXXXXXXXXX ("Sub"). The shares of Sub are capital property. Sub is a taxable Canadian corporation and a Canadian-controlled private corporation. Sub's only property consists of real property that was originally held as a capital property until sometime in XXXXXXXXXX when it began to actively plan for the development of the property. Since XXXXXXXXXX, the real estate in Sub has been held as inventory.

9. The liabilities of DC include a shareholder loan owed in equal proportion to the three shareholders. Other liabilities include income tax liabilities and accrued professional fees, which result from the ongoing operations of DC.

10. The aggregate fair market value as at XXXXXXXXXX of DC's assets (before deducting liabilities) was approximately $XXXXXXXXXX and the aggregate adjusted cost base of such assets was approximately $XXXXXXXXXX.

11. The aggregate capital losses accrued on certain securities (collectively, the "loss properties" or individually a "loss property") held at XXXXXXXXXX was approximately $XXXXXXXXXX.

12. As at XXXXXXXXXX the balance in DC's RDTOH account amounted to approximately $XXXXXXXXXX. DC will earn investment income and realize capital gains in the period from XXXXXXXXXX to the date of dissolution, as described below that will result in additional RDTOH. The amount is not determinable at this time

13. As at XXXXXXXXXX, DC had a $XXXXXXXXXX balance in its CDA.

PROPOSED TRANSACTIONS

14. Each shareholder will cause to be incorporated a new corporation (Holdco1, Holdco2 and Holdco3). The only undertaking of Holdco1, Holdco2 and Holdco3 will be the investing of its funds. Each of these new corporations will be a taxable Canadian corporation and a private corporation.

15. The share capital of each new corporation will consist of an unlimited number of:

(a) common shares, and

(b) two classes of special shares, designated as Class A special shares and Class B special shares.

The holders of the common shares will be entitled to one vote per share.

The Class A special shares will be voting and entitle the holder to a non-cumulative annual dividend not to exceed $XXXXXXXXXX per share to be paid at the discretion of the directors, redeemable and retractable at a redemption price of $XXXXXXXXXX per share (being the consideration for which they are issued)(these shares will mirror the Class D special shares issued by DC).

The Class B special shares will be voting and entitle the holder to a non-cumulative annual dividend to be paid at the discretion of the directors, redeemable and retractable at a redemption price of $XXXXXXXXXX per share (being the consideration for which they are issued).

16. Sib1 will transfer all of her shares of DC, being XXXXXXXXXX common shares and XXXXXXXXXX class D special shares to Holdco1. As sole consideration for such transfer, Holdco1 will issue to Sib1 XXXXXXXXXX common shares and XXXXXXXXXX Class A special shares of its capital stock having a fair market value equal to the fair market value at that time of the shares of DC transferred to Holdco1.

17. Sib2 will transfer all of her shares of DC, being XXXXXXXXXX common shares and XXXXXXXXXX class D special shares to Holdco2. As sole consideration for such transfer, Holdco2 will issue to Sib2 XXXXXXXXXX common shares and XXXXXXXXXX Class A special shares of its capital stock having a fair market value equal to the fair market value at that time of the shares of DC transferred to Holdco2.

18. Sib3 will transfer all of his shares of DC, being XXXXXXXXXX common shares and XXXXXXXXXX class D special shares to Holdco3. As sole consideration for such transfer, Holdco3 will issue to Sib3 XXXXXXXXXX common shares and XXXXXXXXXX Class A special shares of its capital stock having a fair market value equal to the fair market value at that time of the shares of DC transferred to Holdco3.

19. In regard to each of the transfers described in paragraphs 16, 17 and 18 above, each individual and their respective holding company will file a joint election, in prescribed form, and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply in respect of the transfers. The agreed amount in each election will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i)and (ii).

20. Each new holding company, i.e. Holdco1, Holdco2 and Holdco3, will add to the stated capital account maintained for its common and Class A special shares an amount equal to the corresponding proportion of the PUC in respect of the shares of DC transferred to each company. The PUC addition in respect of each company will amount to $XXXXXXXXXX per common share and $XXXXXXXXXX per Class A special share.

21. Immediately before the transfers of property described in paragraph 22 of this letter, the property owned by DC will be determined on a consolidated basis by including the appropriate pro-rata share of the assets of any corporation over which DC has the ability to exercise significant influence, which assets will be classified into the following three categories:

a. cash or near-cash property of DC including cash, bank deposits, term deposits, marketable securities and similar instruments (other than marketable securities and similar investments held as portfolio investments);

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

For greater certainty, any tax accounts will not be considered property for purposes of the proposed transactions described herein.

DC will be considered to have significant influence over Sub.

22. DC will transfer to Holdco1, Holdco2 and Holdco3, at fair market value, one-third of its:

a. cash or near-cash property,
b investment property, and
c business property.

The transfers will be effected in a manner such that Holdco1, Holdco2 and Holdco3 will acquire an equal proportion of each property, including the shares of Sub.

As consideration for the property so transferred, each of Holdco1, Holdco2 and Holdco3 will assume one-third of DC's liabilities, if any, and each will issue to DC Class B special shares having a fair market value and aggregate redemption amount equal to the amount by which the fair market value of the assets of DC transferred to Holdco1, Holdco2 and Holdco3 exceeds the amount of the liabilities assumed by Holdco1, Holdco2 and Holdco3.

Immediately following the transfers set out in this paragraph, the fair market value of each type of property received by each of Holdco 1, Holdco2 and Holdco3 will equal to the amount determined by the formula:

A*B/C

Where

"A" is the fair market value, immediately before the transfer, of all property of that type owned at that time by DC,

"B" is the fair market value, immediately before the transfer, of all of shares of the capital stock of DC owned by the respective transferee corporation, and

"C" is the fair market value, immediately before the transfer, of all the issued shares of the capital stock of DC.

23 DC and each of Holdco1, Holdco2 and Holdco3 will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each property of DC that is an eligible property. The agreed amount in respect of each property so transferred will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

For greater certainty the agreed amount for any eligible property included in the subsection 85(1) elections referred to in this paragraph will not be less than the amount of any liabilities assumed by Holdco1, Holdco2 and Holdco3, as the case may be, as consideration for the transfer of such property and will not exceed the fair market value of each such property.

24. Each of Holdco1, Holdco2 and Holdco3 will add to the stated capital account maintained for its Class B special shares an amount equal to the amount by which the aggregate cost of the properties acquired by Holdco1, Holdco2 and Holdco3 (determined pursuant to subsection 85(1), where relevant) exceeds the amount of liabilities assumed, if any, by Holdco1, Holdco2 and Holdco3 as consideration therefor.

25. Each of Holdco1, Holdco2 and Holdco3 will redeem all of their Class B special shares owned by DC for an amount equal to their fair market value, being the Redemption Price. As payment of the Redemption Price, DC will be issued a non-interest-bearing promissory note ("the Holdco1 note, the Holdco2 note and the Holdco3 note" respectively) payable on demand having a principal amount and fair market value equal to the Redemption Price. DC will accept the Holdco1 note, the Holdco2 note and the Holdco3 note as full payment for the Redemption Price of the Class B special shares of Holdco1, Holdco2 and Holdco3.

At the end of the day on which the Class B special shares of each of Holdco1, Holdco2 and Holdco3 are redeemed, each of Holdco1, Holdco2 and Holdco3 will cause its first taxation year to end.

26. On the day following the redemption of the Class B special shares of Holdco1, Holdco2 and Holdco3 as described in paragraph 25, the shareholders of DC, will, by special resolution, resolve to wind up and dissolve DC under the applicable provisions of the XXXXXXXXXX. In connection with the winding-up, DC will distribute to Holdco1, Holdco2 and Holdco3, respectively, the Holdco1 note, the Holdco2 note and the Holdco3 note. No agreement or resolution relating to the winding-up of DC or the distribution of its property will provide for the cancellation of any shares of DC.

27. As a result of the assignment and distribution of the above notes, the obligations under the notes will be cancelled.

28. Prior to the distribution of the Holdco1 note, the Holdco2 note and the Holdco3 note, DC will elect, pursuant to subsection 83(2) of the Act, in prescribed manner and prescribed form, that the full amount of any resulting dividend referred to in subparagraph 88(2)(b)(i) be deemed to be a capital dividend.

29. Following receipt of the dividend refund to which DC will become entitled as a result of the proposed transactions described herein, DC will distribute one-third of such amount to each of Holdco1, Holdco2 and Holdco3. The refund will not arise until after the end of the fiscal period in which the proposed transactions described above are completed.

30. Following the completion of the transactions described in paragraphs 21 to 29, all properties of DC will have been distributed and all liabilities either discharged or assumed by Holdco1, Holdco2 and Holdco3. Articles of Dissolution will then be filed and DC will be dissolved

PURPOSE OF THE PROPOSED TRANSACTIONS

31. The purpose of the proposed transactions is to transfer to each of Holdco1, Holdco2 and Holdco3 one-third of each asset and liability currently held by DC and to permit the individual shareholders to determine the future investment policies of the new corporation controlled by them independently.

Additional Information

32. Except as described herein, no property has been or will be acquired or disposed of by DC in contemplation of and before the proposed transactions.

33. (Reserved).

34. None of the issued shares referred to herein (including the shares to be issued as part of the proposed transactions):

a. is or will be subject to a guarantee agreement within the meaning referred to in subsection 112(2.2);

b. is or will be part of a dividend rental arrangement as defined in subsection 248(1); or

c. has been or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5).

35. None of DC, Holdco1, Holdco2 and Holdco3 will be a specified financial institution at any time before the completion of the proposed transactions and none of Holdco1, Holdco2 and Holdco3 will be, at any time before the completion of the proposed transactions, a financial intermediary corporation.

36. DC is a private holding corporation and all of Holdco1, Holdco2 and Holdco3 will be private holding corporations.

37. The common shares of DC are not taxable preferred shares.

RULINGS

Provided that the above statements are accurate and constitute complete disclosure of all of the relevant facts, purposes of the proposed transactions and proposed transactions, we confirm the following:

A. Subsection 85(1) will apply to the transfer of the shares of DC by Sib1 to Holdco1, Sib2 to Holdco2 and Sib3 to Holdco3 as described in paragraphs 16 to 20, in respect of which an election under subsection 85(1) will be made. The agreed amount in respect of each transfer of such property will be deemed to be the transferor's proceeds of disposition and the transferee's cost thereof pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

B. Subsection 85(1) will apply, subject to the application of subsection 69(11), to the transfer of each eligible property by DC to Holdco1, Holdco2 and Holdco3 as described in paragraphs 22 to 24, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of each transfer of each eligible property will be deemed to be DC's proceeds of disposition and each transferee corporation's cost thereof pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

C. Provided that DC does not control Holdco1, Holdco2 and Holdco3, directly or indirectly in any manner whatever and provided that none of Holdco1, Holdco2 and Holdco3 controls DC, directly or indirectly in any manner whatever prior to, or as a consequence of, the proposed transactions, and provided that none of the loss properties or properties identical thereto will be acquired by any person affiliated with DC during the period that begins 30 days before and ends 30 days after the transfers described in paragraph 22, paragraph 40(3.4)(a) will not apply to deem a capital loss realized by DC on the disposition of a loss property, as described in paragraph 11, to be nil and any net capital loss of DC for the taxation year as a result of the disposition of the loss properties will be deductible in computing its taxable income, subject to the restrictions in subsection 111(1.1) and within the time specified in paragraph 111(1)(b).

D. On the redemption by Holdco1, Holdco2 and Holdco3 of the Class B special shares held by DC and as a result of the distributions by DC in the course of its winding-up:

(a) by virtue of paragraphs 84(3)(a) and 84(3)(b), each of Holdco1, Holdco2 and Holdco3 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 to redeem the Class B special shares exceeds the PUC of those shares immediately before the redemption;

(b) (i) pursuant to paragraph 88(2)(b) and subsection 84(2), but subject to (ii) and (iii) herein, each of Holdco1, Holdco2 and Holdco3 will be deemed to have received a dividend (the "winding-up dividend") on their common shares and Class D shares of DC, as the case may be, equal to the proportion of the amount by which the aggregate fair market value of the property of DC distributed by DC on the winding-up exceeds the amount by which the PUC of the common shares and the Class D shares, as the case may be, is reduced that the number of shares of such class held by the particular corporation is of the number of issued shares of that class;

(ii) pursuant to subparagraph 88(2)(b)(i), such portion of the winding-up dividend as does not exceed DC's CDA determined immediately before the payment of the winding-up dividend will be deemed to be the full amount of a separate dividend; and

(iii) pursuant to subparagraph 88(2)(b)(iii), the winding-up dividend, to the extent that it exceeds the portion thereof referred to in (ii) herein that is deemed to be a separate dividend, will be deemed to be a separate dividend that is a taxable dividend;

(c) to the extent that the deemed dividends described in (a) and (b) above are taxable dividends, such dividends will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient for the year in which the dividends are 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); and

(d) the amount of the deemed dividends described in (a) and (b) above will, by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54, be excluded from the proceeds of disposition of the shares and any loss arising from such disposition of those shares will be reduced by the amount of such dividends pursuant to subsection 112(3).

E. With respect to the dividends described above:

(a) the taxable dividends will not be subject to tax under Part IV.1 on the basis that such dividends will be excepted dividends by virtue of paragraph (c) of the definition of "excepted dividend" in section 187.1; and

(b) the taxable dividends will not be subject to tax under Part VI.1 on the basis that each such dividend will be an "excluded dividend" by virtue of paragraph 191(1)(b).

F. The common shares of DC will not become taxable preferred shares as a result of the proposed transactions, in and of themselves.

G. By virtue of paragraph 186(4)(a), each of Holdco1, Holdco2 and Holdco3 will be connected with DC and DC will be connected with each of Holdco1, Holdco2 and Holdco3 immediately before the transactions described paragraphs 25 to 30. Consequently, tax under Part IV will only be exigible to the extent provided for in paragraph 186(1)(b).

H. Provided that, as part of the series of transactions or events that include these 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 subparagraph 55(3.1)(b)(iii);

(d) an acquisition of property in the circumstances described in paragraph55(3.1)(c); or

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

which has not been described herein, by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends referred to in Ruling D above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

I. The settlement of the Holdco1 note, the Holdco2 note and the Holdco3 note will not give rise to a "forgiven amount" within the meaning of subsection 80(1).

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

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

These rulings are given subject to the qualifications and limitations set forth in Information Circular 70-6R4 issued on January 29, 2001, and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions described herein are completed before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any amendments thereto which if enacted could have an effect on the rulings provided herein.

COMMENTS

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

(a) the determination of the ACB, PUC or FMV of any shares referred to herein; or

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

2. In particular we are not confirming that a disposition by Holdco 1, Holdco 2, Holdco 3, would:or

(a) be in the ordinary course of business for purposes of paragraph 55(3.1)(c); or

(b) not be part of the series of transactions that includes the reorganization, for purposes of paragraph 55(3.1)(c).

Those determinations can only be made after a review of all the circumstances of any such disposition.

Yours truly,

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