Words and Phrases - "gross FMV butterfly"

Background

Parentco is equally owned by three holding companies (Holdcos 1, 2, and 3) for three siblings holding preferred shares and their respective family trusts holding common shares. Parentco wholly owns Subco which, in turn, holds 10 subsidiaries holding various real estate rental properties.

The first subsidiary of Subco (Subsidiary 1), has more than 5 full-time employees and, accordingly, is considered to carry on an active business, whereas the other nine subsidiaries carry on specified investment businesses.

Subco, prior to the proposed transactions, sold its shares and debt in three corporations, owned jointly with arm's length persons, to Holdco 3 for such transferred properties’ fair market values (FMV) in consideration for the issuance of a note of Holdco 3.

Proposed transactions

1. Parentco, Subco, and all the subsidiaries of Subco other than Subsidiary 10, will amalgamate, with the amalgamated corporation (DC) having the same issued and outstanding share capital as Parentco.
2. DC will choose to end its first taxation year approximately one month after such amalgamation.
3. On the last day of that taxation year, DC will increase the paid-up capital (PUC) of its common shares held by Holdcos 1, 2, and 3 so as to trigger a full refund of its NERDTOH and ERDTOH in amounts not exceeding the safe income on hand applicable to such shares. The Holdcos will be subject to Part IV tax in respect of the resulting deemed taxable dividends calculated by reference to DC’s dividend refund for such taxation year.
4. The three Holdcos will each transfer all their shares of DC to three respective transferee corporations (TC1, TC2, and TC3) on a s. 85(1) rollover basis in consideration for common shares of the respective TCs.
5. The property of DC will be categorized as cash or near-cash property, investment property, and business property. For these purposes, all the rental properties will be treated as business property in light of the effect of the amalgamation to form DC. Accordingly, all the rental properties other than the rental property of Subsidiary 10 will be allocated into three approximately equal pools of assets (Property Pools A, B, and C) with co-ownership interests being potentially held in some of the properties so as to result in approximately equal values of business assets in each of the three pools. The butterfly distribution by DC below will occur on a gross FMV basis so that no liability to DC will be allocated to and deducted from the calculation of the gross FMV of each type of property. Since 1/3 of the shares of Subsidiary 10 will be transferred to each of TC1 and TC2 on a pro rata (1/3) basis, the consolidated look-through method will not be applied to the assets of Subsidiary 10.
6. DC will transfer on a s. 85(1) rollover basis 1/3 of each type of property, including the two respective Property Pools, and the two 1/3 shareholdings (and 1/3 of the debt) in Subsidiary 10, to TC1 and TC2, respectively, in consideration for the assumption of liabilities and the issuance of preferred shares by each TC.
7. TC1 and TC2 will each redeem the preferred shares that they issued to DC in consideration for non-interest-bearing demand promissory notes.
8. TC1 and TC2 will cause their first taxation year-end to occur pursuant to s. 249.1(1).
9. At the beginning of the following day, DC will increase the PUC of its common shares so as to result in three equal deemed dividends to the three Holdcos, that it elects to be capital dividends (so as to result in a full distribution of its capital dividend account.)
10. DC will repurchase and redeem all of the common and preferred shares held in its capital by each of TC1 and TC2 in consideration for the issuance of non-interest-bearing demand promissory notes. It will designate portions of the resulting deemed dividends so as to result in an equal division of its GRIP between the three TCs.
11. The promissory notes owing between DC and TC1 and between DC and TC2 will be set off.
12. At the beginning of the next day, TC3 will amalgamate with DC pursuant to the "Final Amalgamation," with the authorized share capital of the amalgamated corporation (Amalco) being the same as that of TC3.

Purposes

The overall purpose is to permit each sibling to operate independently of the others.

DC and each of TC1 and TC2 choose their respective first taxation years as described above in order for the taxable dividends resulting from the cross-redemptions to be paid and received in separate taxation years so as to avoid a possible Part IV tax circularity issue.

The amalgamation to form DC occurs in order to combine the rental properties and the employees of the predecessor corporations into one rental property business operated by DC throughout the relevant taxation year that includes the butterfly distribution, so that all the DC rental properties may be classified as business property for purposes of the three-types-of-property classification under s. 55(3)(b).

The purpose of the Final Amalgamation is primarily to trigger a short year-end to DC's second taxation year to ensure that DC's NERDTOH and ERDTOH, if any, and any corresponding dividend refund will be nominal so that the Part IV tax payable by each of TC1 and TC2 in respect of the deemed dividends will be nominal, and any Part IV tax payable in respect of a dividend refund to DC for the period after the butterfly distribution will be borne by Holdco 3 and Sibling 3 as the remaining shareholders of DC.

Rulings include

The combined rental business of DC will not be considered to be a specified investment business immediately before the butterfly distribution.

A ruling respecting s. 55(2) not applying and s. 55(3.1) not applying to deny the exemption under s. 55(3)(b).