30 March 1984 Income Tax Severed Letter RCT 5-6014

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.

Dear Sirs:

This is in reply to your letter of February 3, 1984 wherein you have requested our views with respect to the application of subsections 55(2) and (3) of the Income Tax Act (the “Act”) to the following hypothetical situation:

• 1. Holdco is a taxable Canadian corporation with one class of shares issued and outstanding. Mr. A and his spouse each own 25% of Holdco. Mr. B and his spouse each own 25% of Holdco. Mr. and Mrs. A deal at arm's length with Mr. and Mrs. B. The assets of Holdco consist of all of the shares of Opco 1. Opco 1 also owns all the shares of Opco 2. The shareholders have been carrying on business for a number of years through Opco 1 and Opco 2. Due to a difference in business philosophies, they have decided to part ways and divide up the assets contained in Opco 1 and Opco 2, with the exception of certain real property inventory which must be retained in Opco 1 due to the limitations in subsection 85(1).
• 2. To achieve this end, Holdco, Opco 1 and Opco 2 amalgamate to form Amalco. Mr. and Mrs. A exchange their shares in Amalco for shares in Newco A. Each of them will own 50% of Newco A. Mr. and Mrs. B exchange their shares in Amalco for shares in Newco B. Each of them will own a 50% interest in Newco B. All the assets of Amalco (except land inventory) are then divided in two and “butterflied” out to Newco A and Newco B in exchange for redeemable shares representing more than 10% of the votes and value of the transferee corporations. Elections are made under section 85 so these transfers are not taxable. Newco A and Newco B will then redeem the shares held by Amalco for promissory notes. Amalco will then pay a dividend in kind to each of Newco A and Newco B in the form of their respective notes. Newco A and Newco B will continue to own an equal interest in Amalco.

With respect to your first concern, generally we are of the view that when an amalgamation precedes a distribution of assets to shareholders, such an amalgamation would remove the transactions or series of transactions from the purview of paragraph 55(3)(b) of the Act. We are, however, prepared to view each distribution following an amalgamation on a case-by-case basis. For example, where it is demonstrated that there has been an historical relationship between the shareholders of the companies being amalgamated, and all shareholders have been shareholders of the respective companies for a period of time which obviously predates any contemplation of the butterfly, we are prepared to accept that the amalgamation, in and by itself, does not preclude the operation of paragraph 55(3)(b).

With respect to your last query, we agree with your view that subparagraph 55(3)(b)(iv) requires that all the shares of the new corporation must be owned by one individual. However, in situations in which an individual transfers all of his shares of Opco to a Holdco the other shareholders of which are individuals who have effected the transfer of all their shares of Opco, as in the example described above, such transfer will not be considered to have been made after the commencement of the series of transactions for the purposes of subsection 55(2) of the Act.

The above opinion is, of course, not binding on the Department. If you have a particular situation under consideration, we would be pleased to address your further concerns in the form of an advance income tax ruling request.

There are two additional aspects to these transactions which deserve comment. Firstly, a subsequent sale of the shares of Opco might be viewed as an adventure in the nature of trade or, in the alternative, the final steps in a series of transactions in which the dividend on the Opco shares is included. Secondly, the promissory notes of Newcos A and B will be extinguished for no consideration on the payment by Amalco of a dividend in the form of the notes. Section 80 would apply to such extinguishment.

We trust our comments will be of assistance.