Spinoff Butterflies in Trouble?
The purpose of a spinoff butterfly is to move some property of a
distributing corporation to one or more newly incorporated transferee
corporations having the same shareholders in the same proportions as the
distributing corporation. Although it is generally understood that such
transactions are acceptable tax planning, paragraph 55(3.1)(a) raises
As a pre-distribution step in a typical spinoff butterfly,
shareholders of the distributing corporation exchange their common
shares in the distributing corporation for new common and preferred
shares in the distributing corporation on a tax-deferred basis under
subsection 51(1) or 86(1). Such an exchange is a "permitted exchange"
under subsection 55(1), provided that it does not result in an
acquisition of control of the distributing corporation. Thus, one
presumes that the exchange is unobjectionable under the butterfly rules
in section 55. However, the share exchange may technically infringe
paragraph 55(3.1)(a). If that is the case, paragraph 55(3)(b) will not
operate to prevent the application of subsection 55(2).
Paragraph 55(3.1)(a) will cause paragraph 55(3)(b) not to apply
where, in contemplation of and before a distribution made in the course
of the reorganization in which the dividend was received, property
became property of the distributing corporation otherwise than as a
result of certain enumerated exceptions, none of which appears to apply
to a share exchange. Thus, whether paragraph 55(3.1)(a) will apply to
the share exchange turns on whether the old shares become property of
the distributing corporation.
Under corporate law, there is generally a prohibition on a
corporation holding shares in itself (for example, CBCA section
30(1)(a)). An exception to this rule arises when a corporation is
allowed to purchase or otherwise acquire shares issued by it (for
example, CBCA section 34(1)). When a corporation acquires its own
shares, the shares are required to be cancelled (for example, CBCA
section 39(6)); however, corporate legislation does not say that they are
cancelled before they are acquired by the corporation. This omission
suggests that the corporation holds its own shares for the period,
however brief, between the time that it acquires the shares and the time
that it cancels the shares. Therefore, it appears that corporate law
does not preclude the possibility of the old shares becoming property of
the distributing corporation on the share exchange.
In the section 116 context, the CRA took the position that a
clearance certificate was required when a non-resident shareholder
exchanged common shares in a corporation for preferred shares under
subsection 51(1) (CRA document no. 9631575, February 12, 1997). The CRA
determined that there was an acquisition of the old shares by the
corporation. If this view is correct, the distributing corporation
acquires the old shares upon the share exchange, which results in the
old shares becoming property of the distributing corporation.
The purpose of paragraph 55(3.1)(a) is to prevent property from being
acquired by a distributing corporation before a butterfly in order to
change the types of property owned by the distributing corporation that
would permit the tax-free cashing out of a shareholder. The Department
of Finance made a deliberate policy decision to exclude public
corporations from the "types of property" requirement through the
addition of subsection 55(3.02) in 2001. Proposed amendments in Bill C-4
(introduced on October 22, 2013) provide that paragraph 55(3.1)(a) does
not apply to public corporations. Because the paragraph is concerned
with the "types of property" requirement, the exclusion of public
corporations from its application makes sense.
In the private company context, the share exchange does not offend
the policy at which paragraph 55(3.1)(a) is aimed, since it will not
change the types of property that the distributing corporation holds.
The share exchange is simply a necessary pre-distribution step to
facilitate the paragraph 55(3)(b) butterfly. Nevertheless, owing to the
current wording of paragraph 55(3.1)(a), the share exchange may
technically trigger its application.
Notwithstanding the analysis above, the CRA does not appear to
consider a share exchange objectionable: it has issued favourable
rulings in the past (9813073 (1998) and 9727303 (1998)) when a share
exchange took place as a pre-distribution step in a spinoff butterfly.
These rulings were given before the November 26, 2004 Department of
Finance comfort letter was issued. That letter was the impetus for the
exclusion of public corporations from the application of paragraph
Bennett Jones LLP, Calgary