Principal Questions: Where, after a butterfly transaction, a family trust acquires shares of the capital stock of a transferee corporation, whether it has an effect on the application of the definition of "permitted exchange" in subsection 55(1).
Position: General comments provided.
Reasons: See response below.
FEDERAL TAX ROUNDTABLE
APFF CONFERENCE 2010
Question 20
Butterfly Transaction
In the course of a butterfly transaction, being a transaction that meets the requirements of paragraph 55(3)(b), it generally is beneficial for the exchange of shares of the corporation that is the subject of the transaction (the "distributing corporation") to qualify as "permitted exchange" in subsection 55(1). However, such an exchange appears to qualify as a permitted exchange even where, after the butterfly transaction, a family trust (whose beneficiaries are persons unrelated to the transferee corporation, the distributing corporation and their shareholders) acquires an interest in one of the transferee corporations by subscribing for shares of the capital stock of the latter for a nominal value, regardless of whether the trust in question is related or does not deal at arm's length with the transferee corporation or its shareholders.
a) Does the CRA share our interpretation of those provisions of the Income Tax Act?
b) If so, does the CRA agree that such an approach does not contravene paragraph 55(3.1)(b) which implies that an issuance of shares by a corporation is not a disposition of property by that corporation for the purposes of paragraph 55(3.1)(b) (as provided for in the definition of "disposition" in subsection 248(1))?
CRA Response to Question 20(a)
In theory, a transaction referred to, in particular, by one of the rules set out in subparagraphs 55(3.1)(b)(i), (ii) and (iii) will have the effect of making subsection 55(2) applicable despite paragraph 55(3)(b) unless the transaction qualifies as a "permitted exchange" by virtue of subsection 55(1).
Your question seems to be specifically directed to the application of paragraph (b) of the definition of "permitted exchange" in subsection 55(1).
In that regard, an exchange of shares that satisfies the conditions set out in paragraph (b) of the definition of "permitted exchange" in subsection 55(1) in particular must involve shares of the capital stock of a distributing corporation.
Furthermore, an exchange referred to in paragraph (b) of the definition of "permitted exchange" must first be an exchange "in contemplation of the distribution" and satisfy a test relating to the shares of the capital stock of the acquiror which are outstanding "immediately after the exchange"; and, furthermore, certain facts must be established "immediately before the distribution" with regard to that exchange. Accordingly, the exchange of shares of a distributing corporation referred to in paragraph (b) of the definition of "permitted exchange" should, logically, occur before the distribution of the distributing corporation’s property in a particular situation.
In this context, we are of the view that in the particular situation, the fact that there is an issuance of shares of the capital stock of a transferee corporation, after the distribution of the property of the distributing corporation has been completed, would not be relevant for the purposes of the application of the definition of "permitted exchange" in subsection 55(1).
CRA Response to Question 20(b)
This question appears to be directed exclusively to the application of paragraph 55(3.1)(b) in respect of the acquisition of shares of the capital stock of the transferee corporation by a family trust for a nominal value. We will limit our comments to the application of paragraph 55(3.1)(b) in the particular situation.
As you stated, the issuance of treasury shares from the transferee corporation to the family trust is not a transaction within subparagraph 55(3.1)(b)(i) because of the issuance by a corporation of a share of its capital stock not constituting a "disposition" of property for the purposes of the Act as provided for in paragraph (m) of the definition of "disposition" in subsection 248(1).
Furthermore, subparagraph 55(3.1)(b)(iii) would not apply because, in the particular situation, there is an acquisition of shares of the capital stock of a transferee corporation made after the distribution was completed; and not an acquisition of shares of the capital stock of the distributing corporation in contemplation of the distribution.
Finally, in the particular situation, to the extent that the control of the transferee corporation was not acquired by the family trust, subparagraph 55(3.1)(b)(ii) would also not be applicable.
Jean Lafrenière
(613) 941-2956
October 8, 2010
2010-037321.