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Holdings by CIHI must be redistributed as a “deemed * * *
[distribution] by CIHI to Petitioner and by Petitioner to Carlton
followed by a constructive contribution of this amount by Carlton
to Holdings.” We disagree for reasons set forth below.
First, the interest rate Holdings charged CIC was arm’s
length and, as a result, section 1.482-2(a)(1), Income Tax Regs.,
is not applicable to the Holdings/CIC transaction. Because the
Holdings/CIC and CIC/CIHI transactions are separate transactions,
respondent may make reallocations only between CIC and CIHI.
Respondent, however, seeks to consolidate and recast both
transactions as a repayment of the loan between Holdings and CIC
followed by a new loan between Holdings and CIHI, thus triggering
the recognition of foreign exchange gain by CIC.
Second, respondent was not authorized, pursuant to section
1.482-1(d)(3)(ii)(B), Income Tax Regs., to recast the
Holdings/CIC and CIC/CIHI transactions because these transactions
had economic substance. Respondent does not contend that the
Holdings/CIC transaction lacked economic substance. Moreover,
CIC’s and CIHI’s conduct established that the terms of their
agreement were consistent with the economic substance of the
underlying transaction. See sec. 1.482-1(d)(3)(ii)(B), Income
Tax Regs. In 1996, Carlton contemplated various financing
options to acquire RSA and Cinema Media, Ltd. One of those
options was to fund a part of the acquisition internally with
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