In general terms, the Family Law Act (Ontario) provides that upon the breakdown of a marriage, the cumulative net worth acquired by the spouses during the marriage is to be equalized between them. This equalization of net family property is intended to ensure that spouses are fairly compensated for their respective contributions to the marriage, regardless of legal ownership of assets. Where one spouse has accumulated more net family property during the marriage than the other, that spouse is required to make an “equalization payment” to address the shortfall.

The equalization process can become significantly more complex where a couple’s assets include corporate shares, investment properties, trust interests, pensions, retirement accounts, stock options, and other sophisticated financial arrangements. In particular, complications often arise when valuable assets are held within a private corporation.

As part of my corporate and tax practice, I work collaboratively with divorcing spouses and their family law counsel to plan and implement corporate reorganizations that allow assets held within a corporation to be divided on a tax-deferred basis. These transactions are commonly referred to as divisive reorganizations and are typically carried out pursuant to section 55(3)(a) of the Income Tax Act (Canada) (the “ITA”). 

A properly structured divisive reorganization allows each spouse to receive corporate assets in a separate corporation without triggering immediate tax consequences. This provides greater flexibility and control, including the ability to manage the timing of personal tax recognition based on individual cash flow needs. Income tax will generally only be payable when funds are ultimately withdrawn from the respective corporations.

These reorganizations are colloquially known as “butterfly” reorganizations. The term derives from the visual resemblance of the corporate structure and transaction steps—often illustrated diagrammatically—to the shape of a butterfly.

Illustrative Example

Consider the following example. Sarah and David are married. Sarah owns all of the shares of a corporation (“SarahCo”). SarahCo holds various investment assets. SarahCo does not have any refundable dividend tax on hand, so issues relating to such balances are not considered in this example.

Pursuant to their separation agreement, Sarah and David agree that 40% of the assets of SarahCo are to be transferred to a corporation to be owned by David (“DavidCo”) on a tax-deferred basis, in compliance with the detailed rules governing butterfly reorganizations.

General Steps in the Divisive Reorganization

The following steps outline, at a high level, how the tax-deferred transfer of assets may be achieved:

1. Formation of DavidCo

A new corporation (“DavidCo”) is incorporated. Sarah subscribes for all of the common shares of DavidCo for a nominal amount. Sarah initially acts as the sole director and officer of DavidCo.

2. Transfer of SarahCo Shares to DavidCo

Sarah transfers 40% of her common shares in SarahCo to DavidCo pursuant to the tax-deferred rollover provisions of section 85(1) of the ITA. In consideration, DavidCo issues additional common shares to Sarah.

3. Transfer of Assets from SarahCo to DavidCo

SarahCo transfers the assets that David is entitled to receive under the separation agreement (i.e., a 40% proportionate share of the investment assets) to DavidCo pursuant to section 85(1) of the ITA. In consideration, DavidCo issues preferred shares to SarahCo.

4. Redemption of SarahCo Shares.

SarahCo purchases for cancellation the SarahCo common shares held by DavidCo. As consideration, SarahCo issues a promissory note to DavidCo (the “SarahCo–DavidCo P-Note”).

5. Redemption of DavidCo Preferred Shares

DavidCo redeems the preferred shares held by SarahCo and issues a promissory note to SarahCo (the “DavidCo–SarahCo P-Note”).

6. Set-Off of Promissory Notes

The SarahCo–DavidCo P-Note and the DavidCo–SarahCo P-Note are set off against one another and cancelled, as they represent equivalent value.

7. Resulting Asset Ownership

At this stage, DavidCo owns 40% of the assets that were originally held by SarahCo.

8. Transfer of DavidCo Shares to David

Sarah transfers all of her shares in the capital of DavidCo to David pursuant to the tax-deferred rollover provisions of section 73(1) of the ITA.

9. Change in Management of DavidCo

Sarah resigns as director and officer of DavidCo, and David becomes the sole director and officer.

10. Final Ownership Structure

David now owns 100% of the shares of DavidCo, which in turn owns 40% of the assets originally held by SarahCo.

11. Sarah’s Continuing Ownership

Sarah continues to own 100% of the shares of SarahCo, which retains ownership of the remaining 60% of the assets.

Key Takeaways

Divisive (butterfly) reorganizations are a powerful planning tool for equalizing net family property where corporate assets are held in private corporations. They allow spouses to: divide corporate assets on a tax-deferred basis, manage the timing of personal tax based on Individual cash flow needs, avoid forced liquidations and preserve long-term tax efficiency- transforming potentially taxable events into a flexible and orderly separation of economic interests.