921462
D.J. Powrie Memorandum
August 31, 1992
Re: Cross-border butterfly involving real estate assets
Facts
The taxpayer (the "Particular Corporation") is a wholly-owned subsidiary of a U.S. Corporation ("Parent"). The Particular Corporation has two divisions, one whose value is derived principally from real estate located in Canada (the "Real Estate Division") and another whose value is not derived principally from real estate located in Canada. Overall, the assets of the Particular Corporation do not derive their value principally from real estate located in Canada. The Real Estate Division is for sale.
Proposed Transactions
The Particular Corporation proposed that the Real Estate Division would be transferred to a new corporation ("Newco") in a divisive reorganization of the type described in paragraph 55(3)(b).
The first step in the reorganization would be the transfer of a certain percentage of the shares of the Particular Corporation to Newco in exchange for Newco shares. No election would be filed in respect of this transfer so that Parent would realize a capital gain on the transfer and Parent would receive high cost base shares in Newco on the exchange. The taxpayer's representatives were of the view that the gain realized by Parent on the exchange would be protected from tax in Canada under paragraph 4 of Article XIII of the Canada-U.S. Income Tax Convention. After the reorganization was completed, the high cost base shares in Newco (whose assets would derive their value principally from real estate in Canada) would be sold to an unrelated purchaser.
Department's Position
The Department was not convinced that the exemption under the Treaty was available in respect of the shares of Particular Corporation to be transferred to Newco. Further, and more fundamentally, the Department is of the view that the use of paragraph 55(3)(b) to effect a transfer of assets which derive their value principally from real estate in the guise of a Canada-U.S.-treaty-protected share sale is a misuse of the paragraph within the meaning of subsection 245(4). The Department refused to rule in respect of any aspect of the transactions.
Resolution
The taxpayer withdrew its ruling request. The sale of the Real Estate Division is to be effected by way of a direct sale of the assets.