20 February 1990 Ruling 59483 F - Butterfly Reorganizations - Transfer of Property on Net Equity Basis

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.

February 20, 1990

Dear Sirs:

Re:  Subsection 85(1) and Paragraph 55(3)(b) of the Income Tax Act (the "Act")

We refer to your letter of January 26, 1990, in which you requested a technical interpretation in respect of the hypothetical situation described below.

Aco and Bco are taxable Canadian corporations within the meaning of paragraph 89(1)(1) of the Act.  Aco is a shareholder of Bco. It is intended that Bco transfer the following properties to Aco under a reorganization that would be carried out pursuant to paragraph 55(3)(b) of the Act:

The reorganization will be carried out on a "net equity basis", whereby each of the properties will be transferred net of its respective liabilities.  In particular, a liability that is not specifically associated with a particular property will be allocated on a pro-rata basis based on the fair market value of the assets transferred.

The agreements of purchase and sale for Property 1 and Property 2 will indicate that in total $1,900 of liabilities will be assumed by Aco and Aco will issue shares which have a fair market value of $4,100.

Since Aco and Bco have agreed that the transfer be carried out with minimum income tax consequences, it is intended that, when filing the Joint subsection 85(1) elections, the $1,900 in liabilities be allocated in their entirety against Property 2.

You have requested our views as to whether the above transactions will comply with the provisions of subsection 85(1) and paragraph 55(3)(b) of the Act.

Comments

We regret that we are unable to comment on the application of the provisions of paragraph 55(3)(b) of the Act to a transfer of property carried out on a net equity basis with respect to a specific situation such as is described above without having all of the relevant facts. In addition, any comments could only be provided in the context of an advance income tax ruling.  We can, however, provide the following general comments, which are based on a speech given by Michael A. Hiltz of this Directorate at the 1989 Tax Conference held in November of that year at Toronto:

In the Department's view, the liabilities of the particular corporation (determined on a consolidated basis where appropriate) should be allocated to property of each type of the particular corporation (determined on a consolidated basis where appropriate) and should be deducted in the calculation of the net fair market value of the property of each type of the particular corporation, as follows:

1.     Current liabilities will be allocated to cash and near cash property, including accounts receivable, inventory and prepaid expenses, on a proportionate basis, to the extent of the fair market value of such property;

2.     Liabilities, other than current liabilities, that relate to a particular property will be allocated to the particular  property (and effectively to the type to which the particular property belongs) to the extent of its fair market value;

3.     Liabilities, other than current liabilities, that pertain to a type of property, but not to a specific property, will be allocated to that type of property, but not in excess of the  net fair market value of such type of property after the allocations described in 1 and 2 above; and

4.     Remaining liabilities, which have not been allocated in steps 1, 2  and 3, will be allocated on a proportionate basis based on the net value of each type of property of the particular corporation, as determined after steps 1, 2 and 3.

As confirmed in our 1988 paper, where the person who will own the receivables, inventory or prepaids after the butterfly will carry on the business to which those properties relate, the net value of those properties, as determined after the allocation of current liabilities described in 1, may be included in net business property before making the allocations described in 2, 3 and 4 above.

In the same speech, the Department acknowledged that the allocation of liabilities for the purposes of paragraph 55(3)(b) of the Act in the manner described above need not affect the allocation of liabilities for the purposes of a subsection 85(1) election in the manner described in your letter.

As stated in paragraph 24 of Information Circular 70-6R dated December 18, 1978, the comments expressed in this letter are not rulings and are consequently-not binding on the Department.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch