25 September 1997 External T.I. 9715905 - DIVIDEND IN KIND - U.K. DEMERGER

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

What are the tax consequences to a Canadian shareholder as a result of a U.K. "demerger" where stock of subsidiaries is distributed to shareholders.

Position:

Dividend to the Canadian shareholder, equal to the fair market value of the distributed shares at the time they are received.

Reasons:

Would be taxed as a dividend in the U.K. and U.S. but for specific deferral provisions in the U.K. and U.S. tax law. No such provisions in the Act. Similar to a spin-off (divestiture) of a U.S. corporation.

971590
XXXXXXXXXX J. Stalker

September 25, 1997

Dear XXXXXXXXXX:

Re: XXXXXXXXXX Demerger/"Spin-off"

We are writing in response to your letters of June 10 and 12, 1997 and our telephone conversation shortly thereafter (XXXXXXXXXX/Major) in respect of the tax consequences to you as a Canadian shareholder as a result of the 1996 reorganization ("demerger" or "spin-off") of XXXXXXXXXX.

As you know, we have reviewed the relevant excerpts from the XXXXXXXXXX Shareholder Circular as well as other shareholder communications in respect of the demerger of XXXXXXXXXX. We understand you are aware of some of the points we state below; however, we repeat our findings here for clarity.

On XXXXXXXXXX distributed shares of XXXXXXXXXX to its shareholders. The shareholders also retained their existing shares of XXXXXXXXXX. As a result of our review it was confirmed that this distribution was the payment of a dividend in kind to the shareholders of XXXXXXXXXX consisting of the shares of XXXXXXXXXX which is taxable to Canadian shareholders of XXXXXXXXXX. Section 90 (together with paragraph 12(1)(k) of the Income Tax Act (Canada) (the "Act") requires a Canadian resident to include in income any amounts received "as, on account or in lieu of payment of, or in satisfaction of dividends on a share owned by the taxpayer of the capital stock" of a foreign corporation.

The amount of the dividend to a Canadian shareholder is the aggregate of the fair market value of the XXXXXXXXXX shares at the time they are received by the shareholder, and any cash received in lieu of fractional shares. The XXXXXXXXXX shares will then have a cost base equal to the amount of the dividend included in the income of the shareholder. The cost of the shares of XXXXXXXXXX will not change as a result of the demerger.

You have asked why this distribution of property is characterized as a dividend. The term "dividend" is not fully defined in the Act as the definition in subsection 248(1) is only inclusive and not a full description of the meaning of dividend. Accordingly, the term takes on its ordinary meaning.

The meaning of "dividend" was discussed by W.O. Davis, Q.C. in Cangro Resources Limited v. M.N.R. (67 DTC 582 TAB) in reference to other tax cases. Note that section 6 in the 1952 Income Tax Act to which he refers corresponds to paragraphs 12(1)(j) and 12(1)(k) of the current Act. At page 586, he states:

In Crassweller v. M.N.R. (49 DTC 1), it was further held that, under the provisions of s. 3(1) of the Income War Tax Act - now found in s. 6 of the Income Tax Act, c. 148, R.S.C. 1952 - a dividend is not restricted to a distribution of earned income, only.... Consequently, the accepted ordinary meaning is to be given to the word as it is used in the Income Tax Act. The Shorter Oxford Dictionary states that the word "dividend" is derived from the Latin word dividendum and defines it as "a sum of money to be divided among a number of persons; a portion or share of anything divided, especially the share that falls to each distributee....

A further decision of this Board which may usefully be referred to is No. 463 v. Minister of National Revenue, 18 Tax A.B.C. 111, 57 DTC 530, where a taxpayer received payments in the form of dividends and distribution of shares of other companies from two United States corporations and had been advised by the paying corporations that the payments were non-taxable returns of capital under the laws of the United States of America. The said dividends and distributions were taxed in the hands of the recipients as dividends within the meaning of s.6(a)(i) of the Income Tax Act.

A dividend may not necessarily be paid out of profits. Black's Law Dictionary states in the definition of "extraordinary dividend":

Dividend of corporation which is nonrepetitive and generally paid at irregular time because of some unusual corporate event (eg unusually high profits). An "extraordinary dividend" is distinguished from an "ordinary dividend" or "regular dividend" in that it is not declared from ordinary profits arising out of regular course of business of corporation and is generally declared by reasons of unusually large income or unexpected increment in capital assets....

The weight of judicial authority regarding dividends supports the proposition that any payment made by a corporation to its shareholders pro rata is a dividend unless the payment is made (i) on a formal reduction of paid-up capital in compliance with all applicable corporate law procedures respecting reduction of capital or (ii) on winding-up or liquidation of the corporation. The pro rata distribution of property by XXXXXXXXXX to its shareholders does not fall into these exceptions and is therefore a dividend. In a non-tax case, Re Canadian Pacific Ltd (72 OR (2d) 545 Ont. H.C.), Austin J. of the Ontario High Court of Justice held that a payment to shareholders, whether in cash, specie or the shares of another company is a dividend.

Instead of a distribution in cash, XXXXXXXXXX distributed other assets, that is the shares it owned of XXXXXXXXXX.

We wish to stress that our review also confirmed that the distribution of the XXXXXXXXXX shares would be taxed as a dividend in both the U.K. and the U.S. except that it falls within specific deferral provisions of the U.K. Income Tax Act and the U.S. Internal Revenue Code. However, the Act does not provide for any kind of deferral with respect to such a dividend.

You have questioned our reference to the specific deferral provisions in the U.S. Internal Revenue Code by citing Section 355 of that U.S. law. In fact, that is the relevant deferral provision. As stated on XXXXXXXXXX Shareholder Circular in respect of the tax treatment for US shareholders, if the demergers do not qualify under section 355 of the U.S. Internal Revenue Code, a U.S. shareholder will be treated as having received a taxable distribution in an amount equal to the fair market value of the shares distributed to the shareholder on the date of the demerger.

Other particular excerpts from the XXXXXXXXXX information which indicate that this is a dividend include the following (emphasis added):

XXXXXXXXXX

We refer you to an article by Judith M. Woods, a partner at McCarthy Tétrault, entitled "Cross-border Reorganizations" in the 1996 Canadian Tax Foundation Conference Report on page 17:1. In her discussion of "Foreign Demergers" beginning at page 17:7, she states:

This part of the paper deals with demergers involving non-resident public corporations in which the pubic company is split in two. There has been a recent increase in the number of foreign demergers and, as a result, a focus on the relevant Canadian tax aspects....

Demergers create the potential for tax at both the corporate and the shareholder level. Corporate-level tax can arise on the disposition of appreciated assets, and shareholder-level tax can arise on distributions. The tax legislation dealing with demergers in the United States and the United Kingdom is complex, but generally non-recognition treatment is available both at the shareholder and the corporate level.

... The most common way in which foreign companies demerge is by some type of dividend paid to the public shareholders. When received by Canadian-resident shareholders, such dividends are taxed in the same manner as any taxable dividend from a foreign corporation....

In a foreign demerger, it is rare that the demerger is planned with a view to minimizing tax to Canadian shareholders.

You have also referred to IT-65 which deals with stock splits. The XXXXXXXXXX demerger was not a stock split as the original shareholdings in XXXXXXXXXX remained the same.

While there may have been more spin-offs by foreign companies in 1996 than in previous years, several have occurred in prior years. In some of these cases the Department of Finance has been asked to grant a remission order to relieve the resulting tax consequences to Canadians. Only one remission order has been granted in respect of a divestiture. On May 15, 1985 the Department of Finance granted a remission order in respect of the January 1, 1984 divestiture of AT & T; the remission was granted primarily because it was an involuntary spin-off resulting from a court order. However, no other remission orders have been granted because the spin-offs under consideration were voluntary, as was the XXXXXXXXXX demerger described above.

In summary, our research indicates that the XXXXXXXXXX demerger is considered a "dividend distribution in specie". As noted above there are no provisions in the Canadian law to defer the tax in such a situation.

We trust our comments are helpful.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch