28 July 1993 External T.I. 9313265 F - Price Adj Clause & 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.

XXXXXXXXXX 

Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Price Adjustment Clauses in Butterfly Transactions

This is in reply to your letter dated May 4, 1993 wherein you requested clarification of the Department's views on the impact that the operation of a price adjustment clause may have on a divisive reorganization carried out pursuant to paragraph 55(3)(b) of the Income Tax Act (Canada) (the "Act").

You have referred to a paper titled "Butterfly Reorganizations: A Revenue Canada Update" presented by Mr. Ted Harris at the Forty-Third Tax Conference of the Canadian Tax Foundation which indicates that the operation of a price adjustment clause could result in dividends arising in the course of a butterfly reorganization being subject to the provisions of subsection 55(2) of the Act.

In his address to the 1981 Conference of the Canadian Tax Foundation, Mr. J.R. Robertson stated that "(p)rice adjustment clauses with respect to butterfly transactions should not affect any of the transactions or events that are part of the butterfly transactions. A right that the taxpayer has under the price adjustment clause should be considered to have an adjusted cost base of zero and any amounts received if the price adjustment clause becomes operative would be proceeds of disposition for that right." In your view these comments seem to suggest that only the adjustments resulting from the operation of such price adjustment clauses would be subject to tax. You believe this result to be a fair and equitable and compare it to the Department's practice of accepting post butterfly taxable sales of butterflied property between the shareholders.

You have, therefore, requested clarification of the Department's current position on this subject.

Comments

In its response to Question 30 at the 1992 Revenue Canada Round Table, the Department confirmed that the operation of a price adjustment clause may result in any dividends arising in the course of a butterfly reorganization being subjected to the provisions of subsection 55(2) of the Act. In order for an intercorporate dividend to be exempted, pursuant to paragraph 55(3)(b), from the application of subsection 55(2) of the Act, each shareholder/transferee must receive its proportionate share of the fair market value of each type of property owned by the particular corporation immediately before the butterfly. Where the assets of the corporation have been incorrectly valued, a shareholder may not have received its proportionate share of the fair market value of each type of property and, as such, the dividends would not qualify for the exemption provided in paragraph 55(3)(b) of the Act. The operation of a price adjustment clause would not alter the fact that a shareholder did not, in fact, receive its proportionate share of the fair market value of each type of property held by the corporation immediately before the butterfly.

In our view the position concerning a post butterfly taxable sale of butterflied property can be distinguished from a price adjustment clause becoming operational. In the case of a post butterfly taxable sale, each shareholder transferee has initially received its proportionate share of each type of property of the particular corporation such that the initial transfers satisfy the requirements of paragraph 55(3)(b) of the Act. This is not the case where a price adjustment becomes operational.

We trust that the above comments will clarify our position on this matter.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch