7 December 1998 External T.I. 9831215 - XXXXXXXXXX SPIN-OFF

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 				J. Stalker
			983121
December 7, 1998

Dear XXXXXXXXXX:

We are writing in response to your letter of July 18, 1998 concerning the tax consequences to Canadian shareholders as a result of the 1998 spin-off or distribution by XXXXXXXXXX of its subsidiary XXXXXXXXXX Unfortunately, we did not receive your letter until November 30, 1998 because of an apparent misrouting of your letter, and we apologize for the delay.

Senior Department officials have reviewed the XXXXXXXXXX spin-off and spoken to personnel at XXXXXXXXXX head office. As a result it was determined that the spin-off of XXXXXXXXXX by XXXXXXXXXX was a distribution of property owned by XXXXXXXXXX, that is, shares of XXXXXXXXXX, to its shareholders on a pro rata basis. As such a distribution is a dividend, any Canadian shareholder who holds shares of XXXXXXXXXX at the time of the reorganization has received a dividend which is subject to Canadian tax. In contrast to the Internal Revenue Code, the Income Tax Act (Canada) does not provide for any kind of deferral with respect to such a dividend.

The amount of the dividend to a Canadian shareholder is the aggregate of the fair market value of the XXXXXXXXXX shares received by the shareholder, and any cash received in lieu of fractional shares. The XXXXXXXXXX shares will then have an adjusted cost base for income tax purposes (for the purpose of determining any gain or loss on a subsequent disposition) which is equal to the amount of the dividend included in the income of the shareholder less any portion received in cash. The adjusted cost base of the shares of XXXXXXXXXX will not change as a result of the spin-off. (The adjusted cost base is the price paid for the XXXXXXXXXX shares assuming no adjustments.)

It is recognized that the fair market value of the shares of XXXXXXXXXX have declined. Usually a spin-off results in a decline in value of the shares of the reorganizing corporation because a significant amount of assets have been removed from the corporation and given to shareholders. However, this change in value does not alter how the spin-off is treated under the Canadian Income Tax Act.

The characterization of the distribution as a dividend is based on the ordinary meaning of dividend, as supported by jurisprudence, which is a pro rata distribution of property of a corporation to its shareholders. Instead of a distribution of property which was cash, XXXXXXXXXX distributed other assets, that is the shares it owned of subsidiary corporations. As a consequence the fair market value of XXXXXXXXXX decreased, just as it would have if the company had paid substantial dividends in cash instead of property.

This interpretation of the tax consequences of a spin-off to Canadian shareholders is consistent with the view of the Department of Finance. We also note that this interpretation has been confirmed by our Legal Services.

We wish to emphasize that the distribution of the shares as a result of the spin-off would be taxed as a dividend in the United States, unless the transaction falls within specific deferral provisions of the U.S. Internal Revenue Code. However, the Canadian Income Tax Act does not provide for any kind of deferral with respect to such dividend. We note that the shareholder information you enclosed deals only with the U.S. tax consequences to the shareholders of XXXXXXXXXX. For example, one of the answers on page 2 of that information says, “ XXXXXXXXXX ....” However, the tax rules that provide for such U.S. treatment and consequent tax deferral in the United States do not change the fact that, as described above, a dividend has been paid. In the case of Canadian taxation with respect to the dividend described above, the Act does not provide for any treatment of the dividend other than as a taxable dividend.

In contrast, Canadian corporations that wish to minimize the tax consequences to Canadian shareholders can arrange a reorganization in a different manner to take advantage of specific tax deferral rules under the Canadian Income Tax Act. However, based on the review of this issue in respect to the XXXXXXXXXX and other U.S. and UK spin-offs by Department officials, such foreign reorganizations appear to have been planned in order to minimize tax to U.S. and/or UK shareholders but have not contemplated the tax consequences to Canadian shareholders.

Our review included an article by Judith M. Woods, a partner at the law firm 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 (note that a “demerger” is another term for a spin-off):

This part of the paper deals with demergers involving non-resident public corporations in which the public 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.

The Department of Finance has been aware of the spin-offs by foreign corporations since 1984. Revenue Canada has also kept the Department of Finance aware of the high number of such transactions which took place in recent years. In some of these cases the Department of Finance has been asked to a grant remission order to relieve the resulting tax consequences to Canadians. Only one remission order has been granted in respect of a spin-off. On May 15, 1984 the Department of Finance granted a remission order in respect of the January 11, 1984 spin-off 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 on the part of the corporation involved, as is the spin-off described in this letter.

In summary, our research confirms that a Canadian shareholder who received shares of XXXXXXXXXX as a result of the XXXXXXXXXX spin-off has received a dividend which is subject to Canadian income tax.

We trust our comments are helpful.

Yours truly,

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