30 November 1997 Ruling 9727303 - 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.

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:

This is a gross asset butterfly with a spin-off. No new issues

Position:N/A

Reasons:N/A

XXXXXXXXXX
XXXXXXXXXX 			972730
XXXXXXXXXX 

Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: Advance Income Tax Ruling: XXXXXXXXXX ("Distributorco")

This is in reply to your letters of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer.

To the best of your knowledge and the knowledge of the responsible officers of the taxpayers involved none of the issues involved in the requested rulings is being considered by a Tax Services Office or Taxation Centre in connection with an income tax return already filed and none of the issues involved is subject to a notice of objection under section 165 of the Income Tax Act or is otherwise under appeal.

Definitions

Non-Statutory Terms

In this letter unless otherwise expressly stated:

(a) XXXXXXXXXX;

(b) XXXXXXXXXX;

(c) XXXXXXXXXX;

(d) "Butterfly Proportion" means the proportion determined by dividing the gross fair market value of the business assets of Distributorco (determined on a consolidated "look-through" basis) to be transferred to Newco by the gross fair market value of all business assets of Distributorco (also determined on a consolidated “look-through” basis) before the Butterfly Transfer;

(e) "Butterfly Transfer" means the transfer from Distributorco to Newco of shares of Subco 1 and Equityco, any advances or amounts owing by Subco 1, Equityco or Subco 2 to Distributorco and certain other property of Distributorco;

(f) "CBCA" means the Canada Business Corporations Act;

(g) XXXXXXXXXX;

(h) "Subco 2" means XXXXXXXXXX;

(i) "Equityco" means XXXXXXXXXX;

(j) "Corp." means the corporation resulting from the incorporation of Partnership as discussed herein;

(k) "Partnership" means XXXXXXXXXX;

(l) XXXXXXXXXX;

(m) "Subco 1" means XXXXXXXXXX; and

(n) "Shareholders" means XXXXXXXXXX until the completion of the proposed transaction at step 1 under the heading "Proposed Transactions" set out below and thereafter XXXXXXXXXX.

Statutory Terms

In this letter unless otherwise expressly stated:

(a) "Act" means the Income Tax Act, RSC 1985, c.1 (5th supplement), as amended through to the date hereof and unless otherwise stated every reference to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act.

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

(c) "arm’s length" has the meaning assigned in subsection 251(1);

(d) "Canadian-controlled private corporation" has the meaning assigned in subsection 248(1);

(e) "capital property" has the meaning assigned in section 54;

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

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

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

(i) "paid-up capital" has the meaning assigned in subsection 89(1);

(j) "permitted exchange" has the meaning assigned in subsection 55(1);

(k) "permitted redemption" has the meaning assigned in subsection 55(1);

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

(m) "specified shareholder" has the meaning assigned in subsection 248(1) as modified by subsection 55(3.2);

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

(o) "taxable dividend" has the meaning assigned in subsection 89(1); and

(p) "taxable preferred share" has the meaning assigned in subsection 248(1).

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

Facts and Proposed Transactions

Facts

1. Distributorco is a Canadian-controlled private corporation and a taxable Canadian corporation incorporated under the CBCA. Distributorco has two classes of issued and outstanding shares: common shares and Class A Preference shares. The common shares are voting shares entitled to dividends at the discretion of the board of directors of Distributorco and were issued to the current shareholders for $XXXXXXXXXX per share. The Class A Preference shares were issued to the current shareholders for $XXXXXXXXXX per share and are redeemable at the original issue price. The Class A Preference shares are non-voting and are entitled to an annual non-cumulative dividend.

2 The issued and outstanding shares of Distributorco are as follows:

Shareholder Common Shares Class A Preference Shares

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

3 Distributorco has a refundable dividend tax on hand balance which is substantially less than 33 1/3% of the intercorporate dividend arising on the redemption of its Class B Preference shares and of the redemption by Newco of its Class A Preferred shares as discussed below under the heading "Proposed Transactions".

4 In addition to holding the shares of Equityco and Subco 1 described below, Distributorco is directly engaged in the business of XXXXXXXXXX resale. In addition, it owns XXXXXXXXXX plant which is currently inactive XXXXXXXXXX.

Shareholders

5. XXXXXXXXXX is a Canadian-controlled private corporation incorporated under the XXXXXXXXXX. It is owned by XXXXXXXXXX and members of his immediate family, all of whom are residents of Canada.

XXXXXXXXXX is a Canadian-controlled private corporation incorporated under the CBCA. It is wholly-owned by XXXXXXXXXX and members of his immediate family, all of whom are residents of Canada.

XXXXXXXXXX is a Canadian-controlled private corporation incorporated under the XXXXXXXXXX. It is wholly-owned by XXXXXXXXXX and members of his immediate family, all of whom are residents of Canada.

6. None of the Shareholders is related to one another and each of them deals at arm’s length with one another.

7. All of the Shareholders hold shares of Distributorco as capital property.

Subsidiaries

8. Equityco is a Canadian-controlled private corporation incorporated under the CBCA. Equityco’s only outstanding class of shares is common shares. Distributorco owns XXXXXXXXXX of the XXXXXXXXXX outstanding common shares of Equityco. Equityco carries on the business of XXXXXXXXXX. Due to its XXXXXXXXXX% interest, Distributorco exercises significant influence over Equityco.

9. Subco 1 is a corporation incorporated in the state of XXXXXXXXXX, USA. Distributorco is the sole shareholder of Subco 1 owning XXXXXXXXXX common shares. Subco 1 carries on business in the United States as a XXXXXXXXXX.

10. Subco 2 is a corporation incorporated in a state of the United States and is wholly-owned by Subco 1. Subco 2 used to hold a XXXXXXXXXX % interest in the Partnership which has been incorporated as Corp. as described in paragraph 12 below.

11. The Partnership carried on business in the United States as a XXXXXXXXXX.

12. The Partnership was incorporated as a corporation under the laws of the state of XXXXXXXXXX (defined in this letter as Corp.).

13. Corp. caused a corporation named XXXXXXXXXX to be incorporated under the laws of the state of XXXXXXXXXX.

14. XXXXXXXXXX acquired the assets of a XXXXXXXXXX plant for cash.

Determination of Butterfly Proportion: Consolidated Look-Through Basis

15. At the time of the Butterfly Transfer, none of Distributorco, Subco 1, Equityco, Subco 2, Corp. or XXXXXXXXXX has any portfolio investments or rental real estate or other investment property.

16. As of the date of the Butterfly Transfer, Distributorco will determine the gross fair market value of its “cash and near cash” and of its “business property”. The purpose of making this determination of fact is to ensure that in the course of the Butterfly Transfer, Newco receives the same proportion of the gross cash and near cash of Distributorco as it receives of the gross business property of Distributorco and that this is equal to the proportion of the total share value of Distributorco held by Newco prior to the Butterfly Transfer. The process for determining these facts will be as follows:

(a) XXXXXXXXXX will determine the gross fair market value of cash or near cash (comprised of cash, accounts receivable, inventory and other current assets) and of business property (comprised of all other assets).

(b) Corp. will determine the gross fair market value of cash or near cash (comprised of cash, accounts receivable, inventory and any other current assets) and of business property (comprised of all other assets) of its directly owned properties other than Corp.’s direct investment in XXXXXXXXXX and any amounts owing by XXXXXXXXXX to Corp. as of the date of the Butterfly Transfer (these excluded amounts are referred to as the "XXXXXXXXXX Investment").

Corp. will add to its direct holdings of cash and near cash and business property its interest in the cash and near cash and business property of XXXXXXXXXX. Corp.’s interest in XXXXXXXXXX cash and near cash and business property will be determined by allocating the fair market value of the XXXXXXXXXX Investment between cash and near cash and business property based on the same ratio of cash and near cash and business property determined by XXXXXXXXXX in step (a) above. By way of illustration, if the aggregate investment in XXXXXXXXXX by Corp. is $XXXXXXXXXX and in the computation in (a) above it is determined that XXXXXXXXXX % of XXXXXXXXXX property on a gross basis is cash and near cash and XXXXXXXXXX % is business property, then $XXXXXXXXXX would be added to Corp.’s cash and near cash and $XXXXXXXXXX would be added to its business property.

(c) Subco 2 will determine the gross fair market value of cash or near cash (comprised of cash, accounts receivable, inventory and any other current assets) and of business property (comprised of all other assets) other than Subco 2’s direct investment in Corp. and any amounts owing by Corp. to Subco 2 as of the date of the Butterfly Transfer (these excluded amounts are referred to as the "Corp. Investment") and any amounts owing by XXXXXXXXXX to Subco 2 as of the date of the Butterfly Transfer.

Subco 2 will add to its direct holdings of cash and near cash and business property its interest in the cash and near cash and business property of Corp. Subco 2’s interest in Corp.’s cash and near cash and business property will be determined by allocating the fair market value of the Corp. Investment between cash and near cash and business property based on the same ratio of cash and near cash and business property determined by Corp. in step (b) above. Any amounts owing to Subco 2 by XXXXXXXXXX will similarly be included in Subco 2’s cash and near cash and business property by allocating the amount owed between cash and near cash and business property based on the same ratio of cash and near cash and business property determined by XXXXXXXXXX in step (a) above.

(d) Subco 1 will determine the gross fair market value of cash or near cash (comprised of cash, accounts receivable, inventory and any other current assets) and of business property (comprised of all other assets) of its directly owned properties other than Subco 1’s direct investment in Subco 2 and any amounts owing by Subco 2 to Subco 1 as of the date of the Butterfly Transfer (these excluded amounts are referred to as the "Subco 2 Investment") and any amounts owing by XXXXXXXXXX or Corp. to Subco 1 as of the date of the Butterfly Transfer.

Subco 1 will add to its direct holdings of cash and near cash and business property its interest in the cash and near cash and business property of Subco 2. Subco 1’s interest in Subco 2’s cash and near cash and business property will be determined by allocating the fair market value of the Subco 2 Investment between cash and near cash and business property based on the same ratio of cash and near cash and business property calculated by Subco 2 in step (c) above. If any amounts are owing to Subco 1 by either XXXXXXXXXX or Corp., these amounts will similarly be included in Subco 1’s cash and near cash and business property by allocating the amount between cash and near cash and business property based on the same ratio of cash and near cash and business property determined by XXXXXXXXXX in step (a) or Corp. in step (b), as the case may be.

(e) Equityco will determine the gross fair market value of cash or near cash (comprised of cash, accounts receivable, inventory and any other current assets) and of business property (comprised of all other assets).

(f) Distributorco will determine the gross fair market value of cash or near cash (comprised of cash, accounts receivable, inventory and any other current assets) and of business property (comprised of all other assets) of its directly owned properties other than:

(i) its direct investment in Subco 1 and any amounts owing by Subco 1 to Distributorco as of the date of the Butterfly Transfer (these excluded amounts are referred to as the "Subco 1 Investment");

(ii) its direct investment in Equityco and any amounts owing by Equityco to Distributorco as of the date of the Butterfly Transfer (these excluded amounts are referred to as the "Equityco Investment"); and

(iii) any amounts owing by XXXXXXXXXX, Corp. or Subco 2 to Distributorco as of the date of the Butterfly Transfer.

Distributorco will add to its direct holdings of cash and near cash and business property its interest in the cash and near cash and business property of Subco 1 and Equityco. Distributorco’s interest in cash and near cash and business property of Subco 1 will be determined by allocating the fair market value of the Subco 1 Investment between the cash and near cash and business property based on the same ratio of cash and near cash and business property determined in respect of Subco 1 in step (d) above. Similarly, Distributorco’s interest in cash and near cash and business property of Equityco will be determined by allocating the fair market value of the Equityco Investment between the cash and near cash and business property based on the same ratio of cash and near cash and business property determined by Equityco in step (e) above. Any direct advances by Distributorco to XXXXXXXXXX, Corp. or Subco 2 will be allocated on the ratio of cash and near cash and business property determined in step (a), (b) or (c) above, as the case may be.

(g) Consistent with the consolidation method, all intercorporate debt (other than a direct debt owing by a lower-tier corporation to an upper-tier corporation, the treatment of which is discussed above) will be eliminated from the calculation of cash and near cash of the creditor corporation. For example, if as of the date of the Butterfly Transfer Distributorco has an amount owing to Equityco, this amount would be eliminated from Equityco’s cash and near cash for purposes of the calculation in step (e) above.

17. At the end of the foregoing process the gross fair market value of the Distributorco’s cash and near-cash property and of its business property will have been determined. The proportion determined by dividing the gross fair market value of the business assets to be transferred to Newco by the gross fair market value of all of the business assets of Distributorco before the Butterfly Transfer will be the Butterfly Proportion.

Proposed Transactions

The following transactions are proposed:

1. XXXXXXXXXX will transfer the XXXXXXXXXX common shares of Distributorco owned by him to his wholly-owned holding company, XXXXXXXXXX, in exchange for additional common shares of XXXXXXXXXX having a fair market value equal to the fair market value of the common shares of Distributorco so transferred.

XXXXXXXXXX and XXXXXXXXXX will jointly elect, in prescribed form and within the time allowed by subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the common shares of Distributorco. The elected amount in respect of the transfer of Distributorco common shares will be equal to XXXXXXXXXX ACB of those shares. The ACB of those shares will be less than the fair market value of the shares and greater than or equal to the minimum elected amount permitted under subsection 85(1). The aggregate paid-up capital of the additional common shares of XXXXXXXXXX issued in exchange for the Distributorco common shares will be equal to the paid-up capital of the transferred Distributorco common shares.

2. Newco will be incorporated under the XXXXXXXXXX with two classes of shares:

(a) common shares (voting, participating in dividends and on wind up); and

(b) Class A Preferred shares (fixed-value redeemable, retractable preferred shares with one vote per issued share).

Until the proposed transaction described in step 6 below takes place, Newco will have no issued and outstanding shares.

3. The share capital of Distributorco will be amended to add the following classes of shares:

(a) class A common shares (voting, participating in dividends and on wind up); and

(b) Class B Preference shares (fixed-value redeemable, retractable preferred shares with one vote per issued share).

4. Pursuant to section 86 of the Act, the Shareholders will each exchange the XXXXXXXXXX common shares and XXXXXXXXXX Class A Preference shares of Distributorco for XXXXXXXXXX class A common shares and XXXXXXXXXX class B Preference shares of Distributorco.

5. The redemption value of the Class B Preference shares issued by Distributorco in step 4 above will be equal to the Butterfly Proportion multiplied by the aggregate fair market value of all issued Distributorco shares prior to the exchange of shares described in step 4 above.

6. Each of the Shareholders will transfer its XXXXXXXXXX Class B Preference shares of Distributorco to Newco. As consideration for the transfer of the Distributorco Class B Preference shares, Newco will issue XXXXXXXXXX common shares to each of XXXXXXXXXX Shareholders (for an aggregate of XXXXXXXXXX common shares).

Each of the Shareholders and Newco will jointly elect, in prescribed form and within the time allowed by subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the Class B Preference shares of Distributorco. The elected amount in respect of the transfer of Distributorco Class B Preference shares will be equal to the ACB of those shares. The ACB of those shares will be less than the fair market value of the shares and greater than or equal to the minimum elected amount permitted under subsection 85(1). The aggregate paid-up capital of the class A common shares of Newco issued in exchange for the Distributorco Class B Preference shares will be equal to the paid-up capital of the transferred Distributorco Class B Preference shares.

The XXXXXXXXXX Class B Preference shares issued by Distributorco will have a fair market value of more than 10% of the fair market value of all the issued shares of Distributorco.

7. Distributorco will transfer to Newco all of the shares it owns in Subco 1, all of the shares it owns in Equityco and any amounts owing to Distributorco by Subco 1, Equityco, Subco 2, Corp., or XXXXXXXXXX together with a specified amount of Distributorco’s cash and near cash. In exchange, Newco will issue Distributorco XXXXXXXXXX Class A Preferred shares and assume certain liabilities of Distributorco. The XXXXXXXXXX Class A Preferred shares of Newco will have a redemption value equal to the fair market value of the transferred property less the value of the liabilities assumed by Newco. The amount of cash and near cash transferred to Newco will be that amount which when added to the amount of cash and near cash inherent in the shares of Subco 1 and Equityco and any amounts owing to Distributorco by Subco 1, Equityco, Subco 2, Corp. or XXXXXXXXXX will be equal to the Butterfly Proportion of the aggregate cash and near cash of Distributorco on a consolidated look-through basis prior to the proposed transactions.

Distributorco and Newco will jointly elect, in prescribed form and within the time allowed under subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each property. Each property is an eligible property as defined in subsection 85(1.1). The elected amount in respect of each property will be less than or equal to its fair market value and greater than or equal to the minimum elected amount permitted under subsection 85(1).

The XXXXXXXXXX Class A Preferred shares issued by Newco will have a fair market value of more than 10% of the fair market value of all the issued shares of Newco.

8. Distributorco will redeem the XXXXXXXXXX Class B Preference shares held by Newco and will issue as full payment of the aggregate redemption price payable a demand, non-interest bearing promissory note in favour of Newco (the "First Note") with a principal amount and fair market value equal to the redemption value of the XXXXXXXXXX Distributorco Class B Preference shares.

9. Newco will redeem the XXXXXXXXXX Class A Preferred shares held by Distributorco and will issue as full payment of the aggregate redemption price payable a demand, non-interest bearing promissory note in favour of Distributorco (the "Second Note") with a principal amount and fair market value equal to the redemption value of the Class A Preferred shares.

10. Distributorco and Newco will agree to set off the First Note and the Second Note from one another as full payment for both notes and both notes will be cancelled. There will be a difference between the principal amount of the First Note and the Second Note.

Additional Information

1. Neither the Distributorco Class B Preference shares or the Newco Class A Preferred shares will be, at any time during the implementation of the proposed transactions:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) as a "guarantee agreement";

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

(c) a share to which paragraph (g) of the definition "taxable preferred share" in subsection 248(1) applies; or

(d) the subject of a dividend rental arrangement as that term is defined in subsection 248(1).

2. None of Distributorco, Subco 1, Equityco or Subco 2 is, or will be at the time of the redemption of the Distributorco Class B Preference Shares or the Newco Class A Preferred shares, a specified financial institution or a corporation described in any of paragraphs (a) to (f) of the definition "financial intermediary corporation" in subsection 191(1).

3. No liabilities will be incurred by or paid down, and no property will become property of Distributorco, Subco 1, Equityco, Subco 2, Corp. or XXXXXXXXXX, a corporation controlled by any of them, or a predecessor of any such corporation in contemplation of the proposed transactions except as described herein. If any asset is acquired by any such corporation or partnership before the proposed transactions otherwise than as a result of a transaction described in paragraphs 55(3.1)(a) or (b) or if any liability is incurred by any such corporation before the Butterfly Transfer, such assets or liability would have been acquired or incurred, as the case may be, whether or not the proposed transactions described herein are implemented.

4. Other than the transfer of XXXXXXXXXX common shares of Distributorco by XXXXXXXXXX to XXXXXXXXXX and the exchange of Distributorco common and Class A Preference shares of Distributorco by the Shareholders described in steps 1 and 2 respectively under the heading “Proposed Transactions:

a) no specified shareholder of Distributorco has sold, or will sell, any shares of Distributorco or any property 10% or more of the value of which was derived from such shares in contemplation of the proposed transactions (except Newco which will become a specified shareholder of Distributorco when it acquires the Class B Preference shares of Distributorco and will cease to be a specified shareholder when those shares are redeemed); and

(b) no share of Distributorco, Subco 1, Equityco or Subco 2 has been acquired, or will be acquired, by any person in contemplation of the proposed transactions (except by Newco which will acquire shares during the proposed transactions).

5. No person or group of persons has acquired control of Distributorco since its incorporation.

6. None of the Shareholders has a current intention to sell shares deriving their value from shares of Distributorco. Distributorco has no current intention of selling shares of Subco 1 or Equityco or shares deriving their value from such shares, other than as described in the proposed transactions. Subco 1 has no current intention of selling shares of Subco 2.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to spin-off the investment in Subco 1 and Equityco from the on-going operations of Distributorco to segregate these investments from the credit risks of the operations of Distributorco.

Rulings

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

A. The provisions of subsection 85(1) will apply to the transfer by XXXXXXXXXX of his XXXXXXXXXX common shares of Distributorco to XXXXXXXXXX in consideration for additional common shares of XXXXXXXXXX such that the vendor’s proceeds of disposition of the shares and the acquiror’s cost of the shares will be deemed by paragraph 85(1)(a) to be equal to the elected amount in respect of the transfer.

B. The provisions of section 86 will apply to the exchange by the Shareholders of the common shares and Class A Preference shares of Distributorco for class A common shares and Class B Preference shares of Distributorco. As a consequence, the cost to each Shareholder of the class A common shares and Class B Preference shares will be deemed by paragraph 86(1)(b) to be equal to the total ACB of that Shareholder’s common shares and Class A Preference shares prior to the exchange allocated between the class A common shares and Class B Preference shares in the manner described in that paragraph. The proceeds of disposition of the common shares and Class A Preference shares will be deemed by paragraph 86(1)(c) to be the Shareholder’s cost of the class A common shares and Class B Preference shares.

C. The provisions of subsection 85(1) will apply to the transfer by Shareholders of Class B Preference shares of Distributorco to Newco for common shares of Newco such that the vendor’s proceeds of disposition of the shares and the acquiror’s cost of the shares will be deemed by paragraph 85(1)(a) to be equal to the elected amount in respect of the transfer.

D. The provisions of subsection 85(1) will apply to the transfer of eligible property by Distributorco to Newco in consideration for Class A Preferred shares of Newco such that Distributorco’s proceeds of disposition for each property and Newco’s cost will be deemed by paragraph 85(1)(a) to be equal to the elected amount in respect of the property.

E. On the redemption of the Class B Preference shares of Distributorco owned by Newco the amount by which the amount paid to redeem the shares (being the principal amount and fair market value of the First Note) exceeds the paid-up capital in respect of those shares:

a) will be deemed by subsection 84(3) to be a taxable dividend paid by Distributorco and received by Newco:

(b) will be deductible by Newco in computing its taxable income in its taxation year in which the dividend is deemed to have been received pursuant to subsection 112(1) and, for greater certainty, will not be a dividend described in subsection 112(2.1), 112(2.2), 112(2.3) or 112(2.4);

(c) will be an "excepted dividend" as defined in paragraph 187.1(1)(c);

(d) will be an "excluded dividend" for purposes of Part VI.1 by reason of the application of subsection 191(4) provided that the specified amount in respect of the Class B Preference shares is equal to the fair market value of the consideration for which the shares will be issued; and

(e) will be excluded from the proceeds of disposition in respect of the share redeemed pursuant to paragraph (j) of the definition of that term in section 54.

F. On the redemption of the Class A Preferred shares of Newco held by Distributorco, the amount by which the amount paid to redeem the shares (being the principal amount and fair market value of the Second Note) exceeds the paid-up capital in respect of those shares:

(a) will be deemed by subsection 84(3) to be a taxable dividend paid by Newco and received by Distributorco;

(b) will be deductible by Distributorco in computing its taxable income in its taxation year in which the dividend is deemed to have been received pursuant to subsection 112(1) and, for greater certainty, will not be a dividend described in subsection 112(2.1), 112(2.2), 112(2.3) or 112(2.4);

(c) will be an "excepted dividend" as defined in paragraph 187.1(1)(c);

(d) will be an "excluded dividend" for purposes of Part VI.1 by reason of the application of subsection 191(4) provided that the specified amount of the class A preferred shares is equal to the fair market value of the consideration for which the shares will be issued; and

(e) will be excluded from the "proceeds of disposition" in respect of the class A preferred shares redeemed pursuant to paragraph (j) of the definition of that term in section 54.

G. By virtue of paragraph 186(4)(b), Distributorco will be connected with Newco and Newco will be connected with Distributorco. Consequently, Distributorco and Newco shall only be subject to Part IV tax pursuant to paragraph 186(1)(b).

H. The cost amount to Newco of the First Note received from Distributorco will be equal to the principal amount of the First Note.

I. The cost amount to Distributorco of the Second Note received from Newco will be equal to the principal amount of the Second Note.

J. The set-off of the First Note and the Second Note as described in step 10 above will not give rise to a "forgiven amount" within the meaning of subsections 80(1) or 80.01(1).

K. Provided that as part of the series of transactions or events that includes the proposed transactions described herein, there is not:

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

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

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

(d) 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) of the Act, subsection 55(2) of the Act will not apply to the taxable dividends referred to in the Rulings given above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b) of the Act.

L. None of the provisions of subsections 15(1), 56(2) and 246(1) and paragraph 85(1)(e.2) will apply to any of the proposed transactions.

M. 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 given subject to the general limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996, and are binding on Revenue Canada provided that the proposed transactions are completed before XXXXXXXXXX.

These 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 into law, could have an effect on the rulings provided herein.

Opinion

Provided that:

(a) our understanding of the statement of the facts and proposed transactions is complete and accurate;

(b) section 55 is amended in substantially the same form as proposed in Bill C-28 which received first reading on December 10, 1997;

(c) as part of the series of transactions or events that includes the proposed transactions described herein, there is not:

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

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

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

(iv) an acquisition of property in the circumstances described in paragraph 55(3.1)(d);

which has not been described herein,

it is our opinion that by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends referred to above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

Comments

Nothing in this ruling should be construed as implying that Revenue Canada has agreed to or reviewed:

(a) the determination of the fair market value or ACB of any property referred to herein, or the PUC of any shares referred to herein; or

(b) any tax consequences relating to the facts and proposed transactions described herein other that those specifically described in the rulings given above.

Yours truly,

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

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