Subsection 55(1) - Definitions
See Also
Daggett v. MNR, 93 DTC 14 (TCC)
A series of transactions pursuant to which the taxpayer used borrowed funds under a daylight loan to subscribe for common shares of a loss company controlled by him, had the company declare and pay a capital dividend to him in the same amount, used the dividend proceeds to repay the daylight loan and then sold the shares for $1 to an acquaintance, would have given rise to an artificial capital loss contrary to s. 55(1), even if such transactions had been legally effective.
Distribution
See Also
Northern Hot Oil Services Ltd. v. The Queen, 97 DTC 12107 (TCC)
A transaction in which the common shares of a corporation held by the taxpayer were purchased for cancellation for consideration consisting of equipment and cash did not qualify under former s. 55(3)(b) given that the cash and equipment could not be regarded as a single type of property for purposes of that provision and given that it was the parties' intention that the taxpayer receive more than its proportionate share of the equipment of the corporation.
Administrative Policy
2015 Ruling 2014-0548491R3 - Split-up XXXXXXXXXX Butterfly
A split up of DC's business among three brothers (A, B and C) and their respective immediate families is accomplished by split-up style butterfly transfers to ACo and Bco of pro rata portions of the three types of DC's property, so that C remains as a shareholder of DC.
2015 Ruling 2013-0490651R3 - Single-wing Split-up Farm Butterfly
DC carries on a farming business. There is a single-wing butterfly transfer of its three types of property to TC, to which Sibling 1 has transferred his shares of DC, so that Siblings 1 and 2 may now indirectly carry on separate farming businesses.
2014 Ruling 2014-0533601R3 - Spin-off butterfly - subsection 55(2)
Current structure
DC, which is a Canadian-controlled private corporation, carries on the production, processing and sale of XX (the "DC Retained Business") through subsidiaries including Subco 1 (which is wholly-owned) and a chain of U.S. subsidiaries (Foreignco 1, Foreignco 2 and Foreignco 3) as its principal business, and also carries on the "Subco 1 Transferred Business 1") and the "Subco 1 Transferred Business" (also both active businesses) through Subco 1. DC's issued share capital consists of Class A common shares and Class B and C common shares which are convertible into Class A common shares, as well as non-voting non-retractable and redeemable Class A and B preferred shares. The DC shareholders (who mostly are CCPCs but also include individuals and trusts) each hold an equal number of common and preferred shares on a stapled basis (i.e., any sale must consist of an equal number of common and preferred shares).
Subco 1 lands
Subco 1 carries on the Subco 1 Transferred Business 1 on the "Subco 1 Land 1" and "Subco 1 Land 2". Currently certain of the land surrounding the existing operations as described above acts as XX for those operations. Of these XX are presently leased to XX. All leasing revenue received has been reported by Subco 1 as active business income, representing income that is earned in connection with the Subco 1 Transferred Business 1. Subco 1 has also leased portions of the Subco 1 Land 1 and a portion of the Subco 1 Land 2 to third parties that operate XX businesses. Subco 1 acquires the XX of these businesses, and uses XX for its business operations. In addition, a business operates a XX business on an incidental portion of the same acreage that Subco 1 uses primarily as the XX. All leasing revenue received by Subco 1 from the XX businesses has been reported by Subco 1 as active business income, such income being earned in connection with the Subco 1 Transferred Business 1.
Proposed transactions
The following transactions will occur under a Plan of Arrangement to accomplish a spin-off of Subco 1 and 2 Transferred Business through Spinco, which was incorporated but has no shareholders:
- Under a s. 86 reorganization, each DC shareholder will exchange all of its DC common shares for "DC Butterfly Shares" and Class D, E or F common shares (with the aggregate paid-up capital of the exchanged shares being apportioned), such that the aggregate fair market value of the DC Butterfly Shares will be equal to the "Butterfly Ratio" (equal to the relative net FMV of Subco 1 Transferred Business 1 and 2) multiplied by the aggregate FMV of all the DC shares held immediately before the exchange – and the FMV of the Class D, E or F common shares received on the exchange will capture the balance of the FMV of the exchanged Class A, B or C common shares. The Class E and F common shares will be convertible into Class D common shares. "The holders of these shares will not be entitled to stock dividends having a different stated capital amount as [was the case for] the A Common Shares, B Common Shares, and C Common Shares…[and] shall be provided consolidated unaudited quarterly financial statements prepared by DC in accordance with international financial reporting standards…[a right which] does not exist for the holders of the A Common Shares, B Common Shares, and C Common Shares" (para. 23.2). Also under the s. 86 reorganization, each DC shareholder's Class A (or B) Preferred Shares will be exchanged for Class G (or H) Common Shares having an aggregate FMV equal to that of the exchanged shares.
- The DC shareholders will transfer each DC Butterfly Share to Spinco in exchange for one Spinco common share (so that the test in s. (b)(iii) of "permitted exchange" in s. 55(1) is satisfied).
- Subco 1 will transfer the "Subco 1 Retained Business" solely in consideration for the "Sale Note." ("The preference of management was not to further complicate the Proposed Transactions by inserting a sequential butterfly transaction' here instead.)
- Subco 1 will distribute an amount to DC as a reduction of the PUC of its shares and declare dividends equal to any remaining portion of the amount received in 3, with payment effected by set-off of the Sale Note.
- Foreignco 1 will pay a cash dividend to DC.
- With a view to the pro rata cash or near cash test to be satisfied in 7 below, DC will contribute the cash so received to Subco 1.
- DC will transfer its Subco 1 shares to Spinco in consideration for "Spinco Redemption Shares," with a joint s. 85(1) election filed. Having regard to the pro rata three types of property tests, the Suhco 1 land will be classified as business property, and no property will be treated as investment property.
- DC will accept a note from Spinco as full payment for redemption of the Spinco Redemption Shares.
- DC will reduce the stated capital of the DC Butterfly Shares to an amount equaling that of the Spinco Redemption Shares before their redemption ("to ensure that each of Spinco's and DC's respective dividend refunds under subsection 129(1) and respective Part IV tax under paragraph 186(1)(a) (all in respect of the dividends arising on the redemption of the DC Butterfly Shares, and the dividends arising on the redemption of the Spinco Redemption Shares) will be approximately equal to each other, such that each of DC and Spinco will not have any net tax liabilities (i.e., as a result of each corporation's Part IV tax liabilities exceeding such corporation's dividend refund)."
- Similarly to 8, DC will redeem the DC Butterfly Shares.
- The notes issued in 8 and 10 will be set off.
Rulings
: Including application of s. 85.1 to 2, s. 86 to 1 and standard butterfly rulings.
2014 Ruling 2014-0530961R3 - Cross-Border Butterfly
Overview
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. In order that the butterfly transactions could qualify as a tax-free spin-off for Code purposes, TC (a ULC) and Foreign Spinco (an LLC) initially were fiscally transparent for Code purposes – then TC elected to be fiscally regarded in order that it could qualify for Treaty benefits and the Foreign Spinco became a C-corp in order that its spin-off could comply with Code rules. There was provision for a second stage transfer of cash by DC to TC if that was required to satisfy the requirements under the butterfly rules for a pro rata distribution of property of DC. As with other cross-border butterflies, there was a three-party share exchange agreement.
Background
Foreign Pubco is a U.S. resident whose common shares trade on an exchange. Prior to the "Spin-Out," being the distribution of Foreign Spinco Shares as a dividend-in-kind to the shareholders of Foreign Pubco, Foreign Pubco was engaged, through its subsidiaries, in the "Retained Services Business" and the "Transferred Services Business." The Retained Services Business in Canada and the Canadian Transferred Services Business were operated directly by Canco and indirectly through its subsidiaries. Canco was a subsidiary of Canada Holding.
Preliminary transactions
- "Foreign Spinco" was established as an LLC by Foreign Pubco.
- The worldwide Transferred Services Business, other than the Canadian Transferred Services Business, was transferred to Foreign Spinco.
Butterfly and Spin-Out transactions
- Canada Holding and Canco amalgamated through a vertical amalgamation to form DC, which elected to be treated as a corporation for Code purposes.
- The common shares of DC were changed by articles of amendment into a shares of a new class of common shares (the "DC New Common Shares") having X votes per share and shares of a new class of non-voting redeemable retractable non-cumulative special shares (the "DC Special Shares"), with the cumulative stated capital of the issued DC New Common Shares and DC Special Shares not exceeding that of the old common shares.
- Under a three-party transfer agreement between Foreign Pubco, Foreign Spinco and TCo (a newly-incorporated Canadian subsidiary of Foreign Spinco which was fiscally transparent for Code purposes): ( a) TCo paid the purchase price for DC Special Shares transferred to it by Foreign Pubco as described in para. (b) below by issuing TCo Common Shares to Foreign Spinco; (b) Foreign Pubco paid the purchase price for the member ship interests issued to it by Foreign Spinco as described in para. (c) below by transferring all of the DC Special Shares to TCo; and (c) Foreign Spinco paid the purchase price for the TCo Common Shares issued to it by TCo as described in para. (a) above by issuing membership interests to Foreign Pubco.
- DC transferred a proportionate share of each type of its property to "Newco," a newly-incorporated subsidiary (with such transferred assets relating to the Canadian Transferred Services Business and including the shares of some of its subsidiaries and portions of the vendor take-back notes ("Notes 1 and 2") received on a previous sale of subsidiaries in consideration for additional Newco common shares and the assumption of liabilities related to the Canadian Transferred Services Business. In determining the net FMV of each type of property of DC and its subsidiaries (anticipated to be cash or near-cash property, including excess cash from the previous sale of subsidiaries, investment property comprising Note 2, and business property), the net FMV of any accounts receivable, trade receivables, inventories and prepaid expenses of such corporation or partnership remaining after the allocation of current liabilities to cash or near-cash property were reclassified as business property "to the extent that such property will be collected, sold, used or consumed in the ordinary course of business to which such property relates." For the purposes of the related s. 85(1) election "the reference in subparagraph 85(1)(e)(i) to the ‘undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition' shall be interpreted to mean that proportion of the undepreciated capital cost to DC of all of the property of that class immediately before the disposition, that the FMV at that time of the particular property that was transferred was of the FMV at that time of all property of that class."
- DC transferred all of the Newco Common Shares to TCo and became legally obligated to transfer to TCo within XX days any cash or near-cash property required in order to result in a proportionate transfer of that type of property.
- TCo and DC redeemed the TCo Preferred Shares and DC Special Shares respectively for promissory notes, which were accepted as full repayment of the redemption prices ("with the risk of the note being dishonored").
- The promissory notes were set-off against each other.
- TCo elected to become a corporation for Code purposes.Newco paid a dividend to TCo comprising cash and the portions of Notes 1 and 2 received by it in 4.
- TCo, in turn, paid a dividend (net of withholding) to Foreign Spinco comprising the cash and Note interests received in 9 plus the right acquired in 5 to the additional cash transfer. Foreign Spinco in turn distributed such property to Foreign Pubco.
- Foreign Spinco converted from an LLC into a C-Corp.
- 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).
- The only parties to an Agreement were Foreign Pubco and Foreign Spinco "and, therefore, Canada Holding or its subsidiaries (or DC following the Amalgamation) did not acquire any rights pursuant to this agreement as a party thereto."
- Foreign Pubco distributed the Foreign Spinco Shares pro rata to its shareholders as a dividend-in-kind (the "Spin-Out"), with such shares being listed. The Foreign Pubco shareholders who are US residents are not taxable respecting the Spin-Out.
- To comply with s. 86.1 respecting the Spin-Out, Foreign Pubco will provide the Minister with the required s. 86.1(2)(e) information and the Canadian resident shareholders of Foreign Pubco will elect in writing (including the s. 86.1(2)(f) information) for s. 86.1 to apply to the Spin-Out.
Additional information and purposes
DC intends to pay a dividend to Foreign Pubco during its XXXX taxation year after the completion of the Subject Transactions. This dividend will be considered to be paid out of previously taxed income, for US tax purposes, that can be distributed to Foreign Pubco without additional US tax. This dividend and the Canadian butterfly transactions (in 1 to 7) are completely unrelated.
TCo was initially a fiscally disregarded entity for Code purposes in order for the transactions in 1 to 7 to qualify as a tax-free spin-off for such purposes - and it converted to a fiscally regarded entity in 8 to qualify US Treaty benefits.
None of the purposes of the dividend in 9 was to reduce the gain inherent in the Newco Common Shares, as TCo has no intention to dispose of the Newco Common Shares.
Without the amalgamation in 1, two butterfly transactions would have been required.
Foreign Spinco was formed as an LLC in order for the transactions described in 1 to 7 to qualify as a tax-free spin-off for Code purposes., and converted to a C-corp prior to the Spin-Out in order for the distribution of Foreign Pubco's Foreign Spinco Shares to its public shareholders in 14 to comply with the Code rules.
Rulings
- S. 55(3)(b) ruling is premised on 10% or more of the FMV of the Foreign Spinco membership interests or shares not, at any time, during the course the series being derived from the DC Special Shares or TCo Common Shares. For these purposes, 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.
- S. 86 will apply to 2.
- Provided that all of the conditions of ss. 86.1(2)(e) and (f) are met, the Spin-Out in 14is an eligible distribution for purposes of s. 86.1.
2014 Ruling 2013-0513211R3 - Butterfly Transaction
Current structure
The Class A common shares of DC1, a CCPC, are owned equally by Holdco1, Holdco2 and Holdco3 and its Class J preferred shares are owned equally by Trust1, Trust2 and Trust3. The Class A common and Class E preferred shares of DC2 are owned equally by Holdco1, Holdco2 and Holdco3.
Proposed transactions
- Holdco1 and Trust1 will form TC1, Holdco2 and Trust2 will form TC2 and Holdco3 and Trust3 will form TC1.
- DC1 and DC2 will amalgamate to form DC Amalco.
- The three shareholder groupings (comprising a Holdco and Trust) will transfer their DC Amalco shares to their TC in consideration for shares of that TC (with appropriately limited stated capital), electing under s. 85(1).
- DC Amalco will transfer to a Subco of each TC a pro rata portion of each of its three types of property (determined on a net basis) in consideration for the assumption of liabilities and the issuance of redeemable preferred shares, election under s. 85(1).
- Each Subco will redeem such preferred shares for a note.
- Each Subco will be wound up into its respective TC parent, with the notes thereby being assumed by the respective TCs.
- DC Amalco will be wound up into the three TCs, so that the respective notes will be assigned to the respective TC which, as such TC also is the debtor, will result in each such note being extinguished.
- DC Amalco will elect under s. 83(2) to treat the portion of the winding-up dividend referred to in s. 88(2)(b)(i) as a separate capital dividend paid on its classes of shares.
- DC Amalco will make a s. 89(14) designation on the portion of the winding-up dividend referred to in s. 88(2)(b)(iii) which is deemed to be a separate dividend.
- Following receipt of a dividend refund arising under the transactions, DC Amalco will dividend such cash to each TC.
- Within a reasonable time thereafter articles of dissolution will be filed by DC Amalco.
Part IV tax circularity/83(2.1)
"[A]t no time will one of the main purposes of the acquisition of the shares of DC Amalco be to receive a capital dividend. ... The purpose of the incorporation of Subco1, Subco2 and Subco3 is to avoid circularity in the calculation of DC Amalco's refundable dividend tax on hand and Part IV tax, that would otherwise occur if the transfer of property described in [4] were made directly to each TC by DC Amalco."
Rulings
Standard butterfly rulings. S. 88(2) rulings re DC Amalco wind-up (steps 7-9).
2014 Ruling 2013-0498651R3 - Single-Wing Split-up Butterfly
underline;">: Background. The sole shareholders of DC, which holds a farm property, are two siblings (Sibling1 and Sibling2) and their respective spouses (Spouse1 and Spouse2). Prior to the series of transactions, Sibling1 and Sibling2 had DC sold most of its farm machinery and commenced to operate on a share crop basis.
There is no connection between the farm machinery and equipment sales and the series. …
DC owns property ("Property1") which was rezoned… . From XX to XX, XX lots of Property1 have been severed and sold. There may be subsequent sales of lots of Property1.
Proposed transactions
Under a single-wing split-up butterfly of DC, a proportionate share (determined on a net basis) of each of its three types of property, including a co-ownership interest in Property1, will be transferred to TC, which will be owned by Sibling1 and Spouse1.
Rulings
: Typical butterfly rulings including that s. 85(1) will apply to the transfers of eligible property held by DC to TC, and that for this purpose
the "undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition" found in subparagraph 85(1)(e)(i) shall be interpreted to mean that proportion of the undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition, that the fair market value at that time of the property that is transferred is of the fair market value at that time of all property of that class.
2014 Ruling 2012-0446701R3 - Butterfly reorganization
Split-up butterfly is "being undertaken to allow each of [cousins] B and C to carry on separate farming operations from one another, and to independently formulate and implement a strategic development plan in respect of the portion of DC's property to be transferred to BCo and CCo."
2014 Ruling 2012-0432441R3 - Butterfly reorganization
Standard split-up butterfly of DC for division of DC between families of Brother 1 and 2.
2013 Ruling 2013-0491651R3 - Cross-Border Butterfly
Overview
The ordinary shares of Foreign PubCo, which was formed under the laws of Country 1, trade on Exchange 1. The worldwide business operations in one of its two main business segments (the Spin-Off Business), which are not already owned directly or indirectly by Foreign SpinCo, will be transferred directly or indirectly to Foreign SpinCo (a great-grandchild subsidiary held by Foreign PubCo "through" ForCo 1 and ForCo 2) and Foreign PubCo will retain the Retained Business segments. DC (a wholly-owned subsidiary of ForCo 2 and thus a "sister" of Foreign SpinCo) owns A Co, which directly carries on the activities that relate to the DC Spin-Off Business and will become the indirect subsidiary of Foreign SpinCo in preparation for the Spin-Out, by virtue of DC effecting a split-up butterfly 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, are to be retained by DC after the Spin-Out.
Preliminary 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.
- Numerous restructuring steps with a view to the spin-off in 9 occurred outside Canada and did not impact any of the Canadian entities or the types of property analysis for DC as no properties were transferred to or from DC group.
Proposed transactions
- The common shares of DC will be changed by articles of amendment into a shares of a new class of common shares (the "DC New Common Shares") having one vote per share and shares of a new class of non-voting redeemable retractable non-cumulative special shares (the "DC Special Shares"), with the cumulative stated capital of the issued DC New Common Shares and DC Special Shares not exceeding that of the old common shares.
- A three-party transfer agreement will be concluded and implemented 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.
- DC will transfer a proportionate share of each type of its property to TC (with certain cash or near-cash property transferred XX days later) in consideration for TC Preferred Shares. In determining the net FMV of each type of property of DC and its subsidiaries (anticipated to be cash or near-cash property and business property), (a) the net FMV of any accounts receivable, trade receivables, inventories and prepaid expenses of such corporation or partnership remaining after the allocation of current liabilities to cash or near-cash property will be reclassified as business property "to the extent that such property will be collected, sold, used or consumed in the ordinary course of business to which such property relates," and (b) any current ("as determined by the method prescribed by the applicable pension legislation") pension plan, post-retirement benefit or liability insurance liabilities of DC will be allocated to cash or near-cash property, and any such liabilities of a non-current nature will be allocated to business property – and similarly for employee incentive plans.
- TC and DC will redeem the TC Preferred Shares and DC Special Shares respectively for promissory notes, which will be accepted as full repayment of the redemption prices.
- The promissory notes will be set-off against each other.
- ForCo 2 will sell all of its issued and outstanding shares in Foreign SpinCo to Foreign PubCo for book value in exchange for an intercompany loan.
- ForCo 2 will declare a dividend to ForCo 1, and ForCo 1 will declare a dividend to Foreign PubCo, which in each case will be settled with an intercompany loan.
- 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 10, 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.
Rulings
- 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.
- No s. 86 ruling.
2013 Ruling 2013-0502921R3 - Split-Up Butterfly - Farm
Structure
The DC is a CCPC owned (as to both DC-Class A (common) and DC-Class D (pref)) by Son1, Son2 and Mother and which formerly had carried on a farming business. The farm (a.k.a., the "Lands") now is rented out to farmers, with the exception of the "Home Quarter," containing three residences which are rented out to Son1, Son2 and Mother (although Son1 still occupies his residence.) DC holds the "Patronage Reserves" as capital property (namely, membership equity of DC in various co-operatives from which DC purchased agricultural-related supplies for maintaining the Lands and carrying on its business and in respect of which DC is entitled to receive an annual patronage dividend, the amount, if any, of which depends on the level of DC's patronage for such year).
Purpose
To split-up DC between TCs (TC1 to 3) for the three shareholders.
Types of property
The investment property of DC comprises portfolio investments in publicly traded securities, the Lands (including the Home Quarter unless sold prior to the Distribution) "on the basis that they are currently being used by DC to generate income from property in the form of rent," and the Patronage Reserves "on the basis that they currently generate income from property for DC in the form of patronage dividends." Inventory and the remaining farm equipment will be classified as business property "on the basis that it is currently being used… to generate business income from its sale." Cash and term deposits are classified as cash or near-cash property.
Reorganization
- DC will pay a dividend (through issuing demand notes) to each of Son1, Son2 and Mother so as to entitle it to a refund of its RDTOH for that year and will designate such dividends as eligible dividends, and will also pay capital dividends to them, with the notes and shareholder loans then being repaid in cash.
- After having incorporated his or her respective TC (TC1 to 3) and subscribed for Class A voting participating shares, each of Son1, Son2 and Mother transfers his or her DC-Class A and DC Class-D shares to such TC in consideration for non-voting retractable Class C shares of TC, electing under s. 85(1).
- DC transfers pro rata portions of its three types of property (including the Home Quarter and farm equipment to the TCs as tenants-in-common if not yet sold) to the TCs in consideration for non-voting Class D redeemable retractable shares, electing under s. 85(1).
- Each TC redeems its Class D shares for demand promissory notes; and DC redeems its DC-Class D and DC-Class A shares for demand promissory notes, designating pro rata portions of its GRIP as eligible dividends under s. 89(14).
- The promissory notes are set-off.
- DC is dissolved.
Circularity comment
. After giving relatively standard butterfly rulings and rulings that the s. 84(3) deemed dividends arising on the redemptions by the TCs and DC in 4 will be subject to Part IV tax to the extent described in s. 186(1)(b), CRA noted that this "could give rise to what is referred to as a "circular" calculation of RDTOH," and stated that "the district taxation office at which each of the corporations files its T2 income tax return will have to be consulted in order to determine which corporation will receive the dividend refund and which corporation will be subject to the Part IV tax liability under paragraph 186(1)(b)."
2014 Ruling 2013-0498951R3 - Split-up Butterfly
A standard split-up butterfly for the pro rata division of the assets (mostly portfolio shares) of DC (a CCPC with no liabilities other than accrued professional fees) between TC1 for Brother and TC2 for Sister, followed by the winding-up of DC.
2013 Ruling 2013-0490341R3 - No-type of property spin-off butterfly
Preliminary
As a preliminary step under a plan of arrangement, the shareholders of Old Pubco (a Canadian public corporation dealing at arm's length with each shareholder) will transfer (in a s. 85.1 exchange) all their Old Pubco common shares to a newly-incorporated Canadian subsidiary of Old Pubco (New Pubco) in consideration for New Pubco common shares, and New Pubco will reduce the stated capital of its shares (in order to satisfy the solvency test for any future dividends).
Spin-off transactions
- The Old Pubco shares of New Pubco will be converted into New Common Shares (having two votes per share) and new Preferred Shares (which will be redeemable and retractable for the "Butterfly Proportion" of the old common shares of Old Pubco, subject to a price adjustment clause).
- New Pubco will transfer to a newly incorporated subsidiary ("Newco") the Old Pubco New Preferred Shares, in exchange for Newco Common Shares, electing under s. 85(1).
- Old Pubco will transfer to Newco the Spin-off Properties (being shares of various non-resident subsidiaries) in consideration for the issuance of the Newco Preferred Shares, electing under s. 85(1). "[T]he FMV of the property of Old Pubco will be determined as though there was only one type of property, as contemplated by subsection 55(3.02), on a net FMV basis."
- Newco will redeem "from Old Pubco" all of the issued and outstanding Newco Preferred Shares, and Old Pubco will redeem "from Newco" all of the outstanding Old Pubco New Preferred Shares, in each case in consideration for issuance of a non-interest-bearing demand promissory note. In each case, the resulting deemed dividend will be designated to be an eligible dividend.
- The two notes will be set off.
- New Pubco will draw down under the "New Pubco Multicurrency Credit Facilities" and use the proceeds to lend at a small spread to Old Pubco (under the "Old Pubco Internal Multicurrency Debt"), and Old Pubco will use such proceeds to pay off the "Old Pubco Multicurrency External Debt." "Simultaneously, Old Pubco will enter into an internal hedging contract ("Hedging Contract 2") with New Forco Holding 2 [included in the Spin-off Properties] to mitigate foreign exchange exposure in respect of the Old Pubco Internal Multicurrency Debt.
Rulings
- Standard butterfly rulings.
- Ruling re interest deductibility on the Old Pubco Internal Multicurrency Debt to the extent the Old Pubco Multicurrency Internal Debt does not exceed the PUC of the Old Pubco New Preferred Shares, determined immediately before the redemption."
2013 Ruling 2013-0475681R3 - Family holding butterfly transaction
Facts
DC is a CCPC holding company whose assets consist of the shares of Aco (controlled by uncles, aunts and cousins), which are investment property as it does not have significant influence over it, and cash or near cash assets. All the Class B shares of DC, which are voting and non-participating, as well as the Class A shares, which are voting and entitled to discretionary dividends, are held by Sibling 1 to 5, except that Sibling5 holds her Class A shares through TC5. The Class B shares were issued prior to December 20, 2002, so that qualify as shares of a specified class notwithstanding their voting rights. "DC may pay dividends on the Class "A" shares of the capital stock owned by the current shareholders before the Proposed Transactions (such dividends not to exceed the income of DC for the current taxation year)."
Proposed transactions
- Each of TC1 through to TC4, which is solely owned by Sibling 1 to 4, respectively, will acquire the Class A Shares of the respective Sibling for treasury common shares utilizing s. 85.
- DC will transfer a proportionate share (based on the relative fair market value of the shares in its capital held by the particular TC): of its common shares and Class B shares of Aco, as well as its "Fund Units" to each of the five TCs in consideration for Class X preferred shares of that TC; of its Series A and B preferred shares of ACo to each TC in consideration for a non-interest-bearing Note1 of the respective TC; and of cash to each TC in consideration for a non-interest-bearing Note2 of the respective TC.
- Each TC will redeem its Class X preferred shares for a Note3.
- DC will pay a capital dividend on its Class A shares by issuing a Note DC-TC to each TC.
- On a winding-up of DC, it will distribute the Notes1 to 3 to the respective TC thereby paying off the DC-TC Notes and with the distributed Notes being extinguished, and with DC designating the resulting s. 88(2)(b) deemed dividend under s. 89(14), and with any dividend refund to DC being distributed on a pro rata basis.
Rulings
Inter alia on ss. 129(1.2), 55(3)(b) and 80.
2013 Ruling 2012-0449611R3 - single-wing butterfly reorganization
Existing situation
DC, which is a CCPC beneficially owning rental real estate encumbered with mortgages (the "Buildings") and which carries on a specifed investment busines, has Holdco A and B as its (common) shareholders, who also hold shareholder advances and deal with each other at arm's length, and with Holdco B being the controlling shareholder of DC. In connection with the settlement of a lawsuit between Holdco A and its shareholders, and Holdco B and its shareholders, it was agreed that Holdco B would make a payment to the plaintiffs and that there would be a transfer of Buildings on a single-wing butterfly basis to Holdco B.
Proposed transactions
- DC will increase the stated capital of its common shares by the applicable multiple of its RDTOH at the end of the taxation year arising from Holdco A's acqusisition of conrol referred to in 3 below, with such increase not exceeding the safe income on hand attributable to the DC common shares of Holdco A and Holdco B at the safe-income determination time. Holdco A and Holdco B will make s. 55(5)(f) designations in respect of the resulting deemed dividend.
- DC will transfer a proportionate share of its two types of property (cash and near cash; and investment property, namely, the Buildings and related assets) on a net asset butterfly basis under s. 85(1) to a newly-incorporated subsidiary of Holdco B (Holdco B Sub) in consideration for the assumption of liabilities and for Holdco B Sub Special Shares (which will carry more than 10% and less than 50% of the votes for all Holdco B Sub shares), with Holdco B Sub thereby being connected with DC; the shareholder loans will be considered current liabilities for this purpose;
- DC will purchase for cancellation all of the DC common shares held by Holdco B in consideration for issuing a Note, which will be accepted as absolute payment; no s. 256(9) election will be made respecting the resulting acquisition of control of DC by Holdco A.
- Holdco B Sub will redeem all of the Holdco B Sub Special Shares held by DC in consideration for issuing a Note, which will be accepted as absolute payment.
- Holdco B Sub will be wound–up – and then dissolved.
- The two Notes will be set-off.
Purposes of transactions
58. The purpose of the PUC increase [in 1]… is to enable DC to receive a dividend refund equal to the amount of DC's RDTOH at the end of the year that will end immediately before the acquisition of control of DC by Holdco A….
60. The purpose for Holdco B incorporating Holdco B Sub…is to avoid circularity in the calculation of DC's RDTOH and Part IV tax, that would otherwise occur if the Distribution Property were transferred directly to Holdco B by DC.
61. The purpose for DC not filing a subsection 256(9) election [see 3]… is to ensure that the dividend refund that DC will obtain, arising on the PUC increase [in 1]… will occur in the taxation year of DC that will end immediately before the acquisition of control of DC by Holdco A….
Rulings
Standard butterfly rulings.
2012 Ruling 2012-0460811R3 - Public Company Spin-Off Butterfly
Under the proposed transactions for a spin-off butterfly of Spinco by DC (a public corporation and principal business corporation as defined in s. 66(15)):
- no dissent rights were exercised
- Spinco, which is a taxable Canadian corporation and whose common shares have been conditionally accepted for listing but which will not issue any shares until the time of transfer to it below of the DC Butterfly Shares, will elect to be a public corporation by filing the T2073 prescribed form
- each DC shareholder will exchange each of its DC common shares for one DC New Common Share (having the same rights as the old common shares except that the DC New Common Shares will give the holders thereof the right to vote, to the exclusion of any other class of shares of DC, for the election of directors at any meeting of shareholders called for that purpose) and one DC Butterfly Share (which will be non-voting and redeemable and retractable for the "Butterfly Proportion" of the fair market value of an old DC common share immediately before such reorganization)
- each DC stock option holder will exchange its options for new DC stock options and Spinco stock options ("The issuance by Spinco of the Spinco Stock Options will be in anticipation of the [butterfly] distribution ... and will form part of the non-share consideration relating to such transfer." – para. 29)
- each DC Butterfly Shares will be transferred to Spinco in consideration for one Spinco common share, with the Spinco common shares being listed on a designated stock exchange
- the net FMV of each of the three types of property of DC will be determined on a consolidated basis (and where the property of DC is a share of a corporation over which DC has a significant influence, the net FMV of the share of the particular corporation will be multiplied by the proportion that the net FMV of that type of property of the particular corporation is of the net FMV of all the property of the particular corporation - and following the allocation of current liabilities to each cash or near cash property, any remaining net FMV of any accounts receivable, inventories and prepaid expenses of a particular corporation will be reclassified as business property and excluded from cash or near cash property, to the extent that such property will be collected, sold or used by the particular corporation in the ordinary course of the business to which such property relates)
- DC will transfer to Spinco each transferred asset such that following the transfer the net FMV of each type of transferred property will approximate the Butterfly Proportion; and in consideration therefor Spinco will issue the Spinco Stock Options and Spinco Redemption Shares; DC and Spinco will make a joint s. 85(1) election
- Spinco and DC will redeem the Spinco Redemption Shares and DC Butterfly Shares for redemption notes (making a s. 89(14) designation respecting the resulting deemed dividend), and will each satisfy its note by transferring the other note to its debtor
Rulings:
- s. 86 rulings re exchange of DC common shares for new common shares and DC Butterfly Shares
- s. 85.1(1) rulings re transfer of DC Butterfly Shares to Spinco
- cross-cancellation of notes will not give rise to gain or forgiven amounts
2012 Ruling 2011-0425441R3 - Cross Border Butterfly
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 accomplished 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 (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.
Indemnity – effect on net value of types of property
In order to accomplish the butterfly spin-off of Canco's portion of Business B, Canco will first transfer such assets to Newsub under s. 85(1). The letter states (para. 61):
For purposes of applying the types of property classification in regards to Canco and Newsub, any liability that is assumed by Newsub, but in respect of which Canco provides an indemnity to Newsub, will, to the extent of that indemnity, be treated as a liability of Canco and not of Newsub, and any liability that is retained by Canco, but in respect of which Newsub provides an indemnity to Canco, will, to the extent of that indemnity, be treated as a liability of Newsub and not of Canco.
Cash adjusting payment
XXX days after the transfer of Newsub to TSub, Canco will transfer any additional cash or near cash assets to TCo as is required to satisfy the requirement for the butterfly percentage for the transferred net business, and cash and near cash, assets being approximately the same (there being no investment assets) (para. 84.1).
2012 Ruling 2011-0416001R3 - Split-up butterfly
Structure
The DC is a CCPC whose only significant assets is shares (being investment property) of Pubco (a Canadian public company over which it does not have significant influence - whose standard definition referred to s. 3051.04 of the Private Enterprises standards, or IAS 28 for IFRS). Dividends on its Pubco shares are subject to Part IV tax. The TCs are numerous CCPCs controlled by 3rd or 4th generation family members. DC is not connected under s. 186(4) with each TC, which holds less than 10% of the voting shares of DC and deals at arm's length with most of the other TCs.
Reorganization
DC transfers pro rata portions of its Pubco shares and incidental assets to the TCs for preferred shares having nominal stated capital, which are redeemed for promissory notes. DC reduces the stated capital of its shares to a nominal amount, and then assigns the promissory notes to the TCs in the course of its winding-up. DC also distributes the dividend refund, generated on the s. 84(2) dividends deemed to arise on its winding-up, pro rata to the TCs.
Before going on to give relatively standard butterfly rulings and rulings that both the s. 84(3) deemed dividends arising on the redemption of the TC preferred shares and the s. 84(2) dividends arising on the winding-up of DC will be subject to Part IV tax and generate a dividend refund, the letter states (para. 70) that the purpose for the nominal stated capital of the DC shares and TC preferred shares is:
to ensure that each of the TCs and DC's respective dividend refund under subsection 129(1) and respective Part IV tax liabilities under paragraph 186(1)(a) (all in respect of the winding-up dividend arising on the wind-up of DC...and the dividends arising on the redemptions of the TC Preferred Shares of the TCs...), will approximately be equal to each other.
2012 Ruling 2012-0439381R3 - Cross-border spin-off butterfly
Preliminary transactions
. The transactions entail the spin-off by Foreign Pubco of Foreign Spinco Parent including a Canadian business which will have been butterflied (as described below) from DC to TC, a Canadian subsidiary of Foreign Spinco Parent. Accordingly, preliminary transactions are effected to indirectly transfer the "Spin-off Business" to Foreign Spinco Parent. First, the shares of DC will be distributed by its immediate non-resident parent (DC Parent), through a dividend in kind to the shareholder of DC Parent, and thereafter is distributed though dividends-in-kind by further intermmediate corporations, to Foreign Pubco. Furthermore, a "demerger transaction" (perhaps the UK equivalent of a spin-off transaction) is effected pursuant to which DC Parent transfers its portion of the Spin-off business to a subsidiary of its parent (Forco8), and similar demerger transactions are carried out to indirectly transfer the assets of the Spin-off business upstream through a succession of levels of Foreign Spincos and Forcos, followed by further distributions through a succession of dividends in kind of such assets to Foreign Spinco Parent.
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). A s. 20(24) election may be made. The undepreciated capital cost of depreciable property will be pro-rated.
Three types of property
Immediately before the drop-down transaction referred to above the property of DC will be classified as three types of poroperty under a net asset butterfly approach. Following the allocation of current liabilities to cash or near-cash property in accordance with the usual methodology, provided that the net FMV of the cash or near-cash property of such corporation is positive, any remaining net FMV of any accounts receivable, trade receivables, inventories and prepaid expenses of such corporation will be reclassified as business property of such corporation and excluded from the net FMV of the cash or near-cash property, to the extent that such property will be collected, sold, used or consumed in the ordinary course of business to which such property relates (para. 73(b)). The net fair market value of each type of property transferred to Newco will be such as to satisfy the proportionality test in the distribution definition.
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)
2012 Ruling 2011-0431101R3 - Cross-border spin-off butterfly
Background
Foreign Pubco has announced that it will divide itself into three separate publicly traded companies by making a distribution by way of dividend of shares of Foreign Spinco 1 and Foreign Spinco 2 to its shareholders (the "Spin-out"). Foreign Spinco 1 will indirectly hold the Foreign Spin Business (para. 28). Various transactions (para. 102 to 121) to separate the Foreign Spin Business from the Foreign Keep Business, and arrange for the Foreign Spin Business to be held by Foreign Spinco 1, will occur before the Canadian butterfly transactions described below occur (entailing the separation of the DC Spin Business from the DC Keep Business) with (somewhat counter-intuitively) DC being included in what will be spun out as part of Foreign Spinco 1, and TC being retained as an indirect subsidiary of Foreign Pubco.
DC and s. 86 reorganization
The only issued and outstanding shares of DC, a private corporation and a taxable Canadian corporation (and, per para. 149, a deemed specified financial institution), are common shares which currently are owned by Foreign Sub 2, but after the preliminary transactions referred to above, they will be owned by Foreign Sub 1 (para. 118). DC holds foreign subsidiaries (the A Co and E Co and subsidiaries thereof). 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 (which will not be taxable Canadian property):
(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.
Immediately before the butterfly "distribution" by DC described below, the common shares of Foreign Spinco 1 (viewed as the "acquiror") owned by Foreign Sub 1 (viewed as the "participant") will have a fair market value that accords with the formula in (b)(iii) of the "permitted exchange" definition (para. 130). Immediately before that "distribution", the common shares of Foreign Spinco 1 (viewed as the "acquiror") owned by Foreign Sub 1 (viewed as the "participant") also will have a fair market value that accords with the formula in (b)(iii) of the "permitted exchange" definition (para. 131).
Consolidated look-through/leased property as business asset
In applying the consolidated look-through approach to the property of DC (under a net asset butterfly approach), it will not be considered to have any property other than business property (para. 133, 136). In this connection, a leasehold interest which DC is subleasing to a third party will be considered to be a business property (para. 132(h)). DC had recently acquired this property as a result of acquiring another Canadian corporation (Canco 11), winding-up Canco 11, transferring the personnel at the facility to other leased premises of DC, and then subleasing to the third party for the duration of the lease:
The entering into of the sublease was motivated entirely by DC's desire to reduce to the extent possible, the cost of the lease obligation assumed on the liquidation of Canco 11. Controlling lease costs is a normal business transaction for DC as that entity has approximately XX leases for various premises across Canada and routinely reviews its leased space and costs (para. 73).
Following the allocation of current liabilities to cash or near-cash property of a corporation in accordance with the usual methodology, provided that the net FMV of the cash or near-cash property of such corporation is positive, any remaining net FMV of any accounts receivable, trade receivables, inventories and prepaid expenses of such corporation will be reclassified as business property of such corporation and excluded from the net FMV of the cash or near-cash property, to the extent that such property will be collected, sold, used or consumed in the ordinary course of business to which such property relates.
Amounts capitalized under SAB 101 (an SEC Bulletin on revenue recognition) will not be treated as property (para. 132(j)). In particular, "any amounts collected from customers and set up as deferred revenue under SAB 101 will not be considered a liability as there is no legal obligation to repay the amount or provide further services" (para. 134(c)(viii)).
Butterfly distribution
. DC transfers assets to TC including A Co and E Co (the Foreign Subsidiaries of CFAs) in consideration for the assumption of liabilities and the issuance by TC of preferred shares, so that the proportion of the net business assets received by TC approximates the ratio of the FMV of the DC Special Shares to the FMV of all the issued and outstanding DC shares. An s. 85(1) election is made (but with the reference in s. 85(1)(e)(i) to undepreciated capital cost of depreciable property of DC being interpreted as referring to its proportionate UCC (para. 139)). Payments made by DC to TC respecting the assumption by TC of deferred revenue obligations will be considered part of the property transfer for these purposes. A related s. 13(24) election will be made.
Cross-redemption
TC will redeem its preferred shares, and DC will redeem the DC Special Shares, in each case for a demand promissory note. Immediately thereafter, the principal amounts owing thereunder will be set-off against each other.
Refinancing
Amounts owing by DC to related parties that were not assumed will be repaid or refinanced. The debt assumed by TC may also be repaid or refinanced.
Spin-off by Foreign Pubco
Foreign Sub 1 will contribute its shares of Foreign Sub 3 to Foreign Spinco 1, and 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 (as well as all its shares of Foreign Spinco 2, which holds assets that were not involved in the butterfly reorganization) to its shareholders as a dividend-in-kind.
Rulings/Opinions
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 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)
Interest on DC's retained debt will be deductible (subject to the more usual qualifications) to the extent that its aggregate amount does not exceed the contributed capital and accuulated profits of the DC Special Shares which were redeemed. (Ruling K)
DC and TC will be a predecessor corporation and acquiring corporation for purposes of Reg. 5905(5) in respect of the CFAs acquired by TC. (Ruling L)
The Finance Comfort Letter recommends changes to the draft s. 212.3 rule to avoid a deemed dividend to DC on its transfer of the CFAs to TC.
2012 Ruling 2011-0413661R3 -
The distributing corporation ("DC") is controlled by a financial institution ("Owner 1" - perhaps a credit union) and its only assets are a partnership interest in a limited partnership ("LP") together with a portion of the common shares of the general partner thereof. The balance of the interests in LP are held by another credit union. LP apparently has an asset management business.
The assets of DC (i.e., essentially, LP) are divided among its shareholders (all of them non-public corporations, including Owner 1) utilizing conventional split-up butterfly mechanics, so that on completion, DC has been wound-up into the transferee corporation (a "TC") of Owner 1 and all the TCs (including the TC of Owner 1) have been wound up.
The ruling states that DC is not expected to have any business property. A preliminary transaction is for the current liabilities of DC to be paid off through the application of regular partnership distributions received from LP.
2011 Roundtable Q. , 2011-0399401C6 F
where 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, the cash surrender value of each property would be treated as a cash or near cash asset. The excess of the fair market value over the cash surrender value potentially may be treated as an investment asset (see 2010-0358061R3), although CRA may be prepared to be flexible respecting the classification of such excess. 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.
15 December 2009 Ruling 2008-0304371R3
in a single-wing butterfly of a company whose assets consisted of cash and cash equivalents, tenant receivables and a revenue producing rental property, the revenue-producing properties and prepaid rent were considered business property and loans receivable from certain Holdcos, which had no specified terms of repayment, were considered to be near cash assets.
After the allocation of current liabilities to cash and near cash assets, "the remaining net fair market value, if any, of any amounts receivable and prepaid expenses of Opco (other than the Prepaid Rent) will be reclassified as business property and excluded from cash or near-cash property, to the extent that such property will be collected or used in the ordinary course of the business to which such property relates" (para 66(b)).
Furthermore, "following such allocation of liabilities...it is not expected that Opco will have any cash or near cash property...."
2008 Ruling 2007-024122
preliminarily to butterfly transactions involving a CCPC (DC) whose individual shareholders are implementing a settlement agreement in respect of an oppression remedy brought by some of the individual shareholders (H to M, who act as a group): Mr. A (a major shareholder of DC), Mrs A and Mr G are paid retiring allowances; and various of the individual shareholders who are not specified shareholders elect to cash out substantially all their interest in DC by electing to receive a substantial cash dividend (including a capital dividend) on their shares (representing most of the value of those shares) with those shares then being converted into Class B Freeze shares having a nominal value.
In the first gross asset butterfly transaction, DC transfers a portion of each of its three types of property: to a subsidiary (Subco A) of a TC for Mr A (Transferee A), with Subco A then being wound up into Transferee A; and to a TC for G to M (Transferee Z). DC then is dissolved. In the second gross asset butterfly, Transferee Z (now referred to as DC2) transfers a portion of each of its three types of property to TCs for each of its individual shareholders (or a TC (Transferee N) with nominal value for the shareholders of DC who elected to be cashed out).
The liabilities assumed on the butterfly transfers to and by Transferee Z include contingent environmental liabilities (para. 37, 80).
2008 Ruling 2007-025168 -
there are two proposed successive butterfly reorganizations in which DC, which is a CCPC whose assets include development real estate, mortgage receivables and portfolio investments and which is owned by a testamentary trust, a subsidiary ("Newco 1") of the estate and a Mr. B, transfers a portion of its assets on a butterfly reorganization to a corporation ("Transferee A") owned by the same shareholders, and Transferee A then transfers a portion of its assets on a butterfly reorganization to a corporation ("Transferee C") owned by Mr. B.
On both butterfly distributions, the amount of the cash to be transferred to Transferee A or C will be determined within X days of the transfer of the other property to such transferee corporation and an adjustment will be made as required to the amount of cash transferred (para. 41, 53).
At or around the time of the above transactions, and following the exchange by the trust of its exisiting shares of DC for two new classes of shares, one of which will be retained by it and the other transferred by it on a share-for-share exchange to Transferee A, DC will pay in cash a capital dividend on the shares retained or to be retained by the trust.
2007 Ruling 2006-021575
In a net equity butterfly, after the current liabilities are allocated to cash and near-cash property, "any remaining net FMV of any accounts receivable , trade receivables, inventories and prepaid expenses of Canco will be reclassified as business property and excluded from the cash or near-cash property, to the extent that such property will be collected, sold or used in the ordinary course of the business to which such property relates." (para 35(b)(ii))
Business property did not include (and investment property included) assets any income from which would be income from a specified investment business. (para. 33)
2006 Ruling 2006-019750
Vacant land of a distributing corporation used as a parking lot for a facility owned by a subsidiary, and vacant land owned by the distributing corporation for the purpose of constructing a facility, will be considered to be capital property and business property.
2006 Ruling 2006-018106
The cash and near cash property of DC Amalco includes funds in an escrow bank account which, pursuant to the relevant loan agreement, DC Amalco is under an unconditional commitment to expend on property taxes; and its business property includes funds in escrow bank accounts which, pursuant to the relevant loan agreement, DC Amalco is under an unconditional commitment to expend on future acquisitions of furniture, fixtures and equipment (paras. 3 and 22).
2004 Ruling 2003-004375 -
Where TC receives a butterfly property from DC on spin-off butterfly, the sale by TC of some of the butterflied property back to DC after the spin-off butterfly (where such sale will not exceed the limitation in s. 55(3.1)(c)), will not affect the pro rata distribution rule.
2002 Ruling 2002-014073 -
sequential butterfly. In each butterfly, "to the extent a portion of the cash or near cash property of the [DC] Group is committed by the [DC] Group in order to fund the acquisition of a business property (that is to be acquired regardless of the Proposed Transactions), such cash or near cash property will be classified as business property." (para.52(g) and 73(f)) "[T]he net FMV of all accounts receivable, inventory and prepaid expenses of [DC]'s that are initially classified ...as cash or near cash property that will relate to a business that will be carried on by the [TC Groups] and that will be collected or consumed in the ordinary course of such business, will then be reclassified as business property...." (para. 53(a)(ii) and (b)(ii)), 62(a)(ii) and (b)(ii))
2000 Ruling 2000-004066 -
No look-through approach was applied to holdings in public corporation where each holding was less than 20% and neither the taxpayer nor persons related to it were on the board or participated in the decision-making processes of the investees.
1999 Ruling 3-990262
Where the distributing corporation or a look-through corporation has limited partnership interests, the consolidated look-through approach will be used only in cases where such holder on a consolidated basis can exercise significant influence over the affairs of the partnership. (para. 43(a)).
Since space that was subleased was generally either previously occupied or potentially needed for future expansion, the entire leasehold interest will be classified as business property (para. 43(n)(ii)).
Certain "look-through" entities ... have in the past acquired land for future expansion of the business operations. In some circumstances, the expansion plans have been abandoned and such vacant lands are currently held for resale pending of the locating of an acceptable purchaser. Since in all the circumstances, the vacant land was initially acquired for future expansion and either continues to be held for such expansion or for resale, these interests in vacant lands will be classified as "business property" (para. (n)(v)).
1998 Ruling 3-980180
In determining the net fair market value of property of the distributing corporation, liabilities should be valued at their principal amount rather than their fair market value (per summary).
Where the terms of debt require payments to a sinking fund, the liability arising from that debt should be allocated first to the sinking fund assets (per summary).
An amount of cash or near cash assets equal to the amount of unconditional purchase commintments to fund the acquisition cost of business property which will be acquired in the ordinary course of business regardless of whether the butterfly distribution will occur, is classified as business property (para. III.27). Conversely, where there are unconditional commitments to sell business property in the ordinary course of business, an amount equal to the sales proceeds to be received will be classified as cash or near cash property (para. III.28).
Intellectual property which has been primarily developed or acquired for application and use in the business activities of the group is classified as business property notwithstanding that there is incidental licensing of the property (para. III.30).
Real property interests consisting of redundant space within structures which are used, or held for use, in the business activities wthin the group, and real property interests whcih consist of residential properties acquired from relocated employees, are classified as business property (para. III.31).
Where a subsidiary has a net FMV of cash or near cash property of -$200, and a net FMV of business property of $1,200 and a net FMV of investment property of nil, and if the FMV of the shares and debt of the corporation are $900, then the amount added to the consolidated net FMV of the distributing corporation cash or near cash property and net business property will be -$180 and $1,080, respectively (para. III.23.(3)).
1998 Ruling 3-980097
sales proceeds, in the form of cash and a non-convertible note receivable, which DC received on the sale of its interests in [unspecified assets] were treated as business assets because DC directly or indirectly entered into unconditional commitments to use the proceeds to acquire business assets including corporations over which it would exercise significant influence.
1996 Ruling 3-963259
Vacant land held for development, which was capital property, was categorized as investment property. Any tax accounts, such as the balance of any RDTOH account or capital dividend account would not be considered to be property.
Permitted Exchange
Administrative Policy
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.
The ruling letter states that, immediately before the butterfly "distribution" by DC described below, the common shares of Foreign Spinco 1 (viewed as the "acquiror") owned by Foreign Sub 1 (viewed as the "participant") will have a fair market value that accords with the formula in (b)(iii) of the "permitted exchange" definition (para. 130). Immediately before that "distribution", the common shares of Foreign Spinco 1 (viewed as the "acquiror") owned by Foreign Sub 1 (viewed as the "participant") also will have a fair market value that accords with the formula in (b)(iii) of the "permitted exchange" definition (para. 131).
Safe Income Determination Time
See Also
Les Placements E&R Simard Inc. v. The Queen, 97 DTC 1328 (TCC)
On September 10, 1988, the taxpayer transferred its assets to a subsidiary ("Alimentation 1988") in consideration for a demand promissory note and 506,125 Class B shares having a redemption value of $1 per share and nominal paid-up capital. 151,125 of the Class B shares were redeemed in the fiscal years of Alimentation 1988 ending on May 31, 1990, 1991 and 1992.
In finding that the redemptions did not occur as part of the same series of transactions that included the 1988 sale, Tardiff TCJ. noted that they did not occur close in time to the first transaction, the transactions were not interdependent in the sense that there was a real possibility that Alimentation 1988 might never have redeemed the shares, and the fundamental objective underlying the 1988 transaction was for one of the two principals of the taxpayer to retire from the business of the taxpayer. The financial objective of converting, at some time, the Class B shares into cash was secondary. Accordingly, when the shares were redeemed, the relevant time for determining the safe income of Alimentation 1988 under former s. 55(2) was subsequent to September 10, 1988.
Subsection 55(2) - Deemed proceeds or capital gain
Cases
Ottawa Air Cargo Centre Ltd. v. The Queen, 2007 DTC 661, 2007 TCC 193, aff'd 2008 DTC 6177, 2008 FCA 54
Lamarre J. rejected the taxpayer's submission that deemed dividends received by the taxpayer were "subject to" Part IV tax in the sense that the taxpayer could have remitted Part IV tax on those taxable dividends and thus would have been entitled to a refund of Part IV tax. The taxpayer, in fact, did not do this and instead applied non-capital losses against an assessment of Part IV tax when it was made by the Minister on the basis that s. 55(2) did not apply to the deemed dividends. Lamarre J. found (at para. 21) that "the requirement of an actual refund of Part IV is mandatory for the dividend to be re-characterized as a capital gain under subsection 55(2)".
The Queen v. VIH Logging Ltd., 2005 DTC 5095, 2005 FCA 36
Cash dividends paid by a corporation ("Old VIH") to its parent (the taxpayer) in February 1993 came out of safe income of Old VIH given that the computation of Old VIH's safe income included significant income that it had earned after its last fiscal year end (March 31, 1992) and before the date of payment of the dividends. Sharlow J.A. stated (at p. 5101) that
"It does no violence to the language of subsection 55(2) to interpret the phrase 'before the commencement of the series of transactions' to mean 'immediately before the commencement of the series of transactions', rather than 'as of the end of the fiscal year ending before the commencement of the series of transactions', as the Crown contends."
In addition, it was open to the trial judge to find that a stock dividend paid shortly after the payment of the cash dividends, and which reduced the capital gain on a subsequent sale of the shares Old VIH by approximately $45,000, did not result in a significant reduction of the capital gain realized on such sale in the context of transactions which involve dividends totaling over $1.7 million.
Canutilities Holdings Ltd. v. The Queen, 2004 DTC 6475, 2004 FCA 234
The two taxpayers, which were subject corporations, indirectly sold their investment in another public corporation ("ATCOR"). This was accomplished by their common shares of ATCOR being exchanged on the amalgamation of ATCOR with a newly incorporated subsidiary of a related corporation for Class A or B non-voting redeemable shares of the amalgamated corporation having a paid-up capital approximating the respective adjusted cost base of their ATCOR common shares, with the special shares then being redeemed. The Part IV tax payable on the deemed dividends arising on this redemption was refunded because of normal-course dividends paid by the taxpayers to their shareholders that year (and, in one case, the following year).
In finding that the subsequent normal course dividends were part of the same common law series of transactions as the amalgamation/redemption transactions, Rothstein, J.A. stated (at para. 67):
"the fact that CU COH intended to use both the ATCOR/Forest transactions and the normal course dividends to achieve their tax avoidance objective, that they had the ability to ensure that all the transactions would occur, and that all the transactions did indeed occur as intended are sufficient to constitute them all part of a common law series for the purposes of subsection 55(2). It is of no consequence that one or more of the transactions had an independent purpose and existence."
Lamont Management Ltd. v. The Queen, 2000 DTC 6256, Docket: A-583-99 (FCA)
Safe income attributable to shares of a Canadian corporation ("Canpac") that were purchased for cancellation in the hands of the taxpayer included safe income of a foreign corporation in which Canpac had an indirect equity interest of less than 10% and which did not qualify as a foreign affiliate of Canpac. There was no absurdity in safe income attributable to a foreign non-affiliate being calculated without reference to the specific rules applicable to other types of corporations under s. 55(5).
The Queen v. Brelco Drilling Ltd., 99 DTC 5253, Docket: A-228-98 (FCA)
The U.S. subsidiary of the taxpayer, in turn, owned seven U.S. resident corporations five of whom had exempt deficits and two of whom had exempt surpluses. The trial judge found that the taxpayer was required to deduct the exempt deficits in computing its safe income for purposes of subsection 55(2). Before remitting the matter back to the Tax Court to hear evidence as to whether any factors reduced the safe income on hand, Linden J.A. stated (at p. 5260):
"The literature ... unanimously accepts that section 55(2) requires a calculation of safe income on hand, not exempt income generally ... . It is by definition a net calculation which begins with the deemed income in the section 55(5), but which does not end there." [See also Brelco Drilling Ltd. v. The Queen, 2000 DTC 1482 (TCC).]
The Queen v. Nassau Walnut Investments Inc., 97 DTC 5051 (FCA)
Although it had been planned that the portion of deemed dividends received by the taxpayer (arising on the redemption of shares held by it) that did not come out of safe income would be subject to a designation under s. 55(5)(f), all of such amounts were reported by the taxpayer in its return as deemed dividends due to an error by a subsequently-appointed accounting firm. Before going on to find that a late designation under s. 55(5)(f) was available to the taxpayer (or, what might amount to the same thing, that there was a right of the taxpayer to amend its return to reflect the safe income on hand - and noting, at p. 5057, that "the Act itself implicitly recognizes that a designation and an election are not one and the same"), Robertson J.A. found that the assumption of the Minister that the safe income earned by the redeeming corporation should be allocated pro rata amongst all the shares in its capital (with the result that only a pro rata portion of the safe income was applicable to the shares that were redeemed in the hands of the taxpayer) was reasonable.
The Queen v. Placer Dome Inc., 96 DTC 6562 (FCA)
After the taxpayer solicited competing bids for the sale of a significant block of shares it held in another public company ("Falconbridge") both directly and through a holding company ("McIntyre"), it accepted an offer of Falconbridge that required Falconbridge to declare and pay a significant dividend on all the outstanding shares of Falconbridge, and (following the payment of a corresponding dividend by McIntyre) to purchase the shares of Falconbridge and McIntyre held by the taxpayer. The only purpose of the dividends was to permit Falconbridge to make an offer that effectively approximated 118% of the previous market price of the Falconbridge shares (and that exceeded the 115% of the market price which the other bidder could have paid without triggering the statutory requirement for a follow-up offer to the other Falconbridge shareholders). Accordingly, given that the purpose of the transactions was to be determined having regard to the actual state of mind of the taxpayer, rather than its purpose in some objective sense, s. 55(2) did not apply.
In the Tax Court, Bell TCJ. stated (96 DTC 1787 at 1794) that the taxpayer "had not participated in the creation and structure of the Falconbridge bid" and that "that finding alone renders it impossible to conclude that one of the purposes of the Appellant was to effect a significant reduction of the capital gain to be realized".
CPL Holdings Ltd. v. The Queen, 95 DTC 5253 (FCTD)
The two individual shareholders of a corporation operating a machine shop ("Clem Industrial") transferred all their shares of Clem Industrial to the taxpayer (which was a newly-incorporated holding company) in consideration for high-low shares of the taxpayer. They then caused Clem Industrial to pay a large dividend (virtually equal to the fair market value of its outstanding shares) to the taxpayer, which then lent the proceeds back to Clem Industrial in consideration for a demand debenture.
The taxpayer was able to establish that the purpose of these transactions was to make the taxpayer (and therefore, indirectly, its individual shareholders) secured creditors of Clem Industrial which, at the time, was named in a law suit. Accordingly, s. 55(2) did not apply notwithstanding that after the completion of the transactions, 49% of the shares of Clem Industrial were sold by the taxpayer for a nominal amount to an arm's length individual (the foreman of the machine shop).
See Also
D & D Livestock Ltd. v. The Queen, 2013 DTC 1251 [at 1412], 2013 TCC 318
After a preliminary reorganization, all of the shares of the taxpayer (consisting of Class A common shares and Class D preference shares) were owned by another Canadian corporation ("HLL"), whose safe income on hand ("SIOH") respecting the taxpayer was $1.493M, comprised of safe income earned by the taxpayer of $0.976M and safe income of $0.517M in respect of the taxpayer's 50% shareholding of another Canadian corporation ("RTI"). Then:
- The taxpayer paid a stock dividend ("Stock Dividend 1") in the amount of $1.465M to HLL by issuing Class A shares to HLL with a stated capital of that amount in satisfaction of the dividend (thereby increasing the adjusted cost base ("ACB") of HLL's Class A shares of the taxpayer to $2.72M.)
- HLL transferred all its (Class A and D) shares of the taxpayer on a s. 85(1) rollover basis to a newly-incorporated subsidiary (Newco) in consideration for Class A common and Class D preference shares of Newco (so that under s. 85(1)(g) essentially all the ACB of the transferred shares, including the stepped-up ACB of the transferred Class A shares, was allocated to the cost to HLL of the Class D preference shares of Newco, which was $3.47M).
- HLL transferred it Newco Class D preference shares on a s. 85(1) rollover basis to a newly-incorporated subsidiary (Newco 2) in consideration for Class A common shares of Newco 2 ( having a deemed cost under s. 85(1)(h) of $3.47M.)
- Newco 2 satisfied a dividend of $3.47M to HLL by transferring its Class D preference shares of Newco to HLL.
- The taxpayer transferred its shares of RTI on a s. 85(1) rollover basis to a newly-incorporated subsidiary (Newco 3) in consideration for Class A common shares of Newco 3 (having a cost under s. 85(1)(h) of $0.50M.)
- Newco 3 paid a stock dividend ("Stock Dividend 2") in the amount of $0.52M to the taxpayer by issuing Class A shares to the taxpayer (and made s. 55(5)(f) designations for such dividend to be deemed to be 10 separate taxable dividends), thereby increasing the ACB of the taxpayer's Class A shares of Newco 3 to $1.02M.)
- Newco and the taxpayer were wound up.
- HLL transferred its Class A common shares of Newco 3 on a s. 85(1) rollover basis to Newco 2 in consideration for Class A common shares of Newco 2, thereby resulting in the ACB of HLL's Class A shares of Newco 2 being increased from $3.47M (see 3 above) to $4.49M under s. 85(1)(h) (see 6 above).
- Newco 3 was wound up.
- HLL transferred its Class A common shares of Newco 2 to a subsidiary (HLAL) on a s. 85(1) rollover basis in consideration for Class A common shares of HLAL.
- Newco 2's only asset was its 50% shareholding in RTI. HLAL sold its shares of Newco 2 to the other 50% shareholder of RTI for $7.05M, with a capital gain of $2.,566M being reported based on the $4.49M ACB in 8 above (i.e., such capital gain was reduced by the amount of both Stock Dividend 1 and 2).
The parties agreed that Stock Dividend 1 (see 1) reduced the SIOH of HLL in its shares of the taxpayer by $1.465M. At issue was whether Stock Dividend 1 also reduced the SIOH of the taxpayer on its shares of RTI, thereby reducing its SIOH in respect of the Newco 3 shares which were substituted therefor (see 5). CRA considered that such reduction occurred, so that virtually none of Stock Dividend 2 came out of SIOH of the taxpayer respecting its shares of Newco 3 (see 6). The capital gain reported by a successor of the taxpayer on a sale (see 11) of shares of a successor of Newco 3 (namely, shares of Newco 2) was reduced by the bump in the adjusted cost base of the shares of Newco 3 for the amount of Stock Dividend 2, as this bump carried over to the adjusted cost base of such shares of Newco 2– see 8). (The adjusted cost base of such shares of Newco 2 already effectively reflected the basis bump from Stock Dividend 1 as a result of the above series of transactions - see 2 and 3.) Accordingly, CRA had assessed the taxpayer on the basis that s. 55(2) applied to Stock Dividend 2.
In rejecting CRA's position, Graham J stated (at para. 31):
The shares in RTI had value because of the income earned by that company after 1971. That income had not been removed from RTI by way of dividend. The fact that a stock dividend (i.e. Stock Dividend 1) was declared by the [taxpayer] did nothing to change the fact that the shares in RTI obtained their value from the income earned by RTI after 1971.
729658 Alberta Ltd. v. The Queen, 2004 DTC 2909, 2004 TCC 474
Each of the two individual taxpayers, who owned one-half of the shares of a Canadian-controlled private corporation ("Comcare") having an accrued gain of approximately $12.4 million and safe income of approximately $1.9 million, transferred his shares of Comcare to his own newly-incorporated holding company ("Holdco") in consideration for a promissory note and common shares of Holdco, thereby realizing a deemed dividend of approximately $10.4 million. Comcare then paid taxable dividends of $1.9 million to the two Holdcos, and the two Holdcos each sold its shares of Comcare to a third-party purchaser for approximately $10.4 million.
Woods J. accepted the taxpayers position that all of the dividends paid by Comcare to the Holdcos should be considered to come out of safe income and rejected the position of the Minister that only one-sixth of the $1.9 million safe income had been inherited by the Holdco. Woods J. noted (at p. 2913) that "the accepted approach is that gain is first allocated to 'income earned or realized' and, only if dividends exceed this amount, is gain allocated to 'unrealized appreciation in the value of underlying assets'; and in these transactions no tax had been avoided as the individuals had received a deemed dividend equal to the accrued gain on the Comcare shares that was not represented by safe income.
Kruco Inc. v. The Queen, 2001 DTC 668, Docket: 98-3100-IT-G (TCC), aff'd 2003 FCA 284
The safe income of a corporation ("Kruger") from which the taxpayer received a deemed dividend did not exclude income resulting from investment tax credits (which produced income inclusions under s. 12 (1)(t) or reduced capital cost allowance claims by virtue of ss.13(7.1)(e) and 13(21)(f)(vii)). With respect to the position of the Minister that amounts that do not constitute actual income earned ("phantom income") should not be considered as safe income, Dussault T.C.J. indicated that this position failed to reflect that income for tax purposes is not a logical and coherent concept that reflects reality and that the wording of s. 55(2) (and, in particular, s. 55(5)(c)) "does not permit any such orientation in the name of a perhaps desirable but non-existent realism" (p. 685). Furthermore, the approach of the Minister would result in double taxation (as a capital gain in the hands of the taxpayer) of amounts that had already been taxed to the corporation.
However, the safe income of the corporation was reduced by the excess of the $4 million purchase price for an SRTC debenture over the amount of the debenture. Dussault T.C.J. noted (at p. 686) that this excess was "the equivalent of a non-deductible expense and thus must logically be adjusted".
Granite Bay Charters Ltd. v. The Queen, 2001 DTC 615, Docket: 98-2524-IT-G (TCC)
After the individual shareholders ("Cox") of the taxpayer and a related corporation ("Greenstone") had entered into an agreement for the sale of Greenstone to a third party ("Dougan"), Greenstone transferred its non-logging assets to the taxpayer as redemption proceeds for shares of Greenstone held by the taxpayer. When the sale transaction with Dougan fell through, an agent, who for some time had been informally acting on behalf of Cox to find a buyer for Greenstone, identified another purchaser to whom the shares of Greenstone were sold some months later.
In finding that the deemed dividend arising on the share redemption occurred as part of the series of transactions resulting in the disposition of the Greenstone shares to the ultimate purchaser, Bowie J. stated (at pp. 620-1):
"... a change in the identity of the purchaser, where the intention to sell remained intact throughout and the hiatus is as short as this one, cannot divorce the share redemption from the subsequent sale of the Cox shares. .... To conclude that no nexus existed between the corporate reorganization and the redemption of the Greenstone shares in December or January and the sale of the Cox shares in February would be to ignore the obvious tax-avoidance purpose of subsection 55(2), as well as the words of subsection 248(10)."
Lamont Management Ltd. v. The Queen, 99 DTC 871, Docket: 97-2140-IT-G (TCC)
In light of the specific code provided in s. 55(5), it was found that the safe income attributable to shares redeemed in the hands of the taxpayer did not include safe income earned by a U.S. corporation in which the taxpayer was indirectly invested because that corporation was not a foreign affiliate. This was so notwithstanding that "the word 'any' is all-embracing and ... in its natural meaning it excludes limitations" (p. 877).
943963 Ontario Inc. v. The Queen, 99 DTC 802, Docket: 97-2855-IT-G (TCC)
The taxpayer (a Canadian-controlled private corporation) received $1.2 million upon the purchase for cancellation of shares, having a paid-up capital of $732, of a connected corporation (HSP), thereby realizing a deemed dividend (before any application of s. 55(2)) of $1,199,268 (which it subdivided into 10 separate deemed dividends under s. 55(5)(f), the first eight of which totalled to the estimated applicable safe income on hand of $252,265, and the ninth of which was the $566,920 amount of the dividend subject to Part IV tax). In calculating the portion of the deemed dividend that, in turn, was deemed to be proceeds under s. 55(2), the Minister subtracted the Part IV tax dividend amount of $566,920 from $1,200,000 to arrive at $633,080, so that the taxpayer's capital gain was $303,378 based on its adjusted cost base of $329,702. The Minister (contrary to the taxpayer's approach) did not make a further deduction for the safe income amount as this was included in the dividend subject to Part IV tax.
In rejecting a submission (at para. 19) of the taxpayer "that a taxpayer has the right to designate which portion of a dividend that will or will not be subject to Part IV tax," and in confirming the Minister's calculation, Rip J stated (at para. 29) that "paragraph 55(5)(f) is silent with respect to any allocation of the Part IV tax among the designated dividends" and (at para. 31):
It is readily apparent that Part IV tax is exigible on receipt of the first dollar of dividend, on the facts at bar, on amounts first totalling $566,920. Safe income is not safe from Part IV tax.
Meager Creek Holdings Ltd. v. The Queen, 98 DTC 2073, Docket: 96-2817-IT-G (TCC)
Two Canadian corporations owned by the taxpayer paid significant dividends to the taxpayer shortly before the February 1990 federal Budget on the advice of their accountant who feared the introduction of a tax on intercorporate dividends. Six months later, discussions were held with respect to a potential sale of the corporations, and a sale of one-third of the shares occurred a few months later. In finding that the February 1990 dividends were not part of a series of transactions that included the sale, O'Connor TCJ. stated (at p. 2078) that he could not accept the Crown's submission "that any possible or future sale can suffice to bring subsection 55(2) into play".
Brelco Drilling Ltd. v. The Queen, 98 DTC 1422, Docket: 96-1399-IT-G (TCC)
The taxpayer, in computing the safe income attributable to its shares of another corporation ("Tricil") was not required to deduct the exempt deficits of various foreign affiliates of Tricil, and was entitled to include the exempt surpluses of other foreign affiliates of Tricil.
Les Placements E&R Simard Inc. v. The Queen, 97 DTC 1328 (TCC)
On September 10, 1988, the taxpayer transferred its assets to a subsidiary ("Alimentation 1988") in consideration for a demand promissory note and 506,125 Class B shares having a redemption value of $1 per share and nominal paid-up capital. 151,125 of the Class B shares were redeemed in the fiscal years of Alimentation 1988 ending on May 31, 1990, 1991 and 1992.
After finding that the redemption of the shares did not occur as part of the same series of transactions that included the September 10, 1988 sale transaction, Tardiff TCJ. found that there was no safe income attributable to the Class B shares because they had a fixed redemption amount, and, accordingly, could not participate in the earnings of Alimentation 1988.
Deuce Holdings Ltd. v. The Queen, 97 DTC 921 (TCC)
Bell TCJ. found that the safe income of the corporation in question should be computed on an after-tax basis, but should not be reduced by a retiring allowance whose payment had not been agreed to by the parties until after the period of time from which safe income was to be computed.
Gestion Jean-Paul Champagne Inc. v. MNR, 97 DTC 155 (TCC)
In connection with a buy-out of an individual's interest in a corporation ("Champagne") by his brother, the individual and his wife transferred their shares of Champagne to a newly-incorporated holding company, following which Champagne redeemed the transferred shares.
Lamarre Proulx TCJ. found that considering all the retained earnings of Champagne to be attributable to the redeemed shares ran counter to the corporate law principle of the equality of shares and the purposes of s. 55(2), and found that the safe income of Champagne should be prorated among the shareholdings.
454538 Ontario Ltd. v. MNR, 93 DTC 427 (TCC)
Two brothers (the "Mazzoccas"), who constituted two of the three equal shareholders of a corporation ("Tri-M"), transferred their shares of Tri-M on a partial rollover basis to two holding companies and caused the two holding companies to purchase the shareholding of the third shareholder ("Manley"). Immediately thereafter, an arm's length purchaser ("461") lent money to Tri-M sufficient for it to pay a dividend to the two holding companies equal to the estimated accounting retained earnings of Tri-M, following which 461 purchased the shares of Tri-M held by the two holding companies for a reduced purchase price.
In confirming reassessments by the Minister which included the amount of the dividends in the proceeds of disposition realized by the holding companies, Sarchuk J. rejected submissions inter alia:
- that the transactions were grandfathered on the basis that they occurred as part of a series of transactions or events which commenced prior to April 22, 1980 the evidence disclosed that "there was no serious intention on the part of the Mazzoccas to dispose of their interest in Tri-M prior to late summer and fall of 1980" (p. 431);
- that the reference to "income earned or realized" was ambiguous and therefore should be interpreted in the taxpayers' favour to refer to accounting retained earnings (it was clear in light of the wording of ss.55(5)(c) and in light of the decision in Mattabi Mines Ltd. v. MNR, [1988] 2 CTC 294, [1988] 2 S.C.R. 175 that "income" referred to income determined in accordance with the Part I of the Act); and
- that s. 55(2) was void for uncertainty (the problems in application of s. 55(2) were "not surprising given the complexity of the subject matter" and it could not be concluded that it was "couched in such vague or general language that it does not contain an intelligible standard" (p. 437)).
Administrative Policy
14 May 2015 CLHIA Roundtable Q. , 2015-0573821C6
Prior to a sale by Holdco of all the shares of Opco to an arm's length purchaser for $1,000,000, Opco will transfer its interest in the Policy on the life of Mr. X (the sole shareholder of Holdco) to Holdco as a dividend-in-kind. The Policy has a nil ACB, $200,000 FMV, $100,000 CSV and $1,000,000 death benefit. What will be the impact of the dividend-in-kind on the computation of safe income on hand?
Timing of addition to SIOH
After noting that Opco would be deemed by ss. 148(7) and (9) to receive proceeds of disposition equal to the Policy's CSV rather than FMV, CRA stated:
[T]he safe-income determination time for the Dividend-in-Kind… is the time that is immediately before the time that the Dividend-in-Kind is paid to Holdco. Because the income inclusion resulting from the disposition of Opco's interest in the Policy…will be added to Opco's safe income after the Dividend-in-Kind is paid to Holdco, it will not contribute to the capital gain that could be realized on a disposition at fair market value of an Opco share immediately before the time the Dividend-in-Kind is paid.
Effect of non-deductible policy premium on SIOH
After noting that "premiums payable by a taxpayer under a life insurance policy are generally considered to be on account of capital" and referencing "the payment of premiums on the Policy over the period throughout which Opco was a private corporation," CRA stated:
The portion of such premiums that contributes to the increase of the cash surrender value of the Policy would be considered to be on hand at the safe income determination time to the extent that it contributes to the accrued capital gain on a share of the capital stock of Opco at that time. … However, the portion of such premiums that does not contribute to the increase of the cash surrender value of the Policy at that time will not be on hand at the safe income determination time and would therefore reduce the amount of safe income that could reasonably be considered to contribute, immediately before the Dividend-in-Kind, to the accrued capital gain on the Opco shares on which that dividend is received.
10 October 2014 APFF Roundtable Q. , 2014-0538061C6 F
A discretionary trust (the "Trust"), whose beneficiaries were A, A's spouse, their children and a corporation ("Holdco") all of whose participating and voting shares were held by A, received a dividend on its shareholding (being all the non-voting common shares) in Opco, and distributed that dividend to Holdco, making a s. 104(19) designation, and with Holdco claiming a s. 112(1) deduction for its income inclusion under s. 104(13). The Opco dividend amount equalled the safe income on hand respecting the Trust's shares, and no Part IV tax was payable (by virtue inter alia of A being the sole voting shareholder of Opco).
Should the dividend be recognized in the calculation of Holdco's safe income? After noting the availability and making of the s. 104(19) designation in respect of the dividend which was included in Holdco's income under s. 104(13), CRA stated (TaxInterpretations translation):
[I]t would be reasonable to consider that the amount of the dividend allocated to Holdco by virtue of subsection 104(19) which was included in the computation of its income, would increase its safe income by an equivalent amount.
10 October 2014 APFF Roundtable Q. 19, 2014-0538041C6 F
Mr. X holds all 100 of Opco's Class A shares with a fair market value of $1,000,000 and nominal ACB and PUC. Opco pays a stock dividend comprising Class B shares which have a retraction right for $900,000; the 100 Class shares are exchanged for estate freeze Class C preferred shares; and the family trust subscribes for Class shares for $10. What would be the safe income attributable to the Class B shares issued as the stock dividend? CRA responded (Tax Interpretations translation):
When there is a stock dividend of a class having a redemption amount higher than its nominal paid-up capital, it will be necessary to apportion the safe income and the safe income on hand which is attributable to the shares on which the dividend was paid, being the Class A shares, between such shares and the shares received as a stock dividend, being the Class B shares. The apportionment of this safe income and safe income on hand which will thereupon be attributable to the Class B shares will be effected in accordance with the proportion of the gain inherent in the Class B shares as compared to the gain inherent in the Class A shares prior to the stock dividend. The amount of safe income and safe income on hand which would be attributable to the Class B shares would reduce the safe income and safe income on hand which was attributable to the Class A shares prior to the payment of the stock dividend.
10 October 2014 APFF Roundtable Q. , 2014-0534671C6 F
What is the CRA position on D & D Livestock? CRA stated (TaxInterpretations translation):
[S]ubsection 245(2) was not applied in this case. However, the CRA would not hesitate to invoke the GAAR in similar files. … The CRA considers among other things that transactions or series of transactions permitting the double utilization of the same amount of safe income in order to reduce a capital gain realized on an ultimate disposition of shares of a corporation are abusive and go against the object of subsection 55(2). Moreover, Justice Graham emphasized at paragraphs 27 and 28 of the decision… that the transactions in the case resulted in stripping of capital gains.
Furthermore, the CRA is also concerned by planning which can result in an unjustified duplication of fiscal attributes, for example, the duplication of the adjusted cost base of a share, regardless of the fact the that adjusted cost base exists by reason of safe income of a corporation. Similar transaction will be contested by the CRA, as appropriate.
27 June 2014 T.I. 2013-0498191E5 F - Interaction entre 55(2) et l'impôt de partie IV
On a cross-share redemption between two connected Canadian-controlled private corporations, neither of which has a refundable dividend tax on hand account account immediately before the redemption, each corporation is deemed to receive a dividend from the other. Does the application of s. 55(2) to the deemed dividend received by each corporation, which generates an addition to its RDTOH account and, therefore, generates a dividend refund to it and associated Part IV tax on the deemed dividend paid by it to the other corporation, engage the exclusion from s. 55(2) for dividends which are subject to Part IV tax – or does the Part IV tax exclusion not apply so that s. 55(2) applies to the full amount of the deemed dividend received by each corporation? CRA stated (TaxInterpretations translation):
[I]n accordance with sections 129 and 186, it is provided that the dividend refund, the RDTOH account and thus the Part IV tax of a given corporation are calculated as a function of all relevant amounts in this regard for the whole taxation year.
Furthermore … in … 943963 Ontario Inc. … the parties … and the Court accepted that there was a given amount subject to Part IV tax by the appellant, the dividend recipient, notwithstanding that a part of the deemed dividend…was deemed to not be a dividend received, by virtue of subsection 55(2). In other words, the part of the dividend giving rise to a capital gain by virtue of subsection 55(2) did not affect the amount of the "assessable dividend" taken into account for calculating the Part IV tax payable… . The application of subsection 55(2) in that case did not engage any circular calculation. …
Moreover, the fact of calculating the RDTOH account at the end of a taxation year of each corporation in such a situation…involving cross redemptions and thus cross dividends, entails circular calculations by them of their respective RDTOH, dividend refunds and Part IV tax. In policy terms, it does not appear acceptable to us that circular calculations could result in a complete reimbursement of the total RDTOH of each corporation in such a situation.
16 June 2014 STEP Roundtable Q. , 2014-0522991C6
A corporation has insufficient safe income in respect of its shares and, rather than making a s. 55(5)(f) designation, self-assesses itself for a capital gain to the extent of the insufficient safe income on hand? Is it permissible for it to self-assess the dividend received by it as proceeds of disposition?
CRA referred to Nassau Walnut, which found that a s. 55(5)(f) designation is not an election (and "is, in some respects, no different than the deduction provided under subsection 112(1)") and, more generally, referred to Brelco, Lamont and Kruco for the principle "that the safe income of a corporation should not be subject to double taxation when distributed as a dividend to another corporation." CRA then stated:
CRA's long standing practice is to apply subsection 55(2) only to the excess of the taxable dividend paid on a share over the safe income on hand attributable to that share, when issuing an assessment based on subsection 55(2).
2012 Ruling 2011-0403291R3 - Treaty exempt sale
Following a preliminary reorganization (including an amalgamation of predecessors of Amalco so as to "consolidate the tax attributes"), all the shares of Amalco are held by Foreignco3 (resident in the U.S.) which, in turn, is an indirect wholly-owned subsidiary of Foreign Parent, a listed company. Amalco has various direct or indirect (mostly Canadian) subsidiaries carrying on the XYZ Business and also holds the "Keep Assets," which mostly are non-resident or resident subsidiaries. The following transactions occur in order to accomplish an indirect sale of the XYZ Business by Foreignco3 to Buyer (an arm's length purchaser) after a spin-off of the other "Keep Assets" to a newly-incorporated Canadian spinco whose initial common share is held by Foreignco3 ("Canco"):
- On a s. 86 reorganization Foreignco3 will receive "Keep Shares" (non-voting redeemable retractable preferred shares) and New Common Shares in exchange for its old common shares of Amalco (which are taxable Canadian property).
- Foreignco3 will transfer the Keep Shares to Canco in exchange for additional Canco Shares, electing under s. 85(1) at fair market value.
- Amalco will transfer the Keep Assets to Canco in exchange for the Canco Note and the assumption of the Assumed Debts, with a net taxable capital gain resulting.
- Amalco will purchase the Keep Shares from Canco for cancellation (giving rise to an obligation, but with no note issued).
- The obligations arising in 3 and 4 and other obligations are set-off.
- Foreignco3 will sell the New Common Shares (which now derive their value from the XYZ Assets) to the Buyer for cash.
Rulings include:
- the gain realized by Foreignco3 on the transfer of the Keep Shares to Canco in 2 and on the sale in 6 will be exempt from tax under Art. 13 of the Treaty.
- 55(2) will not apply to the deemed dividends arising in 4.
14 March 2014 Memorandum 2013-0499141I7 - IRC 338(h)(10), "earnings" and safe income
An indirect wholly-owned foreign affiliate ("FA") of Canco made an arm's length purchase of all the shares of "US Holdco," whose wholly-owned subsidiaries ("US-Opcos") had accrued gains inherent in the appreciated assets of their active businesses including capital property, depreciable property and intangible property such as goodwill.
After noting (para. 33) that the income realized ("Intangible Property Safe Income") by the US-Opcos under former s. 55(5)(d) on the disposition of the intangible properties was in respect of gains that accrued on those intangible properties in the period before FA acquired the US Holdco shares (the "Pre-acquisition period") and that "the Intangible Property Safe Income was reflected in the purchase price and, therefore, the ACB, of the US Holdco shares that FA acquired," and before concluding (para. 36) that "the Intangible Property Safe Income did not contribute to the gains that accrued on FA's US Holdco shares in the Post-acquisition period and, therefore, did not contribute to the gains that accrued on PrivateCo's… Canco common shares immediately before their redemption," CRA stated (at para. 34):
[A]llocating the Intangible Property Safe Income to the gains that accrued on FA's US Holdco shares in the Post-acquisition period would offend the object and spirit of subsection 55(2) because such an allocation would result in "capital gains stripping" which is what subsection 55(2) is designed to prevent. This is because such an allocation would give rise to a "double counting" of FA's ACB of the US Holdco shares as safe income which could then be allocated to a gain that accrued on the US Holdco shares in the Post-acquisition period and that is attributable to the unrealized appreciation in the value of the underlying assets of the US-Opcos.
See also the summary under Reg. 5907(2)(f).
14 February 2014 T.I. 2012-0454481E5 F - Safe Income
The only source of income of ABC, a CCPC, is its interest in a partnership (P) with a fiscal period end of XX. ABC has an income inclusion under s. 34.2(2) and claims a reserve under s. 34.2(11). May ABC choose not to claim the transitional reserve provided under s. 34.2(11) for a taxation year for the purposes of the computation of its safe income on hand? CRA stated (TaxInterpretations translation):
ABC may not claim an amount in respect of the transitional reserve under subsection 34.2(11) to establish its SIOH immediately before the "safe income determination time" respecting a particular transaction, so long as the corporation does not claim such reserve for the taxation year which includes the stub period… .
The principal reason for our position is the fact that the transitional reserve is temporary and that one could reasonably consider that, in general, the "qualifying transitional income" on which the transitional reserve is based results in an increase in the value of the shares… .
21 March 2014 T.I. 2012-0471021E5 - Safe income and section 34.2
The fiscal period of a partnership ends on June 30, 2013 but the taxation year-end of the private corporation which is a member is December 31, 2013, which is also its "safe-income determination time." Should a negative adjustment be made in computing the "safe income on hand" if the corporate partner has an income inclusion under s. 34.2(2) but there is a loss in the partnership for the stub period from July 1, 2013 to December 31, 2013?
After noting that "an adjustment to carve out from 'safe income' any amounts included in income under subsections 34.2(2) and (12) and any amounts claimed under subsections 34.2(4) and (11) would be contrary to the wording of [s. 55(5)(c)]," CRA went on to state that:
a negative adjustment in respect of the loss should be made in determining the "safe income on hand" of the corporation on the basis that the [s. 34.2(2)] amount would not be on hand to contribute to the fair market value or the gain inherent in the shares of the corporation.
11 October 2013 APFF Roundtable Q. , 2013-0495851C6 F
Buyco acquired all the shares of Opco on 15 January 2010 from Sellco. A CRA audit resulted in a 2011 reassessment to increase Opco's income for its 2008 and 2009 years. CRA stated (TaxInterpretations translation):
[no price adjustment]
[W]here nothing in particular is provided in the purchase contract…respecting…[this situation] the additional income tax payable by Opco, in general, would reduce the safe income on hand attributable to the shares held by Sellco… . [T]he payment of the additional tax by Opco would have the effect of reducing the safe income on hand that can reasonably be considered to contribute to the gain on the shares of Opco held by Buyco [per the summary, "the gain inherent in the Opco's shares"].
[price adjustment to Buyco]
In the situation where the purchase contract…contains a price adjustment clause to the price for the shares payable by Buyco by reason of a new assessment sustained by Opco, the amount received by Buyco by reason of the price adjustment clause, in general, would reduce the acquisition cost of the shares of Opco. Furthermore, the amount of the additional tax payable by Opco by reason of the new assessment for a taxation year ending prior to the acqusisition of control would, in general, have the same effect as [above].
[price adjustment to Opco]
In the situation where the purchase contract…provides that Sellco is responsible for the amount of any new assessment for a taxation year subsequent to the acquisition of the shares and to the extent that Opco received…from Sellco an amount equivalent to the amount of additional tax arising under the new assessment, the calculation of the safe income on hand attributable to the Opco shares held by Buyco would need to take into account the application of ITA paragraph 12(1)(x) or ITA subsection 12(2.2) to the compensation received from Sellco.
16 November 2011 T.I. 2011-0423861E5 F
Holdco, whose common shares of Opco have a nominal adjusted cost base ("ACB") and paid-up capital ("PUC"), a fair market value ("FMV") of $2 million and safe income on hand ("SIOH") attributable to those shares of $900,000, increases the PUC of those shares by $1 million, and transfers those common shares (or to be more precise, new common shares issued in replacement therefor on the PUC increase) to Opco for cancellation in consideration for the issuance by Opco of (i) preference shares of Opco having an FMV, PUC and ACB (determined under s. 85(1)(g)) of $1 million; and (ii) common shares having a FMV of $1 million and nominal PUC and ACB.
If s. 55(2) did not apply to the s. 84(1) dividend, then the ACB of the common shares of Opco held by Holdco following that PUC increase would be determined under s. 53(1)(b) as the excess of the s. 84(1) deemed dividend of $1 million minus $100,000, being the portion of that dividend that did not come out of SIOH - i.e., $900,000.
On the other hand, if s. 55(2) applied to the s. 84(1) dividend, the ACB of those common shares would be the excess of the s. 84(1) deemed dividend received by Holdco (which, by virtue of s. 55(2) would be limited to the SIOH of $900,000) over the nil portion of that deemed dividend that did not come out of SIOH hand - i.e., also $900,000.
Accordingly, in both scenarios, Holdco would realize a $100,000 capital gain on the "dirty s. 85" transfer of the common shares, i.e., the excess of the agreed amount of $1 million over the ACB of $900,000. No amount would bee added to the proceeds of disposition of the common shares because of the exclusion under s. 55(2)(b); and CRA would not apply s. 55(2)(c).
2011 T.I. 2011-0416801E5 F -
respecting queries on how to calculate the safe income on hand ("SIOH") of a CCPC that recognized income on a lumpy basis when it made progress billings, CRA noted that the SIOH attributable to a particular share may be based on a holding period that contains two stub periods (the period from the date of acquisition of the share to the first year-end; and the period from the last year-end to the safe income determination time) and that "in general, SIOH is determined by allocating a pro rata share of the income for the full taxation year to the stub period."
2011 T.I. 2011-0423181E5 F
200 Class A shares of Opco held by a shareholder had a safe income on hand ("SIOH") that was lower than their fmv, and 100 Class F shares had a SIOH which approximated their fmv. The 200 Clas A share are converted under s. 51 into 200 Class F shares.
All the Class F shares following the conversion including the newly issued ones will share proportionately is the SIOH formerly attributed to the exchanged shares.
Income Tax Technical News, No. 34, 27 April 2006 under "Safe Income Calculation"
The Kruco case.
3 June 2003 T.I. 2003-001207
An amount designated by a personal trust in respect of its corporate beneficiary under s. 104(13.1) would not be included in determining the corporate beneficiary's safe income or safe income on hand.
14 December 2000 T.I. 2000-003403
The safe income on hand of a corporation, is not reduced by non-capital losses of a corporation within the group that is acquired by it, although the amount paid to acquire such loss company will reduce the safe income on hand attributable to its shares as the shares of the loss company disappear on the subsequent amalgamation.
11 December 2000 T.I. 2000-005316 -
If Holdco purchases Opco at a time when Opco has unrealized appreciation in certain assets such as inventory or capital property, gain from a subsequent sale of such asset will not increase the safe income attributable to the shares of Opco held by Holdco. However "notwithstanding the above, and as a practical matter, normally we do not require a detailed analysis of all the elements making up the capital gain on a share as long as safe income on hand is computed pursuant to our published guidelines".
2000 Ruling 2000-0003253 -
Where a share is exchanged for a second share on a rollover basis, the full safe income on hand attributable to the first share owned by the transferor immediately before the exchange will flow through to the second share on the exchange provided that the fair market value of the second share received on the exchange is not less than the fair market value of the transferred share immediately before the exchange.
13 April 2000 T.I. 2000 - 000792
Discussion of allocation of safe income when shares of a corporation are exchanged on a rollover basis for more than one class of shares.
Income Tax Technical News, No. 16, 8 March 1999
Reference to Brelco case.
1999 Ruling 3-991044 -
The safe income attributable to shares of a corporation that were sold to an arm's length purchaser included gain arising from an s. 111(4)(e) designation given that no election was made under s. 256(9).
1999 APFF Round Table, Q. 4 (No. 9M19190)
A loss that is denied under s. 40(2)(g)(ii) will be deducted when calculating safe income on hand.
29 June 1998 T.I. 5-980210 -
Where a corporate shareholder transferred public company shares to a new holding company pursuant to s. 85(1), the safe income on hand of the shares of the new holding company would ordinarily include the safe income on hand attributable to the public corporation's shares even if no significant influence is exercised over the public corporation.
17 September 1997 T.I. 972141
The fact that a dividend refund has been received by the payor of a dividend is not normally relevant to consideration of the following expression: "that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series of transactions or events".
29 August 1997
Confirmation of policy expressed in the Read paper (1988 Conference Report) respecting the redemption of preferred shares which were received as a stock dividend.
26 August 1997 T.I. 971365
Where a wholly-owned subsidiary owns shares in the capital of its parent company, an allocation of safe income must be made to the shares of the parent corporation held by the subsidiary.
16 June 1997 T.I. 5-971100 -
Any dividend paid by a payer corporation is considered to be paid first out of the safe income on hand attributable to the recipient corporation's shares of the payer corporation. Accordingly, the amount of the dividend to which s. 55(2) will not apply is the aggregate of the amount of the dividend subject to Part IV tax and the amount, if any, by which the amount of safe income on hand exceeds the amount of the income subject to Part IV tax. Conversely, the recipient corporation would not have to designate any amount under s. 55(5)(f) in any situation where the portion of the taxable dividend that is subject to Part IV tax exceeds the safe income on hand of the corporation.
17 March 1997 T.I. 963272
Discussion of the safe income entitlement of alphabet shares.
16 July 1996 T.I. 5-960491 -
Where preferred shares issued by Newco on the roll-in to Newco of shares of Opco, have a dividend entitlement equal to dividends received by Newco on the shares of Opco, and to proceeds received by Newco on the sale of shares of Opco to the extent of the gain realized by Newco, but with the redemption amount of the shares being reduced on a dollar-for-dollar basis by the amount of the dividends paid out of such gain. RC will not consider the preferred shares to have a dividend entitlement in respect of the gain because of the corresponding reduction in redemption amount. Accordingly, the safe income attributable to the gain could not be attributed to the preference shares.
6 May 1996 T.I. 961124 (C.T.O. "Safe Income - Provision for Capital Item, Dividends")
A write- down in the carrying value of a capital asset to reflect an accrued loss inherent in the property, will not reduce safe income on hand because the write-down does not represent an amount of safe income that has been set aside to pay an amount not currently deductible for tax purposes.
Income Tax Technical News, No. 7, 21 February 1996
After referring to the Clem Industrial case, Mr. Hiltz stated:
"Ordinarily, if an arm's length sale of shares occurs within a short time after a dividend was received on the shares, we will consider this to be strongly indicative that one of the purposes of the dividend was to reduce the capital gain that would otherwise have been realized on the share sale."
1996 Ontario Tax Conference Round Table, "Purpose Test in Subsection 55(2)", 1997 Canadian Tax Journal, Vol. 45, No. 1, pp. 231-214
Discussion of CPL Holdings Ltd. v. The Queen, 95 DTC 5253 (FCTD).
5 July 1995 T.I. 5-941606 -
Discussion of a situation where a Canadian-controlled private corporation ("Holdco") transfers an asset on a rollover basis to a newly-incorporated subsidiary ("Newco"), following which Newco sells the assets to an unrelated third party and pays the after-tax profit to Holdco giving rise to dividend refund to it and Part IV tax to Holdco, with Holdco paying corresponding taxable dividends to its shareholders that are not liable to Part IV tax.
10 April 1995 T.I. 950469 (C.T.O. "Same Income, Feb. 22, 1994 Election")
Discussion of proration formula for determining safe income where an individual realizes a capital gain of $100,000 in connection with bumping the ACB of her shares, then rolls her shares into a holding company in whose hands the shares are redeemed.
28 March 1995 T.I. 943095 (C.T.O. "Safe Income Stock Splits")
"Generally, when a portion of the capital gain inherent in the shares of a corporation is crystallized, the Department's approach ... is to apportion the safe income to which the entire gain is attributable proportionately to each part of the gain. A transferee's safe income attributable to the shares received would be computed by multiplying the safe income attributable to the transferred shares immediately before the transfer by the proportion that the transferee's potential gain (immediately after the transfer) is of the transferor's potential gain (immediately before the transfer)."
27 October 1994 T.I. 941436 (C.T.O. "Safe Income - Foreign Affiliates (H.A.A. 5102-3)")
When computing exempt or taxable surplus of a foreign affiliate for the purpose of determining safe income of a Canadian corporation with a wholly owned U.S. foreign affiliate, the relevant time is that at which the safe income is to be computed (i.e., immediately before the transaction or event, or the commencement of the series of transactions or events).
General discussion of computation of safe income in the context of a foreign affiliate.
20 July 1994 T.I. 940879
Safe income on hand will flow through on an s. 107(2) rollover in a similar manner to rollovers effected under ss.51, 85, 85.1, 86 and 87.
94 CPTJ - Q. 1
Because the Alberta royalty tax credit is not included in a corporation's net income for tax purposes, it would not be included in determining the corporation's safe income or safe income on hand.
3 May 1993 T.I. 923639 (C.T.O. "Safe Income and Part IV Tax")
Where X owns 20% of the shares of Opco having a safe income of $100 and a fair market value of $125, and transfers all of such shares to a new corporation ("Newco") on a rollover basis in exchange for shares of Newco, and Opco then redeems the shares held by Newco for $125 giving rise to a deemed dividend of $125, Newco will not be able to treat itself as having received a safe income dividend of $100 (assuming the appropriate designation under s. 55(5)(f)), and a further separate dividend of$25 subject to Part IV tax, if the payment of the deemed dividend by Opco triggers Part IV tax on $25 of that dividend deemed to be received by Newco:
"It is our view that to the extent that a dividend refund arises in respect of tax paid on the investment income earned by a corporation which pays a dividend (the "payer corporation"), such income would, on an after tax basis, have been included in the calculation of the safe income of the payer corporation. Consequently, when a dividend that gives rise to the dividend refund is paid by the payer corporation, that portion of the dividend [that is sufficient to give rise to the dividend refund would be considered to be paid out of the safe income of the payer corporation ... . Since an amount of $100 (including the $25 dividend subject to tax under Part IV of the Act) which is equal to the total safe income of Opco, is designated as a separate taxable dividend, subsection 55(2) will not apply to this dividend. However, subsection 55(2) will, in our view, apply to the other separate taxable dividend of $25."
20 July 1994 T.I. 940879 (C.T.O. "55(2)")
The rollover under s. 107(2) is accorded the same treatment for safe income purposes as the rollover under s. 85.
On a wind-up of one company into a second company, the safe income on hand of the second company will be reduced by the amount of the loss realized on the intercompany debt which is deemed to be paid in full by virtue of an s. 80(3) election. In addition, any other liabilities of the first company assumed by the second company that are in excess of the fair market value of the property of the first company distributed to the second company, will also reduce the safe income on hand of the second company.
Losses incurred in a taxation year that have not been deducted in computing income under s. 3 by the corporation, or by any corporation over which it has significant influence, will generally reduce safe income on hand of the corporation.
6 April 1994 T.I. 933171 (C.T.O. "Safe Income and SRED Expenditures")
Current SR & ED expenses must be deducted in computing the corporation's safe income on hand even if such expenses have not yet been deducted for tax purposes. However, SR & ED capital expenditures do not reduce the corporation's safe income on hand until the year that such amounts are claimed as a deduction for tax purposes.
93 C.R. - Q. 15
Safe income on hand will be reduced by large corporations tax.
93 C.R. - Q. 12
Discussion of distinction between "safe income" and "safe income on hand".
Calgary District Office Round Table, 3 May 1994, Q. 17
Because an Alberta royalty tax credit is not included in a corporation's income for tax purposes, it also is not included in its safe income or safe income on hand.
31 August 1993 Memorandum (Tax Window, No. 33, p. 4, ¶2639)
Impact of investment tax credits and share purchase tax credits on calculation of safe income.
2 February 1993 T.I. (Tax Window, No. 28, p. 5, ¶2414)
Amounts actually expended but not deductible for tax purposes (e.g., 20% of entertainment expenses), and amounts actually expended but deferred or capitalized for tax purposes (e.g., contributions of an employer to an employee benefit plan pursuant to s. 18(1)(o) or amounts capitalized under s. 18(2)) cannot be included in safe income on hand until such time, if any, as they are deducted for tax purposes.
Amounts not yet expended but deducted for accounting purposes but not for tax purposes (e.g., accrued compound interest, provisions for unfunded future employee pension obligations and provisions for future warranty obligations) reduce safe income on hand if safe income has been set aside to pay these amounts or if the future obligations have reduced a gain that would otherwise be realized on a disposition at fair market value of a share of any corporation.
20 October 1992 T.I. 910248 (September 1993 Access Letter, p. 413, ¶C38-174)
The deduction under s. 110(1)(k) has no effect on safe income.
92 C.R. - Q.35
RC response to suggestion that s. 55(2) does not apply to a taxable dividend arising out of transactions that were structured by the corporation rather than the vendor.
92 C.R. - Q.29
Where a deemed dividend arising on the redemption of a portion of the shares of Opco exceeds the safe income attributable to the redeemed shares and no designation under s. 55(5)(f) is made, the safe income that otherwise would be available will be permanently lost. The same result applies where there is a payment of an ordinary dividend.
28 July 1992 T.I. 5-920803
Where A and B, who are two of the three individual shareholders of OPCO, transfer their common shares of OPCO to separate newly-incorporated holding companies and later, following a conversion of the common shares of OPCO held by the holding companies into preferred shares, have their holding companies receive redemption proceeds of the preference shares out of the capital dividend account of OPCO, the safe income attributable to the common shares of OPCO transferred to their holding companies cannot be attributed to the shares of OPCO held by the third shareholder, even though the subsequent deemed dividend paid out of the capital dividend account of OPCO does not affect its safe income.
Where an amount, otherwise deemed to be a dividend under s. 84(3), is deemed instead to be a capital gain under s. 55(2), it also will not reduce the safe income attributable to the other shares of the corporation.
10 January 1992 Memorandum (Tax Window, No. 17, p. 12, ¶1773)
The reduction in Part I tax caused by the application of available investment tax credits affects the corporation's safe income only in the years following the claim, for example, through a reduction of the amount of CCA or SR&ED expenditures available in those years.
10 January 1992 Memorandum (Tax Window, No. 17, p. 12, ¶1773)
The corporation to which assets are transferred in a butterfly may not be amalgamated with another corporation.
24 February 1992 Memorandum (Tax Window, No. 13, p. 13, ¶1630)
Re circumstances where RC is prepared to consider a reassessment of only the excess of deemed proceeds over safe income notwithstanding the failure to make a timely designation under s. 55(5)(f).
23 January 1992 T.I. (Tax Window, No. 12, p. 6, ¶1574)
Where a corporation pays a dividend in kind comprising part of its assets, its safe income must be pro-rated rather than being allocated fully to the dividend.
6 June 1991 T.I. (Tax Window, No. 4, p. 12, ¶1282)
Where shares of Opco are redeemed by Holdco giving rise to a deemed dividend of $2.2 million at a time that the safe income of Opco is $1.8 million, Holdco designates $1.8 million as a separate taxable dividend under s. 55(5)(f) and Opco receives a dividend refund of tax of $100,000, the $400,000 of income earned by Opco on which it paid refundable tax will be considered to be part of the safe income of Opco. Consequently, s. 55(2) will apply to the dividend of $400,000 because it would not be considered to have been paid out of safe income.
15 May 1991 T.I. (Tax Window, No. 3, p. 18, ¶1239)
S.55(2) generally will not apply to a deemed dividend which deliberately has been made subject to Part IV tax in order to avoid the application of s. 55(2).
13 March 1991 T.I. (Tax Window, No. 1, p. 20, ¶1140)
Crown royalties and other amounts representing cash outlays which are non-deductible under s. 18(1)(m) should be included in computing safe income. However, the resource allowance which does not represent an actual outlay, should be excluded.
26 November 1990 T.I. (Tax Window, Prelim. No. 2, p. 7, ¶1037)
Safe income effectively is transferred on an s. 85 rollover or an interspousal rollover under s. 73(1).
90 C.P.T.J. - Q.20
A corporation with safe income of $100 has one shareholder whose shares, all being of one class, have an accrued gain of $200. If the redemption of 1/2 of the shares results in a deemed dividend of $100, it will be unreasonable to conclude that the $100 gain inherent in the shares being redeemed is wholly attributable to the $100 of safe income and that the $100 gain inherent in the remaining shares is attributable to something other than the safe income.
29 June 1990 T.I. (November 1990 Access Letter, ¶1516)
Where the individual shareholders of Opco transfer their common shares of Opco to Holdco on a share-for-share exchange, the common shares held by Holdco are changed into preferred shares under an s. 86 reorganization and a dividend and deemed dividend are paid on the preferred shares held by Holdco, Holdco will receive only a proportionate share of the safe income of Opco. Holdco may avail itself of the election under s. 55(5)(f).
June 1990 Meeting of Alberta Institute of Chartered Accountants (November 1990 Access Letter, ¶1499, Q. 7)
Safe income is attributable to a particular class of shares in the same proportion in which each class of shares will be entitled to earnings of the corporation if they were distributed on a winding-up.
30 April 1990 T.I. (September 1990 Access Letter, ¶1415)
Employees of Opco, who own all its issued shares, transfer those shares to Newco in exchange for shares of Newco, thereby realizing a capital gain. Immediately thereafter, Opco pays a taxable dividend to Newco equal to the full amount of its safe income on hand prior to the share-for-share exchange. Assuming that the full amount of the unrealized gain on the shares of Opco is greater than Opco's safe income, and a portion of that gain is realized, then a proportionate part of this portion is attributable to safe income and the remaining part may be reasonably considered to be attributable to something else. Accordingly, a portion of the supposed safe income dividend also would be attributable to something other than safe income, and s. 55(2) will apply.
23 March 1990 T.I. (August 1990 Access Letter, ¶1376)
In response to a proposal that entailed purifying a corporation for purposes of the exemption for sales of qualified small business corporation shares by paying a large dividend on special shares which had been issued for a nominal amount, RC noted that the provisions of s. 55(2) are always of concern where a class of shares attracts an inordinately large dividend, whether that dividend is paid periodically or arises on the redemption of shares. Because s. 55(2) can apply where a large dividend of one class of shares reduces the accrued capital gain on another class of shares, no comfort can be drawn from the absence of any reduction of a capital gain on the special shares.
23 February 1990 T.I. (July 1990 Access Letter, ¶1322)
If it is known, at the beginning of a series of transactions, that there will be an acquisition of control of the corporation resulting in a deemed capital loss under s. 111(4), the deemed capital loss should be applied to reduce taxable capital gains realized prior to the commencement of the series for the purpose of computing the corporation's safe income.
12 January 1990 T.I. (June 1990 Access Letter, ¶1258)
A sale of an operating division by Opco followed by the payment of a dividend to Holdco equal to the net after tax proceeds of the sale likely would not be regarded as having been carried out for the prohibited purpose.
10 January 1990 T.I. (June 1990 Access Letter, ¶1259)
Where Opco pays a stock dividend of $500,000 in high-low preferred shares, only a pro-rata portion of its safe income is attributable to the preferred shares on the subsequent redemption thereof.
5 December 1989 T.I. (May 1990 Access Letter, ¶1216)
One corporation ("S1") transfers a capital property under s. 85(1) to a sister corporation ("S2") in consideration for redeemable preference shares which are then redeemed following the sale by S2 of the property to an arm's length purchaser. The safe income attributable to the preferred shares is nil because the entire gain on those shares is attributable to the capital gain on the transferred property, and no dividend entitlement accrued on the preferred shares prior to the commencement of the series of transactions.
15 November 89 T.I. (April 90 Access Letter, ¶1187)
A corporation ("Opco") is owned by siblings who wish to transfer their shares to their children. Each sibling would form a holding company into which he would transfer his common shares of Opco pursuant to s. 85(1) in exchange for preference shares having a redemption amount equal to the fair market value of the transferred common shares, and the children would receive common shares from treasury such that they would have an equity percentage equivalent to what the parents had. S.55(2) would apply on the redemption of the preferred shares. S.55(3)(a) would not apply because nephews and nieces do not deal at arm's length with their uncles and aunts.
89 C.R. - Q.12
The shares of Opco whose value essentially is represented by goodwill, are converted (or "frozen") into high-low preferred shares, which then are transferred to Holdco. Common shares of Opco are then sold to a third-party purchaser. Later, Opco sells the goodwill to an arm's length person and all the preferred shares of Opco are redeemed. The safe income of Opco earned subsequent to the freeze transaction is allocable to the preferred shares only to the extent of their dividend entitlement.
October 1989 Revenue Canada Round Table - Q.5 (Jan. 90 Access Letter, ¶1075)
Mr. A is not permitted to extract the safe income of a corporation prior to the sale of its shares, by having that corporation pay a stock dividend of preferred shares to a newly-incorporated holding company of Mr. A, followed by a redemption of those preferred shares. The principle is that the safe income of a corporation should be attributed to each share of its capital stock after payment of the stock dividend (i.e., safe income must also be allocated to the common shares), and safe income cannot be attributed to only one class of shares.
Read, "Section 55: A Review of Current Issues", 88 C.R., c. 18.
88 C.R. - F.Q.36
S.55(2) will apply if as part of the same series Opco transferred assets to Sisterco, for preference shares which were redeemed, and the shares of either Opco or Sisterco were sold to an arm's length purchaser.
80 C.R. - Q.4
General guidelines.
Articles
Bruce Sinclair, "Current Topics in the Taxation of Real Estate Development", 2014 Conference Report, Canadian Tax Foundation, 12:1-24.
Sale of Projectco before allocation to it by sub LP of condo sale profits (pp. 12:2-3)
Developers often undertake projects in a single-purpose entity ("Projectco") for commercial reasons.…A further level of liability protection can be provided if the project is held in a limited partnership…
[T]he developer will sell the shares of Projectco to another party that has the ability to reduce or shelter the income that will be allocated at the end of the fiscal period of the limited partnership following the sale of the Projectco shares. The sale will take place after the project has been completed and sold, but before profit has been allocated or distributed by the partnership. Typically, the profit will be held by the partnership in the form of cash or a loan to the developer or a related party….
[T]he purchase price for the Projectco shares will exceed the amount by which the value of the assets exceeds the liabilities and the full amount of the latent tax liability of Projectco….
Use of stock dividends to minimize gain to developer (p.12:3-4)
Whether this gain [on the sale of Projectco] is on income or capital account…the developer will seek to minimize [it]…by payment of one or more stock dividends by Projectco in an aggregate amount that will be equal to the purchase price of the Projectco shares less the adjusted cost base (ACB) of the shares, which is assumed to be minimal.
[T]he developer will take the position that the capital gain that would otherwise be realized on the sale of the shares of Projectco at fair market value is attributable to income earned prior to the "safe-income determination time"…
Sale of Projectco on capital account (p. 12:5)
[T]he principle established in the Fraser case [fn 5: Fraser v. Minister of National Revenue, 11964] SCR 657.] should not apply since the sale of the Projectco shares will not be a method of selling the underlying real property—which will already have been substantially or fully sold when the shares are sold under the transaction. For the shares to be considered to be held on income account, it would be necessary to find that the developer was trading or dealing in shares or that the acquisition of the Projectco shares was an adventure in the nature of trade….
VIH indicates Projectco shares are sold for more than FMV (p. 12:6)
[I]n the VIH Logging decision…the Federal Court of Appeal found as a fact based on expert evidence that the fair market value of the shares of the corporation was the fair market value of the assets of the corporation, principally cash, reduced by its liabilities—including the full liability for tax on income arising on the sale of the former assets of the corporation….
Projectco capital gain is attributable to Projectco pre-tax income (p. 12:7)
[W]hile the administrative position of the CRA is clear that the safe income should be reduced by the latent tax, there seems to be little doubt that no portion of the actual capital gain that would have been realized on the sale of the Projectco shares can be attributable to anything other than the pre-tax income of Projectco….
Dubious relevance of stub period accrual (pp. 12:7-8)
[A] typical partnership in which Projectco has an interest will not have reported any income in a prior fiscal period, so Projectco is not required to include a stub period accrual in its income for the taxation year ending on the acquisition of control of Projectco by the purchaser….
[T]he CRA stated in a technical interpretation issued in March 2014 [fn 10: … 2012-0471021E5…] that the amount of partnership safe income attributable to shares of a corporate partner to which the rules in section 34.2 apply should be the adjusted stub period accrual for the year. This is a substantial change from the CRA's former position that the safe income of a corporate partner should include the partner's share of the income of the partnership for the period ending at the safe-income determination time. [fn 11: … 2007-0243151C6…] While some may question whether this former position is supported by case law, [fn 12: See, for example, Canada v. Kruco Inc., 2003 FCA 284] it makes sense to the extent that the income of a partnership contributes to a gain arising on the sale of the shares of a corporate partner….
The CRA's March 2014 technical interpretation takes the position that the stub period accrual rules, where applicable, in effect constitute a code for the determination of income attributable to a corporate partner's interest in a partnership. The method for determining the adjusted stub period accrual is not based on income earned by the partnership for the portion of the fiscal period up to the safe-income determination time. Instead, it is based on income earned in a preceding fiscal period. While the rules in section 55 are somewhat artificial, it seems that an interpretation that achieves a result more in keeping with the economic situation of Projectco—that is, the accrual of income actually earned during the stub period—should be preferred….
[I]n VIH Logging… Woods J recognized that permitting the inclusion of stub period income is an unusual interpretation of paragraph 55(3)(c), which deems income earned and realized for a period to be the taxpayer's income as determined under the Act for the period; however, it was seen as "the only reasonable interpretation." It is equally reasonable to include stub period income earned or realized by a partnership of which a corporation is a partner in the corporate partner's safe income. One may reasonably ask whether this interpretation is in accordance with the provisions of paragraph 55(5)(a). That paragraph deems the portion of a capital gain attributable to income expected to be earned or realized to be a capital gain attributable to anything other than income, and consequently, deemed to be a capital gain under subsection 55(2)….[I]n a seminal 1981 paper, John Robertson noted that at least one of the purposes of the provision was to preclude an argument that a valuation based on a multiple of current income is based on income earned or realized.15 Such future earnings will not have been "earned or realized" in any normal sense. In the case of stub period income of a partnership, the income has been "earned or realized" but has not yet been allocated to a corporate partner.
[t]he amount of sale income of Projectco will include any income arising from the sale of units occurring before the payment of the stock dividend—which dividend will trigger the safe income determination time in respect of the transaction…the result of the application of subsection 52(3)—that is, the creation of" cost in the stock dividend shares—is not confined to subdivision c and will apply for all purposes of the Act…
Effect of latent tax liability on safe income and cost of stock dividends (pp. 12:10-11)
[T]he cost of the stock dividend shares is effectively limited to Projectco's safe income on hand. As discussed previously, the amount of safe income will be based on the taxable income of Projectco either with or without a reduction for the latent tax obligation.
If safe income is based on deducting the fall amount of the latent tax liability, the developer's tax basis in the stock dividend shares will depend on the fair market value of the Projectco shares. If, in turn, the determination of fair market value is based on the reasoning in VIH Logging, the portion of the dividend in excess of safe income will not be subject to the provisions of subsection 55(2), but the stock dividend shares will have no basis to the extent of the excess. If the fair market value is found to be the selling price, then the excess will be deemed to be a capital gain under subsection 55(2) and not a dividend. In this case, the excess will form part of the cost of the stock dividend shares. So in either case the developer will realize a capital gain on the amount of the excess, either as a result of the direct application of subsection 55(2) to the stock dividend or as a result of a reduction in ACB on the sale of the shares. However, there is a difference in circumstances in these two cases. In the former case, where the fair market value of the Projectco shares is based on VIH Logging, no capital dividend will arise on the sale of the stock dividend shares. Clause (a)(i)(A) of the definition of "capital dividend account" in subsection 89(1) provides that the amount of a capital gain for the purposes of computing the capital dividend account is to be determined without reference to subparagraph 52(3)(a)(ii), with the result that there is no increase in capital gain in computing the capital dividend account for tax-deductible stock dividends that are not attributed to safe income and would otherwise reduce ACB. In the latter case, the amount of the excess is deemed to be a capital gain under subsection 55(2) (and does not reduce ACB) because it is not deductible under subsection 112(1) and creates an addition to the capital dividend account.
…[I]f safe income is not based on the deduction of the full amount of the latent tax liability…the cost of the stock dividend shares will be different. If the fair market value of the Projectco shares is not based on VIH Logging, the developer should have full basis in the stock dividend shares because the full fair market value of the shares will be attributable to safe income . If the VIH Logging reasoning applies, the result is not clear. However, it might still be argued that the full amount of the dividend, including the excess over fair market value, is not subject to subsection 55(2) because it is attributable to safe income. The excess may not be subject to subsection 55(2) because it does not reduce the capital gain on a disposition at fair market value, but that does not mean that the excess is also not subject to subsection 55(2) because it is attributable to safe income….
K. A. Siobhan Monaghan, Taxation of Corporate Reorganizations, Chapter 8: Capital Gains Strips and Divisive Reorganizations," (2010, Carswell).
Rick McLean, Understanding Section 55 and Butterfly Reorganizations, 3rd Ed. (2010, CCH).
Matt MacInnis, "Pandora's Box Reopened", CA Magazine, September 2008, p. 48.
Steve Suarez, Firoz Ahmed, "Public Company Non-Butterfly Spinouts", 2003 Conference Report, c. 32.
F. Ahmed, "Allocation of Safe Income to Minority Shareholders", Canadian Current Tax, Vol. 9, No. 3, p. 24.
D. Ewens, "Planning for Safe Income Distribution", Corporate Structures and Groups, Vol. IV, No. 4, 1997, p. 228
Care must be taken when planning for providing a s. 88(1)(d) bump to a purchaser to ensure that safe income distributions are not counter productive.
"Subsection 55(2): Part 1", 1997 Canadian Tax Journal, Vol. 45, No. 2, p. 343.
Hiltz, "Income Earned or Realized: Some Reflections", 1991 Conference Report, c. 15.
Richter, "The Removal of Accrued Gains and Capital Stockholdings through the Use of 'Safe Income'", 1991 Canadian Tax Journal, p. 1349.
Paragraph 55(2)(c)
Administrative Policy
31 August 2011 T.I. 2011-041589 -
CRA will construe paragraph 55(2)(c) so that the amount deemed not to be a dividend is not taxed as a capital gain twice. Paragraph 55(2)(c) will be applied in the year of the increase of the stated capital of the shares; when the shares are sold, the capital gain will be reduced by the amount already included in income pursuant to paragraph 55(2)(c).
Subsection 55(3) - Application
Paragraph 55(3)(a)
Administrative Policy
2015 Ruling 2014-0559181R3 - Internal Reorganization
Current Structure
Parentco (a subsidiary wholly-owned corporation of Ultimate Parentco, which is a listed public corporation) holds all of the common shares of Aco (a CBCA holding corporation), which wholly owns Bco, Cco, Dco and Eco. Bco has four business divisions (Divisions 1, 2, 3 and 4) carried on directly or through subsidiaries.
Proposed transactions
Bco will spin-off Divisions 1, 2 and 3 to what apparently are newly-incorporated subsidiaries of Aco (Cco, Dco and Eco, respectively), using essentially the same spin-off mechanics. For example, under the spin-off to Cco:
- Bco will transfer the Division 1 assets to Cco in consideration for preferred shares, electing under s. 85(1).
- Aco will transfer a proportion of its common shares of Bco (having a fair market value equal to that of the preferred shares issued in 1 to Cco in consideration for Cco common shares, electing under s. 85(1).
- Bco will purchase for cancellation its common shares held by Cco in consideration for issuing a non-interest bearing demand note, with the resulting deemed dividend designated as an eligible dividend.
- Cco will redeem the preferred shares held by Bco in consideration for issuing a non-interest bearing demand note, with the resulting deemed dividend designated as an eligible dividend.
- The two notes will be set off.
Additional information
(transactions kept mum).
Management…has no reason to believe that any person holding, owning or exercising control or direction over any of the shares of the capital stock of Ultimate Parentco is aware of the Proposed Transactions. … [or that the] Proposed Transactions… will have any material impact on the trading price of the shares of the capital stock of Ultimate Parentco or the value of the options held by the Optionholders.
Rulings
Including that "the Proposed Transactions, in and by themselves, will not be considered to result in any disposition of property to, or increase in interest by, an unrelated person described in any of subparagraphs 55(3)(a)(i) to (v)."
14 April 2015 T.I. 2015-0570021E5 F - Présomption de gain en capital
S. 55(3.01)(g) generally permitted two unrelated individuals to spin-off real estate from a jointly owned Opco to a newly-incorporated jointly-owned Realtyco, provided that they first interposed a holding company between themselves and their two companies (Opco and Realtyco), so that s. 55(3)(a)(ii) did not apply to the acquisition of their investment in the holdco. See summary under s. 55(3.01)(g).
11 February 2015 T.I. 2014-0557251E5 F - paragraph 110.1(1)c) and clause 55(3)(a)(i)(B)
In the course of a series of transactions including the redemption of shares subject to s. 84(3), a corporation made a gift of cultural property to an unrelated person with the resulting gain being exempted under s. 39(1)(a)(i.1), claimed a deduction for the eligible amount of the gift under s. 110.1(1)(c) and did not elect under s. 110.1(3) to reduce its deemed proceeds. Would it be considered to have disposed of the property for its fair market value for purposes of s. 55(3)(a)(i)(B)? CRA responded (TaxInterpretations translation):
[I]f subparagraph 69(1)(b)(ii) applies to a gift, the CRA will consider, for purposes of caluse subparagraph 55(3)(a)(i)(B), that there has been a disposition of property made for proceeds not less than its fair market value. In such a case, this disposition will not be considered to be an event contemplated under subparagraph 55(3)(a)(i).
10 October 2014 APFF Roundtable Q. 16, 2014-0538031C6
Facts
The exception in s. 55(3)(a) would not be available where a new corporation was created in the series. Consider this example:
- Husband, Wife and (unrelated) Third Party each subscribe for 1/3 of the voting common shares of newly-incorporated Realtyco.
- They transfer equal portions of their current equal shareholdings of Opco to Realtyco under s. 85(1) in consideration for preferred shares of equivalent fair market value.
- Opco transfers realty to Realtyco under s. 85(1) in consideration for preferred shares of equivalent FMV.
- The cross-shareholdings between Opco and Realtyco are redeemed for notes, thereby giving rise to deemed dividends.
- The notes are set-off.
Questions
Does s. 55(2) not apply in light of s. 55(3.01)(g)(v)? Would this change if before Step 1 Husband and Wife incorporated Holdco and they and Third Party rolled all their Opco shares into Holdco before Holdco (rather than they) proceeds with Steps 1 to 5?
1st Scenario
In finding that the s. 55(3)(a) exception was not available for the deemed dividends arising in Step 4 under the first Scenario, CRA first indicated (TaxInterpretations translation):
Respecting the issuance of shares on an incorporation…prior to the first issuance…the incorporator controls [the corporation] and consequently…he will be considered as being related to that corporation before the first issuance of shares. …[T]he initial subscriptions by Husband and Wife (the incorporators) would not result in an increase in interest described by subparagraphs 55(3)(a)(iii) to (v).
CRA noted:
- The initial subscription for Realtyco shares by Third Party would resulted in a s. 55(3)(a)(ii) increase as Third Party was unrelated to the dividend recipients (Opco and Realtyco) as well as s. 55(3)(a)(v) increase of Third Party relevant to the deemed dividend paid by Realtyco to Opco.
- Third Party also would have a s. 55(3)(a)(ii increase of interest from its transfer of Opco shares to Realtyco for preferred shares (Step 2), as well as when the cross-shareholdings were redeemed (Step 4).
CRA then stated:
Furthermore, as regards the dividend deemed to be received by Opco, an increase in interest of Third Party described in subparagraph 55(3)(a)(v) would result from the transfer of the shares of Opco by Third Party to Realtyco in consideration for preferred shares in the capital of Realtyco, as well as on the redemption of the preferred shares in the capital of Realtyco held by Opco. Finally, on the purchase for cancellation of the shares in the capital of Opco held by Realtyco, Third Party increased its interest in Opco, which is a particular described in subparagraph 55(3)(a)(v) regarding the dividend deemed to be received by Realtyco.
Because paragraph 55(3.01)(g) does not exclude an increase in interest described in subparagraph 55(3)(a)(v), the dividend recipients, Opco and Realtyco, would be unable to utilize the exception…provided in paragraph 55(3)(a). ... [In any event] the condition provided in subpargraph 55(3.01)(g)(v) would not be satisfied as the shares of the recipients of the dividends, Opco and Realtyco, were held by individuals at the moment of receipt of the dividends.
2nd Scenario
Respecting the second Scenario, CRA assumed that Holdco and Realtyco were incorporated by Husband or Wife, so that Holdco was related to Realtyco and Opco, and Husband and Wife were related to Realtyco, and that the original investment of Third Party in Opco was not part of the same series of transactions as the receipt of the dividends in Step 4.
CRA then stated:
The disposition of the shares … of Opco by Husband, Wife and Third Party to Holdco would not result in a disposition described in subparagraph 55(3)(a)(i), (ii) or (v) as, immediately before the disposition, Holdco would be related to Opco and Realtyco, the dividend recipients.
However, the investment of Third Party in Holdco … would result in an increase in interest described in subparagraph 55(3)(a)(ii) as Third Party would be…unrelated to Opco and Realtyco, the dividend recipients.
Finally, the investment of Holdco in Opco…would not constitute an increase in interest described in subparagraph 55(3)(a)(ii) and (v) as … Holdco would be related to Opco and Realtyco immediately before the transfer of the shares.
…[T]he "particular corporation" [under s. 55(3.01)(g)] would be Holdco. …[T]he increase in interest of Third Party in Holdco described in subparagraph 55(3)(a)(ii) would be deemed not to be described in that subparagraph [by s. 55(3.01)(g)].
...[T]he other transactions of the series…would occur between persons related to the dividend recipients since Holdco would control both Opco and Realtyco.
Consequently, based on paragraph 55(3.01)(g)…it is possible that Opco and Realtyco could utilize the exception to the application of subsection 55(2) provided in paragraph 55(3)(a).
...[However] it would be important that the transactions respecting the formation of Holdco and Realtyco (the dividend recipients) be properly effected. …For example, the disposition of the shares of Opco by Husband, Wife and Third Party to Holdco could technically be described by subparagraphs 55(3)(a)(iii) and (v) respecting the dividend deemed to be received by Realtyco. In effect, immediately before the disposition, Holdco would be considered to not be related to Realtyco if the latter did not exist at that moment.
2014 Ruling 2013-0505431R3 - XXXXXXXXXX
Existing structure
Pubco, a CBCA public corporation, and Subco, its wholly-owned CBCA corporation, are partners, along with GPCo (also wholly-owned by Pubco), of Partnership D. Partnership D has a royalty which represents an interest in XX% of the net profits from the production from a specified property of two other partnerships (Partnership E and LP) and from other cash flows generated in Partnership E (the "Royalty"). The net profits are computed by reference to XX% of the interest that Partnership E owns in a specified property and by reference to XX% of the interest in LP of Partnership E. Subco and XX are members of Partnership B, and Pubco, Subco and Partnership B are members of Partnership H. Partnerships D, B and H are general partnerships.
Proposed transactions
- All the issued shares of Subco will be exchanged by Pubco under s. 86 for one new common share and one new preferred share.
- Pubco will acquire an undivided percentage interest in the Royalty from Partnership D in consideration for the issuance of a demand promissory note (the "Royalty Purchase Note"), with the proceeds being allocated by Partnership D to its partners (Subco and Pubco.)
- Subco will transfer its interests in Partnerships D and H and other "Distributed Assets" to a newly-incorporated subsidiary of Pubco (Newco 1) in consideration for redeemable preferred shares of Newco 1 with a price adjustment clause and with a s. 85(1) election made.
- Newco 1 will redeem such preferred shares for the Newco 1 Note (also subject to a price adjustment clause), and with a contemporaneous notice that the deemed dividend is an eligible dividend.
- Subco will redeem the preferred share issued to Pubco in 1 in consideration for transferring the Newco 1 Note and for issuing a further Note, with a contemporaneous eligible dividend notice.
- Newco 1 will then be wound-up into Pubco. Pubco will elect to have s. 80.01(4) apply to the resulting settlement of the Newco 1 Note.
- Pubco will transfer its undivided interest in the Royalty to Partnership D as a contribution to its capital, with a s. 97(2) election being made.
- Partnership B will transfer its interest in Partnership H and certain shares to a newly-incorporated subsidiary of Pubco (Newco 2) in consideration for redeemable preferred shares of Newco 2 with a price adjustment clause and with a s. 85(2) election made.
- Newco 2 will redeem such preferred shares for the Newco 2 Note (also subject to a price adjustment clause), with a contemporaneous eligible dividend notice.
- Newco 2 will then be wound-up into Pubco, with the obligation to pay the Newco 2 Note assumed by Pubco. Newco 2 will be dissolved, but not before XX months have elapsed.
- After Partnership B's next year-end, Partnership B will distribute the Newco 2 Note to Subco and XX, reducing the ACB of their partnership interests by virtue of s. 53(2)(c)(v) of the Act.
- XX will then distribute to Subco its portion of the Newco 2 Note and the Newco 2 Note owed to Subco will be set-off against the XX Note.
- The Royalty Purchase Note (owing by Pubco to Subco) will be repaid in the ordinary course.
Trading in Pubco shares
27. Dispositions and acquisitions of Pubco shares by members of the public will occur during the same time frame as the Proposed Transactions in the ordinary course of public trading of those shares on the stock exchanges on which they are listed. Dispositions and acquisitions of Pubco shares may also occur by virtue of the exercise of employee stock options or through employee participation and other employee incentive plans. The Proposed Transactions do not, in any manner, facilitate any acquisition or disposition of Pubco's shares as described in this paragraph and are not undertaken with such trading in Pubco shares in mind but, rather, are purely internal transactions.
Purposes
The reorganization, by bringing principal revenue sources together in Pubco (which incurs head office and financing costs), will match operating income with related expenses, and will help Pubco to effect an income tax consolidation within Canada and move some of Subco's CCDE balances to it.
Rulings
Include:
S. 55(2) will not apply to the deemed dividends arising in 4, 5 and 9 above provided that there is not a disposition of property or an increase in interest described in any of ss. 55(3)(a)(i) to (v) which is part of the series of transactions or events that includes the proposed transactions (which, by themselves, will not be considered to result in such a disposition or increase in interest.). "For greater certainty, a disposition of a partnership interest in Partnership B to an unrelated person that is undertaken as part of the series of transactions or events that includes the Proposed Transactions will result in the taxable dividend referred to [above]… being subject to the provisions of subsection 55(2).
25 April 2014 T.I. 2014-0528011E5 F - Subsection 55(2) - redemption of shares
A and B each is the sole shareholder of Holdco 1 and Holdco 2, respectively, which each holds 50% of the voting common share of Opco as well as 50% of the voting common shares of Quebeco 1. A and B also each hold 50% of the voting common shares of Quebeco 2. Quebeco 1 holds preferred shares of Quebeco 2 with a redemption amount of $1 million and nominal paid-up capital.
Opco incorporates Quebeco 3 and holds all the voting common shares. Quebeco 2 transfers real property with a fair market value of $100,000 and a nominal cost amount to Quebeco 3 under s. 85(1) in consideration for $100,000 of preferred shares.
Quebeco 3 subsequently redeems the preferred shares held by Quebeco 2 for $100,000 and Quebeco 2 redeems for $1 million the preferred shares held by Quebeco 1.
In finding that s. 55(3)(a)(ii) or (v) could apply to the redemption by Quebeco 2, CRA stated (TaxInterpretations translation):
A or B…would not be related to the recipient of the dividend, Quebeco 1. Furthermore, any increase in the direct interest of A or B in Quebeco 2 would result from the disposition of shares… of Quebeco 2 by Quebeco 1 for proceeds of disposition less than fair market value by reason of the application of paragraph (j) of the definition of "proceeds of disposition" in section 54… . Therefore, the question becomes whether the direct interest of A and B in Quebeco 2 increases significantly… .
CRA then adverted to a discussion earlier in the letter of "significant increase," including quoting 9725615 and indicating that there would need to be a before and after comparison of the percentage intest of A and B in the shares of Quebeco 2.
Respecting the redemption by Quebeco 3, s. 55(3)(a)(ii) could apply if it occurred as part of the same series as the redemption by Quebeco 2 and the latter redemption resulted in a significant increase, as discussed above.
3 January 2014 T.I. 2013-0514021E5 F - Subsection 55(2) - redemption of shares
Structure
Holdco is controlled by Father through his holding of special voting shares, and its equity is held by his three children (C-1, C-2 and C-3) and the C-1, C-2 and C-3 Trusts. Holdco holds 47.5% of the common shares of Opco and 50% of its Class D preferred shares, along with special voting shares giving it voting control of Opco. HoldcoC3, which is controlled by C-3 and owned by C-3 and the C-3 Trust, holds the other 50% of Opco's Class D preferred shares as well as 47.5% of its common shares. C-3 holds Class C preferred shares of Opco directly (whose number is 25% of the number of Class D preferred shares). Nephew Inc., which is wholly-owned by the son of C-1, holds 5% of the common shares of Opco.
Questions
Would the exemption in s. 55(3)(a) apply to the redemption by Opco of all the Class D preferred shares of Holdco or of HoldcoC3?
Holdco redemption
Respecting the Holdco redemption, CRA stated (TaxInterpretations translation) in finding that the "triggers" in ss. 55(3)(a)(ii) and (v) did not apply:
Despite the increase in the interest of Nephew Inc., HoldcoC3 and C-3 resulting from the redemption of the Class D shares of Opco held by Holdco, Nephew Inc., HoldcoC3 and C-3 were all related to the dividend recipient, Holdco, immediately before such increase by virtue of subparagraphs 251(2)(b)(iii) and 251(2)(c)(ii). … Our conclusion would be the same if the transactions respecting a free of Opco to introduce the nephew were part of the [same ] series…as Nephew Inc. was related to Holdco…by virtue of [those provisions].
HoldcoC3 redemption
Here, CRA noted that the triggers in s. 55(3)(a)(ii) and (v) would apply, as Nephew Inc. was not related to the deemed dividend recipient (HoldcoC3), unless the increase in interest of Nephew Inc. was not significant. After quoting 9725615 as to the meaning of "significant," CRA noted that an "increase in interest of only a small percentage ["faible pourcentage"] could be considered by the CRA not to be significant." CRA went on to state:
To the extent that the transactions respecting a freeze of Opco to introduce Nephew were part of a series of operations which included the dividend deemed to be received by HoldcoC3…, the acquisition of the Opco common shares by Nephew Inc. could also represent a "triggering" event described in subparagraphs 55(3)(a)(ii) and (v) to the extent that such acquisition resulted in a "significant" increase in the interest of Nephew Inc. in Opco… .
2013 Ruling 2013-0501811R3 - Internal Reorganization - 55(3)(a)
Starting structure
Aco, Bco and Cco are wholly-owned Canadian subsidiaries of non-resident holding companies, namely, ParentAco, ParentBco and ParentCco, except that shares of Cco also are held by Bco, namely, non-voting redeemable and retractable Class B Preferred Shares with a paid-up capital and adjusted cost base lower than their redemption amount. ParentAco, ParentBco and ParentCco are direct or indirect subsidiaries of a non-resident public corporation (Pubco).
Proposed transactions
:
- ParentAco will sell all the Aco shares to ParentCco for fair market value cash consideration.
- Cco will redeem the Class B Preferred Shares for cash.
- Bco will make a cash distribution to ParentBco, first as a PUC distribution, and next as a dividend.
- Cco will acquire all the Aco shares from ParentCco for FMV consideration comprising cash (in excess of the PUC of the Aco shares so that a deemed dividend arises under s. 212.1) and a common share with full stated capital (but whose PUC is ground to nil under s. 212.1(1)(b).)
- Cco will use borrowed money to pay a dividend to ParentCco (subject to Treaty-reduced withholding).
Additional information re s. 55(3)(a)
- No person/group has direction over more than X% of Pubco's shares.
- More than 10% of the FMV of Pubco's shares is derived from the shares of Cco and [of] Bco.
- The proceeds received in 1, 3, 4 and 5 will be used for general business purposes and not distributed up to the shareholders of Pubco.
- "Management is not aware and has no reason to believe[,] that any person holding, owning or exercising control or direction over any of the shares of the capital stock of Pubco is aware of the Proposed Transactions;" nor will they be publicly disclosed; nor does management have any reason to believe they will have any material impact on the Pubco share trading price.
- No party intends as part of the series "to dispose of any property to, or to increase any interest in any corporation of any person or partnership that is an unrelated person to Bco, in any of the ways described in subparagraphs 55(3)(a)(i) to (v)."
Rulings
: Including that "the Proposed Transactions, in and by themselves, will not be considered to result in any disposition to, or increase in interest by, an unrelated person described in subparagraphs 55(3)(a)(i) to (v)."
16 February 2012 T.I. 2012-0435381E5 F
A percentage increase of 1.28% or 1.33% could be considered not to be significant for purposes of s. 55(3)(a)(ii) or (v).
27 January 2000 T.I. 1999-000937
The exemption in s. 55(3)(a) would not apply to the payment of a dividend by a holding company that was equally owned by two brothers through their own holding companies, where as part of the same series of transactions 25% of its shares (or 50% in total) were acquired by a holding company owned by each brother's daughter.
1999 APFF Round Table, Q. 15
"The Department considers, however, that there is generally a significant increase in the total direct interest of the common shareholders of a given corporation when preferred shares of the capital stock of the given corporation are redeemed and when these preferred shares were issued in consideration for the common shares of the given corporation's capital stock as part of a reorganization of capital."
3 February 1999 Ruling 971084
Ruling that a normal course issuer bid (which would result in some minority shareholders who do not sell their shares having their percentage interest in the corporation increase) came within the exception in s. 55(3)(a). The "Additional Information" contained a statement that because a holding corporation's interest in the public corporation will be not less than o%, the collective interest of the minority shareholders would not increase by more than o%.
1 December 1998 TEI Conference, Q. XXIII
"In determining whether an increase in interest in a corporation is 'significant' in the context of paragraph 55(3)(a), an analysis of the increase both in terms of an absolute dollar amount and on a percentage basis is required. Whether the dollar amount of the increase is significant depends, in part, on a comparison of the increase in relation to the dollar value of all interests in the corporation. However, we are of the view that a large increase in absolute terms may be significant even if it represents a relatively small portion of the total interests in the corporation. ...
In many situations, there may be no increase in the value of a shareholder's interest in a company as expressed in dollars (for example, where shares owned by another shareholder are redeemed at fair market value); in such circumstances, it is our practice to compare the value of a person's interest in the corporation as a percentage of the value of all interest in the corporation immediately before the cancellation of the shares to the value of that person's interests in the corporation as a percentage of the value of all interests in the corporation immediately after the share cancellation."
7 July 1998 TI 964116
"The issuance of shares does not represent an event described in subparagraph 55(3)(a)(ii)."
3 November 1997 T.I. 9725615 [meaning of "significant"]
"In circumstances where no person has acquired any shares of the corporation in question, it is our view that for the purposes of determining whether there has been 'a significant increase ... in the total direct interest' of an unrelated person in the corporation for purposes of ... subparagraph 55(3)(a)(ii) and (iv) [sic] of the Act that one must compare the value of a person's interest in the corporation as a percentage of the value of all interests in the corporation immediately before the share redemption to the value of that person's interest in the corporation as a percentage of the value of all interests in the corporation immediately after the share redemption." Accordingly, in a situation where a substantial preferred share interest of one shareholder was redeemed, there was a significant increase in the total direct interests of the other unrelated shareholders of the corporation.
1997 Ruling 3-970402 -
Ruling that a substantial issuer bid (effected by way of auction tender) in which a major shareholder of the corporation would have a proportionate number of its shares in the corporation purchased for cancellation and minority shareholders who did not tender to the bid could see their proportionate interest in the corporation increase, came within the exemption in s. 55(3)(a).
29 April 1997 T.I. 5-971115 -
"Where a share whose fair market value exceeds its paid-up capital is redeemed for an amount of cash equal to its fair market value, the disposition of the cash to the shareholder on the redemption will ordinarily be described in one or both of clauses 55(3)(a)(i)(A) and (B)."
1996 Ontario Tax Conference Round Table, "Creditor Protection and Butterfly Transactions", 1997 Canadian Tax Journal, Vol. 45, No. 1, pp. 214-215
After it was noted that the exception in s. 55(3)(a) would apply where two individuals hold their investment in Opco through Holdco, and the assets of Opco are spun off to Newco which is a subsidiary of Holdco, whereas that exception would not apply where the two individuals held Opco and Newco directly, RC noted that in the second situation, if Holdco was formed as part of the same series of transactions, the exemption in s. 55(3)(a) also would not be available.
1996 Corporate Management Tax Conference Report, Q. 15
The related-person test should be applied at the time of the relevant disposition of property or increase of interest.
27 June 1995 T.I. 5-942536
A payment of cash on the purchase for cancellation of common shares held by an estate would be considered to be a disposition of property by the corporation to the estate.
16 September 1992 T.I. (Tax Window, No. 24, p. 16, ¶2196)
A beneficiary holding a contingent beneficial interest in an estate whose property includes a share of a corporation, has an "interest" in that corporation for purposes of s. 55(3)(a)(ii).
10 January 1992 Memorandum (Tax Window, No. 17, p. 16, ¶1773)
Where Mr. A and Mr. B, who each own 50% of the shares of A Ltd. and B Ltd., enter into a shareholders' agreement with respect to their shareholdings in both corporations which include clauses that fall under s. 251(5)(b) (for example, the obligation to buy and sell if one withdraws from the business), the two corporations will be related for purposes of the exemption in s. 55(3)(a), unless s. 55(4) applies.
10 January 1992 Memorandum (Tax Window, No. 17, p. 15, ¶1773)
Where a parent, in order to reduce its debt, instructs its subsidiary to sell properties to a third party and use the cash proceeds to pay a dividend on the common shares or redeem the preferred shares, the resulting dividend or deemed dividend may be subject to s. 55(2).
10 January 1992 Memorandum (Tax Window, No. 17, p. 14, ¶1773)
S.55(2) will apply where one wholly-owned subsidiary of a corporation transfers property to another wholly-owned subsidiary of that parent with unused capital losses ("Lossco"), with a view to Lossco immediately reselling the property at a capital gain.
10 January 1992 Memorandum (Tax Window, No. 17, p. 12, ¶1773)
In order for the exemption in s. 55(3)(a) to apply to a transaction involving a transfer of assets from a corporation owned equally by Messrs. A and B to a second corporation owned equally by them, Mr. A and Mr. B must be acting in concert to control the two corporations not only with respect to the series of transactions in question, but also on a continuing basis.
24 February 1992 Memorandum (Tax Window, No. 13, p. 13, ¶1627)
A participation in a phantom stock plan may represent an interest in a corporation.
19 December 1990 T.I. (Tax Window, Prelim. No. 2, p. 6, ¶1054)
The exemption in s. 55(3)(a) generally will be available in a reorganization undertaken to facilitate the division of family assets on divorce. This represents a reversal of a previous position that the exemption was not available because the series of transactions included the divorce, after which the couple are not related to each other.
19 March 1990 T.I. (August 1990 Access Letter, ¶1371)
A single-wing butterfly reorganization carried out as part of a divorce settlement whereby property ends up owned by the wife's corporation will be off-side because the subsequent divorce occurs as part of the series of transactions.
29 January 1990 T.I. (June 1990 Access Letter, ¶1268)
If at the time of the preliminary transaction the taxpayer has the intention of implementing subsequent transactions, the subsequent transactions would be part of the series even though at the time of the preliminary transaction all the important elements of the subsequent transactions such as the identity of the other taxpayers involved had not been determined, or the taxpayer lacked the ability to implement the subsequent transactions.
3 November 89 T.I. (April 90 Access Letter, ¶1172)
A U.S. corporation has a wholly-owned Canadian operating subsidiary ("Subco 1") and a newly incorporated wholly-owned Canadian subsidiary ("Subco 2"). Part of the business of Subco 1 is transferred to Subco 2 for business reasons and a deemed dividend is received in the course of the reorganization. If the shares of Subco 2 are sold to an arm's length buyer in a transaction that was not part of the original series of transactions, then the fact that the subsequent sale would not have occurred if the reorganization had not taken place does not establish a sufficient causal connection to say that the restructuring "resulted in" the sale. However, if one of the purposes of the restructuring was to make the business division of Subco 1 that was transferred to Subco 2 saleable to potential buyers, then RC likely would consider the restructuring and the ultimate sale to form part of the same series of transactions or events.
1 November 89 T.I. (April 90 Access Letter, ¶1172)
The exemption will not be available where a corporation transfers property to a related corporation under the rollover in s. 85(1), the transferee corporation sold the property to an arm's length party so that its capital gain offsets its capital loss and the transferee corporation then redeems the shares which it had issued to the transferor corporation.
Articles
"https://www.ctf.ca/ctfweb/EN/Newsletters/Canadian_Tax_Focus/2015/3/150311.aspx", Canadian Tax Focus, Volume 5, Number 3, August 2015, p.8.
Accessing new s. 55(3)(a) rules by ensuring that all dividends arise under s. 84(3) (pp. 8-9)
Consider a corporate group comprising Parentco, Parentco's subsidiary Holdco, and Holdco's subsidiary Opco. The group intends to transfer one of Opco's existing business lines to Newco, a new subsidiary of Holdco… . [T]he key goal of the structuring is to ensure that all dividends arise under subsection 84(3),…
Alternative 1
1) Holdco forms Newco.
2) Opco transfers the relevant assets to Newco on a tax-deferred basis pursuant to subsection 85 (1) in exchange for shares of Newco. (Preferred shares rather than common shares are typically used, largely to avoid valuation issues.)
3) Newco redeems the shares transferred to Opco in step 2 in exchange for a note.
4) Opco redeems a portion of its shares (with a value equal to the value of the Opco assets transferred to Newco in step 2) and transfers the Newco note to Holdco as an in-kind redemption payment.
5) Holdco transfers the Newco note to Newco in exchange for shares or as a capital contribution (thereby cancelling the note).
Before the budget, step 4 may have consisted of Opco declaring a dividend in kind of the Newco note to preserve Holdco's ACB of the Opco shares. This is no longer an effective strategy, however, because dividends in kind do not fall under the protective cover of proposed paragraph 55(3)(a).
Alternative using butterfly-style mechanics (p. 9)
Some practitioners might consider another way of implementing the transfer, which differs in steps 3 through 6: …
3) Holdco transfers shares of Opco (with a value equal to the value of the OPco assets transferred to Newco in step 2) to Newco in exchange for shares of Newco on a tax-deferred basis.
4) Newco redeems the shares that it issued to Opco in step 2 and issues a note to Opco as an in-kind redemption payment for the redeemed shares.
5) Opco redeems the shares that Newco received in step 3, and issues a note to Newco as an in-kind redemption payment for the redeemed shares.
6) The notes issued in steps 3 and 4 are offset and cancelled.
General preference for 1st (note-redemption) approach (p.9)
The two alternatives differ in their final outcomes with respect to Holdco's ACB of the Newco shares:
- In alternative 1, the ACB is the FMV of the Newco note (plus the nominal incorporating amount).
- In alternative 2, the ACB is Holdco's ACB of the Opco shares that Holdco transferred to Newco in step 3 (plus the nominal incorporating amount).
The two ACB amounts could be the same, but in most circumstances the first amount will be greater.
Benjamin Alarie, Julia Lockhart, "The Importance of Family Resemblance: Series of Transactions After Copthorne", Canadian Tax Journal (2014) 62:1, 273-99.
Purpose of s. 55(3)(a)(ii) (pp. 96-7)
Subparagraph 55(3)(a)(ii)… seems to have been enacted for the purposes of avoiding a relatively straightforward avoidance technique: rolling an asset that the taxpayer intends to sell to a third party into a newly created subsidiary, having the third party subscribe for shares of the subsidiary, and then having the subsidiary use the subscription proceeds to redeem the shares held by the taxpayer. [fn 91: See generally David Tetreault, "Reorganizations of Private Corporations," in 1991 Ontario Tax Conference (Toronto: Canadian Tax Foundation, 1991), 14:1-166.]
Michael N. Kandev, Abraham Leitner, "Through the Looking Glass: Dividing up a Family Business in a Canada-US Cross-Border Context", 2011 Canadian Tax Journal, Vol 59, No. 4, p. 899: Canada-US cross-border divisions of family operations that are structured under s. 55(3)(a) are generally constrained by the stricter rules of Code section 355.
Firoz Ahmed, "Subsection 55(3) Update", Canadian Current Tax, Vol. 15, No. 8, May 2005, p. 1: CRA's "new position is that the acquisition of shares of a corporation representing less than three percent of the fair market value of the shares of the capital stock of the corporation will not generally result in a significant increase in interest even if the shares have a very high value".
K.A. Siobhan Monaghan, "Doomed (or 'Deemed') to Fail", Corporate Structures and Groups, Vol. V, No. 1, p. 253.
Paragraph 55(3)(b)
See Also
Deuce Holdings Ltd. v. The Queen, 97 DTC 921 (TCC)
With respect to a divisive reorganization which entailed the receipt by the taxpayer both of a cash dividend and a deemed dividend, Bell TCJ. rejected a Crown submission that the cash dividend and deemed dividend should be treated as one dividend for purposes of considering the application of s. 55(3)(b). Accordingly, the transaction entailing the deemed dividend was found to comply with the exemption in s. 55(3)(b).
Administrative Policy
1997 Ruling 971037
Favourable rulings given with respect to public company spin-off transactions.
1996 Corporate Management Tax Conference Round Table, Q. 16
"The '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 of the cross-redemption of shares or winding-up of the distributing corporation."
1996 Corporate Management Tax Conference Round Table, Q. 19 (C.T.O. "Butterflies - Tolerance Levels")
"The word 'approximate' provides limited scope for discrepancies ... . In 1991 we indicated that, for purposes of advance rulings, we are prepared to accept a discrepancy of up to one percent."
1996 Tax Ruling 963488
Favourable ruling given on public company butterfly.
93 C.R. - Q. 13
A distribution to all shareholders that does not include all the assets of a particular type owned by the distributing corporation will not comply with s. 55(3)(b).
11 November 1993 Memorandum (Tax Window, No. 30, p. 3, ¶2482)
Where a corporation (A) is owned equally by three shareholders who deal with one another at arm's length and do not act in concert amalgamates with a wholly-owned subsidiary (B) before a butterfly reorganization of the amalgamated corporation occurs, the exemption in s. 55(3)(b)(ii) would not be available because the shareholders of A do not, as a group, exercise control over A, and the amalgamated corporation, A and B would not be related persons pursuant to s. 251(3.1).
8 April 1993 T.I. (Tax Window, No. 30, p. 19, ¶2502)
An acquisition of property will not normally be considered to have occurred in contemplation of a butterfly reorganization where the acquisition occurred in the ordinary course of the particular corporation's business and would have occurred irrespective whether the butterfly reorganization subsequently occurred, the structure and timing of the acquisition was not affected by butterfly-related considerations, and the acquisition was [not] conditional on completion of the butterfly transactions.
13 January 1993 T.I. 922909 (November 1993 Access Letter, p. 496, ¶C38-180)
Discussion of availability of exemption, and of meaning of "reorganization", where a corporation transfers its shares of a wholly-owned subsidiary ("Subco") to two newly incorporated subsidiary corporations, and Subco then transfers to each of the newly incorporated subsidiaries their pro-rata share of the property of Subco.
25 August 1992 T.I. (Tax Window, No. 23, p. 6, ¶2133)
RC will apply the look-through approach to a general partnership interest but not to a limited partnership interest. Accordingly, where Holdco owns shares of the particular corporation ("Opco") which, in turn, is a general partner in a partnership, and on a butterfly reorganization of Opco, Holdco receives a proportionate share of the partnership interest and then, on a dissolution of the partnership, receives a proportionate distribution of property, the exemption in s. 55(3)(b) will apply provided that the partnership agreement shows that the corporation is a general partner. This would be the case, for example, where the partnership agreement provides that all profits, losses and capital distributions will be allocated proportionately to the partners based on their interest in the general partnership.
The exemption will apply even though some of the butterflied properties is sold by one transferee to another, provided that the property so sold is used in the same business as the other assets acquired by the transferee on the butterfly. The exemption also will apply where there are taxable sales of butterflied property to an arm's length third party, or taxable sales of investment property from one transferee to another unless the result of the taxable sales is that one or more transferees may reasonably be considered to have been wholly or partially cashed out.
Where undivided interests in the property of a particular corporation have been distributed to its shareholders in accordance with s. 55(3)(b), the shareholders are permitted to contribute such property to a general partnership of which they are the only partners in proportion to their respective shareholdings.
Tax Professionals Mini Round Table - Vancouver - Q. 3 (March 1993 Access Letter, p. 101)
Where property of a particular corporation is transferred to a wholly-owned subsidiary of a corporate shareholder, the subsidiary must be wound-up into the corporate shareholder (rather than being left extant, or being amalgamated).
26 November 1992 Memorandum (Tax Window, No. 27, p. 13, ¶2351)
RC's position that property received by a corporation on a winding-up of a partnership prior to the butterfly reorganization will not nullify the application of s. 55(3)(b) is not considered to be inconsistent with its position that a foreign corporation whose shares are owned by a corporate partnership is a foreign affiliate of the partnership and not of the corporate partners.
31 August 1992 Memorandum (Tax Window, No. 24, p. 3, ¶2191)
The use of s. 55(3)(b) to effect a transfer of assets deriving their value principally from real estate in the guise of a treaty-protected share sale was a misuse of the Act within the meaning of s. 245(4).
92 CR - Q.30
A faulty evaluation of distributed assets for purposes of attempting to comply with the requisite proportions set out in s. 55(3)(b) will not be corrected by the operation of a price adjustment clause.
92 C.R. - Q25
Even if the decision in The Queen v. Guaranty Properties, 90 D.T.C 6363 stands for the proposition that an amalgamating corporation does not cease to exist, it does not follow that property transferred by a particular corporation to a shareholder which then amalgamates with its parent will comply with the indirect transfer provisions of s. 55(3)(b).
17 July 1992 T.I. 5-913100
The pro rata test in s. 55(3)(b) will be met if, following the transfer of the required percentage of property by the particular corporation to Newco, the particular corporation is wound-up into its parent corporation.
Harris, "An Update to Revenue Canada's Approach to the Butterfly Reorganization", 1991 Conference Report, c 14.
5 July 1991 Memorandum (Tax Window, No. 5, p. 18, ¶1338)
A favourable ruling will not be given in respect of a partial butterfly unless the ACB of the shares of the particular corporation are reduced by a reasonable amount.
11 April 1991 T.I. (Tax Window, No. 2, p. 19, ¶1199)
GIC's which are current assets capable of reasonably prompt liquidation generally will be considered to be cash or near-cash assets.
27 December 1990 T.I. (Tax Window, Prelim. No. 2, p. 6, ¶1058)
Where on the dissolution of a partnership each partner's share of the distributed property is a proportionate interest in the specific items of property that together constitute the partnership property, no property will have become property of the partner upon the dissolution for purposes of the in-contemplation rule.
19 April 1990 T.I. (September 1990 Access Letter, ¶1416)
Where in contemplation of a transfer of property to its shareholders in a butterfly reorganization a partnership of which the particular corporation is a member is dissolved and an undivided interest in each of its assets is distributed to each of the partners including Opco, the subsequent reorganization will not qualify as a butterfly reorganization even if the property distributed on the butterfly does not include property that was received on the winding-up of the partnership.
Hiltz, "The Butterfly Reorganization
Revenue Canada's Approach", 1989 Conference Report, p. 20:32.
Read, "Section 55
A Review of Current Issues", 1988 Conference Report, c. 18.
89 C.M.TC - Q.16
Real estate used partially in an active business and partially in a specified investment business will generally constitute two types of property.
89 C.M.TC - Q.17
RC will not only rule on a butterfly reorganization carried out on a gross asset basis, but will also accept the net equity method if the conditions in the various papers are met. For purposes of the net equity method, tracking the original use of the borrowed funds generally is not necessary.
87 C.R. - Q.57
The transfer of all one type of property to the shareholders may qualify where the ACB of the shares of the transferor is reduced appropriately.
87 C.R. - Q.56
Although property distributed by way of dividend in a butterfly reorganization is subject to the proportionate sharing rules, preferred shares may be redeemed where they are the only class of shares held by the shareholder and the shares were acquired for cash consideration equal to the fixed redemption price.
ATR-47, February 24, 1992
Description of an estate thaw butterfly entailing the transfer of real estate by the estate freeze corporation to a corporation whose common shares are owned by the fathers.
Hiltz, "Section 55: An Update" 1984 Corporate Management Tax Conference Report, p. 40.
Articles
Firoz Ahmed, "Return of the Somersault", Canadian Current Tax, Vol. 11, No. 1, October 2000, p. 1.
Sider, "Corporate Reorganizations: A Review of a Divestiture", 1993 Conference Report, c. 14
Review of the spin-off of certain divisions of Ocelot Energy Inc.
Robertson, "Capital Gains Strips: A Revenue Canada Perspective on the Provisions of Section 55", 1981 Conference Report, p. 81.
Hausman, "U.S.-Canada Cross-Border Reorganizations", 1990 Canadian Tax Journal, p. 678.
Lemons, Matsuba, Olson, "How U.S. Shareholders Can Avoid the Sting of the Canadian Butterfly", 1991 Canadian Petroleum Tax Journal, Spring 1991, p. 67.
Subsection 55(3.1) - Where paragraph (3)(b) not applicable
Paragraph 55(3.1)(a)
Administrative Policy
2014 Ruling 2014-0528291R3 - Butterfly Reorganization
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
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.
2011 Roundtable Q. , 2011-0399401C6 F
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.
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)
Subparagraph 55(3.1)(b)(i)
Administrative Policy
2014 Ruling 2014-0530961R3 - Cross-Border Butterfly
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.
2013 Ruling 2013-0491651R3 - Cross-Border Butterfly
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.
2012 Ruling 2011-0425441R3 - Cross Border Butterfly
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.
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)
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
2011 Ruling 2010-035706
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.
3 October 2011 T.I. 2011-042134E5 -
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)".
Subsection 55(3.2) - Interpretation of paragraph (3.1)(b)
Paragraph 55(3.2)(h)
Articles
Rick McLean, Canadian Tax Highlights, Vol. 22, No. 5, May 2014, p. 6.
Conventional mechanics for butterfly by foreign Pubco of Canco to foreign Spinco caught by s. 55(3.1)(b)(i) (p. 7)
Pubco incorporates a foreign corporation (Spinco) and transfers the foreign spin business to Spinco in consideration for Spinco shares. Pubco transfers to Spinco (for more Spinco shares) Canco shares whose value relative to all shares of Canco equals the value of the Canadian spin business relative to the value of all Canco's property (transfer 1). Spinco then transfers the Canco shares to a newly incorporated Canadian corporation (Newco) for Newco shares (transfer 2). Canco transfers the Canadian spin business to Newco for Newco preferred shares. Newco and Canco cross-redeem their mutual shareholdings. …Pubco distributes the Spinco shares to its shareholders.
Absent paragraph 55(3.2)(h), paragraph 55(3)(b) applies in this situation if at all times in the series less than 10 percent of the FMV of Spinco shares was derived from shares of Canco or Newco and there is no acquisition of control of Newco as a consequence of the transactions. Under paragraph 55(3.2)(h), however, Spinco is deemed to be a transferee corporation in relation to Canco because at one point during the series (between transfers 1 and 2) Spinco is a shareholder and a specified shareholder of Canco. Thus, Pubco's disposition of its Spinco shares to the public (Pubco's shareholders) is a disposition to persons unrelated to Pubco of shares of a transferee corporation that is described in subclause 55(3.1)(b)(i)(A)(I).
Resolution through use of three-party exchange (p. 7)
[Under] a three-party share exchange… (1) Pubco transfers its Canco shares to Newco (but Newco does not issue shares to Pubco); (2) Newco issues shares to Spinco in consideration for Newco's acquisition of Canco shares; and (3) Spinco issues shares to Pubco in consideration for Spinco's acquisition of shares of Newco. …
Spinco is not a shareholder of Canco at any time in the series, and thus paragraph 55(3.2)(h) does not deem Spinco to be a transferee corporation. Therefore, clause 55(3.1)(b)(i)(A) does not apply when Pubco distributes its Spinco shares to the public (provided that the Spinco shares derive less than 10 percent of their value from Newco or Canco shares at all times during the series).
Three-party exchange is a "permitted exchange" (p. 7)
Moreover, subparagraph 55(3.1)(b)(i) does not apply to the three-party share exchange because the transaction is a "permitted exchange" under paragraph (b) of the definition of that term in subsection 55(1). …
The acquirer is not required to acquire the distributing corporation's shares; it must only be "another corporation."
Janice G. Russell, "Cross-Border Butterfly Ruling", (2011) vol. 19, no. 1 Canadian Tax Highlights, 8-9:
Overview description of 2009-0335441R3 (p.8)
The ruling…includes a foreign corporation's (Forpubco's) distribution to its shareholders, as a dividend in kind, of the shares of another foreign corporation (Forspinco) whose subsidiary (Forspinsub) owns shares of a taxable Canadian corporation (Transfereeco) that is a transferee corporation… .
Avoidance of s. 53(3.2)(h) thorough three-party agreement (p. 8)
The ruling's three-party agreement is the primary means for Forspinsub to acquire shares of Transfereeco without either Forspinsub or its parent, Forspinco, ever being a shareholder of Distributingco, the distributing corporation… . Forspinco is thus not deemed to be a transferee corporation under paragraph 55(3.2)(h): if either it or its parent is so deemed, the butterfly exception is denied when Forpubco distributes its Forspinco shares to the public.
Description of three-party agreement (pp. 8-9)
Forpubco transfers its Distributingco special shares to Transfereeco, which pays for them by issuing common shares to Forspinsub, which in payment therefor issues common shares to Forpubco, which in turn pays for the Forspinsub common shares by transferring the Distributingco special shares to Transfereeco. ...The ruling confirms that the paragraph 55 (3)(b) butterfly exception applies to the dividends arising on the cross-redemption of the Distributingco and Transfereeco shares, apparently on the basis of a conclusion that the three -party share exchange is a permitted exchange (subsection 55 (1)) and that paragraphs 55 (3.1)(b) and 55 (3.2 )(h ), read together, do not deny the butterfly exception.
Permitted exchange (p. 9)
A permitted exchange in relation to a distribution by a distributing corporation includes an exchange of its shares by one or more of its shareholders (a participant, Forpubco) for shares of another corporation (an acquiror, Forspinsub) in contemplation of the distribution, where no share of the acquiror (Forspinsub) outstanding immediately after the exchange is then owned by any person or partnership other than a participant (Forpubco) and a pro rata shareholding requirement is met. On the ruling's facts, the pro rata shareholding requirement is met because immediately before the distributed assets' distribution the FMV of Forpubco's common shareholding in Forspinsub equals the amount determined by the formula in subparagraph (b)(iii) of the "permitted exchange" definition.
Kila, Williamson, "Section 55 Case Study: Impact of Proposed Paragraph 55(3.2)(h) on a Cross-Border Spin-off Transaction", Corporate Structures and Groups, Vol. IV, No. 2, 1997, p. 203.
Marc N. Ton-That, Serge Bilodeau, "Breaking Up Is Hard To Do", 96 Conference Report (CTF), p.11:51
Blackmail potential (p. 11:51
The application of paragraph 55(3.2)(h ) for the purposes of subparagraph 55(3.1)(b) could expose a distributing corporation to blackmail. If a corporation does not want a distributing corporation to butterfly its assets, it only needs to acquire 10 percent of the distributing corporation and claim that the acquisition is made in contemplation of the butterfly.
At any time in series (p. 11:51)
Paragraph 55(3.2)(h ) also applies for the purposes of subparagraph 55(3.1)(b) . Paragraph 55(3.2)(h ) deems a corporation to be a transferee if the corporation was a shareholder and a specified shareholder of the distributing corporation at any time in the series. For example, a specified shareholder, Holdco, holds 10 percent of the shares of a distributing corporation, DC. The value of the DC shares represents only 0.1 percent of the value of Holdco. If, prior to the butterfly, Holdco transferred all the shares of DC to a transferee on a permitted exchange, Holdco is not in fact a transferee. If paragraph 55(3.2)(h ) was not introduced, a disposition of shares of Holdco by its specified shareholders would not be subject to subparagraph 55(3.1)(b)(i) because the shares of Holdco do not meet the test under subclause 55(3.1)(b) and the vendor would not be a specified shareholder of DC or of the transferee. With the introduction of paragraph 55(3.2)(h ), the sale of the shares of Holdco is subject to subparagraph 55(3.1)(b)(i), since Holdco is deemed to be a transferee and the specified shareholders of Holdco are also considered to be specified shareholders of a transferee corporation—that is, Holdco.
Paragraph 55(3.01)(g)
Administrative Policy
14 April 2015 T.I. 2015-0570021E5 F - Présomption de gain en capital
After referring to the CRA response to Q. 14(b) [16(b) below?] at the 2014 APFF Roundtable including the caution provided, the questioner referred to a situation where two unrelated individuals (A and B) are equal shareholders of Opco.
- A and B incorporate Holdco, Holdco incorporates Realtyco and A and B transfer their Opco shares to Holdco under s. 85(1).
- Holdco transfers part of its shares of Opco, having a value equal to that of the real estate, to Realtyco under s. 85(1).
- Opco transfer the real estate to Realtyco in consideration for preferred shares of equal value, electing under s. 85(1).
- Opco purchases for cancellation its shares held by Realtyco for a note.
- Realtyco redeems its preferred shares held by Opco for a note.
- The notes are set off.
Does s. 55(2) not apply in light of s. 55(3.01)(g)? CRA responded (TaxInterpretations translation):
The increase in the interest of A and B in Holdco resulting from the transfer of shares in the capital of Opco would be an increase described in subparagraph 55(3)(a)(ii) since neither A nor B would be related to Opco and Realtyco, the dividend recipients. However, these increases in interest could ["pourraient"] be excluded by virtue of paragraph 55(3.01) (g). For purposes of paragraph 55(3.01) (g), Holdco would be the "particular corporation." On this basis, the conditions provided in subparagraphs paragraph 55(3.01) (g)(i) to (v) would be satisfied and, consequently, the increase in the interest of A and B in Holdco, otherwise described in subparagraph 55(3)(a)(ii), would be deemed not to be described in that subparagraph.
Consequently…it is possible that Opco and Realtyco could access the exception to the application of subsection 55(2) provided in paragraph 55(3)(a)… .
…[I]f one or other of the equity investments of A and B in Opco were considered to be made as part of a series of transactions in the course of which the dividends were received by Opco and Realtyco… paragraph 55(3.01)(g) would not apply to the increase in interest described in subparagraph 55(3)(a)(v). Consequently, Realtyco could not utilize the exception to the application of subsection 55(2) provided in paragraph 55(3)(a).
10 October 2014 APFF Roundtable Q. 16, 2014-0538031C6
Facts
The exception in s. 55(3)(a) would not be available where a new corporation was created in the series. Consider this example:
- Husband, Wife and (unrelated) Third Party each subscribe for 1/3 of the voting common shares of newly-incorporated Realtyco.
- They transfer equal portions of their current equal shareholdings of Opco to Realtyco under s. 85(1) in consideration for preferred shares of equivalent fair market value.
- Opco transfers realty to Realtyco under s. 85(1) in consideration for preferred shares of equivalent FMV.
- The cross-shareholdings between Opco and Realtyco are redeemed for notes, thereby giving rise to deemed dividends.
- The notes are set-off.
Questions
Does s. 55(2) not apply in light of s. 55(3.01)(g)(v)? Would this change if before Step 1 Husband and Wife incorporated Holdco and they and Third Party rolled all their Opco shares into Holdco before Holdco (rather than they) proceeds with Steps 1 to 5?
1st Scenario
In finding that the s. 55(3)(a) exception was not available for the deemed dividends arising in Step 4 under the first Scenario, CRA first indicated (TaxInterpretations translation):
Respecting the issuance of shares on an incorporation…prior to the first issuance…the incorporator controls [the corporation] and consequently…he will be considered as being related to that corporation before the first issuance of shares. …[T]he initial subscriptions by Husband and Wife (the incorporators) would not result in an increase in interest described by subparagraphs 55(3)(a)(iii) to (v).
CRA noted:
- The initial subscription for Realtyco shares by Third Party would resulted in a s. 55(3)(a)(ii) increase as Third Party was unrelated to the dividend recipients (Opco and Realtyco) as well as s. 55(3)(a)(v) increase of Third Party relevant to the deemed dividend paid by Realtyco to Opco.
- Third Party also would have a s. 55(3)(a)(ii increase of interest from its transfer of Opco shares to Realtyco for preferred shares (Step 2), as well as when the cross-shareholdings were redeemed (Step 4).
CRA then stated:
Furthermore, as regards the dividend deemed to be received by Opco, an increase in interest of Third Party described in subparagraph 55(3)(a)(v) would result from the transfer of the shares of Opco by Third Party to Realtyco in consideration for preferred shares in the capital of Realtyco, as well as on the redemption of the preferred shares in the capital of Realtyco held by Opco. Finally, on the purchase for cancellation of the shares in the capital of Opco held by Realtyco, Third Party increased its interest in Opco, which is a particular described in subparagraph 55(3)(a)(v) regarding the dividend deemed to be received by Realtyco.
Because paragraph 55(3.01)(g) does not exclude an increase in interest described in subparagraph 55(3)(a)(v), the dividend recipients, Opco and Realtyco, would be unable to utilize the exception…provided in paragraph 55(3)(a). ... [In any event] the condition provided in subpargraph 55(3.01)(g)(v) would not be satisfied as the shares of the recipients of the dividends, Opco and Realtyco, were held by individuals at the moment of receipt of the dividends.
2nd Scenario
Respecting the second Scenario, CRA assumed that Holdco and Realtyco were incorporated by Husband or Wife, so that Holdco was related to Realtyco and Opco, and Husband and Wife were related to Realtyco, and that the original investment of Third Party in Opco was not part of the same series of transactions as the receipt of the dividends in Step 4.
CRA then stated:
The disposition of the shares … of Opco by Husband, Wife and Third Party to Holdco would not result in a disposition described in subparagraph 55(3)(a)(i), (ii) or (v) as, immediately before the disposition, Holdco would be related to Opco and Realtyco, the dividend recipients.
However, the investment of Third Party in Holdco … would result in an increase in interest described in subparagraph 55(3)(a)(ii) as Third Party would be…unrelated to Opco and Realtyco, the dividend recipients.
Finally, the investment of Holdco in Opco…would not constitute an increase in interest described in subparagraph 55(3)(a)(ii) and (v) as … Holdco would be related to Opco and Realtyco immediately before the transfer of the shares.
…[T]he "particular corporation" [under s. 55(3.01)(g)] would be Holdco. …[T]he increase in interest of Third Party in Holdco described in subparagraph 55(3)(a)(ii) would be deemed not to be described in that subparagraph [by s. 55(3.01)(g)].
...[T]he other transactions of the series…would occur between persons related to the dividend recipients since Holdco would control both Opco and Realtyco.
Consequently, based on paragraph 55(3.01)(g)…it is possible that Opco and Realtyco could utilize the exception to the application of subsection 55(2) provided in paragraph 55(3)(a).
...[However] it would be important that the transactions respecting the formation of Holdco and Realtyco (the dividend recipients) be properly effected. …For example, the disposition of the shares of Opco by Husband, Wife and Third Party to Holdco could technically be described by subparagraphs 55(3)(a)(iii) and (v) respecting the dividend deemed to be received by Realtyco. In effect, immediately before the disposition, Holdco would be considered to not be related to Realtyco if the latter did not exist at that moment.
Subsection 55(4) - Avoidance of subsection (2)
See Also
H.T. Hoy Holdings Ltd. v. The Queen, 97 DTC 1180 (TCC)
An arrangement under which the taxpayer maintained control of a company that it effectively had sold to a purchaser until all the taxpayer's shares were redeemed was found to be an arrangement that was structured to circumvent the application of s. 55(2) and, therefore, to be covered by s. 55(4).
Administrative Policy
2011 Roundtable Q. , 2011-0399401C6 F
CRA has accepted that the s. 55(3)(a) exemption may apply where the share ownership includes siblings, as long as the presence of their parents as shareholders allows the s. 55(3)(a) exemption to apply. However, this exemption will not be available under s. 55(4) where ;one of the purposes of the transactions was to cause persons to be related or a corporation to control a corporation so that s. 55(2) did not apply.
Articles
Michael N. Kandev, Abraham Leitner, "Through the Looking Glass: Dividing up a Family Business in a Canada-US Cross-Border Context", Selected US Developments, 2011 Canadian Tax Journal, Vol 59, No. 4, p. 899
CRA has indicated that s. 55(4) should not apply where the parent retains control of the corporate group in order to continue being involved in the management of the underlying business and in order to protect the parent's investment - or in order to maintain a significant dividend income.
Subsection 55(5) - Applicable rules
Cases
The Queen v. Kruco Inc., 2003 DTC 5506, 2003 FCA 284
The taxpayer, which held approximately 32.5% of the common shares of another corporation ("Kruger"), took the position that it received a deemed dividend out of safe income of Kruger when Kruger repurchased the common shares held by the taxpayer. The Minister took the position that safe income on hand was reduced by investment tax credits claimed by Kruger (which resulted in a decrease in the undepreciated capital cost of depreciable properties of Kruger and, therefore, resulted in an increase in the taxable income of Kruger without any corresponding generation of cashflow); and by income inclusions to Kruger under s. 12(1)(t), which also represented taxable income for which there was no corresponding cash inflow.
In rejecting this position of the Minister, Noël J.A. noted (at p. 5512) that paragraph 55(5)(c) only made adjustments with respect to two specific items (ss.20(1)(gg) and 37.1) that represented deductions that were not associated with actual cash outflows and indicated that "what this shows is that Parliament had in mind the issue which the appellant now seeks to address and nevertheless opted to deem a corporation's 'income earned or realized' to be income computed under the Act subject only to the two stated exceptions." Accordingly, no adjustment should be made for other items in computing income earned or realized.
Paragraph 55(5)(e)
Cases
Gestion B. Dufresne Ltée v. The Queen, 99 DTC 5614, Docket: A-573-98 (FCA)
Because of s. 55(5)(e), two corporations each of which was controlled by an individual who was the brother-in-law of the other controlling shareholder (i.e., they were the respective husbands of two sisters) were not related for purposes of applying s. 55(2). Marceau J.A. stated that:
"There is nothing in the text to suggest that the fiction or assumption set out in that 'deeming provision' - to the effect that where applicable for the specific purpose identified, siblings are not to be treated as such, i.e., are to be deemed not to be related to one another but on the contrary to be dealing at arm's length - should apply only at the level of and with regard siblings themselves and have no effect on relationships that stem directly and exclusively from that sibling relationship, such as brothers-and sisters-in-law."
Administrative Policy
21 July 1992 T.I. 5-921027
s. 55(5)(e) would not preclude a finding that two brothers who each owned 50% of the shares of two companies, acted in concert in respect of the control of the companies, with the result that each individual did not deal at arm's length with the corporation, and that the two corporations did not deal with each other at arm's length.
Subparagraph 55(5)(e)(ii)
Administrative Policy
10 October 2014 APFF Roundtable Q. , 2014-0538021C6 F
In Fiducie Famille Salammbô c. Ville de Montréal (2011 QCCQ 11322), a mutations tax case, the Court found that potential non-designated beneficiaries should not be taken into account as beneficiaries at the moment of registration of the land transfer. In considering whether a person is related to each beneficiary under a trust, does CRA accept that it should consider only the persons who have been designated as beneficiaries at the particular time?
After referring to Propep, where the definition of "beneficially interested" in s. 248(25) was stated to apply for determining that an individual was a beneficiary, CRA stated (TaxInterpretations translation):
The CRA believes that the courts would adopt this expanded sense of the concept of beneficiary for purposes of ITA subparagraph 55(5)(e)(ii). The CRA further could consider arguing that this expanded concept of beneficiary is also engaged by the text of ITA subparagraph 55(5)(e)(ii) which refers to "each beneficiary under a trust who is or may (otherwise than by reason of the death of another beneficiary under the trust) be entitled to share in the income or capital of the trust." Consequently, the position stated in [2004-0086961C6]…is not valid.
…It is beyond the scope of this Roundtable to comment on the meaning to be accorded to the term "beneficiary" and under the definition of "beneficially interested" in ITA subsection 248(25) in accordance with the applicable private law… .
8 October 2004 APFF Roundtable Q. 28, 2004-0086961C6
Can CRA indicate whether s. 55(5)(e)(ii) should be interpreted in light of s. 248(25)(a)?
CRA indicated that "the concept of 'person beneficially interested' is irrelevant for the purposes of subparagraph 55(5)(e)(ii)," but it also indicated that it "we feel that the right described in subparagraph 55(5)(e)(ii) I.T.A. and paragraph 248(25)(a) I.T.A. are fairly similar."
Articles
Michael Goldberg, "Not Quite Chicken Soup – Part II: Are Powers to Add and Remove Beneficiaries Safe for Canadian Family Trust Precedents", Tax Topics, Number 2175, November 14, 2013, p.1.
Effect of power to add and remove beneficiaries (PARB) (p. 2)
However, if the beneficially interested concept is applicable for purposes of subsection 55(2), then it appears that PARBs in trusts could cause those trusts to be unable to avail themselves of the exception to that provision, which might otherwise be available under paragraph 55(3)(a). The reason for this is that only trusts that meet the restricted related persons provisions in paragraph 55(5)(e) [Note 6: Generally, trusts where the only beneficiaries are the lineal descendants of an individual and/or registered charities, which is quite typical in many traditional Family Trust situations.] qualify for this exception. In this regard, although the CRA has indicated that "the concept of 'person beneficially interested' is irrelevant for the purposes of subparagraph 55(5)(e)(ii)", it also indicated that it "feel[s] that the right described in subparagraph 55(5)(e)(ii) I.T.A. and paragraph 248(25)(a) I.T.A. are fairly similar". [Note 7: See CRA document No. 2004-0086961C6, October 8, 2004.]
It is unclear whether the CRA's views regarding subparagraph 55(5)(e)(ii) would also be applicable to situations caught by paragraph 248(25)(b). Nevertheless, given the CRA's conclusion, it would appear that the inclusion of a PARB might well be problematic for the purposes of subsection 55(2).
Paragraph 55(5)(f)
Cases
The Queen v. Nassau Walnut Investments Inc., 97 DTC 5051 (FCA)
Although it had been planned that the portion of deemed dividends received by the taxpayer (arising on the redemption of shares held by it) that did not come out of safe income would be subject to a designation under s. 55(5)(f), all of such amounts were reported by the taxpayer in its return as deemed dividends due to an error by a subsequently-appointed accounting firm. In finding that the taxpayer was entitled to make a designation under s. 55(5)(f) after being reassessed by the Minister under s. 55(2), Robertson J.A. characterized the making of a late designation as being in the nature of seeking an amendment to an income tax return, rather than seeking to file a late election, and found that such a late amendment was not objectionable where it arose as a result of a subsequent reassessment by the Minister under s. 55(2) (it being clear that s. 55(5)(f) related directly to the issues surrounding the applicability of s. 55(2)).
See Also
Gestion Jean-Paul Champagne Inc. v. MNR, 97 DTC 155 (TCC)
The taxpayer, which failed to report the receipt of a deemed dividend in its tax return for the relevant taxation year, was found to be entitled to benefit from a designation under s. 55(5)(f) following a reassessment by the Minister under s. 55(2).
Administrative Policy
16 June 2014 STEP Roundtable Q. , 2014-0522991C6
CRA stated that its long-standing practice "is to apply subsection 55(2) only to the excess of the taxable dividend paid on a share over the safe income on hand attributable to that share, when issuing an assessment based on subsection 55(2)." Accordingly when a corporate shareholder receives a dividend in excess of SIOH and does not make s. 55(5)(f) designations to carve the dividend up into safe income and taxable dividends, CRA will only apply s. 55(2) to the portion of the dividend in excess of SIOH. See summary under s. 55(2).
1992 A.P.P.F. Annual Conference, Q. 2 (January - February 1993 Access Letter, p. 50)
RC will accept a designation that is filed with a late-filed income tax return, or a designation that is filed after the filing of the income tax return but before the expiry of the period for filing a notice of objection in respect of the original assessment for that taxation year. RC also has a policy under which it may only assess the appropriate portion of the deemed dividend as proceeds of disposition or a capital gain.
June 1990 Meeting of Alberta Institute of Chartered Accountants (November 1990 Access Letter, ¶1499, Q. 5)
Rulings have been granted wherein a corporation is permitted to make more than one s. 55(5)(f) designation provided that there is an explanation of the specific uncertain elements in the calculation of safe income on hand that results in the need for more than one designation.
June 1990 Meeting of Alberta Institute of Chartered Accountants (November 1990 Access Letter, ¶1499, Q. 6)
There is no provision for a taxpayer to make late or amended designations under s. 55(5)(f).
90 C.P.T.J. - Q.21
It is the practice of RC to accept a designation under s. 55(5)(f) which is filed before the time has expired for filing a notice of objection in respect of the initial assessment for the year in which the dividend is received.
90 C.P.T.J. - Q.19
s. 55(5)(f) does not allow for the use of a formula, rather than an amount, in the designation of a separate taxable dividend.