2009 Ruling 2008-0284591R3 - Split-up Butterfly

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: Whether pre-butterfly acquisition of property results in application of s. 55(3.1)(a).

Position: No.

Reasons: Acquisition of property by distributing corporation not in contemplation of butterfly distribution.

XXXXXXXXXX 								2008-028459

XXXXXXXXXX , 2009

Dear Sir:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent correspondence dated XXXXXXXXXX , and various telephone conversations. You have advised us that to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayers or persons related to the taxpayers;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or persons related to the taxpayers;
(iii) under objection by the taxpayers or persons related to the taxpayers;
(iv) before the courts; or
(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise noted, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (hereinafter referred to as the "Act"). Unless otherwise noted, all references to currency are to Canadian dollars.

DEFINITIONS

(a) "active business income" means income that is described in paragraph (a) of the definition of "income of the corporation for the year from an active business" in subsection 125(7);

(b) "adjusted cost base" or "ACB" has the meaning assigned by section 54;

(c) "agreed amount" is the amount agreed in respect of a disposition of property pursuant to paragraph 85(1)(a);

(d) "BCA" means XXXXXXXXXX ;

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

(f) "capital dividend" has the meaning assigned by section 83;

(g) "capital dividend account" or "CDA" has the meaning assigned by subsection 89(1);

(h) "capital property" has the meaning assigned by section 54;

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

(j) "DC" means XXXXXXXXXX .;

(k) "DC Consolidated Group" means DC and any corporation over which DC has the ability to exercise significant influence;

(l) "DC Note 1" means the promissory note of DC described in Paragraph 29;

(m) "DC Note 2" means the promissory note of DC described in Paragraph 30;

(n) "DC Shareholder 1" means XXXXXXXXXX ;

(o) "DC Shareholder 2" means XXXXXXXXXX ;

(p) "DC Shareholder 3" means XXXXXXXXXX ;

(q) "depreciable property" has the meaning assigned by subsection 13(21);

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

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

(t) "fair market value" or "FMV" means the amount, expressed in money terms, that is the highest price available in an open and unrestricted market between informed and prudent parties dealing at arm's length;

(u) "forgiven amount" has the meaning assigned by subsection 80(1);

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

(w) "Holdco 1" means XXXXXXXXXX .;

(x) "Holdco 2" means XXXXXXXXXX .;

(y) "non-capital loss" has the meaning assigned by subsection 111(8);

(z) "net capital loss" has the meaning assigned by subsection 111(8);

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

(bb) "Paragraph" means a numbered paragraph in this letter;

(cc) "Proposed Transactions" means the transactions described in Paragraphs 17 to 33, which will occur in the order presented in this letter;

(dd) "refundable dividend tax on hand" or "RDTOH" has the meaning assigned by subsection 129(4);

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

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

(gg) "significant influence" has the meaning assigned by section 3051 of the CICA Handbook;

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

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

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

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

(ll) "TC1" means XXXXXXXXXX .;

(mm) "TC1-Sub" means the wholly-owned subsidiary of TC1 to be incorporated in the manner described in Paragraph 18;

(nn) "TC1-Sub Note" means the promissory note of TC1-Sub described in Paragraph 27;

(oo) "TC1-Sub Preferred Shares" means the preferred shares of TC1-Sub described in Paragraph 18;

(pp) "TC2" means XXXXXXXXXX .;

(qq) "TC2 Note" the promissory note of TC2 described in Paragraph 28; and

(rr) "TC2 Preferred Shares" means the preferred shares of TC2 described in Paragraph 19.

FACTS

1. DC is a taxable Canadian corporation and a CCPC and is incorporated under the laws of XXXXXXXXXX . Its taxation year ends on XXXXXXXXXX . DC files its income tax returns with the XXXXXXXXXX Tax Center and its income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

2. The authorized share capital of DC consists of an unlimited number of Class A common shares. DC Shareholder 1 holds the majority of the issued and outstanding Class A common shares and thereby controls DC. DC Shareholder 2 and DC Shareholder 3 hold equal numbers of the remaining issued and outstanding Class A common shares. The number of Class A common shares issued to each shareholder and their adjusted cost base, paid-up capital and fair market value are as follows:

Shareholder Number Issued PUC ACB FMV

DC Shareholder 1 XXXXXXX XXXXXXX XXXXXX XXXXXX
DC Shareholder 2 XXXXXXX XXXXXXX XXXXXX XXXXXX
DC Shareholder 3 XXXXXXX XXXXXXX XXXXXX XXXXXX

3. DC, through its holdings in Holdco 1 and Holdco 2 described in Paragraphs 5 and 7, holds a number of commercial real estate investments from which Holdco 1 and Holdco 2 earn rental income. The commercial real estate rental activity carried on by Holdco 1 and Holdco 2 constitutes a specified investment business such that the income earned by Holdco 1 and Holdco 2 from their respective investments does not constitute active business income.

4. In addition to the shares of Holdco 1 and Holdco 2, DC holds, through a brokerage account administered by XXXXXXXXXX , an investment portfolio consisting of cash, short-term assets, fixed income securities and marketable debt and equity securities. The portfolio investment activity constitutes a specified investment business of DC and therefore income earned by DC from the investment portfolio does not constitute active business income.

5. Holdco 1 is a taxable Canadian corporation and a CCPC. Its taxation year ends on XXXXXXXXXX . Holdco 1 files its income tax returns with the XXXXXXXXXX Tax Center and its income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

The authorized share capital of Holdco 1 consists of an unlimited number of Class A voting common shares, an unlimited number of Class B non-voting preferred shares and an unlimited number of Class C voting preferred shares. The only issued and outstanding shares of Holdco 1 are Class A voting common shares. DC holds XXXXXXXXXX of the issued and outstanding Class A voting common shares of Holdco 1; the balance of those shares are held by persons who are not related to and deal at arm's length with DC, TC1, TC2, DC Shareholder 1, DC Shareholder 2 and DC Shareholder 3. The number of Class A voting common shares issued to each shareholder and the adjusted cost base and paid-up capital of those shares are as follows:

	Shareholder		Number and Class Issued		PUC	  	ACB	  	

	DC 	XXXXXXX  Class A common	$XXXXXX 	$XXXXXX
	XXXXXXXXXX 	XXXXXXX  Class A common	 XXXXXX 	XXXXXX
	XXXXXXXXXX .	XXXXXXX  Class A common XXXXXX 	    XXXXXX
	XXXXXXXXXX  	XXXXXXX  Class A common  	XXXXXX 	XXXXXX 

DC exercises significant influence over Holdco 1.

6. Holdco 2 is a taxable Canadian corporation and a CCPC. Its taxation year ends on XXXXXXXXXX . DC files its income tax returns with the XXXXXXXXXX Tax Center and its income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

7. The authorized share capital of Holdco 2 consists of an unlimited number of Class A voting, participating common shares, an unlimited number of Class B non-voting, participating shares, an unlimited number of Class C non-voting, redeemable, retractable, non-participating shares and an unlimited number of Class D voting, redeemable, retractable, non-participating shares. The only issued and outstanding shares of Holdco 2 are XXXXXXXXXX Class A common shares. DC and TC2 each hold XXXXXXXXXX shares. The remaining XXXXXXXXXX Class A common shares are held by the XXXXXXXXXX , an inter vivos trust that is not related to and deals at arm's length with DC, TC1, TC2, DC Shareholder 1, DC Shareholder 2 and DC Shareholder 3. The number of Class A common shares issued to each shareholder and the adjusted cost base and paid-up capital of those shares are as follows:

	Shareholder		Number and Class Issued		PUC	  	ACB	  	

	DC 	XXXXXXX  Class A common 	  $XXXXXX      XXXXXX
	TC2	XXXXXXX  Class A common	    XXXXXX 	      XXXXXX
	XXXXXXXXXX 	XXXXXXX  Class A common  	  XXXXXX 	      XXXXXX 

DC exercises significant influence over Holdco 2.

8. TC1 is a taxable Canadian corporation and a CCPC. Its taxation year ends on XXXXXXXXXX . TC1 files its income tax returns with the XXXXXXXXXX Tax Center and its income tax affairs are administered by the XXXXXXXXXX Tax Services Office. The authorized share capital of TC1 consists of an unlimited number of Class A voting shares and an unlimited number of Class B non-voting preferred shares. There are XXXXXXXXXX issued and outstanding Class A voting common shares, which are held by DC Shareholder 1, the adjusted cost base and paid-up capital of which is $XXXXXXXXXX . No Class B non-voting preferred shares of TC1 have been issued.

9. TC2 is a taxable Canadian corporation and a CCPC. Its taxation year ends on XXXXXXXXXX . TC2 files its income tax returns with the XXXXXXXXXX Tax Center and its income tax affairs are administered by the XXXXXXXXXX Tax Services Office. The authorized share capital of TC2 consists of an unlimited number of Class A voting, participating shares, an unlimited number of Class B non-voting, participating shares and an unlimited number of Class C non-voting, non-participating, redeemable, retractable shares. DC Shareholder 2 is the sole shareholder of TC2, holding XXXXXXXXXX Class A voting participating shares, XXXXXXXXXX Class B participating shares and XXXXXXXXXX Class C non-participating shares. The aggregate adjusted cost base and paid-up capital of these shares is $XXXXXXXXXX .

10. DC Shareholder 1, DC Shareholder 2 and DC Shareholder 3 are each residents of Canada for the purposes of the Act and are not related to each other.

11. The respective RDTOH balances for DC, TC1 and TC2 were $XXXXXXXXXX , $XXXXXXXXXX and $XXXXXXXXXX as of XXXXXXXXXX . It is not anticipated that any of these corporations will have an RDTOH balance immediately before the commencement of the Proposed Transactions.

12. Prior to XXXXXXXXXX , DC was a participant in XXXXXXXXXX , a joint venture arrangement among DC and XXXXXXXXXX corporations with whom DC dealt at arm's length, XXXXXXXXXX . The assets of the joint venture, in which DC held a XXXXXXXXXX % share, were comprised of cash, an equity balance with the XXXXXXXXXX , receivables, prepaid insurance and a parcel of real estate consisting of land and buildings located at XXXXXXXXXX . DC also held XXXXXXXXXX % of the shares of XXXXXXXXXX , a corporation that held legal title to the aforementioned parcel of land as bare trustee for the benefit of the joint venture participants; the other shares of XXXXXXXXXX . were held by the other participants in the joint venture in proportion to their respective interests in the assets of the joint venture. At no time did this joint venture arrangement constitute a partnership.

13. In XXXXXXXXXX , the joint venture participants decided to sell the commercial real estate assets of the joint venture. To this end, they approached an arm's-length party that was active in acquiring commercial real estate in the local real estate market. The party made an offer to acquire the real estate assets from the joint venture participants, subject to certain due diligence conditions which could not be satisfied because of environmental concerns XXXXXXXXXX . Accordingly, the sale of the joint venture real estate to the arm's length party was never completed.

14. In XXXXXXXXXX , subsequent to the decision to sell the commercial real estate assets of the joint venture, the shareholders of DC decided to explore the possibility of dividing the assets of DC through a divisive "butterfly" reorganization.

15. DC and the other joint venture participants continued to hold the real estate assets after the proposed sale to the arm's length party described in Paragraph 14 did not proceed. In XXXXXXXXXX , another offer to purchase the assets was received by DC and the other joint venture participants from an arm's-length party, however, the purchase price offered for the assets was far less than the previous offer received in XXXXXXXXXX . The joint venture participants did not sell the assets to this prospective purchaser.

16. On XXXXXXXXXX , DC agreed to sell its XXXXXXXXXX % interest in the assets of the joint venture and the shares it held in XXXXXXXXXX . to the other participants in the joint venture, XXXXXXXXXX . The assets and shares were sold in exchange for $XXXXXXXXXX in cash and an assumption of DC's share of the liabilities of the joint venture, which consisted principally of a mortgage secured against the commercial real estate assets of the joint venture and accounts payable relating to the operation of those assets. The transaction closed on XXXXXXXXXX . The cash proceeds received by DC from the sale were deposited into the brokerage account described in Paragraph 4 and used to acquire additional marketable securities. The sale of the XXXXXXXXXX % interest in the assets of the joint venture and the shares of XXXXXXXXXX . was done entirely for business reasons and was not done in contemplation of the proposed butterfly distribution by DC. Accordingly, such sale would have taken place whether or not DC undertook the proposed butterfly and the proposed butterfly would take place whether or not the assets of the joint venture and the shares of XXXXXXXXXX . were sold.

PROPOSED TRANSACTIONS

17. The directors of DC will pass a resolution in accordance with subsection 26(1.4) of BCA to increase the stated capital account maintained in respect of the Class A common shares of DC. DC will be deemed to pay a dividend to the holders of the Class A common shares pursuant to subsection 84(1) as a consequence of the increase to the stated capital account. DC will elect in accordance with subsection 83(2) to deem the full amount of the dividend to be a capital dividend.

18. TC1-Sub will be incorporated under the BCA. TC1-Sub will be a taxable Canadian corporation and a CCPC. The authorized share capital of TC1-Sub will consist of common shares and a class of voting preferred shares ("TC1-Sub Preferred Shares") that will be redeemable and retractable for an amount equal to the fair market value of the consideration for which they were issued and will bear a discretionary dividend entitlement. Upon incorporation, TC1-Sub will issue XXXXXXXXXX common shares to TC1 in exchange for $XXXXXXXXXX .

19. The Articles of Incorporation of TC2 will be amended to authorize an additional class of voting preferred shares ("TC2 Preferred Shares") that will be redeemable and retractable for an amount equal to the fair market value of the consideration for which they were issued. The TC2 Preferred Shares will rank senior to all other authorized classes of shares of TC2. The TC2 Preferred Shares will bear a discretionary dividend entitlement.

20. DC Shareholder 1 will transfer all of the Class A common shares of DC held by DC Shareholder 1 to TC1 in exchange for Class B preferred shares of TC1 having a fair market value equal to the fair market value of the Class A common shares transferred to TC1. DC Shareholder 1 and TC1 will elect in prescribed form and within the time limits prescribed by subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of Class A common shares of DC to TC1. The agreed amount will be limited to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

For the purposes of the BCA, TC1 will add to the stated capital account maintained in respect of its Class B preferred shares an amount equal to the paid-up capital of the Class A common shares of DC acquired by it from DC Shareholder 1. For greater certainty, the increase to the paid-up capital of the Class B preferred shares issued by TC1 will not exceed the maximum amount that could be added to the paid-up capital of such shares having regard to section 84.1.

21. DC Shareholder 2 will transfer the Class A common shares of DC held by DC Shareholder 2 to TC2 in exchange for Class A voting participating shares of TC2 having a fair market value equal to that of the Class A common shares of DC transferred to TC2. DC Shareholder 2 and TC2 will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount will be limited to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

For the purposes of the BCA, TC2 will add to the stated capital account maintained in respect of the Class A voting participating shares of TC2 an amount equal to the paid-up capital of the Class A common shares of DC acquired by it from DC Shareholder 2. For greater certainty, the increase to the paid-up capital of the Class A voting participating shares of TC2 will not exceed the maximum amount that could be added to the paid-up capital of such shares having regard to section 84.1.

22. Immediately before the transfers of property described in Paragraphs 25 and 26, the property of DC will be determined on a consolidated basis by including the appropriate pro-rata share of the property of each corporation that is a member of the DC Consolidated Group, and such property will be classified into the following three types of property for the purposes of the definition of "distribution" in subsection 55(1):

(a) cash or near-cash property, comprising all of the current assets of each member of the DC Consolidated Group, including cash, prepaid expenses and rental deposits;

(b) investment property, comprising all of the assets of DC, other than cash or near-cash property, any income from which would, for the purposes of the Act, be income from property or from a specified investment business; and

(c) business property (of which there is expected to be none), comprising all of the assets of DC, other than cash or near-cash property, any income from which would, for purposes of the Act, be active business income of DC (other than income from a specified investment business), including any goodwill.

For greater certainty, for purposes of this distribution:

(d) tax accounts of each member of the DC Consolidated Group, such as the balance of non-capital losses, net capital losses, RDTOH and/or CDA, if any, will not be considered property;

(e) no amount will be considered to be a liability unless it represents a true legal liability which is capable of quantification; and

(f) the amount of any deferred income tax will not be considered a liability.

23. For the purposes of determining, on a consolidated basis, the net FMV of DC's three types of property immediately before the transfers of property described in Paragraph 25:

(a) in determining the net FMV of each of the three types of property of a member of the DC Consolidated Group, other than DC, the liabilities of that member will be allocated to, and will be deducted in the calculation of the net FMV of each type of property of the member as follows:

(i) current liabilities of the particular member will be allocated to the cash or near-cash property of that member in the proportion that the FMV of each such property is of the FMV of all cash or near-cash property owned by the member to the extent that such allocation does not exceed the aggregate FMV of all cash or near-cash property of that member. To the extent that the total amount of current liabilities exceeds the total FMV of the member's cash or near cash property, the member will be considered to have a negative amount of cash or near-cash property;

(ii) liabilities, other than current liabilities, of the member that relate to a particular property will then be allocated to that particular property (and effectively to the type of property to which the property belongs) to the extent of its FMV. Any excess of such liabilities over the FMV of a particular property and liabilities that pertain to a particular type of property, but not to a particular property, will then be allocated to that particular type of property, but not in excess of the net FMV of such type of property; and

(iii) if any liabilities remain after the allocations described in (a)(i) and (a)(ii) are made ("excess unallocated liabilities"), such excess unallocated liabilities will then be allocated to the cash or near-cash property, investment property and business property, if any, of the member, based on the relative net FMV of each type of property prior to the allocation of such excess unallocated liabilities but after the allocations described in (a)(i) and (a)(ii). However, where the member is considered to have a negative amount of a type of property because of (a) or (b), for the purposes of allocating those remaining liabilities, the net FMV of that type of property will be deemed to be nil resulting in none of those excess unallocated liabilities being allocated to that type of property; and

(b) in determining the net FMV of each type of property of DC, DC will include the appropriate pro-rata share of the net FMV of each type of property of each corporation included in the DC Consolidated Group (other than DC), or such negative amount of such type of property, as determined in accordance with (a) above, and any liabilities of DC will then be allocated to, and will be deducted in the calculation of the net FMV of each type of property of DC as follows:

(i) current liabilities of DC will be allocated to the cash or near-cash property of DC in the proportion that the FMV of each such property is of the FMV of all cash or near-cash property of DC. The total amount of current liabilities so allocated as described herein will not exceed the aggregate FMV of all cash or near-cash property of DC;

(ii) liabilities of DC, other than current liabilities, that relate to a particular property will then be allocated to that particular property (and effectively to the type of property to which the property belongs) to the extent of its FMV. Any excess of such liabilities over the FMV of a particular property and liabilities that pertain to a particular type of property, but not to a particular property, will then be allocated to that particular type of property, but not in excess of the net FMV of such type of property; and

(iii) if any liabilities remain after the allocations described in (b)(i) and (b)(ii) are made ("excess DC unallocated liabilities"), such excess DC unallocated liabilities will then be allocated to the cash or near-cash property, investment property and business property, if any, of DC, based on the relative net FMV of each type of property prior to the allocation of such excess DC unallocated liabilities.

Based on the types of property classifications described in Paragraph 22, and after the allocation of each liabilities of each member of the DC Consolidated Group described in this Paragraph, it is anticipated that DC will only have investment property at the time of the transfers of property described in Paragraphs 25 and 26.

24. Immediately following the transfers of property described in Paragraphs 25 and 26, the FMV of each type of property of DC received by each of TC1-Sub and TC2, as the case may be, will approximate the proportion determined by the formula:

A x B/C

Where:

A is the FMV, immediately before the transfers described in Paragraphs 25 and 26, of all property of that type owned at that time by DC,

B is the FMV, immediately before the transfers described in Paragraphs 25 and 26, of all of the shares of the capital stock of DC, owned by TC1 with respect to the property received by TC1-Sub, or TC2 with respect to the property received by TC2, as the case may be, and

C is the FMV, immediately before the transfers described in Paragraphs 25 and 26, of all the issued shares of the capital stock of DC.

For the purposes of this Paragraph, the FMV of a type of property received by TC1-Sub or TC2 will be considered to "approximate the proportion" determined in respect of that type of property received by the corporation under the preceding formula if the variance between (i) the quotient obtained by dividing B by C in the preceding formula in respect of the corporation, expressed as a percentage, and (ii) the net FMV of the particular type of property received by the corporation, expressed as a percentage of the net FMV of that type of property owned by DC immediately before the transfers of property described in Paragraphs 25 and 26, does not exceed 1%.

25. Immediately following the determination of the net FMV of its types of property as described in Paragraphs 22 and 23, DC will transfer a proportionate share of each type of property, as described in Paragraph 24, to TC1-Sub. It is expected that the property to be transferred to TC1-Sub will consist of the investment portfolio described in Paragraph 4 (or, a portion of the investment portfolio in the event that the circumstances in Paragraph 34.1 arise) and XXXXXXXXXX Class A common shares of Holdco 1 to TC1-Sub. In consideration for the transfer, TC1-Sub will assume any current liabilities of DC relating to the investment portfolio and issue TC1-Sub Preferred Shares to DC. The fair market value of the consideration given by TC1-Sub will equal the total fair market value of the property transferred to TC1-Sub, determined at the time of the transfer. DC and TC1-Sub will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each eligible property by DC to TC1-Sub. In respect of each eligible property transferred, the agreed amount will be limited to an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

For the purposes of the BCA, TC1-Sub will add to the stated capital account maintained in respect of the TC1-Sub Preferred Shares an amount equal to the aggregate cost amount of the property acquired by it from DC, less the fair market value of any current liabilities of DC assumed by TC1-Sub on the transfer. For greater certainty, the increase to the paid-up capital of the TC1-Sub Preferred Shares will not exceed the maximum amount that could be added to the paid-up capital of such shares having regard to subsection 85(2.1).

26. Immediately following the determination of the net FMV of its types of property as described in Paragraphs 22 and 23, DC will transfer a proportionate share of each type of property, as described in Paragraph 24, to TC2. It is expected that the property to be transferred to TC2 will consist of the XXXXXXXXXX Class A common shares of Holdco 2 held by DC (and, in the event that the circumstances in Paragraph 34.1 arise, a portion of the investment portfolio described in Paragraph 4 that is not transferred to TC1-Sub as described in Paragraph 25). In consideration for the transfer, TC2 will issue TC2 Preferred Shares to DC having a fair market value equal to the fair market value of the property transferred to TC2, determined at the time of the transfer. DC and TC2 will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount will be limited to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

For the purposes of the BCA, TC2 will add to the stated capital account maintained in respect of the TC2 Preferred Shares an amount equal to the aggregate cost amount of the shares of Holdco 2 acquired by it from DC (and, in the event that the circumstances in Paragraph 34.1 arise, the aggregate cost amount of any property transferred to TC2 from the investment portfolio). For greater certainty, the increase to the paid-up capital of the TC2 Preferred Shares will not exceed the maximum amount that could be added to the paid-up capital of such shares having regard to subsection 85(2.1).

27. TC1-Sub will redeem the TC1-Sub Preferred Shares issued to DC as described in Paragraph 25 for an amount equal to their fair market value. As consideration for the redemption, TC1-Sub will issue a non-interest-bearing demand promissory note to DC having a principal amount and fair market value equal to the redeemed TC1-Sub Preferred Shares (the "TC1-Sub Note").

28. TC2 will redeem the TC2 Preferred Shares issued to DC as described in Paragraph 26 for an amount equal to their fair market value. As consideration for the redemption, TC2 will issue a non-interest-bearing demand promissory note to DC having a principal amount and fair market value equal to the redeemed TC2 Preferred Shares (the "TC2 Note"). Immediately before the redemption, the TC2 Preferred Shares held by DC will constitute more than 10% of the issued share capital of TC2, having full voting rights under all circumstances, and will have a fair market value of more than 10% of the fair market value of all of the issued shares of TC2.

29. DC will purchase for cancellation the XXXXXXXXXX Class A common shares held by TC1 for an amount equal to their fair market value. As consideration for the purchase for cancellation, DC will issue a non-interest-bearing demand promissory note to TC1 having a principal amount and fair market value equal to that of the XXXXXXXXXX Class A common shares of DC ("DC Note 1").

30. DC will purchase for cancellation the XXXXXXXXXX Class A common shares held by TC2 for an amount equal to their fair market value. As consideration for the purchase for cancellation, DC will issue a non-interest-bearing demand promissory note to TC2 having a principal amount and fair market value equal to that of the XXXXXXXXXX Class A common shares ("DC Note 2").

31. TC1-Sub will be wound-up. On the winding-up of TC1-Sub, all of the property of TC1-Sub will be distributed by TC1-Sub to TC1, and all of the liabilities of such TC1-Sub, including the TC1-Sub Note, will be assumed by TC1.

32. The principal amount of the TC1-Sub Note and the principal amount of DC Note 1 will be set-off in full against each other and each such note will be marked paid in full and cancelled.

33. The principal amount of the TC2 Note and the principal amount of DC Note 2 will be set-off in full against each other and each such note will be marked paid in full and cancelled.

ADDITIONAL INFORMATION

34. As mentioned in Paragraph 4, DC's investment portfolio is held in a segregated brokerage account and is comprised of a combination of cash and short-term assets, fixed-income securities and common equity securities. The cash component of the account fluctuates during the year depending on the activity within the account with respect to acquisitions and dispositions of other categories of investment. The amount of actual cash funds held is minimal with occasional large inflows when an investment is sold and subsequent outflows when the funds are re-invested. As a result, there is little "idle" cash sitting in the account at any particular time. However, the whole investment account is held as a portfolio investment for long-term investing purposes.

34.1 In the event that the transfer of the entire investment portfolio described in Paragraph 4 and XXXXXXXXXX Class A common shares of Holdco 1, as described in Paragraph 25, would result in the acquisition of a type of property of DC by TC1-Sub that has a fair market value which exceeds the proportion, and does not approximate the proportion, determined under Paragraph 24 in respect of that type of property with reference to TC1's proportionate ownership of shares of DC immediately before the transfers described in Paragraphs 25 and 26, DC will, instead of transferring the entire investment portfolio to TC1-Sub, retain a portion of the investment portfolio to ensure that the fair market value of each type of property acquired by TC1-Sub as a consequence of the transfer described in Paragraph 25 will approximate the proportion determined in respect of that type of property with reference to TC1's proportionate ownership of shares of DC immediately before the transfers described in Paragraphs 25 and 26. A portion of the investment portfolio retained by DC will then be transferred to TC2 as part of the transfer described in Paragraph 26.

35. Except as described above, no liabilities have been or will be incurred (other than in the ordinary course of investment property activities) by, and no assets have been or will be acquired (other than in the ordinary course of investment property activities, which includes the disposition of DC's interest in the assets of the XXXXXXXXXX and the shares of XXXXXXXXXX . described in Paragraph 16) by DC in contemplation of and before the proposed transfers of properties described in Paragraphs 25 and 26.

36. None of DC, TC1, TC2, and TC1-Sub is, or will be, at the time of the Proposed Transactions or at any point in time within a series of transactions or events that includes the Proposed Transactions, a specified financial institution or a restricted financial institution.

37. None of the shares of DC, TC1, TC2 and TC1-Sub has been or will be, at any time during the implementation of the proposed transactions described herein:

(a) the subject of any undertaking that is a guarantee agreement;

(b) a share that is issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5); or

(c) the subject of a dividend rental arrangement.

38. For the purpose of subsection 191(4), the terms and conditions of the TC2 Preferred Shares will, at the time of their issue, specify an amount in respect of each share to be issued. The amount to be specified in respect of each share will:

(a) be pursuant to a resolution of the board of directors of the respective issuing corporation;

(b) be expressed as a dollar amount;

(c) not be determined by a formula; and

(d) not exceed the fair market value of the property received by the issuing corporation in consideration for its issuance.

39. None of the TC2 Preferred Shares will be issued for consideration that includes a taxable preferred share.

40. No unanimous shareholders agreements or similar arrangements are or will be in force among the shareholders of DC, TC1, TC2 and TC1-Sub that (i) restrict, in whole or in part, the powers of the directors of to manage the business and affairs of each respective corporation or (ii) affect the power of any shareholder of DC, TC1, TC2 and TC1-Sub to control the election of the board of directors of the respective corporations.

PURPOSE OF THE PROPOSED TRANSACTIONS

41. DC Shareholder 1, DC Shareholder 2 and DC Shareholder 3 no longer agree on a business strategy and have chosen to divide the assets and holdings of DC among themselves.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions, additional information and the purposes of the Proposed Transactions, and provided further that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. Pursuant to subsection 84(1), DC will be deemed to have paid a dividend on the Class A common shares of DC in an amount equal to the increase of the paid-up capital of the Class A common shares resulting from the increase of the stated capital account maintained in respect of that class of shares as described in Paragraph 17, and DC Shareholder 1, DC Shareholder 2 and DC Shareholder 3 will each be deemed to have received a dividend equal to that proportion of the dividend deemed to have been paid by DC that the number of Class A common shares of DC held by DC Shareholder 1, DC Shareholder 2 and DC Shareholder 3 immediately after the increase, as the case may be, is of the total number of issued and outstanding shares of that class immediately after the increase.

B. Provided that DC elects pursuant to subsection 83(2), in respect of the full amount of the dividend that it is deemed to have paid as described in Ruling A, the dividend will be deemed to be a capital dividend to the extent of DC's capital dividend account, determined immediately before the time the dividend is deemed to be paid.

C. The provisions of subsection 85(1) will apply to:

(a) the transfer by DC Shareholder 1 of Class A common shares of DC to TC1 described in Paragraph 20;

(b) the transfer by DC Shareholder 2 of Class A common shares of DC to TC2 described in Paragraph 21;

(c) the transfer of eligible property by DC to TC1-Sub described in Paragraph 25; and

(d) the transfer of eligible property by DC to TC2 described in Paragraph 26,

such that the agreed amount in respect of each transfer of eligible property shall be deemed to be the transferor's proceeds of disposition and the transferee's cost thereof pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to those transfers.

D. Subsection 84(3) will apply on:

(a) the redemption of the TC1-Sub Preferred Shares described in Paragraph 27, to deem TC1-Sub to have paid and DC to have received;

(b) the redemption of the TC2 Preferred Shares described in Paragraph 28; to deem TC2 to have paid and DC to have received; and

(c) the purchases for cancellation by DC of its Class A common shares described in Paragraphs 29 and 30, to deem DC to have paid and TC1 and TC2, as the case may be, to have received,

a dividend on such shares equal to the amount, if any, by which the aggregate amount paid upon such redemption or purchase for cancellation, as the case may be, exceeds the aggregate paid-up capital in respect of such shares immediately before such redemption or purchase for cancellation, and subject to Ruling E, any such dividend, to the extent that it is a taxable dividend, will:

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

(e) be deductible by the recipient pursuant to subsection 112(1) in computing its taxable income in the year in which such a dividend is deemed to have been received, and, for greater certainty, such deductibility will not be prohibited by subsections 112(2.1), (2.2), (2.3) or (2.4);

(f) be excluded in determining the proceeds of disposition of the shares so redeemed or purchased for cancellation pursuant to paragraph (j) of the definition of proceeds of disposition;

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

(h) not be subject to tax under Part IV except to the extent that the payer of the dividend is entitled to a dividend refund for its taxation year in which it paid such dividend;

(i) not be subject to tax under Part IV.1; and

(j) not be subject to tax under Part VI.1, except, in the case of the taxable dividend deemed to be received by TC2, to the extent that the amount paid by DC on the redemption of TC2 Preferred Shares exceeds the amount specified in respect of those shares for the purposes of subsection 191(4).

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

(a) an acquisition of property in circumstances described in paragraph 55(3.l)(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 in the circumstances described in subparagraph 55(3.l)(b)(iii);

(e) an acquisition of property in the circumstances described in subparagraph 55(3.l)(c); or

(f) an acquisition of property in the circumstances described in subparagraph 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 Ruling D and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

F. The set-off of the TC1-Sub Note and DC Note 1 and the TC2 Note and DC Note 2 and the resulting cancellation of those notes described in Paragraphs 32 and 33, will not give rise to a forgiven amount, and none of DC, TC1 or TC2 as the case may be, will realize any gain or incur any loss as a result of such set-offs and cancellations.

G. The provisions of subsections 15(1), 56(2) and 246(1) will not apply to the Proposed Transactions described herein, in and by themselves.

H. Subsection 245(2) will not apply as a result of the Proposed Transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given above.

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the CRA provided that the Proposed Transactions are completed on or before XXXXXXXXXX .

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act, which if enacted, could have an effect on the rulings provided herein.

COMMENTS

1. Notwithstanding the additional information provided in Paragraph 34, it is our position that any cash balance in DC's brokerage account will be considered cash or near-cash property for the purposes of applying the definition of "distribution" in subsection 55(1) to the Proposed Transactions.

2. DC and TC2 will each have a taxation year ending on XXXXXXXXXX in which DC and TC2 will be deemed to have paid dividends to each other (and to have received dividends from each other) as a consequence of the transactions described in Paragraphs 28 and 30. Although it is represented that neither corporation is expected to have an RDTOH balance immediately before the commencement of the Proposed Transactions, it is possible that at least one of these corporations may have an RDTOH balance at the end of its taxation year in which the Proposed Transactions occur. This may give 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, it is not possible to avoid the circularity problem because of a restriction in a shareholders' agreement that precludes the transfer of shares of Holdco 2 to a wholly-owned subsidiary of TC2, thereby making it necessary for DC to transfer the shares of Holdco 2 to DC directly in exchange for TC2 Preferred Shares. Consequently, we must inform you that, in our view, this could result in each of DC, TC1 and TC2 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 DC, TC1 and TC2, the district taxation office at which each of DC, TC1 and TC2 files its 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.

3. Nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:

(a) the determination of the ACB, PUC or FMV of any shares or other property referred to herein; and
(b) any tax consequences relating to the facts and Proposed Transactions described herein other than those described in the rulings given above.

Yours truly,

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