30 November 1997 Ruling 9814273 - 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
XXXXXXXXXX 981427
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sir:

Re: Request for advance income tax ruling on behalf of
XXXXXXXXXX
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.

To the best of your knowledge and that of the taxpayers:

a) None of the issues involved in this ruling request is being considered by any Tax Services Office and/or Taxation Centre in connection with any tax return already filed; and

b) None of the issues involved in this ruling request is under objection or appeal.

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

Facts

Except where specifically otherwise indicated, words and phrases herein have the same meaning for the purpose of this ruling application as are ascribed to such words and phrases in the Income Tax Act (Canada) R.S.C. 1985, c.1 (5th Supp.) as amended as of the date hereof including the amendments contained in Bill C-28 which received Royal Assent on June 18, 1998, (the “Act”).

1. The Corporation is a Canadian-controlled private corporation (“CCPC”) and a taxable Canadian corporation (“TCC”) and has been incorporated under the laws of the Province of XXXXXXXXXX by Articles of Incorporation dated XXXXXXXXXX. Articles of Amendment were issued XXXXXXXXXX.

2. The Corporation has authorized capital consisting of XXXXXXXXXX non-voting Class “A” Special Shares without par value and an unlimited number of Common shares without par value. XXXXXXXXXX Class “A” Special Shares and XXXXXXXXXX Common shares have been issued as follows:

CLASS “A” SPECIAL SHARES

Shareholder	                Number of Shares	                Total

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

COMMON SHARES

Shareholder	                 Number of Shares	                 Total

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

3. XXXXXXXXXX are brothers. XXXXXXXXXX is the son of XXXXXXXXXX and XXXXXXXXXX is the spouse of XXXXXXXXXX. The Corporation carries on the business of XXXXXXXXXX. XXXXXXXXXX is responsible for the XXXXXXXXXX business and XXXXXXXXXX is responsible for the XXXXXXXXXX business. Both play an active role in the operations. XXXXXXXXXX are also active. The nature of the business has not changed since the Corporation was incorporated. The business of the Corporation is an “active business” within the meaning of subsection 248(1) of the Act.

4. Prior to obtaining Articles of Amendment on XXXXXXXXXX, the issued capital of the Corporation consisted of XXXXXXXXXX Common shares. There were issued to XXXXXXXXXX Common shares, there were issued to XXXXXXXXXX common shares and there were issued to XXXXXXXXXX Common shares. On XXXXXXXXXX transferred to XXXXXXXXXX Common shares as part of a corporate reorganization.

5. Articles of Amendment were issued on XXXXXXXXXX, to increase the authorized capital of the Corporation by creating XXXXXXXXXX Class “A” non-cumulative, non-participating, non-voting, redeemable, retractable special shares and an unlimited number of voting Common shares to rank on a parity with the then existing XXXXXXXXXX voting Common shares and the then authorized but unissued voting Common shares. The redemption amount for each Class “A” Special Share is a fixed amount equal to the fair market value of each Common share or fraction thereof from which each Class “A” Special Share was taken in exchange. The estimated fair market value of the issued XXXXXXXXXX Common shares was XXXXXXXXXX. The value was estimated as of XXXXXXXXXX.

6. Share Purchase Agreements, each made as of the XXXXXXXXXX, were entered into between XXXXXXXXXX and the Corporation, XXXXXXXXXX and the Corporation, XXXXXXXXXX and the Corporation and XXXXXXXXXX and the Corporation. Each of XXXXXXXXXX transferred XXXXXXXXXX Common shares to the Corporation in exchange for XXXXXXXXXX Class “A” Special Shares each. Each Agreement provided that for income tax purposes the acquisition cost to the Corporation and the proceeds of disposition of each of XXXXXXXXXX was deemed to be XXXXXXXXXX (the fair market value of their Common shares and the redemption value of the XXXXXXXXXX Class “A” Special Shares issued to each). Subsequently each of XXXXXXXXXX and the Corporation and XXXXXXXXXXand the Corporation jointly made, executed and filed elections under subsection 85(1) of the Act in prescribed form T2057 and within the prescribed time whereby the elected amount and the agreed transferred value of the XXXXXXXXXX Common shares transferred in exchange for the XXXXXXXXXX Class “A” Special Shares was in each case to be the sum of XXXXXXXXXX.

7. At the same time each of XXXXXXXXXX transferred XXXXXXXXXX Common shares to the Corporation in exchange for XXXXXXXXXX Class “A” Special Shares each. Each Agreement provided that for income tax purposes the acquisition cost to the Corporation and the proceeds of disposition to each of XXXXXXXXXX was deemed to be XXXXXXXXXX) (the fair market value of their Common shares and the redemption value of the XXXXXXXXXX Class “A” Special Shares issued to each). Subsequently each of XXXXXXXXXX and the Corporation and XXXXXXXXXX and the Corporation jointly made, executed and filed elections under subsection 85(1) of the Act in prescribed form T2057 and within the prescribed time whereby the elected amount and the agreed transfer value of the XXXXXXXXXX Common shares transferred in exchange for the XXXXXXXXXX Class “A” Special Shares was in each case to be the sum of XXXXXXXXXX.

8. In all cases the Share Transfer Agreements contained price adjustment clauses in the usual form whereby the appropriate adjustments were to be made in the event of any dispute as to the ACB or the fair market value (“FMV”) whether by agreement with the Department, Court Order or mathematical miscalculation with agreements to take the necessary steps to settle any resulting excess or shortfall.

9. On XXXXXXXXXX, a total of XXXXXXXXXX Common shares were subscribed for, by XXXXXXXXXX in each case at a subscription price of XXXXXXXXXX per share.

10. The XXXXXXXXXX corporate reorganization was entered into for the sole purpose of enabling XXXXXXXXXX to crystallize to the extent available to each the enhanced capital gains exemption of five hundred thousand dollars ($500,000.00). The shares of the Corporation qualified for such enhanced capital gains exemption at the time.

11. XXXXXXXXXX, as co-shareholders, have been business partners for a number of years with XXXXXXXXXX primarily responsible for the XXXXXXXXXX business and XXXXXXXXXX primarily responsible for the XXXXXXXXXX business. Recently XXXXXXXXXX have had disagreements relating to the direction that the Corporation should take in future and are unable to reach a consensus on the Corporation's future. As a result of these disagreements, they have decided to amicably go their separate ways and they together with XXXXXXXXXX wish to begin the process of dividing the assets of the Corporation pro rata to their respective shareholdings. It is intended that the XXXXXXXXXX business be continued by XXXXXXXXXX and that the XXXXXXXXXX business be continued by XXXXXXXXXX through separate new corporate entities.

12. Appraisals will be obtained to establish the fair market value of all of the assets of the Corporation which consist primarily of the XXXXXXXXXX business and its goodwill, the XXXXXXXXXX business and its goodwill, current assets consisting of cash, short term investments and various prepaid expenses as well as fixed assets consisting of land, vehicles, furniture and equipment and computer equipment. The land will likely be sold at its fair market value to XXXXXXXXXX. The goodwill and possibly some other assets may have a FMV in excess of their cost amount.

Proposed Transactions

13. XXXXXXXXXX will together incorporate a new company (“Newco I”) under the XXXXXXXXXX. The authorized capital of Newco I will consist of:

a) an unlimited number of voting Common shares (the “Common Shares”);

b) an unlimited number of XXXXXXXXXX Class “A” non-cumulative,
non-participating, non-voting, redeemable, retractable Special shares (the “Class “A” Special Shares”); and

c) an unlimited number of Class “B” non-cumulative, non-participating, voting, redeemable, retractable Special shares (the “Class “B” Special Shares”). For purposes of subsection 191(4) of the Act, the Class “B” Special Shares will be issued for a specific dollar amount in respect of each share. The amount to be specified in respect of each such share will not exceed the FMV of the consideration for which the share was issued. For greater certainty, the specified amount will not be subject to adjustment or described by reference to a formula.

The Common shares and the Class “A” Special Shares will have the same preferences, rights, conditions, restrictions, limitations and prohibitions attached to the presently existing Common shares and Class “A” Special Shares of the Corporation.

14. XXXXXXXXXX will incorporate a new company (“Newco II”) under the XXXXXXXXXX. The authorized capital of Newco II will consist of:

a) an unlimited number of voting Common shares (the “Common Shares”);

b) an unlimited number of XXXXXXXXXX Class “A” non-cumulative,
non-participating, non-voting, redeemable, retractable Special shares (the “Class “A” Special Shares”); and

c) an unlimited number of Class “B” non-cumulative, non-participating, voting, redeemable, retractable Special shares (the “Class “B” Special Shares”). For purposes of subsection 191(4) of the Act, the Class “B” Special Shares will be issued for a specific dollar amount in respect of each share. The amount to be specified in respect of each such share will not exceed the FMV of the consideration for which the share was issued. For greater certainty, the specified amount will not be subject to adjustment or described by reference to a formula.

The Common shares and the Class “A” Special Shares will have the same preferences, rights, conditions, restrictions, limitations and prohibitions attached to the presently existing Common shares and Class “A” Special Shares of the Corporation.

15. Each of XXXXXXXXXX will transfer at FMV all of their Class “A” Special Shares and Common shares of the Corporation to Newco I. As consideration, Newco I will issue an identical number of Class “A” Special Shares having a FMV equal to the FMV of the Class “A” Special Shares being transferred and which will have the same redemption and retraction value per share. Their Common shares will also be transferred to Newco I on the basis of an exchange of one (1) Common share of Newco I for each Common share of the Corporation so transferred. The aggregate PUC of the Class “A” Special Shares and the Common shares to be issued by Newco I will be equal to the PUC attributable to the transferred shares.

16. XXXXXXXXXX will transfer at FMV all of his Class “A” Special Shares and Common shares of the Corporation to Newco II. As consideration, Newco II will issue an identical number of Class “A” Special Shares that will have a FMV equal to the FMV of the Class “A” Special Shares of the Corporation being transferred and which will have the same redemption and retraction value per share. His Common shares will also be transferred to Newco II on the basis of an exchange of one (1) Common share of Newco II for each Common share of the Corporation so transferred. The aggregate PUC of the Class “A” Special Shares and the Common shares to be issued by Newco II will be equal to the PUC attributable to the transferred shares.

17. With respect to these transfers from the shareholders to Newco I and Newco II, each shareholder and the respective corporation will file a joint election pursuant to subsection 85(1) of the Act in prescribed form and within the time referred to in subsection 85(6) of the Act. The agreed amount in these elections will be equal to each transferor's ACB of the shares so transferred immediately before the transfer. The fair market value of both classes of transferred shares will exceed the agreed amounts. Both Newco I and Newco II will add to their respective stated capital accounts for both classes of shares to be issued an aggregate amount equal to the aggregate PUC of the transferred shares.

18. The Corporation will declare a dividend to Newco I and Newco II to the extent of the cash on hand such that Newco I will receive XXXXXXXXXX% of the cash and Newco II will receive XXXXXXXXXX% of the cash. The dividends will not be in excess of the “safe income on hand” of the Corporation for purposes of subsection 55(2) of the Act. “Safe income on hand” refers to the income earned or realized, within the meaning of paragraph 55(5)(c) of the Act, by a corporation to the extent that it is on hand and can reasonably be considered to contribute to the capital gain that could be realized on a disposition at FMV of all of the common shares of the corporation.

19. The appraisals will indicate that the fair market value of the marine insurance business is approximately XXXXXXXXXX of the fair market values of the combined XXXXXXXXXX business and the XXXXXXXXXX business and that the fair market value of the general insurance business is approximately XXXXXXXXXX of the combined fair market values of the XXXXXXXXXX business and the XXXXXXXXXX business.

20. The Corporation will then transfer at FMV XXXXXXXXXX of its assets to Newco I and XXXXXXXXXX of its assets to Newco II in such a manner that each of the transferees will receive assets in that proportion. The XXXXXXXXXX business will be transferred to Newco I and the XXXXXXXXXX business will be transferred to Newco II. All non-cash properties and other assets will be transferred in the same proportion. The aggregate purchase price for the transferred assets will be equal to the FMV of such assets at the time of closing. The purchase price in respect of each of the assets transferred to Newco I and Newco II will be paid by each transferee by the assumption of specific liabilities and by the allotment and issuance by each transferee of that number of Class “B” Special Shares having an aggregate redemption value equal to the purchase price less assumed liabilities of such assets.

21. Each of Newco I and Newco II will jointly elect with the Corporation pursuant to subsection 85(1) of the Act, in prescribed form and within the time referred to in subsection 85(6) of the Act, to transfer the assets of the Corporation as follows:

a) non-depreciable capital property will be transferred at an agreed amount that is equal to the cost amount of the property;

b) depreciable property of a prescribed class will be transferred at an agreed amount which is not less than the least of the amounts specified in subparagraphs 85(1)(e)(i) to 85(1)(e)(iii) of the Act and not greater than its FMV; and

c) eligible capital property will be transferred at an agreed amount which is not less that the least of the amounts specified in subparagraphs 85(1)(d)(i) to 85(1)(d)(iii) of the Act.

The amount, if any, of the assumed liabilities allocated to any asset transferred, pursuant to the election under subsection 85(1) of the Act, will not exceed the agreed amount in respect of that asset. Each transferee will add to the stated capital account in respect of the Class “B” shares issued by each transferee an amount equal to the aggregate of the cost amounts (determined pursuant to subsection 85(1), where relevant) of the properties transferred less the principal amount of the liabilities assumed by that transferee.

22. Each of Newco I and Newco II will redeem all of the Class “B” shares issued to the Corporation for the redemption amount of such shares. The redemption amount for such shares will be paid by the issuance and delivery by Newco I and Newco II respectively of demand non-interest-bearing promissory notes having a principal amount and a fair market value equal to the aggregate of the redemption amounts for the Class “B” shares (the “Promissory Notes”). The Corporation will accept these notes as full payment for the redemption amount of the Class “B” shares.

23. The Corporation will then commence proceedings to dissolve pursuant to the XXXXXXXXXX and as a result thereof will distribute proportionately all of its remaining assets and liabilities to its shareholders. Upon the dissolution, the Corporation will re-negotiate the Promissory Notes to the particular corporation which issued such notes (Newco I and Newco II) and such notes will be cancelled. Articles of Dissolution will be filed by the Corporation on receipt of the appropriate tax clearances.

24. As a result of completing all of the above described transactions (the “Butterfly Transfers”), the Corporation will have transferred directly to Newco I and Newco II all of its assets such that the net fair market value of the assets transferred to each of them will be equal to the proportion of the net fair market value of each type of property owned by the Corporation before the Butterfly Transfers that:

- the aggregate of the fair market value at that time of all of the shares in the capital stock of the Corporation then owned by that transferee corporation is of;

- the fair market value at that time of all of the issued shares of the capital stock of the Corporation.

Additional Information

25. None of the Corporation, Newco I or Newco II is or will be a “specified financial institution”, as defined in subsection 248(1) of the Act.

26. There are not, and will not be, at any time prior to the completion of the proposed transactions described above, any agreements (or undertakings) which constitute or include a “guarantee agreement”, as defined in subsection 112(2.2) of the Act, in respect of any shares referred to in this ruling request.

27. None of the dividends described in this ruling request will be received on a share of the capital stock of a corporation as part of a dividend rental arrangement of the particular corporation. The expression “dividend rental agreement” has the meaning assigned by subsection 248(1) of the Act.

28. None of the shares referred to in this ruling request has been or will be issued or acquired as part of a transaction or event or a series of transactions or events contemplated by subsection 112(2.5) of the Act.

29. Except as described in this letter, no assets have been or will be acquired or liabilities incurred or paid by the Corporation, Newco I or Newco II in contemplation of and before the transfers of property described in paragraph 20.

Purpose of the Proposed Transactions

30. The purpose of the proposed transactions is to permit a distribution by the Corporation in such a manner that its assets including its XXXXXXXXXX business and its XXXXXXXXXX business can be distributed to its shareholders in order to allow the shareholders to pursue their different business interests.

Rulings

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

A Upon the filing of the appropriate elections, the provisions of paragraph 85(1)(a) of the Act will apply to the transfers of shares by the shareholders as more particularly described in paragraphs 15 and 16 of the proposed transactions.

As a result, the proceeds of disposition to each of the transferors and the cost of each of the transferees of the transferred shares will be deemed to be the agreed amounts in accordance with paragraph 85(1)(a) of the Act and the provisions of paragraph 85(1)(e.2) of the Act will not be applicable in respect of those transfers.

B Upon the filing of the appropriate elections, the provisions of paragraph 85(1)(a) of the Act will apply with respect to the transfer of assets more particularly described in paragraph 20 of the proposed transactions. As a result, the proceeds of disposition to the transferors and the cost to each of the transferees of such assets will be deemed to be the agreed amounts in accordance with paragraphs 85(1)(a) of the Act and the provisions of paragraph 85(1)(e.2) of the Act will not be applicable in respect of those transfers.

C By virtue of subsection 84(3) of the Act, Newco I and Newco II will be deemed to have paid and Corporation will be deemed to have received a dividend equal to the amount by which the principal amounts of the Promissory Notes issued on the redemption by Newco I and Newco II of the Class “B” shares exceeds the PUC of such shares.

D Pursuant to paragraph 88(2)(b) and subsection 84(2) of the Act, but subject to paragraph E below, Corporation will be deemed to have paid, and Newco I and Newco II will be deemed 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 Corporation distributed by Corporation on the winding-up exceeds the PUC of the common shares and the Class “A” Special Shares, that the number of shares of such class held by each of Newco I and Newco II is of the number of shares of that class that are cancelled.

E Pursuant to subparagraph 88(2)(b)(i) of the Act, such portion of the winding-up dividend referred to in paragraph D above as does not exceed Corporation’s capital dividend account (“CDA”) determined immediately prior to the payment of the winding-up dividend will be deemed, for the purposes of subsection 83(2) of the Act to be the full amount of a separate dividend.

F The deemed dividends referred to in paragraphs C and D above, to the extent that they are taxable dividends, will:

a) be included in each recipient’s income pursuant to paragraph 12(1)(j) of the Act;

b) be deductible by the recipient pursuant to subsection 112(1) of the Act 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) of the Act;

c) not be subject to Part IV of the Act except as required under paragraph 186(1)(b) of the Act;

d) will not be subject to tax under Part IV.1 of the Act; and

e) will not be subject to Part Vl.l of the Act.

G The application of the provisions of section 84.1 of the Act to the proposed transactions described in paragraphs 15 and 16 of the proposed transactions will not result in a reduction of the paid-up capital of any of the shares under paragraph 84.1(1)(a) of the Act or in a dividend being deemed to have been paid under paragraph 84.1(1)(b) of the Act.

H 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 in the circumstances described in subparagraph 55(3.1)(b)(ii);

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

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

which has not been described herein, 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 above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b) of the Act.

I Section 80 of the Act will not apply as a result of the cancellation of the Promissory Notes as described in paragraph 23 of the proposed transactions.

J The provisions of subsections 15(1), 56(2) and section 246 of the Act will not apply to the proposed transactions in and by themselves.

K Subsection 245(2) of the Act will not be applied as a result of 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 forth in Information Circular 70-6R3 issued by Revenue Canada on December 30, 1996, and are binding provided that the proposed transactions are completed before XXXXXXXXXX.

The above 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, could have an effect on the rulings provided herein.

Nothing in this ruling should be construed as implying that Revenue Canada has reviewed, accepted or otherwise agreed to:

a) the determination of the adjusted cost base of any share or the paid-up capital of any shares referred to herein; or

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

Yours truly,

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

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