2003 Ruling 2002-0157683 - 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.

Position: Acceptable.

Reasons: No contentious issues.

XXXXXXXXXX 2002-015768

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

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 taxpayers. We also acknowledge receipt of your facsimiles and emails as well as the information provided in various telephone conversations.

Throughout this letter, certain individuals and corporations will be referred to as follows:

XXXXXXXXXX . Aco
XXXXXXXXXX . Bco
XXXXXXXXXX . Cco
XXXXXXXXXX . Dco
XXXXXXXXXX X
XXXXXXXXXX Y

Aco, Bco, Cco, X and Y file their income tax returns at the XXXXXXXXXX Taxation Centre and their tax affairs are administered by the XXXXXXXXXX Tax Services Office.

To the best of your knowledge, and that of any of the Taxpayers, none of the issues involved in this ruling request is:

(i) involved in an earlier return of any 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 any of the Taxpayers or a related person;

(iii) under objection by any of the Taxpayers or a related person;

(iv) before the courts; or

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

The Proposed Transactions described herein will not result in any of the Taxpayers being unable to pay its outstanding tax liabilities.

Unless otherwise indicated, all references to monetary amounts are in Canadian dollars.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.1, 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" ("ACB") 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) "BCA" means the Business Corporations Act XXXXXXXXXX;

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

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

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

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

(i) "depreciable property" has the meaning assigned by subsection 13(21);

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

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

(l) "FMV" means fair market value;

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

(n) "Paragraph" refers to a numbered paragraph in this letter;

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

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

(q) "Proposed Transactions" means the transactions described in Paragraphs 10 to 19 below;

(r) "refundable dividend tax on hand" ("RDTOH") has the meaning assigned by 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) "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" and "stated capital account" have the meanings assigned by section XXXXXXXXXX of the BCA;

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

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

(z) "Taxpayers" refers to Aco, Bco, Cco, X and Y; and

(a.1) "undepreciated capital cost" ("UCC") has the meaning assigned by subsection 13(21).

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

FACTS

1. X and Y are adults and unrelated to each other. They are both residents of Canada for the purposes of the Act.

2. The issued and outstanding shares of Aco consist of a single class of common shares. X and Y are the only shareholders of Aco. X owns XXXXXXXXXX Aco common shares and Y owns XXXXXXXXXX Aco common shares. The Aco common shares have a nominal ACB and PUC.

3. The assets of Aco consist of:

(a) XXXXXXXXXX% of the shares of Bco having a nominal PUC and ACB. The remaining XXXXXXXXXX% of the shares of Bco are held by XXXXXXXXXX, a corporation solely owned by XXXXXXXXXX , who is a cousin to Y.

(b) XXXXXXXXXX% of the shares of Dco together with a shareholder advance of XXXXXXXXXX% of the total shareholder advances to Dco. The remaining shares of Dco are owned by unrelated third parties.

(c) Cco preferred shares having a nominal PUC and ACB and an aggregate redemption amount of $XXXXXXXXXX. The preferred shares were issued on a transfer of property by Aco to Cco pursuant to section 85 many years ago. That transfer is not part of the same series of transactions as the Proposed Transactions.

(d) XXXXXXXXXX buildings as follows:

(i) XXXXXXXXXX;

(ii) XXXXXXXXXX;

(iii) XXXXXXXXXX;

(iv) XXXXXXXXXX;

(v) XXXXXXXXXX; and

(e) Miscellaneous current assets.

4. All of the real estate has been owned by Aco for a significant period of time and is capital property to Aco.

5. The assets of Bco consist of a XXXXXXXXXX building, XXXXXXXXXX, and miscellaneous current assets and inter-corporate accounts.

6. The property of Cco consists of a XXXXXXXXXX building, XXXXXXXXXX.

7. At their most recent year-ends, none of Aco, Bco or Cco had any balances in their RDTOH or CDA accounts.

8. Neither X nor Y desires to own XXXXXXXXXX, described in Paragraph 3(d)(i) above, as it is located in XXXXXXXXXX and is some distance from the remaining real estate thereby causing additional expense and difficulty with respect to maintenance, collecting rents, etc. X and Y are therefore proposing to list this property for sale for cash consideration. Any net cash received on the sale of the property will be divided proportionately between them.

9. The common shares of Cco are held by XXXXXXXXXX The PUC and ACB of the common shares is approximately $XXXXXXXXXX and the FMV is estimated to be $XXXXXXXXXX.

PROPOSED TRANSACTIONS

10. Y will incorporate a new corporation (referred to as "Yco") pursuant to the BCA. The authorized capital of Yco will include Class A Voting Common Shares and two classes of Preferred Shares (Class B Preferred Shares and Class C Preferred Shares) all in an unlimited number. The Preferred Shares will have the following attributes:

(a) redeemable and retractable for a redemption amount equal to the fair market value of the property received therefor (net of liabilities assumed) by the corporation at the time of issuance;

(b) entitled to a non-cumulative dividend at the fixed rate of XXXXXXXXXX% per annum (or such greater amount as may be set by the directors of the corporation from time to time, not to exceed a reasonable amount) of the redemption amount;

(c) entitled to a return of the redemption amount on a liquidation, dissolution, or winding-up of the corporation in preference to the common shares;

(d) may be purchased, redeemed or cancelled by the corporation in the manner provided in the BCA at the option of either the corporation or the holder for a price not less than the lesser of:

(i) the aggregate redemption amount of such shares to be purchased at the particular time; and

(ii) the realizable value of the net assets of the corporation immediately before such purchase;

(e) any preference, right, condition or limitation attaching to the Preferred Shares can only be amended by a special resolution of the holders of each class of shares of the corporation each voting separately as a class;

(f) a restriction on the payment of dividends on other classes of shares so that no such dividends may be paid on any other class of shares of the corporation so as to reduce the value of the Preferred Shares then outstanding; and

(g) the holders of the Class C Preferred Shares will be entitled to one vote per share at all meetings of the shareholders. The Class B Preferred Shares will be non-voting except as provided for by the BCA.

For the purposes of subsection 191(4), the terms or conditions of the Class C Preferred Shares will specify an amount in respect of each such share, to be designated by a resolution of the directors at the time of their issue, for which the share is to be redeemed, acquired or cancelled. The amount specified in respect of each such share at the time of issue 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 the share will be issued.

11. The Cco common shares held by the XXXXXXXXXX children will be repurchased by Cco at fair market value, which will result in a deemed divided to the children equal to the difference between the repurchase amount and the paid-up capital of the shares so repurchased.

12. Y will subscribe for XXXXXXXXXX Class A Common Shares of Yco for nominal consideration.

13. Y will transfer all of his XXXXXXXXXX common shares of Aco to Yco pursuant to subsection 85(1) at fair market value. The sole consideration paid by Yco will be the issuance of non-voting Class B Preferred Shares having an aggregate redemption amount and retraction amount equal to the fair market value of the transferred Aco shares. For purposes of the BCA, the addition to the stated capital of the Yco Class B Preferred Shares will be $XXXXXXXXXX. Y and Yco will elect, jointly and 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 the Aco common shares to Yco. The agreed amount specified in the election will be equal to the ACB to Y of the transferred shares immediately before the transfer, which amount will not exceed the fair market value of such shares at the time of transfer.

14. Immediately before the transfer of property described in Paragraph 16 below, the property owned by Aco will be determined on a consolidated look-through basis by including the appropriate pro-rata share of the assets of the corporations over which Aco has the ability to exercise significant influence, namely Bco and Dco, and all such property will be classified into the following three types of property for the purposes of a distribution pursuant to paragraph 55(3)(b), as follows:

(a) cash or near-cash property, comprising all of the current assets of Aco, including cash in bank accounts and investment accounts, mortgages and notes receivable, GICs, T-Bills, commercial paper, deposits and prepaid expenses;

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

For the purposes of this distribution, the rental properties of Aco (net of related long-term debt) will be categorized as investment property.

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

For greater certainty, the FMV of the shares of Bco and Dco held by Aco and of any indebtedness receivable by Aco from Bco and Dco will be allocated among the three types of property described above by multiplying the FMV of the shares of the particular corporation or amount of indebtedness receivable from the particular corporation, as the case may be, by the proportion that the net FMV of each type of property owned by the particular corporation (as determined in this Paragraph and Paragraph 15 below) is of the total net FMV of all the property owned by the particular corporation.

15. In determining, on a consolidated look-through basis, the net FMV of each type of property of Aco, the liabilities of Aco, Bco and Dco will be allocated to, and will be deducted in the calculation of, the net FMV of each type of property of the particular corporation in the following manner:

(a) current liabilities of the particular corporation will be allocated to the cash or near-cash property of that corporation in the proportion that the FMV of each such property is of the FMV of all cash or near-cash property owned by that corporation. To the extent that the total current liabilities so allocated exceed the total FMV of all cash or near-cash property of that particular corporation, that corporation will be considered to have a negative amount of cash or near-cash property;

(b) liabilities, other than current liabilities, of the particular corporation that relate to a particular property will then be allocated to the particular property (and effectively to the type of property 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. To the extent that the allocation of liabilities to a type of property, as described herein, exceeds the total FMV of that type of property of that particular corporation, that corporation will be considered to have a negative amount of that type of property; and

(c) any liabilities, other than current liabilities, of the particular corporation which do not relate to a type of property will then be allocated to the cash or near-cash property, investment property and business property of that corporation based on the relative net FMV of each type of property prior to the allocation of such liabilities, but after the allocation of liabilities described in Paragraphs 15(a) and (b) above.

16. Aco will then transfer to Yco a portion of its cash or near-cash property, investment property and business property such that the net FMV of each type of property so transferred to Yco (after allocating and deducting, in the manner described in Paragraph 15 above, the liabilities of Aco which are to be assumed by Yco) will be equal to the proportion of the net FMV of all property of Aco of that type determined immediately before such transfer that

(a) the aggregate FMV, immediately before the transfer, of all of the shares of the capital stock of Aco owned by Yco at that time

is of

(b) the aggregate FMV, immediately before the transfer, of all of the issued and outstanding shares of the capital stock of Aco at that time.

More specifically, the following properties are to be transferred to Yco:

Asset FMV
Dco common shares XXXXXX of the FMV of the Dco shares and
advances held by Aco
Bco common shares $XXXXXXXXXX
Cco preferred shares $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
Net current assets XXXXXXXXXX of the FMV

For greater certainty, XXXXXXXXXX is excluded from the properties that are the subject of the distribution since it will be sold for cash consideration prior to the distribution and the proceeds distributed proportionately.

As consideration for the property so transferred, Yco will assume certain liabilities of Aco, and Aco will receive XXXXXXXXXX voting Class C Preferred Shares in the capital of Yco. The aggregate redemption amount and retraction amount of the XXXXXXXXXX Class C Preferred Shares will be equal to the FMV of the property transferred, net of liabilities assumed. Pursuant to subsection XXXXXXXXXX of the BCA, the addition to the stated capital of the Class C Preferred Shares will be equal to the aggregate cost (determined pursuant to subsection 85(1), where relevant) of the transferred property, net of liabilities assumed.

In respect of the transfer of property described above, Aco and Yco will elect, jointly and 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 eligible property from Aco to Yco. The agreed amount specified in each election in respect of an eligible property so transferred that has an FMV in excess of its cost amount to Aco will be an amount that is not less than the least of:

(a) the amounts specified in subparagraphs 85(1)(d)(i), (ii) or (iii) in the case of eligible capital property, if any;

(b) the amounts specified in subparagraphs 85(1)(e)(i), (ii) or (iii) in the case of depreciable property of a prescribed class; and

(c) the amounts specified in subparagraphs 85(1)(c.1)(i) or (ii) in the case of capital property (other than depreciable property of a prescribed class).

In each case, the agreed amount will not exceed the FMV of the respective property immediately before the transfer, nor will it be less than the amount permitted under paragraph 85(1)(b).

17. Immediately following the transfer of property described in Paragraph 16 above, the XXXXXXXXXX Class C Preferred Shares of Yco owned by Aco will be redeemed for their FMV. Yco will pay the redemption amount by issuing a non-interest-bearing demand promissory note payable to Aco (the "Yco Note") having a principal amount and FMV equal to the aggregate FMV of the XXXXXXXXXX Class C Preferred Shares. Aco will accept the Yco Note as full payment of the redemption amount of the XXXXXXXXXX Class C Preferred Shares with the risk of the Yco Note being dishonoured.

18. Aco will repurchase and cancel the XXXXXXXXXX Aco common shares held by Yco for an amount equal to their FMV. Aco will pay the purchase price by issuing a non-interest-bearing demand promissory note payable to Yco (the "Aco Note") having a principal amount and FMV equal to the aggregate FMV of the repurchased shares. Yco will accept the Aco Note as full payment of the repurchase amount of the XXXXXXXXXX Aco common shares with the risk of the Aco Note being dishonoured.

19. Yco will repay the principal amount of the Yco Note by setting off and cancelling the Aco Note and transferring it to Aco in return for the cancellation and transfer back to Yco of the Yco Note by Aco. Both the Aco Note and the Yco Note will be marked "Paid In Full" and cancelled.

ADDITIONAL INFORMATION

20. None of the corporations referred to herein is, or will be at any time during the Proposed Transactions, a specified financial institution or a restricted financial institution.

21. No property has or will become property of Aco, Bco, Cco or Dco, or of any corporation controlled by any of them, and no liabilities have been or will be incurred by any of the them or by any corporation controlled by any of them, in contemplation of and before the proposed transfer of property described in Paragraph 16 above, except as described herein.

22. None of the individuals and corporations described herein has any intention of disposing of any assets currently owned by it as part of a series of transactions which include the Proposed Transactions, or will dispose of any of its assets to an unrelated person subsequent to the Proposed Transactions, except as described herein.

23. None of the shares referred to herein, including the shares to be issued as described in the Proposed Transactions, are 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) the subject of a dividend rental arrangement referred to in subsection 112(2.3) as that term is defined in subsection 248(1); or

(c) 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).

24. None of the corporations described herein or any transferee corporation has been, or will be, at any time before the completion of the Proposed Transactions described herein, a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1).

25. Each of the corporations involved and each transferee corporation 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.

26. Neither X nor Y is contemplating an acquisition of control of any corporation described herein or of any transferee or other corporation, except as described herein.

PURPOSE OF THE PROPOSED TRANSACTIONS

27. X and Y wish to separate their interests from each other in order to pursue their own individual investment and estate planning objectives.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purposes 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 20(1.2) and 26(5) of the Income Tax Application Rules, and of paragraph 88(2.2)(b), which applies for the purpose stated in the preamble to subsection 88(2.2), the provisions of subsection 85(1) will apply to:

(a) the transfer of the shares of Aco held by Y to Yco, as described in Paragraph 13 above; and

(b) the transfer of each eligible property of Aco to Yco, as described in Paragraph16 above;

such that the agreed amount in respect of each such transfer will be deemed to be the transferor's proceeds of disposition of the property and the transferee's cost thereof, and the transferor's cost of the shares received as consideration for the disposition. For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to herein.

B. As a result of the redemption or purchase for cancellation of shares in the transactions described in Paragraphs 17 and 18 above:

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

(i) Yco will be deemed to have paid, and Aco will be deemed to have received, a taxable dividend equal to the amount, if any, by which the amount paid to redeem the XXXXXXXXXX Yco Class C Preferred Shares held by Aco exceeds the PUC thereof, immediately before such redemption, and

(ii) Aco will be deemed to have paid, and Yco will be deemed to have received, a taxable dividend equal to the amount, if any, by which the amount paid to purchase for cancellation the XXXXXXXXXX Aco common shares held by Yco exceeds the PUC thereof, immediately before such purchase for cancellation;

(b) the taxable dividends deemed to be received by Aco and Yco as a result of the redemption and purchase for cancellation referred to in Ruling B(a) above will be included in each corporation's income pursuant to subsection 82(1) and paragraph 12(1)(j), and will be deductible by each corporation in computing its taxable income for the taxation year in which such dividend is deemed to have been received pursuant to subsection 112(1), respectively. For greater certainty, subsections 112(2.1), (2.2), (2.3) or (2.4) will not apply to deny the application of the subsection 112(1) deduction in respect of such dividends;

(c) the dividends deemed to be received by Aco and Yco, as the case may be, referred to in Ruling B(a) above, will be excluded from the proceeds of disposition of such shares by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54, and any loss arising from the disposition of such shares will be reduced by the amount of such dividends pursuant to subsection 112(3);

(d) by virtue of paragraph 186(4)(b), Aco will be connected with Yco, and Yco will be connected with Aco. Consequently, provided that neither Aco nor Yco is entitled to a dividend refund in respect of its taxation year in which it is deemed to pay the dividends referred to in Ruling B(a) above, Aco and Yco will not be subject to Part IV tax under subsection 186(1) in respect of such dividend;

(e) neither Aco nor Yco will be subject to Part IV.1 tax under section 187.2 in respect of the dividends referred to in Ruling B(a) above; and

(f) neither Aco nor Yco will be subject to Part VI.1 tax under section 191.1 in respect of the dividends referred to in Ruling B(a) above.

C. The cancellation of the promissory notes described in Paragraph 19 above will not give rise to a "forgiven amount" within the meaning assigned by subsection 80(1) or 80.01(1).

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 shares in the circumstances described in subparagraph 55(3.1)(b)(iii);

(d) an acquisition of property in the circumstances described in paragraph 55(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, then by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends referred to in Ruling B(a) above.

E. Subsections 15(1) and 56(2) will not apply to the Proposed Transactions described herein, in and by themselves.

F. Subsection 245(2) will not apply to the Proposed Transactions, in and by themselves, 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 70-6R5 dated May 17, 2002 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, could have an effect on the rulings provided herein.

COMMENTS

1. 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, the paid-up capital in respect of any shares referred to herein, or the non-capital losses or net capital losses of any corporation; 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 Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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