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butterfly transaction

A butterfly transaction is a tax free method of dividing up assets in a corporation between shareholders who are going their separate ways. It can also be carried out by a single shareholder who has two different businesses in a corporation with a view to separating the divisions so that they are each in a separate corporation. It is called a butterfly reorganization because when drawn out the transaction has the look of a butterfly. Two winged butterflies and single winged butterflies refer to the detailed way in which the transaction is carried out. In essence the butterfly transactions consist of a series of tax free rollovers under section 85 of the Income Tax Act and cross redemptions of shares. A butterfly reorganization cannot be undertaken in contemplation of an arm’s length sale. So in the case of a business with different divisions, if there is ever to be a sale of one of the divisions the butterfly division has to be done before any sale is being considered, otherwise it will not qualify.

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There are over 350,000 tax audit and review actions conducted by the Canada Revenue Agency on a yearly basis. Around 15,000 of these tax audits deal with “cash only” businesses (i.e. the underground economy). Additionally, an estimated 35,000 are tax shelter audits.

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