2009 Ruling 2009-0313981R3 - Butterfly Ruling

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: Standard split-up butterfly.

Position: Ruling Issued

Reasons: Satisfied statutory and administrative requirements

XXXXXXXXXX 									2009-031398

XXXXXXXXXX , 2009

Dear Sirs,

Subject: Advance Income Tax Ruling Request
XXXXXXXXXX

This is in reply to your letters of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the taxpayers referred to above. We also acknowledge our subsequent telephone conversations and correspondence concerning your request. The information or documents submitted with your request are part of this letter only to the extent described herein.

We understand that to the best of your knowledge and that of the taxpayers on whose behalf this ruling is being requested, none of the issues involved in this ruling request:

(a) is in an earlier return of the taxpayers or related persons;
(b) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or related persons;
(c) is under objection by the taxpayers or related persons;
(d) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; and
(e) is the subject of a ruling previously considered by the Income Tax Rulings 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;

XXXXXXXXXX

"ACB" means "adjusted cost base" as that expression is defined in subsection 248(1);

"agreed amount" means the amount that the taxpayer and the corporation have jointly elected in prescribed form in respect of an eligible property;

"Brother1" means XXXXXXXXXX ;

"Brother2" means XXXXXXXXXX ;

"Brother1Co" means XXXXXXXXXX ;

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

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

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

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

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

"DC" means XXXXXXXXXX .

"distribution" has the meaning assigned by subsection 55(1);

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

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

"excepted dividend" has the meaning assigned by subsection 187.1;

"excluded dividend" has the meaning assigned by subsection 191(1);

"FMV" or "fair market value" means the highest price available in an open and unrestricted market between informed prudent parties acting at arm's length and under no compulsion to act and contracting for a taxable purchase and sale;

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

"hard ACB" means the ACB attributable to shares as modified by paragraph 84.1(2)(a.1);

"JV1" means XXXXXXXXXX ;

"JV2" means XXXXXXXXXX ;

"OldDC" means XXXXXXXXXX ., a predecessor of DC;

"PUC" means paid-up capital as that expression is defined in subsection 89(1);

"Paragraph" refers to a numbered paragraph in this letter;

"pre-1972 capital surplus on hand" has the meaning assigned by subsection 88(2.1);

"Predecessor1" means XXXXXXXXXX .;

"Predecessor2" means XXXXXXXXXX .;

"Predecessor3" means "XXXXXXXXXX .

"primarily" means greater than 50%;

"private corporation" has the meaning assigned by subsection 89(1);

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

"Proposed Transactions" means the proposed transactions described in Paragraphs 41 to 55;

"refundable dividend tax on hand" ("RDTOH") has the meaning assigned by subsection 129(3);

"Regulations" means the Income Tax Regulations promulgated under the Act;

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

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

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

"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 XXXXXXXXXX ;

"Subco" means XXXXXXXXXX .

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

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

"TC1" means XXXXXXXXXX

"TC1 Redemption Debt" means the promissory note described in Paragraph 51;

"TC2" means XXXXXXXXXX

"TC2 Redemption Debt" means the promissory note described in Paragraph 51; and
"undepreciated capital cost" has the meaning assigned by subsection 13(21).

Facts

1. Brother 1 is an individual resident in Canada. His social insurance number is XXXXXXXXXX

2. Brother 2 is an individual resident in Canada. His social insurance number is XXXXXXXXXX

3. Brother 1 and Brother 2 are brothers.

4. TC1 is a taxable Canadian corporation and a CCPC incorporated pursuant to the XXXXXXXXXX on XXXXXXXXXX . Its business number is XXXXXXXXXX and its fiscal period ends on XXXXXXXXXX . The authorized capital of TC1 is as follows:

An unlimited number of:

• Class A - common voting shares
• Class B - common non-voting shares
• Class C - preferred non-voting shares
• Class D - preferred non-voting shares
• Class E - preferred voting shares
• Class F - preferred non-voting shares

The Class A shares are entitled to one vote per share and to receive dividends, if and when declared by the directors of the corporation. On dissolution, Class A shares are entitled to the residue of the corporation after payment of the redemption amount, together with declared but unpaid dividends, if any, in respect of the Class C, D, E and F shares in the capital stock of the corporation. The Class A and B shares rank pari passu in the residue. No dividend may be declared in respect of a Class A share where there are declared and unpaid dividends in respect of a Class C, D or F share.

The Class C shares are non-voting and entitled to discretionary non-cumulative dividends of up to XXXXXXXXXX % of the redemption amount annually. The redemption amount of a Class C share is set by the directors at the time the shares are issued and is calculated as the difference between the FMV of property acquired less the value of any non-share consideration issued divided by the number of Class C shares issued. Once declared, no dividend may be declared in respect of any other class of shares ranking junior to the Class C shares until that dividend has been paid. The Class C shares are redeemable and retractable and rank in priority to the Class A, B and E shares and pari passu with the Class D and F shares.

The Class C shares contain price adjustment provisions permitting the adjustment to the redemption amount of the issued shares where the Minister of National Revenue, a competent authority or the Board of Directors have determined that any of the values used on issue of the Class C shares are in error.

The Class F shares are non-voting and entitled to discretionary non-cumulative dividends of up to XXXXXXXXXX % of the redemption amount annually. The redemption amount of a Class F share is set by the directors at the time the shares are issued and is calculated as the difference between the FMV of property acquired less the value of any non-share consideration issued divided by the number of Class F shares issued. Once declared, no dividend may be declared in respect of any other class of shares ranking junior to the Class F shares until that dividend has been paid. The Class F shares are redeemable and retractable and rank in priority to the Class A, B and E shares and pari passu with the Class C and D shares.

The Class F shares contain price adjustment provisions permitting the adjustment to the redemption amount of the issued shares where the Minister of National Revenue, a competent authority or the Board of Directors have determined that any of the values used on issue of the Class F shares are in error.

5. TC1 was incorporated for the purpose of implementing the Proposed Transactions.

6. Brother 1 is the legal and beneficial owner of XXXXXXXXXX Class A common voting shares in the capital stock of TC1. There are no other shares issued by TC1. The shares are held as capital property.

7. Brother1Co is a taxable Canadian corporation and a CCPC incorporated pursuant to the Companies Act (XXXXXXXXXX ) on XXXXXXXXXX . It was continued pursuant to the XXXXXXXXXX on XXXXXXXXXX . Its business number is XXXXXXXXXX .

8. The authorized capital of Brother1Co consists of XXXXXXXXXX common voting shares. Brother1 is the legal and beneficial owner of XXXXXXXXXX common voting shares and his spouse is the legal and beneficial owner of XXXXXXXXXX common voting shares in the capital stock of Brother1Co. No other shares of Brother1Co are currently issued and outstanding. The shares are held as capital property.

9. TC2 is a taxable Canadian corporation and a CCPC incorporated pursuant to the XXXXXXXXXX on XXXXXXXXXX . Its business number is XXXXXXXXXX and its fiscal period ends on XXXXXXXXXX . The authorized capital of TC2 is as follows:

An unlimited number of:

• Class "A" - common voting shares
• Class "B" - common voting shares
• Class "C" - common non-voting shares
• Class "D" - preferred non-voting shares
• Class "E" - preferred non-voting shares
• Class "F" - preferred voting shares

The Class A shares are entitled to one vote per share and to receive dividends if and when declared by the directors of the corporation. Upon dissolution, the Class A shares are entitled to receive the residue of the corporation after payment of the redemption amount in respect of the Class D, E and F shares in the capital stock of the corporation together with declared but unpaid dividends of any Class. The Class A, B and C shares rank pari passu in the residue.

The Class "D" shares are non-voting and entitled to discretionary non-cumulative dividends of up to XXXXXXXXXX % of the redemption amount annually. The redemption amount of a Class "D" share is calculated as the difference between the FMV of property acquired less the value of any non-share consideration issued divided by the number of Class "D" shares issued. The Class "D" shares are redeemable and retractable and rank in priority to the Class "A", "B", "C" and "F" shares and pari passu with the Class "E" shares.

The Class "D" shares contain price adjustment provisions permitting the adjustment to the redemption amount of the issued shares where the Minister of National Revenue, a competent authority or the Board of Directors have determined that the values used on issue of the Class "D" shares are in error.

The Class "E" shares are non-voting and entitled to discretionary non-cumulative dividends of up to XXXXXXXXXX % of the redemption amount annually. The redemption amount of a Class "E" share is calculated as the difference between the FMV of property acquired less the value of any non-share consideration issued divided by the number of Class "E" shares issued. The Class "E" shares are redeemable and retractable and rank in priority to the Class "A", "B", "C" and "F" shares and pari passu with the Class "D" shares.

The Class "E" shares contain price adjustment provisions permitting the adjustment to the redemption amount of the issued shares where the Minister of National Revenue, a competent authority or the Board of Directors have determined that any of the values used on issue of the Class "E" preferred non-voting shares are in error.

10. Brother2 is the legal and beneficial owner of XXXXXXXXXX Class "A" common voting shares in the capital stock of TC2. The shares are held as capital property. No other shares are issued by TC2.

11. Predecessor1 was a taxable Canadian corporation incorporated pursuant to the Companies Act (XXXXXXXXXX) on XXXXXXXXXX . It was continued pursuant to the XXXXXXXXXX on XXXXXXXXXX .

12. Predecessor2 was a taxable Canadian corporation incorporated pursuant to the XXXXXXXXXX on XXXXXXXXXX . It was continued pursuant to the XXXXXXXXXX on XXXXXXXXXX

13. Predecessor1 and Predecessor2 were amalgamated pursuant to the XXXXXXXXXX at the earliest moment on XXXXXXXXXX to form OldDC.

14. OldDC's business number was XXXXXXXXXX .

15. Since formation, the business activities of OldDC included the acquisition of real properties as capital property. XXXXXXXXXX Income from the above activities had been reported as income from a specified investment business. When a real property was sold, the transaction was reported as a capital transaction.

16. The business activities of OldDC have included the acquisition of real properties as inventory. Properties acquired in this manner were developed for the purpose of resale to third parties. Income from the development and resale activities had been reported as income from an active business. OldDC and its successor DC, have not owned real property inventory since XXXXXXXXXX , after disposing of its inventory in the ordinary course of carrying on its business activities.

17. Predecessor3 was a taxable Canadian corporation incorporated pursuant to the XXXXXXXXXX on XXXXXXXXXX . Its business number is XXXXXXXXXX .

18. Following incorporation, Predecessor3 carried on business as a XXXXXXXXXX
19. Predecessor3 ceased business activities in XXXXXXXXXX . At XXXXXXXXXX , the only property of Predecessor3 consisted of a debt receivable from OldDC in the amount of $XXXXXXXXXX . The debt was financed by retained earnings, contributed surplus and stated capital.

20. The voting shares of OldDC and Predecessor3 were controlled by the same group of persons, therefore these corporations were related by virtue of subparagraph 251(2)(c)(i).

21. OldDC and Predecessor3 were amalgamated pursuant to the XXXXXXXXXX on XXXXXXXXXX , to form DC. Its business number is XXXXXXXXXX .

Immediately before the amalgamation, the issued and outstanding share capital of Predecessor3 was legally and beneficially owned as follows:

Shareholder Shares

  	Brother1 	   XXXXXXXXXX  Class A shares
			  XXXXXXXXXX  Class E shares		

      Brother2 	   XXXXXXXXXX  Class A shares
			  XXXXXXXXXX  Class E shares		

The Class A shares are entitled to vote, the Class E shares are not.

Immediately before the amalgamation, the issued and outstanding share capital of OldDC was legally and beneficially owned as follows:

	Shareholder		Shares		

	  Brother1		XXXXXXXXXX  Class A shares
				XXXXXXXXXX  Class E shares
	  Brother2		XXXXXXXXXX  Class A shares
				XXXXXXXXXX  Class E shares
	  Brother1Co	XXXXXXXXXX  Class E shares
	  TC2			XXXXXXXXXX  Class E shares	

The Class A shares were entitled to vote, the Class E shares were not.

There were no dispositions, or other transfers or issuances of shares of OldDC or Predecessor3 that occurred as part of the series of transactions that included the amalgamation to form DC.

At all times, Brother1 and Brother2 acted in concert to control OldDC, Predecessor3 and DC.

22. As a consequence of the amalgamation, OldDC, Predecessor3 and DC are deemed to be related to each other pursuant to subsection 251(3.2).

23. The authorized capital of DC is as follows:

An unlimited number of:

• Class A - common voting shares
• Class B - common voting shares
• Class C - common non-voting shares
• Class D - common non-voting shares
• Class E - preferred non-voting shares
• Class F - preferred voting shares
• Class G - common voting shares

The Class A shares are entitled to one vote per share and to receive dividends if and when declared by the directors of the corporation. On dissolution, the Class A shares are entitled to receive the residue of the corporation after payment of the redemption amount in respect of the Class C, D, E and F shares in the capital stock of the corporation. The Class A and B shares rank pari passu in the residue.

The Class E shares are non-voting and entitled to a non-cumulative dividend at a rate per share set by the Board of Directors at the point of issuance. The redemption amount of a Class E shares is calculated as the difference between the FMV of property acquired less the value of any non-share consideration issued divided by the number of Class E shares issued. The Class E shares are redeemable and retractable and rank in priority to the Class A, B, C, D and G shares and pari passu with the Class F shares.

The Class E shares contain price adjustment provisions permitting the adjustment to the redemption amount of the issued shares where the Minister of National Revenue, a competent authority or the Board of Directors have determined that any of the values used on issue of the Class E shares are in error.

24. Immediately after the amalgamation on XXXXXXXXXX , the issued and outstanding share capital of DC was legally and beneficially owned as follows:

	Shareholder		Shares 				

        Brother1		XXXXXXXXXX  Class A shares
				XXXXXXXXXX  Class E shares	

        Brother2		XXXXXXXXXX  Class A shares
				XXXXXXXXXX  Class E shares	

Brother1Co XXXXXXXXXX Class E shares

        TC2			XXXXXXXXXX  Class E shares	

25. Immediately after Brother1 acquired XXXXXXXXXX Class E shares in the capital stock of DC from Brother1Co as described in Paragraph 36 below, the issued and outstanding share capital of DC was legally and beneficially owned as follows:

	Shareholder	Shares 				

        Brother1	XXXXXXXXXX  Class A shares
			XXXXXXXXXX  Class E shares	

        Brother2	XXXXXXXXXX  Class A shares
			XXXXXXXXXX  Class E shares	

        TC2		XXXXXXXXXX  Class E shares	

26. Each of the above shareholders holds their shares as capital property. No other shares are issued by DC.

27. DC is a taxable Canadian corporation and a CCPC and its fiscal period ends on XXXXXXXXXX .

28. Since XXXXXXXXXX , DC has carried on the business activities previously carried on by OldDC.

29. DC also participates in two joint ventures ("JV") described as JV1 and JV2. Under the JV arrangement, a nominee corporation holds legal title to real property on behalf of each of the JV participants. Voting rights are granted to each participant on the basis of proportionate ownership.

30. DC owns XXXXXXXXXX % of JV1 and XXXXXXXXXX % of JV2. Gains, profits and losses are reported by each of the JV participants on the basis of their proportionate ownership in the JV. The business activities carried on by each of the JVs is substantially similar to DC.

31. For greater certainty:

(a) neither of the JV's described in Paragraphs 29 and 30 is a partnership (or any other legal entity); and
(b) DC has beneficial ownership of its proportionate share of the property of each JV (the legal title of which is held by a nominee corporation).

32. Subco is a taxable Canadian corporation and a CCPC incorporated pursuant to the XXXXXXXXXX on XXXXXXXXXX . Its business number is XXXXXXXXXX . The authorized capital is as follows:

An unlimited number of:

• Class A - common voting shares
• Class B - common non-voting shares
• Class C - non-voting redeemable non-cumulative preferred shares
• Class D - non-voting redeemable non-cumulative preferred shares
• Class E - voting redeemable non-cumulative preferred shares

33. The issued and outstanding share capital of Subco is legally and beneficially owned as follows:

	Shareholder				Shares 				

        DC 					XXXXXXXXXX  Class "A" shares		

        Third party shareholders
        resident in Canada		XXXXXXXXXX  Class "A" shares		

34. DC holds shares in the capital stock of Subco as capital property. No other shares are issued by Subco.

35. Since incorporation the business activities of Subco have been substantially similar to those of DC.

36. Effective XXXXXXXXXX , in anticipation of the series of transactions described in the Proposed Transactions, Brother1 purchased the XXXXXXXXXX Class E shares in the capital stock of DC issued to Brother1Co at their FMV of $XXXXXXXXXX per share or $XXXXXXXXXX in aggregate. Consideration paid consisted of a non-interest bearing debt, evidenced by a demand promissory note.

37. DC, the JVs and Subco have not owned real property inventory since XXXXXXXXXX . All real property inventory owned prior to this date was sold and the transaction reported as income from a business.

38. At the earliest possible moment on XXXXXXXXXX , DC, TC1 and TC2 will not have a balance in their CDA or GRIP accounts and TC1 and TC2 will not have a balance in their RDTOH account.

39. Except as otherwise described herein, none of the properties owned by DC, the JVs and Subco are currently listed for sale or subject to negotiations for sale with any person.

40. On XXXXXXXXXX , DC declared and paid a cash dividend on the issued and outstanding Class A shares of DC held by Brother 1 and Brother 2. DC elected in prescribed manner and in the prescribed form on XXXXXXXXXX pursuant to section 83(2) to have the rules therein apply to the full amount of the dividend.

Proposed Transactions

41. On XXXXXXXXXX , prior to the distribution of property described in Paragraph 48, DC will sell its beneficial interest in JV2 to a third party at fair market value for consideration that consists only of money or indebtedness that cannot be converted into other property or a combination thereof.

42. Brother2 will transfer all of his Class A shares and Class E shares in the capital stock of DC to TC2. Brother2 will jointly elect with TC2 in prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the shares will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii). Consideration will consist of a debt issued by TC2 of an amount equal to the lesser of the aggregate hard ACB in respect of the Class A and Class E shares and the aggregate of the agreed amounts in respect of the Class A and E shares, and a number of Class D shares in the capital stock of TC2 with a FMV and redemption amount equal to the difference between the FMV of the Class A and Class E shares less the FMV of the debt issued. As a consequence of the above share transfers TC2 will own XXXXXXXXXX Class A and XXXXXXXXXX Class E shares in the capital stock of DC. Pursuant to the XXXXXXXXXX , the aggregate stated capital of the Class E shares issued by TC2 to Brother2 will be equal to either the agreed amount less the FMVof the debt issued, or $XXXXXXXXXX , whichever is greater.

43. Brother1 will (contemporaneously with Brother2 in Paragraph 42) transfer all of his Class A shares and Class E shares in the capital stock of DC to TC1. Brother1 will jointly elect with TC1 in prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the shares will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii). Consideration will consist of a debt issued by TC1 of an amount equal to the lesser of the aggregate hard ACB in respect of the Class A and Class E shares and the aggregate of the agreed amounts in respect of the Class A and E shares, and a number of Class C shares in the capital stock of TC1 with a FMV and redemption amount equal to the difference between the FMV of the Class A and Class E shares less the FMV of the debt issued. As a consequence of the above share transfers TC1 will own XXXXXXXXXX Class A and XXXXXXXXXX Class E shares in the capital stock of DC. Pursuant to the XXXXXXXXXX , the aggregate stated capital of the Class F shares issued by TC1 to Brother1 will be equal to either the agreed amount, less the FMV of the debt issued, or $XXXXXXXXXX , whichever is greater.

44. [Reserved]

45. Immediately before the transfer of property described in Paragraph 48, the property owned by DC will be classified into the following three types of property for the purposes of the distribution, as follows:

a) cash or near-cash property, comprising all of the current assets of DC, including cash, short-term certificates of deposit, pre-paid expenses and trade accounts receivable;
b) investment property, 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 income from property or from a specified investment business; and
c) business property, 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 income from a business carried on by DC (other than a specified investment business).

For greater certainty, for the purposes of this distribution:

a) tax accounts or other tax related amounts of DC, such as the balance of non-capital losses, net capital losses, RDTOH, GRIP and/or CDA, if any, will not be considered property or a liability, as the case may be;
b) no amount will be considered to be a liability unless it represents a true legal liability which is capable of quantification; and
c) the amount of any deferred or future income tax will not be considered to be a property or a liability, as the case may be, for the purposes of the Proposed Transactions.

46. DC has significant influence over Subco. Consequently, DC will be required to use the consolidated look-through method for determining the appropriate proportion of each of the three types of property (cash or near cash, business and investment property) that the shares of Subco will represent. For greater certainty, the fair market value of the shares of Subco will be allocated between the three types of property by multiplying the FMV of the shares of Subco by the proportion that the net FMV of each type of property owned by Subco is of the aggregate net FMV of all of the property owned by Subco.

47. 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 48:

(a) in determining the net FMV of each of the three types of property of Subco, the liabilities of Subco will be allocated to, and will be deducted in the calculation of the net FMV of each type of property of Subco as follows:

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

(ii) liabilities, other than current liabilities, of Subco 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 Subco, 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 Subco 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 Subco, 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.

48. DC will contemporaneously transfer to each of TC1 and TC2, a pro rata portion of the net FMV of each type of property owned by DC, as determined in accordance with Paragraphs 45, 46 and 47 such that immediately following such property transfers and liability assumptions, the net FMV of each of the three types of property of DC so transferred to each of TC2 and TC1 will, for greater certainty, approximate the proportion determined by the formula:

A x B/C

where:

A is the net FMV, immediately before the transfer, of all property of that type owned at that time by DC;
B is the FMV, immediately before the transfer, of all of the shares of the capital stock of DC owned, at that time, by either TC2 or TC1, as the case may be; and
C is the FMV, immediately before the transfer, of all the issued and outstanding shares of the capital stock of DC at that time.

For the purposes of this Paragraph, the expression "approximate that proportion" means that the discrepancy of that proportion, if any, will not exceed one percent (1%), determined as a percentage of the net FMV of the property that each of TC2 or TC1 will receive as compared to what it would have received had it received its appropriate pro rata share of DC's property.

49. As consideration for the property transferred by DC to each of TC2 and TC1, as the case may be, each of TC2 and TC1 will:

a) assume an appropriate amount of liabilities of DC (so that on a net basis each of TC2 and TC1 will receive its pro rata share of each type of property owned by DC); and

b) issue to DC a number of its Class D shares, in the case of TC2, and a number of its Class C shares, in the case of TC1, having an aggregate redemption amount and aggregate FMV equal to the FMV of the property received by TC2 or TC1, as the case may be, less the amount of the liabilities of DC assumed by the particular corporation as described in (a).

For greater certainty, the increase to the PUC of the Class D shares of TC2 and the Class C shares of TC1 will be determined having regard to subsection 85(2.1).

50. In respect of the transfers described in Paragraph 48 above, DC will jointly elect with TC2 or TC1, as the case may be, in prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each type of property that is an eligible property. The agreed amount in respect of each type of eligible property transferred will be as follows:

(i) in the case of capital property (other than depreciable property of a prescribed class) and inventory, an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii);

(ii) in the case of the depreciable property of a prescribed class, an amount equal to the least of the amounts described in subparagraphs 85(1)(e)(i), (ii) and (iii); and

(iii) in the case of eligible capital property, an amount equal to the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii).

51. Each of TC2 and TC1 will redeem all of the issued Class D shares, in the case of TC2, and Class C shares, in the case of TC1, at their redemption amount in exchange for consideration consisting of a debt (the "TC2 Redemption Debt" in the case of TC2 and the "TC1 Redemption Debt" in the case of TC1) evidenced by non-interest bearing promissory notes, payable on demand, and each of which will have a principal amount and FMV equal to the aggregate redemption amount of the shares redeemed. DC will accept the TC2 Redemption Debt and the TC1 Redemption Debt as payment in full for the shares redeemed.

52. On the day after the redemptions described in Paragraph 51 above, the shareholders of DC will by a special resolution resolve to wind-up and dissolve DC pursuant to the XXXXXXXXXX . On the wind-up of DC, under the terms of the agreement governing the winding-up of DC, the TC1 Redemption Note and the TC2 Redemption Note will be assigned and distributed to TC1 and TC2, respectively. As a result of the assignment and distribution of the TC1 Redemption Note and the TC2 Redemption Note by DC, the obligation of each of TC1 and TC2 under its own note will be cancelled.

53. DC will elect pursuant to subsection 83(2) of the Act, in prescribed manner and prescribed form, that the full amount of any resulting dividend, on the Class A shares, referred to in subparagraph 88(2)(b)(i), be deemed to be a capital dividend within the meaning of subsection 83(2).

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

55. Following receipt of the dividend refund to which DC will become entitled as a result of the Proposed Transactions, DC will immediately distribute it (under the terms of the agreement governing the winding-up of DC) to each of TC1 and TC2 in the same proportions as described in Paragraph 48. Within a reasonable time following the distribution of such dividend refund, articles of dissolution will be filed by DC with the appropriate Corporate Registry and upon receipt of a certificate of dissolution, DC will be dissolved.

Additional information

56. The Proposed Transactions described herein will occur in the order presented unless otherwise indicated, with the exception of the filing of the applicable election forms described in Paragraphs 42, 43 and 50, which will be filed by the applicable due date following completion of the Proposed Transactions.

57. Except as described herein, no property has or will become property of DC and no liabilities have been or will be incurred by DC in contemplation of and before the distributions otherwise than on a basis which would not cause the provisions of paragraph 55(3.1)(a) to operate to deny the exception in paragraph 55(3)(b) to the dividends resulting from the transactions described in Paragraphs 51 and 52.

58. None of the shares of DC or of any of the shares of TC2 or TC1 will be at any time during a series of transactions or events that includes the Proposed Transactions:

a) the subject of a "guarantee agreement" as defined in subsection 112(2.2);

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" as that term is defined in subsection 248(1).

59. None of DC, TC1 or TC2 will be, at any time before the completion of the Proposed Transactions, a "specified financial institution" as that term is defined in subsection 248(1).

60. Each of TC1 and TC2 has obtained the consent of the Minister of National Revenue for a change in its fiscal period and will take all of the required steps to implement such change.

Purpose of the Transactions

61. The above transactions are proposed to permit Brother1 and Brother2 to divide the business currently carried on by DC into separate, but equal, business units owned and operated by separate corporations for estate and succession planning purposes.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, all relevant 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. Provided that the requisite elections are filed in prescribed form and within prescribed time, the provisions of subsection 85(1) will apply to the transfer by each of Brother1 and Brother2 of his Class A and Class E shares in the capital stock of DC to the respective TC described in Paragraphs 42 and 43 and, subject to the application of subsection 69(11), the transfer by DC of each eligible property to each of the transferee corporations described in Paragraph 48, such that the agreed amount in respect of each transfer of eligible property will be deemed to be the transferor's proceeds of disposition and the transferee's cost thereof pursuant to paragraph 85(1)(a). In respect of depreciable property, to the extent that the transferor's capital cost exceeds the transferor's proceeds of disposition of the property, the transferee's capital cost of each such property will be determined in accordance with subsection 85(5).

B. Paragraph 85(1)(e.2) shall not apply to the transfers described in Ruling A.

C. On the redemption by TC2 of the Class D shares and TC1 of the Class C shares, as described in Paragraph 51 above, by virtue of paragraphs 84(3)(a) and 84(3)(b), each of TC2 and TC1 will be deemed to have paid, and DC will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid in respect of the redemption of the shares issued by each of TC2 and TC1 exceeds the PUC of those shares immediately before the redemption;

D. As a result of the winding-up of DC as described in Paragraph 52:

(a) By virtue of paragraph 88(2)(b) and subsection 84(2), but subject to (b) to (d) herein:

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

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

(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 DC'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 53, to be the full amount of a separate dividend;

(c) pursuant to subparagraph 88(2)(b)(ii), the portion of a winding-up dividend that is equal to the lesser of:

(I) DC's pre-1972 capital surplus on hand as determined immediately before the payment of the winding-up dividend, and

(II) the amount by which the winding-up dividend exceeds the portion thereof in respect of which DC will elect under subsection 83(2) shall be deemed not to be a dividend, and

(d) 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 and the portion referred to in (c) herein that is deemed not to be a dividend, will be deemed to be a separate dividend that is a taxable dividend.

E. To the extent that a dividend described in Rulings C or D is a taxable dividend, each such dividend:

(a) will be excluded from the proceeds of disposition of the shares so redeemed or purchased for cancellation, as the case may be, by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54;

(b) will be included in the recipient's income pursuant to section 82 and paragraph 12(1)(j);

(c) will be deductible pursuant to subsection 112(1) in computing the taxable income of the recipient for the year in which the dividend is deemed to have been received and such deduction will not be denied by any of subsections 112(2.1), (2.2), (2.3) or (2.4);

(d) will not be subject to tax under Parts IV.1 or VI.1 of the Act on the basis that the dividends will be "excepted dividends" within the meaning of section 187.1 and "excluded dividends" within the meaning of subsection 191(1);

(e) will not be subject to tax under Part IV of the Act except to the extent that the payor of the dividend is entitled to a dividend refund for the taxation year in which it paid such dividend; and

(f) by virtue of subsection 112(3), the loss, if any, in respect of the disposition of the shares on which the dividend is deemed to be received will be reduced.

F. The cancellation of the TC2 Redemption Debt and the TC1 Redemption Debt, as described in Paragraph 52 above, will not, in and of itself, result in a forgiven amount within the meaning of either subsection 80(1) or section 80.01.

G. 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(3.1)(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 property in the circumstances described in subparagraph 55(3.1)(b)(iii);

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

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

H. The provisions of subsections 15(1), 56(2), 56(4) and 246(1) will not apply as a result of the Proposed Transactions described herein, in and by themselves.

I. 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.

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 DC as described in Paragraph 55) 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, FMV, or V-day value 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.

2. 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 or the redemption amount of the shares issued as consideration, whether pursuant to a price adjustment clause or otherwise, will be effective retroactively to the time of the transfer and issuance of shares. In addition, any such adjustment could affect Ruling G above. Furthermore, none of the rulings given in this letter are intended to apply to, or in the event of, the operation of a price adjustment clause, since such adjustment will be due to circumstances that do not constitute proposed transactions that are seriously contemplated. The general position of the CRA with respect to price adjustment clauses is stated in Interpretation Bulletin IT-169.

3. DC is expected to have a balance in its RDTOH at its year-end on XXXXXXXXXX , and the taxation year of each of TC1 and TC2 in which it redeems its preferred shares owned by DC will, subject to the comments below, coincide with the taxation year of DC in which it distributes the TC1 Redemption Debt and the TC2 Redemption Debt to TC1 and TC2, respectively, on the wind-up of DC. 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 you are aware of the Department's position as set out herein. In order to avoid this problem, you have advised that each of TC1 and TC2 has obtained the consent of the Minister of National Revenue for a change of its fiscal period so that the redemptions by TC1 and TC2 and the winding-up of DC can be completed in different fiscal periods of DC. Provided that the redemptions by TC1 and TC2 and the winding-up of DC are completed in different fiscal periods, the circularity problem set out herein will not apply to DC, TC1 and TC2. If such transactions are not completed in such manner for any reason, the circularity problem set out herein will apply. In that case, the local tax service office at which DC, TC1 and TC2 file their tax returns will have to be consulted to determine which of DC, TC1 and TC2 are liable for Part IV tax under paragraph 186(1)(b) and the amount of such liability.

Yours truly,

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