1 June 1990 Ministerial Letter ACC9178 F - Butterfly Transactions - Dividend Treatment in the Case of an Arm's Length Disposition

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.

Fact Situation II

The facts are the same as in Fact Situation I except that:

(a)     A had transferred the building to X Co at the beginning; and

(b)     there was no corporate-owned insurance and no buy-sell agreement in place at his death.

B, C and Mrs. A agree that they would like to distribute the building to Mrs. A in satisfaction of her 60% interest in X Co which she inherited from A.  The fair market value of the building represents 60% of the fair market value of all of X Co's property.

Question 1:

If the building is transferred by way of a "single-winged butterfly" of X Co to a new holding corporation ("A Co") to which Mrs. A has transferred her shares of X Co, will the dividends deemed to be paid on the cross-redemption of shares of X Co and A Co be exempt from the application of subsection 55(2) of the Act by virtue of paragraph 55(3)(b)?

Response:

Yes, assuming that the building and all of the other property of X Co constituted business property for the purposes of paragraph 55(3)(b).

Question 2:

Would the response to Question 1 be different if, before A's death, X Co ceased to use the building in its business and leased it instead to an arm's-length tenant, so that the building produced income from property rather than income from an active business?

Response:

Yes.  The building would be classified as an investment property for the purposes of paragraph 55(3)(b).  The exemption in paragraph 55(3)(b) would therefore not apply because A Co would not have received its pro rata share of each type of property of X Co.

As the series of transactions that includes the dividends would result in an increase in interest in X Co by B and C, both of whom would be considered to deal at arm's length with A Co and X Co by virtue of paragraph 55(5)(e), the dividends would not qualify for the exemption in paragraph 55(3) (a).

Question 3:

Would the response to Question 2 be different if A's shares of X Co were bequeathed not to Mrs. A but to a spousal trust for Mrs. A with A's father appointed as the sole trustee?

Response:

Yes.  In this situation A's father, who is related to A's brothers, would ordinarily, subject to the terms of the trust, control both A Co and X Co. Subject to the application of subsection 55(4), each of the brothers would be deemed to be related to, and not to deal at arm's length with, A Co and X Co and the dividends would qualify for the exemption in paragraph 55(3)(a) provided that the "butterfly" transactions that result in the deemed dividends are not part of a larger series of transactions that results in the disposition of property to, or an increase in interest in any corporation by, a third party who deals at arm's length with A Co or X Co.  If the principal purpose of establishing the spousal trust with A's father as sole trustee could reasonably be considered to be to cause the brothers to be related to, or not to deal at arm's length with, A Co and X Co, subsection 55(4) would apply to deem them not to be related and to deal with each other at arm's length for the purposes of section 55.

Question 4:

Would any future sale of the shares or assets of A Co to an arm's length third party be considered to be part of the series of transactions that included the deemed dividends or would such a future sale have to be specifically contemplated at the time of such dividends in order to be considered part of the series?

Response:

Subsection 248(10) of the Act deems a series of transactions to include transactions or events completed in contemplation of the series.  It is Revenue Canada's view that a preliminary transaction will form part of a series if, at the time the preliminary transaction is carried out, the taxpayer intends to implement the subsequent transactions constituting the series, and the subsequent transactions are eventually carried out.  Thus the preliminary and subsequent transactions may form part of the same series even though at the time of the completion of the preliminary transaction the taxpayer may not have determined all of the important elements of the subsequent transactions -- such as, for example, the identity of other parties involved -- or lacked the ability to implement the subsequent transactions.  In the present example, A's father would have to have formed the intention, at the time of the preliminary "butterfly" transactions, to sell the shares or assets of A Co in order for the subsequent sale to be considered to be part of a series that included the preliminary transactions.