In a different article dealing with resolving shareholder disputes, I dealt with a couple of alternatives to resorting to litigation as a solution. In some circumstances, particularly if the parties are capable of more reasonable discussion, and the nature of the business permits, it is possible to divide the business of the Corporation into separate components, with each of the shareholders acquiring one or more components of the business.
A transaction in which the components of a business are divided is commonly referred to as a “butterfly,” the label referring to the graphical depiction of how the transaction is structured. Normally dividing assets between two or more shareholders would result in the corporation being considered to have disposed of its assets at fair market value. The butterfly transaction is designed to permit the assets of the corporation to be distributed on a tax-deferred basis. In other words, there will be no tax at the time of the division of the assets; rather tax will only arise if as and when the assets are actually sold.
There are two types of butterfly transactions, one being where all of the assets are divided between the shareholders and the other being referred to as a “partial butterfly” or “one wing butterfly” in which assets will be transferred to one of the shareholders while the remaining shareholder or shareholders continue as shareholders of the Corporation.
The butterfly transaction, whether full or partial, from a practical perspective, can only be used where the Corporation has separate divisions of more or less equal value, or the business is otherwise capable of being divided. If the value of the separate divisions is grossly disproportionate, the use of the butterfly procedure becomes problematic because of the technical requirements of the Income Tax Act (the “Act”), that require each shareholder to receive a pro-rata share of each category of the corporation’s assets.
Using a butterfly procedure to separate the interests of shareholders will generally require the parties to have a more reasoned approach to resolving their differences and being willing to accept a negotiated solution rather than continue to work in an acrimonious environment which can create an unhealthy level of stress.
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