7 July 1991 Income Tax Severed Letter - \"Partial Butterflies\" Transactions

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.

Subject: "Partial Butterflies" pursuant to paragraph 55(3)(b) of the Income Tax Act (the "Act")

We are writing in response to your memorandum of April 30, 1991 where in you made reference to a reassessment you had authorized under subsection 55(2) of the Act. You also requested our comments concerning the reduction to be made to the adjusted cost base (the "ACB") of the shares of the "particular corporation" referred to in paragraph 55(3)(b) of the Act as a result of a "partial butterfly" (the "ACB Reduction"). We also acknowledge our meeting of May 30, 1991 concerning this matter.

As discussed at our meeting, the situation involving the above reassessment did not qualify as a "butterfly" transaction since, as you indicated, the XXX and therefore further comments are not warranted with regard to that situation. In regard to "partial butterflies" and the ACB Reduction we offer the following general comments.

In the paper (the "1991 Paper") presented by J.R. Robertson at the 1981 Canadian Tax Foundation (the "CTF") Conference (at page 96) it was acknowledged that the reorganization referred to in paragraph 55(3)(b) of the Act could take place by way of a distribution of all of one type of property pro rata to all shareholders. The comments in the paper (the "1984 Paper") presented by M.A. Hiltz at the 1984 Corporate Management Tax Conference of the CTF (at pages 42 and 43) elaborated on our earlier comments by referring to such a distribution of assets as a "partial butterfly" and by detailing that the ACB Reduction was a requirement in order to obtain a favourable advance income tax ruling. Those comments do not represent an extension of the comments found in the 1981 Paper to allow "partial butterflies", as is suggested in your memorandum. In the paper presented by R.J.L. Read at the 1988 CTF Conference (at page 18:10) we indicated that the distribution of all of one type of property pro rata to all shareholders should be referred to as a "partial double-winged butterfly" and that a distribution of property of one type "... to one or more (but not all) shareholders ..." should be referred to as a "partial single-winged butterfly". We also indicated therein that the ACB Reduction applied with respect to both types of "partial butterflies" and indicated methods which might be utilized to accomplish same.

It should be noted that the comments contained in the 1984 Paper indicated that the ACB Reduction was to be a reasonable amount reflecting the reduction in value of the shares of the "particular corporation" referred to in paragraph 55(3)(b) of the Act as a result of the "partial butterfly". This does not mean that the ACB Reduction is to be equal to the fair market value of the property so distributed, as stated in your memorandum.

The provisions of paragraph 55(3)(b) of the Act do not contain an explicit legislative requirement for the ACB Reduction. However, as discussed at page 43 of the 1984 Paper, in our view it is appropriate to require an ACB Reduction to finalize a "reorganization" of the type contemplated by that paragraph.

We trust that the above comments will be of assistance to you. Please contact the writer if you have any further questions concerning this matter.