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)
Paragraph 55(3)(a) Related
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)
Paragraph 55(3)(a) Related
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
Illustration #1 (cont’d)
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
Illustration #1 (cont’d)
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
Illustration #1 (cont’d)
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
Illustration # 4 - Basic Spin-Off Butterfly
Roll 50% of Opco Shares to Newco under
Section 85
50%
A
Opco
25% 25%
50%
B
Newco
50%
Illustration # 4 - Basic Spin-Off Butterfly
Opco transfers assets of Business 2 to
Newco
B A
Opco Newco
$1M Business 1
$1M
Business 2
50% 50%
Illustration # 4 - Basic Spin-Off Butterfly
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.)