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:

1. Bco will transfer the Division 1 assets to Cco in consideration for preferred shares, electing under s. 85(1).
2. 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).
3. 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.
4. 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.
5. 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)."

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).

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).

Facts

The exception in s. 55(3)(a) would not be available where a new corporation was created in the series. Consider this example:

1. Husband, Wife and (unrelated) Third Party each subscribe for 1/3 of the voting common shares of newly-incorporated Realtyco.
2. 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.
3. Opco transfers realty to Realtyco under s. 85(1) in consideration for preferred shares of equivalent FMV.
4. The cross-shareholdings between Opco and Realtyco are redeemed for notes, thereby giving rise to deemed dividends.
5. 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.

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

1. All the issued shares of Subco will be exchanged by Pubco under s. 86 for one new common share and one new preferred share.
2. 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.)
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.
9. 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.
10. 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.
11. 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.
12. 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.
13. 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).

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.

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… .

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

:

1. ParentAco will sell all the Aco shares to ParentCco for fair market value cash consideration.
2. Cco will redeem the Class B Preferred Shares for cash.
3. Bco will make a cash distribution to ParentBco, first as a PUC distribution, and next as a dividend.
4. 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).)
5. 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)."

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).

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.

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%.

"The issuance of shares does not represent an event described in subparagraph 55(3)(a)(ii)."

"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.

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).

"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)."

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.

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).

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.

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.

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.

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.

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.

Favourable rulings given with respect to public company spin-off transactions.

Favourable ruling given on public company butterfly.

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.

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.

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.

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.

GIC's which are current assets capable of reasonably prompt liquidation generally will be considered to be cash or near-cash assets.

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.

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.