| 19(1) | File No. 5-9459 |
| P. Diguer | |
| (613) 957-2123 |
February 20, 1990
Dear Sirs:
Re: Paragraph 55(3)(b) of the Income Tax Act (Canada) (the "Act")
We are writing in response to your letter dated January 23, 1990 wherein you requested our opinion regarding the allocation of liabilities for the purposes of paragraph 55(3)(b) of the Act.
The situation you describe in your above mentioned letter does not include information which is essential for determining the allocation of liabilities in a net equity method butterfly and as such, we are unable to provide a detailed reply with regards to the concerns expressed in your letter.
Nevertheless, we can offer the following general comments with regards to this particular matter.
The Department's view on the appropriate order of allocation of debts for purposes of a net equity method butterfly were expressed in Mr. R.J.L. Read's address to the 1988 Conference of the Canadian Tax Foundation. These views were subsequently updated by Mr. M.A. Hiltz in his reply to question 2.2 of his presentation "Questions Concerning The Butterfly Reorganization" to the 1989 Conference of the Canadian Tax Foundation.
As indicated in the above mentioned presentations, it is the Department's view that, in determining the net fair market value of each type of property of the particular corporation (determined on a consolidated basis where appropriate) immediately before the proposed transfers of property, all current assets of the particular corporation (including any cash, accounts receivable, inventory and prepaid expenses of the particular corporation) must initially be classified as cash or near cash property of the particular corporation. The liabilities of the particular corporation (determined on a consolidated basis where appropriate) will then be allocated to, and be deducted in the calculation of, the net fair market value of each type of property of the particular corporation, as follows:
(i) current liabilities will be allocated to cash or near cash property to the extent of the aggregate fair market value of all property of that type;
(ii) liabilities, other than current liabilities, that relate to a particular asset will be allocated to the particular asset and to the type of property of the particular asset to the extent of the fair market value of the particular asset and any such liabilities not so allocated will be considered to relate to the type of property of the particular asset but not to the particular asset for the purposes of the allocation described in subparagraph (iii) below;
(iii) liabilities, other than current liabilities, that relate to a type of property but not to a particular asset will be allocated to that type of property to the extent of the net fair market value, determined after the allocation described in subparagraph (ii) above, of that type of property; and
(iv) any liabilities not otherwise allocated in accordance with the rules described above will be allocated to all types of property in proportion to, and to the extent of, the net fair market value, determined after the allocations described in subparagraphs (i), (ii) and (iii) above, of each such type of property;
Any accounts receivable, inventory and prepaid expenses initially classified as cash or near cash property of the particular corporation that relate to a business of the particular corporation and that will be collected, sold or consumed by a corporation in the ordinary course of its business may, in appropriate circumstances, be reclassified as business property of the particular corporation. Where such a reclassification is being made the net fair market value, determined after the allocation of current liabilities described in (i) above, of any property that is so reclassified will be included in determining the net fair market value of the business property of the particular corporation before making the allocations described in (ii), (iii) and (iv) above.
We trust our comments will be of assistance.
Yours truly,
for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch