Subsection 55(3.1) - Where paragraph (3)(b) not applicable

Paragraph 55(3.1)(a)

Administrative Policy

2017 Ruling 2016-0674681R3 - Sequential Split-Up Butterfly

sale of securities for cash proceeds that are reinvested, and tendering shares for shares of offeror

Preliminarily to a butterfly distribution that was favourably ruled upon, DC1 sold portfolio investment units for cash, and may reinvest the proceeds in marketable securities or other investments – transactions that are represented to be independent of the butterfly transactions. It will also tender a small percentage stake in a public company for shares of the offeror.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution sequential split-up butterfly with 1% tolerance, triggering of capital gains to generate CDA and RDTOH, and year end change to accommodate RDTOH division 656
Tax Topics - Income Tax Act - Section 129 - Subsection 129(1) capital gain deliberately triggered to generate CDA and RDTOH addition and year end change granted to isolate dividend refund 499
Tax Topics - Income Tax Act - Section 249.1 - Subsection 249.1(7) CRA accommodates year end change so that dividend refund of full RDTOH balance is generated in Year 1 202

2014 Ruling 2014-0528291R3 - Butterfly Reorganization

preliminary and subsequent transactions

DC was not controlled by either of its two shareholders (WCo and SCo). Prior to a butterfly transfer to Newco, formed by SCo, DC will proceed with a sale of assets for cash equal to their fair market value. Following the butterfly, Newco will amalgamate with ECO, which is partly owned by SCo.

2013 Ruling 2013-0491651R3 - Cross-Border Butterfly

preliminary LP acquisition, cross-border debt repayments and dividend: not part of series
Background

Foreign PubCo will spin-off Foreign SpinCo to its shareholders. Foreign SpinCo is a great-grandchild subsidiary held by it "through" ForCo 1 and ForCo 2.) DC (a wholly-owned subsidiary of ForCo 2 and thus a "sister" of Foreign SpinCo) will effect a split-up butterfly of the Canadian portion of the Spin-Off Business to TC, a direct newly-incorporated Newco subsidiary of ForCo2. Activities directly carried on in Canada by other subsidiaries of DC, namely, B Co (whose commons shares also were held by ForCo11, a subsidiary of Foreign PubCo), C Co, D Co (wholly-owned by C Co), and LP 1 and E Co, the GP of LP 1 (the "DC Retained Business") are to be retained by DC after the Spin-Out.

Preliminary transaction (before ruled-upon butterfly transactions)
  • LP 1 was acquired by DC at a time that "the directors of DC had no knowledge or expectation of the Proposed Transactions," with such acquisition being represented to be part of the series which includes 3.
  • ForCo 10 (described in redacted para. 61 and likely owned outside the DC group) repaid debt owing to B Co, B Co paid a dividend to DC and ForCo11,and DC paid a dividend to ForCo2 with such transactions being represented not have been effected before the proposed transactions were contemplated.

See detailed summary under s. 55(1) - distribution.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution cross-border b/f with 3-party exchange, cash-out of ineligible shareholders, proportionate allocation of foreign spinco debt, pension liability classification, prelim non-series dividend 945
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3.1) - Paragraph 55(3.1)(b) - Subparagraph 55(3.1)(b)(i) cross-border b/f with 3-party exchange, pro rata application of upper tier debt, cash-out of ineligible shareholders 457
Tax Topics - Income Tax Act - Section 86 - Subsection 86(1) exchange for substantively identical common shares 114

7 October 2011 Roundtable, 2011-0399401C6 - Butterfly, life insurance policies, grandfathering

two siblings are the shareholders of two transferee corporations which are to receive two life insurance policies taken out by the distributing corporation on the life of each sibling to fund the redemption of the other's shares on the other's death, with the cash surrender value of each property would be treated as a cash or near cash asset. CRA would accept that each type of property transferred may be determined on a net basis (thereby using liabilities of the DC), although such liabilities would have to be allocated following a predetermined pattern. Although CRA may be prepared to be flexible respecting the classification of the excess of the fair market value of the policies over their cash surrender value, it would not accept DC incurring a debt to "balance" the assets transferred, as s. 55(3.1)(a) would prohibit the resulting acquisition of cash by DC.

2000 Ruling 1999-001072 -

A reallocation of mortgage balances in respect of two of the properties to be transferred would result in an acquisition of property by the distributing corporation in contemplation of a distribution even though both properties were properties of the same type for purposes of the distribution.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Fair Market Value - Other 33

Income Tax Technical News, No. 16, 18 December 1998

discussion whether Parthenon would indicate that a distributing corporation would not be considered to control its subsidiaries if ultimate control was elsewhere.

1996 Corporate Management Tax Conference Roundtable Q. 18, 5-962079 -

"Where the butterfly is being carried out on a 'net equity' basis, the repayment of a debt (whether owing to a third party or a shareholder) could be viewed as resulting in property becoming property of the distributing corporation in contemplation of the distribution, thus contravening paragraph 55(3.1)(a), where the repayment of the debt changes the mix of property of the distributing corporation."

Income Tax Regulation News, Release No. 3, 30 January 1995 under "Butterfly Reorganizations"

Where in contemplation of a butterfly, a corporation transfers property to a partnership in consideration for a partnership interest, the acquisition of the partnership interest will come within the prohibition in s. 55(3.1)(a). Similarly, where in contemplation of a butterfly, a corporation acquires property from a partnership, the acquisition will come within the prohibition in s. 55(3.1)(a).

Articles

Marshall Haughey, "Spinoff Butterflies in Trouble?", Canadian Tax Focus, Volume 3, No. 4, November 2013, p. 3.

Exchange of shares to DC on permitted exchange (p. 3)

As a pre-distribution step in a typical spinoff butterfly, shareholders of the distributing corporation exchange their common shares in the distributing corporation for new common and preferred shares in the distributing corporation on a tax-deferred basis under subsection 51(1) or 86(1). Such an exchange is a "permitted exchange" under subsection 55(1), provided that it does not result in an acquisition of control of the distributing corporation. Thus, one presumes that the exchange is unobjectionable under the butterfly rules in section 55. However, the share exchange may technically infringe paragraph 55(3.1)(a). If that is the case, paragraph 55(3)(b) will not operate to prevent the application of subsection 55(2).

Application of s. 55(3.1)(a) to permitted exchange? (p. 3)

Paragraph 55(3.1)(a) will cause paragraph 55(3)(b) not to apply where, in contemplation of and before a distribution made in the course of the reorganization in which the dividend was received, property became property of the distributing corporation otherwise than as a result of certain enumerated exceptions, none of which appears to apply to a share exchange. Thus, whether paragraph 55(3.1)(a) will apply to the share exchange turns on whether the old shares become property of the distributing corporation.

Acquisition by DC on permitted exchange (p. 3)

[I]t appears that corporate law does not preclude the possibility of the old shares becoming property of the distributing corporation on the share exchange.

CRA position (p. 4)

Notwithstanding the analysis above, the CRA does not appear to consider a share exchange objectionable: it has issued favourable rulings in the past (9813073 (1998) and 9727303 (1998)) when a share exchange took place as a pre-distribution step in a spinoff butterfly. These rulings were given before the November 26, 2004 Department of Finance comfort letter was issued. That letter was the impetus for the exclusion of public corporations from the application of paragraph 55(3.1)(a).

Firoz Ahmed, "Subsection 55(3) Update", Canadian Current Tax, Vol. 15, No. 8, May 2005, p. 69:

Discussion of effect of contractual agreements on property-becoming-property test in s. 55(3.1)(a).

Vance Sider, "Section 55: Administrative Developments", 1995 Corporate Management Tax Conference Report, c. 8.

Paragraph 55(3.1)(b)

Administrative Policy

22 January 2016 External T.I. 2015-0617601E5 F - Pipeline followed by butterfly

where pipeline transaction followed by split-up butterfly, the opco also is a distributing corporation

CRA considered transactions in which, during the second year of conventional pipeline transactions, the Newco ("Corporation 2") was split between the estate beneficiaries under a butterfly reorg:

  • The shares of the opco (“Corporation 1”), whose ACB was stepped up on death, are sold by the estate to its newly-incorporated Corporation 2 for high-PUC prefs (rather than the more usual note);
  • after the wind-up of Corporation 2 into Corporation 1 a year later under s. 88(1), the shares (both common and pref) of Corporation 1 are distributed to the two beneficiaries;
  • two months later, there is a split-up butterfly of Corporation 2 between the two newcos (Corporations 3 and 4) of the two beneficiaries, so that Corporations 3 and 4 between them continue to carry on the business which previously was carried on by Corporations 1 and 2. In the meantime during the year following the winding up of Corporation 1, there is no bulk redemption (“rachat massif”) of the prefs of Corporation 2 or the successor prefs of Corporations 3 and 4.

After concluding that s. 84(2) likely would not apply, CRA turned to the butterfly rules, and stated (TaxInterpretations translation):

We could argue that all the transactions related to the implementation of the pipeline structure, the winding-up of Corporation 1 and the dividends resulting from the redemptions occurring as part of the butterfly transaction would be part of the same series of transactions. Included in the transactions, there would be two distributions (as defined in subsection 55(1))…: the first distribution on the winding-up of Corporation 1…and the second on the butterfly transaction itself.

For purposes of paragraph 55(3.1)(b), there would be two distributing corporations…for purposes of determining if the dividends received in the course of the transactions for dividing the business between Corporation 3 and Corporation 4 came within the paragraph 55(3)(b) exception.

…[T]he distribution consisting of the winding-up of Corporation 1 into Corporation 2 would not need to come within the exception provided by paragraph 55(3)(b) because by virtue of paragraph 88(1)(d.1), such distribution would not generate an intercorporate dividend which was subject to subsection 55(2). However, none of the events stipulated in paragraph 55(3.1)(b) could occur in the course of the series taking into account that Corporation 1 and Corporation 2 should be the distributing corporations for purposes of determining if dividends received in the course of the transactions for dividing the business between Corporation 3 and Corporation 4 would come within the paragraph 55(3)(b) exception.

Furthermore, in addition to establishing if paragraph 55(3)(b.1) applied taking into account two distributing corporations and two transferee corporations, it would be necessary to examine if paragraphs 55(3.1)(a) , (c) and (d) applied to the transactions in the series taking into account one distributing corporation, namely Corporation 2, and two transferee corporations.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 84 - Subsection 84(2) pipeline transaction can be coupled with a butterfly split-up 454

Articles

Christian Desjardins, Nik Diksic, "Cross-Border Butterflies in the Context of Public Spin-Off Transactions", 2015 CTF Annual Conference paper

History of s. 55(3.1)(b) (pp. 29:3)

[The main purpose of the original version of subsection 55(3.1) was to prevent…using the butterfly exemption rules to indirectly gain a treay exemption for a gain on a share sale that would not otherwise qualify for treaty protection. ...

[T]he changes proposed by the 1994 federal budget and as described in the Department of Finance explanatory notes accompanying the November 1994 draft legislation ensured that all purchase butterfly transactions (domestic and cross-border) would be denied the protection of the paragraph 55(3)(b) exemption. The new provisions also introduced a 10 percent de minimis exception to allow for sales and purchases by shareholders with insignificant interests... .

Denial of s. 55(3)(a) exemption (pp. 29:5)

[The following list] illustrates the basic manner in which a Canadian butterfly transaction is integrated into a cross-border spin-off. ...:

1) Foreign Pubco establishes Canadian Newco (the TC).
2) Foreign Pubco transfers shares of its Canadian subsidiary (the DC) with a FMV equal to the net FMV of the spin business to the TC.
3) DC transfers the spin business to the TC on a tax-deferred basis under subsection 85(1).
4) The TC shares owned by the DC, and the DC shares owned by the TC are cross-redeemed in exchange for promissory notes of equal value.
5) The promissory notes are set-off against each other and cancelled.
6) Foreign Pubco transfers its foreign spin assets to Foreign Spinco.
7) Foreign Pubco transfers the TC (which owns the spin business) to Foreign Spinco
8) The remaining spinoff steps are completed, and Foreign Spinco is ultimately distributed to the Foreign Pubco shareholders.

In [the base case outlined above]..., Foreign Pubco's gain or loss from the disposition of the spinoff shares is not included in computing its taxable income earned in Canada. In addition, the ultimate spinoff transaction is typically designed to be a tax-free transaction to Foreign Pubco (no recognition of gain or loss). As a result, paragraph 55(3.01)(e) deems Foreign Pubco to have disposed of those shares for proceeds that are less than FMV, and therefore the exemption in paragraph 55(3)(a) does not apply.

Requirement for Canadian spin business to represent under 10% of Foreign Spinco (pp. 29:8)

[T]he Canadian spin business must be relatively insignificant in the context of the overall spin-off and...other spin assets need to be contributed to Foreign Spinco before the contribution (or butterfly) of the Canadian spin business assets to ensure that the Foreign Spinco shares never derive 10 percent or more of their FMV from the TC shares. [fn 20: [The] 10 percent threshold must be maintained throughout the series of transactions-- for example, by ensuring that there are sufficient other assets in Foreign Spinco when it incorporates the TC. ...]

If the shares of Foreign Spinco derive 10 percent or more of their FMV from the Canadian spin business (or the shares of TC), then the transfer of the Foreign Spinco shares is subject to subclause 55(3.1)(b)(i)(A)(II), and therefore the paragraph 55(3)(b) exemption is unavailable. ...

No transfer of TC to a person (Foreign Spinco) who will cease to be related to Foreign Pubco (p. 29:8-10)

Another essential consideration that the Canadian separation transaction must satisfy to qualify under paragraph 55(3)(b) is that any transfer of the DC shares by Foreign Pubco must be a "permitted exchange". ...

Subparagraph 55(3.1)(b)(i) does not permit a transfer of the shares of the TC by a specified shareholder of the TC (i.e., Foreign Pubco) to a person who will cease to be related to the transferor as part of the series….

A potential solution to this issue is to slightly reorder the steps outlined above by establishing the TC under Foreign Spinco at the outset so that no subsequent transfer of the TC shares is required. The DC shares can then be transferred in sequential permitted exchanges from Foreign Pubco to Foreign Spinco and then to the TC. ...

Three-party exchange to address deemed transferee rule (pp. 29:11)

Adjusting the steps as illustrated... raises the issue of the deemed transferee rule in paragraph 55(3.2)(h)….[which] provides that each corporation that is a shareholder (and specified shareholder) of a DC at any time during the course of a series of transactions or events that includes a distribution is deemed to be a TC in relation to the DC. In the modified steps noted in figure 4, Foreign Spinco is deemed a TC if, at any time in the series, it was a shareholder of the DC… .

The solution…is the so-called three-party share exchange….

[F]oreign Pubco, Foreign Spinco, and the TC enter into a three-party share exchange agreement as follows:

1) Foreign Pubco transfers the DC shares directly to TC as consideration for the shares of Foreign Spinco issued in step 3.
2) The TC issues common shares to Foreign Spinco as consideration for the DC shares.
3) As consideration for the TC shares, Foreign Spinco issues shares to Foreign Pubco.

3-party exchange as permitted exchange (pp. 29:14-16)

These steps ...avoid the transitory acquisition of the DC shares by Foreign Spinco, which would otherwise qualify Foreign Spinco as a TC under paragraph 55(3.2)(h). The question, therefore, is whether a transfer that bypasses Foreign Spinco in this manner can still qualify as a permitted exchange.

The first requirement in the definition of "permitted exchange" is that there be an exchange of the DC shares for shares "of another corporation", which for the purposes of the provision is defined as "the acquiror". There is, however, no requirement that the acquiror be the corporation that actually acquires the DC shares. Instead, the only requirement is that the transferor (Foreign Pubco) receive shares of the acquiror as consideration for the transfer of the DC shares. ...

The second requirement is that no share of the capital stock of the acquiror outstanding immediately after the exchange be owned at that time by any person or partnership other than a participant. The only participant in figure 5 is Foreign Pubco, and Foreign Pubco owns all of the shares of Foreign Spinco immediately after the exchange. ...

The final requirement is that subparagraph (b)(iii) of the definition of permitted exchange apply. ...

As in the above example, if Foreign Pubco is the only DC shareholder and the only participant to the exchange, variables B and C are the same, and the fraction equals 1. As a result, the requirement in paragraph (b)(iii) is met. [fn 28: [I] t is often preferable to consolidate the DC shareholdings in the group in a single shareholder/participant immediately before the three-party share exchange. ...[P]ursuant to paragraph 55(3.2)(c) a person who acquires a share of the DC in contemplation of the butterfly distribution is deemed, in respect of the acquisition, not to be related to the person from whom it acquired the share, unless it acquired all of the shares of the DC that were owned by the other person. ...]

Substituted property issue under s. 55(3.1)(b)(i)(C) on 3-party exchange (pp. 29:16-17)

Clause 55(3.1)(b)(i)(C) examines, inter alia, whether the property (or substituted property) is acquired by a person who is unrelated to the vendor, or who ceases to be related to the vendor as part of the series, unless the property is acquired on a permitted exchange. ...

[I]t is unclear whether the Foreign Spinco shares qualify as property substituted for the DC shares. ...

[I]n our view, a subsequent disposition of substituted property that is acquired on a relevant excluded transaction (a permitted exchange, permitted acquisition or permitted redemption) should not be tested under clause 55(3.1)(b)(i)(C). Rather, a subsequent disposition of the property should be retested, starting with clause 55(3.1)(b)(i)(A). In this case, the Foreign Spinco shares do not qualify as property under this clause because they do not derive 10 percent or more of their FMV from the DC or TC shares; therefore, any disposition of them shares should not violate subparagraph 55(3.1)(b)(i). ...

We understand that this general interpretation has been accepted by the CRA, after consultation with the Department of Finance… .

Narrow meaning of “reorganization” in context of ss. 55(3.1)(b) to (d) (p. 29:18)

[T]he CRA has given a relatively narrow meaning to the term ["reorganization"] in this context:

[T]he "reorganization" referred to in section 55 would normally include only transfers of property by the distributing corporation to its shareholders (or corporations related to its shareholders) and the cross-redemption of shares or winding up of the distributing corporation. [fn 32:… 1996 Corporate Management Tax Conference ... 24:17-18.]

The CRA adopted this interpretation in the first cross-border butterfly ruling in 2006... with a specific statement in the comments section….

In the context of a cross-border butterfly, therefore, it is necessary to ensure only that the series of transactions or events does not include prohibited transactions or events described in 55(3.1)(a) or (b), and the continuity-of-interests rules in paragraphs 55(3.1)(c) and (d) should be largely irrelevant.

Reverse foreign spin-offs problematic (pp. 29:20-21)

Consider a reverse foreign spinoff, in which the keep assets are butterflied to the TC as part of the three-party share exchange, and the Foreign Spinco that is distributed to the Foreign Pubco shareholders is the existing shareholder of the DC.

In figure 6, Foreign Spinco (the existing shareholder of the DC) is a deemed TC under paragraph 55(3.2)(h), and therefore the transfer of its shares is problematic, regardless of whether the DC shares represent far less than 10 percent of the FMV of Foreign Spinco. Unlike the more typical transaction outlined above, here the new Foreign Keepco, rather than the existing Foreign Spinco, is a party to the three-party share exchange and therefore the shares of Foreign Spinco remain tainted and cannot be distributed outside the group without violating paragraph 55(3.1)(b). Furthermore, because Foreign Spinco is a deemed transferee corporation at the beginning of the series of transactions that includes the butterfly, it cannot easily (or perhaps ever) be cleansed of its TC status as part of the series. This … may not have arisen if, for example, Foreign Spinco held the DC shares through a single purpose foreign holding company. In this case, deemed TC status would extend only to that foreign holding company, and not to Foreign Spinco. Rather, Foreign Spinco would be tested only under the 10 percent de minimis rule… .

No rollover in 3-party exchange (p. 29:27)

If the transferred DC shares in a cross-border butterfly transaction are taxable Canadian property, any gain realized by the non-resident transferor is taxable under the Act (subject to possible application of a treaty exemption), unless the transfer is completed on a rollover basis under subsection 85(1). ...

Because the three-party share exchange is structured to ensure that the transferor (Foreign Pubco) does not receive the share consideration directly from TC, it may be difficult to take a seemingly opposite position in the context of subsection 85(1).

Non-application of s. 212.1 on 3-party exchange (p. 29:29)

Paragraph 212.1(1)(b) also provides that in computing the PUC of any shares issued by the purchaser corporation, the PUC may be reduced when any increase in the PUC in respect of the shares of purchaser corporation exists "by virtue of the disposition" of the subject shares. ... In the context of the three-party share exchange, the increase in the PUC in respect of the shares of TC issued to Foreign Spinco is clearly related to the disposition of the preferred shares of the DC. In other words, the increase exists "by virtue of the disposition" of the preferred shares of DC by Foreign Pubco to the TC. Consequently, the PUC of the newly issued shares of the TC will be limited to the PUC of the DC preferred shares pursuant to paragraph 212.1(1)(b).

Words and Phrases
reorganization

Subparagraph 55(3.1)(b)(i)

Administrative Policy

2014 Ruling 2014-0530961R3 - Cross-Border Butterfly

pro rata allocation of Foreign Spinco debt

In connection with a spin-off by a U.S. public company (Foreign PubCo) of a U.S. subsidiary (Foreign Spinco) to which one of its businesses was transferred, there was a butterfly split-up of an indirect Canadian subsidiary (DC) directly and indirectly holding Canadian portions of the two businesses in question, so that the Canadian transferee corporation (TCo) of DC was a subsidiary of Foreign Spinco. Following the Canadian butterfly transactions and before the spin-off by Foreign Pubco of Foreign Spinco, Foreign Spinco borrowed the "External Debt" from third party lenders (which did not relate to any particular assets of Foreign Spinco) and "distributed" the applicable portion thereof to Foreign Pubco so as to qualify as a tax-free distribution under Code s. 361(b). In connection with the s. 55(3.1)(b)(i)(A)(II) rule, CRA indicated that indebtedness of Foreign SpinCo will be considered to reduce the FMV of each property of Foreign SpinCo pro rata in proportion to the relative FMV of all property of Foreign SpinCo. See summary under s. 55(1) – distribution.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution U.S./Cda b/f including conversion of Foreign Spinco and TC from fiscally disregarded to regarded for Code purposes/2-stage transfer to TC of cash assets/post-b/f dividend by DC/s. 86.1 treatment/proportionate allocation of Foreign Spinco debt 1382
Tax Topics - Income Tax Act - Section 86.1 - Subsection 86.1(2) spin-off by U.S. pubco of U.S. spinco after Canadian butterfly 109

2013 Ruling 2013-0491651R3 - Cross-Border Butterfly

cross-border b/f with 3-party exchange, pro rata application of upper tier debt, cash-out of ineligible shareholders

Background

Foreign PubCo will spin-off Foreign SpinCo to its shareholders. Foreign SpinCo is a great-grandchild subsidiary held by it "through" ForCo 1 and ForCo 2). DC (a wholly-owned subsidiary of ForCo 2 and thus a "sister" of Foreign SpinCo) will effect a split-up butterfly of the Canadian portion of the Spin-Off Business to TC, a direct newly-incorporated Newco subsidiary of ForCo2. Activities directly carried on in Canada by other subsidiaries of DC, namely, B Co (whose commons shares also were held by ForCo11, a subsidiary of Foreign PubCo), C Co, D Co (wholly-owned by C Co), and LP 1 and E Co, the GP of LP 1 (the "DC Retained Business") are to be retained by DC after the Spin-Out.

Three-Party Exchange

Immediately prior to the distribution by DC and following a share capital reorganization of DC in which old common shares of DC will be exchanged for "DC New Common Shares" and "DC Special Shares", a three-party transfer agreement will be concluded between Forco 2, Foreign SpinCo and TC (a newly-incorporated Canadian subsidiary of Foreign SpinCo) in which: ( a) TC will agree to pay the purchase price for DC Special Shares transferred to it by ForCo 2 as described in para. (b) below by issuing TC Common Shares to Foreign SpinCo; (b) ForCo 2 will agree to pay the purchase price for the common shares issued to it by Foreign SpinCo as described in para. (c) below by transferring all of the DC Special Shares to TC; and (c) Foreign SpinCo will agree to pay the purchase price for the TC Common Shares issued to it by TC as described in para. (a) above by issuing common shares to ForCo 2.

Spin-Off

Following completion of the butterfly, Foreign PubCo will not distribute shares of Foreign SpinCo to shareholders who are domiciled in countries where Foreign SpinCo shares cannot be offered through the proposed Spin-Out, and to shareholders who hold a small number of Foreign SpinCo shares. Instead, it will issue the affected Foreign SpinCo share to an independent trustee who will sell them in the open market and distribute the net cash proceeds to such ineligible shareholders. Subject to the foregoing, Foreign PubCo will distribute the remaining outstanding shares in Foreign SpinCo pro rata to its shareholders under a scheme of arrangement on a proportionate basis.

Ruling

S. 55(3)(b) ruling is premised on 10% or more of the FMV of the Foreign SpinCo shares not, at any time, during the course the series being derived from the DC Special Shares or TC Common Shares. For these purposes, any indebtedness of Foreign SpinCo will be considered to reduce the FMV of each property of Foreign SpinCo pro rata in proportion to the relative FMV of all property of Foreign SpinCo.

See detailed summary under s. 55(1) - distribution.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution cross-border b/f with 3-party exchange, cash-out of ineligible shareholders, proportionate allocation of foreign spinco debt, pension liability classification, prelim non-series dividend 945
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3.1) - Paragraph 55(3.1)(a) preliminary LP acquisition, cross-border debt repayments and dividend: not part of series 212
Tax Topics - Income Tax Act - Section 86 - Subsection 86(1) exchange for substantively identical common shares 114

2012 Ruling 2011-0425441R3 - Cross Border Butterfly

upper tier debt applied pro rata re 10% limitation

Overview

A non-resident public company (Foreign Pubco) will be spinning off Business A to its shareholders, to be accomplished by a dividend-in-kind of its shares of Foreign Spinco (also non-resident) to its shareholders. Business B will be retained. Preliminarily to this spin-off, an indirect Canadian subsidiary of Foreign Pubco (Canco – which is the distributing corporation) will transfer the Canadian business relating to Business B as well as related foreign subsidiaries held directly (Forsub) or through a partnership (Forlp) and a partner thereof (Canco Sub 4) to the transferee corporation (TCo – a ULC). This will be facilitated through a direct transfer of the Newco holding company for such assets (Newsub) to TSub (a subsidiary of TCo), with TSub then being wound up into TCo. TCo (which will be directly held by Newco 3 and through transactions which are heavily redacted – see perhaps para. 122) will be indirectly transferred to Foreign Pubco, whereas Canco will become an indirect subsidiary of Foreign Spinco.

External borrowing

After the butterfly reorganization and before the spin-off of Foreign Spinco, Foreign Spinco will borrow money (the "External Debt") from arm's length lenders and use the proceeds to make a distribution to Foreign Pubco.

Application of 10% test

The butterfly ruling is given provided inter alia that xxx% or more of the fair market value "of the common shares of Foreign Spinco that Foreign Pubco owns was not, at any time during the course of any series of transactions or events…derived from the shares of Canco, TCo, Newco 3, Forco [or companies to which Newco 3 is transferred, namely, Newco 4 and New Holdco]."

The letter then states:

For the purposes of subclause 55(3.1)(b)(i)(A)(II), in determining whether XXX% or more of the FMV of the common shares of Foreign Spinco that Foreign Pubco owns was derived from the shares of Canco, TCo, Newco 3, Forco, Foreign Pubco, Newco 4 and New Holdco as described [above], the External Debt of Foreign Spinco…will be considered to reduce the FMV of each property of Foreign Spinco pro rata in proportion to the relative FMV of all property of Foreign Spinco.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution cross-border b/f with 3-party exchange to address s. 55(3.2)(h)/indemnity neutralizes liability assumption/Newco 3 is implicit DC 329

2012 Ruling 2012-0439381R3 - Cross-border spin-off butterfly

underline;">: Background. After preliminary transactions, DC becomes owned by Foreign Pubco. In order to accomplish a butterfly spin-off of the spin-off business of CD to a newly-incorporated subsidiary (TC) of a non-resident subsidiary of Foreign Pubco (Foreign Spinco Parent), various transactions occur including those set-out below.

DC and s. 86 reorganization

Each common share of DC will be changed into one redeemable retractable non-voting DC preferred shares (a DC New Preferred Share1) and one DC New Common Share.

Three-Party Share Exchange

In the context of a three-party transfer agreement (the "Three-Party Share Exchange") between Foreign Pubco, Foreign Spinco Parent and TC (a newly-incorporated Canadian subsidiary of Foreign Spinco Parent):

a) TC will agree to pay the purchase price for DC New Preferred Shares1 transferred to it by Foreign Pubco as described in para. (b) below by issuing TC Common Shares to Foreign Spinco Parent;

b) Foreign Pubco will agree to pay the purchase price for the common shares issued to it by Foreign Spinco Parent as described in para. (c) below by transferring all of the DC New Preferred Shares1 to TC; and

c) Foreign Spinco Parent will agree to pay the purchase price for the TC Common Shares issued to it by TC as described in para. (a) above by issuing common shares to Foreign Pubco (para. 66).

Permitted exchange

Immediately before the transfer of Newco common shares by DC to TC described below, the common shares of Foreign Spinco Parent (viewed as the "acquiror") owned by Foreign Pubco (viewed as the "participant") will have a fair market value that accords with the formula in (b)(iii) of the "permitted exchange" definition (para. 71).

Drop-down of Canadian Spin-off Business to Newco

DC will transfer its assets of the Spin-off Business to a newly-incorporated subsidiary (Newo) in consideration for assumption of liabilities and the issuance of common shares (para 74-75).

Butterfly distribution

. DC transfers its common shares of Newco to TC in consideration for TC preferred shares (para. 80).

Cross-redemption

TC will redeem its preferred shares, and DC will redeem the DC Preferred Shares1, in each case for a demand promissory note. Immediately thereafter, the principal amounts owing thereunder will be set-off against each other.

Spin-off by Foreign Pubco

Foreign Pubco will distribute all its shares of Foreign Spinco Parent to its shareholders as a dividend-in-kind.

Rulings

S. 55(2) will not apply to the deemed dividends arising on the cross-redemptions (referred to in Ruling D) provided that:

10% or more of the FMV of the Foreign Spinco Parent common shares that Foreign Pubco owns was not, at any time during the course of any series of transactions or events that includes the dividends described in Ruling D (a) and (b), derived from the DC New Preferred Shares1 or the TC Common Shares. (Ruling F)

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution cross-border b/f as part of foreign spin-off including (U.K.?) demergers 750

2012 Ruling 2011-0431101R3 - Cross-border spin-off butterfly

As preliminary transactions to a butterfly distribution by DC, which is owned by a non-resident subsidiary (Foreign Sub 1) of a non-resident publicly-traded corporation (Foreign Pubco), each common share of DC will be changed into one redeemable retractable non-voting DC special share and one DC New Common Share.

Permitted exchanges/Three-Party Share Exchange

Foreign Sub 1 will concurrently make the following transfers of its shares of DC:

(i) transfer all the DC Special Shares to TC, a newly-incorporated private corporation subsidiary of Foreign Sub 1 (para. 126(a)) in consideration for the issue of common shares of TC; and

(ii) transfer all the DC New Common Shares to Foreign Sub 15, a newly-incorporated LLC subsidiary of Foreign Spinco 1 which, in turn will be a non-Canadian subsidiary of Foreign Sub 1 (para. 126(b)).

In connection with the transfer in (ii) above, Foreign Sub 1, Foreign Sub 15, and Foreign SpinCo 1 will enter into a three-party agreement (the "Three-Party Share Exchange"), whereby:

(a) Foreign Sub 15 will agree to pay the purchase price for the DC Common Shares transferred to it by Foreign Sub 1 by issuing membership interests in the capital of Foreign Sub 15 to Foreign SpinCo 1 having an aggregate FMV at that time equal to the aggregate FMV of the DC Common Shares so transferred to it by Foreign Sub 1 as described in [para. (b) below]...;

(b) Foreign Sub 1 will pay the purchase price for the Foreign SpinCo 1 Common Shares issued to it by Foreign SpinCo 1 as described in [para. (c) below], by transferring all of the DC Common Shares to Foreign Sub 15; and

(c) Foreign SpinCo 1 will agree to pay the purchase price for the membership interests in Foreign Sub 15 by issuing common shares to Foreign Sub 1 having an aggregate FMV at that time equal to the aggregate FMV of the membership interests in Foreign Sub 15 so issued by Foreign Sub 15 to Foreign SpinCo 1 described in para. (a) above.

Following a butterfly distribution by DC to TC, Foreign Sub 1 will then distribute all its shares of Foreign Spinco 1 to Foreign Pubco. Foreign Pubco will distribute all its shares of Foreign Spinco 1 to its shareholders as a dividend-in-kind. Accordingly, the shares of Foreign Spinco 1 will be disposed of by a specified shareholder of DC (Foreign Sub 1) to persons who are not related to Foreign Sub 1.

CRA's butterfly ruling indicates that s. 55(2) will not apply to the deemed dividends arising on the cross-redemptions (referred to in Ruling D) occurring on the butterfly reorganization provided that:

10% or more of the FMV of the Foreign SpinCo 1 Common Shares was not, at any time, during the course of the series of transactions or events that includes the dividends described in Ruling D, derived from the DC New Common Shares or derived from the membership interest in Foreign Sub 15....For the purposes of subclause 55(3.1)(b)(i)(A)(II), in determining whether 10% or more of the FMV of the common shares of Foreign SpinCo 1 was derived from the DC New Common Shares that Foreign Sub 15 owns or derived from the membership interest in Foreign Sub 15 that Foreign SpinCo 1 owns, as described in Ruling F(I) above, any indebtedness of Foreign SpinCo 1, that is not a secured debt and that is not a debt related to a particular property, will be considered to reduce the FMV of each property of Foreign SpinCo 1 (or indirectly the FMV derived from DC Common Shares owned by Foreign Sub 15) pro rata in proportion to the relative FMV of all property of Foreign SpinCo 1. (Ruling F)

Paragraph 55(3.1)(c)

Administrative Policy

29 November 2016 CTF Roundtable Q. 2, 2016-0669651C6 - Computation of safe income

moratorium on providing interpretations on safe income allocation to discretionary dividend shares

CRA characterized hypothetical transactions involving the use of discretionary dividend shares as entailing a transfer of value from two related corporations to two unrelated persons, and noted that they thus departed from normal business standards and were not explicable without more facts.

Rather than commenting on the contrived presented facts, CRA commented more generally on discretionary shares, and indicated that it will no longer be commenting on safe income allocation questions until it has studied the area further, whose potential for value shifting and valuation difficulties it finds troubling. This moratorium respecting interpretive issues relating to the use of discretionary dividend shares does not detract from the Rulings Directorate being “open for business” with respect to other s. 55 issues relating to 55.

CRA was not receptive to a suggestion that safe income computations could be skipped in the simple case of a holdco/opco structure and no or limited differences in accounting versus taxable income, stating that it is the duty of taxpayers and their representatives to be careful making claims that a dividend is not subject to the application of s. 55(2).

2010 Ruling 2010-0357061R3 - Split-up butterfly

After describing the distribution of property by the distributing corporation (DC) to three transferee corporations (TC1, TC2 and TC3) under a reorganization that is ruled to qualify as a butterfly reorganization and which is later represented not to include an acquisition described in s. 55(3.1)(c) "which is not described herein," the ruling describes a co-ownership agreement that is entered into by TC1, TC2 and TC3:

The co-ownership agreement will indicate that: (i) the co-owners do not intend to create a partnership; (ii) no co-owners can act on behalf of another co-owner without obtaining prior consent from that co-owner; (iii) each co-owner has a well-defined separation of interests in and ownership of the properties subject to eh co-ownership agreement; (iv) a co-owner cannot charge and/or grant security over the co-owned properties as a whole (i.e. the other co-owner's interest) as each co-owner only has the right to deal with its own interest in the co-owned properties; (v) profit and loss is calculated by each co-owner individually and there is no mechanism in the agreement that deals with the allocation of profit or loss; and (vi) the liability of the co-owners is limited to their own expenses.

The ruling letter summary states that provided the representation that there is no partnership is accurate, the entering into of this co-ownership agreement will not taint the butterfly.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 96 co-ownership not a partnership 225

3 October 2011 External T.I. 2011-0421341E5 - Paragraphs 55(3.1)(c) or (d)

before a distribution made in the course of a butterfly reorganization, Opco sells real estate used in operating its business (and representing more than 10% of the value of the business) to a non-related person for fair market value consideration consisting solely of cash. S. 55(3.1)(c) would not apply because the real property would not be described in s. 55(3.1)(c)(ii); and similarly s. 55(3.1)(d) would not apply. S. 55(3.1)(a) would not apply because of the exception in s. 55(3.1)(a)(iv)(C). 8 June 2005 Comfort Letter distinguished.

x1995 Tax Executives Institute Round Table, Q. 2, File No. 951074

S.55(3.1)(c) would apply to deny the protection of the butterfly exemption in a situation where a corporate 30% shareholder of the distributing corporation transfers the property received by it to a partnership between itself and its wholly-owned subsidiary, where the other shareholders of the distributing corporation were unrelated corporations.

31 July 1995 T.I. 951844 (C.T.O. "50731")

Example of a problem arising because s. 55(3.1)(c)(ii)(B) is not modified by the parenthetical expression "(other than money and indebtedness that is not convertible into other property)".