2003 Ruling 2002-0175753 - 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 reorganization

Position: Acceptable

Reasons: Meets the requirements under paragraph 55(3)(b).

XXXXXXXXXX 2002-017575

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX

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

To the best of XXXXXXXXXX and the client's knowledge, none of the issues involved in the ruling is:

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

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

? under objection by the taxpayer or a related person;

? before the courts; and

? the subject of a ruling previously considered by the Directorate.

Definitions

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

Unless otherwise indicated, all references to statute are to the Income Tax Act, (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended, (the "Act");

(a) "adjusted cost base", "capital property" and "proceeds of disposition" have the meanings assigned by section 54 ;

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

(b) "Canadian-controlled private corporation", "income of the corporation for the year from an active business" and "specified investment business" have the meanings assigned by subsection 125(7) ;

(c) "cost amount", "dividend rental agreement", "net income stabilization account ("NISA")" and "specified financial institution" have the meanings assigned by subsection 248(1) ;

(c.1) "depreciable property" has the meaning assigned by subsection 13(21);

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

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

(e.1) "FMV" means fair market value;

(f) "paid-up capital", "taxable Canadian corporation" and "taxable dividend" have the meanings assigned by subsection 89(1);

(f.1) "prepaid expenses" means the rights arising from the prepayment of expenses;

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

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

(i) XXXXXXXXXX; and

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

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

Facts

1. XXXXXXXXXX ("DC") is a Canadian-controlled private corporation and a taxable Canadian corporation. It was incorporated on XXXXXXXXXX under the laws of the province of XXXXXXXXXX and its fiscal year ends on XXXXXXXXXX. DC carries on a farming business.

The authorized share capital of DC consists of the following:

- an unlimited number of Class A special shares (the "DC Class A Shares"). The DC Class A Shares are non-voting, retractable at $XXXXXXXXXX per share and bear a non-cumulative dividend entitlement of XXXXXXXXXX% per share and rank in priority to all other classes of shares with respect to payment of dividend and repayment of capital;

- an unlimited number of Class B special shares (the "DC Class B Shares"). The DC Class B Shares are voting, redeemable at $XXXXXXXXXX per shares and bear a non-cumulative dividend entitlement of XXXXXXXXXX% per share and rank before the Class C special shares with respect to the payment of dividend and repayment of capital; and

- an unlimited number of Class C special shares (the "DC Class C Shares"). The DC Class C Shares are voting and are without par value.

The aggregate paid-up capital of the DC Class A Shares, the DC Class B Shares and the DC Class C Shares is $XXXXXXXXXX, $XXXXXXXXXX and $XXXXXXXXXX respectively.

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

	Shareholder's 	Number of Class A	Number of Class B	Number of Class C
	Name	Shares	Shares	Shares

XXXXXXXXXX

All of the shares of DC represent capital property to the shareholders.

None of the shareholders made an election for property owned on February 22, 1994 as allowed under subsection 110.6(19) in respect of their shares in the capital stock of DC.

DC does not have any refundable dividend tax on hand and will not have any such amount at the end of the taxation year in which the proposed transactions described herein are completed.

3. XXXXXXXXXX ("Father") and XXXXXXXXXX ("Mother") are spouses of one another.

XXXXXXXXXX ("SIB1") and XXXXXXXXXX ("SIB2") are brothers and are the sons of Father and Mother. SIB1 and SIB2 are deemed by subparagraph 55(5)(e)(i) not to be related. Father, Mother, SIB1 and SIB2 are individuals who are resident in Canada.

4. The assets of DC consist of the following:

? current assets - accounts receivable and inventory;
? land & buildings;
? equipment & vehicles
? XXXXXXXXXX quotas;
? a NISA; and
? an investment in a co-operative.

The land and buildings, which represent capital property to DC, include XXXXXXXXXX residences which are being rented to the shareholders plus XXXXXXXXXX additional rented single family dwellings. One of the rented dwellings is occupied by XXXXXXXXXX ("SIB3") who is another son of Father and Mother and who works full-time on the farm. Another one, which was bought last year, was rented to a part-time employee of the farm. The income realized from the rented dwellings has been reported as income from an active business for tax purposes.

5. SIB2 recently incorporated a new company ("Opco") under the XXXXXXXXXX, which is a Canadian-controlled private corporation and a taxable Canadian corporation. SIB 2 owns XXXXXXXXXX% of the common shares of the corporation. The corporation has already started the construction of a barn.

The authorized capital of Opco includes the following classes of shares:

- an unlimited number of Class A special shares (the "Opco Class A Shares"). The Opco Class A Shares are non-voting, bear a non-cumulative dividend entitlement and are retractable and redeemable at $ XXXXXXXXXX per share plus any dividend declared and unpaid. They rank in priority to all other classes of shares of the company for the payment of dividend;

- an unlimited number of Class B special shares (the "Opco Class B Shares"). The Opco Class B Shares are voting, bear a non-cumulative dividend entitlement, and are retractable and redeemable at $ XXXXXXXXXX per share plus any dividend declared and unpaid. They rank in preference and priority to the common shares for the payment of dividend; and

- an unlimited number of common shares (the "Opco Common Shares"), which are voting and are entitled to receive the remaining property of the corporation upon dissolution.

6. PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to distribute, on a tax-free basis, a portion of the assets of DC to a new corporation, Opco, in order to allow Father, Mother and SIB1 to separate their respective business interests from SIB2.

PROPOSED TRANSACTIONS

7. SIB2 will sell to Opco his XXXXXXXXXX DC Class C Shares, which represent all of his shareholdings in DC, for consideration consisting solely of XXXXXXXXXX Opco Common Shares, such that the aggregate FMV of the XXXXXXXXXX Opco Common Shares so issued is equal to the aggregate FMV of the XXXXXXXXXX DC Class C Shares.

SIB2 and Opco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the rules in subsection 85(1) apply to such transfer. The agreed amount will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii). The agreed amount will not be greater than the FMV of the XXXXXXXXXX DC Class C Shares.

The aggregate addition to the paid-up capital of the Opco Common Shares will be equal to the aggregate paid-up capital of the shares of the XXXXXXXXXX DC Class C Shares.

8. Immediately before the transfers of property described in the following paragraphs, the property of DC will be classified into three types of property for the purposes of the definition "distribution" in subsection 55(1), as follows:

(a) cash or near-cash property, comprising all of the current assets of DC, including any cash or demand promissory notes;

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

(c) 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. DC does not have any investment property.

8. In determining the net FMV of each type of property to be owned by DC, immediately before the transfers of property described in paragraph 10 below, the liabilities of DC will be allocated to and deducted in the calculation of the net FMV of each type of property of DC as follows:

(a) Current liabilities of DC (including the current portion of long-term debt) will be allocated to each cash or near-cash property in the proportion that the FMV of each such property is of the FMV of all cash or near-cash property. The allocation of current liabilities will not exceed the aggregate FMV of all cash or near-cash property of DC;

(b) 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 Opco 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 FMV thereof, determined after the allocation of current liabilities described in (a) will be included in the net FMV of business property and will not be included in the net FMV of cash or near-cash property;

(c) Liabilities (other than current liabilities) that relate to a particular property will be allocated to that particular property (and effectively to the type to which the particular property belongs) to the extent of the property's FMV. Any excess of such liabilities over the FMV of that property will be allocated to the type of property to which the property belongs. Liabilities that pertain to a type of property, but not to a particular property, will be then allocated to that type of property, but not in excess of the net FMV of such type of property after the allocation of liabilities to a particular property; and

(d) Any liabilities that remain after the allocations described in steps (a) and (c) above ("excess unallocated liabilities") will then be allocated to the cash or near-cash property and business property, if any, based on the relative remaining net FMV of each type of property determined prior to the allocation of such excess unallocated liabilities.

8. DC will transfer certain of its cash or near-cash property and its business property to Opco (the "Distribution") 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 8 and 9 above) Opco receives property of that type the net FMV of which (calculated in accordance with the rules in paragraphs 8 and 9 above) 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 Opco;

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

As consideration for the transfer, Opco will assume certain liabilities of DC and issue such number of its Class A special shares (the "Opco Special Preferred Shares") to DC that will have an aggregate redemption amount, retraction value and fair market value equal to the amount by which, the aggregate fair market value of the properties transferred to Opco, exceeds the aggregate of the liabilities of DC assumed by Opco.

In respect of the property so transferred, DC and Opco will jointly elect in prescribed form and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of any property that is eligible property. The agreed amount under such elections in respect of each of the eligible properties 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 inventory, the amount determined in paragraph 85(1)(c.2);

(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); and

(d) 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) will be interpreted to mean that proportion of the undepreciated capital cost to the taxpayer of all of the property of that class that the FMV of the assets that are transferred immediately before the disposition is of the FMV of all property of that class immediately before the disposition.

For greater certainty, the agreed amount for any eligible property included in the subsection 85(1) election referred to herein will not exceed the FMV of such property and will not be less than the amount of any liabilities assumed by Opco as consideration of such property.

The addition to the paid-up capital of the Opco Special Preferred Shares will not exceed the amount by which the aggregate agreed amounts under subsection 85(1) in respect of the eligible property exceeds any debts assumed by Opco.

11. Opco will redeem the Opco Special Preferred Shares that were issued to DC as described in paragraph 10 above, and will issue as consideration therefor a non-interest-bearing demand promissory note (the "Opco Note") having a principal amount and FMV equal to the aggregate redemption amount and fair market value of the Opco Special Preferred Shares. DC will accept such promissory note in full satisfaction of the redemption amount of the Opco Special Preferred Shares.

12. DC will redeem the XXXXXXXXXX DC Class C Shares owned by Opco following the transaction described in paragraph 7 above, and will issue as consideration therefor a non-interest-bearing demand promissory note (the "DC Note") having a principal amount and FMV equal to the aggregate redemption amount and FMV of the of XXXXXXXXXX DC Class C Shares. Opco will accept such promissory note in full satisfaction of the redemption amount of the XXXXXXXXXX DC Class C Shares.

13. The Opco Note and the DC Note will be set-off against one another and cancelled.

14. Consideration to avoid land transfer tax

XXXXXXXXXX if it occurs as part of a reorganization that qualifies under paragraph 55(3)(b) of the Act, such that the transfer of the real estate to Opco may be exempt from XXXXXXXXXX land transfer tax.

Consequently, you believe that, in order to meet the exemption and avoid the land transfer tax, before any transactions mentioned above regarding the reorganization would take place, the following will have to be done:

(a) SIB 2 will incorporate a numbered company ("Newco");

(b) Then, bare legal title to the land will be transferred from DC to Newco which will agree to hold legal title in trust for Opco;

(c) With respect to the transaction described in paragraph 10 above, it is only the beneficial interest in the land that will be transferred.

SUBSEQUENT TRANSACTION

15. After the reorganization has been completed, Father and Mother will transfer to SIB 3 their DC Class C Shares.

ADDITIONAL INFORMATION

16. Neither DC nor Opco is or will be, at the time the proposed transactions described above are implemented, a specified financial institution.

17. None of the shares of DC or Opco has been or will be, at any time during the implementation of the proposed transactions described herein:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) as a "guarantee agreement";

(b) a share that is issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5); or

(c) the subject of a dividend rental arrangement.

16. Except as described in this letter, no property has been or will be acquired by DC and no liabilities have been or will be incurred by DC in contemplation of the proposed transactions described above.

17. Other than as described herein, no significant transactions have been completed in contemplation of the proposed transactions described herein and none are contemplated after the proposed transactions are completed.

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 of the XXXXXXXXXX DC Class C Shares held by SIB 2 to Opco as described in paragraph 7 above; AND

(ii) the transfer of each eligible property by DC to Opco, which is the subject of an election under subsection 85(1), as described in paragraph 10 above,

such that the agreed amounts in respect of each such transfer 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 referred to herein.

B. As a result of the redemption by Opco of the Opco Special Preferred Shares as described in paragraph 11 above and the redemption by DC of the XXXXXXXXXX DC Class C Shares as described in paragraph 12 above:

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

(i) Opco 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 amount of the Opco Special Preferred Shares exceeds the paid-up capital thereof; and

(ii) DC will be deemed to have paid, and Opco 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 DC Class C Shares exceeds the paid-up capital thereof;

(b) the taxable dividends deemed to have been received by each of DC and Opco 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 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 subsections 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), as Opco will be connected with DC and DC will be connected with Opco; 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. By virtue of paragraph 191(2)(a), DC will have a substantial interest in Opco immediately before the redemption of the Opco Special Shares as described in paragraph 11 above and Opco will have a substantial interest in DC immediately before the redemption of the DC Class C Shares, as described in paragraph 12 above. Consequently, 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) an acquisition of property in the circumstances described in subparagraph 55(3.1)(a);

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

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

(d) an acquisition of shares of DC as described in subparagraph 55(3.1)(b)(iii);

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

(f) 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).

D. The provisions of subsection 80(1) or section 80.01 will not apply to the settlement of the Opco Note and the DC Note as described in paragraph 13 above.

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

F. 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 given.

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 FMV of any shares referred to herein; or

(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