Peter Rogers, CGA Sept 5, 2013 presentation

Butterflies in the Valley

Peter Rogers, CGA

September 5, 2013

Section 55 Overview

• Anti-avoidance provision to prevent capital gains stripping via tax free inter-corporate dividends

• Subsection 55(2):

– Re-characterizes otherwise tax free inter-corporate dividends into capital gains

– Deemed dividends on share redemptions deemed to be proceeds of disposition

When Subsection 55(2) Applies

Applies when all four of the following conditions are met:

1. A dividend is received by a corporation resident in Canada;

2. The dividend is a taxable dividend as defined by 89(1);

3. The dividend is deductible 112(1), 112(2), or 138(6); and

4. Either of the following:

a) the purpose test, or

b) the results test

Four Exceptions to 55(2)

• “Part IV Tax”

• The “Safe Income”

• “Paragraph 55(3)(a) Related Person”

• “Paragraph 55(3)(b) Butterfly”

Safe Income

• For a dividend to qualify as paid from safe income it must reasonably be attributed to:

– income earned or realized,

– by any corporation,

– throughout the holding period of a share, and

– ending at the “safe income determination time”

Concept of Safe Income

Structure Sale

Mr. A

Holdco

ACo

$5,000 Safe Dividend

Section 85 Rollover

Holdco sells the shares of ACo for $20,000

55(3)(a) Related Persons

Special Rules

• For the purpose of 55(3)(a) “Unrelated Person” defined by 55(3.01)(a) to be a person not related to the dividend recipient

• 55(5)(e)(i) deems siblings not to be related

• 55(e)(iv) a person and a trust are not related unless the person is related to each beneficiary

Paragraph 55(3)(a) Related

Person Exception None of the five following conditions apply:

• Subparagraph 55(3)(a)(i)

A disposition of property to an unrelated person for proceeds of disposition less than fair market value

• Subparagraph 55(3)(a)(ii)

A significant increase in the direct interest in any corporation by an unrelated person. (Exception: Sale of shares at FMV)


Person Exception (cont’d) • Subparagraph 55(3)(a)(iii)

A disposition of shares of the dividend paying corporation to an unrelated person (also 10% attribution rule excluding shares of the dividend recipient)

• Subparagraph 55(3)(a)(iv)

A disposition of shares of the dividend recipient to an unrelated person after the dividend was received (also 10% attribution rule)


Person Exception (cont’d) • Subparagraph 55(3)(a)(v)

A significant increase in the total of all direct interests in the dividend paying corporation by unrelated persons

Illustration #1 - 55(3)(a)

Current Structure

Daughter Parent Son

Opco(CCPC)

PropertyFMV $2M

Proposal – Butterfly son’s interest to Sonco

50% NV Com

50% NV Com

100% V Pfd

Illustration #1 (cont’d)

Daughter Parent Son

Opco Sonco

50% NV Com

100% V Pfd

100% V Pfd

100% NV Com

Property FMV $1.5M

Property FMV $500K


Final Structure

Daughter Parent Son

Opco Sonco

• 55(3)(a) not applicable as conditions in 55(3)(a)(ii) and (v) are met

• Need to qualify as a 55(3)(b) Butterfly

100% NV Com

100% V Pfd

100% NV Com


Alternative Structure

Daughter Parent Son

Opco Sonco

PropertyFMV $1M

PropertyFMV $1M

• 55(3)(a) applies

100% NV Com

100% V Pfd

100% V Pfd

100% NV Com


Alternative Structure

55(4) Risk

• 55(4) deems persons not to be related if one of the main purposes of one or more transactions is to cause persons to be related to avoid 55(2)

Illustration # 2

Current Structure

A

Holdco

Opco

InvestmentAssets

100%

FMV $1.5M

100%

FMV $1M

FMV $500K

Illustration # 2 (cont’d)

Consider: Butterfly the Investment Assets to

Newco

17

A

Holdco

Opco

Newco

Pfd FMV/ACB = $500K

Com

Com

Investment assets

Illustration # 2 (cont’d)

Consider: Butterfly the Investment Assets

to Newco

• 55(3)(a) does not apply if done in

contemplation of a sale of Opco

Illustration # 3 - Basic Split-Up Butterfly

Current Structure

Facts:

1. A and B are unrelated

persons

2. Business 1 and 2 are

active businesses

3. Opco is a CCPC

A B

Opco

Business 1 Business 2

50% 50%

FMV $1M FMV $1M

Illustration # 3 - Opco rolls assets to

Aco and Bco pursuant to Section 85

Opco

Aco Bco

$1M Business 1

$1M Business 2

Illustration # 3 - Basic Split-Up

Butterfly Final Position

B

Business 2

A

Business 1

Aco Bco

100% 100%

Illustration # 4 - Basic Spin-Off Butterfly

Current Structure

A B

Opco

Business 1 Business 2

50% 50%

FMV $1M FMV $1M


Roll 50% of Opco Shares to Newco under

Section 85

50%

A

Opco

25% 25%

50%

B

Newco

50%


Opco transfers assets of Business 2 to

Newco

B A

Opco Newco

$1M Business 1

$1M

Business 2

50% 50%


Final Structure

BA

Opco Newco

Business 2Business 1

50% 50% 50% 50%

FMV $1M FMV $1M

55(3)(b) - Butterfly

• Maintain continuity of ownership (i.e. no cashing out)

• Pro-rata asset distribution test

Cash and new cash assets

Investment assets

Business assets

• Act is silent regarding liabilities

• Tax accounts ignored for the Pro-rata test

55(3)(b) - Butterfly

Pro-Rata Test – continued:

– Gross asset Butterfly

Liabilities allocated pro-rata

– Net asset Butterfly

Net liabilities against assets to which they most relate

Butterfly Rules

• 55(3.1)(a) pre-butterfly restrictions

• 55(3.1)(b) restrictions on shares of a DC & TC

• 55(3.1)(c) TC post butterfly restrictions

• 55(3.1)(d) DC post butterfly restrictions

55(3.1)(a) Butterfly Rules

Butterfly rules – paragraph 55(3)(b) & subsection 55(3.1)

1. Paragraph 55(3.1)(a). Denies the Butterfly Exemption if property becomes property of the DC in contemplation of a distribution with certain exceptions including:

– Related part transactions

– A sale of property at FMV for cash or non-convertible debt

55(3)(b) Butterfly Rules

Paragraph 55(3.1)(b) prohibits

• A specified shareholder from selling shares of a TC or DC to an unrelated person

• An acquisition of control of a DC otherwise than by a permitted transaction.

• Acquiring shares of a DC in contemplation of a butterfly other than by a permitted transaction or from a related person

– 55(3.2) provides special rules for the purposes of 55(3.1)(b)

55(3)(c)&(d)Butterfly Rules

Paragraph 55(3.1)(c) and (d):

• 55(3.1)(c) denies the Butterfly Exemption to a dividend received by a TC where the TC disposes of distributed property to a person unrelated to the transferee corporation

• Subparagraph 55(3.1)(d) is a mirror provision to 55(3.1)(c) that applies to a DC

Illustration # 5 - 55(3)(b)

Current Structure

Opco

Daughter Parent Son

US Subco

Bldg 1 Bldg 2

50% NV

Com

FMV $1.2M

100% V

Pfd

FMV $2.6M

50% NV

Com

FMV $1.2M

FMV $1M FMV $4M FMV $1M

Illustration #5 – 55(3)(b)

Daughter Parent Son

100% NV Com FMV

$366,500

(7.33%)

100%

Opco

Dtrco Sonco

US Subco

V pfd

NV Com

FMV

$833,500

(16.67%)

NV Com

FMV

$833,500

(16.67%)

NV Com FMV

$366,500

(7.33%)

100%

Daughter Parent Son

Opco

Dtrco Sonco

Building 1 Building 2

US Subco

100%

50%

NV Com

100%

V Pfd

50%

NV Com

100%

100%

Illustration # 5 - 55(3)(b)

Final Restructure

Butterfly Issues

• Circle RDTOH

• Share Valuation

• Provincial Sales Tax

• Property Transfer Tax

• Asset Valuation

• Part IV.ITax

• Part VI.I Tax

• 15(1) Benefit

• Debt Forgiveness

Typical Butterfly Split-Ups

• Investment holding companies

• Real estate

• Family farms

• Divisible business (i.e. geographical etc.)