[LETTERHEAD OF ERNST & YOUNG LLP]
June 4, 1999
Mickey Lorber
TomaHawk Corporation
8315 Century Park Court
Suite 200
San Diego, CA 92123
Dear Mr. Lorber:
You have requested our opinion as to certain U.S. and Canadian federal income
tax consequences relating to the proposed domestication (the "Domestication") of
TomaHawk Corporation ("Old TomaHawk," the "Alberta Company," or the "Company"),
a Canadian corporation, into a Delaware corporation ("New TomaHawk" or the
"Delaware Company") as described in the Registration Statement on Form S-4 (the
"Registration Statement") filed on or about July 8, 1999.
You have also requested our opinion as to certain U.S. and Canadian federal
income tax consequences relating to the one-for-fifteen share consolidation of
the Common Stock of the Company, along with a change in the authorized capital
of the Company (together referred to as the "Share Consolidation"), as described
in the TomaHawk Corporation Notice of an Annual and Special Meeting of Common
Shareholders dated August 21, 1998 (the "Meeting Notice").
To the extent any opinions contained herein relate to Canadian federal income
tax consequences, those opinions are presented based upon the views and in
reliance upon the Ernst & Young International member firm in Canada ("E&Y
Canada").
In rendering these opinions, Ernst & Young LLP ("E&Y US") and E&Y Canada have
relied upon the following documents (together referred to as the "Documents"):
1. The Statement of Facts and Representations, dated May 7, 1999 provided
by the management of the Company to E&Y US;
2. The Statement of Facts and Representations dated May 6, 1999 provided
by the management of the Company to E&Y Canada;
3. The Registration Statement; and
4. The Meeting Notice.
You have advised E&Y US and E&Y Canada that the Documents provide a complete and
accurate description of all relevant facts and circumstances surrounding the
Domestication and the Share Consolidation. Neither E&Y US nor E&Y Canada has
made any independent verification with respect to any of the facts and
representations set forth in the Documents and, therefore, have relied upon the
completeness, truth and accuracy of the Documents for purposes of rendering
these opinions. Any omissions from or modifications to the Documents may affect
the conclusions stated herein, perhaps in an adverse manner.
SUMMARY OF FACTS PROVIDED BY THE COMPANY
I. CORPORATE AND CAPITAL STRUCTURE
The Company is incorporated under the laws of Alberta, Canada. On November 17,
1992, the Company formed TomaHawk Imaging and Financial Inc. ("TIFI"), a
Canadian corporation. In 1993, TIFI acquired 100 percent of the outstanding
stock of TomaHawk II, Inc. ("TII"), an Illinois corporation. Since its
acquisition, the stock of TII was the only significant asset of TIFI. Effective
February 19, 1999, TIFI was amalgamated with and into the Company (the
"Amalgamation"), leaving the Company as the sole shareholder of TII. Currently,
the Company is a holding company and its only asset is the stock of TII.
TII is an engineering and manufacturing services firm providing document
imaging, engineering, and manufacturing solutions to commercial and government
customers. TII's current services include:
- scanning and conversion of technical documents in large and small
formats to computer intelligent or computer-aided-design ("CAD")
formats;
- reverse engineering of parts and components that do not have plans,
drawings or models to allow for creation of CAD format document;
- three dimensional design and analysis;
- tool design;
- numerical control programming for the automated manufacture of parts
and components; and
- precision machining and inspection of parts and components.
These services address significant needs of both large and small organizations
in various industries, including defense, aerospace, automotive, engineering,
architecture, telecommunications, and utilities.
As of the date of this letter, the authorized stock of the Company consists of
the following: an unlimited number of shares of Common Stock (the "Common
Stock") without par value; an unlimited number of shares of nonvoting Class B
Common Stock (the "Class B Common Stock") without par value; an unlimited number
of shares of Preferred Stock (the "Preferred Stock") without par value; 100,000
shares of 6% non-cumulative, redeemable, retractable, nominal par value Series A
Preferred Stock (the
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"Series A Preferred Stock"); an unlimited number of shares of Class A Series
I Preferred Stock (the "Class A Series I Preferred Stock"); an unlimited
number of shares of Class A Series II Preferred Stock (the "Class A Series II
Preferred Stock"); and an unlimited number of shares of Class A Series III
Preferred Stock (the "Class A Series III Preferred Stock").
Currently, the Company has approximately 84,744,165 shares of Common Stock
issued and outstanding. The Common Stock is quoted on the Alberta Stock Exchange
under the trading symbol "TKC." The holders of the Common Stock are entitled to,
among other things:
- one vote per share on all matters submitted to a shareholder vote;
- receive a pro rata share of any dividends declared by the Board of
Directors out of funds legally available therefor (subject to
preferences that may be applicable to outstanding preferred shares, if
any); and
- if the Company is liquidated, dissolved or wound-up, receive a pro
rata share of all assets remaining after the Company pays its
liabilities and the liquidation preference, if any, of any outstanding
preferred shares.
The holders of Common Stock have no preemptive rights and no rights to convert
their Common Stock into any other securities. Moreover, there are no redemption
or sinking fund provisions with respect to such shares. All of the outstanding
Common Stock are fully paid and non-assessable. The rights, preferences and
privileges of holders of Common Stock are subject to, and may be affected
adversely by, the rights of the holders of shares of the Class A Series III
Preferred Stock and any series of preferred stock which the Company may
designate and issue in the future.
Currently, the Company has 750,000 shares of Class A Series III Preferred Stock
issued and outstanding. The Class A Series III Preferred Stock is not publicly
traded. Holders of the Class A Series III Preferred Stock are entitled to a pro
rata share of any dividend declared by the Board of Directors, so long as such
dividend is paid out of funds legally available for paying dividends. If the
Company liquidates, dissolves, sells all of its assets, or distributes any of
its capital, before anything is distributed to the holders of the Common Stock,
holders of the Class A Series III Preferred Stock are entitled to receive $0.001
for each share of Class A Series III Preferred Stock held, and a pro rata
portion of any unpaid dividends that have accrued with respect to each share.
For each Cdn. $2.50 of cumulative cash flow, a share of Class A Series III
Preferred Stock is convertible into ten shares of Common Stock. The Company's
articles of incorporation also permit it to apply to the Alberta Stock Exchange
to amend the terms of the conversion rights, and to cancel the Class A Series
III Preferred Stock if they are not eligible for conversion by December 31,
1999. If TII becomes insolvent or files, or has filed against it, a petition in
bankruptcy, or ceases to carry on its business, the Class A Series III Preferred
Stock must be surrendered for cancellation.
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As of April 30, 1999, warrants to purchase a total of 167,502 shares of Common
Stock at an exercise price of $0.32 per share were outstanding. These warrants
expired on May 5, 1999.
In addition, as of December 31, 1998, options to purchase a total of 7,475,970
shares of Common Stock were issued and outstanding. Options owned by Management
are as follows: Steven M. Caira owns options to acquire 2,500,000 shares;
Michael Lorber owns options to acquire 500,000 shares; Phillip Card owns options
to acquire 700,000 shares; and John Peace owns options to acquire 710,250
shares. These options were granted under the Company's stock option plan. All of
the above options are exercisable at prices ranging from Cdn $0.17 to Cdn $0.23
per share and expire on various dates through November 17, 2003.
As of December 31, 1998, the following individuals/entities owned 5% or more
of Company's outstanding Common Stock: Norman F. Siegel owned 21.5%(1);
Steven M. Caira owned 11.7%(2); Sprint Enterprise Limited owned 8.2%(3); and
Elliott Broidy owned 5.3%(4). The remainder of the outstanding Common Stock
is publicly-held. The Company has no other classes of common stock currently
outstanding.
As of December 31, 1998, the 5% shareholders of the Class A Series III Preferred
Stock were as follows: David Smoot owned 45%; 434556 B.C. Ltd owned 45%; Audisc
foundation owned 5%; and 436949 B.C. Ltd owned 5% The Company has no other
classes of preferred stock currently outstanding.
In addition to the Domestication (discussed below), the shareholders of the
Company are being asked to approve a change in the capital structure of the
Company. If approved, the authorized capital structure of the Company would
change from the structure described above to:
- 20,000,000 shares of Common Stock, U.S.$.001 par value per share ("New
Common Stock");
- 750,000 shares of Class A Preferred Stock, U.S.$.001 par value per
share ("Class A Preferred Stock"); and
- 750,000 shares of Preferred Stock, U.S.$.001 par value per share
("Preferred Stock").
The change in capital structure would occur in conjunction with a
one-for-fifteen share consolidation of the Common Stock of the Company described
below under "The Share Consolidation." The only difference between the Common
Stock and Class A Series III
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(1) Includes 1,474,565 shares issuable under stock options exercisable within
60 days of April 30, 1999.
(2) Includes 2,525,000 shares issuable under stock options exercisable within
60 days of April 30, 1999, including 25,000 shares issuable under stock
otpions owned by Renee Caira, Mr. Caira's spouse.
(3) Includes 912,328 shares issuable under stock options exercisable within
60 days of April 30, 1999.
(4) Includes 225,000 shares issuable under stock options exercisable within
60 days of April 30, 1999.
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referred stock that is currently outstanding and the New Common Stock and
Class A Preferred Stock that will be issued pursuant to the Share
Consolidation, will be that the New Common Stock and Class A Preferred Stock
will have a stated par value.
II. THE AMALGAMATION
TIFI was incorporated in Alberta, Canada on November 17, 1992. Effective March
8, 1993, TIFI acquired all of the issued and outstanding shares of TII, an
Illinois company incorporated on February 3, 1993.
Effective February 19, 1999, the Company and TIFI combined into one corporation
through an amalgamation pursuant to the Alberta Act (the "Amalgamation"). The
combined entity retained the name TomaHawk Corporation. The Company does not
carry on any business other than holding the shares of TII.
III. THE SHARE CONSOLIDATION
In order to simplify the capital structure of the Company through a reduction of
the number of outstanding shares, as well as enhance the per share value of the
Common Stock, the Company proposes to consummate a Share Consolidation. If the
shareholders approve the Domestication (discussed below), then, prior to
completing the Domestication, the Company will effect a one-for-fifteen share
consolidation of the Common Stock of the Company along with the change in
authorized capital described above (together referred to as the "Share
Consolidation"). This Share Consolidation was authorized by the shareholders on
September 22, 1998.
In the Share Consolidation, the holders of the Common Stock will exchange 15
shares of Common Stock for 1 share of New Common Stock. Additionally, the
conversion ratio of the Class A Series III Preferred Stock will change from 10
shares of Common Stock for each share of Preferred Stock to 0.667 shares of
Common Stock for each share of Preferred Stock. No fractional shares will be
issued in the Share Consolidation. Instead, any fractional shares remaining
after aggregating all fractional shares held by a shareholder will be rounded up
to the nearest whole share. Accordingly, upon consummation of the Share
Consolidation, the Company will have 5,649,611 shares of New Common Stock, and
750,000 shares of Class A Preferred Stock outstanding.
The rights of the holders of the New Common Stock after the Share Consolidation
will be the same, in all material respects, to the rights of the holders of the
Common Stock prior to the Share Consolidation. Similarly, the rights of the
holders of the Class A Preferred Stock after the Share Consolidation will be the
same, in all material respects, to the rights of the holders of the Class A
Series III Preferred Stock prior to the Share Consolidation. Following the Share
Consolidation, the only class of preferred stock that will be outstanding will
be the Class A Preferred Stock.
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In addition to the share exchanges described above, the terms of the outstanding
warrants or options will be modified to reflect the one-for-fifteen Share
Consolidation. No other modifications will be made to the options or warrants.
In conjunction with the Share Consolidation, the Company will change its name to
TomaHawk International Inc.
IV. THE DOMESTICATION
The Board of Directors of the Company believes that the reincorporation of the
Company in the State of Delaware is in the best interests of the Company as the
focus of its operations and business is in the United States. There is no
business reason for its incorporation in Canada. The Company has no facilities
or operations in Canada, and most of its shareholders and customers are in the
United States. Furthermore, reincorporation will simplify the corporate
structure of the Company and reduce its Canadian corporate tax and reporting
obligations.
In order to effectuate the Domestication, the Company will:
1. Hold an Extraordinary General Meeting of its shareholders to vote on
the Domestication. Approval of the Domestication requires the
affirmative vote of the holders of 66 2/3% of the Common Stock of the
Company represented and voting at the meeting; and
2. File Articles of Domestication with the Secretary of the State of
Delaware.
The Domestication will be completed upon the approval of the Secretary of the
State of Delaware.
V. THE MERGER
The Board of Directors of the Company believes that it is in the best interests
of the Company and its shareholders to merge New TomaHawk with TII. Accordingly,
following the Domestication, the Company intends to merge with and into TII,
with TII surviving (the "Merger").
STEPS OF PROPOSED TRANSACTION
For the reasons discussed above, the Company proposes the following transaction:
1. As a preliminary step to the proposed Domestication of the Company, the
Company will consummate a one-for-fifteen Share Consolidation. Each
shareholder owning Common Stock will exchange 15 shares of Common Stock for
one share of New
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Common Stock. Additionally, the conversion ratio of the
Class A Series III Preferred Stock will change from 10 shares of Common
Stock for each share of Preferred Stock to 0.667 shares of Common Stock for
each share of Preferred Stock. In connection with the Share Consolidation,
the Company will amend its articles of incorporation to amend its
authorized shares as described above.
2. The Company will consummate the Domestication by filing Articles of
Domestication with the Secretary of State of Delaware. Pursuant to Alberta
law, Dissenters will receive cash in exchange for their stock in the
Company.
3. The Company will reincorporate TII from Illinois to Delaware (the "TII
Reincorporation").
4. Following the Domestication and the reincorporation of TII to Delaware, the
Company will merge with and into TII, with TII surviving.
SUMMARY OF REPRESENTATIONS MADE BY THE COMPANY
I. THE SHARE CONSOLIDATION
A. U.S. FEDERAL INCOME TAX REPRESENTATIONS
The following summarizes the representations that have been made by the Company
to E&Y US in connection with the Share Consolidation as stated in the "Statement
of Facts and Representations" dated May 7, 1999 attached hereto:
1. The fair market value of the New Common Stock or Class A Preferred Stock to
be received by each exchanging shareholder will be approximately equal to
the fair market value of the Common Stock or Class A Series III Preferred
Stock surrendered in exchange therefor.
2. The Company will pay its expenses incurred in connection with the Share
Consolidation and each shareholder will pay his or her expenses incurred in
connection with the Share Consolidation.
3. The Company has no plan or intention to redeem or otherwise acquire any of
the stock to be issued in the Share Consolidation.
4. Following the Share Consolidation, the Company will continue to conduct the
same business that it conducted prior to the Share Consolidation.
5. The Share Consolidation is a single, isolated transaction and is not part
of a plan to periodically increase the proportionate interest of any
shareholder in the assets or earnings and profits of the Company.
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6. The Company is not under the jurisdiction of a court in a Title 11 or
similar case within the meaning of I.R.C. Section 368(a)(3)(A).
B. CANADIAN FEDERAL INCOME TAX REPRESENTATIONS
The following summarizes the representations that have been made by the Company
to E&Y Canada in connection with the Share Consolidation as stated in the
"Statement of Facts and Representations" dated May 6, 1999 attached hereto:
1. The Old TomaHawk shares will be consolidated ("Consolidation") before the
Domestication at a ratio of between 1:10 and 1:15. All shares of Old
TomaHawk will be replaced by the reduced number of shares of the same class
of stock of Old TomaHawk in the same proportions for all shareholders. No
other consideration will be received by the shareholders on the
Consolidation. There will be no changes in the total capital represented by
the issue or in the interest, rights or privileges of the shareholders and
there will not be any concurrent changes in the capital structure of New
TomaHawk or the rights and privileges of other shareholders.
II. THE DOMESTICATION
A. U.S. FEDERAL INCOME TAX REPRESENTATIONS
The following summarizes the representations that have been made by the Company
to E&Y US in connection with the Domestication as stated in the "Statement of
Facts and Representations" dated May 7, 1999 attached hereto:
1. The fair market value of the New TomaHawk Common Stock or Class A Preferred
Stock received by each shareholder will be approximately equal to the fair
market value of the Old TomaHawk New Common Stock or Class A Preferred
Stock surrendered in exchange therefor.
2. Immediately following consummation of the transaction, the shareholders of
the Company will own all of the outstanding shares of New TomaHawk Common
Stock and Class A Preferred Stock and will own such stock solely by reason
of their ownership of Old TomaHawk stock immediately prior to the
transaction.
3. Immediately following consummation of the transaction, the Company will
possess the same assets and liabilities, except for dividends paid in the
normal course of business, assets used to pay dissenters to the
transaction, and assets used to pay expenses incurred in connection with
the transaction, as those possessed by the Company immediately prior to the
transaction.
4. New TomaHawk has no plan or intention to reacquire any of its stock issued
in the transaction.
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5. New TomaHawk has no plan or intention to sell or otherwise dispose of any
of the assets of Old TomaHawk acquired in the transaction, except for
dispositions made in the ordinary course of business.
6. The liabilities of Old TomaHawk assumed by New TomaHawk plus the
liabilities, if any, to which the transferred assets are subject were
incurred by Old TomaHawk in the ordinary course of its business and are
associated with the assets transferred.
7. Following the transaction, New TomaHawk will continue the historic business
of Old TomaHawk or use a significant portion of historic business assets of
Old TomaHawk in a business.
8. The shareholders will pay their respective expenses, if any, incurred in
connection with the transaction.
9. Prior to and in connection with the Domestication, neither Old TomaHawk nor
a related person (as defined in Treas. Reg. Section 1.368-1(e)(3)
determined without regard to Treas. Reg. Section 1.368-1(e)(3)(i)(A))
redeemed or otherwise acquired any Old TomaHawk stock, or made an
extraordinary distribution with respect to the stock of Old TomaHawk.
10. Neither New TomaHawk nor a related person (as defined in Treas. Reg.
Section 1. 368-1(e)(3)) has any plan or intention, in connection with the
Domestication, to redeem or otherwise acquire stock of New TomaHawk deemed
issued in the Domestication.
11. No two parties to the Domestication are investment companies as defined in
I.R.C. Section 368(a)(2)(F)(iii) and (iv).
B. CANADIAN FEDERAL INCOME TAX REPRESENTATIONS
The following summarizes the representations that have been made by the Company
to E&Y Canada in connection with the Domestication as stated in the "Statement
of Facts and Representations" dated May 6, 1999 attached hereto:
1. Old TomaHawk is a Canadian corporation incorporated in Canada and listed on
the Alberta Stock Exchange.
2. TomaHawk Imaging and Financial Inc. ("TIFI") has been amalgamated with and
into Old TomaHawk.
3. Old TomaHawk's assets consist of its investment in TII, other than an
immaterial cash balance.
4. All cash and non-cash transfers from Old TomaHawk directly to TII or
indirectly to TIFI, prior to TIFI's amalgamation into Old TomaHawk, and
from TIFI to TII are, and
9
have been, additional paid-in capital contributions, which directly or
indirectly increase Old TomaHawk's investment basis in TII.
5. As of March 28, 1999, Old TomaHawk's and TIFI's total additional paid in
capital to TII, since TII's inception, is approximately $9,064,000.
6. Since TII's inception, it has not paid any dividends to Old TomaHawk or
TIFI, nor has TII advanced any material cash and non-cash property to, nor
has TII received any advances of cash or non-cash property from Old
TomaHawk or TIFI.
7. Old TomaHawk's management and control is in the United States and will
continue to be in the United States after the Domestication.
8. TII is a U.S. Corporation, incorporated under the laws of Illinois.
9. Old TomaHawk will be continued or domesticated into Delaware by Articles of
Continuance.
10. Old TomaHawk's shareholders will continue to hold shares of Old TomaHawk
after the continuance unless they dissent until such shares are converted
to shares of New TomaHawk. Dissenting shareholders will be entitled to have
their shares purchased by Old TomaHawk prior to continuance.
11. The current fair market value of the stock of TII is estimated between
$8,000,000 and $10,000,000 as of February 28, 1999.
12. New TomaHawk and TII (the "Predecessor Corporations") will be resident
corporations in the Unites States prior to the proposed merger.
13. The merged corporations ("Amalco") will be resident in the United States
after the proposed merger.
14. Substantially all or all the assets and liabilities of the Predecessor
Corporations immediately before the merger becomes assets and liabilities
of Amalco by virtue of the merger.
15. Substantially all or all of the shares of the capital stock of the
Predecessor Corporations (except any shares or options owned by any
Predecessor Corporation) are exchanged for or become by virtue of the
merger (i) shares of the capital stock of Amalco, or (ii) if, immediately
after the merger, Amalco is controlled by another foreign corporation
resident in the U.S., shares of the capital stock of that foreign parent
corporation.
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DISCUSSION OF AUTHORITIES
I. U.S. FEDERAL INCOME TAX CONSEQUENCES
A. THE SHARE CONSOLIDATION
1. REQUIREMENTS OF I.R.C. Section 368(a)(1)(E)
Generally, a transaction that affects the capital structure of a single
corporation pursuant to a plan of reorganization is a recapitalization within
the meaning of I.R.C. Section 368(a)(1)(E). As illustrated in Treas. Reg.
Section 1.368-2(e), a recapitalization includes the issuance by a corporation
of preferred stock in satisfaction of outstanding bonds; or the issuance by a
corporation of common stock in exchange for all or part of the corporation's
outstanding preferred stock. Moreover, because a recapitalization involves
only a single corporation, neither the continuity of business enterprise nor
the continuity of shareholder interest requirements of Treas. Reg. Section
1.368 -1(b) and Treas. Reg. Section 1.368-1T apply(5).
2. SECTION 1032
Generally, a corporation will recognize no gain or loss upon the receipt of
money or other property in exchange for stock (including treasury stock) of
such corporation. I.R.C. Section 1032. Moreover, Treas. Reg. Section
1.1032-1(b) provides that I.R.C. Section 1032(a) applies to the acquisition
by a corporation of shares of its own stock where the corporation acquires
such shares in exchange for shares of its own stock.
3. SECTIONS 354 AND 351(G)
Generally, a shareholder will recognize no gain or loss upon an exchange of
stock or securities in a corporation for a different class of stock or
securities of the same corporation, if such exchange occurs in connection
with a recapitalization. I.R.C. Section 354(a)(1). An exception to this
general rule applies when a shareholder receives "nonqualified preferred
stock" (as defined in I.R.C. Section 351(g)(2)) in exchange for stock other
than nonqualified preferred stock. I.R.C. Section 354(a)(2)(C). In such case,
the nonqualified preferred stock is taxable to the recipient shareholder.
"Nonqualified preferred stock" is defined as stock that is limited and
preferred as to dividends and that does not participate in corporate growth
to any significant extent, and is either (i) puttable by the holder, (ii)
mandatorily redeemable by the issuer or a related person; (iii) callable by
the issuer or a related person, and, as of the issue date, it is more
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(5) Rev. Rul. 77-415, 1977-2 CB 311 (continuity of interest requirement not
applicable for qualification as a Type E reorganization); Rev. Rul. 82-34,
1982-1 CB 59 (continuity of business enterprise requirement not applicable
for qualification as a Type E reorganization).
11
likely than not that such right will be exercised; or (iv) has a dividend
rate that varies in whole or in part (directly or indirectly) by reference to
interest rates, commodity prices, or other similar indices. I.R.C. Sections
351(g)(3)(A) and 351(g)(2)(A). Generally, stock that is subject to a call or
put right or obligation is nonqualified preferred only if the right or
obligation may be exercised within the 20 year period beginning on the issue
date of such stock and such right or obligation is not subject to a
contingency which, as of the issue date, makes remote the likelihood of the
redemption or purchase. I.R.C. Section 351(g)(2)(B).
4. SECTION 305
Section 305(a) provides generally that gross income does not include the
amount of any distribution of the stock of a corporation made by such
corporation to its shareholders with respect to its stock. I.R.C. Sections
305(b) and (c) provide exceptions to the general rule of I.R.C. Section
305(a). In particular, I.R.C. Section 305(c) provides that certain
transactions, including a recapitalization, will be treated as a taxable
distribution with respect to any shareholder whose proportionate interest in
the earnings and profits or the assets of the corporation is increased by
such transaction. Treas. Reg. Section 1.305-7(c) provides that a
recapitalization (whether or not an isolated transaction) will be deemed to
result in a distribution to which I.R.C. Section 305(c) applies if (i) it is
pursuant to a plan to periodically increase a shareholder's proportionate
interest in the assets or the earnings and profits of the corporation, or
(ii) a shareholder owning preferred stock with dividends in arrears exchanges
his stock for other stock and, as a result, increases his proportionate
interest in the assets or the earnings and profits of the corporation. An
increase in a preferred shareholder's proportionate interest occurs in any
case where the fair market value or the liquidation preference, whichever is
greater, of the stock received in the exchange (determined immediately
following the recapitalization), exceeds the issue price of the preferred
stock surrendered.
In addition, it is possible that a transaction structured as a
recapitalization exchange may be recharacterized as a distribution subject to
I.R.C. Section 305. SEE BAZLEY V. COMMISSIONER, 331 U.S. 737 (1947), 1947-2
C.B. 79 (holding that an exchange of old stock for new stock and debentures
lacked a bona fide business purpose, and, instead, constituted a distribution
of debentures taxable as a dividend).(6) However, where a transaction that
effects a reshuffling of a corporation's capital structure has a bona fide
business purpose, is an isolated transaction and is not pursuant to a plan to
increase periodically the proportionate interest of any shareholder in the
earnings and profits of the corporation, it will be respected as a
recapitalization exchange. SEE Rev. Rul. 86-25, 1986-1 C.B. 202
(distinguishing BAZLEY and concluding that an exchange of outstanding common
stock for either (i) shares of new voting common and new nonvoting common, or
(ii) shares of new voting common and new nonvoting preferred constitutes a
Type E recapitalization, if the exchange is pursuant to a bona fide business
purpose, is an isolated transaction, and is not pursuant to a plan to
increase periodically the proportionate interest of any shareholder).
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(6) The taxpayer had argued that the share exchange constituted a Type E
recapitalization, and that the receipt of the debentures was a tax-free
receipt of securities in connection with the recapitalization. The court
disregarded the share exchange, reasoning that it had no economic substance.
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5. SECTION 306
I.R.C. Section 306 generally provides that if a shareholder disposes of
"section 306 stock," the amount realized on such disposition shall be
ordinary income. I.R.C. Section 306(c)(1)(B) defines "section 306 stock" as
stock (other than common stock) which:
(i) was received, by the shareholder selling or otherwise disposing of such
stock, in pursuance of a plan of reorganization (within the meaning of
I.R.C. Section 368(a)), or in a distribution or exchange to which I.R.C.
Section 355 (or so much of I.R.C. Section 356 as relates to I.R.C.
Section 355) applied, and
(ii) with respect to the receipt of which gain or loss to the shareholder was to
any extent not recognized by reason of part III, but only to the extent
that either the effect of the transaction was substantially the same as the
receipt of a stock dividend, or the stock was received in exchange for
"section 306 stock."
Treas. Reg. Section 1.306-3(d) provides that for purposes of I.R.C. Section
306(c)(1)(B), stock will be "section 306 stock" if cash received in lieu of
such stock would have been treated as a dividend under I.R.C Section
356(a)(2) or would have been treated as a distribution to which I.R.C.
Section 301 applies by virtue of I.R.C. Section 356(b) or I.R.C. Section
302(d).(7)
As described above, the shareholders of the Company will exchange 15 shares
of outstanding Common Stock for 1 share of New Common Stock, and one share of
Class A Series III Preferred Stock for one share of Class A Preferred Stock
in accordance with the corporate business purposes described above. The terms
of the New Common Stock and the Class A Preferred Stock will not be
substantially different from the terms of the Common Stock and the Class A
Series III Preferred Stock exchanged, respectively. As described above, the
Class A Preferred Stock will not be subject to a call or put right or
obligation. In addition, the Class A Series III Preferred Stock does not have
any dividends in arrears. Therefore, the Class A Series III Preferred Stock
and the Class A Preferred Stock should not be considered "nonqualified
preferred stock" under I.R.C. Section 351(g). Alternatively, if the Class A
Series III Preferred Stock and the Class A Preferred Stock are considered
"nonqualified preferred stock" under I.R.C. Section 351(g), the exchange of
"nonqualified preferred stock" for "nonqualified preferred stock" will be
tax-free under I.R.C. Section 354(a)(2)(C)(i). As a result, the exchange will
constitute a recapitalization within the meaning of I.R.C. Section
368(a)(1)(E), and will be tax-free to the Company and the exchanging
shareholders under I.R.C. Section 1032 and I.R.C. Section 354(a)(1),
respectively.
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(7) Treas. Reg. Section 1.306-3(d) EXAMPLE (2) illustrates the application of
Section 306 to a recapitalization transaction. Shareholders X and Y each own
one-half of the outstanding common and preferred stock of Corporation C.
Pursuant to a recapitalization transaction, each shareholder exchanges his
preferred stock for preferred stock of a new issue which is not substantially
different from the preferred stock previously held. The example concludes
that unless the preferred stock exchanged was itself Section 306 stock, the
preferred stock received is not Section 306 stock.
13
B. THE DOMESTICATION
1. REQUIREMENTS OF I.R.C. Section 368(a)(1)(F)
A transaction that constitutes a mere change in identity, form, or place of
organization of one corporation, however effected, generally constitutes a
reorganization within the meaning of I.R.C. Section 368(a)(1)(F).(8) For a
transaction to qualify as a Type F reorganization, there can be no change in
the existing shareholders or assets of the corporation.(9) In addition, the
transaction must satisfy the continuity of business enterprise requirement
and be accomplished pursuant to a plan of reorganization. When a transaction
qualifies as a Type F reorganization, the part of the taxable year before the
reorganization and the part of the taxable year following the reorganization
constitute a single taxable year of the corporation, notwithstanding that the
reorganization may qualify under another provision of I.R.C. Section
368(a)(1).(10)
The Internal Revenue Service (the Service) has determined that the
domestication of a foreign corporation can constitute a Type F
reorganization. In Rev. Rul. 88-25, 1988-1 C.B. 116, corporation X was
incorporated in Country Y. For valid business reasons, the shareholders of X
decided that it would be advantageous for X to become a State A corporation.
Accordingly, pursuant to State A corporate law, X filed a certificate of
domestication and a certificate of incorporation in State A. Upon filing the
certificate of domestication and the certificate of incorporation, X was
considered by State A to be incorporated in State A and became subject to
State A law. The ruling states that for federal income tax purposes, the
conversion of X from a Country Y to a State A corporation under the State A
domestication statute is treated as a transfer by X of all of its assets and
liabilities to a new domestic corporation, DX in exchange for DX stock; and a
liquidating distribution by X to its shareholders of the DX stock received in
exchange for X's assets and liabilities. Because there was no alteration in
shareholder or asset
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(8) The requirement that only one corporation may undergo a Type F
reorganization was added to the Code in 1982. However, notwithstanding its
literal parameters, more than one corporate entity can be involved in a Type
F reorganization provided that only one of the corporations is an operating
company. SEE H.R. Rep. No. 760, 97th Cong., 2d Sess. 541 (1982), 1982-2 CB
600, 634-635.
(9) HELVERING V. SOUTHWEST CONSOLIDATED CORPORATION, 315 U.S. 194 (1942) (a
"transaction which shifts the ownership of the proprietary interest in a
corporation is hardly `a mere change in identity, form, or place of
organization . . .'"); Rev. Rul. 57-276, 1957-1 CB 126; Rev. Rul. 58-422,
1958-2 CB 145; Rev. Rul. 66-284, 1966-2 CB 115 (receipt of cash by dissenting
shareholders does not disqualify transaction as a Type F reorganization where
dissenting shareholders own less than 1 percent of the outstanding stock of
the corporation. This is considered a DE MINIMIS change in the corporation's
shareholders.); Rev. Rul. 96-29, 1996-1 CB 50 (redemption of shareholders and
a public offering both occurred pursuant to the same plan as a change in the
state of incorporation; although the IRS did not expressly rule that complete
identity of shareholders was no longer a requirement, complete identity of
shareholders was lacking, and the redemption, if treated as part of the Type
F reorganization, would not have been of such a significant amount that
continuity of interest would have been lacking).
(10) Rev. Rul. 57-276; Section 381(b).
14
continuity, or business enterprise, the effect of the conversion was a mere
change in the place of organization of X within the meaning of I.R.C. Section
368(a)(1)(F).(11)
In connection with the Domestication, shareholders of Old TomaHawk who
dissent to the transaction will be entitled to receive cash in exchange for
their Old TomaHawk stock. In the event that there are dissenters, their
redemption will not prevent the identity of shareholder and asset
requirements of a Type F reorganization from being satisfied. Courts have
characterized transactions as Type F reorganizations, even when accompanied
by a redemption, reasoning that the redemption was functionally unrelated to
the reorganization.(12)
2. REQUIREMENTS OF I.R.C. Section 367(b)
The Service has held that a domestication of a foreign corporation pursuant
to a domestication state statute will qualify as an I.R.C. Section
368(a)(1)(F) reorganization. Rev. Rul. 87-27, 1987-1 CB 134; Rev. Rul. 88-25,
1988-1 CB 116.
Generally in a reorganization under I.R.C. Section 368(a)(1)(F), I.R.C.
Section 354 provides the shareholders of the transferor corporation with
tax-free treatment. However, I.R.C. Section 367(b) overrides this tax-free
treatment in certain cases when a U.S. shareholder exchanges shares of a
foreign corporation in an exchange described in I.R.C. Section 354 and
pursuant to an I.R.C. Section 368(a)(1)(F) reorganization. Treas. Regs.
Section 1.367(b)-7(a)(1)(i) & (ii).
For purposes of I.R.C. Section 367(b), an I.R.C. Section 368(a)(1)(F)
reorganization is treated as:
(1) a transfer of assets by the foreign transferor corporation to the acquiring
corporation in exchange for stock of the acquiring corporation and the
assumption by the acquiring corporation of the transferor's liabilities,
followed by
(2) a distribution of the stock of the acquiring corporation by the transferor
corporation to the shareholders of the transferor corporation, and
concluding with
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(11) SEE ALSO Rev. Rul. 87-27, 1987-1 CB 134 (reincorporation of U.S.
corporation as a U.K. corporation constitutes a Type F reorganization); Rev.
Rul. 87-66, 1987-2 CB 168 (reincorporation of foreign corporation as U.S.
corporation constituted both a Type D and a Type F reorganization).
(12) SEE REEF CORPORATION V. COMMISSIONER, 368 F.2d 125 (5th Cir. 1966),
CERT. DENIED, 386 U.S. 1018 (1967) (holding that a transaction qualified as a
Type F reorganization even though the stock of a 48% shareholder group was
redeemed as part of the transaction. The court reasoned that the redemption
was functionally unrelated to the reorganization transaction and, as a
result, there was an identity of shareholders in the reorganized
corporation.); AETNA CASUALTY AND SURETY CO. V. UNITED STATES, 568 F.2d 811
(2d Cir. 1976) (holding that a transaction involving a squeeze out of a 38.9%
minority interest in a triangular merger resulted in a Type F reorganization.
The court viewed the transaction as two separate steps: a Type F
reorganization and a redemption). SEE ALSO CASCO PRODUCTS CORP. V.
COMMISSIONER, 49 T.C. 32 (1967) (involving the merger of a corporation with a
newco, incorporated in the same state and a squeeze out of a 9% minority
interest. Allowing a net operating loss carryback, the court specifically
refused to determine whether the transaction qualified as a Type F
reorganization, and instead held that the transaction was simply a redemption
of the 9% minority interest).
15
(3) an exchange by the transferor corporation's shareholders of the stock of
the transferor corporation for stock of the acquiring corporation under
I.R.C. Section 354. Treas. Reg. Section 1.367(b)-1(f).
It is irrelevant that the applicable domestic or foreign law treats the
acquiring corporation as a continuance of the transferor corporation. Thus,
an I.R.C. Section 368(a)(1)(F) reorganization will be considered a transfer
subject to I.R.C. Section 367(b).
I.R.C. Section 367(b) recharacterizes an I.R.C. Section 368(a)(1)(F)
reorganization as a taxable transaction for certain U.S. shareholders of
foreign corporations in otherwise tax-free transfers between domestic and
foreign corporations. Under Temp. Reg. Section 7.367(b)-7(c)(2)(i), an
exchanging U.S. shareholder must include in gross income the "all earnings
and profits amount" of the acquired foreign corporation if: (1) the assets of
the acquired foreign corporation are acquired by a domestic corporation
pursuant to a reorganization described in I.R.C. Section 368(a)(1)(F); (2)
the exchanging U.S. shareholder is a domestic corporation; and (3) such
domestic corporation receives stock of a domestic corporation in exchange for
its stock in the acquired foreign corporation.. If the shareholder fails to
include this amount in income, the shareholder must recognize gain on the
transaction. Temp. Reg. Section 7.367(b)-7(c)(2)(ii). The "all earnings and
profits amount" is the net positive earnings and profits for all taxable
years which are attributable to periods in which the U.S. shareholder held
such stock under the principles of I.R.C. Section 1248. Treas. Reg. Section
1.367(b)-2(f).
Temp. Reg. Section 7.367(b)-7(c)(1) provides that if an exchanging U.S.
Shareholder, other than a domestic corporation, receives stock of a domestic
corporation, the exchanging U.S. Shareholder must include in gross income the
"Section 1248 amount" attributable to the stock exchanged, to the extent that
the fair market value of the stock exchanged exceeds its adjusted basis. For
this purpose, a U.S. Shareholder is any U.S. person who owns at least 10
percent, directly or indirectly, of the vote of a controlled foreign
corporation at any time during the 5 year period ending on the date of the
sale or exchange. (In this opinion, we refer to those U.S. shareholders that
meet the 10 percent ownership definition by capitalizing the word
"shareholders," viz. "U.S. Shareholders.") A controlled foreign corporation
is any foreign corporation, if more than 50 percent of its total combined
voting power of all classes of stock of such corporation entitled to vote, or
the total value of the stock of such corporation, are owned by U.S.
shareholders on any day during the taxable year. I.R.C Section 957(a). Only
U.S. shareholders owning 10 percent or more of the combined voting power of
such corporation are counted for this determination. I.R.C Section 951(b).
The "Section 1248 amount" is the foreign corporation's net positive earnings
and profits accumulated after December 31, 1962 which are attributable to the
period during which the U.S. Shareholder held such stock and while such
corporation was a controlled foreign corporation. Treas. Reg. Section
1.367(b)-2(d).
16
Therefore, Temp. Reg. Section 7.367(b)-7(c) will only apply if the acquired
foreign corporation was a controlled foreign corporation at any time during
the five year period ending on the date of exchange.
If Proposed Regulation Section 1.367(b)-3(b) is finalized at least 30 days
before the reorganization, the treatment in the preceding paragraph may be
revised to require U.S. Shareholders to include the "all earnings and profits
amount" (as defined above) of the foreign corporation as a deemed dividend.
This may be required even though the foreign corporation was not a controlled
foreign corporation at any time. As an alternative, the U.S. Shareholder may
elect to recognize gain realized on the exchange of its acquired foreign
corporation stock as if it sold the stock for fair market value. Prop. Reg.
Section 1.367-3(b)(2)(iii). Lastly, the Proposed Regulations, once finalized
and effective, would require a U.S person owning less than 10 percent of
acquired foreign corporation to recognize gain realized on the exchange.
Prop. Reg. Section 1.367(b)-3(c).
In any case, because I.R.C. Section 367(b) applies to the reorganization, all
U.S. shareholders who realize gain or other income from the exchange, whether
or not recognized for U.S. tax purposes, must comply with notice requirements
under Treas. Reg. Section 1.367(b)-1(c). Failure to comply with the notice
requirements can result in the Service imposing a gain on an otherwise
non-taxable transaction.
Generally, if a foreign corporation is the transferor corporation in an
I.R.C. Section 368(a)(1)(F) reorganization in which the acquiring corporation
is a domestic corporation, then the taxable year of the transferor
corporation ends with the close of the date of the transfer, and the taxable
year of the acquiring corporation ends with the close of the date on which
the transferor's taxable year would have ended but for the I.R.C. Section
368(a)(1)(F) reorganization. Treas. Reg. Section 7.367(b)-1(e).
3. DISSENTERS
According to the Registration Statement, a registered shareholder is entitled
under Alberta law, in addition to any other right he may have, to dissent (a
"Dissenting Shareholder") and to be paid by the Company the fair value of the
shares of Common Stock hold by him in respect of which he dissents,
determined as of the close of business on the last business day before the
day on which the resolution from which he dissents was adopted.
A "redemption" occurs when a corporation acquires its stock from a
shareholder in exchange for property, whether or not the stock so acquired is
canceled, retired, or held as treasury stock. I.R.C. Section 317(b). For this
purpose, "property" means money, securities, and any other property, except
stock in the corporation making the distribution. I.R.C. Section 317(a).
17
If a corporation redeems its stock, such redemption may be treated either as
a sale or exchange in part or full payment in exchange for the stock, or as a
distribution under I.R.C. Section 301. I.R.C. Sections 302(a) & (d).
When a redemption is accorded sale or exchange treatment, the shareholder
recognizes gain or loss on the transaction equal to the fair market value of
the property received in the redemption less the shareholder's tax basis in
the stock redeemed. I.R.C. Section 1001.
If the redemption fails to qualify for sale or exchange treatment under
I.R.C. Section 302, the distribution will be treated as an I.R.C. Section 301
distribution. I.R.C. Section 302(d). An I.R.C. Section 301 distribution will
be treated as follows:
1. a dividend to the extent of the Company's current and accumulated earnings
and profits;
2. a return of basis to the extent the distribution exceeds the Company's
current and accumulated earnings and profits;
3. capital gain to the extent the distribution exceeds the Company's current
and accumulated earnings and profits and the shareholder's basis in his
Company stock. I.R.C. Sections 301(c) & 316(a).
Consistent with Rev. Rul. 88-25, the Domestication of the Company as a
Delaware corporation will constitute a reorganization within the meaning of
I.R.C. Section 368(a)(1)(F). According to the Documents, New TomaHawk will
continue to hold and use Old TomaHawk's historic assets. In addition, except
for dissenters, there should be an identity of shareholders from Old TomaHawk
to New TomaHawk. The fact that the Share Consolidation will occur as a
preliminary step to the Domestication will not prevent the Domestication from
qualifying under Section 368(a)(1)(F).
C. STEP TRANSACTION DOCTRINE
The step transaction doctrine is a judicially created concept with pervasive
applicability in the tax law. Generally, the step transaction doctrine
permits a series of formally separate steps to be combined and treated as a
single transaction if the facts and circumstances indicate that the steps are
"integrated, interdependent, and focused toward a particular result." SEE
GENERALLY PENROD V. COMMISSIONER, 88 T.C. 1415 (1987).
For most purposes of the Code, a reorganization of a corporation under I.R.C.
Section 368(a)(1)(F) is treated as if there had been no change in the
corporation and, thus, as if the reorganized corporation is the same entity
as the corporation that was in existence prior to the reorganization.
Consistent with this, the Service has taken the position in several revenue
rulings that for purposes of determining whether a transaction qualifies as
18
a Type F reorganization, it is analyzed and treated as a separate
transaction, even if it is part of a larger transaction.(13)
For example, in Rev. Rul. 69-516, 1969-2 C.B. 56, the Service treated as two
separate transactions, a reorganization under I.R.C. Section 368(a)(1)(F) and
a reorganization under I.R.C. Section 368(a)(1)(C) undertaken as part of the
same plan. In that ruling, a corporation changed its place of organization by
merging into a corporation formed under the laws of another state and,
immediately thereafter, it transferred substantially all of its assets in
exchange for stock of an unrelated corporation. The ruling holds that the
change in place of organization qualified as a reorganization under I.R.C.
Section 368(a)(1)(F).
The Service took a similar approach in Rev. Rul. 96-29, SUPRA, in analyzing
two situations. In Situation 1, the Service determined that the
reincorporation of a corporation in another state qualified as a Type F
reorganization, even though it was a step in a transaction in which the
corporation issued common stock in a public offering and then redeemed stock
having a value of 40 percent of the aggregate value of its outstanding stock
prior to the offering. In Situation 2, a corporation acquired the assets of
another corporation by way of merger. The acquiring corporation then
reincorporated in another state. The Service concluded that the
reincorporation qualified as a Type F reorganization, even though it was a
step in a larger acquisitive transaction.(14)
As illustrated above, the Service has taken the position that if a Type F
reorganization is part of a larger transaction, it will be analyzed
separately from the other steps to determine whether it meets the statutory
requirements. Accordingly, the fact that the Company will merge with and into
TII following the Domestication transaction will not preclude the
Domestication transaction from qualifying as a Type F reorganization. The
Merger transaction will be analyzed as a separate and independent step from
the Domestication.
II. CANADIAN FEDERAL INCOME TAX CONSEQUENCES
All Statutory references to the Canadian Federal INCOME TAX ACT ("Tax Act").
A. SHARE CONSOLIDATION
Where, in the course of a reorganization of the capital of a corporation, a
shareholder disposes of capital property that was all the shares of any
particular class of the capital stock of the corporation ("Old Shares") owned
by the shareholder at the time of disposition, and the consideration received
from the corporation consists solely of one other class of shares of the
capital stock of the corporation ("New Shares"), the tax consequences to the
shareholder are as follows:
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(13) SEE ALSO REEF CORPORATION V. COMMISSIONER, AETNA CASUALTY AND SURETY
COMPANY V. COMMISSIONER, and CASCO PRODUCTS CORPORATION V. COMMISSIONER,
SUPRA.
(14) SEE ALSO Rev. Rul. 79-250, 1979-2 CB 156 (modified by Rev. Rul. 96-29).
19
1. The adjusted cost base to the shareholder of the New Shares is deemed to be
equal to the adjusted cost base of the Old Shares;
2. The shareholder is deemed to dispose of the Old Shares for proceeds of
disposition equal to the adjusted cost base to the shareholder of the of New
Shares; and
3. The paid up capital of the New Shares will equal the paid up capital of the
Old Shares.
Therefore, there should be no immediate tax consequences as a result of the
share exchange (section 86).
B. THE DOMESTICATION
1. RESIDENTS OF CANADA
This discussion generally addresses certain Canadian federal income tax
consequences of a continuance ("Continuance") of a Canadian resident
corporation into the United States for shareholders resident in Canada, who
hold shares of a company as "capital property," and who deal at arm's length
with the company all within the meaning of section 251 of the Tax Act.
Generally, shares will be considered "capital property" unless the holder is
a trader or dealer in securities (subsections 39(4) and (5) of the Tax Act),
has acquired the shares as an adventure in the nature of trade (definition of
"business" in subsection 248(1) of the Tax Act), or holds the shares
otherwise than for investment purposes.
A. NON-DISSENTING SHAREHOLDERS
There is no specific provision in the Tax Act which deems a shareholder of a
Canadian corporation to have disposed of his/her shares as a result of the
Canadian corporation being granted Articles of Continuance under the laws of
a foreign jurisdiction. Generally, a continuance will not result in adverse
consequences to the shareholders.(15) On a Continuance, the shares will
constitute "foreign property" for purposes of deferred income plans such as
registered retirement savings plans (definition of "foreign property" in
subsection 206(1) of the Tax Act and definition of "Canadian corporation" in
subsection 89(1) of the Tax Act). A deferred income plan may not hold more
than 20% of its investments (based on original cost provided this is the
method followed by the plan) in foreign property without incurring tax
penalties (sections 205 to 207 of the Tax Act).
Shareholders resident in Canada who receive dividends after a Continuance
will be subject to U.S. withholding tax. Pursuant to Article X 2(b) of the
Canada -United States Tax Convention, 1980 (the "Treaty") the applicable
withholding tax rate would be 15% of the amount of the dividend for dividends
paid to individuals or corporate shareholders owning less than 10% of the
company's outstanding voting shares. For corporate
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(15) Income Tax Rulings TR-1, June 24, 1974 and TR-49, March 7, 1977 provide
support for the proposition that a continuance from one jurisdiction to
another does not result in a disposition of the shares of the continuing
corporation by its shareholders.
20
shareholders owning more than 10% of the company's outstanding voting shares,
the dividend withholding rate under Article X 2(a) of the Treaty is 5%. A
Canadian shareholder must include in income for Canadian tax purposes 100% of
the Canadian dollar equivalent of the amount of the dividend (paragraph
12(1)(k) and section 90 of the Tax Act). Such dividend would not be eligible
for the dividend tax credit (section 121 of the Tax Act). Depending on the
shareholder's particular circumstances, such withholding tax may or may not
qualify for a credit against Canadian federal income tax or a deduction
against taxable income (section 126 and subsections 20(11) and 20(12)of the
Tax Act).
Subsection 95(1) defines the term "foreign affiliate" of a taxpayer resident
in Canada for the purposes of the rules in the Tax Act which deals with the
taxation of shareholders of non-resident corporations. A corporation not
resident in Canada will be considered to be a foreign affiliate of a
shareholder where the shareholder has an equity percentage in that
corporation that is not less than 1% and the total of the equity percentages
of the taxpayer and persons related to the taxpayer in that corporation is
not less than 10%. For purposes of the10% equity test, the equity percentages
are to be determined without reference to the equity percentages of any
person related to the shareholder.
A corporation resident in Canada, owning shares of a non-resident corporation
that is a foreign affiliate is entitled to certain rollover privileges on a
merger, reorganization or dissolution of the affiliate and to certain
deductions in respect of dividends received from it. The deduction for
dividends is provided in section 113 and the regulations thereunder and is
dependent on the source from which the dividends are paid. A corporation may
also elect under section 93 of the Tax Act following the disposition of
shares of a foreign affiliate, to treat a portion of the proceeds as a
dividend and not proceeds of disposition in certain circumstances.
b. DISSENTING SHAREHOLDERS
In circumstances where dissenting shareholders are entitled to require a
company to purchase for cash ("Cash Proceeds") all of their shares at fair
market value if such company proceeds with a Continuance, the following
generally describes certain Canadian federal income tax consequences thereof.
The shareholders will be deemed to have received a dividend equal to the
excess, if any, of the Cash Proceeds over the paid up capital of their shares
(subsection 84(3) of the Tax Act). An individual shareholder must include in
income 125% of the actual amount of the dividend (paragraph 12(1)(k) and
subsection 82(1) of the Tax Act) and is entitled to claim a dividend tax
credit equal to 13.33% of the grossed up amount in calculating his/her
Canadian federal income tax liability (section 121 of the Tax Act). A
shareholder that is a private corporation resident in Canada and which owns
not more than 10% of the shares of a corporation, which shares represent not
more than 10% of the voting shares and not more than 10% of the fair market
value of all shares will be subject to a refundable tax of 33-1/2% under Part
IV of the Tax Act. The Part IV tax is refundable to the corporation at the
rate of $1 for every $3 of dividends paid.
21
Any other corporation will not be subject to tax on the dividend unless the
dividend is re-characterized as proceeds of disposition. Specifically the Tax
Act contains an anti-avoidance provision which would treat the dividend as
proceeds of disposition for purposes of calculating any capital gain, where
one of the results of the dividend was to effect a significant reduction in
the capital gain that would have been realized had the shares been disposed
of at fair market value (subsection 55(2) of the Tax Act).
In addition to the dividend, all shareholders will be considered to have
disposed of their shares for an amount ("Proceeds") equal to the paid-up
capital of his/her shares (definition of "disposition" and definition of
"proceeds of disposition" in section 54 of the Tax Act). To the extent that
the Proceeds exceed the shareholder's adjusted cost base of his/her shares, a
capital gain will arise (sections 39 and 40 of the Tax Act), three-quarters
of which (paragraph 38(a) of the Tax Act) will be included in income for
Canadian federal income tax purposes in the year of the dissent. To the
extent that the Proceeds are less than a shareholder's adjusted cost base of
his/her shares, a capital loss will arise (sections 39 and 40 of the Tax
Act), three-quarters of which can be used to reduce current year capital
gains to nil (paragraph 3(b) of the Tax Act). If the capital loss exceeds
current year capital gains, any excess can be carried back three years or
forward indefinitely to offset capital gains in those periods (paragraph
111(1)(b) of the Tax Act). If the adjusted cost base of the shareholder's
shares is equal to the paid up capital of his/her shares, no capital gain or
loss will arise.
2. SHAREHOLDERS NOT RESIDENT IN CANADA
The following summary is generally applicable on a Continuance to
shareholders who are not resident in Canada, who do not use or hold or are
not deemed to use or hold their shares in carrying on a business in Canada,
including a life insurance business, who deal at arm's length with the
Company and who hold their shares as "capital property" (as defined above).
a. NON-DISSENTING SHAREHOLDERS
A non-dissenting non-resident shareholder will continue to hold his/her
shares upon a Continuance. Since a Continuance is not considered to be a
disposition of shares (as discussed above), no capital gain or loss should
arise as a result of a Continuance. Following a Continuance, a shareholder
will continue to have an adjusted cost base of his/her shares equal to the
adjusted cost base immediately prior to a Continuance. Dividends received by
a shareholder after a Continuance will not be subject to tax in Canada.
b. DISSENTING SHAREHOLDERS
In circumstances where a dissenting shareholder is entitled to require a
company to purchase all of his/her shares at fair market value if the company
proceeds with a Continuance, the following generally describes certain
Canadian income tax consequences thereof. The shareholder, individual or
corporation, will generally be
22
considered to have received a dividend equal to the excess of the Cash
Proceeds (defined above) over the paid up capital of his/her shares
(subsection 84(3) of the Tax Act). The dividend will be subject to Canadian
withholding tax of 25% of the amount of the dividend (subsection 212(1) of
the Tax Act) or such lower rate as provided under the terms of an applicable
double taxation treaty. Pursuant to Article X:2(b) of the Treaty, the
withholding tax rate is 15% of the amount of the dividend for dividends paid
to individuals or corporate shareholders owning less than 10% of the
company's outstanding voting shares. For corporate shareholders owning more
than 10% of the company's outstanding voting shares, the dividend withholding
rate under Article X:2(a) of the Treaty is 5% of the amount of the dividend.
Shareholders also will be considered to have disposed of their shares for
proceeds equal to the paid-up capital of the shares (definition of
"disposition" and "proceeds of disposition" in section 54 of the Tax Act).
Such shareholders will be subject to Canadian taxation in respect of capital
gains on shares only if such shares constitute "taxable Canadian property" to
them. The shares generally will not constitute "taxable Canadian property" of
a shareholder unless at any time within the five years preceding the
disposition of the shares, the shareholder, together with persons not dealing
at arm's length with the shareholder, or any combination thereof, owned
and/or had options to acquire: (a) 25% or more of the issued shares of any
class of series of capital stock of the company, (b) the shareholder, upon
ceasing to be a resident of Canada, elected under the Tax Act to have the
shares treated as "taxable Canadian property", or (c) the shares were
acquired in circumstances in which they were deemed to be taxable Canadian
property (definition of "taxable Canadian property" in subsection 115(1) of
the Tax Act).
3. CANADIAN FEDERAL INCOME TAX CONSEQUENCES TO THE COMPANY
A company will be deemed to have a year end immediately prior to a
Continuance and will be deemed to have disposed of each of its assets for
proceeds equal to fair market value and to have immediately reacquired such
assets at a cost equal to fair market value (subsections 250(5.1) and
128.1(4) of the Tax Act and Article IV:3 of the Treaty). The deemed
disposition may give rise to income or loss, or capital gains or capital
losses to the extent that the fair market value of the assets differs from
their cost or adjusted cost base. Such income or loss, capital gain or
capital loss will be included in computing such company's taxable income for
the fiscal period ending immediately prior to a Continuance. To the extent
that such amounts exceed available deductions, such amounts will be subject
to Canadian federal income tax at an effective rate of 39%.
In addition, a 25% Exit Tax will apply to the amount by which the aggregate
fair market value of a company's assets immediately prior to a Continuance
exceeds the aggregate of its liabilities (including liability for Canadian
federal income tax for the final taxation year) and its paid-up capital of
all of its issued and outstanding shares excluding the paid-up capital in
respect of all dissenting shareholders whose shares have been redeemed. The
general rate of tax of 25% will be reduced to 5% pursuant to section 219.3 of
the Tax Act and Article X:2 of the Treaty. The Exit Tax is payable by such
company.
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Upon a Continuance a company is deemed for Canadian federal income tax
purposes to have been incorporated in the jurisdiction it is continued into
and not to have been incorporated elsewhere (Article IX:3 of the Treaty) and
should generally only be subject to tax in Canada in respect of business
income attributable to a permanent establishment in Canada, gains realized on
disposition of taxable Canadian property and withholding tax in respect of
Canadian source passive income such as dividends and interest (subsection
2(3) and Part XIII of the Tax Act).
OPINIONS
I. THE SHARE CONSOLIDATION
A. U.S. FEDERAL INCOME TAX CONSEQUENCES
Based on the Documents, the applicable law, and any caveats or qualifications
as stated herein, for U.S. federal income tax purposes:
1. The Share Consolidation, as described above, will constitute a
recapitalization and, therefore, a reorganization within the meaning of
I.R.C. Section 368(a)(1)(E). The Company will be `a party to a
reorganization' within the meaning of I.R.C. Section 368(b).
2. No gain or loss will be recognized by the Company on the receipt of the
Common Stock and Class A Series III Preferred Stock solely in exchange for
the New Common Stock and Class A Preferred Stock as described above. I.R.C.
Section 1032(a).
3. No gain or loss will be recognized to the exchanging shareholders upon the
exchange of their Common Stock for New Common Stock or Class A Series III
Preferred Stock for Class A Preferred Stock, as described above. I.R.C.
Section 354(a)(1).
4. The basis of the New Common Stock or Class A Preferred Stock received by
the exchanging shareholders will be equal to the basis of the shares
surrendered in exchange therefor. I.R.C. Section 358(a)(1). Such basis must
be allocated pro rata among the shares of New Common Stock or Class A
Preferred Stock received in the Share Consolidation.
5. The holding period of the New Common Stock or Class A Preferred Stock
received by the exchanging shareholders will include the period during
which the Common Stock or Class A Series III Preferred Stock surrendered in
exchange therefor was held, provided that the Common Stock or Class A
Series III Preferred Stock is held as a capital asset on the date of the
exchange. I.R.C. Section 1223(1). Such holding period must be allocated pro
rata among each share of New Common Stock or Class A Preferred Stock
received in the Share Consolidation.
B. CANADIAN FEDERAL INCOME TAX CONSEQUENCES
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Based on the Documents, the facts summarized above, and the applicable law,
as well as any caveats or qualifications as stated herein, for Canadian
federal income tax purposes:
1. The Share Consolidation will result in a disposition of the Common Stock
for proceeds equal to their adjusted cost base for Canadian federal income
tax purposes, consequently no capital gain or loss will arise as a result
of the Share Consolidation.
2. The adjusted cost base and paid-up capital of the New Common Stock received
by the shareholder on the Share Consolidation will be the adjusted cost
base and paid-up capital of the pre-consolidated Common Stock divided by
the new number of new Common Stock held by a shareholder.
II. THE DOMESTICATION
A. U.S. FEDERAL INCOME TAX CONSEQUENCES
Based on the Documents, the facts summarized above, and the applicable law, as
well as any caveats or qualifications as stated herein, for U.S. Federal income
tax purposes:
1. The Domestication, as described above, will be treated for U.S. federal
income tax purposes as a transfer by the Alberta Company of all of its
assets and liabilities to the Delaware Company in exchange for stock of the
Delaware Company, followed by a liquidating distribution by the Alberta
Company to its shareholders of the Delaware Company stock received in
exchange for the Alberta Company's assets and liabilities. Rev. Rul. 88-25,
1988-1 C.B. 116.
2. The Domestication, as described in (1) above, will constitute a
reorganization under I.R.C. Section 368(a)(1)(F). The Company will be `a
party to a reorganization' within the meaning of I.R.C. Section 368(b).
3. No gain or loss will be recognized by the Alberta Company on the deemed
transfer of its assets to the Delaware Company solely in exchange for stock
of the Delaware Company and the assumption by the Delaware Company of the
liabilities of the Alberta Company. I.R.C. Sections 361(a) and 357(a).
4. No gain or loss will be recognized by the Delaware Company upon the deemed
receipt of assets of the Alberta Company in exchange for stock of the
Delaware Company. I.R.C. Section 1032(a).
5. The basis of the assets of the Alberta Company in the hands of the Delaware
Company will be the same as the basis of such assets in the hands of the
Alberta Company immediately prior to the exchange.
I.R.C. Section 362(b).
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6. The holding period of the assets of the Alberta Company acquired by the
Delaware Company will include the period during which those assets were
held by the Alberta Company immediately prior to the exchange. I.R.C.
Section 1223(2).
7. No gain or loss will be recognized by the non-U.S. shareholders of the
Alberta Company who do not exercise dissenters' rights upon the deemed
receipt of stock of the Delaware Company solely in exchange for their
Alberta Company stock. I.R.C. Section 354(a)(1). No gain or loss will be
recognized by U.S. shareholders of the Alberta Company who do not exercise
dissenters' rights upon the deemed receipt of stock of the Delaware Company
solely in exchange for their Alberta Company stock assuming: (1) the
Alberta Company has not been a controlled foreign corporation (as described
above) at any time during the five years ending on the date of the
exchange; and (2) Proposed Regulation Section 1.367(b)-3(b) is not
effective as of the date of the Domestication. E&Y US has not made, and
will not make, any determination as to whether the Alberta Company is,
or has ever been, a controlled foreign corporation. In addition, in
order to protect the presumed non-taxable nature of the transaction,
U.S. shareholders are required to comply with notice requirements under
Treas. Reg. Section 1.367(b)-1(c). The form of notice is prescribed at
Treas. Reg. Section 7.367(b)-1(c)(2).
8. A non U.S. shareholder who does not exercise dissenters' rights will have a
basis in the Delaware Company Common Stock and Class A Preferred Stock
after the Domestication equal to such shareholder's basis in his/her
Alberta Company New Common Stock and Class A Preferred Stock prior to the
Domestication. I.R.C. Section 358(a)(1). A U.S. shareholder who does not
exercise dissenters' rights will have a basis in the Delaware Company
Common Stock and Class A Preferred Stock after the Domestication equal to
such U.S. shareholder's basis in his/her Alberta Company New Common Stock
and Class A Preferred Stock prior to the Domestication, increased by any
income (deemed dividends) or gain recognized by the U.S. shareholder on the
exchange. I.R.C. Section 358(a)(1)(B).
9. A shareholder who does not exercise dissenters' rights will have a holding
period for the Delaware Company Common Stock and Class A Preferred Stock
after the Domestication equal to such shareholder's holding period of the
Alberta Company New Common Stock and Class A Preferred Stock prior to the
Domestication. I.R.C. Section 1223(1).
10. Cash received as a result of the exercise of dissenters' rights by a
shareholder who dissents from the Domestication ("Dissenting Holder") and
who is subject to U.S. federal income tax will be treated as cash received
in redemption of the Dissenting Holder's shares of the Company's stock. As
a result, such Dissenting Holder may have to recognize capital gain/loss or
ordinary income as a result of the Domestication. Each Dissenting Holder
should consult with his/her own tax advisor as to the specific tax
consequences of the Domestication to him/her.
26
11. The taxable year of the Alberta Company will end on the date of the
Domestication. The Delaware Company's first taxable year will begin on the
day after the Domestication, and will end on December 31, 1999. Treas. Reg.
Section 7.367(b)-1(e).
The opinion set forth above does not address certain U.S. federal income tax
consequences applicable to U.S. shareholders of the Company who own or owned
(directly or indirectly) 10% or more of the voting power of the Company at any
time during the five year period ending on the date of the Domestication.
B. CANADIAN FEDERAL INCOME TAX CONSEQUENCES
Based on the Documents, the facts summarized above, and the applicable law, as
well as any caveats or qualifications as stated herein, for Canadian federal
income tax purposes:
1. Generally non-dissenting shareholders will not be considered to have
disposed of their shares of the Alberta Company upon the Domestication.
2. Non-dissenting shareholders will continue to have an adjusted cost base of
their Delaware Company shares equal to the adjusted cost base of their
Alberta Company shares immediately prior to the Domestication.
3. On the Domestication, the Delaware Company shares will constitute "foreign
property" for purposes of deferred income plans. A deferred income plan may
not hold more than 20% of its investments (based on original cost) if that
is the method adopted by the plan in foreign property without incurring tax
penalties. Those non-dissenting Canadian resident shareholders holding
their Alberta Company shares in a deferred income plan are advised to
carefully review their foreign property limits.
4. Non-dissenting Canadian resident shareholders must include in income for
Canadian tax purposes 100% of the Canadian dollar equivalent of the amount
of dividends received from the Delaware Company after the Domestication.
Such dividend would be subject to U.S. withholding tax. Depending on the
shareholder's particular circumstances, such withholding tax may or may not
qualify for a credit against Canadian federal income tax or a deduction
against Canadian income tax or a deduction against Canadian taxable income.
5. Dividends received by a Non-dissenting Non-resident shareholder after the
Domestication will not be subject to Canadian federal income tax.
6. Dissenting shareholders generally will be considered to have received a
dividend ("Dividend") on the purchase of their shares by the Alberta
Company equal to the excess, if any, of the Cash Proceeds over the paid up
capital of their shares.
7. Dissenting Canadian resident individual shareholders are required to
include in income 125% of the actual amount of the Dividend and are
entitled to claim a
27
dividend tax credit equal to 13.33% of the grossed up amount in calculating
Canadian federal income tax payable.
8. Dissenting Canadian resident corporate shareholders would not be subject to
tax on the Dividend (unless the Dividend is re-characterized as proceeds of
disposition) under Part I of the Tax Act. A private company holding not
more than 10% of the voting shares will be subject to a refundable tax of
33-1/3% under Part IV of the Tax Act. The Part IV tax is refundable at the
rate of $1 for every $3 of dividends paid.
9. Dissenting shareholders also will be considered to have disposed of their
Alberta Company shares for Proceeds equal to the paid-up capital of their
Alberta Company shares on the purchase of their shares by the Alberta
Company.
10. To the extent that the Proceeds exceed a dissenting Canadian resident
shareholder's adjusted cost base of his/her shares, a capital gain will
arise, three-quarters of which will be included in income for Canadian
federal income tax purposes in the year of the dissent. To the extent that
the Proceeds are less than a shareholder's adjusted cost base of his/her
shares, a capital loss will arise, three-quarters of which can be used to
reduce current year capital gains to nil. If the capital loss exceeds
current year capital gains, any excess can be carried back three years or
forward indefinitely to offset capital gains in those periods. If the
adjusted cost base of the shareholder's shares is equal to the paid up
capital of his/her shares, no capital gain or loss will arise.
11. Dissenting Non-resident shareholders generally will be subject to Canadian
withholding tax of 25% of the amount of the Dividend or such lower rate as
provided under the terms of an applicable double taxation treaty. Depending
on a Dissenting Non-resident shareholder's particular circumstances, such
withholding tax may or may not qualify for a credit against income tax or a
deduction against taxable income in his/her jurisdiction of taxation.
12. Dissenting non-resident shareholders will be subject to Canadian taxation
in respect of capital gains on their Alberta Company shares only if such
shares constitute "taxable Canadian property" to them. The Common Shares
generally will not constitute "taxable Canadian property" of a shareholder
unless at any time within the five years preceding the disposition of the
shares, the shareholder, together with persons not dealing at arm's length
with the shareholder, or any combination thereof, owned and/or had options
to acquire: (a) 25% or more of the issued shares of any class of series of
capital stock of the company, (b) the shareholder, upon ceasing to be a
resident of Canada, elected under the Tax Act to have the shares treated as
"taxable Canadian property," or (c) the Common Shares were acquired in
circumstances in which they were deemed to be taxable Canadian property
(definition of "taxable Canadian property" in subsection 115(1) of the Tax
Act).
13. The Alberta Company will be deemed to have a year end immediately prior to
the Domestication and will be deemed to have disposed of all of its assets
for proceeds
28
equal to fair market value and to have immediately reacquired such
assets at a cost equal to fair market value on the effective date of the
Domestication. To the extent that the deemed proceeds exceed the cost or
adjusted cost base of the Alberta Company's assets on that date, the
Alberta Company may be subject to tax in Canada for the fiscal period
ending immediately prior to the Domestication. To the extent that such
amounts exceed available deductions, such amounts will be subject to
Canadian federal income tax at an effective rate of 39%.
14. A 25% Exit Tax will apply to the amount by which the aggregate fair market
value of the Alberta Company's assets immediately prior to the
Domestication exceeds the aggregate of its liabilities (including liability
for Canadian federal income tax under Part I of the Tax Act for the final
taxation year) and its paid-up capital of all of its issued and outstanding
shares excluding the paid-up capital in respect of all dissenting
shareholders whose shares have been redeemed. The general rate of tax of
25% will be reduced to 5% pursuant to the U.S. Treaty. The Exit Tax is
payable by the Company.
15. Upon the Domestication, the Company is deemed for Canadian federal income
tax purposes to have been incorporated in Delaware and not to have been
incorporated elsewhere and should generally only be subject to tax in
Canada in respect of business income attributable to a permanent
establishment in Canada, gains realized on disposition of taxable Canadian
property and withholding tax in respect of Canadian source passive income
such as dividends and interest.
SCOPE OF OPINIONS
I. U.S. FEDERAL INCOME TAX OPINIONS
The scope of the U.S. federal income tax opinions is expressly limited solely
to the U.S. federal income tax consequences set forth in the section above
entitled "Opinions." No opinion has been requested, and no determination has
been made, nor has any opinion been expressed on any other issues including,
but not limited to, any state, foreign, consolidated return, employee
benefit, alternative minimum tax, or I.R.C. Section 306 or Section 382
consequences to the parties to this transaction. In addition, no opinion has
been expressed regarding (i) the valuation of any assets or stock of the
Company; (ii) the status of the Company as a controlled foreign corporation;
(iii) the status of the Company as a Passive Foreign Investment Corporation
("PFIC"); (iv) the U.S. federal income tax consequences of the Amalgamation;
(v) the U.S. federal income tax consequences of the TII Reincorporation; (vi)
the U.S. federal income tax consequences of the Merger, except to the extent
the Merger could affect the Domestication by reason of the step-transaction
doctrine; or (vii) the U.S. federal income tax consequences of the exchange
or conversion of any options, warrants or similar interests.
The opinions, as stated above, are based upon an analysis of the Internal
Revenue Code, Treasury Regulations, current case law, and published IRS
authorities. The foregoing are
29
subject to change, and such change may be retroactively effective. If so, the
opinions, as set forth above, may be affected and may not be relied upon. In
addition, the above opinions are based on the information contained in the
Documents. Any variation or differences in the Documents may affect the
opinions, perhaps in an adverse manner. No obligation has been undertaken to
update these opinions for changes in facts or law occurring subsequent to the
date hereof. This letter sets forth opinions as to the interpretation of
existing U.S. federal income tax law, and is not binding on the IRS or any
court of law.
II. CANADIAN FEDERAL INCOME TAX OPINIONS
The scope of the Canadian federal income tax opinions is expressly limited
solely to the Canadian federal income tax consequences set forth in the
section above entitled "Opinions." No opinion has been requested, and no
determination has been made, nor has any opinion been expressed, on any other
issues including, but not limited to, any provincial, foreign, consolidated
return, employee benefit, or alternative minimum tax consequences to the
parties to this transaction. In addition, no opinion has been expressed
regarding (i) the valuation of any assets or stock of the Company; (ii) the
Canadian federal income tax consequences of the Amalgamation; (iii) the
Canadian federal income tax consequences of the TII Reincorporation; (iv) the
Canadian federal income tax consequences of the Merger; or (v) the Canadian
federal income tax consequences of the exchange or conversion of any options,
warrants or similar interests.
The opinions, as stated above, are based upon an analysis of the Income Tax
Act (Canada), as amended to date, the Income Tax Regulations, draft
legislation released prior to the date hereof amending the Act and
Regulations, case law, the Canada - U.S. Tax Convention as amended to date,
and E&Y Canada's understanding of the current administrative practices and
policies of the Department of National Revenue, Customs, Excise and Taxation.
The foregoing are subject to change, and such change may be retroactively
effective. If so, the opinions, as set forth above, may be affected and may
not be relied upon. In addition, the opinions are based on the information
contained in the Documents. Any variation or differences in the Documents may
affect the opinions, perhaps in an adverse manner. No obligation has been
undertaken to update these opinions for changes in facts or law occurring
subsequent to the date hereof.
This letter sets forth, opinions as to the interpretation of existing
Canadian federal income tax law, and is not binding on Revenue Canada or any
court of law.
Very truly yours,
/s/ Ernst & Young LLP
cc: Michael E. Bertolino, Ernst & Young LLP Senior Tax Manager, San Diego
Brian B. Gibney, Ernst & Young LLP Tax Partner, Washington National
30
Kirsten Simpson, Ernst & Young LLP Senior Tax Manager, Washington National
Amy F. Eisenberg, Ernst & Young LLP Tax Manager, Century City
David H. Hemmerling, Ernst & Young LLP Tax Partner (International), Irvine
Deanne Parker, Ernst & Young LLP Tax Manager (International), Irvine
David Van Dyke, E&Y Canada Tax Partner, Calgary
Ron Sirkis, E&Y Canada Tax Partner, Calgary,
Cindy Rajan, E&Y Canada Tax Manager, Calgary
31