2001 Ruling 2001-0107473 - Split-up 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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Standard Split-Up Butterfly Ruling.

Position: Favourable rulings provided.

Reasons: Complies with rules in section 55.

XXXXXXXXXX 2001-010747

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("DC") - XXXXXXXXXX
XXXXXXXXXX ("Sib1") - XXXXXXXXXX
XXXXXXXXXX ("Sib2") - XXXXXXXXXX
XXXXXXXXXX ("Sib3") - XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We also acknowledge receipt of your correspondence dated XXXXXXXXXX and our telephone conversations in connection herewith.

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

(i) dealt with in an earlier return of one of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of one of the taxpayers or a related person;

(iii) under objection by one of the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired.

Definitions

In this letter, unless otherwise expressly stated:

(a) "Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, and unless otherwise stated, every reference herein to a section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "adjusted cost base" (also referred to as "ACB") has the meaning assigned by section 54;

(c) "agreed amount" in respect of property means the amount that the transferor and the transferee of the property have agreed upon in their election under subsection 85(1) in respect of the property;

(d) "BCA" means the "Canada Business Corporations Act";

(e) "capital dividend" has the meaning assigned in subsection 83(2);

(f) "capital dividend account" (also referred to as "CDA") has the meaning assigned by subsection 89(1);

(g) "capital property" has the meaning assigned by section 54;

(h) "cost amount" has the meaning assigned by subsection 248(1);

(i) "dividend refund" has the meaning assigned by subsection 129(1);

(j) "eligible property" has the meaning assigned by subsection 85(1.1);

(k) "Mr.A" refers to the late XXXXXXXXXX;

(l) "Mrs. A" refers to XXXXXXXXXX;

(m) XXXXXXXXXX;

(n) "paid-up capital" (also referred to as "PUC") has the meaning assigned by subsection 89(1);

(o) "private corporation" has the meaning assigned by subsection 89(1);

(p) "proceeds of disposition" has the meaning assigned by section 54;

(q) "refundable dividend tax on hand" (also referred to as"RDTOH") has the meaning assigned by subsection 129(3);

(r) "restricted financial institution" has the meaning assigned by subsection 248(1);

(s) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(t) "significant influence" has the meaning assigned by section 3050 of the CICA Handbook;

(u) "specified financial institution" (also referred to as "SFI") has the meaning assigned by subsection 248(1);

(v) "specified investment business" ("SIB") has the meaning assigned by the definition in subsection 125(7) and subsection 248(1);

(w) "stated capital" has the meaning assigned by the BCA and XXXXXXXXXX;

(x) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(y) "taxable dividend" has the meaning assigned by subsection 89(1); and

(z) "Xco" refers to XXXXXXXXXX.

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as set forth below.

Facts

1. Sib1, Sib2 and Sib3 are siblings and are each resident in Canada.

2. A spousal trust (the "Trust") was established for the benefit of Mrs. A. The Trust is administered by Mrs. A, Sib1 and Sib2 as trustees of the estate of Mr. A.

3. DC is a taxable Canadian corporation and a private corporation. DC was incorporated on XXXXXXXXXX under the provisions of the BCA. DC has a XXXXXXXXXX fiscal year end.

4. The authorized share capital of DC includes:

(a) XXXXXXXXXX voting common shares,

(b) XXXXXXXXXX class A preferred shares, and

(c) an unlimited number of class B preferred shares.

The class A preferred shares are entitled to XXXXXXXXXX of a vote per share issued, are redeemable and retractable at $XXXXXXXXXX per share and are entitled to dividends at the discretion of the directors.

The class B preferred shares are non-voting, redeemable and retractable at $XXXXXXXXXX per share and entitled to non-cumulative dividends at XXXXXXXXXX% per month.

5. The issued share capital of DC as of XXXXXXXXXX consisted of XXXXXXXXXX common shares with an aggregate PUC of $XXXXXXXXXX and XXXXXXXXXX class A preferred shares with an aggregate PUC of $XXXXXXXXXX. The ownership of the shares is divided as follows:

Common
Class A

PUC
ACB
Sib1
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
Sib2
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
Sib3
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
Trust

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

6. The common shares of DC are capital property in the hands of each of the shareholders.

7. The XXXXXXXXXX outstanding class A preferred shares of DC were issued in XXXXXXXXXX. As consideration, DC received XXXXXXXXXX preferred shares of Xco, a company controlled by Mr. A. The preferred shares of Xco had a fair market value of $XXXXXXXXXX and had been issued to Mr. A in XXXXXXXXXX for $XXXXXXXXXX cash.

8. At the time of the proposed transactions, the assets of DC will consist of cash and marketable securities with a fair market value of approximately $XXXXXXXXXX and a book value of approximately $XXXXXXXXXX. The marketable securities consist of bonds, debentures, notes, Canadian equities and foreign equities.

9. DC will not have any liabilities at the time of the proposed transactions.

10. At the time of the proposed transactions, DC will have a balance of $XXXXXXXXXX in its RDTOH account and a balance of approximately $XXXXXXXXXX in its CDA.

Proposed Transactions

11. DC will redeem the XXXXXXXXXX class A preferred shares held by the Trust for an amount equal to their redemption value of $XXXXXXXXXX. Payment of the redemption value will be satisfied in cash, leaving approximately $XXXXXXXXXX of cash in DC.

12. Each of the remaining shareholders of DC will cause to be incorporated a new corporation ("Holdco1, Holdco2 and Holdco3") under the XXXXXXXXXX . Each of these new corporations will be a taxable Canadian corporation and a private corporation.

13. The share capital of each new corporation will consist of an unlimited number of:

(a) common shares, and

(b) class A preference shares, and

(c) class B preference shares.

The holders of the common shares will be entitled to one vote per share.

The class A preferred shares will be voting, redeemable and retractable at a redemption price of $XXXXXXXXXX per share and entitle the holder to a non-cumulative dividend entitlement to be paid at the discretion of the directors.

The class B preferred shares will be voting, redeemable and retractable at a redemption price of $XXXXXXXXXX per share and entitle the holder to a non-cumulative dividend entitlement to be paid at the discretion of the directors.

14. Sib1 will subscribe for XXXXXXXXXX common shares of Holdco1 on incorporation for the aggregate consideration of $XXXXXXXXXX . Sib2 will subscribe for XXXXXXXXXX common shares of Holdco2 on incorporation for the aggregate consideration of $XXXXXXXXXX. Sib3 will subscribe for XXXXXXXXXX common shares of Holdco3 on incorporation for the aggregate consideration of $XXXXXXXXXX.

15. Sib1 will transfer all XXXXXXXXXX of his common shares of DC to Holdco1. As sole consideration for such transfer, Holdco1 will issue to Sib1 XXXXXXXXXX common shares and XXXXXXXXXX class A preference shares of its capital stock having an aggregate fair market value equal to the fair market value at that time of the shares of DC transferred to Holdco1.

16. Sib2 will transfer all XXXXXXXXXX of his common shares of DC to Holdco2. As sole consideration for such transfer, Holdco2 will issue to Sib2 XXXXXXXXXX common shares and XXXXXXXXXX class A preference shares of its capital stock having an aggregate fair market value equal to the fair market value at that time of the shares of DC transferred to Holdco2.

17. Sib3 will transfer all XXXXXXXXXX of her common shares of DC to Holdco3. As sole consideration for such transfer, Holdco3 will issue to Sib3 XXXXXXXXXX common shares and XXXXXXXXXX class A preference shares of its capital stock having an aggregate fair market value equal to the fair market value at that time of the shares of DC transferred to Holdco3.

18. In regard to each of the transfers described in paragraphs 0, 0 and 0 above, each individual and their respective holding company will file a joint election, in prescribed form, and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply in respect of the transfers. The agreed amount in each election will be equal to the adjusted cost base of the transferred shares.

19. Each new holding company i.e. Holdco1, Holdco2 and Holdco3, will add to the stated capital account maintained for its common and class A preference shares an amount that, in aggregate, does not exceed $XXXXXXXXXX.

20. Immediately before the transfers of property described in paragraph 0 below, the property owned by DC will be classified into the following three different types of property for the purposes of the definition of "distribution" in subsection 55(1) and paragraph 55(3)(b):

(a) cash or near cash property of DC including cash, bank deposits, term deposits, marketable securities and similar instructions (other than marketable securities and similar investments held as portfolio investments);

(b) investment property, comprising all of the assets of DC, other than cash or near cash property, any income from which would, for the purposes of the Act, be income from property or from a specified investment business; and

(c) business property, comprising all of the assets of DC, other than cash or near-cash property, any income from which would, for the purposes of the Act, be income from a business (other than a specified investment business).

For the purpose of calculating the fair market value of each type of property, as described above, DC will not have significant influence over any corporation.

It is not expected that DC will own any business property immediately before the proposed transfers of property described in paragraph 0 below. For greater certainty, any tax accounts, such as the balance of RDTOH or the capital dividend account of DC, will not be considered property for purposes of the classification described in this paragraph.

21. Immediately following the determination of the net fair market value of its cash or near cash property and its investment property as described in paragraphs 0 above, DC will transfer one-third of each type of property owned by it at that time to each of Holdco1, Holdco2 and Holdco3.

As consideration for the property so transferred, each of Holdco1, Holdco2 and Holdco3 will issue to DC, XXXXXXXXXX class B preference shares having a fair market value and aggregate redemption amount equal to the fair market value of the assets of DC transferred to each of Holdco1, Holdco2 and Holdco3.

Immediately following the transfers set out in this paragraph, the net fair market value of each type of property so transferred by DC to each of Holdco1, Holdco2 and Holdco3, will approximate that proportion of the net fair market value of all property of DC of that type determined immediately before such transfer that:

(a) the aggregate fair market value, immediately before the transfers, of all of the shares of DC owned by the respective transferee corporation at that time

is of

(b) the aggregate fair market value, immediately before the transfers, of all the issued and outstanding shares of DC at that time.

22. DC and each of Holdco1, Holdco2 and Holdco3 will elect jointly, 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 DC that is an eligible property. The agreed amount in respect of each property so transferred will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

23. Each of Holdco1, Holdco2, and Holdco3 will add to the stated capital account maintained for its class B preference shares an amount equal to the aggregate cost of the properties acquired by Holdco1, Holdco2, and Holdco3.

24. DC will assign the right to one-third of its RDTOH balance at that time to each of Holdco1, Holdco2 and Holdco3. In exchange, each holding company will issue class B preference shares to DC with an aggregate redemption amount equal to one-third of DC's RDTOH balance.

25. Each of Holdco1, Holdco2 and Holdco3 will redeem all of their class B preference shares owned by DC for an amount equal to their fair market value, being their redemption amount. As consideration for these redemptions, DC will be issued non-interest-bearing promissory notes ("the Holdco1 note, the Holdco2 note and the Holdco3 note" respectively) payable on demand having a principal amount and fair market value equal to the redemption price. DC will accept the Holdco1 note, the Holdco2 note and the Holdco3 note as full payment for the redemption amount of the preferred shares so redeemed.

26. On XXXXXXXXXX, the shareholders of DC, will, by special resolution, resolve to wind up and dissolve DC under the applicable provisions of the CBCA. In connection with the winding-up, DC will distribute to Holdco1, Holdco2 and Holdco3, respectively, the Holdco1 note, the Holdco2 note and the Holdco3 note. As a result of the assignment and distribution of the above notes, the obligations under the notes will be cancelled.

27. Prior to the distribution of the Holdco1 note, the Holdco2 note and the Holdco3 note, DC will elect, pursuant to subsection 83(2) of the Act, in prescribed manner and prescribed form, to treat a portion of the resulting dividend, referred to in subparagraph 88(2)(b)(i), to be a capital dividend.

28. Following receipt of the dividend refund to which DC will become entitled as a result of the proposed transactions described herein, DC will distribute one-third of such amount to each of Holdco1, Holdco2 and Holdco3 pursuant to the assignment described in paragraph 24 above.

29. Following the completion of the transactions described in paragraph 21 to 28, all properties of DC will have been distributed and all its liabilities will have been discharged. Articles of Dissolution will be filed and DC will be dissolved.

Additional Information

30. None of the transactions or events described in the facts of this letter occurred as part of the same series of transactions or events as the proposed transactions described in this letter.

31. No liabilities have been incurred by, and no assets have been acquired by or disposed of by DC or any predecessor thereof in contemplation of the proposed transactions described herein. Except as described in this letter, no liabilities will be incurred by, and no assets will be acquired by or disposed of by DC or any predecessor thereof in contemplation of the proposed transactions described herein. No property of DC that is transferred pursuant to the proposed transactions described herein will be transferred to any other person as part of a series of transactions that includes the proposed transactions described herein.

32. None of DC, Holdco1, Holdco2 and Holdco3 will, at the time the proposed transactions described herein are implemented, be a specified financial institution or a restricted financial institution.

33. None of the issued shares referred to herein (including shares to be issued as part of the proposed transactions):

(a) is or will be the subject of any undertaking or agreement that is referred to in subsection 112(2.2) as a "guarantee agreement";

(b) is 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) is the subject of a dividend rental arrangement as that term is defined in subsection 248(1).

Purpose of the Proposed Transactions

34. In XXXXXXXXXX, DC was formed by Mr. A. Each child of Mr. A had an equal ownership in the company. On XXXXXXXXXX, Mr. A passed away. The children, Sib1, Sib2 and Sib3 wish to separate their investment interests in DC on a pro rata basis. They wish to separate their interests to provide more flexibility in their investment activities, and to allow each of them to effect their own personal estate plan.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. On the redemption by Holdco1, Holdco2 and Holdco3 of the class B preferred shares held by DC, as described in paragraph 0 above, and as a result of the distributions by DC in the course of its winding-up, as described in paragraph 0 above:

(a) by virtue of paragraphs 84(3)(a) and 84(3)(b), each of Holdco1, Holdco2 and Holdco3 will be deemed to have paid, and DC will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid to redeem the class B preferred shares exceeds the PUC of those shares immediately before the redemption;
(b) (i) pursuant to paragraph 88(2)(b) and subsection 84(2), but subject to (b)(ii) and (iii) herein, each of Holdco1, Holdco2 and Holdco3 will be deemed to have received a dividend (the "winding-up dividend") on their common shares of DC, equal to the amount by which the aggregate fair market value of the property of DC distributed by DC on the winding-up exceeds the PUC of the common shares;
(ii) pursuant to subparagraph 88(2)(b)(i), such portion of the winding-up dividend as does not exceed DC's CDA determined immediately before the payment of the winding-up dividend and in respect of which DC has elected, as described in paragraph 0 above, will be deemed to be the full amount of a separate dividend; and
(iii) pursuant to subparagraph 88(2)(b)(iii), the winding-up dividend, to the extent that it exceeds the portion thereof referred to in (ii) herein that is deemed to be a separate dividend, will be deemed to be a separate taxable dividend;
(c) to the extent that the deemed dividends described in (a) and (b) above are taxable dividends, such dividends will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient for the year in which the dividends are deemed to have been received and such deduction will not be denied by any of the provisions of subsections 112(2.1), (2.2), (2.3) or (2.4); and
(d) the amount of the deemed dividends described in (a) and (b) above will, by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54, be excluded from the proceeds of disposition of the shares on which they are deemed to have been paid and any loss arising from such disposition of those shares will be reduced by the amount of such dividends pursuant to subsection 112(3).

(e) by virtue of paragraph 186(4)(a), DC will be connected with each of Holdco1, Holdco2 and Holdco3 and Holdco1, Holdco 2 and Holdco3 will be connected with DC. Consequently,
(i) provided that each of Holdco1, Holdco2 and Holdco3 is not entitled to a dividend refund (within the meaning of subsection 129(1) of the Act) in respect of its taxation year in which it is deemed to pay the dividend referred to in (a) above, DC will not be subject to Part IV tax in respect of such dividend, and
(ii) Holdco1, Holdco2 and Holdco3 will, pursuant to paragraph 186(1)(b), be subject to Part IV tax in an amount equal to that proportion of the dividend refund to which DC will become entitled (within the meaning of subsection 129(1)) for its taxation year in which the dividend, referred to in (b)(iii) above, is paid, that the amount of such dividend received by each of Holdco1, Holdco2 and Holdco3 is of the aggregate of all taxable dividends paid by DC in its taxation year in which such dividend is paid.

B. Provided that as part of the series of transactions or events that includes the proposed transactions, 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, by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends referred to in Ruling A above, and for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001 and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed by XXXXXXXXXX.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted into law, could affect the rulings provided herein.

Comments

Nothing in this letter should be considered as confirmation of the income tax consequences of any of the transactions described in this letter other than as specifically described. In addition, nothing in this letter should be construed as confirmation, express or implied, of the fair market value or adjusted cost base of any property or the paid-up capital of any share and any of the balances of the CDA or RDTOH referred to herein.

In particular we are not confirming that a disposition by Holdco1, Holdco2 and Holdco3 of the property received on the distribution described in paragraph 0 above, would:

a) be in the ordinary course of business for purposes of paragraph 55(3.1)(c); or

b) not be part of the series of transactions that includes the transactions described in paragraphs 0 to 0 above, for purposes of paragraph 55(3.1)(c).

Those determinations can only be made after a review of all the circumstances of any such disposition.

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