2004 Ruling 2003-0049423 - 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: This is a split-up butterfly ruling that is almost identical to previous ruling 2001-007736 given to the same taxpayers which had expired due to estate reasons.

Position: Ruling given.

Reasons: Complies with the law.

XXXXXXXXXX 2003-004942

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in various telephone conversations.

The proposed transactions that are the subject of this ruling request are the same as those contained in Advance Ruling No. 2001-007736, dated XXXXXXXXXX, 2001, for which the time limit had expired.

Throughout this letter, the corporate and individual taxpayers will be referred to as follows:

	XXXXXXXXXX 	Aco
	XXXXXXXXXX .	Bco
	XXXXXXXXXX .	Cco
	XXXXXXXXXX .	Dco
	XXXXXXXXXX 	Mr. L
	XXXXXXXXXX 	Mrs. L
	XXXXXXXXXX 	Mr. M
	XXXXXXXXXX 	Mrs. M

Aco, Bco and Cco file their corporate 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 the parties to this ruling, none of the issues in this ruling request is:

(i) 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; or

(iv) before the courts.

You have confirmed that the proposed transactions described herein will not result in any taxpayer identified in this ruling being unable to pay its outstanding tax liabilities.

Unless otherwise indicated, all reference 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 provisions 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) and, where applicable, its predecessor statutes;

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

(j) "dividend refund" has the meaning assigned by paragraph 129(1)(a);

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

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

(m) "forgiven amount" has the meaning assigned by subsections 80(1) and 80.01(1);

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

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

(p) "Paragraph" means a numbered paragraph in this letter;

(q) "pre-1972 capital surplus on hand" ("pre-1972 CSOH") has the meaning assigned by subsection 88(2.1);

(r) "proposed transactions" means the transactions described in Paragraphs 9 to 23 below;

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

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

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

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

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

FACTS

1. Each of Aco, Bco and Cco is a taxable Canadian corporation and a private corporation. Aco, Bco and Cco were all incorporated under the laws of XXXXXXXXXX.

2. Aco is a holding company with ownership interests in various real estate rental properties and shares of private corporations. Bco and Cco are both holding companies for the respective interests of the family of Mr. L and Mrs. L and the family of Mrs. M and the late Mr. M.

3. The assets of Aco consist of:

(a) cash;

(b) accounts receivable; and

(c) investments in real estate and shares of private corporations:

(i) XXXXXXXXXX% ownership interest in XXXXXXXXXX real estate property; and

(ii) XXXXXXXXXX common shares of Dco.

The legal description of the XXXXXXXXXX property is XXXXXXXXXX.

4. As at Aco's XXXXXXXXXX year-end, Aco had RDTOH of approximately $XXXXXXXXXX, pre-1972 CSOH of approximately $XXXXXXXXXX and a nominal amount in its capital dividend account. It is not anticipated that the amounts of CDA or RDTOH will be substantially different at the time of the transfer of property described in Paragraph 17 below.

5. The ownership of Aco, Bco and Cco is set out below:

(a) The number and class of issued shares in the capital of Aco, and the aggregate PUC and ACB to each shareholder of such shares are as follows:

Aggregate
Aggregate
Shareholder
Class
Number
ACB
PUC

Mrs. L

Class A
Preference
XXXXXXX
XXXXXXX
XXXXXXX

Mrs. M

Class A
Preference
XXXXXXX
XXXXXXX
XXXXXXX

Bco
Common
XXXXXXX
XXXXXXX
XXXXXXX

Cco
Common
XXXXXXX
XXXXXXX
XXXXXXX

The Class A Preference shares of Aco are non-voting, redeemable, retractable for an amount of $XXXXXXXXXX and entitled to non-cumulative dividends at the rate of XXXXXXXXXX % per annum of the redemption amount.

(b) The issued shares in the capital of Bco are held as follows:

Shareholder
Class
Number

Mr. L

Class A
Preference
XXXXXXX

Mr. L

Common
XXXXXXX

(c) The issued shares in the capital of Cco are held as follows:

Shareholder
Class
Number

Mr. M

Testamentary
Family Trust
Class A
Preference
XXXXXXX

Mr. M

Testamentary
Spousal Trust
Common
XXXXXXX

6. The Common and Class A Preference shares of each of Aco, Bco and Cco represent capital property to their respective shareholders.

7. The Common shares of Aco have a fair market value in excess of the ACB of such shares to the respective holder of such shares. The Class A Preference shares of Aco have a fair market value equal to or in excess of the ACB of such shares to the respective holder of such shares.

8. Mr. L and Mrs. L are spouses, while Mrs. M is the surviving spouse of the late Mr. M. Mr. L and the late Mr. M were brothers.

PROPOSED TRANSACTIONS

9. Each of Bco and Cco will file articles of amendment under the BCA to create a new class of preferred shares ("Class B Preference Shares"). The Class B Preference Shares will be non-voting, entitled to non-cumulative dividends at the rate of XXXXXXXXXX% per month on the redemption amount at the discretion of its directors, and redeemable and retractable for an amount equal to the fair market value of the consideration received by the corporation for the issuance of such shares.

10. Mrs. L will transfer, at fair market value, her XXXXXXXXXX Class A Preference shares of Aco to Bco. In consideration for such transfer, Bco will issue to Mrs. L Class B Preference Shares with a fair market value and redemption amount equal to the fair market value at the time of the transfer of the XXXXXXXXXX Class A Preference shares of Aco.

Bco will add to the stated capital account maintained for its Class B Preference Shares an amount not exceeding the aggregate PUC of the XXXXXXXXXX Class A Preference shares of Aco.

11. Mrs. L and Bco 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. The agreed amount in respect of the transfer of the XXXXXXXXXX Class A Preference shares of Aco will be equal to the adjusted cost base to Mrs. L immediately before the transfer, which amount will be less than the fair market value of such shares.

12. Mrs. M will transfer, at fair market value, her XXXXXXXXXX Class A Preference shares of Aco to Cco. In consideration for such transfer, Cco will issue to Mrs. M Class B Preference Shares with a fair market value and redemption amount equal to the fair market value at the time of the transfer of the XXXXXXXXXX Class A Preference shares of Aco.

Cco will add to the stated capital account maintained for its Class B Preference Shares an amount not exceeding the aggregate PUC of the XXXXXXXXXX Class A Preference shares of Aco.

13. Mrs. M and Cco 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. The agreed amount in respect of the transfer of the XXXXXXXXXX Class A Preference shares of Aco will be equal to the adjusted cost base to Mrs. M immediately before the transfer, which amount will be less than the fair market value of such shares.

14. Bco will incorporate a new wholly-owned subsidiary corporation ("Subco L") under the BCA. Subco L will be a taxable Canadian corporation and a Canadian-controlled private corporation.

The authorized share capital of Subco L will consist of an unlimited number of:

(a) Class A Preference shares having the following attributes:

(i) a redemption amount for each share equal to a proportionate amount of the FMV of the consideration received by the corporation upon the issuance of the Class A Preference shares;

(ii) subject to redemption or retraction at the redemption amount and entitled to receive the redemption amount upon the liquidation, dissolution or winding-up of the corporation, but otherwise non-participating;

(iii) a right to a non-cumulative preferential dividend of XXXXXXXXXX% per month on the redemption amount, at the discretion of the board of directors;

(iv) a right to one vote per share; and

(v) retractable at the option of the holder and redeemable at the option of the corporation.

(b) Common shares which are fully participating and entitled to one vote per share.

The Class A Preference shares will specify an amount for the purposes of subsection 191(4), to be designated by a resolution of the directors at the time of their issue not to exceed the fair market value of the consideration received for their issue. The amount specified will not be described by reference to a formula or subject to change thereafter.

Bco will subscribe for XXXXXXXXXX Common shares for a nominal amount on incorporation.

15. Cco will incorporate a new wholly-owned subsidiary corporation ("Subco M") under the BCA. Subco M will be a taxable Canadian corporation and a Canadian-controlled private corporation.

The authorized share capital of Subco M will consist of an unlimited number of:

(a) Class A Preference shares having the following attributes:

(i) a redemption amount for each share equal to a proportionate amount of the FMV of the consideration received by the corporation upon the issuance of the Class A Preference shares;

(ii) subject to redemption or retraction at the redemption amount and entitled to receive the redemption amount upon the liquidation, dissolution or winding-up of the corporation, but otherwise non-participating;
(iii) a right to a non-cumulative preferential dividend of XXXXXXXXXX% per month on the redemption amount, at the discretion of the board of directors;

(iv) a right to one vote per share; and

(v) retractable at the option of the holder and redeemable at the option of the corporation.

(b) Common shares which are fully participating and entitled to one vote per share.

The Class A Preference shares will specify an amount for the purposes of subsection 191(4), to be designated by a resolution of the directors at the time of their issue not to exceed the fair market value of the consideration received for their issue. The amount specified will not be described by reference to a formula or subject to change thereafter.

Cco will subscribe for XXXXXXXXXX Common shares for a nominal amount on incorporation.

16. Immediately before the transfer of property described in Paragraph 17 below, the property owned by Aco will be classified into three types of property for the purposes of a distribution:

(a) cash or near cash property, comprising all of the current assets of Aco (including any cash, bank deposits, term deposits, marketable securities (other than portfolio investments and similar instruments) and loans receivable from related parties;

(b) 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 a business (other than a specified investment business) carried on by Aco; and

(c) 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.

Aco will not have any business property at the time of the transfer described in Paragraph 17 below. For greater certainty, any tax accounts, such as the balance of RDTOH, pre-1972 CSOH, or capital dividend account of Aco will not be considered property for purposes of the proposed transactions.

17. Immediately following the determination of the fair market value of its cash or near cash property and investment property, as described in Paragraph 16 above, Aco will transfer to each of Subco L and Subco M a pro-rata share (50%) of all of its cash or near cash property and investment property in a manner such that the fair market value of the cash or near cash property and investment property so transferred to Subco L or Subco M, as the case may be, will be equal to that proportion of the fair market value of all the cash or near cash property and investment property of Aco immediately before the transfer that:

(a) the aggregate fair market value, immediately before the transfer, of the Aco shares owned by Subco L or Subco M, as the case may be,

is of

(b) the aggregate fair market value, immediately before the transfer, of all the issued shares of the capital stock of Aco.

For greater certainty, the transfer of property described above will be made on a gross market value basis. Each of Subco L and Subco M will have received a pro-rata share (50%) of each type of property of Aco, as described above. Similarly, each of Subco L and Subco M will assume the same pro-rata share of each liability of Aco.

18. As consideration for the transfer of property described in Paragraph 17 above, each of Subco L and Subco M will:

(a) assume a pro-rata share of the liabilities of Aco, and the liabilities so assumed by Subco L or Subco M, as the case may be, will not exceed the aggregate of the agreed amounts, determined under Paragraph 19 below, in respect of all eligible property transferred to that transferee; and

(b) issue Class A Preference shares to Aco having an aggregate redemption price and aggregate fair market value equal to the amount by which the aggregate fair market value of the properties so transferred exceeds the pro-rata share of the liabilities assumed.

Each of Subco L and Subco M will add to the stated capital account maintained for its Class A Preference shares an amount equal to the aggregate of the cost amounts of the properties transferred less the amount of the liabilities assumed by Subco L or Subco M, as the case may be.

19. In respect of the transfers described in Paragraph 17 above, Aco and Subco L and Aco and Subco M will respectively elect, jointly and in prescribed form and 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 Aco that is an eligible property transferred to Subco L or Subco M, as the case may be. The agreed amount in respect of each property so transferred will be:

(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); and

(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).

20. Each of Subco L and Subco M will redeem its respective Class A Preference shares owned by Aco at the aggregate redemption price thereof, which amount will be equal to the fair market value of such shares. The redemption price will be paid and satisfied by the issuance of a non-interest-bearing demand promissory note by each of Subco L and Subco M (the "Subco L Note" and "Subco M Note"), each of which will have a fair market value and principal amount equal to the redemption price of the Class A Preference shares issued by Subco L and Subco M, respectively. Aco will accept each such note in full payment of the respective redemption price.

21. Subco L and Subco M will then be wound up, each into its respective parent, Bco and Cco.

22. Following the wind-up of Subco L and Subco M, the shareholders of Aco will, pursuant to the provisions of the BCA, sign a special resolution consenting to the dissolution of Aco. On the winding-up of Aco, Aco will distribute to Bco and Cco, respectively, the Subco L Note and the Subco M Note and 50% of Aco's dividend refund receivable arising on the winding-up dividend. As a consequence of the distribution of the Subco L Note to Bco and the Subco M Note to Cco, the said notes will be settled and extinguished.

No agreement or resolution relating to the winding-up of Aco or distribution of its property will provide for the cancellation of any shares of Aco.

23. Prior to the distribution described in Paragraph 22 above, Aco will elect pursuant to subsection 83(2), in prescribed manner and prescribed form, that the full amount of any dividend referred to in subparagraph 88(2)(b)(i) be deemed to be a capital dividend. The resolution approving payment of the capital dividend will provide that, to the extent that the amount of the capital dividend payable exceeds the balance of Aco's capital dividend account at the time the dividend becomes payable, the directors of Aco will elect to treat the excess as a separate dividend that is a taxable dividend that became payable at that time.

ADDITIONAL INFORMATION

24. Except as described herein, no property has been or will be acquired by or disposed of by Aco in contemplation of and before the proposed transfer of properties described in Paragraph 17 above.

25. None of Aco, Bco or Cco has any intention of disposing of any of their assets, as part of a series of transactions which includes the proposed transactions, otherwise than on a basis which would not cause the provisions in paragraphs 55(3.1)(c) or 55(3.1)(d) to deny the exception in paragraph 55(3(b) to the dividends resulting from the transactions described in Paragraphs 20 and 22 above.

26. None of Aco, Bco or Cco is, or will be at the time of the proposed transactions, a specified financial institution.

27. None of the shares of Aco, Bco or Cco is, or will be at any time during the implementation of the proposed transactions:

(a) the subject of any undertaking that is a guarantee agreement;

(b) the subject of a dividend rental arrangement; 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).

PURPOSE OF THE PROPOSED TRANSACTIONS

28. An application for a winding-up order with respect to Aco pursuant to XXXXXXXXXX was granted by the XXXXXXXXXX. The purpose of the proposed transactions is to accomplish, on a tax-deferred basis, the distribution of the property of Aco pursuant to the winding-up order granted by the XXXXXXXXXX.

RULINGS GIVEN

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

A. The provisions of subsection 85(1), subject to the application of subsection 69(11), will apply to the transfer by Aco of its properties to Subco L and Subco M, as described in Paragraph 17 above, such that the agreed amount in respect of each transfer of eligible property will be deemed to be the transferor's proceeds of disposition and the transferee's cost thereof pursuant to paragraph 85(1)(a).

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

B. On the redemption by Subco L and Subco M of their respective Class A Preference shares held by Aco, as described in Paragraph 20 above, and as a result of the distributions by Aco in the course of its winding-up, as described in Paragraph 22 above:

(a) by virtue of paragraphs 84(3)(a) and 84(3)(b), each of Subco L and Subco M will be deemed to have paid, and Aco 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 Class A Preference shares of Subco L or Subco M, as the case may be, exceeds the aggregate paid-up capital thereof;

(b) (i) pursuant to paragraph 88(2)(b) and subsection 84(2), but subject to Rulings B(b)(ii), (iii) and (iv) below, Aco will be deemed to have paid, and each of Bco and Cco to have received, a dividend (the "winding-up dividend") on the Common shares and Class A Preference shares of Aco equal to the proportion of the amount by which the amount of the funds and property distributed by Aco to each of Bco and Cco in respect of the Common shares and Class A Preference shares of Aco on the winding-up exceeds the amount by which the paid-up capital of the Common shares and the Class A Preference shares of Aco is reduced as a result of the distribution, that the number of Common shares and Class A Preference shares of Aco held by Bco or Cco, as the case may be, is of the number of Common shares and Class A Preference shares outstanding immediately before the distribution;

(ii) pursuant to subparagraph 88(2)(b)(i), such portion of the winding-up dividend referred to in Ruling B(b)(i) above as does not exceed Aco's capital dividend account determined immediately before the payment of the winding-up dividend will be deemed, for the purposes of the subsection 83(2) election referred to in Paragraph 23 above to be the full amount of a separate dividend;

(iii) pursuant to subparagraph 88(2)(b)(ii), the portion of the winding-up dividend that is equal to the lesser of:

(A) Aco's pre-1972 CSOH immediately before the payment of the winding-up dividend; and

(B) the amount by which the winding-up dividend exceeds the portion thereof in respect of which Aco will elect under subsection 83(2) will be deemed not to be a dividend; and

(iv) pursuant to subparagraph 88(2)(b)(iii), the winding-up dividend, to the extent it exceeds the total of the portion referred to in Ruling B(b)(ii) above that is deemed to be a separate dividend and the portion referred to in Ruling B(b)(iii) above that is deemed not to be a dividend, will be deemed to be a separate dividend that is a taxable dividend;

(c) to the extent that the deemed dividends referred to in Rulings B(a) and (b) above are taxable dividends, they will be deductible by each recipient pursuant to subsection 112(1); and

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

C. Part IV.1 of the Act will not apply to the deemed dividends described in Ruling B above because the dividends will be excepted dividends pursuant to paragraph (c) of the definition of "excepted dividend" in section 187.1.

D. Part VI.1 of the Act will not apply to the deemed dividends described in Ruling B above because the dividends will be excluded dividends pursuant to paragraph 191(4)(d).

E. By virtue of the provisions of paragraph 55(3)(b), the provisions of subsection 55(2) will not apply to the deemed dividends described in Ruling B above, provided that, as part of the series of transactions that includes the proposed transactions described herein, there is no:

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

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

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

(d) acquisition of property in the circumstances described in paragraph 55(3.1)(d) which has not been described herein.

F. The extinguishment of the Subco L Note and the Subco M Note, as described in Paragraph 22 above, will not give rise to a forgiven amount.

G. The provisions of subsection 88(1) will apply to the winding-up of Subco L and Subco M, as described in Paragraph 21 above.

H. The common shares of Aco will not, as a result of the implementation of the proposed transactions, in and by themselves, become taxable preferred shares.

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

J. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, to re-determine 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, reviewed or has made any determination in respect of:

(a) the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;

(b) the amount of any non-capital loss, net capital loss or any other amount of any corporation referred to herein; and

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

Yours truly,

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