An estate acquires the shares of Corporation 1 on a stepped-up basis under s. 70(5) and, in August 20X0, transfers the shares to Corporation 2 (whose common shares are held by it) in consideration for preferred shares with full paid-up capital and adjusted cost base (and without s. 84.1 applying). One year later, Corporation 1 is wound up into Corporation 2 under s. 88(1). The estate then distributes its shares of Corporation 2 to the two beneficiaries in full or partial satisfaction of their capital interests. Corporation 2 does not massively redeem the preferred shares and continues to carry on the business previously carried on by Corporation 1.
Two months after the wind-up, both shareholders of Corporation 2 transfer their shares thereof to Corporations 3 and 4, respectively; and Corporation 2 makes a distribution as described in s. 55(1) to Corporations 3 and 4 within the s. 55(3)(b) butterfly exception, with Corporations 3 and 4 using the property received to continue to carry on a business. Is such a post-pipeline butterfly permissible? CRA responded (TaxInterpretations translation):
[W]e have been willing to confirm the non-application of subsection 84(2) when the corporation continues to carry on its business for a year before the winding-up of the corporation in favour of its shareholder (the new corporation) and when the reimbursement of the note was effected gradually during the course of the second year of the implementationputting in of the structure (or when…shares…were redeemed progressively).
…Corporations 3 and 4 continued to carry on the business of Corporation 1.
The question is whether the interposition of Corporations 3 and 4 and the distribution of the property of Corporation 2 in favour of these corporations in a butterfly transaction would permit us to conclude that the property or funds were distributed or otherwise appropriated in any manner whatever by the first corporation (Corporation 1) to its initial shareholder (the estate and the beneficiaries of the estate).
One of the important facts …is that following the winding-up…there would not be a bulk redemption of the preferred shares in the capital of Corporation 2…and there would not be a bulk redemption of the shares in the capital of Corporations 3 and 4…received in consideration for the preferred shares in the capital of Corporation 2. …[T]he beneficiaries of the estate, who would remain the holders of such shares…of Corporation 3 or Corporation 4…would only receive progressively...the property or funds of which could derive from Corporation 1, and only over a period of months that we have accepted in the past…. [W]e could accept, in such a case, that the beneficiaries of the estate would not receive the property or funds of Corporation 1, in any manner whatever, on the winding-up, discontinuance or reorganization of the business of Corporation 1 and that what they received came instead from Corporation 2, or Corporations 3 or 4. In such circumstances, subsection 84(2) would not apply.