A-407-82
The Queen (Appellant)
v.
Special Risks Holdings Inc. (Respondent)
Court of Appeal, Heald, Le Dain JJ. and Kerr
D.J.—Ottawa, December 1 and 30, 1982.
Income Tax — Practice — Motion to strike pleadings —
Discovery — Documents — Appeal from order deleting pas
sage from statement of defence and refusing R. 448 list of
documents — Respondent engaging in series of transactions
with three other corporations, including disposition of R.M.
Ltd. shares — Respondent subsequently electing to pay divi
dend out of TPUS and CSOH accounts — Minister reassess
ing dividend tax on assumption certain provisions applied
because respondent controlled R.M. Ltd. immediately before
share disposition and not arm's length immediately after —
Respondent's statement of claim in reassessments appeal
alleging disposition occurred while R.M. Ltd. briefly con
trolled by another — Subject passage alleging tax-avoidance
motive for transactions — Respondent not denying motive —
Continuity of control only issue — Motive immaterial since
appellant's pleading not alleging dispositions sham or other
wise contrary to law — Such allegations present in earlier
cases where tax-avoidance motive warranting careful scrutiny
of transactions by Court — Appellant entitled to list of
documents re matters specified in motion since might relate to
control of R.M. Ltd., and also re all other matters in dispute
— Appeal allowed in part — Income Tax Act, S.C. 1970-71-
72, c. 63, ss. 89(1)(1)(ii) (as am. by S.C. 1974-75-76, c. 26, s.
53), 89(5)(a)(ii) (enacted by S.C. 1974-75-76, c. 26, s. 53),
186(2), 245, 246, 247 — Federal Court Rules, C.R.C., c. 663,
R. 448, Fm. 21.
Practice — Discovery — Production of documents
Appeal from (inter alia) order refusing R. 448 list of docu
ments — Respondent disposing of R.M. Ltd. shares and
subsequently electing to pay dividend out of TPUS and CSOH
accounts — Minister reassessing dividend tax — Continuity of
respondent's control of R.M. Ltd. only issue — Appellant
entitled to list of documents re matters specified in motion
since might relate to control of R.M. Ltd., and also re all other
matters in dispute — Appeal allowed in part — Federal Court
Rules, C.R.C., c. 663, R. 448, Fm. 21.
The respondent and the corporations H.R.G. Ltd., R.M. Ltd.
and M.H.R. Ltd. engaged in a series of transactions among
themselves. As part of these dealings, the respondent (in
December, 1976) disposed of its shares in R.M. Ltd. In March
of 1978, the respondent elected to pay a dividend out of its
TPUS and CSOH accounts; however, in tax reassessments
issued by the Minister, the amount debited against the TPUS
account was reduced, the amount drawn from the CSOH
account was increased, the total of these two amounts was less
than the amount of the dividend, and additional tax was
therefore exacted. The Minister's calculations were based upon
the premise that certain provisions of the Act applied. In turn,
this premise derived from the view that the respondent had
controlled R.M. Ltd. immediately prior to the disposition of
shares, and had not been dealing with R.M. Ltd. at arm's
length immediately after the disposition. The respondent
appealed the reassessments. In its statement of claim, it
outlined the relevant transactions, and took the position that
the provisions in question did not apply, because the disposition
occurred in the midst of an 11-day period during which R.M.
Ltd. was controlled by M.H.R. Ltd. and not by the respondent.
The appellant's statement of defence set forth its contrary view,
and further alleged that, in engaging in the transactions con
cerned, the respondent "entered into a scheme ... with the
hope and expectation of avoiding tax on the distribution of
dividends". On motion by the respondent, this statement was
struck from the appellant's pleading. At the same time, a
motion by the appellant under Rule 448, for an order compel
ling the respondent to provide a list of documents and a
verifying affidavit, was dismissed. The appellant appealed both
decisions.
Held: (1) The deletion from the statement of defence was
rightly made. The passage in question is concerned with the
respondent's reasons for entering into the "scheme". The
respondent does not deny that its objective was to avoid taxa
tion on the dividend distribution; however, it has contended
that, in the absence of sham, a taxpayer is free to arrange its
affairs so as to achieve this end. The respondent has therefore
maintained that it had a legal right to take the steps which it
did, and that the appellant, whose pleading contains no allega
tion of sham, is not entitled to delve into the respondent's
underlying motives. According to the pleadings and the parties
themselves, at issue is the continuity of the respondent's control
of R.M. Ltd. Nonetheless, the appellant argues that the
impugned passage is relevant. Her position is that since a
tax-avoidance "scheme" was pleaded, the Court has a duty to
scrutinize carefully every aspect of the "scheme", in order to
determine whether the transactions involved actually produced,
in fact and in law, the relationships aimed at by the several
companies. The cases relied upon as supporting this argument
were to be distinguished. In those in which a duty to scrutinize
has been found, the Minister had pleaded matters such as:
artificiality in the taxpayer's supposed carrying on of a busi
ness; sham; lack of a valid business purpose; and the provisions
dealing with artificial transactions. By contrast, the appellant
herein alleged none of these things, nor did she plead the
tax-avoidance or dividend-stripping sections of the Act. In the
absence of any such allegation that the relevant transactions
were invalidated by a particular enactment or otherwise con
trary to law, the respondent's motives are not material.
(2) The appellant's motion sought a list comprising, inter
alia, documents relating to negotiations between H.R.G. Ltd.
and the respondent regarding the acquisition of R.M. Ltd., and
documents and agreements between H.R.G. Ltd. and the
respondent regarding control of M.H.R. Ltd. The materials in
each of these two categories might well relate to the control of
R.M. Ltd., which has been put in issue by the pleadings. The
appellant is therefore entitled to a list of those items, but
paragraph (1) of Rule 448 implies more than this. It speaks of
documents "relating to any matter in question in the
cause...." In this case, the factual allegations in three para
graphs of the statement of claim are in dispute. Consequently,
the appellant is entitled to a list and a verifying affidavit which
encompass the documents pertaining to each and every one of
those allegations.
CASES JUDICIALLY CONSIDERED
DISTINGUISHED:
Rose v. Minister of National Revenue, [1973] F.C. 65;
73 DTC 5083 (C.A.); Her Majesty The Queen v. Daly,
[1981] CTC 270 (F.C.A.).
REFERRED TO:
Stubart Investments Limited v. Her Majesty The Queen
(1981), 81 DTC 5120 (F.C.A.); W.T. Ramsay Ltd. v.
Inland Revenue Commissioners, [1982] A.C. 300 (H.L.).
COUNSEL:
P. Plourde for appellant.
G. Du Pont for respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
Verchere, Noël & Eddy, Montreal, for
respondent.
The following are the reasons for judgment
rendered in English by
HEALD J.: This is an appeal from an interlocu
tory order of the Trial Division [Federal Court,
T-4602-81, order dated May 11, 1982] which:
(a) granted the respondent's motion to delete para
graph 8 from the statement of claim and to make
certain amendments to paragraph 12 of the state
ment of claim;
(b) ordered that the words "but adds that Plaintiff
entered into a scheme described in said paragraphs
with the hope and expectation of avoiding tax on
the distribution of dividends" be struck from para
graph 3 of the appellant's statement of defence;
and
(c) ordered that the appellant's motion that the
respondent be ordered to produce' documents pur
suant to Rule 448 [Federal Court Rules, C.R.C.,
c. 663] be dismissed.
While the notice of appeal purports to appeal
against all three branches of the Trial Division
order supra, the appellant's memorandum of fact
and law limits the appeal to paragraphs (b) and
(c) supra and the appeal was argued on this basis.
The relevant facts are summarized in the rea
sons of the learned Motions Judge as follows (A.B.
pages 48 and 49):
The proceedings are an appeal against assessments dated
March 19, 1981, resulting from elections made by Defendant
[sic] in March 1978 and December 1978 pursuant to subsec
tion 83(1) of the Income Tax Act to pay dividends out of its tax
paid undistributed surplus on hand account (TPUS) and its
1971 capital surplus on hand account (CSOH). A number of
inter-corporate transactions and share subscriptions and
changes were involved between Plaintiff, Hogg Robinson
Group Ltd., Richards, Melling & Co. Ltd., and Melling Hogg
Robinson Ltd., which need not be gone into here. As a result
Plaintiff paid a dividend of $185,000 on March 31, 1978,
calculating that $181,604 of this was paid out of its TPUS
account and $3,396 out of its CSOH account, and another
dividend on December 29, 1978 of $1,346,231 out of its 1971
CSOH account. The Minister in the re-assessment calculated
that with respect to the March 13, 1978 election an amount of
$129,334.35 was deemed to be paid from the TPUS account
and $51,171.65 from the CSOH account, and assessed addi
tional tax accordingly.
Plaintiff relies on Sections 3, 83, 86, 89, 184 and 248 of the
Act as applicable to the 1978 taxation year and on Section 26
of the Income Tax Application Rules. Defendant relies on the
same sections.
Defendant admits a number of paragraphs of Plaintiff's
Statement of Claim including an admission in Paragraph 3 of
Paragraphs 10, 11, 12, 14, 16 and 18 of it, but in the said
paragraph then goes on to say "the Plaintiff entered into a
scheme described in said paragraphs with the hope and expec
tation of avoiding tax on the distribution of dividends".
' The reference to production of documents pursuant to Rule
448 in the order made by the Motions Judge (A.B. page 51) is
clearly inaccurate. The notice of motion pursuant to Rule 448
(A.B. page 32) asked for an order "compelling the plaintiff to
make and file and serve on the defendant a list of the docu
ments...." This is also the language used in paragraph 448(1).
In Paragraph 4 Defendant denies paragraphs 13, 15 and 17
adding that in assessing Plaintiff the Minister assumed that
Plaintiff, in effect, controlled at all relevant times, Richards,
Melling & Co. Ltd. Paragraphs 5 and 8 supplement this
contention that Plaintiff was not dealing at arms [sic] length
with the said company after it disposed of its shares,
paragraph 8 concluding that the amount referred to in para
graph 89(1)(a)(ii) of the Act is deemed to be nil in accordance
with the provisions of paragraph 89(5)(a)(ii) of the Act. The
parties agree that this is the issue between them.
In respect of that portion of the order set out in
paragraph (b) supra, the reasons given by the
Motions Judge read as follows (A.B. pages 49 and
50):
Plaintiff objects strongly to the allegation in paragraph 3 of
the Defence that it entered into a scheme with the hope and
expectation of avoiding tax on the distribution of dividends,
pointing out that it is well established that a taxpayer may
arrange his affairs in such a manner as to minimize or avoid
taxation, and in the absence of sham is entitled to do so. There
is no allegation of sham in this case and Defendant [sic] admits
that the various manoeuvres with the shares were carried out.
Plaintiff does not deny that the objective was to avoid taxation
on the dividend distributions but contends that it had a legal
right to take the steps it did, and that Defendant has no right to
go into its motives for doing so. Defendant [sic] contends that it
is the substance, not the form of the transactions which must be
looked into, and that for a brief period of 11 days control
passed out of the hands of Plaintiff, before returning to it.
Defendant has not pleaded Section 245 of the Act dealing with
Artificial Transactions, Section 246 respecting Tax Avoidance,
or Section 247 dealing with Dividend Stripping. I therefore find
that the allegation in the latter part of Paragraph 3 of the
Defence relating to Plaintiff's motives should be struck.
It is the position of the appellant that the respond
ent controlled Richards, Melling & Co. Ltd.
(R.M.C.) immediately before it disposed of its
R.M.C. shares on December 23, 1976 and was not
dealing at arm's length with R.M.C. immediately
after that disposition. Thus, in the submission of
the appellant, subparagraph 89(1)(1)(ii) of the
Income Tax Act [R.S.C. 1952, c. 148, as am. by
S.C. 1970-71-72, c. 63; subpara. 89(1)(1)(ii) as
am. by S.C. 1974-75-76, c. 26, s. 53] 2 applies and
pursuant thereto, the amount referred to therein is
2 89. (1) In this subdivision,
(1) "1971 capital surplus on hand" of a corporation at any
particular time after May 6, 1974, means the amount, if
any, by which the aggregate of
(Continued on next page)
deemed to be nil in accordance with the provisions
of subparagraph 89(5)(a)(ii) of the Act [enacted
by S.C. 1974-75-76, c. 26, s. 53]. 3 The respondent,
on the other hand, pleads each and every step of
the various transactions and takes the position that
the deeming provisions of subparagraph
89(5)(a)(ii) do not apply to the circumstances of
this case because the respondent did not control
R.M.C. immediately before its disposition of the
R.M.C. shares owned by it. Based on the transac
tions outlined in paragraphs 9 to 18 inclusive of
the statement of claim, I perceive the respondent's
position to be that from December 20, 1976 to
December 31, 1976, the respondent did not control
R.M.C. within the meaning of subsection 186(2)
of the Act. 4 Thus, put another way, the issue
(Continued from previous page)
(ii) subject to subsection (5), all amounts each of which
is an amount in respect of a capital property of the
corporation owned by it on December 31, 1971 and
disposed of by it after that date and before the particu
lar time equal to the amount, if any, by which the lesser
of its fair market value on the day fixed by proclamation
for the purposes of subdivision c and the corporation's
proceeds of disposition thereof exceeds its actual cost to
the corporation determined without reference to the
Income Tax Application Rules, 1971, other than sub
sections 26(15), (17) and (21) to (27) thereof,
3 89....
(5) For the purposes of determining the 1971 capital
surplus on hand or paid-up capital deficiency of a corpora
tion at any particular time after May 6, 1974, the following
rules apply:
(a) the amount referred to in subparagraphs (1)(l)(ii) and
(xiv) in respect of a capital property of the corporation
shall be deemed to be nil, where the property disposed of is
(ii) a share of the capital stock of another Canadian
corporation that was controlled, within the meaning
assigned by subsection 186(2), by the corporation
immediately before the disposition and that was dis
posed of by the corporation after 1971 to a person with
whom the corporation was not dealing at arm's length
immediately after the disposition, other than by a dispo
sition referred to in paragraph (b), or
"186.... .
(2) For the purpose of this Part, one corporation is con
trolled by another corporation if more than 50% of its issued
share capital (having full voting rights under all circum
stances) belongs to the other corporation, to persons with
whom the other corporation does not deal at arm's length, or
to the other corporation and persons with whom the other
corporation does not deal at arm's length.
between the parties is the continuity of respond
ent's control of R.M.C. Based on the statement of
claim, I understand the respondent to be saying
that up until December 20, 1976, the respondent
controlled R.M.C. Then, on December 20, 1976,
that control passed to Melling, Hogg, Robinson
Ltd. (M.H.R.). However, the respondent did not
control M.H.R. pursuant to subsection 186(2)
because M.H.R.'s voting shares were divided
equally between another company and the
respondent. Therefore, the respondent could not be
said to have control of R.M.C. This, in respond
ent's view, was the position when the respondent
disposed of its R.M.C. shares on December 23,
1976. It was not until December 31, 1976 that
respondent regained control of M.H.R. Thus, in
respondent's view, the respondent did not control
R.M.C. from December 20, 1976 to December 31,
1976, a period of 11 days. During that 11-day
period when it was not in control of R.M.C., that
is, on December 23, 1976, the respondent disposed
of its R.M.C. shares.
The appellant submits that the impugned por
tion of paragraph 3 of her statement of defence
should be read together with paragraph 4 of the
statement of defence and, if that is done, it will be
seen that the impugned portion is necessary and
relevant to the issues as defined by the pleadings.
It is the appellant's position that since paragraph 3
alleges that the respondent entered into the
"scheme" pleaded by the respondent "with the
hope and expectation of avoiding tax on the distri
bution of dividends", the Court has a duty to
carefully scrutinize all aspects of that "scheme" to
ascertain whether the parties in fact achieved the
position that they set out to achieve, or put another
way, the test should be whether subject series of
transactions has been effectively implemented in
every way so that the legal relationships which the
parties claim to have created have in fact and in
law really been brought into existence. Counsel for
the appellant said that the Crown intended to
challenge the result of the scheme and that the
impugned portion of paragraph 3 was necessary
and relevant to that intention. In support of this
submission, counsel relied on the Court's decision
in Rose v. Minister of National Revenue. 5 In that
case, the former Chief Justice of this Court said at
page 69:
5 [[1973] F.C. 65;] 73 DTC 5083 [C.A.] per Jackett C.J.
It does not seem to be in doubt that the reason for the
scheme under which the corporations in question would be
constituted a partnership to undertake management services for
Central Park Estates Limited was to achieve tax advantages for
the individuals owning the shares of some or all of those
corporations. While this does not affect the result actually
achieved by what was done, it does, in my view, warrant a very
careful appraisal of the evidence when considering whether
what was projected with that end in view was actually carried
out. [Footnote omitted.]
However, a perusal of the record in that case
shows that the Minister pleaded, in paragraph 7 of
his reply to the amended notice of appeal, that the
taxpayer's "alleged participation in the alleged
Central Park Management Company partnership
was not the carrying on of a bona fide active
financial, commercial or industrial business but an
artificial attempt to create the appearance of the
carrying on of such a business". It is also noted
that the Minister, in paragraph 16 of his memo
randum of fact and law in the Rose case, submit
ted, inter alia, that "the arrangement under which
the partnership agreement and the management
agreement were set up was a sham". In my view,
this is a very significant difference between the
case at bar and the Rose case (supra). In Rose,
artificiality was pleaded. Here there is no such
pleading. The decision in Rose and the comments
of the former Chief Justice supra in that decision
must be considered in the light of the pleadings in
that case. In the case of Her Majesty The Queen v.
Daly, 6 in writing the judgment of the majority of
the Court, I said:
In a case of this kind, where it is acknowledged that what is
sought by a certain course of action is a tax advantage, it is the
duty of the Court to examine all of the evidence relating to the
transaction in order to satisfy itself that what was done resulted
in a valid, completed transaction.
Likewise, I observe that in Daly (supra), the
Crown pleaded that there was "no business pur
pose" for the procedure adopted (statement of
defence, paragraph 7) and pleaded further that the
Crown assessed the taxpayer on the basis that
"there was no valid or legitimate business purpose
for the procedure ..." (statement of defence, para
graph 8). Additionally, the Crown also pleaded the
provisions of section 245 of the Act and the prede-
6 [1981] CTC 270 [F.C.A.] at p. 279.
cessor section to section 245. Those sections deal
with artificial transactions.
Accordingly, it is my view that the jurispru
dence of this Court as developed in the Rose case
and the Daly case must be evaluated in the light of
the issues made relevant by the pleadings in those
cases. In Rose, the Minister pleaded artificiality.
In Daly, the Crown pleaded lack of valid or legiti
mate business purpose. In the case at bar there is
no such plea. I take it that the references by the
learned Motions Judge to sections 245, 246 and
247 of the Act were meant to refer to the circum
stance that in this case the Crown had not pleaded
facts which, if proven at trial, would bring into
play one or more of those sections so as to attract
tax liability.
The state of the pleadings herein is that the
appellant did not allege facts which would estab
lish a sham, lack of valid business purpose, artifi
cial transactions under section 245, tax avoidance
under section 246 or dividend stripping under sec
tion 247.
On the contrary, the appellant admits most of
the paragraphs of the statement of claim which
establish the so-called "scheme". The only para
graphs which it denies are paragraphs 13, 15 and
17. Paragraph 13 relates to control of R.M.C. I do
not read paragraphs 15 and 17 as being relevant to
the question of control. They are included in the
narrative of the entire series of transactions. Thus,
the only matter put in issue by the appellant is the
matter of control of R.M.C. The Motions Judge
said that the respondent did not deny that the
objective was to avoid taxation on the dividend
distribution. Likewise, before us, respondent's
counsel did not deny this objective. However, there
is here no allegation by the appellant that subject
scheme is contrary to law or invalidated by a
particular enactment.' Had the appellant pleaded
facts sufficient to constitute sham, lack of a valid
and bona fide purpose or any of the statutory
' Compare: Stubart Investments Limited v. Her Majesty The
Queen (1981), 81 DTC 5120 [F.C.A.] at page 5124, and W. T.
Ramsay Ltd. v. Inland Revenue Commissioners, [1982] A.C.
300 [H.L.] at page 323.
prescriptions alluded to by the Motions Judge, the
situation might have been different. As it is how
ever, I fail to see how, on the pleadings as present
ly constituted, the respondent's reasons for
instituting subject "scheme" can be material to
any fairly arguable defence open to the appellant.
Accordingly, I think that the impugned portion of
paragraph 3 is immaterial and that the Motions
Judge was right in striking it from the statement
of defence.
I turn now to the appeal from that part of the
order detailed in paragraph (c) supra. The reasons
of the Motions Judge for refusing this portion of
the appellant's motion read as follows [at pages
4-5]:
Turning now to Defendant's Motion under Rule 448, a letter
annexed to the accompanying affidavit indicates the documents
sought.
Paragraph (a) seeks documents relating to negotiations be
tween Hogg Robinson and Plaintiff as to acquisition of Rich-
ards, Melling & Co. Ltd., and Paragraph (b) seeks documents
as to the capital reorganization of that company. Details of the
reorganization have already been produced, and any writings or
memoranda of any discussions go to motive and are irrelevant.
With respect to Paragraphs (c) and (d) concerning the incorpo
ration of Melling Hogg Robinson Ltd. and the distribution of
its shares between the Hogg Robinson Group and Plaintiff, and
the purchase of shares of Richards, Melling & Co. by Melling
Hogg Robinson, here again it appears that these documents
have already been produced by Plaintiff in its list filed pursuant
to Rule 447, or have been admitted by Defendant in the
paragraphs of Plaintiff's Statement of Claim admitted by it. If
the documentation is incomplete additional company records
(as distinct from correspondence) can no doubt be obtained on
discovery. Paragraph (e) asks for documents and agreements
between the Hogg Robinson Group and Plaintiff respecting
control of Melling Hogg Robinson Ltd. Here again this appears
to go to motive, and in the absence of allegations of sham this
information need not be provided. For these reasons Defend
ant's motion fails.
With respect, I am unable to agree with the
decision by the Motions Judge to dismiss the
appellant's motion for an order compelling the
respondent to make and file and serve the list of
documents contemplated by Rule 448(1). As noted
earlier herein, the appellant has denied
paragraph 13 of the statement of claim, thereby
putting in issue the question of control of R.M.C.
Paragraph (a) of the letter which is referred to in
the reasons of the Motions Judge (supra) asks for
"documents relating to negotiations between Hogg
Robinson and Plaintiff as to acquisition of Rich-
ards, Melling & Co. Ltd." Such documents might
well be relevant to the question of control of
R.M.C. The request for documents relative to the
acquisition of control of R.M.C. connotes wider
parameters than "writings or memoranda of any
discussions" going to motive. I therefore conclude
that the appellant is entitled to have a Rule 448(1)
list in respect of any and all such documents.
Likewise I think that paragraph (e) of the letter, in
asking for all documents and agreements between
the Hogg Robinson Group and the respondent
respecting control of M.H.R., is asking for docu
ments which might well relate to the issue of
control of R.M.C. because of the transactions
between the respondent, the Hogg Robinson
Group and M.H.R. concerning R.M.C. shares.
Accordingly I think the appellant is also entitled to
have a Rule 448 (1) list in respect of any and all
documents which are within the purview of para
graph (e) of subject letter.
I have dealt specifically with the matters
described in the letter of April 1, 1982 in respect
of which, in my view, the appellant is entitled to
Rule 448 discovery. However, Rule 448 (1) pro
vides for "a list of the documents ... relating to
any matter in question in the cause ...." The
matters in question or in issue on these pleadings
are the allegations of fact contained in paragraphs
13, 15 and 17 of the statement of claim. I think,
therefore, that the appellant is entitled to compli
ance with the provisions of Rule 448(1) in respect
of each and every allegation of fact contained in
paragraphs 13, 15 and 17 of the statement of
claim.
To summarize then the disposition I would pro
pose to make in this appeal: I would dismiss the
appeal from paragraph (b) of the order of the
Trial Division; I would allow the appeal from
paragraph (c) of the order of the Trial Division
and order the respondent, pursuant to the provi
sions of Rule 448(1), within 20 days from the date
of judgment in this Court, to make and file and
serve on the appellant a list of the documents that
are or have been in its possession, custody or power
relating to each and every allegation of fact con
tained in paragraphs 13, 15 and 17 of the state
ment of claim herein and contemporaneously
therewith, to make and file an affidavit verifying
such a list in Form 21, and to serve a copy thereof
on the appellant.
On the questions of costs, I note that the
Motions Judge awarded costs to the respondent in
respect of the respondent's motion to amend the
statement of claim and to strike a portion from the
statement of defence as well as in respect of the
appellant's motion to file a Rule 448 list. Since
success on the appeal is divided, I would make no
order as to costs either in this Court or in the Trial
Division.
LE DAIN J.: I agree.
KERR D.J.: I agree.
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