Butterfly Transactions

Butterfly transactions are used when shareholders in a business are going their separate ways. It’s a tax-free way of dividing assets between parties or between two companies in the same corporation. These transactions are essentially rollovers completed under section 85 of the Income Tax Act. Parties involved in butterfly transactions must ensure that they don’t put a foot wrong in completing the transaction. Any misstep could negate the tax-free benefit of the process.

In an arm’s length transaction, both parties act in their own best interests as if they have no relationship with each other. They can work fairly and negotiate a deal that doesn’t favour one party over the other. If parties are too close, e.g., family members, one might favour the other by offering a lower rate. On the opposite end of the scale, one party may force the other party to pay a higher price for goods purchased.

A spinoff butterfly is a butterfly transaction in which assets are distributed directly to the shareholders through a series of processes that involve other corporations being created. The asset distribution between shareholders is proportionate to each shareholder’s investment in the company.

Corporate divorce is the act of separation by parties in a partnership, LLC, or corporation. Its most common causes include differences in financial decision approaches, differing perspectives in the business’ direction, and failing to follow corporate formalities. When a corporate divorce occurs, the party wanting to remain in the business (mainly those with higher shares) buys the other parties’ shares. In some cases, a third-party buyer approved by all parties will buy the whole business. When this happens, each party should consult their lawyers to protect their standing and interest.

Income diversion means diverting income before an individual earns it. In this case, the responsibility of the individual on such income is overridden by another. One example of diversion is when a business owner charges an employee’s salary directly from a client. Thus, the revenue did not reach the business owner and was therefore non-taxable. Simply put, diversion of income reduces the total taxable income of an individual by diverting income flow from source to expenditure. This process is legal, but the tax law in Canada may ignore its legality to determine the proper taxable recipient of income.

Transferring shares by a corporation requires necessary documents and often has certain restrictions. The Artice of Incorporation stipulates all the relevant limitations. There should be a Director’s Resolution approving the transfer. Other documentary requirements include a Share Purchase Agreement, the director’s resolution approving the SPA, a new shares certificate indicating the share transfer signed by the president and the secretary, updating shareholders’ ledgers and registers, and resignation and Form 1. The resignation should suggest that the person exiting the corporation is also resigning as director or officer.

The taxability of capital gains is not affected by your total income level. Only 50% of a capital gain will be taxable, but that 50% capital gain will be treated as income regardless of your income bracket.