2001 Ruling 2001-0051623 - 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 Department.

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

Principal Issues: This is a split-up butterfly of XXXXXXXXXX . (Holdco) among XXXXXXXXXX widow and his three adult children by a prior marriage. The major assets of Holdco consist of shares of XXXXXXXXXX . (Fco). The main issues relate to the sale of XXXXXXXXXX shares in exchange for XXXXXXXXXX shares prior to the butterfly, and whether the sale of XXXXXXXXXX shares after the butterfly are "in the ordinary course of business".

Position: The split-up butterfly qualifies under paragraph 55(3)(b).

Reasons: The acquisition of the XXXXXXXXXX shares in exchange for the XXXXXXXXXX shares prior to the butterfly is excluded from paragraph 55(3.1)(a) because the sale was not in contemplation of the butterfly. Because sales of XXXXXXXXXX shares by the transferee corporations will not be considered to be "in the ordinary course of business", sales of XXXXXXXXXX shares will be limited to no more than 10% of the FMV of the property received by the transferee corporation on the distribution pursuant to paragraph 55(3.1)(c).

XXXXXXXXXX 2000 - 005162

XXXXXXXXXX, 2001

Dear Sirs:

Re: XXXXXXXXXX

Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayer. We also acknowledge receipt of your facsimiles as well as the information provided in various telephone conversations.

Throughout this letter, the corporate and individual taxpayers will be referred to as follows:

XXXXXXXXXX Holdco

XXXXXXXXXX Mr. J

XXXXXXXXXX Mrs. J

XXXXXXXXXX Ms. K

XXXXXXXXXX Ms. L

XXXXXXXXXX Mr. M

XXXXXXXXXX Mr. R

XXXXXXXXXX Fco

XXXXXXXXXX Gco

XXXXXXXXXX Pubco

The Tax Services Office of Holdco is XXXXXXXXXX and Holdco's corporate tax returns are filed at the XXXXXXXXXX Taxation Centre. Holdco is resident in Canada for the purposes of the Act.

To the best of your knowledge, and that of any of the taxpayers, none of the issues involved in this ruling request is:

(i) involved in an earlier return of any 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 any of the taxpayers or a related person;

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

(iv) before the courts; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

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

(b) "adjusted cost base" ("ACB") has the meaning assigned to that term by section 54;

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

(d) "arm's length" has the meaning assigned to that term by section 251;

(e) "CBCA" means the Canada Business Corporations Act and, where applicable, its predecessor statutes;

(f) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned to that term by subsection 125(7);

(g) "capital dividend account" ("CDA") has the meaning assigned to that term by subsection 89(1);

(h) "capital property" has the meaning assigned to that term by section 54;

(i) "cost amount" has the meaning assigned to that term by subsection 248(1);

(j) "paid-up capital" ("PUC") has the meaning assigned to that term by subsection 89(1);

(k) "public corporation" has the meaning assigned to that term by subsection 89(1);

(l) "refundable dividend tax on hand" ("RDTOH") has the meaning assigned to that term by subsection 129(3);

(m) "safe-income determination time" has the meaning assigned to that term by subsection 55(1);

(n) "safe income on hand" in respect of a particular share of a corporation at a particular time means the portion of the unrealized gain inherent in such share of the corporation at that time that cannot reasonably be considered to be attributable to anything other than income earned or realized (as determined pursuant to subsection 55(5)), to the extent that it is on hand, by any corporation after 1971 and before the safe-income determination time for the transaction, event or series of transactions or events that includes the proposed transactions described below;

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

(p) "specified financial institution" ("SFI") has the meaning assigned to that term by subsection 248(1);

(q) "substantial interest" has the meaning assigned to that term by subsection 191(2);

(r) "taxable Canadian corporation" ("TCC") has the meaning assigned to that term by subsection 89(1); and

(s) "taxable dividend" has the meaning assigned to that term by subsection 89(1).

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

FACTS

1. Holdco is a taxable Canadian corporation and a Canadian-controlled private corporation incorporated under the provisions of the CBCA on XXXXXXXXXX.

2. Holdco's issued and outstanding share capital consists of XXXXXXXXXX Class A voting common shares (the "Class A Shares"). Mrs. J, Ms. K, Ms. L and Mr. M each hold XXXXXXXXXX Class A Shares as capital property. Ms. K, Ms. L and Mr. M are siblings and Mrs. J is their step-mother.

3. The aggregate paid-up capital of the XXXXXXXXXX Class A Shares to each shareholder is $XXXXXXXXXX. Ms. K, Ms. L and Mr. M each acquired their XXXXXXXXXX Class A Shares of Holdco by subscription from treasury on XXXXXXXXXX at an aggregate subscription price of $XXXXXXXXXX. Mrs. J acquired her shares of Holdco as a result of a bequest from her spouse, the late Mr. J, who died on XXXXXXXXXX. Mr. J had also acquired his XXXXXXXXXX Class A Shares of Holdco by subscription from treasury on XXXXXXXXXX at an aggregate subscription price of $XXXXXXXXXX.

4. The above mentioned subscriptions for XXXXXXXXXX Class A Shares of Holdco were effected in the context of an estate freeze pursuant to which, on XXXXXXXXXX, Mr. J transferred, pursuant to section 85, XXXXXXXXXX Class A Shares of Holdco to Holdco in consideration for XXXXXXXXXX Class G shares of Holdco. These Class G shares of Holdco held by Mr. J were redeemed by Holdco between XXXXXXXXXX. The only other shares that were ever issued from the capital stock of Holdco were XXXXXXXXXX Class E shares that were issued to Mr. J in XXXXXXXXXX. These Class E shares were also redeemed in XXXXXXXXXX.

5. The assets of Holdco consist of the following:

(a) cash;

(b) XXXXXXXXXX shares of the capital stock of Fco, a taxable Canadian corporation and a public corporation; and

(c) shares representing XXXXXXXXXX% of the capital stock of Gco, a taxable Canadian corporation and a Canadian-controlled private corporation. These shares were acquired by Holdco in XXXXXXXXXX from Fco in the context of a reorganization undertaken by Fco to divest itself of its non-core assets in order for Fco to effect its initial public offering.

6. The XXXXXXXXXX Fco shares held by Holdco represent approximately XXXXXXXXXX% of the issued and outstanding shares of Fco and carry with them approximately XXXXXXXXXX% of the available votes. Of the Fco shares held by Holdco, XXXXXXXXXX shares are subject to a statutory hold period and a contractual escrow which will expire in XXXXXXXXXX, while the remaining XXXXXXXXXX shares are free trading. At current market prices and without discounting for the escrow, the Fco shares held by Holdco have a fair market value in excess of $XXXXXXXXXX.

7. The Fco shares held by Holdco are subject to a voting trust agreement (the "Voting Agreement") pursuant to which an unrelated, arm's length individual, Mr. R, is entitled to vote such shares for so long as they are held by Holdco. However, the Voting Agreement does not in any way affect the right of Holdco to dispose of its Fco shares, in whole or in part. The Voting Agreement does, however, provide that any transfer by Holdco of its Fco shares to an affiliated entity will require such transferee to undertake to be bound by the Voting Agreement.

8. The late Mr. J and Mr. R were the founding shareholders of the company currently known as Fco. Although now a public company of significant value, Fco was originally a struggling company managed only by Mr. J and Mr. R. As a result of many years of working together, Mr. J and Mr. R developed a close personal relationship. Due to illness, Mr. J's role in Fco gradually declined to the point where, by the time of the public issue, he was not involved in the day-to-day affairs of Fco. Nevertheless, out of respect for the original arrangement under which Mr. J and Mr. R had pooled their resources to create Fco, Mr. J caused Holdco to enter into the Voting Agreement.

9. Prior to Mr. J's death, Holdco sold some Fco shares as part of a secondary distribution of Fco shares offered in connection with a public offering of Fco shares. Since Mr. J's death, Holdco has not sold any shares of Fco, however, the shareholders of Holdco are considering the possibility of Holdco effecting future sales. Because of the close relationship between Mr. R and the late Mr. J's family, Mr. R is aware of the possibility that Holdco (or, to the extent that the butterfly contemplated herein is accomplished, its shareholders) will sell substantial blocks of Fco shares in the future, subject to applicable securities legislation and escrow requirements.

10. It is the taxpayers' understanding that, with the knowledge that Holdco was considering divesting itself of a significant number of its Fco shares, Mr. R became concerned about his ability to ultimately control Fco and, as a result, attempted to solicit offers for a takeover bid for Fco. In fact, on XXXXXXXXXX Pubco, a taxable Canadian corporation and a public corporation whose subordinate voting shares are listed on the XXXXXXXXXX Stock Exchange and on the XXXXXXXXXX Stock Exchange, entered into a series of agreements with certain of the principal shareholders of Fco (the "Support Agreements") relating to the proposed acquisition by Pubco of all the Fco common shares. Holdco is one of the shareholders of Fco that entered into such an agreement with Pubco and it is expected that, in pursuance of that agreement, the following events will occur in the following order:

(a) Holdco will subscribe for common shares of a newly incorporated company ("Newco") for a nominal subscription price. Newco will have never issued shares of its capital stock, never carried on any activity and will have no assets prior to the proposed transactions other than the nominal subscription capital;

(b) Holdco will transfer all of its shares of Fco to Newco. As consideration for such transfer, Newco will issue additional common shares to Holdco. In respect of such transfer, the transferor and the transferee will elect, jointly and 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 Fco shares to Newco. The agreed amount specified in such election will be equal to the ACB of the transferred shares at the time of the transfer, which will not be greater than the fair market value of the shares. The paid-up capital of the Newco shares so issued will equal the ACB of the Fco shares so transferred.

(c) through one or more increases in paid-up capital, Newco will increase the paid-up capital of the Newco common shares by amounts that will, in aggregate, not exceed the safe income on hand of Newco in respect of the Fco shares held by Newco;

(d) Fco will propose a statutory plan of arrangement under section 192 of the CBCA (the "Plan") to its shareholders;

(e) Holdco, as well as the other shareholders of Fco who signed Support Agreements, will vote in favor of the Plan;

(f) Fco will adopt the Plan, which will be approved by a court; and

(g) in accordance with the Plan, Pubco will issue to Holdco a fraction of a Pubco subordinate voting share, as determined by a formula, for each Newco share held by Holdco.

The taxpayers have represented that none of the transactions described in paragraphs (a) to (g) above will be carried out in contemplation of the proposed transactions. Originally, the proposed transactions were to have been carried out before the Fco shares were acquired by Pubco, and were to have been carried out irrespective of the acquisition of Fco shares by Pubco.

11. The assets of Gco include cash and near cash, as well as investments in several Canadian-controlled private corporations. The remaining XXXXXXXXXX% of the shares of Gco that are not owned by Holdco are owned by a holding company controlled by Mr. R ("Rco"). Because the investment objectives of Holdco and Rco are different, Holdco and Rco are considering a divisive reorganization of Gco. At present, discussions concerning such a divisive reorganization are still at a preliminary stage.

12. As at XXXXXXXXXX, Holdco had a balance of refundable dividend tax on hand of $XXXXXXXXXX. It is anticipated that this amount will increase before the proposed transactions are carried out in light of Holdco's activities and the returns of passive investments in XXXXXXXXXX, and that Holdco may have a small positive balance in its capital dividend account.

PROPOSED TRANSACTIONS

13. Immediately following the adoption of the Plan by Fco, and the issuance by Pubco to Holdco of the Pubco subordinate voting shares, Mrs. J, Ms. K, Ms. L and Mr. M will subscribe for common shares of one of four corporations ("Jco", "Kco", "Lco" and "Mco"), respectively, for a nominal subscription price. Jco, Kco, Lco and Mco have never issued shares of their respective capital stock, never carried on any activity, and will have no assets prior to the proposed transactions other that the nominal subscription capital.

14. Immediately following the share subscriptions described in paragraph 13 above, Mrs. J, Ms. K, Ms. L and Mr. M will each transfer their XXXXXXXXXX Class A Shares of Holdco to Jco, Kco, Lco and Mco, respectively. As consideration for such transfers, Jco, Kco, Lco and Mco will issue shares to Mrs. J, Ms. K, Ms. L and Mr. M, respectively. The share consideration received by Mrs. J, in particular, will be comprised of one Jco common share. In respect of each such transfer, the transferor and the transferee will elect, jointly and 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 Holdco shares to Jco, Kco, Lco and Mco. The agreed amount specified in each election will be equal to the ACB of the transferred shares at the time of the transfer, which will not be greater than the fair market value of the shares. The paid-up capital of the Jco, Kco, Lco and Mco shares so issued will equal the paid-up capital of the Class A Shares of Holdco so transferred.

15. Immediately following the transfers described in paragraph 14 above, Holdco will transfer one-quarter of each of the assets listed in paragraph 5 above (except that the Fco shares will have been first exchanged for Newco shares, as described in paragraph 10(b) above, and then exchanged for Pubco subordinate voting shares in accordance with the Plan, as described in paragraph 10(g) above), to each of Jco, Kco, Lco and Mco. As consideration for such transfers, Jco, Kco, Lco and Mco will each assume one-quarter of the liabilities of Holdco and issue redeemable, retractable, Preferred shares to Holdco having an aggregate redemption value equal to the fair market value of the assets of Holdco so transferred to it less the amount of the liabilities assumed by it. The paid-up capital of the Jco, Kco, Lco and Mco Preferred shares so issued will equal the cost amount of the assets so transferred less the amount of the liabilities assumed.

With respect to Jco, the redeemable, retractable, Preferred shares to be issued will also be voting shares and will result in Holdco owning more than 10%, but less than 50%, of the votes attaching to the outstanding shares of Jco. For the purposes of subsection 191(4), the terms and conditions of the Jco Preferred shares will specify an amount in respect of each such share for which the share is to be redeemed, acquired or cancelled. The amount to be specified in respect of each Jco Preferred share, at the time of its issuance by a resolution to be made by the board of directors of Jco, will be expressed as a dollar amount, will not be determined by a formula, and will not exceed the fair market value of the property received by Jco as consideration for such a share.

In respect of each such transfer, the transferor and the transferee will elect, jointly and 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 Holdco assets to Jco, Kco, Lco and Mco. The agreed amount specified in each election will be equal to the cost amount of the transferred asset which will not be greater than the fair market value of that asset. The value of the liabilities assumed as consideration for any transferred asset will not exceed the cost amount of such asset.

16. Immediately following the transfers described in paragraph 15 above, Jco, Kco, Lco and Mco will each redeem its Preferred shares held by Holdco by issuing to Holdco a non-interest-bearing promissory note payable on demand in an amount equal to the aggregate redemption value of the Preferred shares so redeemed. Jco, Kco, Lco and Mco will each have their first year-end on the date of such redemptions.

17. Immediately following the redemption of the Preferred shares described in paragraph 16 above, Holdco will purchase for cancellation its XXXXXXXXXX Class A Shares from Jco, Kco, Lco and Mco, respectively, by issuing a non-interest-bearing promissory note payable on demand to each of Jco, Kco, Lco and Mco. The amount of each such promissory note will be equal to the aggregate fair market value of the Class A Shares being purchased for cancellation. To the extent that there is a capital dividend account balance in Holdco, the repurchase will be effected in two separate stages in order to facilitate the movement of that account to Jco, Kco, Lco and Mco, respectively.

18. Immediately following the purchase for cancellation of the Holdco shares described in paragraph 17 above, the promissory notes issued by Holdco referred to in paragraph 17 above will be offset against the promissory notes issued by each of Jco, Kco, Lco and Mco referred to in paragraph 16 above.

19. Immediately following the offset of promissory notes described in paragraph 18 above, Holdco will be dissolved in accordance with the CBCA.

ADDITIONAL INFORMATION

20. None of the taxpayers have any outstanding tax liabilities that could be affected by the proposed transactions.

21. No property has or will become property of Holdco in contemplation of, and before the proposed transactions.

22. None of the shares of Holdco, Jco, Kco, Lco or Mco will be disposed of, except as described herein, as part of the series of transactions or events that includes the proposed transactions.

23. None of Jco, Kco, Lco and Mco will dispose of more than 10% of their respective property which is owned immediately following the proposed transactions, as part of the series of transactions or events that includes the proposed transactions.

24. None of the shares of Holdco, Jco, Kco, Lco or Mco are or will be, at any time during the implementation of the proposed transactions:

(a) the subject of any undertaking or agreement that is referred to in subsection 112(2.2) as a "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 referred to in subsection 112(2.3) as that term is defined in subsection 248(1).

25. None of Holdco, Jco, Kco, Lco or Mco is or will be, at the time the dividends are deemed to be paid, as described in paragraphs 13 to 19 above, a specified financial institution.

PURPOSE OF THE PROPOSED TRANSACTIONS

26. The purpose of the proposed transactions is to allow Mrs. J, Ms. K, Ms. L and Mr. M to each hold, through their respective holding company, their pro rata share of the fair market value of the property of Holdco, in particular, the shares of Pubco. This will permit each such person to develop their own investment policy with respect to their share of the underlying assets of Holdco, and particularly the shares of Pubco.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided 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) as it may apply to the transfers referred to herein, the provisions of subsection 85(1) will apply to:

(a) the transfer of the Class A Shares of Holdco held by each of Mrs. J, Ms. K, Ms. L and Mr. M to Jco, Kco, Lco and Mco, respectively, as described in paragraph 14 above; and

(b) the transfer of Holdco's assets to Jco, Kco, Lco and Mco, respectively, as described in paragraph 15 above;

such that the agreed amounts in respect of each such transfer will be deemed to be the transferor's proceeds of disposition of the property and the transferee's cost thereof, and the transferor's cost of the shares received as consideration for the disposition. For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to herein.

B. As a result of the redemption by Jco, Kco, Lco and Mco of their respective Preferred shares and the purchase for cancellation by Holdco of its Class A Shares, as described in paragraphs 16 and 17 above:

(a) by virtue of paragraphs 84(3)(a) and 84(3)(b):

(i) Jco, Kco, Lco and Mco will each be deemed to have paid, and Holdco will be deemed to have received, a taxable dividend equal to the amount by which the amount paid to redeem the respective Jco, Kco, Lco and Mco Preferred shares exceeds the PUC thereof, immediately before such redemption; and

(ii) Holdco will be deemed to have paid, and Jco, Kco, Lco and Mco will each be deemed to have received, a taxable dividend equal to the amount by which the amount paid to purchase the Holdco Class A Shares held by Jco, Kco, Lco and Mco, respectively, exceeds the PUC thereof, immediately before such purchase;

(b) the taxable dividends deemed to be received by Holdco, Jco, Kco, Lco and Mco as a result of the purchase for cancellation and redemptions referred to in Ruling B(a) above will be included in each corporation's income pursuant to paragraph 12(1)(j), and will be deductible by each corporation in computing its taxable income pursuant to subsection 112(1), respectively. For greater certainly, the provisions of subsections 112(2.1), 112(2.2), 112(2.3), and 112(2.4) will not apply to deny the application of the subsection 112(1) deduction in respect of such dividends;

(c) the dividends deemed to have been received by Holdco, Jco, Kco, Lco and Mco, respectively, as a result of the purchase for cancellation and redemptions referred to in Ruling B(a) above will be excluded from the proceeds of disposition of such shares by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54;

(d) none of Holdco, Jco, Kco, Lco and Mco will be subject to Part IV.1 tax under section 187.2 or to Part VI.1 tax under section 191.1 in respect of the dividends referred to in Ruling B(a) above.

(e) by virtue of paragraph 186(4)(a), Holdco will be connected with Jco, Kco, Lco and Mco, respectively, and Jco, Kco, Lco and Mco will each be connected with Holdco. Provided that none of Holdco, Jco, Kco, Lco and Mco is entitled to a dividend refund in respect of its taxation year in which it is deemed to pay the dividends referred to in Ruling B(a)(i) or (ii) above, none of Holdco, Jco, Kco, Lco and Mco will be subject to Part IV tax under subsection 186(1) in respect of such dividend.

C. Provided that, as part of the series of transactions or events that includes the proposed transactions described herein, 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)(b)(iii); or

(d) an acquisition of property in the circumstances described in paragraphs 55(3.1)(c) or 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 the rulings given in Ruling B(a) above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption from subsection 55(2) provided by paragraph 55(3)(b).

D. The provisions of subsections 15(1), 69(4) and 246(1) will not apply to the proposed transactions described herein, in and by themselves.

E. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

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, could have an effect on the rulings provided herein.

COMMENTS

1. Nothing in this ruling should be construed as implying that the Canada Customs and Revenue Agency has agreed to or reviewed:

(a) the determination of the fair market value or ACB of any particular asset or the paid-up capital or safe income on hand in respect 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

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