2096 Ruling 9606443 - 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 Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

XXXXXXXXXX                                      3-960644

Attention: XXXXXXXXXX

XXXXXXXXXX, 1996

Dear Sirs,

Re: XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above referenced taxpayers. In your letters of XXXXXXXXXX, you provided us of additional information in respect of, and amendments to, the facts and proposed transactions described in your original letter. We also acknowledge the information provided during our various telephone conversations (XXXXXXXXXX).

We understand that to the best of your knowledge and that of the taxpayers involved:

(i) none of the issues involved in the requested rulings is being considered by a District Taxation Office or a Taxation Centre in connection with a tax return already filed, and

(ii) none of the issues involved in the requested rulings is the subject of any notice of objection or is under appeal.

Unless otherwise stated all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, consolidated to June 23, 1994 (the "Act").

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

Facts:

1) XXXXXXXXXX was incorporated on XXXXXXXXXX and is registered to carry on business in XXXXXXXXXX district taxation office and taxation centre is XXXXXXXXXX, respectively.

2) XXXXXXXXXX is a private corporation, a taxable Canadian corporation ("TCC") and a Canadian controlled private corporation ("CCPC") as defined by subsections 89(1) and 125(7) of the Act, respectively.

3) XXXXXXXXXX is both related and associated as defined in subsections 251(2) and 256(1) of the Act, respectively, with the following corporate taxpayers who carry on an active business:

XXXXXXXXXX

4) XXXXXXXXXX are each a TCC and CCPC, as defined in the Act.

5) XXXXXXXXXX each have a XXXXXXXXXX year end; XXXXXXXXXX fiscal period ends XXXXXXXXXX.

6) XXXXXXXXXX is in the business of

XXXXXXXXXX

7) XXXXXXXXXX is in the business of XXXXXXXXXX in the business of XXXXXXXXXX is in the business of XXXXXXXXXX

8) XXXXXXXXXX is authorized to issue an unlimited number of shares of the following classes:

Class XXXXXXXXXX:

- voting, participating, convertible into any Class of shares on unanimous approval of each shareholder, pre-emptive right to acquire any Class "XXXXXXXXXX" share offered for issue other than for conversion privileges, (common shares)

Class XXXXXXXXXX:

- non-voting, participating, convertible into any Class of share on unanimous approval of each shareholder, pre-emptive right to acquire any Class "XXXXXXXXXX" share offered for issue other than for conversion privileges, (common shares)

Class XXXXXXXXXX:

- non-voting, non-participating, cumulative, variable rate not to exceed XXXXXXXXXX% of issue price, redeemable at issue price plus any unpaid dividends thereon (whether declared or not), non-convertible, pre-emptive right to acquire any Class "XXXXXXXXXX" share offered for issue other than for conversion privileges, preferred over Classes "XXXXXXXXXX"

Class XXXXXXXXXX:

- non-voting, discretionary participation, non-cumulative, variable rate not to exceed XXXXXXXXXX%, retractable at $XXXXXXXXXX per share plus all declared and unpaid dividends thereon, convertible into Class "XXXXXXXXXX" shares upon unanimous approval of the holders of the Class "XXXXXXXXXX" shares as the case may be, no pre-emptive right, preferred over Classes "XXXXXXXXXX" shares, shall rate equally on a pro rata basis with the Class "XXXXXXXXXX" shares, but no such dividend shall be paid until all the preferential cumulative dividends on the Class "XXXXXXXXXX" shares have been declared and paid

Class XXXXXXXXXX:

- non-voting, discretionary participation, non-cumulative, variable rate not to exceed XXXXXXXXXX%, retractable at $XXXXXXXXXX per share plus all declared and unpaid dividends thereon, convertible into Class "XXXXXXXXXX" shares upon unanimous approval of the holders of the Class "XXXXXXXXXX" shares, no pre-emptive right, preferred over Classes "XXXXXXXXXX" shares, shall rate equally on a pro rata basis with the Class "XXXXXXXXXX" shares, but no such dividend shall be paid until all the preferential cumulative dividends on the Class "XXXXXXXXXX" shares have been declared and paid

Class XXXXXXXXXX:

- series issue, non-voting, non-participating, cumulative based on defined net before tax profit earned XXXXXXXXXX redeemable at issue price (referred to as the "redemption amount") plus any unpaid declared dividends thereon unless the wells specified in the series are abandoned due to uneconomic recovery then redemption amount shall be XXXXXXXXXX, non-convertible, no pre-emptive right, no dividend preference, liquidation preference over all other Classes of shares

9) The issued and outstanding share capital of XXXXXXXXXX along with the aggregate paid-up capital ("PUC") of each class of shares, is as follows:

PUC

XXXXXXXXXX

10) The shares of XXXXXXXXXX are held equally by each of XXXXXXXXXX shareholders as capital property. The shareholders, the number of shares of each class held by each, and respective adjusted cost bases ("ACB") are as follows:

Social
Insurance Class XX Class XX Class XX
Number Number ACB Number ACB Number ACB

XXXXXXXXXX

11) XXXXXXXXXX are residents of Canada. The shares held by each shareholder have a fair market value ("FMV") in excess of the shareholder's ACB.

12) The Class XXXXXXXXXX shares held by each shareholder were acquired from XXXXXXXXXX in exchange for Class XXXXXXXXXX common shares of XXXXXXXXXX.

13) XXXXXXXXXX has incorporated a corporation,

XXXXXXXXXX

is authorized to issue an unlimited number of shares of the following classes:

Class XXXXXXXXXX:

- voting, participating, pre-emptive right to acquire any Class "XXXXXXXXXX" share offered for issue, (common)

Class XXXXXXXXXX:

- non-voting, participating, pre-emptive right to acquire any Class "XXXXXXXXXX" share offered for issue, (common)

Class XXXXXXXXXX:

- non-voting, non-participating, cumulative dividend at a rate of XXXXXXXXXX% per annum of the redemption amount, redeemable by corporation at issue price plus any unpaid dividends thereon (whether declared or not), non convertible, pre-emptive right to acquire any Class "XXXXXXXXXX" share offered for issue, priority over all other Classes of shares on liquidation or dissolution

Class XXXXXXXXXX:

- non-voting, non-participating, non-cumulative dividend rate at XXXXXXXXXX% per annum of redemption price, redeemable at option of holder at issue price plus any unpaid but declared preferential dividend thereon, no preemptive right, preferred over Classes "XXXXXXXXXX" shares, but no such dividend shall be paid until all the preferential cumulative dividends on the Class "XXXXXXXXXX" shares have been declared and paid, created for the special purpose of being issued in exchange for property (other than a promissory note or promise to pay) or issued shares of the Corporation of a different class or series, and may not be issued for any other purpose

Class XXXXXXXXXX:

- non-voting, non-participating, non-cumulative dividends at XXXXXXXXXX% per annum of issue price, redeemable by holder at issue price plus any unpaid but declared preferential dividend thereon, no pre-emptive right, preferred over Classes "XXXXXXXXXX" shares, but no such dividend shall be paid until all the preferential cumulative dividends on the Class "XXXXXXXXXX" shares have been declared and paid, created for the special purpose of being issued in exchange for property (other than a promissory note or promise to pay) or issued shares of the Corporation of a different class or series, and may not be issued for any other purpose

Class XXXXXXXXXX:

- voting, non-participating, redeemable and retractable at issue price, no pre-emptive right, dividends as declared by the Board, liquidation preference over Classes "XXXXXXXXXX" shares

14) XXXXXXXXXX does not own shares in any corporation over which it could be considered to have a significant influence or an interest in any partnership.

15) Immediately before the transfers described in paragraph 23 below, the property of XXXXXXXXXX will be classified into three types of property for the purposes of paragraph 55(3)(b) of the Act, as follows:

(i) cash or near cash property, comprising all of the current assets of XXXXXXXXXX, including any cash, deposits, marketable securities and accounts receivable, inventory and rights arising from prepaid expenses and current portion of loan receivable from a related company;

(ii) investment property, comprising all of the assets of XXXXXXXXXX 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, within the meaning of subsection 125(7) of the Act. It will include the non-current portion of loan receivable from a related company; and

(iii) business property,comprising all of the assets of XXXXXXXXXX other than cash or near cash property, any income from which would be income from a business (other than a specified investment business).

Proposed transactions

16) XXXXXXXXXX will amend its shares' articles by changing the share attributes of its authorized Class XXXXXXXXXX share. The Class XXXXXXXXXX share will become voting rather than a non-voting share, and will also become convertible to Class XXXXXXXXXX share on a fair market value basis; otherwise its rights will remain unchanged.

17) XXXXXXXXXX each incorporated their own respective holding companies pursuant to the provisions of the XXXXXXXXXX already has incorporated XXXXXXXXXX; hereafter these XXXXXXXXXX corporations will be referred to as "Holdco". Each Holdco will be a TCC and CCPC, for purposes of the Act. The authorized share capital of each Holdco will be as described in paragraph 13 above. XXXXXXXXXX will each subscribe for XXXXXXXXXX Class XXXXXXXXXX common shares for $XXXXXXXXXX per share of their own Holdco prior to the transactions which follow. XXXXXXXXXX will be the sole shareholders of their respective Holdcos during the series of transactions described herein.

18) Prior to XXXXXXXXXX has declared and paid taxable dividends and it has declared and paid dividends to the individuals who are shareholders on its capital dividend account. The dividends were paid in cash. XXXXXXXXXX will elect in respect of the full amount of such dividends in accordance with subsection 83(2) of the Act. Subsequent to this and prior to XXXXXXXXXX transferred all of their Class XXXXXXXXXX shares of XXXXXXXXXX to XXXXXXXXXX Holdco. Consideration consisted uniquely of Holdco Class XXXXXXXXXX preferred shares with a total FMV and redemption amount equal to the FMV of the XXXXXXXXXX shares immediately before the transfer.

19) Each respective transferor and transferee will jointly elect under subsection 85(1), within the time referred to in subsection 85(6), with respect to the transfer of XXXXXXXXXX shares.

20) The agreed amount for each respective transfer will be equal to the ACB of the shares to the transferor. The agreed amount will not exceed the FMV of the XXXXXXXXXX shares transferred at the time of transfer.

21) The amount added to the stated capital of the Class XXXXXXXXXX preferred shares of each Holdco, at the time they are issued for the shares of XXXXXXXXXX, will be equal to that portion of the PUC of that class of shares of XXXXXXXXXX that the number of shares transferred of that class is of the total number of shares issued in that class by XXXXXXXXXX, (which will be $XXXXXXXXXX in total for each Holdco) to the stated capital of Class XXXXXXXXXX shares to each Holdco.

22) Immediately after the share transfers described in paragraph 18 above, XXXXXXXXXX declared a dividend on or before XXXXXXXXXX payable to the shareholders of record at XXXXXXXXXX. The amount of the dividend declared was equal to the balance of XXXXXXXXXX retained earnings for accounting purposes on XXXXXXXXXX immediately prior to the said dividend less $XXXXXXXXXX. The dividend will be paid by the end of the following month as stated in paragraph 31 below.

23) XXXXXXXXXX will transfer sometime after the issuance of the present ruling, all of its cash or near cash property, business property and investment property to each Holdco (a "transferee") such that the fair market value of each such type of property of XXXXXXXXXX to be transferred will be equal to the proportion of the fair market value of that type of property of XXXXXXXXXX determined immediately before the transfer referred to herein that:

(a) the fair market value, immediately before the transfer, of all shares of the capital stock of XXXXXXXXXX owned by the particular transferee

            is of

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

XXXXXXXXXX will transfer XXXXXXXXXX of each type of its assets to each Holdco. Each Holdco will receive:

- XXXXXXXXXX cash and near cash assets (approximately $XXXXXXXXXX),

- a XXXXXXXXXX undivided interest in XXXXXXXXXX business assets; for this purpose, business assets include all properties used in XXXXXXXXXX

- XXXXXXXXXX investment assets (approximately $XXXXXXXXXX), and

- a promissory note payable by XXXXXXXXXX equally to each respective Holdco in respect of excess debt as described below.

Prior to the transfers outlined in this paragraph, XXXXXXXXXX total liabilities will exceed the aggregate cost amount of its assets. The term "cost amount" has the meaning assigned by subsection 248(1) of the Act. As part of the asset transfer and as part of the debt assumption, XXXXXXXXXX will issue a promissory note payable to each Holdco in an amount equal to XXXXXXXXXX of the amount by which the aggregate debt exceeds the aggregate cost amount. For the purposes of paragraphs 23 to 30 inclusive, total liabilities or aggregate debt means total indebtedness of XXXXXXXXXX at the time of the transfer excluding the dividend payable. As consideration each Holdco will assume XXXXXXXXXX of the gross amount of XXXXXXXXXX debt and issue preferred shares as described in the following paragraphs.

XXXXXXXXXX will hold in trust each Holdco portion of the undivided interest in the business assets. XXXXXXXXXX would execute a Declaration of Trust indicating that it will: a) hold the interests as bare trustee for the Holdco's; b) maintain the interests on behalf of the Holdco's by paying lease payments and other costs and charges when due; c) not encumber, assign or surrender the interests without first obtaining the consent of the Holdco's; d) provide the Holdco's with any notices or assignments which may receive with respect to the rights; e) at the request of any Holdco, to transfer to such Holdco its interests in the properties.

24) XXXXXXXXXX and each respective Holdco will jointly elect under subsection 85(1), within the time referred to in subsection 85(6), for the said transfer of the assets\XXXXXXXXXX undivided interest in each asset. The agreed amount in respect of the transfer of each respective asset will be the cost amount of the asset. The agreed amount in respect of an undivided interest in a asset transferred will be equal to that portion of the cost amount of the asset that the FMV of the interest in the asset transferred is of the FMV of the whole interest in the asset, which will equate XXXXXXXXXX of the cost amount of the asset. In each case the agreed amount will not exceed the FMV of the asset\interest in the asset transferred at the time of the transfer.

25) For purposes of determining the agreed amount of an interest in depreciable property of a prescribed class, the cost amount, as referred to in paragraph 24 above, will be described in terms of its undepreciated capital cost ("UCC"). In this circumstance, the reference to "the UCC" found in subparagraph 85(1)(e)(i) of the Act will be interpreted to mean that portion of the UCC of all the property of that class that the FMV of the asset of that class transferred is of the FMV of all the assets of that class. The terms "depreciable property" and "UCC" have the meaning assigned by subsection 13(21) of the Act.

26) XXXXXXXXXX

27) As consideration for the transfers, each Holdco will assume liabilities and issue Class XXXXXXXXXX shares to XXXXXXXXXX The amount that will be added to the stated capital of the preferred shares so issued by each Holdco will be nominal, as the case may be, and will not exceed the aggregate of the agreed amounts in respect of the transfers less the aggregate of the liabilities assumed. The aggregate redemption amount with respect to the preferred shares issued by each Holdco will be equal to the aggregate of the FMV's of the assets\interests in assets received less liabilities assumed by each Holdco.

28) In each case, the type of liabilities assumed by each transferee will be specifically allocated to the type of particular assets\interest in assets transferred. The amount allocated to any specific asset\interest in an asset will not exceed the proportionate cost amount of the asset\interest in that asset.

29) The XXXXXXXXXX Holdcos will each subscribe for XXXXXXXXXX share of XXXXXXXXXX and each will pay $XXXXXXXXXX for each share. These shares will remain outstanding for the purposes of ownership of XXXXXXXXXX as a joint venture operator.

30) Each Holdco will redeem the Class XXXXXXXXXX shares issued to XXXXXXXXXX as consideration for the transfer of the assets\interest in assets. The share redemption will be satisfied by the issuance of a promissory note to XXXXXXXXXX by each respective Holdco, equal to the redemption amount of the said Class XXXXXXXXXX shares. The redemption proceeds will be a deemed dividend, pursuant to subsection 84(3), to the extent proceeds exceed paid-up capital.

XXXXXXXXXX

31) On XXXXXXXXXX will issue a promissory note to each Holdco as payment of the dividend payable as described in paragraph 22. Immediately thereafter, XXXXXXXXXX will repurchase its outstanding Class XXXXXXXXXX shares held by each respective Holdco for cancellation. In consideration, XXXXXXXXXX will issue a promissory note to each Holdco in the amount of the purchase price of the said shares. The purchase price will represent the FMV of the shares at time of purchase. Each Holdco will report the actual and the deemed dividend.

32) XXXXXXXXXX and each Holdco will agree to payment of the promissory notes, as described in paragraphs 30 and 31, issued in the course of the divisive reorganization by means of offsetting the indebtedness.

33) XXXXXXXXXX will be engaged to act as a contract operator by the XXXXXXXXXX Holdcos in respect of the jointly owned XXXXXXXXXX Holdcos will enter into a joint venture agreement to define the business relationship of the XXXXXXXXXX corporations in respect of property and XXXXXXXXXX acquired from XXXXXXXXXX and property which may be acquired in the future. In respect of each XXXXXXXXXX it is the intention to operate as a joint venture and not as a partnership.

34) Due to cross shareholdings in XXXXXXXXXX each Holdco would be associated with each other, and with both XXXXXXXXXX for purposes of the Act. Therefore, there will be no change to the small business deduction available to the corporate group due to the divisive reorganization.

35) It is not contemplated that a Holdco will be wound up or amalgamated with any other corporation as part of the divisive reorganization.

36) The Holdcos will not dispose of any property acquired otherwise than in the ordinary course of the business of XXXXXXXXXX.

Purpose of Proposed Transactions

The purpose of the proposed transactions is to achieve a divisive reorganization of XXXXXXXXXX whereby each Holdco will receive its proportionate share of XXXXXXXXXX assets and liabilities rather than be a minority shareholder so as to:

37) a) Facilitate the estate planning for each shareholder,

XXXXXXXXXX

b) Facilitate estate planning for each shareholder as the shares of their Holdco can be transferred on death to their respective spouses and/or family members. After the transactions, the beneficiaries will own 100% of a corporation which owns directly the business assets. The beneficiaries would have the choice to retain the shares, sell the shares, retain or sell the business assets. Without the divisive reorganization, the beneficiaries would only own XXXXXXXXXX of a corporation and would be forced to sell their shares to the surviving shareholders under their current agreement.

c) Facilitate the business planning for each shareholder by enhancing the ability of a Holdco to access financing for similar or separate business ventures by directly providing property as security and having direct access to business cash flow.

Additional information

It is our understanding that:

(a) neither the Class XXXXXXXXXX shares of each Holdco nor the common shares of XXXXXXXXXX will be subject to a guarantee agreement, within the meaning referred to in subsection 112(2.2) of the Act, that is given by a specified financial institution or a specified person in relation to any such specified financial institution for any of the purposes described in that subsection. Specified financial institution ("SFI") has the meaning referred to in subsection 248(1) of the Act, while the expression "specified person" has the meaning assigned by paragraph (h) of the definition "taxable preferred share" in subsection 248(1) of the Act;

(b) none of the shares referred to in (a) herein has been or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5) of the Act;

(c) XXXXXXXXXX has received amounts described in paragraph 12(1)(a) of the Act and has claimed a reserve under paragraph 20(1)(m) of the Act. The amount described herein are reported on the balance sheet as deferred revenue. As part of the reorganization and the transfer described in paragraph 23 above, the sale agreement will specifically provide that an amount of assets transferred equal to the outstanding deferred revenue at the effective date of transfer will be payment for the assumption of the deferred revenue liability. Each Holdco will assume XXXXXXXXXX of the deferred revenue liability and will accordingly receive XXXXXXXXXX of the assets transferred. For this purpose, the assets transferred to the Holdcos will be of the same type in each case.

(d) XXXXXXXXXX and each Holdco will file joint elections, in the form and within the time referred to in subsection 20(25) of the Act, to have the rules of subsection 20(24) apply in respect of XXXXXXXXXX deferred revenue obligation to be assumed by each Holdco.

(e) No election has been made under subsection 21(2) of the Act.

Rulings

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 herein, our rulings are as follows:

A) Paragraph 85(1)(b) of the Act will not apply to alter the agreed amount in respect of the property transferred by XXXXXXXXXX to the respective Holdcos and for the purpose of that paragraph, the issuance of a promissory note payable by XXXXXXXXXX in consideration for the assumption of the excess debt described in paragraph 23 above will be accepted.

B) The taxable dividends referred to in paragraphs 30 and 31 above will be deductible by XXXXXXXXXX and each Holdco in computing their taxable income pursuant to the provisions of subsection 112(1) of the Act, and for greater certainty, the provisions of subsections 112(2.2) and (2.4) of the Act will not apply to deny the subsection 112(1) deduction in respect of such dividend.

C) Provided that a liability of XXXXXXXXXX to be assumed by each Holdco as described in paragraphs 27 and 28 represented

(i) borrowed money that was used by XXXXXXXXXX for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy), or

(ii) an amount payable for property acquired by XXXXXXXXXX for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or for property that is an interest in a life insurance policy)

then an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by each Holdco in computing its income) pursuant to a legal obligation to pay interest on such a liability of XXXXXXXXXX so assumed by each Holdco will be deductible by each Holdco pursuant to the provisions of paragraph 20(1)(c) of the Act provided that each Holdco continues to use the borrowed money for the purpose described in (i) herein or continues to use the property for the purpose described in (ii) herein, as the case may be.

D) The provisions of subsection 80(1) of the Act will not apply to the extinguishment of the debt obligations in respect of XXXXXXXXXX and each Holdco referred to in paragraph 32, as a result of the cancellation of the promissory note issued by each Holdco and XXXXXXXXXX as described in paragraphs 30 and 31, and no gain or loss will arise as a result of such extinguishment.

E) 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 on the circumstances described in subparagraph 55(3.1)(b)(ii); or

(c) an acquisition of property in the circumstances described in paragraph 55(3.1)(c),

then by virtue of paragraph 55(3)(b) of the Act, subsection 55(2) of the Act will not apply to the taxable dividends referred to in the rulings given in paragraph B) above, and for greater certainty, subsection 55(3.1) of the Act will not apply to deny the exemption under paragraph 55(3)(b) of the Act.

F) Provided that the assets received by each Holdco is reasonable consideration for them assuming XXXXXXXXXX deferred revenue obligation and provided that it has been included in computing the income of XXXXXXXXXX pursuant to paragraph 12(1)(a) of the Act, the provisions of subsection 20(24) of the Act will apply in computing the income of XXXXXXXXXX and each Holdco in respect of the amount assumed.

G) The provisions of subsections 15(1) and 56(2) of the Act will not be applied as a result of the proposed transactions in and by themselves.

H) As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act 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 out in Information Circular 70-6R2, issued by Revenue Canada, Customs, Excise and Taxation on September 28, 1990, and the Special Release thereto issued on September 30, 1992, and are binding provided that the proposed transactions take place prior to XXXXXXXXXX.

Our rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act.

Nothing in this letter should be interpreted as confirming, for the purpose of the Act, the cost or adjusted cost base to any person, or the paid-up capital or fair market value of any shares at any particular time.

Yours truly,

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