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.
CRA Tax Audits
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.