1998 Ruling 9825343 - FOREIGN AFFILIATE REORGANIZATION

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

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.

XXXXXXXXXX
XXXXXXXXXX 982534
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: XXXXXXXXXX
Advance Income Tax Ruling

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

All of the above-referenced taxpayers file their T2 Returns with the XXXXXXXXXX Taxation Centre.

To the best of your knowledge and that of the taxpayers involved, none of the issues involved in this request:

(a) is involved in an earlier return of the taxpayer or a related person,

(b) is being considered by a tax services office or taxation centre in connection with a tax return already filed by the taxpayer or a related person,

(c) is under objection,

(d) is before the courts or, if a judgement has been issued, the time limit for appeal has not expired, and

(e) is the subject of a ruling previously issued by the Income Tax Rulings and Interpretations Directorate.

Definitions

In this letter the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, chapter 1, R.S.C. 1985 (5th supp.), as amended as at the date hereof, and all references to a Part, section, subsection, paragraph, subparagraph or clause is a reference to the specified provision of the Act;

(b) "adjusted cost base" has the meaning assigned to that term by section 54;

(c) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in their election under subsection 85(1);

(d) "Canadian partnership" has the meaning assigned in subsection 102(1);

(f) "capital property" has the meaning assigned to that term by section 54;

(g) "cost amount" has the meaning assigned to that term by subsection 248(1);

(h) "eligible property" has the meaning assigned to that term by subsection 85(1.1);

(i) "foreign affiliate" and "controlled foreign affiliate" each has the meaning assigned to that term by subsection 95(1);

(j) "forgiven amount" has the meaning assigned to that term by subsection 80(1) and 80.01(1);

(k) "paid-up capital" has the meaning assigned to that term by subsection 89(1);

(l) "private corporation" has the meaning assigned to that term by subsection 89(1);

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

(n) "restricted financial institution" has the meaning assigned to that term by subsection 248(1);

(o) "series of transactions or events" has the meaning assigned to that term by subsection 248(10);

(p) "specified financial institution" has the meaning assigned to that term by subsection 248(1);

(q) "stated capital account" has the meaning assigned to that term by the Canada Business Corporations Act ("CBCA");

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

(s) "taxable Canadian corporation" has the meaning assigned to that term by subsection 89(1); and

(t) "taxable dividend" has the meaning assigned to that term by subsection 89(1).

Facts

1. XXXXXXXXXX. ("Canco"), a corporation incorporated under the laws of Canada, is a taxable Canadian corporation and a private corporation and is not a specified financial institution.

2. Canco is an indirectly held wholly-owned subsidiary of XXXXXXXXXX ("U.S. Parent"). U.S. Parent, a XXXXXXXXXX corporation, is engaged directly or indirectly through subsidiaries in the business of manufacturing, marketing, distributing and selling XXXXXXXXXX (collectively, the "Products"). U.S. Parent, which operates its business on a global basis, has been a publicly traded company in the United States since XXXXXXXXXX.

3. Canco has existing and outstanding XXXXXXXXXX common and XXXXXXXXXX special shares, being all of the existing and outstanding shares of the corporation, all of which are owned by XXXXXXXXXX. ("U.S. SUBCO"), a XXXXXXXXXX corporation. Both the stated capital and the paid-up capital of the common shares and special shares of Canco is $XXXXXXXXXX and $XXXXXXXXXX, respectively. The common shares of Canco are capital property of U.S. SUBCO. U.S. SUBCO is a subsidiary wholly-owned corporation of XXXXXXXXXX ("U.S. OPCO"), a XXXXXXXXXX corporation. U.S. OPCO is a subsidiary wholly-owned corporation of U.S. Parent.

U. S. SUBCO owns all of the issued and outstanding shares of XXXXXXXXXX ("HCo"), a U.S. corporation. HCo is presently a dormant company.

U. S. SUBCO has recently incorporated an unlimited liability company under the laws of XXXXXXXXXX ("XXXXXXXXXX Co"). XXXXXXXXXX Co is a taxable Canadian corporation.

XXXXXXXXXX Co has recently incorporated a wholly-owned, limited liability XXXXXXXXXX subsidiary ("Subco") with an authorized share capital of common and preferred shares. Subco is a taxable Canadian corporation. XXXXXXXXXX Co has subscribed for common shares of Subco for nominal consideration.

4. In addition to the U.S. SUBCO shares, U.S. OPCO owns, inter alia, XXXXXXXXXX% of the shares of XXXXXXXXXX ("XXXXXXXXXX CO "), a company incorporated under the laws of XXXXXXXXXX and engaged in marketing, distributing and selling Products for the U.S. Parent group in XXXXXXXXXX. In addition to the U.S. OPCO shares, U.S. Parent owns, inter alia, XXXXXXXXXX of the shares of XXXXXXXXXX corporation engaged in the manufacture, distribution and sale of Products for the U.S. Parent group.

5. Each of U.S. Parent, U.S. OPCO and U.S. SUBCO is a non-resident of Canada for the purposes of the Act and a resident of the United States for the purposes of the Canada- U.S. Income Tax Convention (the "U.S. Treaty"). More particularly, each of U.S. Parent, U.S. OPCO and U.S. SUBCO is a corporation governed by subchapter C of the Internal Revenue Code of the United States and is subject to tax in the U.S. on its worldwide income as a U.S. domestic corporation. None of U.S. Parent, U.S. OPCO or U.S. SUBCO is a "limited liability company" ("LLC"), governed by LLC legislation of a particular State of the U.S.

6. Canco owns all of the issued and outstanding shares of three taxable Canadian corporations. Two of those corporations are partners in a Canadian partnership. Canco also owns all or substantially all of the shares of a number of entities engaged in sales, marketing, distributing and/or manufacturing of Products, including

XXXXXXXXXX

Canco also owns all of the shares of XXXXXXXXXX ("XXXXXXXXXX Opco"), an XXXXXXXXXX corporation incorporated in XXXXXXXXXX and a non-resident of Canada for the purposes of the Act. XXXXXXXXXX Opco is resident in XXXXXXXXXX Opco does not have any subsidiaries. XXXXXXXXXX Opco does have a XXXXXXXXXX% interest in the issued shares of XXXXXXXXXX.

Canco has also recently incorporated a XXXXXXXXXX is not and will not be resident in Canada.

7. Each of the XXXXXXXXXX is a foreign affiliate and a controlled foreign affiliate of Canco.

8. The shares of the XXXXXXXXXX constitute capital property of Canco.

9. Each of Canco, XXXXXXXXXX Opco and the Indicated Affiliates has a year end of XXXXXXXXXX.

10. The fair market value of the shares of Canco is not derived principally (i.e., more than 50%) from real property situated in Canada and U.S. SUBCO does not now and has never had a permanent establishment in Canada for the purposes of the U.S. Treaty.

Proposed Transactions

11. Canco will undergo a formal reduction in its stated capital in respect of its common shares pursuant to the provisions of the Canada Business Corporations Act such that, after the reduction, the stated capital of Canco, as reflected in its stated capital account, will be nominal (say $XXXXXXXXXX). $XXXXXXXXXX cash consideration will be paid by Canco to U.S. Subco for each $XXXXXXXXXX reduction in the stated capital of the common shares. Canco will also redeem all of the issued and outstanding special shares for an amount equal to the paid-up capital (being the fair market value) of the special shares so redeemed. U.S. SUBCO will apply to Revenue Canada for a certificate under section 116 in respect of the redemption.

12. Canco will transfer all of the issued and outstanding shares of the Indicated Affiliates to XXXXXXXXXX in exchange for additional common shares of XXXXXXXXXX having a fair market value equal to the fair market value of the shares of the Indicated Affiliates so transferred. As part of the series of transactions or events that includes the proposed transactions described herein, XXXXXXXXXX will not dispose of the shares of the Indicated Affiliates to any person that, at any time, will be a person that is not related to Canco.

13. Subsequent to the transfer of shares described in paragraph 12 above, pursuant to a reorganization of the capital of Canco, U.S. SUBCO will exchange all of the issued and outstanding common shares of Canco held by U.S. SUBCO for new preferred shares (the "Canco Preferred Shares") and new common shares of Canco. The Canco Preferred Shares will have the following attributes: voting, discretionary as to dividends and redeemable and retractable for an amount (the "Canco PS Redemption Amount") equal to the aggregate fair market value of the shares of XXXXXXXXXX and XXXXXXXXXX Opco owned by Canco at the time of the exchange. The paid-up capital (which will be nominal by virtue of the formal reduction of the stated capital in respect of the shares of Canco) will be allocated all to the new common shares except for $XXXXXXXXXX. U.S. SUBCO will apply to Revenue Canada for a certificate under section 116 in respect of the reorganization.

14. Immediately following the reorganization of capital described in paragraph 13 above, U.S. SUBCO will transfer the Canco Preferred Shares to XXXXXXXXXX Co in exchange for common shares of XXXXXXXXXX Co. U.S. SUBCO and XXXXXXXXXX Co will jointly file an election under subsection 85(1) in prescribed form and within the time limit set out in subsection 85(6) in respect of the Canco Preferred Shares. The amount jointly elected upon (the "Canco PS Elected Amount") will be equal to the fair market value of the Canco Preferred Shares. The amount added to the capital of XXXXXXXXXX Co for XXXXXXXXXX corporate law purposes will be equal to the fair market value of the Canco Preferred Shares at the time of the transfer. U.S. SUBCO will apply to Revenue Canada for a certificate under section 116 in respect of the transfer.

15. Immediately following the transfer by U.S. SUBCO of the Canco Preferred Shares to XXXXXXXXXX Co described in paragraph 14 above, Canco will transfer the XXXXXXXXXX Shares and its shares of XXXXXXXXXX Opco to Subco in exchange for preferred shares of Subco (the "Subco Preferred Shares") which will have the following attributes: voting, discretionary as to dividends and redeemable and retractable at an amount (the "Subco PS Redemption Amount") equal to the fair market value of the shares of XXXXXXXXXX (the "XXXXXXXXXX Shares") and XXXXXXXXXX Opco at the time of transfer plus any accrued and unpaid dividends on the Subco Preferred Shares. Canco and Subco will jointly file an election under subsection 85(1) in prescribed form and within the time limit set out in subsection 85(6) in respect of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares. The amount jointly elected upon in respect of the XXXXXXXXXX Shares will be equal to the adjusted cost base of the XXXXXXXXXX Shares (being an amount equal to the adjusted cost base of the shares of the Indicated Affiliates) plus an amount equal to the amount to be elected upon by Canco under subsection 93(1), as described in paragraph 16 below. The amount jointly elected upon in respect of the shares of XXXXXXXXXX Opco will be equal to the adjusted cost base of such shares to Canco plus an amount equal to the amount to be elected upon by Canco under subsection 93(1), as described in paragraph 16 below. The paid-up capital of the Subco Preferred Shares will be equal to the aggregate of the agreed amounts in respect of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares.

16. Canco will file elections under subsection 93(1) in the prescribed form and within the time limit set out in subsection 5902(5) of the Income Tax Regulations (the "Regulations") in respect of the transfer of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares referred to in paragraph 15. In respect of each election Canco will designate an amount not exceeding the maximum amount that could be designated by Canco and obtain the result that the whole amount designated be treated as a dividend from "exempt surplus", in accordance with the rules in section 5902 of the Regulations.

17. Subco will redeem the Subco Preferred Shares held by Canco at their fair market value, being the Subco PS Redemption Amount. The Subco PS Redemption Amount will be satisfied by Subco's issuance of a demand, non-interest bearing promissory note to Canco with a principal amount and fair market value equal to the Subco PS Redemption Amount (the "Subco Note"). Subco will cancel the Subco Preferred Shares so redeemed. Canco will accept the Subco Note in full satisfaction of the Subco PS Redemption Amount.

18. Subco will be voluntarily dissolved in accordance with the provisions of the XXXXXXXXXX. Pursuant thereto, XXXXXXXXXX Co will acquire the XXXXXXXXXX Shares and the shares of XXXXXXXXXX Opco and will assume the obligations under the Subco Note issued to Canco.

19. Canco will redeem the Canco Preferred Shares held by XXXXXXXXXX Co at their fair market value, being the Canco PS Redemption Amount in exchange for a demand, non-interest bearing promissory note issued by Canco to XXXXXXXXXX Co having a principal amount and fair market value equal to the Canco PS Redemption Amount (the "Canco Note"). Canco will cancel the Canco Preferred Shares so redeemed. XXXXXXXXXX Co will accept the Canco Note in full satisfaction of the Canco PS Redemption Amount.

20. The Canco Note and the Subco Note will be set off against each other and cancelled.

21. U.S. Parent will transfer to U.S. OPCO all of the shares of XXXXXXXXXX owned by it. U.S. OPCO will then transfer to U.S. SUBCO all of the outstanding shares of XXXXXXXXXX CO and XXXXXXXXXX owned by it.

22. U.S. SUBCO will transfer to HCo all of the outstanding shares of XXXXXXXXXX CO and XXXXXXXXXX owned by it in exchange for HCo voting common shares having a fair market value equal to the fair market value of the XXXXXXXXXX CO and XXXXXXXXXX shares. Immediately following this transfer all of the issued and outstanding shares of HCo will be owned by U.S. SUBCO.

U. S. SUBCO will transfer to HCo, as a capital contribution, its minority interests in each of XXXXXXXXXX.

23. XXXXXXXXXX Co will transfer the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares to HCo in exchange for preferred shares of HCo (the "HCo Preferred Shares") having a fair market value equal to the aggregate fair market value of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares so transferred. As part of the series of transactions or events that includes the proposed transactions described herein, HCo will not dispose of the XXXXXXXXXX shares or the XXXXXXXXXX Opco shares to any person that, at any time, will be a person that is not related to XXXXXXXXXX Co.

24. The HCo Preferred Shares will have the following attributes: voting, fixed cumulative dividend with a "compounding" feature and redeemable and retractable XXXXXXXXXX years after the day following the date of issue for an amount (the HCo PS Redemption Amount") equal to the fair market value of the XXXXXXXXXX Shares and XXXXXXXXXX Opco shares at the time of the transfer plus accrued and unpaid dividends. The HCo Preferred Shares will contain a price adjustment clause pursuant to which the redemption price of the shares will be adjusted accordingly in the event of a final determination which results in an adjustment in the fair market value of the HCo Preferred Shares. The HCo Preferred Shares will also provide that no dividend may be paid on any other class of shares which would impair HCo's ability to redeem the HCo Preferred Shares at the HCo PS Redemption Amount i.e., reduce the fair market value of the HCo Preferred Shares below an amount equal to the HCo PS Redemption Amount.

25. HCo will establish a branch (the "XXXXXXXXXX Branch") in XXXXXXXXXX which will carry on certain sales and marketing activities of U.S. Parent group products in XXXXXXXXXX. For XXXXXXXXXX income tax purposes, the XXXXXXXXXX Shares will subsequently be "allocated" to the XXXXXXXXXX Branch in consideration for an interest free intra-company advance with a principal amount equal to the fair market value of the XXXXXXXXXX Shares (i.e., the aggregate fair market value of the shares of the Indicated Affiliates). The XXXXXXXXXX Branch will be a branch for XXXXXXXXXX commercial and tax law purposes.

Additional Information

26. There will not, as part of a transaction or event or a series of transactions or events that includes the proposed transactions, be any disposition of property by a non-resident person that is not related to U.S. Parent in the circumstances described in paragraph 55(3.01)(e) such that for purposes of paragraph 55(3)(a) the property would be deemed to be disposed of for proceeds of disposition that are less than its fair market value.

27. There will not be, before the completion of the proposed transactions described herein, any "guarantee agreements" within the meaning of subsection 112(2.2) in relation to the Canco Preferred Shares issued by Canco, the Subco Preferred Shares issued by Subco, and none of such shares will be issued or acquired as part of a transaction or a series of transactions of the type described in subsection 112(2.5).

28. None of Canco, XXXXXXXXXX Co, or Subco will be at any time before the completion of the proposed transactions described herein, a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1).

29. The Canco Preferred Shares issued by Canco and the Subco Preferred Shares issued by Subco will not be, at any time before the completion of the proposed transactions described herein, shares to which paragraph (g) of the definition of “taxable preferred share” in subsection 248(1) or paragraph (1)(e) of the definition of “taxable RFI share” in subsection 248(1) will apply to deem the share to be a taxable preferred share or a taxable RFI share.

30. Canco will not have any RDTOH at any time during the proposed transactions.

31. U.S. SUBCO will be electing under Regulation 301.7701-3(c) to the Internal Revenue Code to classify XXXXXXXXXX Co as a "branch" of U.S. SUBCO for all U.S. federal income tax purposes. As a result, XXXXXXXXXX Co will be disregarded as a separate entity for U.S. tax purposes.

32. It is expected that HCo will pay dividends of between $XXXXXXXXXX U.S. per year on the HCo Preferred Shares. In response to certain changes in XXXXXXXXXX, it is expected that XXXXXXXXXX Opco will pay one or more dividends in an aggregate amount of approximately $XXXXXXXXXX U.S. to HCo in the XXXXXXXXXX. It is expected that HCo will then pay dividends in similar amounts to US SUBCO during the next XXXXXXXXXX years. It is also expected that dividends of approximately $XXXXXXXXXX U.S. will be paid from the Indicated Affiliates to XXXXXXXXXX, then dividends of similar amounts will be paid from XXXXXXXXXX to HCo and then dividends of similar amounts will be paid from HCo to U.S. SUBCO over the next XXXXXXXXXX years. As a result, dividends of approximately $XXXXXXXXXX U.S. (being the dividends of $XXXXXXXXXX U.S. and $XXXXXXXXXX U.S. referred to above) in aggregate are expected to be paid on the HCo common shares over the next XXXXXXXXXX years.

Undertaking of Taxpayers

As a result of the subsection 93(1) elections to be made by Canco in respect of the sale of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares to Subco, described in paragraphs 15 and 16 herein, XXXXXXXXXX and XXXXXXXXXX Opco will have an "exempt deficit" as defined in subsection 5907(1) of the Regulations in respect of Subco. Immediately following this transaction, the exempt surplus of each of the Indicated Affiliates in respect of Subco will be the same as the exempt surplus of that Indicated Affiliate in respect of Canco immediately before the transaction. At the conclusion of the proposed transactions, XXXXXXXXXX Opco and the Indicated Affiliates will have that same exempt deficit or exempt surplus, respectively, in respect of XXXXXXXXXX Co.

XXXXXXXXXX Co and the U.S. Parent group of companies hereby undertake that no transactions will be undertaken that will result directly or indirectly in the exempt surplus of the Indicated Affiliates (determined at the completion of the proposed transactions) being repatriated or otherwise utilized without XXXXXXXXXX and XXXXXXXXXX Opco each first having received dividends sufficient to eliminate its respective exempt deficit. For greater certainty, nothing herein shall preclude the payment of dividends by the Indicated Affiliates, and then by XXXXXXXXXX or XXXXXXXXXX Opco, before the elimination of its respective exempt deficit.

Purpose of the Proposed Transactions

U.S. Parent is proposing to enter into the above-noted transactions for the following reasons.

Firstly, U.S. Parent wishes to establish a central holding company (i.e., XXXXXXXXXX) for its primary XXXXXXXXXX sales, marketing and manufacturing companies operating in XXXXXXXXXX will receive dividends from the Indicated Affiliates free of withholding tax. XXXXXXXXXX will, inter alia, repatriate dividends to its parent or perform a "treasury" function for the Indicated Affiliates i.e., investing excess funds and acting as "banker" for the Indicated Affiliates, lending funds to or making equity investments in the group, as required.

Secondly, the allocation of the XXXXXXXXXX Shares to the XXXXXXXXXX Branch will ensure that dividends from the Indicated Affiliates (which, as indicated above, will flow tax-free to XXXXXXXXXX) may be distributed by XXXXXXXXXX to its shareholder, HCo, without triggering any XXXXXXXXXX tax.

Thirdly, the transfer of the XXXXXXXXXX Shares to HCo will allow access to the U.S. treaty network if, due to a change of law or application of a "look through" by any of the jurisdictions in which the Indicated Affiliates are resident, withholding taxes are imposed on dividends from the Indicated Affiliates.

XXXXXXXXXX

Fourth, a U.S. withholding tax that did not exist in the current structure could arise if dividends were to be paid by HCo to Canco. By transferring the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares from Canco to XXXXXXXXXX Co and then transferring the XXXXXXXXXX Shares and XXXXXXXXXX Opco shares from XXXXXXXXXX Co to HCo in exchange for HCo Preferred Shares, U.S. withholding tax will be avoided on dividends paid by HCo to XXXXXXXXXX Co since XXXXXXXXXX Co (but not Canco) will be treated as a "look through" entity for U.S. federal income tax purposes.

XXXXXXXXXX

Lastly, the transfer of the XXXXXXXXXX Shares and XXXXXXXXXX Opco shares to HCo in exchange for the HCo Preferred Shares will "freeze" the value of the shares taken back by XXXXXXXXXX Co at their then current fair market value. XXXXXXXXXX, U.S. Parent organized the Indicated Affiliates and XXXXXXXXXX Opco as subsidiaries of Canco, without regard to adverse Canadian or foreign income tax consequences. In that U.S. Parent is now a U.S. public company, it is required to maximize value of the company's assets for its shareholders. In the circumstances, it is incumbent on U.S. Parent to ensure that the future growth, if any, in respect of the Indicated Affiliates and XXXXXXXXXX Opco accrues to the U.S. public company. The "freeze" will accomplish this, while at the same time ensuring that XXXXXXXXXX Co continues to earn an arm's length return on its investment. In order to accomplish this, the HCo Preferred Shares will provide for an arm's length dividend rate. For U.S. income tax reasons, the HCo Preferred Shares cannot be redeemed or retracted for a period of XXXXXXXXXX years from the day following the date of their issuance. The value of the HCo Preferred Shares will be maintained despite the limitation on retraction and redemption in a number of ways. Firstly, the HCo Preferred Shares will bear a higher dividend rate than would otherwise be the case if the HCo Preferred Shares could be immediately retracted. Secondly, the HCo Preferred Shares will have a cumulative dividend entitlement i.e., dividends may not be paid on the common shares of HCo (or any other class which may be created) before accumulated dividends are paid on the HCo Preferred Shares. Thirdly, if dividends are not actually paid in a year, the HCo Preferred Shares will have a compounding dividend feature which will ensure that XXXXXXXXXX Co receives the same overall return which it would otherwise have received had dividends been paid each year on the HCo Preferred Shares. Lastly, U.S. SUBCO will transfer to HCo all of the shares of XXXXXXXXXX CO in exchange for common shares of HCo. U.S. SUBCO will also transfer to HCo all of the shares of XXXXXXXXXX for common shares of HCo. The transfer of the XXXXXXXXXX CO and XXXXXXXXXX Shares will therefore help support the underlying value of the HCo Preferred Shares by ensuring that there are significant assets in HCo other than the shares of the Indicated Affiliates held by XXXXXXXXXX or XXXXXXXXXX Opco shares held by HCo.

Rulings Given

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

A. Subsection 85.1(3) will apply to the transfer by Canco to XXXXXXXXXX of the shares of the Indicated Affiliates, as described in paragraph 12 above, and subsection 85.1(4) will not apply thereto.

B. Subsection 86(1) will apply to the reorganization of the capital of Canco pursuant to which U.S. SUBCO will exchange its common shares of Canco for new Canco common shares and the Canco Preferred Shares as described in paragraph 13 above such that the cost of the new Canco common shares and the Canco Preferred Shares received by U.S. SUBCO on the exchange will be deemed by paragraph 86(1)(b) of the Act to be an amount equal to that proportion of the aggregate adjusted cost base to U.S. SUBCO, immediately before the exchange, of the Canco common shares, that

i) the fair market value, immediately after the exchange, of the new Canco common shares or the Canco Preferred Shares, as the case may be,

is of

ii) the fair market value, immediately after the exchange, of all the shares of Canco received by U.S. SUBCO on the exchange.

C. The provisions of subsection 85(1), other than paragraph 85(1)(e.2), will apply to the transfer by U.S. SUBCO of the Canco Preferred Shares to XXXXXXXXXX Co as described in paragraph 14 above with the result that the agreed amount for purposes of paragraph 85(1)(a) of the Act (the Canco PS Elected Amount) will be deemed to be U.S. SUBCO's proceeds of disposition and XXXXXXXXXX Co's cost thereof, and the cost to U.S. SUBCO of the common shares of XXXXXXXXXX Co will be determined in accordance with the provisions of paragraph 85(1)(h).

D. The gain on the transfer by U.S. SUBCO of the Canco Preferred Shares to XXXXXXXXXX Co in exchange for common shares of XXXXXXXXXX Co will be exempt from tax under the Act by virtue of Article XIII of the U.S. Treaty. Pursuant to subsection 212.1(1), the paid-up capital of the XXXXXXXXXX Co common shares will be equal to the paid-up capital of the Canco Preferred Shares and no dividend will be deemed to arise on the transfer.

E. The provisions of subsection 85(1), other than paragraph 85(1)(e.2), will apply to the transfers by Canco of the XXXXXXXXXX Shares and the shares of XXXXXXXXXX Opco to Subco as described in paragraph 15 above with the result that the agreed amounts for purposes of paragraph 85(1)(a) will be deemed to be Canco's proceeds of disposition for the purpose of the subsection 93(1) elections to be made by Canco. For greater certainty and notwithstanding the elections made by Canco under subsection 93(1), pursuant to subsection 85(1) the cost of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares to Subco will be equal to their respective agreed amounts; pursuant to subsection 85(1) the cost of the Subco Preferred Shares to Canco will be equal to the aggregate of the agreed amounts in respect of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares; and pursuant to subsection 85(2.1), the paid-up capital of the Subco Preferred Shares will be equal to the aggregate of the agreed amounts in respect of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares.

F. Provided the elections by Canco under subsection 93(1), described in paragraph 16 herein, are filed in prescribed manner and within prescribed time, the deemed proceeds of disposition of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares, respectively, as otherwise determined under subsection 85(1), will be reduced by the respective "elected amount" referred to in subsection 93(1).

G. As a result of the redemption of the Subco Preferred Shares, Canco will be deemed to have received a dividend pursuant to subsection 84(3) equal to the difference between the Subco PS Redemption Amount and the paid-up capital of the Subco Preferred Shares.

H. The deemed dividend arising on the redemption of the Subco Preferred Shares will be included in the income of Canco under subsection 82(1) but will be deductible in computing Canco's taxable income under subsection 112(1). For greater certainty, the deduction under subsection 112(1) will not be disallowed by virtue of subsections 112(2.1), (2.2), (2.3) or (2.4).

I. By virtue of the definition of "substantial interest" in paragraph 191(2)(a), Canco will have a substantial interest in Subco immediately before the redemption of the Subco Preferred Shares as described in paragraph 17 above. Consequently, no tax will be payable under either section 187.2 or section 191.1 in respect of the taxable dividends arising on the redemption of the Subco Preferred Shares as the dividends will be "excepted dividends" by virtue of paragraph (b) of the definition of excepted dividend in section 187.1 and "excluded dividends" by virtue of paragraph (a) of the definition thereof in subsection 191(1).

J. Provided that Subco is not entitled to a dividend refund (within the meaning of subsection 129(1)) in respect of its taxation year in which it is deemed to pay the dividend referred to in ruling G above, Canco will not be subject to Part IV tax under subsection 186(1) in respect of the dividends referred to in ruling G above.

K. By virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the deemed dividend, referred to in ruling G above, received by Canco, provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events which includes the redemption by Subco of its Subco Preferred Shares held by Canco. For greater certainty, the proposed transactions described herein, in and by themselves, will not be considered to result in any disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v).

L. Subsection 88(1) will apply to the dissolution of Subco as described in paragraph 18 above and for greater certainty:

(i) Subco will be deemed under paragraph 88(1)(a) to have disposed of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares for an amount equal to the "cost amount" thereof;

(ii) XXXXXXXXXX Co will be deemed to have disposed of the Subco Shares for proceeds of disposition determined in accordance with paragraph 88(1)(b); and

(iii) XXXXXXXXXX Co will be deemed under paragraph 88(1)(c) to have acquired the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares for an amount equal to the amount deemed by paragraph 88(1)(a) to be Subco’s proceeds of disposition thereof.

M. As a result of the redemption of the Canco Preferred Shares, XXXXXXXXXX Co will be deemed to have received a dividend under subsection 84(3) equal to the difference between the Canco PS Redemption Amount and the paid-up capital of the Canco Preferred Shares.

N. The deemed dividend arising on the redemption of the Canco Preferred Shares held by XXXXXXXXXX Co will be included in the income of XXXXXXXXXX Co under subsection 82(1) but will be deductible in computing XXXXXXXXXX Co's taxable income under subsection 112(1). For greater certainty, the deduction under subsection 112(1) will not be disallowed by virtue of subsection 112(2.1), (2.2), (2.3) or (2.4).

O. By virtue of the definition of "substantial interest" in paragraph 191(2)(a), XXXXXXXXXX Co will have a substantial interest in Canco immediately before the redemption of the Canco Preferred Shares as described in paragraph 19 above. Consequently, no tax will be payable under either section 187.2 or section 191.1 in respect of the taxable dividends arising on the redemption of the Canco Preferred Shares as the dividends will be "excepted dividends" by virtue of paragraph (b) of the definition of excepted dividend in section 187.1 and "excluded dividends" by virtue of paragraph (a) of the definition thereof in subsection 191(1).

P. Provided that Canco is not entitled to a dividend refund (within the meaning of subsection 129(1)) in respect of its taxation year in which it is deemed to pay the dividend referred to in ruling M above, XXXXXXXXXX Co will not be subject to Part IV tax under subsection 186(1) in respect of the dividends referred to in ruling M above.

Q. By virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the deemed dividend, referred to in ruling M above, received by XXXXXXXXXX Co, provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events which includes the redemption by Canco of its Canco Preferred Shares held by XXXXXXXXXX Co. For greater certainty, the proposed transactions described herein, in and by themselves, will not be considered to result in any disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v).

R. The set off and cancellation of the Canco note and the Subco Note, as described in paragraph 20, will not give rise to a "forgiven amount" within the meaning of subsection 80(1) or 80.01(1).

S. Subsection 85.1(3) will apply to the transfer by XXXXXXXXXX Co to HCo of the XXXXXXXXXX Shares and the XXXXXXXXXX Opco shares, described in paragraph 23 above, and subsection 85.1(4) will not apply thereto.

T. At the completion of the proposed transactions HCo and XXXXXXXXXX will each be a foreign affiliate of XXXXXXXXXX Co.

U. The allocation, for XXXXXXXXXX tax purposes, by HCo of its shares of XXXXXXXXXX to the XXXXXXXXXX Branch will be a non-event for the purposes of the Act.

V. The provisions of subsection 15(1), 56(2), 69(11), and 246(1) will not be applied as a result of the proposed transactions, in and by themselves.

As a result of the proposed transactions, in and by themselves, subsection 245(2) will not be applied 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 by 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. In particular, we are not commenting on the possible effect, if any, of proposed section 212.2 of the Act.

Comments

1. 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 adjusted cost base of any particular asset or the paid-up capital of any shares referred to herein; or

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

Specifically, nothing should be construed as acceptance by Revenue Canada of the fair market value of the HCo Preferred Shares.

2. You have informed us, in paragraph 24 above, that the redemption price of the HCo Preferred Shares will be adjustable in the event of a final determination which results in an adjustment in the fair market value of the HCo Preferred Shares.

Nothing in this letter should be interpreted as confirming that,

(a) for purposes of the Act, any adjustment made pursuant to any such price adjustment clause in respect of a transaction subsequent to the time of such transaction will be effective, retroactively, to the time of such transaction, or

(b) for the purposes of the Act, any amount paid pursuant to any such price adjustment clause, in respect of a transaction subsequent to the time of such transaction will be an additional payment of the redemption or purchase price of any shares redeemed or repurchased.

The operation of a price adjustment clause is not a proposed transaction and, consequently, advance rulings are not given by the Department in respect thereof. The Department's general position with respect to price adjustment clauses in agreements is set out in Interpretation Bulletin IT-169 dated August 6, 1974.

Yours truly,

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

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