Principal Questions: Whether a butterfly transaction can be undertaken by Newco in the second year following the implementation of a post-mortem pipeline with respect to the shares of the capital stock of Opco, without triggering the application of subsection 84(2).
Position Taken: In some situations, this will be possible depending on the facts and the circumstances.
Reasons: Even if a butterfly transaction is undertaken by Newco in the second year following the implementation of the pipeline, there are situations where we will consider that funds or property of Opco will not be distributed to or appropriated in any manner whatever by the estate or its beneficiaries as a result of the butterfly or after such butterfly. However, for the paragraph 55(3)(b) exception to apply with respect to the dividends received in the course of the butterfly reorganization, all the conditions provided for in that paragraph and in subsection 55(3.1) will have to be met. Our Directorate will give comfort on that issue only in the context of a ruling request.
XXXXXXXXXX 2015-061760
Sylvie Labarre, CPA, CA
January 22, 2016
Mrs,
Subject: post-mortem planning and butterfly transaction (Pipeline followed by butterfly)
This is in response to your email of 10 November 2015 in which you asked if it is possible to effect a butterfly transaction in the second year following the implementation of the post-mortem planning "pipeline" technique without this causing subsection 84(2) to apply.
Unless otherwise stated, all statutory references herein are to the provisions of the Income Tax Act.
Hypothetical situation
A shareholder holds all the shares in the capital of Corporation 1 that operates a business. The shareholder dies and as a result of his death, the estate becomes the shareholder of Corporation 1. Subsection 70(5) applies in respect of the disposition of shares in the capital of Corporation 1 held by the deceased. Therefore, the shares would have an adjusted cost base equal to their fair market value to the estate.
In August 20X0, the estate of the deceased transfers all the shares in the capital of Corporation 1 that it holds to Corporation 2 to implement a "pipeline" structure. Voting and participating shares in the capital of Corporation 2 are held by the estate. The estate receives preferred shares in the capital of Corporation 2 in consideration for the transferred shares. The paid-up capital of the preferred shares of the capital stock of Corporation 2 received as consideration is higher than the paid-up capital of the transferred shares and equals the adjusted cost base to the estate for shares in the capital of Corporation 1. Section 84.1 does not cause any reduction in paid-up capital.
Corporation 1 continues to carry on its business which it carried on before the death of the deceased until its winding-up. This winding-up occurs in September 20X1 being one year after the transfer of the shares by the estate of the shares in the capital of Corporation 1 to Corporation 2. Subsection 88(1) applies to the winding-up.
After the winding-up, the estate distributes the shares it holds in the capital of Corporation 2 to its two beneficiaries in full or partial settlement of their capital interests in the estate.
After the winding-up, Corporation 2 does not sell all of its assets. Instead, it continues to carry on the business previously carried on by Corporation 1. Corporation 2 does not proceed with any bulk redemption of preferred capital shares in its capital now held by the two beneficiaries of the estate.
Two months after the winding-up of Corporation 1, each of the shareholders of Corporation 2 transfers all the shares in the capital of Corporation 2 to their own corporations, being Corporation 3 and Corporation 4, respectively.
Following this transfer, Corporation 2 makes a distribution within the meaning of subsection 55(1) to Corporation 3 and Corporation 4, so that paragraph 55(3)(b) applies to transactions (hereinafter after "butterfly transaction"). Corporation 3 and Corporation 4 continue to carry on a business using the property received in the distribution.
There is no bulk redemption of the shares in the capital of Corporation 3 and Corporation 4, as the case may be, received in exchange for preferred shares in the capital of Corporation 2.
Question
You asked if Corporation 2 and its shareholders could proceed with a butterfly transaction after the parties have implemented a "pipeline" structure as in the described situation.
Our Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.
Comments on subsection 84(2)
In the given situation, subsection 84(2) could apply if there were distribution or otherwise appropriation of goods or funds in any manner whatever to or for the benefit of the shareholders of any class of shares in its capital stock, on the winding-up, discontinuance or reorganization of its business.
If no post-mortem planning mechanism were engaged in, the estate which received the property or funds of the Corporation (in which the deceased held shares) would be taxable in respect of a dividend on shares which had paid a low capital notwithstanding they had a high adjusted cost base if subsection 70(5) applied in respect of shares held by the deceased. The estate would incur a capital loss which it likely could not utilize. However, if the conditions of subsection 164(6) were satisfied, the deceased individual could potentially benefit from the loss.
In the context of post-mortem planning, a so-called "pipeline" can be implemented. After the implementation of such a structure, the estate would now hold shares in the capital of a new corporation shares with a high paid-up capital, or a note. However, it would not be sufficient to implement the structure in order to conclude that subsection 84(2) does not result in a dividend for the shareholders of the first Corporation (the one whose shares were transferred to the new corporation), that is to say, the estate or the beneficiaries of the estate. Indeed, subsection 84(2) is broad enough to cover certain indirect property distributions to such shareholders, by means of the new corporation or otherwise. In the case of a so-called "pipeline" structure, subsection 84(2) does not result in tax consequences to the extent that its conditions for application are not engaged. In the context of advance rulings respecting post-mortem planning, we 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 second year of the implementation of the structure (or when the shares of the capital stock the new Corporation received as consideration for the share capital of the former Corporation shares were redeemed progressively).
In the current situation, Corporation 1 continues carrying on its business for a year before being wound-up in favor of Corporation 2. In addition, the business of Corporation 1 is now carried on by Corporation 2. As well, after the butterfly transaction, Corporation 3 and Corporation 4 continue to carry on the business of Corporation 1.
The question is whether the interposition of Corporation 3 and Corporation 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 way whatever by the first corporation (Corporation 1) to its initial shareholder (the estate and the beneficiaries of the estate).
One of the important facts of the hypothetical situation described above is that following the winding-up of Corporation 1 into Corporation 2, there would not be a bulk redemption of preferred shares in the capital of Corporation 2, received for the shares in the capital of Corporation 1 and there is no bulk redemption of shares in the capital of Corporations 3 and 4, as applicable, received in consideration for the preferred shares in the capital of Corporation 2. We understand that the beneficiaries of the estate, who would remain the holders of such shares in the capital of Corporation 3 or Corporation 4, as applicable, and 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. If our understanding is correct, we 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 Corporation 3 or Corporation 4. In such circumstances, section 84(2) would not apply.
Comment on paragraph 55(3)(b)
In addition, to qualify for the exception in paragraph 55(3)(b) with respect to inter-corporate dividends resulting from the butterfly transaction, all the legislative requirements would have to be met, including those set out in paragraph 55(3.1)(b). In the context of the application of subsection 55(3.1), it is necessary to establish which transactions are part of the "series" in the course of which the dividends described in paragraph 55(3)(b) are received. We could argue that all the transactions related to the implementation of the pipeline structure, the winding-up of Corporation 1 and the dividends resulting from redemptions occurring as part of the butterfly transaction would be part of the same series of transactions. Included in the transactions, there would be two distributions (as that term is defined in subsection 55(1)) on the facts of the hypothetical situation: the first distribution on the winding-up of Corporation 1 into Corporation 2 and the second on the butterfly transaction itself.
For the purposes of paragraph 55(3.1)(b), there would be two distributing corporations for which the conditions of this paragraph should be examined (Corporation 1 and Corporation 2) for the purposes of determining if the dividends received in the course of the transactions for separating the business between Corporation 3 and Corporation 4 came within the paragraph 55(3)(b) exception.
It should be noted that the distribution consisting of the winding-up of Corporation 1 into Corporation 2 would not need to come within the exception provided by paragraph 55 (3)(b) because by virtue of paragraph 88(1) d.1), this distribution would not generate an inter-corporate dividend which was subject to subsection 55(2). However, none of the events stipulated in paragraph 55(3.1) b) could occur in the course of the series taking into account that Corporation 1 and Corporation 2 should be the distributing corporations for purposes of determining if dividends received in the course of the transactions for dividing the business between the Corporation 3 and Corporation 4 would come within the paragraph 55(3)(b) exception.
Furthermore, in addition to establishing if paragraph 55(3.1)(b) applied taking into account two distributing corporations and two transferee corporations, it would be necessary to examine if paragraphs 55(3.1)(a)(c) and (d) applied to the transactions in the series taking into account one distributing corporation, namely Corporation 2, and two transferee corporations.
We would need to consider all relevant facts of a given situation in the context of an application for advance rulings to allow us to conclude whether subsection 55(3.1) applies in this situation.
We hope that our comments will be helpful.
Stéphane Charette, CPA, CMA, MBA
to the Director
Reorganisations Division
Income Tax Rulings Directorate
Legislative Policy and
Regulatory Affairs Branch