7 May 1990 Income Tax Severed Letter RRRR394 - Butterfly — allocation of liabilities

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.

Butterfly - Allocation of Liabilities
Question

Would the Department please provide its latest guidelines on the allocation of liabilities for purposes of a net equity method butterfly transaction.

Department's Position

As stated in a speech given by michael A. Hiltz at the 1989 Conference of the Canadian Tax Foundation, in the Department's view, the liabilities of the particular corporation referred to in paragraph 55(3)(b) of the Act (determined on a consolidated basis where appropriate) should be allocated to property of each type of the particular corporation (determined on a consolidated basis where appropriate) and should be deducted in the calculation of the net fair market value of the property of each type of the particular corporation,as follows:

• 1. Current liabilities will be allocated to cash and near cash property, including accounts receivable, inventory and prepaid expenses, on a proportionate basis, to the extent of the fair market value of such property.

As confirmed in our 1988 paper, where the person who will own the receivables, inventory or prepaids after the butterfly will carry on the business to which those properties relate, the net value of those properties, as determined after the allocation of current liabilities described in 1, may be included in net business property before making the allocations described in 2, 3 and 4 below.

• 2. Liabilities, other than current liabilities, that relate to a particular property will be allocated to the particular property (and effectively to the type to which the particular property belongs) to the extent of its fair market value;
• 3. Liabilities, other than current liabilities, that pertain to a type of property, but not to a specific property, will be allocated to that type of property, but not in excess of the net fair market value of such type of property after the allocations described in 1 and 2 above; and
• 4. Remaining liabilities, which have not been allocated in steps 1, 2 and 3, will be allocated on a proportionate basis based on the net value of each type of property of the particular corporation, as determined after steps 1, 2 and 3.

It will be appreciated that variations from the above will occur, depending on a particular situation.

Prepared by: S. Shinerock