2001 Ruling 2001-0103653 - 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: Standard 55(3)(b) butterfly of rental properties to shareholders on a net equity basis.

Position: Favourable ruling provided to taxpayers.

Reasons: Proposed transaction complies with section 55(3)(b)

XXXXXXXXXX 2001-010365
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: ADVANCE INCOME TAX RULING
XXXXXXXXXX ("DCo")
XXXXXXXXXX ("CCo")
XXXXXXXXXX ("BCo")
XXXXXXXXXX ("ACo")

XXXXXXXXXX ("Mr. A")

XXXXXXXXXX ("Mr. B")

This is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling on behalf of the above named taxpayers. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX/van Voorst).

We understand that, to the best of your knowledge and that of DCo, CCo, BCo, ACo, and Mr. A (collectively "the taxpayers"), none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayers or a related person,

(ii) is being considered by a tax services office or taxation center in connection with a previously filed tax return of the taxpayers or a related person,

(iii) is under objection by the taxpayers or a related person,

(iv) is before the courts or, if a judgment 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.

You advised that the proposed transactions described herein, will have no impact on the ability of the taxpayers or related persons to pay their outstanding tax liabilities.

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

DEFINITIONS

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

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

(b) "ACB" means "adjusted cost base" which 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 an election under subsection 85(1);

(d) XXXXXXXXXX;

(e) "cash or near cash" means current assets and similar assets including cash, short-term deposits, accounts receivable, inventory, prepaid expenses, and marketable securities and similar investments (other than marketable securities and similar instruments held as portfolio investments);

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

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

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

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

(j) "CCo" means XXXXXXXXXX;

(k) "distribution" has the meaning assigned by subsection 55(1);

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

(m) "dividend rental arrangement" has the meaning assigned by subsection 248(1);

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

(o) "FMV" means fair market value;

(p) "financial intermediary corporation" has the meaning assigned by subsection 191(1);

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

(r) "BCo" means XXXXXXXXXX;

(s) "Mr. A" means XXXXXXXXXX;

(t) "Mr. B" means XXXXXXXXXX;

(u) "ACo" means XXXXXXXXXX;

(v) "permitted exchange" has the meaning assigned by subsection 55(1);

(w) "prepaid expenses" means rights arising from the prepayment of expenses;

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

(y) "PUC" means "paid-up capital" which has the meaning assigned by subsection 89(1);

(z) "RDTOH" means "refundable dividend tax on hand" which has the meaning assigned by subsection 129(3);

(aa) "related group" has the meaning assigned by subsection 251(4);

(bb) "series of transactions or events" has the meaning assigned by subsection 248(10);

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

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

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

(ff) "taxable preferred share" has the meaning assigned by subsection 248(1); and

(gg) "TCC" means "taxable Canadian corporation" which has the meaning assigned by subsection 89(1).

FACTS

1. DCo was incorporated under the XXXXXXXXXX. DCo is a CCPC and a TCC. The taxation year-end of DCo is XXXXXXXXXX. DCo deals with the XXXXXXXXXX Tax Services Office and files its corporate income tax returns at the XXXXXXXXXX Taxation Centre.

The authorized capital of DCo consists of:

? XXXXXXXXXX common shares (the "Common Shares") without par value;
? XXXXXXXXXX , preferred shares with a par value of XXXXXXXXXX each;
? XXXXXXXXXX , preferred shares with a par value of XXXXXXXXXX each;
? XXXXXXXXXX , preferred shares with a par value of XXXXXXXXXX each; and
? XXXXXXXXXX , preferred shares with a par value of XXXXXXXXXX each.

Pursuant to XXXXXXXXXX, the capital of the issued Common Shares is $XXXXXXXXXX in aggregate and the capital of each class of preferred shares is $XXXXXXXXXX.

2. The shareholdings of DCo are detailed in the following schedule:

Shareholder
Number
Class
Redemption
Amount
BCo
XXXXXXXXXX
Common Shares

CCo
XXXXXXXXXX
Common Shares

CCo
XXXXXXXXXX
XXXXXXXXXX
$XXXXXXXXXX
CCo
XXXXXXXXXX
XXXXXXXXXX
$XXXXXXXXXX
BCo
XXXXXXXXXX
XXXXXXXXXX
$XXXXXXXXXX

Mr. A

XXXXXXXXXX
XXXXXXXXXX
$XXXXXXXXXX

The shares of DCo constitute capital property to each shareholder of DCo. The FMV of each shareholder's shares of DCo exceeds the ACB of the shares to the shareholder.

The ACB of the shares of DCo to each shareholder is nominal, except for BCo's XXXXXXXXXX Common Shares that have an ACB of $XXXXXXXXXX in total.

3. DCo has made advances to ACo and CCo of approximately $XXXXXXXXXX respectively. DCo has received advances from ACo and CCo of approximately $XXXXXXXXXX respectively. The advances referred to herein are interest-bearing without specific repayment terms and payable on demand.

4. CCo was incorporated under the XXXXXXXXXX. CCo is a CCPC and a TCC. The taxation year-end of CCo is XXXXXXXXXX. CCo deals with the XXXXXXXXXX Tax Services Office and files its corporate income tax returns at the XXXXXXXXXX Taxation Centre.

5. Mr. A, ACo and BCo are related. CCo is not related to Mr. A, ACo or BCo. CCo is related to Mr. B.

6. BCo has a taxation year-end of XXXXXXXXXX. ACo has a taxation year-end of XXXXXXXXXX.

7. CCo owns shares of the capital stock of DCo representing XXXXXXXXXX% of the voting shares of DCo and XXXXXXXXXX% of the total FMV of all of the issued shares of DCo.

8. DCo has capital loss carry-forwards available of $XXXXXXXXXX.

9. The preferred shares of DCo are not shares of a "specified class" as defined in subsection 55(1).

10. DCo's property consists of cash or near cash, and long-term investments in real estate (collectively "Investment property").

11. At the time of the distribution the assets of DCo will consist of the following:

a) Cash or near cash of approximately $XXXXXXXXXX; and

b) Investment property as follows:

Capital property which consists of two real estate rental properties (referred to herein as "XXXXXXXXXX" and "XXXXXXXXXX") that have net book values, FMV's and mortgages payable thereon summarized as at XXXXXXXXXX as follows:

a) XXXXXXXXXX

i. Net book value of land, building, furniture and paving $XXXXXXXXXX

ii. FMV $XXXXXXXXXX

iii. Mortgage payable $XXXXXXXXXX

b) XXXXXXXXXX

i. Net book value of land, building, furniture and paving $XXXXXXXXXX

ii. FMV $XXXXXXXXXX

iii.Mortgage payable $XXXXXXXXXX

Legal title to XXXXXXXXXX is held by another TCC as bare trustee for DCo, the beneficial owner. References to a transfer of this real property are references to the transfer of beneficial interest in the property.

12. It is intended that the XXXXXXXXXX real estate property and CCo's share of DCo's cash or near cash would be distributed to CCo on a "net equity basis", (the "DCo Butterfly").

PROPOSED TRANSACTIONS (Prior to XXXXXXXXXX)

13. CCo will incorporate a new corporation ("Subco") under the XXXXXXXXXX . Subco will be a TCC and a CCPC. Subco's authorized share capital will consist of XXXXXXXXXX voting common shares having no par value and XXXXXXXXXX shares. The XXXXXXXXXX shares will be voting, redeemable, retractable preferred shares with a par value of $XXXXXXXXXX each. The redemption value of the XXXXXXXXXX shares will be determined at the time the shares are issued and defined as being an amount equal to the FMV of the consideration received by Subco for the issuance of such shares.

The rights and restrictions of the XXXXXXXXXX shares will specify an amount in respect of each such share for purposes of subsection 191(4). The amount specified in respect of each such share, at the time of issuance, will be expressed as a dollar amount, will not be determined by a formula or subject to change thereafter and will not exceed the FMV of the consideration for which each such share will be issued.

14. Mr. B will subscribe for 1 common share of Subco as nominee of CCo.

PROPOSED TRANSACTIONS (XXXXXXXXXX)

15. ACo and CCo will repay their advances from DCo.

16. DCo will then repay the advances from ACo and CCo.

17. CCo will transfer, at FMV, all of its common shares, XXXXXXXXXX preferred shares, and XXXXXXXXXX preferred shares of DCo (being all of CCo's shares of the capital stock of DCo) to Subco, and will receive, as sole consideration therefor, XXXXXXXXXX common shares of Subco (including the one share subscribed for in paragraph 14 above) having a FMV equal to the FMV of the DCo shares transferred.

CCo and Subco will jointly elect in prescribed form within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the shares of DCo to Subco. The agreed amount in respect of the shares will be an amount equal to the lesser of (i) the adjusted cost base of the shares, and (ii) the FMV of the shares.

18. Immediately before the transfers described in paragraph 20 below ("DCo Butterfly"), the property owned by DCo will be classified into the following three categories:

(a) cash or near cash property, comprising all of the current assets and similar assets of DCo including cash, short-term deposits, accounts receivable, inventory, prepaid expenses, and marketable securities and similar investments (other than marketable securities and similar instruments held as portfolio investments);

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

(c) investment property, comprising all of the assets of DCo, other than any cash or near cash property, any income from which would be income from property or from a specified investment business (including marketable securities and similar instruments held as portfolio investments).

DCo will not have any business property at the time of the DCo Butterfly. For greater certainty, any tax accounts, such as the balance of any losses available for carryforward, RDTOH, or capital dividend account of DCo, will not be considered property for purposes of the Proposed Transactions.

19. In determining the net fair market value of each type of property of DCo immediately before the transfers of property described in paragraph 20 below, the liabilities of DCo will be allocated to, and deducted in the calculation of, the net fair market value of each type of property of DCo, as follows:

(a) current liabilities of DCo will be allocated to cash or near cash property in the proportion to, and to the extent that, the FMV of each such property is of the FMV of all cash or near cash property;

(b) liabilities of DCo, other than current liabilities, that relate to a particular property will then be allocated to the type to which the particular property belongs to the extent of its FMV. 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; and

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

For greater certainty, deferred income taxes payable (or future income taxes payable) do not represent a liability of DCo to be allocated as described herein to the various types of property owned by DCo.

20. Immediately following the determination of the net fair market value of its cash or near cash property and investment property, as described above in paragraphs 18 and 19, DCo will transfer to Subco a pro-rata share of all of its cash or near cash property and investment property in a manner such that the net fair market value of the cash or near cash property and investment property so transferred to Subco will be equal to that proportion of the net fair market value of all the cash or near cash property and investment property of DCo, immediately before the transfer, that:

(a) the aggregate FMV, immediately before the DCo Butterfly, of the DCo shares owned by Subco,

is of

(b) the aggregate FMV, immediately before the DCo Butterfly, of all the issued shares of the capital stock of DCo.

Subco's pro-rata share of DCo's Investment property will be represented by the XXXXXXXXXX rental property, net of that portion of the mortgage on such property to be assumed by Subco.

21. As consideration for the property so transferred on the DCo Butterfly, Subco will:

(a) assume liabilities of DCo not exceeding the aggregate of (i) the agreed amounts, determined under paragraph 22 below, in respect of any eligible property transferred and (ii) the FMV of the properties that are transferred that are not eligible properties, and

(b) issue to DCo XXXXXXXXXX shares having an aggregate redemption price and aggregate FMV equal to the amount by which the aggregate FMV of the properties so transferred exceeds the liabilities assumed.

22. DCo and Subco will jointly elect in prescribed form within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each property of DCo that is an eligible property transferred to Subco. The agreed amount in respect of such property so transferred will be:

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

(b) in the case of land, an amount equal to the lesser of (i) the adjusted cost base of the land plus $XXXXXXXXXX and (ii) the FMV of the land; and

(c) 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).

It is the intent that the agreed amount chosen for the land transferred will result in a capital gain being recognized by DCo on the disposition equal to $XXXXXXXXXX, being Subco's share of the capital loss carryforward in DCo.

23. DCo will repurchase the XXXXXXXXXX common shares, and will redeem the XXXXXXXXXX preferred shares held by Subco (being all of Subco's shares of the capital stock of DCo) for a non-interest-bearing demand note ("DCo Note") acknowledging an indebtedness equal to the aggregate FMV of the shares repurchased and the shares redeemed. Subco will accept the DCo Note in full satisfaction of the purchase price and redemption amounts of the shares.

24. Subco will pay a cash dividend to CCo on its common shares in the amount of approximately XXXXXXXXXX -times DCo's dividend refund for its XXXXXXXXXX taxation year multiplied by XXXXXXXXXX%. The purpose of the dividend is to transfer CCo's portion of the RDTOH generated from DCo's fiscal XXXXXXXXXX rental income from Subco to CCo.

DCo, Subco, CCo, and BCo will each have a taxation year ending on XXXXXXXXXX.

PROPOSED TRANSACTIONS (XXXXXXXXXX)

25. Subco will redeem all of the XXXXXXXXXX shares held by DCo for a non-interest-bearing demand note ("Subco Note") acknowledging an indebtedness equal to the aggregate redemption amount of the XXXXXXXXXX shares, as described in paragraph 21. DCo will accept the Subco Note in full satisfaction of the redemption amount of the XXXXXXXXXX shares.

26. DCo Note and Subco Note will be set off against each other and cancelled in full satisfaction of the obligations under each note.

PROPOSED TRANSACTIONS (XXXXXXXXXX)

27. CCo and Subco (referred to in this paragraph as "predecessor corporations") will amalgamate under the provisions of the XXXXXXXXXX to form a new corporation ("New CCo") in such a manner that:

(a) all of the property (except any amounts receivable from any predecessor corporation or shares of the capital stock of any predecessor corporation) of the predecessor corporations immediately before the merger will become property of New CCo by virtue of the merger;

(b) all of the liabilities (except any amounts payable to any predecessor corporation) of the predecessor corporations immediately before the merger will become liabilities of New CCo by virtue of the merger; and

(c) all shares of Subco will be cancelled on the amalgamation and the shareholders of CCo will be the shareholders of New CCo.

The amalgamation of CCo and Subco will limit the amount of Part IV tax payable by virtue of paragraph 186(1)(b) by DCo on the redemption of the Subco XXXXXXXXXX shares to the RDTOH of Subco at its year-end immediately before the amalgamation.

ADDITIONAL INFORMATION

28. The transactions are scheduled to take place over the year-end of DCo, CCo and Subco.

29. BCo and Mr. A will remain as shareholders of DCo.

30. There are not, and will not be at any time prior to the completion of the Proposed Transactions, any agreements or undertakings which constitute or include a guarantee agreement in respect of any issued share of DCo or Subco.

31. Neither DCo nor Subco has entered into a dividend rental arrangement in respect of any of the shares to be redeemed or repurchased as part of the Proposed Transactions.

32. None of the issued shares of any corporation described herein was 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).

33. The common shares of DCo are not, and will not be at any time before completion of the proposed transactions described herein, taxable preferred shares.

34. Neither DCo nor Subco is, or will be, at any time before completion of the proposed transactions described herein, a specified financial institution.

35. No property has or will become property of DCo in contemplation of and before the distribution by DCo of its assets, other than as described herein.

DCo will not issue, redeem or cancel any shares as part of the series of transactions that includes the DCo Butterfly, other than as described herein.

36. No person (the "Vendor") who is a shareholder of DCo, a specified shareholder of Subco, or a specified shareholder of BCo will, as part of the series of transactions or events that includes the DCo Butterfly, dispose of any share of DCo, CCo or BCo or any property deriving, at any time during the series of transactions or events that includes the DCo Butterfly, 10% or more of its value from any such share, to a person who is not related to the Vendor or who ceases to be related to the Vendor as part of the series of transactions or events or to a partnership, other than as described herein.

37. Other than on the amalgamation of CCo and Subco, Subco will not dispose of more than a 10% interest in the XXXXXXXXXX property received by it during the DCo Butterfly to a person who is not related to Subco or who as part of the series of transactions ceases to be related to Subco or to a partnership.

38. DCo will not as part of the series of transactions or events that includes the DCo Butterfly, dispose of more than 10% of the FMV of the XXXXXXXXXX property that it continues to own after the DCo Butterfly, to a person who is not related to DCo, or as part of the series of transactions or events, ceases to be related to DCo or to a partnership.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the reorganization is to distribute each type of property of DCo pro-rata to one of its shareholders so as to leave each shareholder of DCo in a position to manage its own affairs.

RULINGS REQUESTED AND GIVEN

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

We confirm that

A. Subsection 84(3) will apply on the repurchase of the DCo common shares as described in paragraph 23 and on the redemption of the XXXXXXXXXX preferred shares as described in paragraph 23 to deem DCo to have paid and Subco to have received a dividend at that time on such shares equal to the amount, if any, by which the amount paid in respect of such repurchase or redemption exceeds the PUC in respect of those shares immediately before such repurchase or redemption.

B. Subsection 84(3) will apply on the redemption of the XXXXXXXXXX shares of Subco as described in paragraph 25 to deem Subco to have paid and DCo to have received a dividend at that time on such shares equal to, the amount, if any, by which the amount paid in respect of the redemption exceeds the PUC, immediately before such redemption, of such XXXXXXXXXX shares redeemed.

C. Any such dividend referred to in Ruling A or B above;

(a) will be included in computing the income, pursuant to subsection 82(1) and paragraph 12(1)(j), of the person deemed to have received such dividend;

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

(c) will be excluded in determining the proceeds of disposition to the recipient of the shares so redeemed or repurchased pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54;

(d) will reduce the loss, if any, in respect of the disposition of the shares on which the dividend is deemed to be received by virtue of subsection 112(3);

(e) will not be subject to tax under Part IV.1 because the dividends will be excepted dividends pursuant to paragraph (c) of the definition of "excepted dividend" in section 187.1;

(f) the taxable deemed dividends referred to in Ruling A above will not be subject to tax under Part VI.1 on the basis that Subco will have a substantial interest, within the meaning assigned by paragraph 191(2)(b), in DCo at the time such taxable dividends are paid and, therefore, such dividends will be "excluded dividends" within the meaning of subsection 191(1); and

(g) provided that the amount paid on the redemption of the XXXXXXXXXX shares of Subco is equal to the amount specified in respect of such shares as described in paragraph 13, the dividends described in Ruling B will not be subject to tax under Part VI.1 of the Act on the basis that such dividends will be deemed by paragraph 191(4)(d) to be an "excluded dividend" as defined in subsection 191(1).

D. Provided that as part of the series of transactions or events that includes the DCo Butterfly:

(a) there is not a disposition of property in the circumstances described in subparagraph 55(3.1)(b)(i);

(b) there is not an acquisition of control in the circumstances described in subparagraph 55(3.1)(b)(ii);

(c) there is not an acquisition of shares in the circumstances described in subparagraph 55(3.1)(b)(iii)

(d) there is not an acquisition of property in the circumstances described in paragraph 55(3.1)(c); and

(e) there is not an acquisition of property in the circumstances described in paragraph 55(3.1)(d)

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

E. The provisions of subsection 55(2) of the Act will not apply to the taxable dividend received by Cco as described in paragraph 24.

F. The set off of the DCo Note and Subco Note against each other will not give rise to a "forgiven amount" within the meaning of subsection 80(1) or 80.01(1).

G. The provisions of subsections 15(1), 56(2), 56(4), and 246(1) will not apply to any of the transactions described herein, in and of themselves.

OTHER COMMENTS

Nothing in this ruling should be construed as implying that Canada Customs and Revenue Agency is making a determination or ruling in respect of:

(a) the cost or fair market value of any particular asset;

(b) the paid-up capital of any shares referred to herein;

(c) the balance of the capital dividend account or the refundable dividend tax on hand of any corporation; or

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

The rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001 and is binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

Yours truly,

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