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Butterfly Transactions

The problem is simple: two shareholders want to divide a jointly owned company and go their separate ways with a pro rata share of the original company without incurring tax. Alternatively, a taxpayer wants to divide their company into two companies, again without incurring tax.

Despite the simplicity of the problem, the solution often requires undertaking a complex “butterfly transaction”. 

The complexity comes from the numerous anti-avoidance provisions that can trip up an unwary practitioner implementing a butterfly transaction, which could create an unintentional tax liability.

Why is it called a
“butterfly transaction”?

Tax practitioners use the word “butterfly” because on an organizational chart the split of the business looks like “wings”. A butterfly transaction can also be known as a “divisive reorganization”

Do you have a business partner that wants to split from the company?

If you have a business partner (or are that business partner) that wants to leave a company, but continue in the same line of business, you may be a good candidate for a butterfly transaction.

 

Consider the simple scenario where a business operates out of two buildings, and there are two business partners. Each property has a significant unrealized capital gain. If one business partner intends to leave the business but wanted to keep a property to continue in the same line of business, the main concern would be triggering the unrealized gain on the property. The realization of the gain could be avoided by implementing a butterfly transaction.

Why is it called a
“butterfly transaction”?

Tax practitioners use the word “butterfly” because on an organizational chart the split of the business looks like “wings”. A butterfly transaction can also be known as a “divisive reorganization”

Do you have a business partner that wants to split from the company?

If you have a business partner (or are that business partner) that wants to leave a company, but continue in the same line of business, you may be a good candidate for a butterfly transaction.

 

Consider the simple scenario where a business operates out of two buildings, and there are two business partners. Each property has a significant unrealized capital gain. If one business partner intends to leave the business but wanted to keep a property to continue in the same line of business, the main concern would be triggering the unrealized gain on the property. The realization of the gain could be avoided by implementing a butterfly transaction.

Why do I need to do a butterfly transaction?

The Department of Finance never set out to impose tax taxpayers from splitting up their business when business partners went their separate ways in new businesses. However, subsection 55(2) of the Income Tax Act (the “ITA)”) is a specific anti-avoidance rule which creates a deemed capital gain on certain reorganizations. This unintentionally caught business owners splitting up or dividing their company in two. As a result, subsection 55(3) of the ITA was added to allow taxpayers to split up their business in certain circumstances without incurring tax. The CRA has allowed taxpayers to rely on subsection 55(3) of the ITA to undertake butterfly transactions.

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