2003 Ruling 2002-0162673 - 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: Routine butterfly

Position: Acceptable

Reasons: Meets the requirements of the law.

XXXXXXXXXX 2002-016267

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("W") -
XXXXXXXXXX ("S") -
XXXXXXXXXX ("DC") -

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

You have been advised by your clients that to the best of their knowledge, none of the issues discussed in this ruling:

a. is in an earlier return;

b. is being considered by a Tax Services Office or a Taxation Centre in connection with a previously filed tax return;

c. is under objection;

d. is the subject of a previously issued ruling; or

e. is before the courts.

DEFINED TERMS

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

1. "Act" means the Income Tax Act, 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, subparagraph is a reference to the relevant provision of the Act;

2. "adjusted cost base" ("ACB") has the meaning assigned by section 54 and subsection 248(1);

3. "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;

4. "BCA" means the Business Corporations Act XXXXXXXXXX;

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

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

7. "capital property" has the meaning assigned by section 54;

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

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

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

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

l2. "private corporation" has the meaning assigned by subsection 89(1);

13. "refundable dividend tax on hand" ("RDTOH") has the meaning assigned by subsection 129(3);

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

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

16. "short-term preferred share" has the meaning assigned by subsection 248(1);

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

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

19. "stated capital account" has the meaning assigned by section 26 of the BCA;

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

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

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

23. "Transferee" refers to a taxable Canadian corporation to be incorporated pursuant to the BCA, all of the issued and outstanding shares of which will be owned by W.

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

FACTS

1. DC was incorporated under the laws of the Province of XXXXXXXXXX on XXXXXXXXXX and is a taxable Canadian corporation and a CCPC.

2. The authorized share capital of DC consists of the following:

- an unlimited number of Class "A" Common, voting shares (the "DC Class "A" Common Shares");
- an unlimited number of Class "B" Common, non-voting shares; and
- an unlimited number of Class "A" Preferred, voting shares.

3. The issued share capital of DC is held as follows:

Shareholder

W XXXXXXXXXX DC Class A Common Shares with a stated capital of $XXXXXXXXXX and an adjusted cost base of $XXXXXXXXXX. W owns XXXXXXXXXX% of the issued and outstanding DC Class A Common Shares.

S XXXXXXXXXX DC Class A Common Shares with a stated capital of $XXXXXXXXXX and an adjusted cost base of $XXXXXXXXXX. S owns XXXXXXXXXX% of the issued and outstanding DC Class A Common Shares.

It is represented that the DC Class "A" Common shares are not taxable preferred shares or short-term preferred shares.

4. Each of W and S are individuals who are residents of Canada for the purposes of the Act. They are unrelated to each other, and each deals with the other at arm's length for the purposes of the Act.

5. The shares in the capital of DC are capital property to each of W and S.

6. The business of DC consists of the rental of real property to XXXXXXXXXX, a corporation incorporated under the BCA ("Retailco"). It is represented that the business carried on by DC is not a specified investment business. Retailco carries on the business of XXXXXXXXXX. Retailco is wholly-owned by S and is a CCPC.

7. DC was originally incorporated to hold a single property which was rented to Retailco. The original shareholdings of DC on incorporation were as follows:

Shareholder	Number of shares	%	Class of shares	Stated capital

W	XXXXXXXXXX 	"A"	       $XXXXXXXXXX  

S	XXXXXXXXXX 	"A"       $XXXXXXXXXX  

8. On XXXXXXXXXX S and W transferred certain personally-owned real property (the "Personal Properties") to DC. Each of S and W filed an election under subsection 85(1) with DC in respect of the transfer of Personal Properties. The Personal Properties were rented to Retailco for use in its business operations. As consideration for the transfer, DC assumed mortgages outstanding against the Personal Properties, issued indebtedness to W/S and issued a further XXXXXXXXXX Class "A" Common Shares to S and XXXXXXXXXX Class "A" Common Shares to W.

Shareholder Number of Class "A" shares after this transaction

	W	XXXXXXXXXX 

	S	XXXXXXXXXX 

9. Presently, the real property owned by DC consists of XXXXXXXXXX retail locations and an office building, all used in the business of Retailco. The real property owned by DC is capital property to DC.

10. Currently, DC has nil balances in its RDTOH account and in its CDA account.

11. A single property (the "XXXXXXXXXX") is still owned personally by S and W jointly, each as to a 50% undivided interest. This building is rented to Retailco and used in its retail business.

ADDITIONAL INFORMATION

12. None of the corporations referred to herein is or will be, at any time during the series of transactions herein described, a specified financial institution or a restricted financial institution.

13. No property has or will become property of either DC or any corporation controlled by it, and no liabilities have been or will be incurred by either DC or any corporation controlled by DC, in contemplation of and before the transfers of property except as outlined herein.

14. Except as outlined herein and except in the normal course of carrying on a business, neither DC nor Transferee has any specific intention of disposing of any assets currently owned by it to an unrelated person following the proposed transactions and neither DC nor the Transferee will dispose of any of its assets as part of a series of transactions which includes the proposed transactions.

15. 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", as defined in subsection 112(2.2), in respect of any of the shares of DC or Transferee.

16. Neither DC nor Transferee has, or will have, entered into a "dividend rental arrangement", as defined in subsection 248(1), in respect of the shares to be redeemed or to be purchased for cancellation as part of the proposed transactions.

17. None of the shares of DC or Transferee has been or will be issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5).

18. Neither DC nor Transferee 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).

19. Each of DC and Transferee 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.

20. None of the parties is contemplating an acquisition of control of any of DC, or Transferee, or any other corporation, except as described herein.

PROPOSED TRANSACTIONS

21. W will incorporate Transferee pursuant to the BCA. The authorized capital of Transferee will include an unlimited number of Class "A" voting common shares and at least two classes of preferred shares (Class "E" Preferred Shares and Class "F" Preferred Shares). These preferred shares will have the following attributes:

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

(ii) entitled to a non-cumulative dividend at the fixed rate of XXXXXXXXXX% per annum;

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

(iv) 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:

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

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

(v) 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;

(vi) 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

(vii) the holders of the Class "E" Preferred Shares will be entitled to one vote per share at all meetings of the shareholders. The Class "F" Preferred Shares will be non-voting except as provided by the BCA.

For the purposes of subsection 191(4), the terms and conditions of the Class "E" Preferred Shares will specify an amount in respect of each such share, to be designated by a resolution of 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 shares will be issued.

22. W will subscribe for XXXXXXXXXX Class "A" Common Shares of Transferee for nominal consideration.

23. W will transfer all of his DC Class "A" Common Shares to Transferee in exchange for XXXXXXXXXX Class "F" Preferred Shares of Transferee (the "Transferee Class "F" Preferred Shares").

For purposes of the BCA, the addition to the stated capital account of the Transferee Class "F" Preferred Shares will be $XXXXXXXXXX.

W and Transferee will jointly elect, pursuant to subsection 85(1), in prescribed form and within the time specified in subsection 85(6) to have the rules in subsection 85(1) apply to the transfer of the DC Class "A" Common Shares to the Transferee. The agreed amount will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) and will be less that the fair market value of the DC Class "A" Common Shares..

24. S will sell his 50% undivided interest in XXXXXXXXXX to W on a taxable basis. As consideration W will assume all of the mortgage indebtedness of the XXXXXXXXXX Property, and for the remainder of the purchase price assign a portion of his shareholder's loan account in DC to S. Under the laws of the Province of XXXXXXXXXX, the assumption by S of a portion of W's shareholder's loan account in DC will not result in a novation of such debt.

25. Immediately before the transactions described in paragraph 27 below, the property owned by DC will be classified into three types of property for purposes of the definition "distribution" in subsection 55(1) as follows:

(i) cash or near-cash property, comprising of the current assets of DC including, cash, accounts receivables, and rights arising from the prepayment of certain expenses ("prepaid expenses");

(ii) 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 a specified investment business;

(iii) business property, comprising all of the assets of DC other than cash or near-cash and investment property, any income of which would, for the purposes of the Act, be income from a business other than a specified investment business, which includes all of the real properties owned by DC which are rented to Retailco.

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

26. In determining the net fair market value of each type of property of DC immediately before the transfers described in paragraph 27 below, the liabilities of DC will be allocated to, and will be deducted in the calculation of, the net fair market value of each type of property of that corporation in the following manner:

(i) current liabilities of DC will be allocated to the cash or near-cash property 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. The allocation of current liabilities as described herein will not exceed the aggregate fair market value of the cash or near-cash of DC;

(ii) accounts receivable, inventories and prepaid expenses that are initially classified in accordance with paragraph (a) as cash or near-cash property, that will relate to a business carried on by DC or Transferee and that will be collected, sold or consumed by such corporation in the ordinary course of business will be reclassified as business property and the net fair market value thereof, determined after the allocation of current liabilities described in (a) 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;

(iii) liabilities of DC other than current liabilities, 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 fair market value. 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

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

27. DC will transfer XXXXXXXXXX% of its cash or near-cash property, XXXXXXXXXX% of its investment properties and XXXXXXXXXX% of its business properties to Transferee such that in respect of each of these types of property owned by DC immediately before the transfer (calculated in accordance with the rules in paragraphs 25 and 26) Transferee receives property of that type the net FMV of which (calculated in accordance with the rules in paragraphs 25 and 26) is equal to that proportion determined by the formula

A*B/C

Where:

"A" is the net FMV, immediately before the transfer, of all property of that type owned at that time by DC,

"B" is the FMV, immediately before the transfer, of all the shares of the capital stock of DC owned at that time by Transferee, and

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

As consideration, Transferee will issue XXXXXXXXXX Class "E" Voting Preferred Shares (the "Transferee Special Preferred Shares") to DC and may assume certain liabilities of DC. The aggregate redemption and retraction amount of the Transferee Special Preferred Shares will be equal to the fair market value of the property acquired less the amount of any liabilities of DC assumed by Transferee. XXXXXXXXXX, the addition to the stated capital account of the Transferee Special Preferred Shares will equal the aggregate cost (determined pursuant to subsection 85(1), where relevant) of the transferred assets, less the amount of any liabilities assumed on the transfer.

In respect of the transfer of the properties described above, DC will jointly elect with the Transferee, in prescribed form and within the time limit specified in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of each eligible property (the "Eligible Property") which is transferred to Transferee. The agreed amount in respect of each Eligible Property so transferred will be equal to:

(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); and

(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).

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 subparagraph 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 capital cost of the property immediately before the disposition is of the capital cost of all property of that class immediately before the disposition.

For greater certainty, the agreed amount of the Eligible Property will not exceed the FMV of such property and will not be less than the amount of any liabilities assumed by Transferee as consideration for the transfer of such property.

28. Immediately following the transfers of property described in paragraph 27, Transferee will redeem the XXXXXXXXXX Transferee Special Preferred Shares owned by DC for an amount equal to their fair market value and will issue as consideration a non-interest-bearing demand promissory note (the "Transferee Note") having a principal amount and fair market value equal to the fair market value of the XXXXXXXXXX Transferee Special Preferred Shares. DC will accept the Transferee Note as full payment of the redemption amount of the XXXXXXXXXX Transferee Special Preferred Shares as well as the risk of the note being dishonoured.

Transferee will, immediately before such share redemption, be connected to DC within the meaning assigned by subsection 186(4) since DC will own more than 10% of the issued share capital having full voting rights under all circumstances of Transferee and shares of the capital stock of Transferee having a FMV of more than 10% of the FMV of all of the issued shares of the capital stock of Transferee.

29. DC will repurchase and cancel the XXXXXXXXXX DC Class "A" Common Shares owned by the Transferee for an amount equal to their fair market value and will issue as consideration a demand non-interest-bearing promissory note (the "DC Note") having a principal amount and fair market value equal to the aggregate fair market value of the repurchased DC Class "A" Common Shares. DC will accept the note as full and absolute payment of the repurchase amount as well as the risk of the note being dishonoured.

DC will, immediately before such repurchase of shares, be connected to Transferee within the meaning assigned by subsection 186(4) since Transferee will own more than 10% of the issued share capital having full voting rights under all circumstances of DC and shares of the capital stock of DC having a fair market value of more than 10% of the fair market value of all the issued shares of the capital stock of DC.

30. Transferee will pay the principal amount of the Transferee Note by set-off and by cancelling the DC Note and transferring same to DC in return for the cancellation and transfer back to Transferee of the Transferee Note. Both notes will be marked "paid in full" and cancelled.

PURPOSE OF THE PROPOSED TRANSACTIONS

W and S wish to separate their interests from each other in order to pursue their own individual investment and estate planning objectives.

RULINGS

Provided that the above statements constitute a complete and accurate disclosure of all the relevant facts, purposes of the proposed transactions and proposed transactions, we rule as follows:

A. The provisions of subsection 85(1) will apply to:

(i) the transfer by W to Transferee, as described in paragraph 23 above, of his XXXXXXXXXX DC Class "A" Common Shares;

(ii) the transfers by DC to Transferee, as described in paragraph 27 above, of each Eligible Property;

such that the agreed amount in respect of each transfer will be deemed to be the proceeds of disposition to the transferor and the cost thereof to the Transferee pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to herein.

For the purposes of the joint elections described in paragraph 28, the reference to "the undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition in subparagraph 85(1)(e)(i) will be read as "the proportion of the undepreciated capital cost to the taxpayer of all property of that class that the capital cost of the property immediately before the disposition is of the capital cost of all property of that class immediately before the disposition."

B. As a result of the redemption by Transferee of the XXXXXXXXXX Transferee Special Preferred Shares as described in paragraph 28 above and the repurchase by DC of the XXXXXXXXXX DC Class "A" Common Shares as described in paragraph 29 above:

(a) by virtue of subsection 84(3):

(i) Transferee will be deemed to have paid and DC will be deemed to have received, a taxable dividend equal to the amount by which the amount paid in respect of the redemption of the Transferee Special Preferred Shares exceeds the paid-up capital thereof; and

(ii) DC will be deemed to have paid, and Transferee will be deemed to have received, a taxable dividend equal to the amount by which the amount paid in respect of the repurchase of the DC Class "A" Common Shares exceeds the paid-up capital thereof;

(b) the taxable dividends deemed to have been received by each of DC and Transferee as described above:

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

(ii) will be excluded from the proceeds of disposition of the shares so redeemed or repurchased, as the case may be, by virtue of paragraph (j) of the definition "proceeds of disposition" in section 54;

(iii) will, 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 subsection 112(2.1), (2.2), (2.3) or (2.4); and

(iv) will not be subject to tax under Part IV, except as provided in paragraph 186(1)(b); and

(c) any loss arising from the disposition of the shares will be reduced by the amount of the taxable dividends by virtue of subsection 112(3).

C. No tax will be payable under either section 187.2 or section 191.1 in respect of the dividends described in Ruling B above.

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

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

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

(c) an acquisition of 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 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 80(1) or subsection 80.01 will not apply to the settlement of the Transferee Note and the DC Note as described in paragraph 30 above.

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

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

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

The above rulings are based on the Act in its present form 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

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 adjusted cost base, paid-up capital or fair market value of any shares referred to herein; and

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

Yours truly,

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