2007 Ruling 2007-0241741R3 - butterfly reorganization

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Prior to a proposed butterfly reorganization, DC1 exchanged its shares of a corporation for shares of another corporation, whether such share exchange would be subject to the application of the butterfly denial rule in paragraph 55(3.1)(a)?

Position: No.

Reasons: Paragraph 55(3.1)(a) does not apply to such share exchange, because "in contemplation" requirement as described therein was not met.

XXXXXXXXXX 									2007-024174

XXXXXXXXXX , 2007

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. In your letters of XXXXXXXXXX provided additional information concerning the facts and proposed transactions described in your original letter. We also acknowledge the information provided during our various telephone conversations (XXXXXXXXXX).

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein:

(i) is in an earlier return of one of the taxpayers or a related person;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of one of the taxpayers or a related person;

(iii) is under objection by one of the taxpayers or a related person; (iv) is before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has expired; or

(v) is the subject of a ruling previously issued by this Directorate.

Definitions

In this letter, the following terms have the meanings specified:

"Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof, and unless otherwise stated, every reference herein to a part, section, subsection, paragraph, subparagraph or clause is a reference to the relevant provision of the Act;

"agreed amount" means the amount agreed on by the transferor and transferee in respect of the transfer of an eligible property in a joint election filed pursuant to subsection 85(1);

"BCA" means the Business Corporations Act (XXXXXXXXXX);

"CBCA" means the Canada Business Corporations Act, R.S.C. 1985, c.C-44, as amended;

"Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7);

"CRA" means the Canada Revenue Agency;

"capital dividend" means a dividend to which subsection 83(2) applies;

"CDA" means "capital dividend account" as defined in section 89;

"capital property" has the meaning assigned by section 54;

"cost amount" has the meaning assigned by subsection 248(1);

"dividend refund" has the meaning assigned by paragraph 129(1)(a);

"dividend rental arrangement" has the meaning assigned by subsection 248(1);

"eligible dividend" has the meaning assigned by subsection 89(1);

"eligible property" has the meaning assigned by subsection 85(1.1);

"FMV" means fair market value, being the highest price available in an open and unrestricted market between informed prudent parties acting at arm's length and without compulsion to act, expressed in terms of cash;

"Family" means XXXXXXXXXX;

"general rate income pool" ("GRIP") has the meaning assigned by subsection 89(1);

"guarantee agreement" has the meaning assigned by subsection 112(2.2);

"paid-up capital" ("PUC") has the meaning assigned by subsection 89(1);

"Paragraph" refers to a numbered paragraph in this advance income tax ruling;

"proceeds of disposition" has the meaning assigned by section 54;

"Proposed Transactions" means the transactions described in Paragraphs 10 to 24;

"RDTOH" means "refundable dividend tax on hand" as that expression is defined in subsection 129(3);

"related persons" has the meaning assigned by subsection 251(2);

"restricted financial institution" has the meaning assigned by subsection 248(1);

"series of transactions or events" includes the transactions or events referred to in subsection 248(10);

"significant influence" has the meaning assigned by section 3050 of the CICA Handbook;

"specified financial institution" has the meaning assigned by subsection 248(1);

"specified investment business" has the meaning assigned by subsection 125(7);

"stated capital" has the meaning assigned by the provisions of CBCA or BCA;

"subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1);

"taxable Canadian corporation" ("TCC") has the meaning assigned by subsection 89(1); and

"taxable dividend" has the meaning assigned by subsection 89(1).

Our understanding of the relevant facts, proposed transactions and purpose of the proposed transactions is as follows:

Facts

1. XXXXXXXXXX. ("DC1") is a CCPC and a TCC. It was incorporated on XXXXXXXXXX under the Canada Business Corporations Act ("CBCA"). Its issued and outstanding share capital consists of XXXXXXXXXX Class E voting common shares.

XXXXXXXXXX. ("TC1"), XXXXXXXXXX. ("TC2") and XXXXXXXXXX. ("TC3") each hold XXXXXXXXXX Class E shares of DC1.

The assets of DC1 consist of:

a) XXXXXXXXXX Class D non-voting, redeemable and retractable shares and XXXXXXXXXX Class E voting common shares of XXXXXXXXXX. ("Subco1");

b) Portfolio investments in hedge funds (which XXXXXXXXXX ("Foreignco #1") and XXXXXXXXXX. ("Foreignco #2")) and other similar instruments in which DC1 does not have a significant influence;

c) Investments in limited partnerships (as a limited partner);

d) Loan receivable from TC1 ("TC1 receivable");

e) Loan receivable from XXXXXXXXXX. ("Realtyco"), a subsidiary wholly-owned corporation of Subco1 ("Realtyco receivable"); and

f) Other receivables.

Foreignco #1 and Foreignco #2 are non-resident corporations. They are not related to DC1.

DC1 holds the assets described in a) to f) above as capital property.

The current FMV of DC1 is estimated to be in excess of $XXXXXXXXXX.

DC1's taxation year ends on XXXXXXXXXX. DC1 files its federal tax returns at the XXXXXXXXXX Taxation Centre and the XXXXXXXXXX TSO administers its federal tax matters.

DC1 had RDTOH on the date its XXXXXXXXXX taxation year ended.

DC1 paid to each of TC1, TC2 and TC3 a dividend of $XXXXXXXXXX in XXXXXXXXXX and another dividend of $XXXXXXXXXX in XXXXXXXXXX. DC1 has paid dividends to each of TC1, TC2 and TC3 of various amounts from time to time in the past.

None of the shares of DC1 has been acquired by any person in contemplation of the Proposed Transactions described below.

2. TC1 is a CCPC and a TCC. It was incorporated under the CBCA. Its issued and outstanding share capital consists of:

a) XXXXXXXXXX non-voting common shares;

b) XXXXXXXXXX Class A voting, redeemable and retractable shares, entitled to non-cumulative dividends;

c) XXXXXXXXXX Class B non-voting, redeemable and retractable shares, entitled to non-cumulative dividends.

All of the issued and outstanding shares of TC1 are held by XXXXXXXXXX ("Individual 1"). Consequently, Individual 1 controls TC1. Individual 1 is a resident of Canada for the purposes of the Act.

TC1 has been continued under the Business Corporations Act (XXXXXXXXXX) ("BCA"). It was converted into an XXXXXXXXXX unlimited liability corporation ("XXXXXXXXXX"). The reason for TC1's conversion into an XXXXXXXXXX was for U.S. tax purposes.

Specifically, on the death of Individual 1, his shares in TC1 will go to a spousal trust. Since Individual 1's spouse is a U.S. citizen, the U.S. tax consequences resulting from the ownership of a Canadian corporation will likely result in double taxation. In order to mitigate these adverse tax consequences, TC1 was converted into an XXXXXXXXXX.

TC1's taxation year ends on XXXXXXXXXX. TC1 files its federal tax returns at the XXXXXXXXXX Taxation Centre and the XXXXXXXXXX TSO administers its federal tax matters.

TC1 had RDTOH on the date its XXXXXXXXXX taxation year ended.

3. TC2 is a CCPC and a TCC. It is governed by the CBCA. Its issued and outstanding share capital consists of:

a) XXXXXXXXXX non-voting common shares;

b) XXXXXXXXXX Class A voting, redeemable and retractable shares, entitled to non-cumulative dividends;

c) XXXXXXXXXX Class B non-voting, redeemable and retractable shares, entitled to non-cumulative dividends.

All of the issued and outstanding Class A and Class B shares of TC2 are held by XXXXXXXXXX ("Individual 2"). All of the issued and outstanding common shares of TC2 are held by XXXXXXXXXX ("Trust 1"). TC2's taxation year ends on XXXXXXXXXX. TC2 files its federal tax returns at the XXXXXXXXXX Taxation Centre and the XXXXXXXXXX TSO administers its federal tax matters.

TC2 had RDTOH on the date its XXXXXXXXXX taxation year ended.

Individual 2 and Trust 1 are residents of Canada for the purposes of the Act. Individual 2 controls TC2.

4. TC3 is a CCPC and a TCC. It is governed by the CBCA. Its issued and outstanding share capital consists of:

a) XXXXXXXXXX non-voting common shares;

b) XXXXXXXXXX Class A voting, redeemable and retractable shares, entitled to non-cumulative dividends;

c) XXXXXXXXXX Class B non-voting, redeemable and retractable shares, entitled to non-cumulative dividends.

All of the issued and outstanding Class A and Class B shares of TC3 are held by XXXXXXXXXX ("Individual 3"). All of the issued and outstanding common shares of TC3 are held by XXXXXXXXXX ("Trust 2").

TC3's taxation year ends on XXXXXXXXXX. TC3 files its federal tax returns at the XXXXXXXXXX Taxation Centre and the XXXXXXXXXX TSO administers its federal tax matters.

TC3 had RDTOH on the date its XXXXXXXXXX taxation year ended.

Individual 3 and Trust 2 are residents of Canada for the purposes of the Act. Individual 3 controls TC3.

5. Subco1 is a taxable CCPC and a TCC. It is governed by the CBCA. Its issued and outstanding share capital consists of:

a) XXXXXXXXXX Class B voting, redeemable shares, entitled to a XXXXXXXXXX % non-cumulative dividend;

b) XXXXXXXXXX Class D non-voting, redeemable and retractable shares, entitled to a XXXXXXXXXX % non-cumulative dividend;

c) XXXXXXXXXX Class E voting common shares.

XXXXXXXXXX ("Individual 4") holds all of the XXXXXXXXXX Class B shares of Subco1. DC1 holds all of the Class D shares and all of the Class E shares of Subco1.

Subco1 is controlled by Individual 4 who holds XXXXXXXXXX% of the issued and outstanding voting shares of Subco1. Individual 4 is the father of Individuals 1, 2 and 3.

The assets of Subco1 consist of:

i) cash;

ii) Shares of various wholly-owned Canadian subsidiaries (which include XXXXXXXXXX .("Opco"), a CCPC and a TCC) and a foreign subsidiary;

iii) Portfolio investments in marketable securities, hedge funds and other similar instruments in which Subco1 does not have a significant influence;

iv) Investments in limited partnerships (as a limited partner);

v) Loan receivable from Realtyco, its subsidiary wholly-owned corporation;

vi) Loan receivable from Individual 4; and

vii) Other receivables.

6. Prior to XXXXXXXXXX, DC1 transferred some of its Foreignco #1 shares to XXXXXXXXXX. ("Foreignco #3") in exchange for shares of Foreignco #3. DC1 also transferred some of its Foreignco #2 shares to XXXXXXXXXX. ("Foreignco #4") in exchange for shares of Foreignco #4.

Both Foreignco #3 and Foreignco #4 are non-resident corporations. They are not related to DC1.

On or about XXXXXXXXXX, DC1 transferred its Foreignco #3 shares to Opco in exchange for non-voting, redeemable and retractable preferred shares of Opco ("Opco Preferred Shares1") having an aggregate FMV equal to the aggregate FMV of the Foreignco #3 shares so transferred to Opco.

On or about XXXXXXXXXX, DC1 transferred all of its remaining shares of Foreignco #1 to Foreignco #3 in exchange for shares of Foreignco #3.

On or about XXXXXXXXXX, DC1 transferred all of its remaining Foreignco #3 shares to Opco in exchange for non-voting, redeemable and retractable preferred shares of Opco ("Opco Preferred Shares2") having an aggregate FMV equal to the aggregate FMV of the Foreignco #3 shares so transferred to Opco (the Opco Preferred Shares1 and the Opco Preferred Shares2 are collectively referred to as the "Opco Preferred Shares").

The reason why DC1 exchanged its Foreignco #1 shares for Foreignco #3 shares was to reduce its investment risk. Specifically, Foreignco #1 was a single manager, multi-strategy hedge fund. While Foreignco #1 had achieved remarkable (top decile or better) returns throughout the XXXXXXXXXX, more recently it had achieved results more reflective of top quartile industry averages. In addition, XXXXXXXXXX, the principal of Foreignco #1, might be in the later stages of his career and the future direction of the firm was unclear. Foreignco #3 was a multi-manager fund of funds with top quartile historical results. As a fund of funds, it had over XXXXXXXXXX hedge fund managers in its portfolio, thus reducing manager specific risk.

Also, the reason why DC1 exchanged its Foreignco #2 shares for Foreignco #4 shares was to achieve better returns while reducing concentration risk in its portfolio. Both Foreignco #2 and Foreignco #4 were fund of fund hedge funds, although the investment managers were different and thus their holdings were very different. Foreignco #2 was and had been the largest investment of DC1, representing XXXXXXXXXX% of its investments, a concentration DC1 was seeking to reduce.

Consequently, the exchanges by DC1 of the Foreignco #1 shares for the Foreignco #3 shares and of the Foreignco #2 shares for the Foreignco #4 shares was a strategic investment decision, a decision that was and should be made on a continuous basis by a manager of this type of portfolio. As such these decisions had been made and were being undertaken on a continuous basis and would have been undertaken whether or not the Proposed Transactions were implemented.

In addition, DC1 had to exchange the Foreignco #1 shares for the Foreignco #3 shares and the Foreignco #2 shares for the Foreignco #4 shares on or before its 2007 taxation year ending XXXXXXXXXX (i.e. prior to the implementation of the Proposed Transactions), because proposed paragraph 85.1(6)(f) would deny foreign share for foreign share exchange rollover treatment under subsection 85.1(5), applicable for taxation years that begin after 2006, if the exchanged foreign share was, immediately before the exchange, a specified participating interest of the transferor (as defined in proposed definition of "specified participating interest" in subsection 248(1)).

You represented that DC1's Foreignco #1 shares and Foreignco #2 shares would be specified participating interests of DC1, as they were not an exempt interest (as defined in proposed definition of "exempt interest" in subsection 94.1(1)).

Consequently, the exchanges by DC1 of the Foreignco #1 shares for the Foreignco #3 shares and of the Foreignco #2 shares for the Foreignco #4 shares had no connection with the Proposed Transactions.

7. On or about XXXXXXXXXX, Opco donated some of its shares of Foreignco #3 to the XXXXXXXXXX ("Foundation"), a private foundation that was incorporated under the CBCA on XXXXXXXXXX. The directors of the Foundation are Individual 1, Individual 2, Individual 3 and Individual 4 and a majority of votes is needed for decision-making. The Foundation is therefore not controlled by any single individual.

The Family is a philanthropic family and has over the last XXXXXXXXXX years made significant donations to the Foundation. Over the last few years the Family has made annual donations to the Foundation ranging from $XXXXXXXXXX to as high as $XXXXXXXXXX. As such the decision for DC1 to transfer its Foreignco #3 shares to Opco (in return for the Opco Preferred Shares) would allow Opco to fund its donations to the Foundation.

In addition, DC1 had to exchange the Foreignco #3 shares for the Opco Preferred Shares on or before its XXXXXXXXXX taxation year ending XXXXXXXXXX, because proposed paragraph 85(1.11)(b) would deny, inter alia, share for share exchange rollover treatment under subsection 85(1), applicable for taxation years that begin after XXXXXXXXXX, if the exchanged shares were, immediately before the exchange, specified participating interests of the transferor.

You also represented that DC1's Foreignco #3 shares and Foreignco #4 shares would be specified participating interests of DC1, as they were not an exempt interest.

Consequently, the exchange by DC1 of the Foreignco #3 shares for the Opco Preferred Shares was not made in connection with, and was therefore in no way in contemplation of, the Proposed Transactions.

8. Individual 1, Individual 2 and Individual 3 are siblings. They are therefore related to each other pursuant to paragraph 251(2)(a). Consequently, DC1, TC1, TC2 and TC3 are related to each other pursuant to subparagraphs 251(2)(c)(ii) and (iii).

However, for the purposes of section 55, by virtue of subparagraph 55(5)(e)(i):

a) Individual 1, Individual 2 and Individual 3 are not related to each other and are not related to DC1; and

b) TC1, TC2 and TC3 are not related to each other and are not related to DC1.

Purpose of the Proposed Transactions

9. The purpose of the Proposed Transactions is to transfer to each of TC1, TC2 and TC3 its proportionate share of the properties of DC1 such that each of TC1, TC2 and TC3 will be able to separate its interests from another to allow for easier succession planning and the ability to pursue different and independent course of actions.

Proposed Transactions

10. DC1 will sell to Subco1 at FMV some of its portfolio investments in marketable securities, private companies and all of its portfolio investments in limited partnerships for consideration that consists only of money or indebtedness that is not convertible into other property, or of any combination thereof. In order to simplify the distribution referred to in Paragraph 15, such indebtedness will take the form of three equal notes payable ("Subco1-TC1 receivable", "Subco1-TC2 receivable", "Subco1-TC3 receivable").

11. DC1 will file articles of amendment

(a) to create in its share capital a new class of common shares (the "DC1 New Common Shares") having attributes slightly different from those of the existing issued DC1 Class E common shares; and

(b) to amend the formula that determines the redemption amount of each of the authorized non-voting, redeemable and retractable preferred shares (the "DC1 Preferred Shares").

TC1, TC2 and TC3 will each file articles of amendment to create in its share capital a new class of non-voting, redeemable and retractable preferred shares.

12. Each of TC1, TC2 and TC3 will transfer to DC1 all of its DC1 Class E common shares ("Share Exchanges") in exchange for

(a) DC1 Preferred Shares having an aggregate redemption amounts and FMV equal to the sum of $XXXXXXXXXX plus one-third of DC1's GRIP balance at the end of the taxation year in which the Share Exchanges take place; and

(b) DC1 New Common Shares.

The aggregate FMV of the DC1 Preferred Shares and the DC1 New Common Shares that each of TC1, TC2 and TC3 received described above will be equal to the aggregate FMV of the DC1 Class E common shares that each of TC1, TC2 and TC3 so transferred to DC1.

No election under subsection 85(1) will be made with respect to the Share Exchanges.

13. For the purposes of the CBCA, the aggregate amount that will be added to the stated capital account of the DC1 Preferred Shares issued by DC1 to each of TC1, TC2 and TC3 as described in Paragraph 12 will be $XXXXXXXXXX, for an aggregate amount of $XXXXXXXXXX. In addition, the aggregate amount that will be added to the stated capital account of the DC1 New Common Shares issued by DC1 to TC1, TC2 and TC3 as described in Paragraph 12 will be equal to the PUC of the DC1 Class E common shares so transferred by each of TC1, TC2 or TC3 to DC1 as described in Paragraph 12 less $XXXXXXXXXX.

14. Immediately before the transfers of property described in Paragraph 15, the properties of DC1 (other than the Subco1 shares, the Opco Preferred Shares and the Realtyco receivable) will be classified into the following types of property for the purposes of paragraph 55(3)(b):

a) Cash or near cash property, comprising all of the current assets of DC1 including any cash, marketable securities (other than those held as portfolio investments), accounts receivable (which, for greater certainty, will include the TC1 receivable, the Subco1-TC1 receivable, the Subco1-TC2 receivable and the Subco1-TC3 receivable) and prepaid expenses;

b) Investment property, comprising of all the assets of DC1 (other than cash or near cash property), any income from which would constitute income from property or from a specified investment business including marketable securities, investments in private companies, hedge funds and limited partnerships held as portfolio investment;

c) Business property, comprising of all of the assets of DC1 (other than cash or near cash), any income from which would be income from a business (other than a specified investment business).

It is anticipated that, excluding the Subco1 shares, the Opco Preferred Shares and the Realtyco receivable, DC1 will not own any business property immediately before the transfers of property described in Paragraph 15.

For greater certainty, any tax accounts of DC1, including the balance of its RDTOH, its CDA, its GRIP account and any losses available for carry forward, will not be considered property of DC1 for the purposes of the Proposed Transactions.

15. DC1 will then transfer to each of TC1, TC2 and TC3 one-third of:

a) its shares of Subco1;

b) its Opco Preferred Shares;

c) its Realtyco receivable;

d) its cash or near cash property (for greater certainty, the TC1 receivable will be transferred to TC1, the Subco1-TC1 receivable will be transferred to TC1, the Subco1-TC2 receivable will be transferred to TC2 and the Subco1-TC3 receivable will be transferred to TC3);

e) its investment property; and

f) its business property, if any;

such that the FMV of each type of property described in a) to f) above so transferred to each such transferee as described herein will be equal to that proportion of the FMV of all the properties of DC1 of that type determined immediately before such transfer that:

i. the aggregate FMV, immediately before such transfer, of all of the shares of DC1 owned by TC1, TC2 or TC3, as the case may be,

is of

ii. the aggregate FMV immediately before such transfer of all of the issued and outstanding shares of DC1 (such proportion is hereinafter referred to as the "TC1 Proportion", "TC2 Proportion" and "TC3 Proportion", as the case may be).

16. As consideration for the transfers of property described in Paragraph 15, each of TC1, TC2 and TC3 will issue to DC1 non-voting, redeemable and retractable preferred shares, as the case may be, having an aggregate FMV equal to the aggregate FMV of the properties of DC1 transferred to TC1, TC2 and TC3, as the case may be, at the time of the transfer described in Paragraph 15. For greater certainty, no liabilities of DC1 will be assumed by either of TC1, TC2 or TC3 as consideration for the transfer. The aggregate amount of the liabilities of DC1 immediately before the transfers described in Paragraph 15 will not exceed the aggregate cost amount of the properties so transferred by DC1 to TC1, TC2 and TC3.

17. In respect of the transfer described in Paragraph 15, DC1 and each of TC1, TC2 and TC3 will file a joint election under subsection 85(1) in prescribed form and within the time referred to in subsection 85(6), but prior to the dissolution of DC1 described in Paragraph 20, with respect to each property that is an eligible property of DC1.

Since it is expected that DC1 will have unused capital losses, unused non-capital losses and unused donations at the time of the transfer, the agreed amount in respect of such property will exceed the cost amount of the property to DC1 immediately before the transfer in order to utilize such tax attributes. The agreed amount in respect of each such property for the purposes of the Act will not exceed the FMV of the property at the time of the disposition nor will it be less than the lesser of the cost amount of the property to DC1 immediately before the transfer and the FMV thereof at that time.

18. The aggregate amount that will be added to the stated capital account of the TC1, TC2 and TC3 preferred shares issued by each of TC1, TC2 and TC3 as described in Paragraph 16, as the case may be, will not exceed the aggregate cost, as determined under section 85 of the Act, of the properties transferred by DC1 to TC1, TC2 and TC3, as the case may be.

19. Each of TC1, TC2 and TC3 will redeem all of its outstanding preferred shares owned by DC1 and each will issue to DC1 as payment therefor, a non-interest bearing demand promissory note having a principal amount and FMV equal to the aggregate redemption amounts and FMV of its preferred shares so redeemed ("TC1 Note", "TC2 Note" and "TC3 Note", as the case may be).

20. Following the transactions described in Paragraph 19, TC1, TC2 and TC3, as the shareholders of DC1, will, by special resolution, resolve to liquidate and dissolve DC1 pursuant to the applicable provisions of the CBCA.

On the wind-up of DC1, under the terms of the agreement governing the winding-up of DC1, the TC1 Note, the TC2 Note and the TC3 Note will be assigned and distributed to TC1, TC2 and TC3, respectively. As a result of the assignment and distribution of the TC1 Note, the TC2 Note and the TC3 Note by DC1, the obligation of each TC1, TC2 and TC3 under its own note will be cancelled.

All of the liabilities of DC1 will be assumed by TC1, TC2 and TC3 such that

a) The aggregate of the liabilities of DC1 assumed by TC1 will be equal to the TC1 Proportion of all the liabilities of DC1;

b) The aggregate of the liabilities of DC1 assumed by TC2 will be equal to the TC2 Proportion of all the liabilities of DC1; and

c) The aggregate of the liabilities of DC1 assumed by TC3 will be equal to the TC3 Proportion of all the liabilities of DC1.

Immediately after the distribution of TC1 Note, TC2 Note and TC3 Note by DC1 To TC1, TC2 and TC3 as described herein but before the formal dissolution of DC1, DC1 will not own or acquire any property or carry on any activity or undertaking.

21. DC1 will designate the dividend that it is deemed by subsection 84(2) to have paid on the DC1 Preferred Shares to TC1, TC2 and TC3, at the time of distributing the TC1 Note, the TC2 Note and the TC3 Note to TC1, TC2 and TC3 described in Paragraph 20, to be an eligible dividend by notifying in writing at that time each of TC1, TC2 and TC3 that the dividend is an eligible dividend, pursuant to subsection 89(14). 22. DC1 will file an election in prescribed manner and prescribed form pursuant to subsection 83(2) in respect of the full amount of the dividend, on the DC1 New Common Shares, referred to in subparagraph 88(2)(b)(i), which is deemed to be paid out of its CDA.

23. Following receipt of the dividend refund to which DC1 will become entitled as a result of the Proposed Transactions described herein, DC1 will immediately distribute it (under the terms of the agreement governing the winding-up of DC1) to each of TC1, TC2 and TC3 in the same proportions as described in paragraph 15 above. Within a reasonable time following the distribution of such dividend refund, articles of dissolution will be filed with the appropriate Corporate Registry and upon receipt of a certificate of dissolution, DC1 will be dissolved.

24. The agreement respecting the transfer of property described in Paragraph 15 will contain a price adjustment clause which will allow the parties thereto to alter the transfer price, the agreed amount and the consideration paid in the event that the taxation authorities do not concur with the FMV and/or cost amount assigned to the property transferred by the parties.

25. [Reserved]

Additional Information

26. None of the corporations referred to herein is or will be, at any time during the series of transactions herein described, a specified financial institution or a restricted financial institution.

27. No property has been or will be acquired by DC1 and no liabilities have been or will be incurred by of DC1 in contemplation of and before the transfers of property as described in Paragraph 15, except as described herein.

28. There are not, and will not be at any time prior to the completion of the Proposed Transactions, any agreements or undertakings which constitute or include a "guarantee agreement" in respect of any of the DC1 Preferred Shares, the DC1 New Common Shares, the TC1 preferred shares, the TC2 preferred shares or the TC3 preferred shares.

29. None of DC1, TC1, TC2 or TC3 has, or will have, entered into a "dividend rental arrangement" in respect of any of the DC1 Preferred Shares, the DC1 New Common Shares, the TC1 preferred shares, the TC2 preferred shares or the TC3 preferred shares.

30. None of the DC1 Preferred Shares, the DC1 New Common Shares, the TC1 preferred shares, the TC2 preferred shares or the TC3 preferred shares has been, or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5) of the Act.

31. None of the corporations described above is or will be, at any time before the completion of the Proposed Transactions described above, a corporation described in any of the paragraphs (a) to (f) of the definition "financial intermediary corporation" in subsection 191(1).

32. Each of TC1, TC2 and TC3 will have the financial capacity to honour, upon presentation for payment, the amount payable under the promissory note issued by it as part of the Proposed Transactions.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are as follows:

A. Subject to the application of subsection 69(11), the provisions of subsection 85(1) will apply to the transfer of each eligible property by DC1 to TC1, TC2 and TC3 described in Paragraph 15 in respect of which a joint election under subsection 85(1) is made such that the agreed amount in respect of each transfer will be deemed to be the proceeds of disposition to the transferor and the cost thereof to the transferee pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to herein.

B. The provisions of subsection 86(1) will apply, and the provisions of subsection 86(2) will not apply, to the Share Exchanges described in Paragraph 12.

C. Subsection 84(3) will apply on the redemption by each of TC1, TC2 and TC3 of its preferred shares owned by DC1, as described in Paragraph 19, to deem DC1 to have received and each of TC1, TC2 and TC3 to have paid, as the case may be, a dividend on such shares equal to the amount, if any, by which the aggregate amount paid upon such redemption exceeds the aggregate PUC in respect of such shares immediately before such redemption.

D. As a result of the distribution by DC1 in the course of its winding-up as described in Paragraphs 20 and 23:

(a) pursuant to paragraph 88(2)(b) and subsection 84(2), but subject to (b) and (c) herein:

(i) TC1, TC2 and TC3 will each be deemed to have received a winding-up dividend on the DC1 Preferred Shares equal to the proportion, of the amount by which the aggregate FMV of the property of DC1 distributed to each of TC1, TC2 and TC3 in respect of the DC1 Preferred Shares on the winding-up exceeds the amount by which the PUC of the DC1 Preferred Shares is reduced, that the number of the DC1 Preferred Shares held by each of TC1, TC2 and TC3, as the case may be, is of the total number of issued DC1 Preferred Shares, and, pursuant to subparagraph 88(2)(b)(iii), such winding-up dividend will be deemed to be a taxable dividend; and

(ii) TC1, TC2 and TC3 will each be deemed to have received a winding-up dividend on the DC1 New Common Shares, equal to the proportion, of the amount by which the aggregate FMV of the property of DC1 distributed to each of TC1, TC2 and TC3 in respect of the DC1 New Common Shares on the winding-up exceeds the amount by which the PUC of the DC1 New Common Shares is reduced, that the number of the DC1 New Common Shares, held by each of TC1, TC2 and TC3, as the case may be, is of the total number of issued DC1 New Common Shares,

(b) pursuant to subparagraph 88(2)(b)(i), such portion of the winding-up dividend referred to in paragraph (a)(ii) above as does not exceed DC1's CDA determined immediately before the payment of the winding-up dividend will be deemed, for the purposes of the subsection 83(2) election referred to in Paragraph 22, to be the full amount of a separate dividend, and

(c) pursuant to subparagraph 88(2)(b)(iii), the winding-up dividend described in paragraph (a)(ii) above, to the extent that it exceeds the portion thereof referred to in (b) herein that is deemed to be a separate dividend, will be deemed to be a separate dividend that is a taxable dividend.

E. To the extent that each deemed dividend referred to in Rulings C and D above is a taxable dividend, each such dividend:

(a) will be included, pursuant to subsection 82(1) and paragraph 12(1)(j), in computing the income of the person deemed to have received such dividend;

(b) will be deductible, pursuant to subsection 112(1), by the corporation deemed to have received the dividend;

(c) will not be a dividend to which any of subsections 112(2.1), (2.2), (2.3) or (2.4) will apply;

(d) will be excluded, pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54, in determining the proceeds of disposition to the recipient corporation of the shares so redeemed or purchased;

(e) by virtue of subsection 112(3), will reduce the loss, if any, in respect of the disposition of the shares on which the dividend is deemed to be received; and

(f) will not be subject to tax under Parts IV.1 or VI.1 by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1 and paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

F. No taxes under Part IV will be payable in respect of the dividends described in Rulings C and D above except to the extent of the amount, if any, determined under paragraph 186(1)(b).

G. Provided that, as part of the series of transactions or events that includes the Proposed Transactions described above, there is not:

(a) an acquisition of property in circumstances described in paragraph 55(3.1)(a);

(b) a disposition of property in the circumstances described in subparagraph 55(3.1)(b)(i);

(c) an acquisition of control in the circumstances described in subparagraph 55(3.1)(b)(ii);

(d) an acquisition of shares of a distributing corporation in the circumstances described in subparagraph 55(3.1)(b)(iii); or

(e) an acquisition of property in the circumstances described in subparagraph 55(3.1)(c) or 55(3.1)(d);

which has not been described herein, then by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends described in Rulings C and D. For greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

H. The cancellation of the TC1 Note, the TC2 Note and the TC3 Note, as described in Paragraph 20, will not, in and of itself, give rise to a forgiven amount, within the meaning thereof in subsection 80(1) or 80.01(1).

I. Provided that DC1 designated the dividend described in Paragraph 21 to be an eligible dividend in prescribed manner and within the time referred to in subsection 89(14), the portion of that dividend that each of TC1, TC2 and TC3 received will be added to the GRIP account of each of TC1, TC2 and TC3 under paragraph G(a) of the definition of GRIP in subsection 89(1) in the taxation year in which each received that portion from DC1.

J. The provisions of subsections 15(1), 56(2), 56(4), 69(4) and 246(1) will not apply to any of the Proposed Transactions, in and of themselves.

K. The provisions of subsection 245(2) will not be applied as a result of the Proposed Transactions, in and of themselves, to re-determine the tax consequences confirmed in the rulings given above.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the CRA provided that the Proposed Transactions (other than the filing of articles of dissolution of DC1 as described in Paragraph 23) are completed by XXXXXXXXXX.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

Comments

1. Unless otherwise confirmed, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the PUC of any share or the ACB or FMV of any property referred to herein;

(b) the balance of CDA, GRIP or RDTOH of any corporation; or

(c) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above. In particular, we are not commenting on any tax consequences relating to the transactions described in Paragraph 6.

2. You have informed us, in Paragraph 24, that the transactions described in Paragraph 15 will be subject to a price adjustment clause. Nothing in this letter should be construed as confirmation, express or implied, that, for the purpose of any of the rulings given above, any adjustment to the FMV of the properties transferred and the redemption amount of the shares issued as consideration, will be effective retroactively to the time of the transfer and issuance of shares. In addition, any such adjustment could affect the ruling given in Ruling G above. Furthermore, none of the rulings given in this letter are intended to apply to the operation of a price adjustment clause, since its coming into effect will be due to circumstances that do not constitute proposed transactions that are seriously contemplated. The general position of the CCRA with respect to price adjustment clauses is stated in Interpretation Bulletin IT-169.

3. Each of DC1, TC1, TC2 and TC3 had RDTOH at its year-end on XXXXXXXXXX (and will have a balance at its year-end on XXXXXXXXXX), and the taxation year of each of TC1, TC2 and TC3 in which it redeems its preferred shares owned by DC1 will coincide with the taxation year of DC1 in which it distributes the TC1 Note, the TC2 Note and the TC3 Note to TC1, TC2 and TC3, respectively, on the wind-up of DC1. In addition, DC1 paid dividends to each of TC1, TC2 and TC3 as described in Paragraph 1. Consequently, this gives rise to the so-called circularity problem with respect to RDTOH, which is described in the paper given by Mr. R. Read of this Department on pages 18:23/24 of the 1988 Conference Report of the Canadian Tax Foundation. As explained in that paper, it is important to ensure that the dividends deemed by subsection 84(3) to be paid on the redemption or purchase for cancellation of shares, are paid by a corporation that does not have any RDTOH and that does not receive any dividends from another corporation which was entitled to a dividend refund during the taxation year of the first mentioned corporation in which such corporation would redeem or purchase for cancellation its shares.

You have indicated that while you are aware of the Department's position as set out herein, you do not propose to avoid the problem of circularity as described herein. Consequently, we must inform you that, in our view, this will result in each of DC1, TC1, TC2 and TC3 being subject to Part IV tax under paragraph 186(1)(b). It is also our view that the circularity problem causes uncertainty as to which corporation is ultimately entitled to a dividend refund and which corporation is ultimately liable for Part IV tax. Since the problem will affect the assessment of the income tax returns of DC1, TC1, TC2 and TC3, the district taxation office at which each of DC1, TC1, TC2 and TC3 files its respective T2 income tax return will have to be consulted in order to determine which corporation will receive the dividend refund and which corporation will be subject to the Part IV tax liability under paragraph 186(1)(b) described in these comments.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch