30 November 1997 Ruling 9805113 - BUTTERFLY REORGANIZATION

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.

Principal Issues: A gross asset butterfly

Position: Favourable rulings given

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

XXXXXXXXXX 980511
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: XXXXXXXXXX ("Distributor")
XXXXXXXXXX ("Father")
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

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

We understand that to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this advance ruling request is being considered by a Tax Services Office or a Taxation Centre in connection with a tax return already filed and none of the issues is under objection or appeal.

Definitions

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

(a) "Act" means the Income Tax Act, 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 provision of the Act;

(b) XXXXXXXXXX;

(c) "adjusted cost base" ("ACB") has the meaning assigned to that term in section 54;

(d) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned to that term by subsection 125(7);

(e) "capital dividend account" ("CDA") has the meaning assigned to that term in subsection 89(1);

(f) "capital property" has the meaning assigned to that term in section 54;

(g) "cost amount" has the meaning assigned to that term in subsection 248(1);

(h) XXXXXXXXXX;

(i) "paid-up capital" ("PUC") has the meaning assigned to that term by subsection 89(1);

(j) "refundable dividend tax on hand" ("RDTOH") has the meaning assigned to that term by subsection 129(3);

(k) "specified financial institution" ("SFI") has the meaning assigned to that term by subsection 248(1);

(l) "specified investment business" has the meaning assigned to that term by subsection 125(7);

(m) "taxable Canadian corporation" ("TCC") has the meaning assigned to that term by subsection 89(1); and

(n) "taxable dividend" has the meaning assigned to that term by subsection 89(1).

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

Facts

1. XXXXXXXXXX, all of whom are over the age of majority, are the children of Father. Each of the children and Father is a resident of Canada. For taxation years prior to XXXXXXXXXX has also been a resident of the United States, but has historically filed personal returns in Canada on the basis that the provisions of the Canada-United States Income Tax Convention resolve his residency in favour of Canada.

2. Distributor is a TCC and a CCPC, which was incorporated by way of letters patent under the XXXXXXXXXX.

3. The authorized share capital of Distributor consists of an unlimited number of Class A common shares, an unlimited number of Class B common shares, XXXXXXXXXX Second Preference shares, an unlimited number of Third Preference shares, an unlimited number of Fourth Preference shares and an unlimited number of Fifth Preference shares.

4. The Class A common shares are voting, fully participating, bear a discretionary, non-cumulative dividend, and are convertible into an equal number of Class B common shares at the option of the holder. The Class B common shares are voting, fully participating, bear a discretionary, non-cumulative dividend and are entitled, on dissolution, to an aggregate payment of $XXXXXXXXXX in priority to the Class A common shares. The Second Preference shares are voting, carry a XXXXXXXXXX% non-cumulative dividend, and are redeemable at the amount paid-up thereon, or $XXXXXXXXXX per share. The Third Preference shares are non-voting, carry a discretionary, non-cumulative dividend at a rate linked to Distributor's banker's prime rate in effect from time to time, and are redeemable and retractable at the amount paid-up thereon, or $XXXXXXXXXX per share. The Fourth Preference shares are non-voting, carry a discretionary, non-cumulative dividend to a maximum of XXXXXXXXXX% and are redeemable and retractable at a price of $XXXXXXXXXX per share. The Fifth Preference shares are non-voting, carry a discretionary, non-cumulative dividend to a maximum of XXXXXXXXXX% and are redeemable and retractable at a price of $XXXXXXXXXX per share.

5. With respect to those classes of shares constituting the Second Preference shares, Third Preference shares and Fifth Preference shares of Distributor:

(a) the paid-up capital in respect of the class immediately before the beginning of the series of transactions or events that includes a distribution by Distributor was not less than the fair market value of the consideration for which the shares of that class then outstanding were issued;

(b) under neither the terms and conditions of the shares nor any agreement in respect of the shares are the shares convertible into or exchangeable for shares other than shares of a specified class within the meaning of the Act or shares of the capital stock of a transferee corporation in relation to Distributor;

(c) under neither the terms and conditions of the shares nor any agreement in respect of the shares is any holder of the shares entitled to receive on the redemption, cancellation or acquisition of the shares by Distributor or by any person with whom Distributor does not deal at arm's length (excluding any premium for early redemption) an amount greater than the total of the fair market value of the consideration for which the shares were issued and the amount of any unpaid dividends thereon; and

(d) the cost of each share of the class, at the time of its issuance, to its original owner, was equal to the fair market value at that time of the consideration for which it was issued.

6. The following shares in the capital of Distributor are issued and outstanding and are owned beneficially and of record by the following individuals:

				XXXXXXXXXX 

				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX 

				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX 

				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX 

7. The XXXXXXXXXX Second Preference shares owned by Father have an aggregate ACB and PUC of $XXXXXXXXXX and a fair market value of $XXXXXXXXXX.

8. The aggregate ACB, PUC and fair market value of each class of shares owned by each of the children are as follows:

Shareholder Shares Held PUC ACB FMV

				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX 

				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX 

				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX 

				XXXXXXXXXX
				XXXXXXXXXX
				XXXXXXXXXX 

A range is used to describe the fair market value of the Class A common shares since the value of these shares is subject to daily fluctuations in the market.

9. Each of the children also holds demand, non-interest-bearing debt of Distributor.

10. Distributor is a family investment holding corporation. Its assets consist of a portfolio of cash, interest-bearing indebtedness due from arm's length persons, pieces of art, short-term investments and marketable securities held directly or indirectly in one or more managed mutual funds. These assets represent portfolio investments of Distributor as it does not have significant influence, within the meaning of section 3050 of the CICA Handbook, over any corporations in which it holds these investments and marketable securities. At the end of its XXXXXXXXXX taxation year, i.e. XXXXXXXXXX, Distributor's RDTOH was $XXXXXXXXXX after giving effect to a dividend refund for the year of $XXXXXXXXXX.

11. On XXXXXXXXXX, Distributor paid a capital dividend of $XXXXXXXXXX to the current shareholders of record of its Class A common shares, i.e. XXXXXXXXXX on a pro-rata basis and issued non-interest-bearing promissory notes as payment. XXXXXXXXXX accepted the non-interest-bearing promissory notes as payment in full satisfaction of the capital dividend.

Proposed Transactions

To be Implemented on or before XXXXXXXXXX

12. Distributor proposes to:

(a) surrender for cash value or assign the ownership to Father or to XXXXXXXXXX (spouse of Father) for fair market value consideration an insurance policy on the life of Father; and

(b) transfer to XXXXXXXXXX for fair market value consideration, in the form of cash or indebtedness, all of Distributor's capital equipment, i.e. furniture and computers. (All issued shares of XXXXXXXXXX are registered in the names of Father and XXXXXXXXXX (spouse of Father) jointly, in their capacities as trustees for their grandchildren.)

13. Distributor will redeem, in accordance with the provisions of the Second Preference shares, all of the Second Preference shares owned by Father for aggregate consideration, payable in cash, of $XXXXXXXXXX.

14. Distributor will redeem, in accordance with the provisions of the Third Preference shares and Fifth Preference shares, all of the Third Preference shares and the Fifth Preference shares owned by XXXXXXXXXX for consideration, payable by the delivery of non-interest-bearing demand promissory notes, of $XXXXXXXXXX per Third Preference share and $XXXXXXXXXX per Fifth Preference share.

15. Non-interest-bearing debt held by one or more of XXXXXXXXXX will be assigned for FMV, inter se, in order to equalize the amount owed by Distributor to each of them.

16. XXXXXXXXXX will each cause the incorporation of a new corporation pursuant to the XXXXXXXXXX. The authorized capital of each of XXXXXXXXXX will consist of an unlimited number of common shares and a class of preference shares ("the preference shares") which will be redeemable and retractable at an amount equal to the fair market value of the property for which they are issued and which will be entitled to dividends, within limits, in the discretion of the directors. The first taxation year end of each of XXXXXXXXXX will be XXXXXXXXXX.

17. The sole shareholder of XXXXXXXXXX will be XXXXXXXXXX. On the incorporation of XXXXXXXXXX, 1 common share will be issued to XXXXXXXXXX for aggregate consideration of $XXXXXXXXXX.

18. The sole shareholder ofXXXXXXXXXX will be XXXXXXXXXX. On the incorporation of XXXXXXXXXX, 1 common share will be issued to XXXXXXXXXX for aggregate consideration of $XXXXXXXXXX.

19. The sole shareholder of XXXXXXXXXX will be XXXXXXXXXX. On the incorporation of XXXXXXXXXX, 1 common share will be issued to XXXXXXXXXX for aggregate consideration of $ XXXXXXXXXX.

20. The sole shareholder of XXXXXXXXXX will be XXXXXXXXXX. On the incorporation of XXXXXXXXXX, 1 common share will be issued to XXXXXXXXXX for aggregate consideration of $XXXXXXXXXX.

21. XXXXXXXXXX will transfer all of their Class A Common shares of Distributor to XXXXXXXXXX, respectively, in consideration for the issuance by the relevant transferee corporation of common shares. The children and each of XXXXXXXXXX will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfers of the Distributor shares. The amount agreed upon in such elections will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii). For greater certainty, the agreed amount will not be greater than the aggregate fair market value, at the time of the disposition, of their respective Class A Common shares in the capital of Distributor.

22. Each of XXXXXXXXXX will add to the stated capital account maintained for its common shares an amount equal to the aggregate PUC of all Class A Common shares of Distributor transferred to that transferee.

23. XXXXXXXXXX will each assign their Distributor promissory notes (each child now being owed an identical principal amount by Distributor) to XXXXXXXXXX, respectively, in consideration for the delivery by the relevant transferee corporation of a non-interest-bearing, demand promissory note in the same principal amount.

24. Immediately before the transfers of property as described in paragraph 25 below, the property of Distributor will be classified into three types of property for the purposes of the definition of "distribution" in subsection 55(1), as follows:

(a) cash or near-cash property, comprising all of the current assets of Distributor, including any cash, term deposits and marketable securities (other than portfolio investments);

(b) investment property, comprising all the assets of Distributor, 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; and

(c) business property, comprising all of the assets of Distributor, other than cash or near-cash property, any income from which would, for purposes of the Act, be income from an active business carried on by Distributor.

For greater certainty, any tax accounts, such as the balance of any RDTOH account or CDA of Distributor, will not be considered property of Distributor for purposes of the proposed transactions described herein.

25. Distributor will transfer one-quarter of:

(a) its cash or near-cash property;

(b) its investment property; and

(c) its business property, if any,

to each of XXXXXXXXXX in consideration for the assumption by each of XXXXXXXXXX, respectively, of 1/4 of Distributor's liabilities (including amounts owing to each of XXXXXXXXXX, respectively) and the issuance of that number of preference shares of XXXXXXXXXX having an aggregate redemption amount ("redemption amount") equal to the amount by which the fair market value of the Distributor's assets acquired by each of XXXXXXXXXX exceeds the liabilities assumed. The preference shares of XXXXXXXXXX will represent capital property to Distributor. The Distributor promissory notes previously acquired from XXXXXXXXXX will be merged and extinguished upon the assumption by each of XXXXXXXXXX of the indebtedness evidenced by those promissory notes.

26. Each of XXXXXXXXXX will be connected with Distributor pursuant to subsection 186(2) and paragraph 186(4)(a).

27. Distributor and each of XXXXXXXXXX will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each property of Distributor that is a capital property. The amount agreed upon in such elections in respect of each capital property so transferred will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) of the Act. For greater certainty, the agreed amount for any capital property included in the subsection 85(1) elections referred to herein will not be greater than the fair market value, at the time of the disposition, of such property. Further, the principal amount of any liabilities assumed will not exceed the elected amount.

28. Each of XXXXXXXXXX will add to the stated capital account maintained for its preference shares an amount equal to the aggregate of the cost amounts (determined pursuant to subsection 85(1), where relevant) of the properties transferred to that transferee less the principal amount of liabilities assumed.

29. Each of XXXXXXXXXX will redeem its preference shares held by Distributor for an amount equal to their redemption amount and satisfy the price by the delivery to Distributor of a non-interest-bearing demand promissory note (XXXXXXXXXX) having a principal amount equal to the redemption amount. Distributor will accept these notes as full payment for the redemption amount of the preference shares of XXXXXXXXXX.

To be Implemented between XXXXXXXXXX

30. The shareholders of Distributor will pass a special resolution authorizing the liquidation and winding-up of the corporation. Distributor will make a winding-up distribution to:

(a) XXXXXXXXXX, consisting of the note received from XXXXXXXXXX on the redemption of its preference shares and one-quarter of Distributor's dividend refund receivable arising on the winding-up dividend;

(b) XXXXXXXXXX, consisting of the note received from XXXXXXXXXX on the redemption of its preference shares and one-quarter of Distributor's dividend refund receivable arising on the winding-up dividend;

(c) XXXXXXXXXX, consisting of the note received from XXXXXXXXXX on the redemption of its preference shares and one-quarter of Distributor's dividend refund receivable arising on the winding-up dividend; and

(d) XXXXXXXXXX, consisting of the note received from XXXXXXXXXX on the redemption of its preference shares and one-quarter of Distributor's dividend refund receivable arising on the winding-up dividend.

31. Prior to the distribution referred to in the immediately preceding paragraph, Distributor 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 amount of the capital dividend will be based upon the best possible estimate of Distributor's CDA at that time. The form of 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 Distributor's CDA at the time the dividend becomes payable, the directors of Distributor will elect to treat the excess as a separate dividend that is a taxable dividend that became payable at that time.

32. The XXXXXXXXXX Note, XXXXXXXXXX Note, XXXXXXXXXX Note and XXXXXXXXXX Note will merge and be extinguished on the winding-up distribution.

33. All properties and liabilities of Distributor will then have been distributed or discharged, as the case may be. On the receipt of a clearance certificate from theXXXXXXXXXX, Articles of Dissolution will be filed for Distributor with theXXXXXXXXXX.

Additional Information

34. Except as described in this letter, no assets have been or will be acquired by Distributor or a corporation controlled by Distributor in contemplation of and before the proposed transfer of properties described in paragraph 25 above.

35. There will not be, as part of the series of transactions or events that includes the transactions described herein:

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

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

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

(d) an acquisition of property in the circumstances described in subparagraph 55(3.1)(d)

which has not been described herein.

36. None of Distributor, XXXXXXXXXX is, or will be at the time of the proposed transactions, an SFI.

37. None of the shares of Distributor, XXXXXXXXXX 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 as that term is defined in subsection 248(1).

Purpose of Proposed Transactions

The purpose of the proposed transactions is to divide the assets of Distributor in order to separate the financial interests of the four adult children of Father and thereby provide each child with the option of managing his or her own assets and pursuing independent investment objectives.

Rulings

Provided that the above statements are accurate and constitute complete disclosure of all of the relevant facts, proposed transactions and the purpose of proposed transactions, we confirm the following:

A. The redemption by Distributor of the Second Preference shares held by Father will constitute a "permitted redemption" within the meaning of subsection 55(1).

B. Each redemption by Distributor of Third Preference shares and Fifth Preference shares held by XXXXXXXXXX will constitute "permitted redemptions" within the meaning of subsection 55(1).

C. The provisions of subsection 85(1) will apply to the transfers of property referred to in paragraphs 22 and 25 above such that the agreed amount in respect of each such property will be deemed to be the transferor's proceeds of disposition and the transferee's cost thereof pursuant to paragraph 85(1)(a).

D. Subsection 84.1(1) will not apply to reduce the PUC of the common shares of XXXXXXXXXX issued, respectively, to XXXXXXXXXX, as described in paragraph 22 above, provided that the PUC of the common shares received as consideration for the transfer of Distributor shares is not greater than the PUC of the Distributor shares.

E. By virtue of subsection 84(3), XXXXXXXXXX will be deemed to have paid, and Distributor to have received, a dividend equal to the amount by which the principal amount of the promissory note issued on the redemption by XXXXXXXXXX of their preference shares exceeds the PUC of such shares.

F. Pursuant to paragraph 88(2)(b) and subsection 84(2), but subject to G below, Distributor will be deemed to have paid, and XXXXXXXXXX to have received, a dividend (the "winding-up dividend") equal to the proportion of the amount, if any, by which the aggregate FMV of the property of Distibutor distributed by Distributor on the winding-up exceeds the PUC of the Class A common shares, that the number of shares of such class held by each of XXXXXXXXXX is of the number of shares of that class that are cancelled.

G. Pursuant to subparagraph 88(2)(b)(i), such portion of the winding-up dividend referred to in F above as does not exceed Distributor's CDA determined immediately prior to the payment of the winding-up dividend will be deemed, for the purposes of subsection 83(2), to be the full amount of a separate dividend. To the extent that the amount elected for the purposes of subsection 83(2) exceeds Distributor's CDA balance at the time that the dividend becomes payable, the excess will be deemed, by reason of subsection 184(3), to be a separate dividend that is a taxable dividend payable at that time.

H. The deemed dividends referred to in paragraphs E and F above, to the extent that they are taxable dividends, will:

(a) be included in each recipient's income pursuant to paragraph 12(1)(j);

(b) be deductible by the recipient pursuant to subsection 112(1) in computing its taxable income for the year in which such dividend is deemed to have been received, and such deduction will not be prohibited by any of subsections 112(2.2) or (2.4);

(c) be excluded in computing the proceeds of disposition to the holder of the shares so redeemed or cancelled pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54; and

(d) by virtue of subsection 112(3), reduce the loss, if any, in respect of the disposition of the shares on which the dividend is deemed to be received.

I. The provisions of subsection 55(2) will not apply to the dividends described in ruling E and F above, by virtue of the application of paragraph 55(3)(b) 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.

J. Parts IV.I and VI.1 will not apply to any of the dividends deemed to have been paid in the course of the proposed transactions described above.

K. Part IV will not apply to any of the dividends deemed to have been paid in the course of the transactions described above except as required under paragraph 186(1)(b).

L. The extinguishment of the debt obligations as a result of the merger of the Distributor promissory notes referred to in paragraph 25 above will not give rise to a "forgiven amount" within the meaning thereof in subsection 80(1) and 80.01(1).

M. The extinguishment of the debt obligations as a result of the merger of the XXXXXXXXXX Note, the XXXXXXXXXX Note, the XXXXXXXXXX Note and the XXXXXXXXXX Note on the winding-up of Distributor will not give rise to a "forgiven amount", within the meaning thereof in subsections 80(1) and 80.01(1).

N. Distributor will not realize any capital gain or incur any capital loss upon the extinguishment of the debt obligations as a result of the merger of the XXXXXXXXXX Note, the XXXXXXXXXX Note, the XXXXXXXXXX Note and the XXXXXXXXXX Note.

O. The provisions of subsections 15(1), 56(2), 56(4) and 246(1) will not apply to any of the proposed transactions described above, in and by themselves.

P. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, 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 70-6R3 dated December 30, 1996, issued by Revenue Canada and are binding provided that the proposed transactions are completed by XXXXXXXXXX.

These 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 into law, could have an effect on the rulings provided herein.

Opinion

Provided that:

(a) our understanding of the facts and proposed transactions is complete and accurate;

(b) section 55 is amended in substantially the same form as proposed in Bill C-28 which was passed by the House of Commons on April 21, 1998;

(c) as part of the series of transactions or events that includes the proposed transactions described herein, there is not:

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

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

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

(iv) an acquisition of property in the circumstances described in paragraph 55(3.1)(d);

which has not been described herein,

it is our opinion that, by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends described in rulings E and F above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

Comments

Nothing in this letter should be construed as implying that the Department has agreed to or accepted:

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

(b) any tax consequences arising from the facts or proposed transactions described above other than those specifically confirmed in the rulings given.

Yours truly,

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

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