2002 Ruling 2002-0123693 - 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: Split up butterfly

Position: Standard butterfly

Reasons: N/A

XXXXXXXXXX 2002-012369

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX in which you requested advance income tax rulings on behalf of the above named taxpayers. We acknowledge your letter of XXXXXXXXXX and the information provided during our various telephone conversations in connection with your request.

We understand that 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) the subject of a ruling previously issued by the Income Tax Rulings Directorate; or

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

DEFINITIONS

In this letter, unless otherwise expressly stated:

(a) "ACB" means "adjusted cost base" as that expression is defined in section 54 and subsection 248(1);

(b) "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, subparagraph or Part is a reference to the relevant provision of the Act;

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

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

(e) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

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

(g) "CDA" means "capital dividend account" as that expression is defined in subsection 89(1);

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

(i) "DC" refers to XXXXXXXXXX;

(j) "depreciable property" has the meaning assigned by subsection 13(21);

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

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

(m) "guarantee agreement" has the meaning assigned by subsection 112(2.2);

(n) "Mr. A" refers to XXXXXXXXXX;

(o) "Mr. B" refers to XXXXXXXXXX;

(p) "prepaid expenses" means rights arising from the prepayment of expenses;

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

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

(s) "PUC" means "paid-up capital" as that expression is defined in subsection 89(1);

(t) "RDTOH" means "refundable dividend tax on hand" as that expression is defined in subsection 129(3);

(u) "Regulations" mean the Income Tax Regulations (Canada);

(v) "related person" has the meaning assigned by section 251;

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

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

(y) "SFI" means "specified financial institution" which has the meaning assigned by subsection 248(1);

(z) "SIB" means "specified investment business" which has the meaning assigned by subsection 125(7) and subsection 248(1);

(aa) "stated capital" has the meaning assigned by the BCA;

(bb) "Subco" means the corporation to be incorporated, as described in paragraph 9 below;

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

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

(ee) "Transferee" means the corporation to be incorporated, as described in paragraph 8 below.

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

FACTS

1. Mr. A and Mr. B are each older than 17 years of age and are residents of Canada for the purposes of the Act. Mr. A is not related to Mr. B.

Mr. A's social insurance number is XXXXXXXXXX and his residential address is XXXXXXXXXX. Mr. B's social insurance number is XXXXXXXXXX and his residential address is XXXXXXXXXX.

2. DC is a Canadian-controlled private corporation and a taxable Canadian corporation and was incorporated under the laws of XXXXXXXXXX. DC provides XXXXXXXXXX services. DC's year-end is XXXXXXXXXX. DC's business number is XXXXXXXXXX and its head office address is XXXXXXXXXX.

3. The authorized share capital of DC consists of an unlimited number of common shares.

4. The issued and outstanding shares of DC are held as follows:

Shareholder		Class			ACB			PUC

Mr. A			1 Common	$XXXXXXXXXX 	$XXXXXXXXXX
Mr. B			1 Common	$XXXXXXXXXX 	$XXXXXXXXXX 

None of the shares of DC were acquired in contemplation of the proposed transactions set forth below. The common share in the capital of DC is capital property to Mr. B.

5. The assets of DC include:

a. cash, accounts receivable, prepaid expenses, inventory and capital assets;

b. investments, consisting of:

i. XXXXXXXXXX% of the shares of XXXXXXXXXX, a Canadian-controlled private corporation and a taxable Canadian corporation, which owns XXXXXXXXXX;

ii. XXXXXXXXXX% of the shares of XXXXXXXXXX, a Canadian-controlled private corporation and a taxable Canadian corporation, which owns and operates a XXXXXXXXXX; and

iii. less than XXXXXXXXXX% of the shares of XXXXXXXXXX ., a Canadian -controlled private corporation and a taxable Canadian corporation, which operates a XXXXXXXXXX; and

c. advances to a related corporation with a principal amount of $XXXXXXXXXX (as of XXXXXXXXXX) that carry no specific provision for interest or repayment.

6. As at XXXXXXXXXX, DC had a balance of $XXXXXXXXXX in its RDTOH account. DC does not currently have a balance in its CDA.

7. The tax services office and taxation centre for each of DC, Mr. A and Mr. B is XXXXXXXXXX, respectively.

PROPOSED TRANSACTIONS

8. Mr. B will incorporate Transferee under the BCA. Transferee will be a taxable Canadian corporation and a private corporation. Mr. B will be the first and sole director of Transferee. The authorized share capital of Transferee will include:

a. an unlimited number of Class A voting common shares, which will entitle the holder to 1 vote per share;

b. an unlimited number of Class B voting common shares;

c. an unlimited number of Class C non-voting common shares; and

d. an unlimited number of Class D redeemable, non-voting preferred shares.

No shares of Transferee will be issued prior to the transactions described in paragraph 11 below.

9. Transferee will incorporate Subco under the BCA. Subco will be a taxable Canadian corporation and a private corporation. Mr. B will be the first and sole director of Subco. The authorized share capital of Subco will include:

a. an unlimited number of Class A voting common shares, which will entitle the holder to 1 vote per share;

b. an unlimited number of Class B voting common shares;

c. an unlimited number of Class C non-voting common shares; and

d. an unlimited number of Class D redeemable, preferred shares.

On incorporation, Transferee will subscribe for XXXXXXXXXX Class A common shares of Subco for cash consideration of $XXXXXXXXXX per share. Transferee will obtain a loan from Mr. B to finance the subscription.

10. Articles of amendment will be filed on behalf of Subco under the BCA, to divide the Class D preferred shares into an unlimited number of Class D Series I, redeemable, retractable, voting preferred shares (the "Preferred Shares") with a redemption and retraction amount of $XXXXXXXXXX per share. The Preferred Shares will entitle the holder thereof to non-cumulative dividends on the redemption amount at 4/5 of the rate prescribed by paragraph 4301(c) of the Regulations.

11. Mr. B will transfer his 1 common share in DC to Transferee in exchange for Class A voting common shares of Transferee having an aggregate fair market value equal to the fair market value of the common share of DC transferred to Transferee.

Mr. B and Transferee will jointly elect, in prescribed form and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of the DC common share as described in this paragraph to Transferee. The agreed amount specified in the election will be equal to the PUC of the transferred share, which amount will be less than its fair market value at the time of the transfer.

The amount to be added to the stated capital of the Class A voting common shares of Transferee to be issued as described in this paragraph will not exceed the PUC of the common share of DC to Mr. B immediately before the transfer.

12. Immediately before the transfers of property described in paragraph 14 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, comprising all of the current assets of DC, including cash, accounts receivable, prepaid expenses, inventory and advances to related corporations;

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 SIB; 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 SIB).

Any tax accounts of DC, such as the amount of RDTOH, the balance of any CDA, or any deferred income tax debit balance, will not be considered property for purposes of the classification described in this paragraph.

13. In determining the net fair market value of each type of property of DC immediately before the transfers of property described in paragraph 14 below, the liabilities of DC will be allocated to, and deducted in the calculation of the net fair market value of each type of property of DC as follows:

a. current liabilities of DC will be allocated to the cash or near cash property of DC in the proportion that the fair market value of each such property is of the fair market value of all cash or near cash property owned by DC, and, the allocation of current liabilities as described in this paragraph will not, however, exceed the total fair market value of the cash or near cash property of DC;

b. following the allocation of current liabilities in paragraph a. above, any remaining net fair market value of any accounts receivable (excluding the advances to related corporations), inventory, and prepaid expenses of DC, that are initially classified in accordance with paragraph 12a. above as cash or near cash property, that will relate to a business that will be carried on by DC or Transferee and that will be collected, sold, or consumed by such corporation in the ordinary course of that business, will then be reclassified as business property and the net fair market value thereof, determined after the allocation of current liabilities as described in paragraph a. above, will be included in the net fair market value of business property and will not be included in the net fair market value of cash or near cash property;

c. liabilities of DC, other than current liabilities, that relate to a particular property will then be allocated to the particular property (and effectively to the type of property to which the property belongs) to the extent of its fair market value and the liabilities pertaining to a type of property but not to a particular property will then be allocated to that type of property, but not in excess of the net fair market value of such type of property after the allocation of liabilities to a particular property as described herein; and

d. if any liabilities ("excess DC unallocated liabilities") remain after the allocations described in paragraphs a. and c. above are made, such excess DC unallocated liabilities will then be allocated to the cash or near cash property, investment property and business property, if any, of DC based on the relative net fair market value of each type of property prior to the allocation of the excess DC unallocated liabilities, but after the allocation of the liabilities described in paragraphs a. and c. above.

14. Immediately following the determination of the net fair market value of its cash or near cash property, its business property and its investment property as described in paragraphs 12 and 13 above, DC will transfer at fair market value a portion of each type of property owned by it at that time to Subco such that immediately following the transfer, the net fair market value of each type of property so transferred by DC to Subco, determined in accordance with the guidelines described in paragraphs 12 and 13 above, 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 transfer, of all of the shares of DC owned by Transferee at that time;

is of

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

Subco will receive 50% of the shares of each corporation described in paragraph 5b. above owned by DC immediately prior to the transfer of property described in this paragraph.

For the purpose of this paragraph and paragraph 21 below, the expression "approximate that proportion" means that the discrepancy from that proportion, if any, would not exceed XXXXXXXXXX%, determined as a percentage of the net fair market value of each type of property which Subco has received (or DC has retained) as compared to what Subco would have received (or DC would have retained) had it received (or retained) its appropriate pro rata share of the net fair market value of that type of property; however, the aggregate net fair market value of all property of DC transferred to Subco as described in this paragraph will be equal to that proportion determined by paragraphs a. or b. above of the aggregate net fair market value of all property of DC immediately before the transfers.

As consideration for the property so transferred, Subco will:

c. assume a portion the liabilities of DC (not to exceed the cost to Subco, as determined under section 85, where relevant, of the property transferred to Subco) such that the net fair market value of each type of property of DC transferred to Subco as described in this paragraph will approximate its proportionate share, as determined by the formula described in paragraphs a. and b. above, of the total net fair market value of that type of property owned by DC immediately before such transfers; and

d. issue Preferred Shares to DC having an aggregate fair market value and redemption amount equal to the amount by which the aggregate fair market value of the property transferred to Subco exceeds the amount of the liabilities assumed by Subco as described in paragraph c. above.

Subco will add to the stated capital account in respect of the Preferred Shares it issues an amount not exceeding the cost to Subco (as determined under section 85, where relevant) of the property transferred to it, less any liabilities assumed by it.

After completion of the transactions described in this paragraph, DC will own more than 10% of the voting shares of Subco, having a fair market value that is more than 10% of the fair market value of all the issued and outstanding shares of Subco. The fixed redemption amount of $XXXXXXXXXX per Preferred Share (or fraction thereof) issued by Subco as consideration for the property transferred by DC to Subco is considered to be the amount specified in respect of each Preferred Share of Subco for the purposes of subsection 191(4).

15. In respect of the transfers described in paragraph 14 above, DC and Subco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of each property transferred by DC to Subco, as described in paragraph 14 above, that is an eligible property the fair market value of which at the time of the transfer exceeds or may exceed the cost amount thereof to DC. The agreed amount in each such election in respect of a particular eligible property so transferred will not be less than:

a. in the case of capital property (other than depreciable property of a prescribed class) and inventory, an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii);

b. in the case of depreciable property of a prescribed class, an amount equal to the least of the amounts described in subparagraphs 85(1)(e)(i), (ii) and (iii); and

c. in the case of eligible capital property, an amount equal to the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii).

In each case, the agreed amount will not exceed the fair market value of the respective property, nor will it be less than the amount of any liabilities assumed by Subco as consideration for the transfer of such property.

For the purposes of the joint election described in this paragraph, the reference to "the undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition" in subparagraph 85(1)(e)(i) shall be interpreted to mean that proportion of the undepreciated capital cost to DC of all of the property of that class that the fair market value of the asset immediately before the disposition is of the fair market value of all property of that class immediately before the disposition.

16. Immediately following the transfer of property described in paragraph 15 above, Subco will redeem the Preferred Shares held by DC at their aggregate redemption amount and fair market value and will pay the redemption amount by issuing to DC a non-interest-bearing demand promissory note (the "Subco Redemption Note") having a principal amount and fair market value equal to the redemption amount of the Preferred Shares. DC will accept the Subco Redemption Note as full payment for the redemption amount of the Preferred Shares so redeemed.

17. At the end of the day on which the Preferred Shares are redeemed, as described in paragraph 16 above, Subco will cause its first taxation year to end. This transaction will occur one day prior to the transaction described in paragraph 18 below.

18. On XXXXXXXXXX, DC will purchase for cancellation at fair market value all of the DC common shares of its capital stock owned by Transferee. DC will pay the purchase price for such shares by issuing to Transferee a non-interest-bearing demand promissory note (the "DC Note") having a principal amount and fair market value equal to the aggregate fair market value of the shares so purchased. Transferee will accept the DC Note in full payment of the purchase price of the shares. DC will not file an election under subsection 256(9).

19. Following the purchase for cancellation described in paragraph 18 above, Transferee will, by special resolution, resolve to liquidate and dissolve Subco under the applicable provisions of the BCA. In connection with the winding-up of Subco, all of the property of Subco will be distributed to Transferee and Transferee will assume all of the liabilities of Subco, including Subco's liability under the Subco Redemption Note.

20. Following the distribution of property described in paragraph 19 above, DC and Transferee will set-off the principal amounts of the DC Note and the Subco Redemption Note, and each note will then be cancelled.

21. Immediately following the proposed transactions described above, the net fair market value of each type of property retained by DC, determined in the manner described in paragraphs 12 and 13 above, will approximate that proportion of the aggregate net fair market value of that type of property of DC determined immediately before the transfer described in paragraph 14 above that:

a. the aggregate fair market value, immediately before the transfer of property described in paragraph 14 above, of the shares of DC owned by Mr. A;

is of

b. the aggregate fair market value, immediately before the transfers of property, of all of the issued and outstanding shares of DC.

ADDITIONAL INFORMATION

22. 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.

23. No liabilities have been incurred by, and no assets have been acquired by or disposed of by DC or any predecessor corporation 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 corporation 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.

24. Except as set out in this ruling request, no shareholder of DC is contemplating the sale of any shares of DC.

25. Neither DC nor Transferee is or will be at the time the proposed transactions described herein are implemented, a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1), a SFI or a restricted financial institution.

26. None of the shares of DC or the shares of Transferee has or will have, at any time during the implementation of the proposed transactions described herein, been:

a. the subject of any guarantee agreement;

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

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to distribute a proportionate share of the assets of DC to a new corporation in order to separate the interests of the two directing minds of DC. In essence, the proposed transaction is a split up of the existing operations into two operations, one for each shareholder of DC. The shareholders' respective vision of the future direction of DC differs. Accordingly, they wish to separate their respective interests in the operations and proceed independently of each other.

RULINGS

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

A. Subject to the application of subsection 69(11), subsection 85(1) will apply to the transfer of each eligible property owned by DC to Subco, as described in paragraph 14 above, that is the object of an election as described in paragraph 15 above such that the agreed amount in respect of each such transfer will be deemed to be the proceeds of disposition thereof to DC and the cost thereof to Subco pursuant to paragraph 85(1)(a).

B. On the redemption by Subco of the Preferred Shares owned by DC, as described in paragraph 16 above, and on the purchase for cancellation by DC of the DC common share owned by Transferee, as described in paragraph 18 above:

a. by virtue of subsection 84(3):

i. Subco 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 in respect of the redemption of the Preferred Shares exceeds the PUC of those shares immediately before the redemption; and

ii. DC be deemed to have paid, and Transferee will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid in respect of the purchase for cancellation of the DC common share exceeds the PUC of that share immediately before the purchase for cancellation;

b. the taxable dividends deemed to have been received by each of DC and Transferee as described in paragraphs a.i. and a.ii. above:

i. will be included in the recipient's income pursuant to section 82 and paragraph 12(1)(j);

ii. will be excluded from the proceeds of disposition of the shares so redeemed or purchased for cancellation, as the case may be, by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54;

iii. will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient for the year in which the dividend is 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

iv. will not be subject to tax under Part IV, except as provided in paragraph 186(1)(b), as DC will be connected with Subco and TC will be connected with DC, by virtue of subsection 186(4);

c. the taxable dividend received by DC, referred to in paragraph a.i. above, will not be subject to tax under Parts IV.1 or VI.1 by virtue of subsection 191(4); and

d. the taxable dividend received by Transferee, referred to in paragraph a.ii. above, will not be subject to tax under Parts IV.1 or VI.1 by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1 and paragraph (a) of the definition of "excluded dividend" in subsection 191(1) because Transferee will have a substantial interest, within the meaning assigned by subsection 191(2), in DC immediately before the purchase for cancellation of the DC common share.

C. The extinguishment of the DC Note and the Subco Redemption Note as described in paragraph 20 above will not, in and of itself, result in a forgiven amount within the meaning of either subsection 80(1) or section 80.01. In addition, neither DC nor Transferee will otherwise realize any gain or incur any loss as a result of the extinguishment.

D. 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 subparagraph 55(3.1)(c); or

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

which has not been described herein, then by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends referred to in Ruling B above, and for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

E. The provisions of subsections 15(1), and 56(2) will not apply as a result of the proposed transactions described herein, in and by themselves.

F. As a result of the proposed transactions described herein, in and by themselves, subsection 245(2) will not be applied to redetermine the tax consequences confirmed in the rulings given.

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, could affect the rulings provided herein.

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

COMMENTS

Nothing in this letter should be construed as implying that the Canada Customs and Revenue Agency has reviewed, accepted or otherwise agreed to:

a. the determination of the ACB, the PUC or the fair market value 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 Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch