U.S. Securities and Exchange Commission

Form 40-F

OR

For the fiscal year ended December 31, 2004 Commission File Number 9682

Domtar Inc.

Not Applicable

Canada

2621

Not applicable

395 de Maisonneuve Blvd. West, Montreal, Quebec, Canada H3A 1L6 (514) 848-5400

CT Corporation System, 111 Eighth Avenue, New York, N.Y. 10011, (212) 664-1666

Securities registered or to be registered pursuant to Section 12(b) of the Act.

Securities registered or to be registered pursuant to Section 12(g) of the Act.

Not Applicable

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

8 3/4% Notes due 2006, 9 1/2% Debentures due 2016, 7.875% Notes due 2011, 5.375% Notes due 2013

For annual reports, indicate by check mark the information filed with this Form:

     Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

Common Shares — 230,237,354 shares

     Indicate by check mark whether the Registrant by filing the information contained in this form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). If “Yes” is marked, indicate the file number assigned to the Registrant in connection with such Rule.

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the last 90 days.

FORWARD-LOOKING STATEMENTS

This annual report on Form 40-F contains forward-looking statements, including, without limitation, those regarding expectations for market growth and developments; expectations for growth and profitability; and statements preceded by “believes”, “expects”, “anticipates”, “foresees”, or similar expressions, are forward-looking statements. Since these statements are based on current plans, estimates and projections, they involve risks and uncertainties, which may cause actual results to materially differ from those expressed in such forward-looking statements. These risks and uncertainties include, but are not limited to: (1) operating factors such as continued success of manufacturing activities and the achievement of efficiencies therein, continued success of product development, acceptance of new products or services by targeted customers, success of the existing and future collaboration arrangements, changes in business strategy or development plans or targets; (2) industry conditions, such as strength of product demand, intensity of competition, prevailing and future global market prices for products and the pricing pressures thereto, financial condition of the customers and competitors, the potential introduction of competing products and technologies by competitors; and (3) general economic conditions such as rates of economic growth in the Company’s principal geographic markets or fluctuations in exchange and interest rates.

Form 40-F

Domtar Inc.

March 24, 2005

TABLE OF CONTENTS

Exhibits

DISCLOSURE CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

In accordance with the rules of the Securities and Exchange Commission, Domtar maintains a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed by Domtar is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, in a timely manner. Under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, Domtar has evaluated the effectiveness of the design and operation of these disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, Domtar’s Chief Executive Officer and Chief Financial Officer concluded that Domtar’s system of disclosure controls and procedures is effective.

Change in Internal Controls over Financial Reporting

Domtar maintains a system of internal controls over financial reporting. There were no changes in Domtar’s internal controls that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, Domtar’s internal control over financial reporting.

2004 FINANCIAL RESULTS

Management’s
Discussion and Analysis

MONTREAL, QUEBEC, FEBRUARY 28, 2005

Management’s Discussion and Analysis (MD&A) relates to the financial condition and results of Domtar’s operations. Throughout this MD&A, unless otherwise specified, “Domtar”, “we”, “us” and “our” refer to Domtar Inc., its subsidiaries, as well as its joint ventures, and “the Corporation” refers to Domtar excluding its interest in joint ventures including, among others, Norampac Inc. (“Norampac”). Domtar’s common shares are listed on the Toronto and New York stock exchanges. Except where otherwise indicated, all financial information reflected herein is determined on the basis of Canadian generally accepted accounting principles (GAAP). This MD&A should be read in conjunction with Domtar’s audited consolidated financial statements and notes thereto.

     In accordance with industry practice, in this MD&A, the term “ton” or the symbol “ST” refers to a short ton, an imperial unit of measurement equal to 0.9072 metric tons, and the term “tonne” or the symbol “MT” refers to a metric ton. In this MD&A, unless otherwise indicated, all dollar amounts are expressed in Canadian dollars, and the term “dollars” and the symbols “$” and “CAN$” refer to Canadian dollars. The term “U.S. dollars” and the symbol “US$” refer to United States dollars.

FORWARD-LOOKING STATEMENTS

This MD&A contains statements that are forward-looking in nature. Statements including the words “believe”, “expect”, “anticipate”, “aim”, “target”, “plan”, “intend”, “continue”, “estimate”, “may”, “will”, “should” and similar expressions are forward-looking statements. Forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by management, are inherently subject to known and unknown risks and uncertainties such as, but not limited to, general economic and business conditions, product selling prices, raw material and operating costs, changes in foreign currency exchange rates, our ability to integrate acquired businesses into our existing operations, and other factors referenced herein and in Domtar’s continuous disclosure filings. Therefore, Domtar’s actual results may be materially different from those expressed or implied by such forward-looking statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

2004 Overview

In 2004, stronger demand, which led to better pricing in U.S. dollar terms and higher shipments for most of our major products, combined with the positive effects of restructuring efforts, was not sufficient to offset the impact of the ongoing decline in the value of the U.S. dollar and higher costs for purchased wood, freight and softwood lumber duties.

Our business

Domtar’s reporting segments correspond
to the following business activities:
Papers, Paper Merchants, Wood and Packaging.

¹ Including sales of Domtar paper through our Paper Merchants business.
² Excluding sales of Domtar paper.

SALES BY SEGMENT – 2004

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MANAGEMENT’S DISCUSSION AND ANALYSIS

PAPERS

We are the third largest integrated manufacturer and marketer of uncoated freesheet paper in North America. We operate six pulp and paper facilities in Canada and five in the United States, with an annual paper production capacity of approximately 2.7 million tons, complemented by strategically located warehouses and sales offices. Over 50% of our paper production capacity is located in the United States and approximately 90% of our paper sales are made to customers in the United States. Uncoated and coated freesheet papers are used for business, commercial printing and publication and technical and specialty applications. The chart below illustrates our principal paper products and our annual paper production capacity.

     We sell paper primarily through a large network of owned and independent merchants that distribute our paper products throughout North America. We also sell our products to a variety of customers, including business offices, office equipment manufacturers, retail outlets, commercial printers, publishers and converters. In addition, we sell pulp in excess of our own internal requirements. We also purchase pulp to optimize paper production and reduce freight costs. In 2004, our net market pulp position (shipments less purchases) was approximately 700,000 tons.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Our Papers business is our most important segment, representing 56% of consolidated sales in 2004, or 62% when including sales of Domtar paper through our own Paper Merchants business.

PAPER MERCHANTS

Our Paper Merchants business comprises the purchasing, warehousing, sale and distribution of various products made by Domtar and other manufacturers. These products include business and printing papers, graphic arts supplies and certain industrial products. Domtar-owned paper merchants operate in the United States and Canada. On November 18, 2004, we announced that we had gathered all our merchant operations under a single banner and umbrella name, the Domtar Distribution Group, thereby creating the fifth largest paper merchant organization in North America. Ris Paper, acquired in July 2000, operates throughout the Northeast, Mid-Atlantic and Mid-West areas from 20 locations in the United States, including 17 distribution centers. The Canadian business operates as Buntin Reid in three locations in Ontario; JBR/La Maison du Papier in two locations in Quebec; and The Paper House in three locations in Atlantic Canada. Our Paper Merchants business represented 21% of consolidated sales in 2004, or 15% when excluding sales of Domtar paper.

WOOD

Our Wood business comprises the manufacturing and marketing of lumber and wood-based value-added products and the management of forest resources. We operate 10 sawmills (six in Quebec and four in Ontario, following the permanent closure of the Chapleau sawmill effective March 6, 2005) and one remanufacturing facility (in Quebec), for an annual capacity of 1.1 billion board feet of lumber. We also have investments in four businesses that produce wood products. We seek to optimize 18 million acres of forestland directly licensed or owned by the Corporation in Canada and the United States through efficient management and the application of certified sustainable forest management practices such that a continuous supply of wood is available for future needs. Our Wood business represented 11% of consolidated sales in 2004.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

PACKAGING

Our Packaging business comprises our 50% ownership interest in Norampac, a joint venture between Domtar Inc. and Cascades Inc. We do not manage the day-to-day operations of Norampac. The Board of Directors of Norampac is composed of four representatives each from Domtar Inc. and Cascades Inc. The Chairman of the Board is proposed by Domtar Inc. and appointed by the Board, while the President and Chief Executive Officer is proposed by Cascades Inc. and appointed by the Board. Norampac’s debt is non-recourse to Domtar Inc. As required by GAAP, we account for our 50% interest in Norampac using the proportionate consolidation method.

     Norampac’s network of 26 corrugated packaging plants, strategically located across Canada and the United States, provides full-service packaging solutions and produces a broad range of products. Norampac’s eight containerboard mills (located in Ontario, Quebec, British Columbia, New York State and northern France), having a combined annual capacity of approximately 1.6 million tons, directly or indirectly supply essentially all the containerboard requirements of the converting plants. Our Packaging business represented 12% of consolidated sales in 2004.

BUSINESS STRATEGY

Our overall strategic objective is to be a world leader in the paper industry. We have developed our business strategies around three pillars: meeting and anticipating the ever-changing needs of customers, providing our shareholders with attractive returns, and fostering a dynamic and creative environment for our employees in which shared human values and personal commitment prevail.

Our business strategies are to continue to

Through these strategies, we aim to be one of the most attractive investments in the North American basic materials sector by providing superior returns to our shareholders.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Summary of financial results

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Notes to financial highlights

SPECIFIED ITEMS AFFECTING RESULTS AND NON-GAAP MEASURES

Our operating results include specified items that, in our view, do not typify our normal operating activities, thus affecting the comparability of our results from period to period. To measure our performance and that of our business segments from period to period without variations caused by these specified items, we focus on operating profit excluding specified items, net earnings excluding specified items, net earnings per share excluding specified items and other such measures excluding specified items. We define specified items as items such as the impacts of impairment of assets, facility or machine closures, changes in income tax legislation, debt restructuring, unrealized mark-to-market gains and losses on hedging contracts not considered as hedges for accounting purposes, foreign exchange impact on long-term debt translation and other items that, in our view, do not typify normal operating activities.

     Operating profit excluding specified items, net earnings excluding specified items, net earnings per share excluding specified items and other such measures excluding specified items are non-GAAP measures. We believe that it is useful for investors and other users to be aware of the specified items that positively or adversely affected our GAAP results, and that these non-GAAP measures provide investors and other users with a measure of performance to compare our results between periods without regard to these specified items. Measures excluding specified items have no standardized meaning prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies and therefore should not be considered in isolation.

     The following tables reconcile our net earnings and net earnings per share, determined in accordance with GAAP, to our net earnings excluding specified items and net earnings per share excluding specified items, and reconcile our operating profit to our operating profit excluding specified items:

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MANAGEMENT’S DISCUSSION AND ANALYSIS

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MANAGEMENT’S DISCUSSION AND ANALYSIS

     Our policy is to utilize derivative financial instruments such as commodity swap contracts for purposes of managing risk and not for speculative purposes. Notwithstanding the fact that these contracts do not meet the accounting criteria for hedge effectiveness, we believe that, from an operational and cash flow point of view, these contracts are effective in managing our risk.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

2004 VS 2003 ANNUAL OVERVIEW

SALES OF $5.1 BILLION

Sales in 2004 amounted to $5,115 million, a decrease of $52 million over sales of $5,167 million in 2003. This decrease is attributable to the negative impact of a 7% decline in the year-over-year average value of the U.S. dollar relative to the Canadian dollar, partially offset by higher shipments for the majority of our products and higher average selling prices for lumber, pulp and packaging products.

     Overall, our U.S. dollar denominated average transaction prices for 2004 were higher than those of 2003 due to significantly higher average selling prices for lumber as well as higher average selling prices for pulp and packaging products. Our U.S. dollar denominated average transaction prices for papers in 2004 were below those of 2003.

OPERATING PROFIT OF $49 MILLION

Cost of sales increased by $46 million or 1% in 2004 compared to 2003. This increase mainly reflects higher shipments for the majority of our products, higher costs, particularly for purchased wood and freight, as well as higher duties on our softwood lumber exports to the U.S. These factors were partially offset by the positive impact of a weaker U.S. dollar on our U.S. dollar denominated costs as well as savings realized from restructuring activities.

     Selling, general and administrative (SG&A) expenses decreased by $13 million or 4% in 2004 compared to 2003. Excluding specified items, SG&A decreased by $19 million or 6% in 2004 compared to 2003. This decrease is attributable to the $11 million impact of higher royalty revenues relating to a license (expiring in May 2007) granted for the use of our wood preserving patent as well as the positive impact of a weaker U.S. dollar on our U.S. dollar denominated costs.

     Operating profit in 2004 amounted to $49 million compared to an operating loss of $95 million in 2003. Excluding specified items, operating profit totaled $66 million in 2004 compared to $126 million in 2003. This decrease in operating profit excluding specified items is largely attributable to the $175 million negative impact of a weaker U.S. dollar (including

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MANAGEMENT’S DISCUSSION AND ANALYSIS

the effect of our hedging program), higher costs, particularly for purchased wood and freight, as well as higher softwood lumber duties. Partially offsetting the effect of higher costs and a weaker U.S. dollar were higher average selling prices for lumber, pulp and packaging products as well as higher overall shipments for the majority of our products, savings realized from restructuring activities and lower amortization expense.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

As a result of the above-mentioned factors, EBITDA for 2004 compared to 2003 was as follows:

SPECIFIC COST REDUCTION INITIATIVES

At the beginning of 2004, we announced plans to strengthen our quality and profitability improvement (Q&P) programs through a two-pronged program aimed at improving our results by $200 million by the end of 2005. The first goal was to improve the profitability of our Canadian pulp and paper operations by $50 million. The second goal was to increase our profitability by $150 million through improvements in volume/mix and cost reductions. Due to the volatility of our current business environment, we have decided to refocus the program and aim to deliver on specific cost reduction initiatives. Although our Q&P programs are an integral part of our management approach, we wanted to focus on cost reduction initiatives.

     These initiatives aim to achieve a run-rate of $100 million in cost reductions at the end of 2005. As at December 31, 2004, we have achieved a run-rate of $30 million in savings stemming from the restructuring of our Canadian pulp and paper operations announced in the first quarter of 2004. Although cost reductions will continue throughout 2005, the full impact of these actions will only be reflected in our 2006 results. Among the difficult but necessary decisions taken to allow the achievement of this objective, we find, among others:

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MANAGEMENT’S DISCUSSION AND ANALYSIS

The complete implementation of these measures will reduce our total workforce by 8%. The announcement of the indefinite closure of the pulp mill, one paper machine and its sheeter at our Cornwall paper mill, which will impact 390 positions, is not included in the 8% workforce reduction.

NET LOSS OF $42 MILLION

Net loss for 2004 amounted to $42 million ($0.19 per common share) compared to a net loss of $193 million ($0.86 per common share) in 2003. Excluding specified items, net loss amounted to $33 million ($0.15 per common share) compared to $10 million ($0.05 per common share) in 2003. The decline in net earnings excluding specified items was attributable to the factors mentioned above as well as to lower income tax recovery, partially offset by lower financing expenses.

LIQUIDITY AND CAPITAL

Cash flows provided from operating activities in 2004 amounted to $122 million compared to $348 million in 2003. Additions to property, plant and equipment amounted to $204 million in 2004 compared to $236 million in 2003. We posted a negative free cash flow¹ of $41 million compared to positive $123 million in 2003. This was due to the continued weakness of the U.S. dollar relative to the Canadian dollar, the impact of higher costs across our operations and higher working capital requirements.

     Our total long-term debt decreased by $25 million, largely due to the $127 million positive impact of a weaker U.S. dollar on our U.S. dollar denominated debt, partially offset by net borrowings of $102 million. Our net debt-to-total capitalization ratior ² as at December 31, 2004 stood at 49.5% compared to 48.4% as at December 31, 2003.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Q4 2004 vs Q4 2003 QUARTERLY OVERVIEW

SALES OF $1.2 BILLION

Sales in the fourth quarter of 2004 amounted to $1,209 million, an increase of $32 million over sales of $1,177 million in the fourth quarter of 2003. This increase is mainly attributable to higher average selling prices for the majority of our products except for hardwood pulp. Partially mitigating this rise in sales was the negative impact of a 7% decline in the quarter-over-quarter average value of the U.S. dollar relative to the Canadian dollar.

     Overall, our U.S. dollar denominated average transaction prices for the fourth quarter of 2004 were higher than those of the fourth quarter of 2003 due to significantly higher average selling prices for lumber and higher average selling prices for papers, softwood pulp and packaging products.

OPERATING LOSS OF $12 MILLION

Cost of sales increased by $10 million or 1% in the fourth quarter of 2004 compared to the fourth quarter of 2003. This increase mainly reflects higher shipments, as well as higher overall costs for purchased wood, fiber, chemicals, freight and energy. These factors were partially offset by the positive impact of a weaker U.S. dollar on our U.S. dollar denominated costs as well as savings realized from restructuring activities.

     SG&A expenses decreased by $7 million or 8% in the fourth quarter of 2004 compared to the fourth quarter of 2003. Excluding specified items, SG&A decreased by $4 million or 5% in the fourth quarter of 2004 compared to the fourth quarter of 2003. The decrease in SG&A excluding specified items was mainly attributable to higher royalty revenues relating to a license granted for the use of our wood preserving patent as well as the positive impact of a weaker U.S. dollar on our U.S. dollar denominated costs.

     Operating loss in the fourth quarter of 2004 amounted to $12 million compared to an operating loss of $265 million in the fourth quarter of 2003. Excluding specified items, operating loss totaled $2 million in the fourth quarter of 2004 compared to an operating loss of $33 million in the fourth quarter of 2003. This improvement in operating profit excluding specified items is largely attributable to higher average selling prices for the majority of our products except for hardwood pulp as well as savings realized from restructuring activities and lower amortization expense. The improvement in operating profit was partially mitigated by the negative impact of a weaker U.S. dollar (including the effect of our hedging program) and higher overall costs, particularly for purchased wood, fiber and chemicals.

     As a result of the above-mentioned factors, EBITDA in the fourth quarter of 2004 amounted to $90 million compared to $55 million in the fourth quarter of 2003.

     Net loss in the fourth quarter of 2004 amounted to $26 million ($0.11 per common share) compared to $231 million ($1.01 per common share) in the fourth quarter of 2003.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Excluding specified items, net loss amounted to $20 million ($0.09 per common share), a $23 million improvement over a net loss of $43 million ($0.19 per common share) in the fourth quarter of 2003. This improvement was due to the above-mentioned factors and a decrease in financing expenses, partially offset by a decrease in income tax recovery.

Papers

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MANAGEMENT’S DISCUSSION AND ANALYSIS

SALES AND OPERATING PROFIT

Sales in our Papers business amounted to $2,891 million in 2004, a decrease of $143 million or 5% in comparison to 2003. This decrease was mainly attributable to the negative impact of a weaker U.S. dollar and overall lower average selling prices for paper, partially offset by higher shipments for paper and pulp and higher average selling prices for pulp.

     Operating loss in our Papers business totaled $8 million in 2004 (or $5 million when excluding specified items) compared to an operating loss of $93 million (or an operating profit of $126 million when excluding specified items) in 2003. Excluding specified items, the decrease of $131 million in operating profit is largely the result of the negative impact of a weaker U.S. dollar, higher purchased wood and freight costs and lower average selling prices for papers. Partially offsetting these factors were higher shipments for paper and pulp, higher average selling prices for pulp, savings realized from restructuring activities and lower amortization expense.

PRICING ENVIRONMENT

In our Papers business, our average transaction prices, denominated in U.S. dollars, decreased in 2004 compared to 2003. Within Canada, the decline of the U.S. dollar negatively impacted our Canadian dollar denominated prices, which are derived from U.S. dollar denominated prices.

     Our average transaction prices for our basket of copy and offset grades decreased on average by approximately US$5/ton in 2004 compared to 2003. However, our average transaction prices for copy 20 lb sheets and offset 50 lb rolls, which represented approximately 40% of our paper sales in 2004 in terms of shipments, were higher on average by US$13/ton and US$23/ton, respectively, in 2004 compared to 2003.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Our average transaction prices for Northern Bleached Softwood Kraft (NBSK) pulp increased by US$69/tonne and our average transaction prices for Northern Bleached Hardwood Kraft (NBHK) pulp increased by US$2/tonne in 2004 compared to 2003. We announced a US$30/tonne price increase for softwood and hardwood pulp effective February 1, 2005.

OPERATIONS

Our paper shipments increased by 63,000 tons in 2004 compared to 2003. Our paper shipments to capacity ratio stood at 95% for 2004 compared to 91% in 2003. This improvement is mainly attributable to the fact that, in 2003, our Papers business had been impacted by weak economic conditions, our decision to both curtail production to match customer demand and end the practice of selling seconds, labor issues, and the impact of production disruptions caused by the mid-August 2003 power outage in the eastern United States and eastern Canada.

     In November 2003, employees at our Vancouver paper mill went on strike after rejecting our offer for the renewal of their collective agreement. In January 2004, the strike was resolved and a new five-year labor agreement was signed with the Communications, Energy and Paperworkers Union of Canada. The mill resumed operations in early February 2004.

     Negotiations are ongoing for the renewal of certain collective agreements that expired between April 2004 and September 2004 for our Cornwall, Ottawa-Hull, Espanola and Lebel-sur-Quévillon mills. The collective agreement at our Windsor mill will expire in April 2005.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

INITIATIVES

In January 2004, we proceeded with our plan to reorganize production activities at our Vancouver paper mill to adjust our production to customer demand and increase the mill’s profitability. Accordingly, we shut down one of the mill’s two paper machines and restructured the activities of the other to optimize manufacturing of our Domtar Luna coated paper. This process resulted in the permanent curtailment of 45,000 tons of paper manufacturing capacity and the elimination of 85 permanent positions.

     In the first quarter of 2004, we continued to implement best practices at our Cornwall, Espanola, Ottawa-Hull, Port Huron and Windsor mills. In all, 330 positions will be affected over the course of 2004 to 2006. In order to accomplish this plan, we will invest approximately $11 million in capital expenditures in 2005 and 2006. Once fully implemented, these initiatives, in conjunction with the reorganization of operations at our Vancouver paper mill, are expected to generate annual savings of approximately $50 million. As at December 31, 2004, the implementation of this initiative was on track and we have achieved savings of $30 million on an annualized basis.

     In line with the continued implementation of best practices across our operations, we announced further initiatives in the fourth quarter of 2004 aimed at improving our competitive position and operational flexibility. We announced the temporary closure of the pulp mill, one paper machine and its sheeter at our Cornwall mill, effective March 8, 2005, until economic and market conditions allow these assets to operate profitably. This resulted in a temporary production curtailment of 150,000 tons of pulp and 85,000 tons of paper, and will impact approximately 390 positions. We further announced that 400 permanent positions mainly related to our paper operations as well as management and staff functions will be eliminated by the end of 2005. These mesures, in conjunction with the restructuring of our lumber operations in northeastern Ontario, should generate additional annualized savings of approximately $50 million.

     In addition, with respect to our capital expenditures program, we pursued investments in the roll-out of an Enterprise Resource Planning (ERP) system and a paper logistics management system with the goal of improving the quality and efficiency of our services.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Paper merchants

SALES AND OPERATING PROFIT

Our Paper Merchants business generated sales of $1,057 million, a decrease of $17 million or 2% in comparison to 2003. This decrease was attributable to the negative impact of a weaker U.S. dollar and lower average paper selling prices, partially offset by higher shipments.

      Operating profit totaled $20 million in 2004, or $21 million when excluding specified items (reflecting an operating margin of 2.0%), compared to $20 million (reflecting an operating margin of 1.9%) in 2003. The $1 million increase in operating profit excluding specified items was primarily due to higher shipments, partially offset by the negative impact of a weaker U.S. dollar.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Wood

SALES AND OPERATING PROFIT

Sales in our Wood business amounted to $541 million, an increase of $104 million over sales of $437 million in 2003. This increase is largely due to a significant rise in average selling prices for lumber and higher shipments, partially offset by the negative impact of a weaker U.S. dollar.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Operating loss in our Wood business totaled $27 million (or $13 million when excluding specified items) in 2004 compared to an operating loss of $68 million (or $66 million when excluding specified items) in 2003. The $53 million reduction in operating loss when excluding specified items was largely the result of significantly higher average selling prices for lumber, partially offset by the negative impact of a weaker U.S. dollar, higher softwood lumber duties, higher road construction and maintenance costs and higher amortization expense.

     Cash deposits of $69 million were made on our softwood lumber exports to the U.S. in 2004 compared to $45 million in 2003. Since May 22, 2002, cash deposits of $145 million (US$105 million) for countervailing and antidumping duties have been made and expensed by Domtar (at a stable rate of 27.22%). As of January 1, 2005, cash deposits for countervailing and antidumping duties are being made and expensed by Domtar at a new rate of 20.95%.

PRICING ENVIRONMENT

Our average transaction prices for Great Lakes 2x4 studs and random lengths increased by US$92/MFBM and US$124/MFBM, respectively, in 2004 compared to 2003. Our Canadian dollar denominated prices rose by a lesser amount, given that these are derived from U.S. dollar denominated prices.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OPERATIONS

During the first quarter of 2004, we created a 50-50 joint venture with Gogama Forest Products Ltd. to form a fully integrated sawmill, kiln and planer operation in northern Ontario that will produce approximately 60 million board feet per year of lumber previously dried and dressed at our Sault Ste. Marie planer facility.

     Throughout 2004, certain of our operations were negatively impacted by temporary mill closures, which were beyond our control. Production at our White River sawmill, which was halted in mid-2003, reopened only in late February 2004. In addition, our Timmins sawmill and Gogama joint venture were affected by labor disruptions at transportation suppliers. Operations at our Chapleau sawmill were reduced to one shift, effective April 30, 2004, due to a substantial reduction in fiber supply availability. Furthermore, in the third quarter of 2004, we announced a temporary halt to woodland operations in our Val d’Or and Malartic forests, effective October 4, 2004, due to a shortage of logs resulting from a dispute between the Algonquin communities of Lac Simon and Winneway and the Government of Quebec. This temporary halt lasted for six weeks.

     In early 2005, we announced, in conjunction with Tembec Inc. (Tembec), the restructuring of our northeastern Ontario sawmill operations, resulting in the permanent closure of our Chapleau sawmill as of March 6, 2005 and an investment in a new finger-jointed plant with Tembec, to be located on the current site of Tembec’s Kirkland Lake sawmill, which is slated for closure. This measure will impact approximately 67 permanent positions. This initiative arose from a review of our northeastern Ontario sawmill operations in light of prevailing challenging conditions, namely higher energy costs, a declining U.S. dollar and countervailing

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MANAGEMENT’S DISCUSSION AND ANALYSIS

and antidumping duties on softwood lumber exports to the United States. This initiative will allow us to add a third shift at our Elk Lake sawmill in April 2005 to process fiber that will become available after the closure of the Tembec sawmill at Kirkland Lake.

     Throughout 2003, extended holiday shutdowns taken at several mills in order to avoid inventory buildups in a declining product-pricing environment negatively impacted our operations. In addition, certain of our operations were negatively impacted by temporary and permanent mill closures. Our Ste-Marie sawmill was closed in 2002 due to the Canada-U.S. softwood lumber dispute and reopened only at the end of May 2003, and our Grand-Remous sawmill ceased operations in 2002 due to a dispute between the Barriere Lake First Nation and the Governments of Quebec and Canada and reopened only at the end of April 2003. The sale of the Sault Ste. Marie hardwood lumber facility in March 2003, and the Daveluyville remanufacturing facility in April 2003, as well as the closure of the Sault Ste. Marie planer facility in August 2003 due to its non-cost competitiveness, also impacted our operations negatively in 2003. Furthermore, production at our White River sawmill was halted in mid-2003 due to difficult market conditions and overcapacity within the North American market as well as the Canada-U.S. softwood lumber dispute.

     Finally, we continued to pursue specific modernization projects at our facilities aimed at improving profitability in our Wood business. In 2004, the Matagami, Ste-Marie, Timmins and Malartic facilities achieved productivity improvement gains in comparison to 2003. We will continue to examine opportunities to further improve the profitability of our Wood business through additional cost reductions and strategic initiatives.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Packaging

SALES AND OPERATING PROFIT

Our 50% share of Norampac’s sales amounted to $626 million in 2004, an increase of $4 million or 1% compared to 2003. This increase was mainly due to higher average selling prices for both containerboard and corrugated containers, partially offset by the negative impact of a weaker U.S. dollar.

     Our 50% share of Norampac’s operating profit amounted to $53 million in 2004 (or $52 million when excluding specified items) compared to $48 million in 2003. This $4 million or 8% increase in operating profit when excluding specified items is mainly attributable to higher average selling prices for both containerboard and corrugated containers and lower energy costs, partially offset by the negative impact of a weaker U.S. dollar and higher freight costs.

PRICING ENVIRONMENT

Norampac’s average Canadian dollar net selling prices for containerboard products increased by 2% in 2004 compared to 2003, as the increase in U.S. dollar pricing more than offset the decline in the U.S. dollar. Norampac’s average Canadian dollar net selling prices for corrugated boxes remained relatively stable in 2004 compared to 2003. Since the beginning of 2004, several price increases were realized for both containerboard and corrugated containers.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OPERATIONS

Norampac’s North American integration level, the percentage of containerboard produced by Norampac that is consumed by its own box plants, increased to 64% in the fourth quarter of 2004, up from 60% in the fourth quarter of 2003.

     Containerboard production at the Burnaby mill restarted in early-December after the strike that began in April 2004 was resolved.

     During the year, Norampac acquired two corrugated products plants in Thomson, Connecticut and Lancaster, New York.

     During the second quarter of 2004, Norampac announced the closure, slated for the first quarter of 2005, of its Concord, Ontario corrugated product plant, aimed at improving efficiency and profitability.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Financing expenses
and income taxes

FINANCING EXPENSES

In 2004, financing expenses amounted to $148 million (or $153 when excluding specified items of $5 million relating to our proportionate share of Norampac’s foreign exchange gain on the translation of a portion of its long-term debt) compared to $169 million in 2003 (or $161 million when excluding specified items of $9 million relating to our proportionate share of Norampac’s foreign exchange gain on the translation of a portion of its long-term debt and $17 million relating to refinancing costs). This $8 million decrease in financing expenses when excluding specified items is largely due to the positive impact of a weaker U.S. dollar on our U.S. dollar interest expense.

INCOME TAXES

In 2004, our income tax recovery totaled $52 million compared to an income tax recovery of $67 million in 2003. The variation in our income tax recovery results from a combination of factors, including the relative effect of permanent differences in a minimal profit/loss situation, the mix and level of earnings subject to different tax jurisdictions and differences in tax rates applicable to our foreign subsidiaries. A tax recovery adjustment of $4 million recorded in the second quarter of 2004 following the reassessment of prior years by tax authorities further explains the variation in the income tax recovery.

Balance sheet

Our total consolidated assets were $5,688 million as at December 31, 2004 compared to $5,848 million as at December 31, 2003. Receivables amounted to $233 million as at December 31, 2004, an increase of $36 million when compared to $197 million as at December 31, 2003. This increase reflects higher sales in December 2004 compared to December 2003, mainly due to higher average selling prices for all our major products, partially offset by the impact of a weaker U.S. dollar on our U.S. dollar denominated receivables. Total inventories as at December 31, 2004 were $723 million, an increase of $53 million when compared to $670 million as at December 31, 2003. This increase mainly reflects higher levels of raw materials (roundwood inventory) held at the sawmills due to a longer work period in December 2004 compared to December 2003 and a carrier strike, as well as to higher production levels compared to shipments. This increase in inventory was partially offset by the impact of a weaker U.S. dollar on our U.S. dollar denominated inventories. Property, plant and equipment as at December 31, 2004 totaled $4,215 million

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MANAGEMENT’S DISCUSSION AND ANALYSIS

compared to $4,533 million as at December 31, 2003. This $318 million decrease was mainly due to a greater level of amortization expense compared to capital expenditures and the impact of a weaker U.S. dollar on our U.S. mill assets. Other assets stood at $265 million as at December 31, 2004 compared to $212 million as at December 31, 2003. This $53 million increase was mainly attributable to higher funding of our pension assets compared to pension expense and a reclassification of investment tax credits receivable.

     Trade and other payables were $654 million as at December 31, 2004, an increase of $2 million compared to $652 million as at December 31, 2003. This increase is mainly attributable to provisions for restructuring costs, mitigated by the timing of payments and purchases in December 2004 versus December 2003 and the impact of a weaker U.S. dollar on our U.S. dollar denominated trade and other payables. Long-term debt (including the portion due within one year) was $2,034 million as at December 31, 2004, a decrease of $25 million compared to $2,059 million as at December 31, 2003. This decrease is mainly attributable to the positive impact of a weaker U.S. dollar on our U.S. dollar denominated debt, partially offset by additional net borrowings. Accumulated foreign translation adjustments were negative $190 million as at December 31, 2004 compared to negative $145 million as at December 31, 2003. This variation reflected the net impact of a weaker U.S. dollar on the net assets of our self-sustaining U.S. subsidiaries, or $141 million, net of the impact of a weaker U.S. dollar on the long-term debt designated as a hedge of the above-mentioned net assets, or $117 million, and its corresponding income tax effect of $21 million.

Liquidity and
capital resources

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Our principal cash requirements are for working capital, capital expenditures, principal and interest payments on our debt and dividend payments. We expect to fund our liquidity needs primarily with internally generated funds from our operations and, to the extent necessary, through borrowings under our revolving credit facility. We also have the ability to fund liquidity requirements through the issuance of debt and/or equity. The availability and cost of debt financing is dependent, among other things, upon our credit ratings.

OPERATING ACTIVITIES

Cash flows provided from operating activities totaled $122 million in 2004 compared to $348 million in 2003. This $226 million decrease mainly reflects increased requirements for working capital, primarily due to receivables and inventory fluctuations and the above-mentioned decrease in EBITDA. Our operating cash flow requirements are primarily for salaries and benefits, the purchase of fiber, energy and raw materials and other expenses such as property taxes.

     In the first quarter of 2004, we terminated, prior to maturity, interest rate swap contracts, which were initially designated as a hedge of the fair value of the 5.375% notes due November 2013 for net cash proceeds of $20 million (US$15 million). The resulting gain of $17 million, recorded under “Other liabilities and deferred credits”, is being amortized over the original designated hedging period of the underlying 5.375% notes due in November 2013.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

INVESTING ACTIVITIES

Cash flows used for investing activities totaled $183 million in 2004, compared to $238 million in 2003. This $55 million decrease in cash flows used for investing activities was mainly due to lower additions to property, plant and equipment ($204 million in 2004 compared to $236 million in 2003) and higher proceeds on disposals of property, plant and equipment ($41 million in 2004 compared to $11 million in 2003) due to sales of surplus land. These factors were partially offset by an increase in cash flows used for Norampac’s business acquisitions. We intend to limit our annual capital expenditures to below 75% of amortization. Capital expenditures required to maintain existing operations are expected to amount to approximately $125 million in 2005.

     Free cash flow in 2004 was negative $41 million compared to positive $123 million in 2003, reflecting a deterioration of $164 million due mainly to reduced operating cash flows as a result of the above-mentioned factors.

FINANCING ACTIVITIES

In 2004, cash flows provided from financing activities amounted to $64 million compared to cash flows used for financing activities of $96 million in 2003. This increase is largely due to higher borrowings made under our revolving credit facility and lower net repayments made on our long-term debt.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

As at December 31, 2004, our net debt-to-total capitalization ratio stood at 49.5% compared to 48.4% as at December 31, 2003. Net indebtedness, including $174 million representing our 50% share of the net indebtedness of Norampac, was $2,004 million as at December 31, 2004. This compares to $2,030 million as at December 31, 2003, including $180 million for our 50% share of the net indebtedness of Norampac. The $26 million decrease in net indebtedness was largely due to the positive impact of a weaker U.S. dollar on our U.S. dollar denominated debt, partially offset by increased borrowings under our revolving credit facilities.

     We have a bank credit facility comprised of a US$71 million ($86 million) bank term loan as at December 31, 2004 compared to US$76 million ($99 million) as at December 31, 2003 and a US$500 million revolving credit facility. The term loan bears interest based on the U.S. dollar LIBOR rate or the U.S. prime rate, plus a margin that varies with Domtar’s credit rating.

     As at December 31, 2004, US$112 million ($135 million) was drawn, US$9 million ($10 million) of letters of credit was outstanding and no amounts were drawn in the form of bank overdraft and included in “Bank indebtedness” under the US$500 million revolving credit facility, resulting in US$379 million ($456 million) of availability for future drawings. A provision of $5 million was recorded related to the letters of credit. As at December 31, 2003, US$23 million ($30 million) was drawn, US$8 million ($10 million) of letters of credit was outstanding and US$5 million ($7 million) was drawn in the form of bank overdraft and included in “Bank indebtedness”, resulting in US$464 million ($600 million) of availability under this facility. Borrowings under this revolving credit facility bear interest at a rate based on the Canadian dollar bankers’ acceptance or prime rate, or the U.S. dollar LIBOR rate or prime rate, plus a margin that varies with Domtar’s credit rating. This bank facility also requires commitment fees in accordance with standard banking practices.

     Our borrowing agreements contain restrictive covenants. In particular, our unsecured bank credit facility contains covenants that require compliance with certain financial ratios on a quarterly basis. In addition, the indentures related to the 10% and 10.85% debentures limit the amount of dividends that may be paid, the amount of shares that may be repurchased for cancellation and the amount of new long-term debt that may be incurred.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

CREDIT RATINGS

The above ratings represent a risk assessment of our public unsecured debt securities. The rating by Dominion Bond Rating Service is the fourth most favourable rating in terms of quality within ten rating gradations with the “low” indicating a ranking in the lower end of this rating category. The rating by Moody’s is the fourth most favourable rating in terms of quality within nine rating gradations with the numerical modifier 3 indicating a ranking in the lower end of this rating category. The rating by Standard & Poor’s is the fourth most favourable rating in terms of quality within ten rating gradations with the “minus” indicating a ranking in the lower end of this rating category. Both Moody’s and Standard & Poor’s have a “negative outlook” with respect to our credit ratings.

     A reduction in our credit ratings could impact our access to and cost of capital and financial flexibility in the future. The above ratings are not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the above rating agencies.

     In 2004, common shares amounting to $19 million were issued pursuant to our stock option and share purchase plans versus $15 million in 2003. We did not purchase for cancellation any of our common shares in either of the years ended December 31, 2004 or December 31, 2003.

     As at February 28, 2005, we had 230,408,313 common shares, 69,576 Series A Preferred Shares and 1,470,000 Series B Preferred Shares issued and outstanding.

     As at February 28, 2005, we had 5,215,929 common share purchase options issued and outstanding under the Executive stock option and Share purchase plan.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OFF BALANCE SHEET ARRANGEMENTS

In the normal course of business, we finance certain of our activities off balance sheet through leases and securitizations.

LEASES

On an ongoing basis, we enter into operating leases for property, plant and equipment. Minimum future rental payments under these operating leases, determined as at December 31, 2004, amounted to $136 million, of which $30 million related to our proportionate 50% share of Norampac.

SECURITIZATIONS

The Corporation sells a portion of its Canadian and U.S. receivables through securitization programs. The Corporation uses securitization of its receivables as a source of financing by reducing its working capital requirements. This securitization consists of the sale of receivables, or the sale of senior beneficial interest in them, to special purpose trusts managed by financial institutions for multiple sellers of receivables. The agreements normally allow the daily sale of new receivables to replace those that have been collected. They also limit the cash that can be received from the sale of the senior beneficial interest. The subordinate interest retained by the Corporation is included in “Receivables” and will be collected only after the senior beneficial interest has been settled.

     As at December 31, 2004, the value of securitized receivables amounted to $236 million compared to $227 million as at December 31, 2003. The Corporation expects to continue to sell receivables on an ongoing basis, given the attractive discount rates. Should it decide to discontinue these programs, its working capital and bank debt requirements would increase. Such sales of receivables are contingent upon retaining specified credit ratings. The loss of such ratings would, absent appropriate waivers, increase working capital and bank debt requirements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

GUARANTEES

INDEMNIFICATIONS

In the normal course of business, the Corporation offers indemnifications relating to the sale of its businesses and real estate. In general, these indemnifications may relate to claims from past business operations, the failure to abide by covenants and the breach of representations and warranties included in the sales agreements. Typically, such representations and warranties relate to taxation, environmental, product and employee matters. The terms of these indemnification agreements are generally for an unlimited period of time. As at December 31, 2004, the Corporation is unable to estimate the potential maximum liabilities for these types of indemnification guarantees as the amounts are contingent upon the outcome of future events, the nature and likelihood of which cannot be reasonably estimated at this time. Accordingly, no provisions have been recorded in the financial statements. These indemnifications have not yielded significant expenses in the past.

PENSION PLANS

We have indemnified and held harmless the trustees of Domtar’s pension funds, and the respective officers, directors, employees and agents of such trustees, from any and all costs and expenses arising out of the performance of their obligations under the relevant trust agreements, including in respect of their reliance on authorized instructions of Domtar or for failing to act in the absence of authorized instructions. These indemnifications survive the termination of such agreements. As at December 31, 2004, we had not recorded a liability associated with these indemnifications, as we do not expect to make any payments pertaining to these indemnifications.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

E.B. EDDY ACQUISITION

On July 31, 1998, the Corporation acquired all of the issued and outstanding shares of E.B. Eddy Limited and E.B. Eddy Paper, Inc. (E.B. Eddy), an integrated producer of specialty paper and wood products. The purchase agreement includes a purchase price adjustment whereby, in the event of the acquisition by a third party of more than 50% of the shares of the Corporation in specified circumstances, the Corporation may have to pay up to a maximum of $120 million, an amount which is gradually declining over a 25-year period. As at December 31, 2004, the maximum amount of the purchase price adjustment was $110 million. No provision was recorded related to this potential purchase price adjustment, as the Corporation does not expect to make any payments pertaining to this purchase price adjustment.

DEBT AGREEMENTS

Certain debt agreements require the Corporation to indemnify the parties in the event of changes in elements such as withholding tax regulations. As the nature and scope of such indemnifications is contingent on future events, none of which can be foreseen as at December 31, 2004, and the structure of such transactions make these events unlikely, no provisions have been recorded in the financial statements.

LEASES

The Corporation has guaranteed to various lessors $8 million of residual value of its assets under operating leases with expiry dates in 2006. If the fair value of the assets at the end of the lease terms is lower than the residual value guaranteed, the Corporation would be held liable for the shortfall. The Corporation’s management does not believe that these are likely to be called upon and, as such, no provisions have been recorded in the financial statements with respect to these guarantees.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

CONTRACTUAL OBLIGATIONS
AND COMMERCIAL COMMITMENTS

In the normal course of business, we enter into certain contractual obligations and commercial commitments. The following tables provide our obligations and commitments as at December 31, 2004:

For 2005 and the foreseeable future, we expect cash flows from operations and from our various sources of financing to be sufficient to meet our contractual obligations and commercial commitments.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Selected quarterly financial information

Selected quarterly financial information for the eight most recently completed quarters ending December 31, 2004 is disclosed above.

     Sales and operating profit experienced a steady decline throughout 2003. This was mainly in line with the steady weakening of the U.S. dollar and continued low selling prices. In addition, lower shipments further impacted our results during this period. Our quality and profitability improvement programs initiated in 2002 were hampered by difficult market conditions in 2003, but did enable us, when excluding the impact of lower volumes, to more than offset the impact of inflation on salaries and benefits.

     The first quarter of 2004 started in much the same fashion as the fourth quarter of 2003, mostly due to the impact of higher shipments and sustained efforts to reduce costs being offset by lower selling prices. However, the second and third quarters of 2004 showed a marked improvement, despite the continued weakening of the U.S. dollar, due to higher average selling prices for all our products as price increases were being implemented. Our paper shipments have remained relatively stable from the beginning of the year through to the third quarter of 2004. The fourth quarter of 2004 was weak, as demand for the majority of our products slowed, the weakness of the U.S. dollar continued to impact our results and we continued to face high costs for fiber and energy usage. Shipments for papers, lumber and

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MANAGEMENT’S DISCUSSION AND ANALYSIS

corrugated containers for the fourth quarter of 2004 were lower than the third quarter, mainly due to seasonally weaker demand. Typically, second and third quarters are seasonally stronger in terms of results, as demand normally picks up during the spring and summer months.

     In light of the volatility in our current business environment (weakness of the U.S. dollar, high costs for freight and purchased wood and the ongoing Canada – U.S. softwood lumber dispute), we decided to refocus on specific cost reduction initiatives aimed at achieving a run-rate of $100 million in cost reductions by the end of 2005. In addition, we will continue to work on improving both our volumes and mix.

2003 COMPARED TO 2002

Sales in 2003 amounted to $5,167 million, down $692 million or 12% from sales of $5,859 million in 2002. This decrease was mainly attributable to the effect of an 11% rapid decline in the year-over-year average value of the U.S. dollar relative to the Canadian dollar (approximate $490 million impact, including the effect of our hedging program) as well as lower shipments for the majority of our products, except corrugated containers, caused

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MANAGEMENT’S DISCUSSION AND ANALYSIS

primarily by weak demand (approximate $150 million impact). Overall, our U.S. dollar denominated average transaction prices for 2003 were unchanged in comparison to 2002 and remained low compared to historical average prices. Within Canada, however, the decline of the U.S. dollar negatively impacted our Canadian dollar denominated prices, which are derived from U.S. dollar denominated prices.

     Cost of sales decreased by $351 million in 2003 or 7% compared to 2002. This decrease was mainly due to the impact of a weaker U.S. dollar on our U.S. dollar denominated operating expenses, lower shipments and the impact of our quality and profitability improvement programs. These factors were partially offset by higher energy costs and the inclusion in 2003 ($10 million) of fewer investment tax credits related to research and development expenses from current and prior years compared to 2002 ($16 million). The 2002 results were impacted by the reversal of a $28 million provision, of which $8 million was recorded in the first quarter of 2002 and $20 million was recorded in the second half of 2001, for countervailing and antidumping duties pertaining to the Canada-U.S. softwood lumber dispute.

     SG&A expenses decreased by $10 million or 3% (or $6 million or 2% when excluding specified items) in 2003 compared to 2002. This mainly reflected the impact of a weaker U.S. dollar on our U.S. dollar denominated costs. Lower employee profit-sharing expenses in 2003 compared to 2002 and other cost reduction initiatives also contributed to the decrease in SG&A. These factors were partially offset by an increase in stock-based compensation and pension expenses.

     Operating loss was $95 million in 2003 compared to an operating profit of $384 million in 2002. Excluding specified items, operating profit amounted to $126 million in 2003, down $321 million or 72% from an operating profit excluding specified items of $447 million in 2002. This decrease was largely due to the $222 million impact of the weaker U.S. dollar (including the effect of our hedging program), lower shipments for the majority of our products, except corrugated containers, higher energy costs and higher countervailing and antidumping duties on our softwood lumber exports to the U.S. However, the positive impact of our quality and profitability improvement programs, when excluding the impact of lower shipments, allowed us to more than offset the impact of inflation on salaries and benefits.

     As a result of the above-mentioned factors, EBITDA for 2003 amounted to $514 million compared to $809 million in 2002.

     Net loss for 2003 amounted to $193 million ($0.86 per common share) compared to net earnings of $141 million (or $0.62 per common share) in 2002. Excluding specified items, net loss amounted to $10 million ($0.05 per common share) in 2003, down $193 million from net earnings excluding specified items of $183 million ($0.80 per common share) in 2002. The year-over-year deterioration in net earnings was attributable to the factors mentioned above, partially offset by a decrease in financing expenses due to lower interest rates, the positive impact of a weaker U.S. dollar on our U.S. interest expense and lower debt levels and lower income taxes.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Cash flows provided from operating activities in 2003 amounted to $348 million compared to $677 million in 2002. Additions to property, plant and equipment amounted to $236 million in 2003 compared to $226 million in 2002. Despite difficult market conditions, we generated free cash flow of $123 million in 2003 compared to $454 million in 2002. Free cash flow generated in 2003 was applied primarily to debt reduction and the payment of dividends.

     Our total long-term debt decreased by $455 million, largely due to the $408 million positive impact of a weaker U.S. dollar on our U.S. dollar denominated debt and net repayments of $47 million. Our net debt-to-total capitalization ratio as at December 31, 2003 was 48.4% compared to 49.4% as at December 31, 2002.

Accounting changes

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND FINANCIAL STATEMENT PRESENTATION

On January 1, 2004, we adopted the new Canadian Institute of Chartered Accountants’ (CICA) Handbook Section 1100 “Generally Accepted Accounting Principles” recommendations and Section 1400 “General Standards of Financial Statement Presentation” recommendations. Section 1100 describes what constitutes Canadian GAAP and its sources and provides guidance on sources to consult when selecting accounting policies and determining appropriate disclosures when a matter is not dealt with explicitly in the primary sources of GAAP, thereby recodifying the Canadian GAAP hierarchy. Section 1400 provides general guidance on financial statement presentation and further clarifies what constitutes fair presentation in accordance with GAAP.

     Accordingly, we reclassified delivery costs as well as countervailing and antidumping duties on exports of softwood lumber to the United States from “Sales” to “Cost of sales”.

     The adoption of these recommendations had no other significant impact on the consolidated financial statements.

HEDGING RELATIONSHIPS

On January 1, 2004, we adopted the new CICA Accounting Guideline No.13 (AcG-13) “Hedging Relationships”. This accounting guideline addresses the identification, designation, documentation and effectiveness of the hedging relationships for the purpose of applying hedge accounting. In addition, it deals with the discontinuance of hedge accounting and establishes conditions for applying hedge accounting. Under this guideline, documentation of the information related to hedging relationships is required and the effectiveness of the hedges must be demonstrated and documented. As of January 1, 2004, we had in place all necessary hedge documentation to apply hedge accounting for interest rate swaps, forward foreign exchange contracts, foreign currency options and bunker oil and electricity swaps.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

For the exposure to price risk associated with sales of NBSK pulp swaps, as well as old corrugated containers, unbleached kraft linerboard and semi-chemical medium paper swaps, we do not meet the Canadian GAAP criteria for hedge effectiveness. As a result, we account for these contracts at their fair value. The fair value of these contracts is re-evaluated each quarter and a gain or loss is recorded in the Consolidated earnings. Notwithstanding the fact that these commodity swap contracts do not meet the Canadian GAAP criteria under AcG-13, we believe, from an operational and a cash flow point of view, that these contracts are effective in managing our risk. For the year ended December 31, 2004, a gain of $1 million (nil per common share) is included in “Selling, general and administrative” expenses representing the gain on the marked to market of the commodity swaps.

ASSET RETIREMENT OBLIGATIONS

On January 1, 2004, we adopted retroactively with restatement of prior periods the new CICA Handbook Section 3110 “Asset Retirement Obligations”, which requires entities to record a liability at fair value, in the period in which it incurs a legal obligation associated to the retirement of an asset. The associated costs are capitalized as part of the carrying value of the related asset and depreciated over its remaining useful life. The liability is accreted using a credit adjusted risk-free interest rate. Section 3110 is analogous to Statement of Financial Accounting Standards (SFAS) 143 “Accounting for Asset Retirement Obligations”, which was adopted for U.S. GAAP purposes on January 1, 2003. Asset retirement obligations in connection with the adoption of Section 3110 were primarily linked to landfill capping obligations, asbestos removal obligations and demolition of certain abandoned buildings. For such assets, a liability is initially recognized in the period in which sufficient information exists to estimate a range of possible settlement dates. The adoption of Section 3110 has decreased the December 31, 2003 retained earnings by $3 million or $0.01 per common share (2002 - nil), decreased assets by $7 million and decreased liabilities by $4 million.

EMPLOYEE FUTURE BENEFITS

  On January 1, 2004, the CICA amended CICA Handbook Section 3461 “Employee Future Benefits”. Section 3461 requires additional disclosures on the assets, cash flows and net periodic benefit cost of defined benefit pension plans and other employee future benefit plans. The new annual disclosures are effective for years ending on or after June 30, 2004. We adopted the amendments of Section 3461 and provided additional disclosures of the defined benefit pension plans and other employee future benefit plans in the notes to the consolidated financial statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Impact of accounting pronouncements
not yet implemented

CONSOLIDATION OF VARIABLE INTEREST ENTITIES

In June 2003, the CICA issued Accounting Guideline No. 15 (AcG-15) “Consolidation of Variable Interest Entities”. AcG-15 has been revised to harmonize with the new Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46R) “Consolidation of Variable Interest Entities”. AcG-15 requires that an enterprise holding other than a voting interest in a variable interest entity (“VIE”) could, subject to certain conditions, be required to consolidate the VIE if it is considered its primary beneficiary whereby it would absorb the majority of the VIEs expected losses and/or receive the majority of its expected residual returns. In addition, AcG-15 prescribes certain disclosures for VIEs that are not consolidated but in which an enterprise has a significant variable interest. AcG-15 applies to annual and interim periods beginning on or after November 1, 2004. Effective January 1, 2004, we adopted FIN 46R on a U.S. GAAP basis. There was no initial impact on the consolidated financial statements under U.S. GAAP following the adoption of this recommendation. We do not expect this guideline to have an initial impact on our consolidated financial statements under Canadian GAAP.

FINANCIAL INSTRUMENTS

In January 2005, the CICA issued three new accounting proposed sections in relation to financial instruments: proposed Section 3855 “Financial Instruments - Recognition and measurement”, proposed Section 3865 “Hedges” and proposed Section 1530 “Comprehensive Income”. Proposed Sections 3855, 3865 and 1530 apply to fiscal years beginning on or after October 1, 2006.

     Proposed Section 3855 expands on Section 3860 “Financial Instruments - Disclosure and Presentation”, by prescribing when a financial instrument is to be recognized on the balance sheet and at what amount. It also specifies how financial instrument gains and losses are to be presented.

     Proposed Section 3865 provides alternative accounting treatments to proposed Section 3855 for entities that choose to designate qualifying transactions as hedges for accounting purposes. It replaces and expands on AcG-13 “Hedging Relationship” and the hedging guidance in Section 1650 “Foreign Currency Translation” by specifying how hedge accounting is applied and what disclosures are necessary when it is applied.

     Proposed Section 1530 introduces a new requirement to present certain revenues, expenses, gains and losses, that otherwise would not be immediately recorded in income, in a comprehensive income financial statement with the same prominence as any other financial statements that constitute a complete set of financial statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

The application of these new accounting sections for financial instruments is not expected to have a significant effect on our financial position or results of operations but will require us to present a new financial statement entitled “Comprehensive Income”.

Critical accounting policies

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect our results of operations and financial position. On an ongoing basis, management reviews its estimates, including those related to environmental matters, useful lives, impairment of long-lived assets and goodwill, pension and other employee future benefit plans, income taxes and asset retirement obligations based upon currently available information. Actual results could differ from those estimates.

     The following critical accounting policies reflect matters that contain a significant level of management estimates about future events, reflect the most complex and subjective judgments, and are subject to a fair degree of measurement uncertainty.

ENVIRONMENTAL MATTERS

Environmental expenditures for effluent treatment, air emission, landfill operation and closure, asbestos containment and removal, bark pile management, silvicultural activities and site remediation (together referred to as environmental matters) are expensed or capitalized depending upon their future economic benefit. In the normal course of business, we incur certain operating costs for environmental matters that are expensed as incurred. Expenditures for property, plant and equipment that prevent future environmental contamination are capitalized and amortized on a straight-line basis over 10 to 40 years. Provisions for environmental matters are not discounted and are recorded when remediation efforts are likely and can be reasonably determined.

     While we believe that we have determined the costs for environmental matters likely to be incurred, based on known information, our ongoing efforts to identify potential environmental concerns that may be associated with our former and present operations may lead to future environmental investigations. These efforts may result in the determination of additional environmental costs and liabilities, which cannot be reasonably estimated at this time.

     As at December 31, 2004, we had a provision of $57 million for environmental matters and other asset retirement obligations. Additional costs, not known or identifiable, could be incurred for remediation efforts. Based on policies and procedures in place to monitor environmental exposure, we believe that such additional remediation costs would not have a material adverse effect on our financial position, earnings or cash flows.

     In addition, the pulp and paper industry in the United States is subject to Cluster Rules and Boiler M.A.C.T. (maximum achievable control technology) Rules that further regulate

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MANAGEMENT’S DISCUSSION AND ANALYSIS

effluent and air emissions. We comply with all present regulations and we anticipate spending approximately $52 million over the next three years to meet such requirements.

     As at December 31, 2004, anticipated payments in each of the next five years are as follows:

In 2004, our operating expenses for environmental matters totaled $69 million and we capitalized an additional $22 million for environmental projects mainly related to the improvement of air emissions, effluent treatment as well as remedial actions taken to address environmental compliance. In 2005, we expect to capitalize approximately $27 million for environmental projects, including Cluster Rules and Boiler M.A.C.T. Rules obligations. We are not able to estimate the total amount of capital expenditures (other than Cluster Rules and Boiler M.A.C.T. Rules obligations) that may be required beyond 2005 for environmental compliance. However, we do not expect any additional required expenditure to have a material adverse effect on our financial position, earnings or cash flows.

USEFUL LIVES

Our property, plant and equipment are stated at cost less accumulated amortization, including asset impairment write-down. Interest costs are capitalized for capital projects in excess of $10 million with a duration in excess of one year. For timber limits and timberlands, amortization is calculated using the unit of production method. For all other assets, amortization is calculated using the straight-line method over the estimated useful lives of the assets.

     On a regular basis, we review the estimated useful lives of our property, plant and equipment. Assessing the reasonableness of the estimated useful lives of property, plant and equipment requires judgment and is based on currently available information. Changes in circumstances such as technological advances, changes to our business strategy, changes to our capital strategy or changes in regulation can result in the actual useful lives differing from our estimates. Revisions to the estimated useful lives of property, plant and equipment constitute a change in accounting estimate and are dealt with prospectively by amending amortization rates. A change in the remaining estimated useful life of a group of assets, or their estimated net salvage value, will affect the amortization rate used to amortize the group of assets and thus affect amortization expense as reported in our results of operations. A change of one year in the composite estimated useful life of our fixed asset base would impact annual depreciation expense by approximately $20 million.

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In 2004, we recorded total amortization expense of $368 million (or $379 million when including specified items pertaining to write-downs in the value of property, plant and equipment as a result of closures) compared to $385 million in 2003 (or $609 million when including specified items pertaining to impairment losses and closures). As at December 31, 2004, we had property, plant and equipment with a net book value of $4,215 million ($4,533 million in 2003).

     With the write-downs in the value of property, plant and equipment recorded in the fourth quarter of 2003, our future amortization expense was reduced by approximately $20 million on an annual basis.

IMPAIRMENT OF LONG-LIVED ASSETS

We review the carrying amount of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable through future operations. This is accomplished by determining whether projected undiscounted future cash flows from operations exceed the net carrying amount of the assets as of the assessment date (Step I test). Impaired assets are recorded at fair value, determined principally by using discounted future cash flows expected from their use and eventual disposition (Step II test). Estimates of future cash flows and fair value require judgment and may change over time.

     During the fourth quarter of 2004, as a result of operating losses and the potential impact that a weaker U.S. dollar may have on the results of operations, we conducted Step I of the impairment tests on most of our Canadian pulp and paper manufacturing facilities, our Wood segment and three container board mills in our Packaging segment.

     Estimates of future cash flows used to test the recoverability of a long-lived asset included key assumptions related to trend prices and the long-term forecasted exchange rate for the U.S. dollar. Other significant assumptions are the estimated useful life of the long-lived assets and the effect of the ongoing softwood lumber dispute with the United States.

     The trend prices were based on an analysis of external price trends, including RISI, as well as normalized pulp, paper, wood and unbleached kraft linerboard pricing over a business cycle at the mills subjected to the impairment tests.

     The forecasted Canadian-U.S. foreign exchange rate assumptions were based on management’s best estimate using independent market information, as well as analysis of historical data, trends and cycles. Management expects the longer-term average rate to be between CAN$1.00 = US$0.72 and CAN$1.00 = US$0.75.

     We concluded that the recognition of an impairment loss for the business units analyzed was not required.

     Certain pulp and paper and packaging mills are particularly sensitive to the key assumptions. Given the inherent imprecision and corresponding importance of the key assumptions used in the impairment test, it is reasonably possible that changes in future conditions may lead management to use different key assumptions which could require a material change in the

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net carrying amount of these assets. The total net carrying amount of these mills was $529 million as at December 31, 2004.

     During the fourth quarter of 2003, as a result of operating losses at our Lebel-sur-Quévillon pulp mill and our Wood business, we conducted impairment tests of the long-lived assets of these business units. In addition, due to the decision to close one paper machine at our Vancouver paper mill and the potential impact that a weaker U.S. dollar may have on the results of operations of our Canadian pulp and paper mills, we also conducted impairment tests of the long-lived assets of our Vancouver paper mill and other Canadian pulp and paper mills. As a result of these tests, in December 2003, we recorded an impairment loss of $201 million related to the impairment of our Lebel-sur-Quévillon pulp mill.

     In the Step II test, performed in 2003 on our Lebel-sur-Quévillon pulp mill only, the assumptions used to determine the discounted future cash flows (fair value) of the business unit were the same as those used in the Step I tests, except that future cash flows used were on an after-tax basis and were discounted at our risk-adjusted weighted average cost of capital.

GOODWILL

Goodwill is not amortized and is subject to an annual impairment test, or more frequently if events or changes in circumstances indicate that it might be impaired. Testing for impairment is accomplished mainly by determining whether the fair value of a segment, based upon discounted cash flows, exceeds the net carrying amount of that segment as of the assessment date. If the fair value is greater than the net carrying amount, no impairment is necessary. In the event that the net carrying amount exceeds the sum of the discounted cash flows, a second test must be performed whereby the fair value of the segment’s goodwill must be estimated to determine if it is less than its net carrying amount. Fair value of goodwill is estimated in the same way as goodwill was determined at the date of the acquisition in a business combination, that is, the excess of the fair value of the segment over the fair value of the identifiable net assets of the segment. Estimates of cash flows and fair value require judgment and may change.

PENSION AND OTHER EMPLOYEE FUTURE BENEFIT PLANS

Domtar contributes to several defined contribution, multi-employer and 401(k) plans. The pension expense under these plans is equal to Domtar’s contribution and represented $17 million in 2004 ($19 million in 2003). Domtar also has several defined benefit pension plans covering substantially all employees, including one closed plan for certain non-unionized employees in Canada. Non-unionized employees in Canada joining Domtar after June 1, 2000 participate in defined contribution plans. The pension expense and the obligation related to the defined benefit plans are actuarially determined using management’s most probable assumptions.

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We account for pension and other employee future benefits in accordance with CICA recommendations. As such, assumptions are made regarding the valuation of benefit obligations and performance of plan assets. Deferred recognition of differences between actual results and those assumed is a guiding principle of these recommendations. This approach allows for a gradual recognition of changes in benefit obligations and plan performance over the expected average remaining service life of the active employee group covered by the plans.

     Pension and other employee future benefit assumptions include the discount rate, the expected long-term rate of return on plan assets, the rate of compensation increase, health care cost trend rates, mortality rates, employee early retirements and terminations or disabilities. Changes in these assumptions result in actuarial gains or losses which, in accordance with CICA recommendations, we have elected to amortize over the expected average remaining service life of the active employee group covered by the plans only to the extent that the unrecognized net actuarial gains and losses are in excess of 10% of the greater of the accrued benefit obligation and the market-related value of plan assets as at the beginning of the year.

     We set our expected rate of return on plan assets annually to reflect the current view of long-term investment returns, including consideration of asset mix, equity risk premium, plan expenses and active investment management premium. A rate of return on plan assets of 7.7% was considered appropriate by our management. Pension and other employee future benefit costs for 2005 will be based on a 7.2% expected rate of return on plan assets in order to reflect our current view of long-term investment returns.

     We set our discount rate assumption annually to reflect the rates available on high-quality, fixed income debt instruments, with a duration that is expected to match the timing and amount of expected benefit payments. High-quality debt instruments are corporate bonds with a rating of AA or better. The discount rates as at December 31, 2004 for pension and other employee future benefit plans were estimated at 5.8% for the accrued benefit obligation and 6.1% for the net periodic benefit cost.

     The rate of compensation increase is another significant assumption in the actuarial model for pension (set at 3.4% for the accrued benefit obligation and 3.8% for the net periodic benefit cost) and for other employee future benefits (set at 3.5% for both the accrued benefit obligation and the net periodic benefit cost) and is determined based upon our long-term plans for such increases.

     For measurement purposes, a 7.7% weighted average annual rate of increase in the per capita cost of covered health care benefits was assumed for 2005, based on external data and our own historical trends for health care costs. The rate was assumed to decrease gradually to 4.1% by 2012 and remain at that level thereafter.

     The following table provides a sensitivity analysis of the key weighted average economic assumptions used in measuring the accrued pension benefit obligation, the accrued other employee future benefit obligation and related net periodic benefit cost for 2004. The

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sensitivity analysis should be used with caution as it is hypothetical and changes in each key assumption may not be linear. The sensitivities in each key variable have been calculated independently of each other.

SENSITIVITY ANALYSIS

The assets of the pension plans are held by a number of independent trustees and are accounted for separately in Domtar’s pension funds. Based on the fair value of the assets held at December 31, 2004, the plan assets are comprised of 5% in cash and short-term investments, 46% in bonds and 49% in Canadian, U.S. and foreign equities. The long-term asset allocation percentages are not expected to differ materially from the current composition.

     The latest actuarial valuations were conducted as at December 31, 2003 for plans representing approximately 39% of total plan asset fair value and as at December 31, 2001 for plans representing approximately 61% of total plan asset fair value. These valuations indicated a funding deficiency. Our funding policy is to contribute annually the amount required to provide for benefits earned in the year and to fund past service obligations over periods not exceeding those permitted by the applicable regulatory authorities. Past service obligations primarily arise from improvements to plan benefits. We expect to contribute for a total amount of $89 million in 2005 compared to $80 million in 2004. The next actuarial valuations will be completed between December 31, 2004 and December 31, 2006.

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INCOME TAXES

We use the asset and liability method of accounting for income taxes. Under this method, future tax assets and liabilities are determined according to differences between the carrying amounts and tax bases of the assets and liabilities. The change in the net future tax asset or liability is included in earnings and in the “Accumulated foreign currency translation adjustments” account in “Shareholders’ equity”. Future tax assets and liabilities are measured using enacted or substantively enacted tax rates and laws expected to apply in the years in which assets and liabilities are expected to be recovered or settled. For these years, a projection of taxable income and an assumption of the ultimate recovery or settlement period for temporary differences are required. The projection of future taxable income is based on management’s best estimate and may vary from actual taxable income.

     On an annual basis, we assess the need to establish a valuation allowance for future tax assets and, if it is deemed more likely than not that our future tax assets will not be realized based on these taxable income projections, a valuation allowance is recorded. As at December 31, 2004, we expect that our future tax assets will not be fully recovered from future taxable income, and we have therefore set up a valuation allowance of $5 million.

     Our future tax assets are mainly composed of temporary differences related to accounting provisions for acquisitions, restructuring, environmental matters, as well as loss carryforwards. The majority of these accruals will be utilized or paid out over the next five years. Our future tax liabilities are mainly composed of temporary differences pertaining to plant, equipment and others. Estimating the ultimate settlement period, given the amortization rates in effect are based on information as it develops, requires judgment and our best estimates. The reversal of timing differences is expected at future substantially enacted tax rates, which could change due to changes in income tax laws or the introduction of tax changes through the presentation of annual budgets by different governments. As a result, a change in the timing and the income tax rate at which the components will reverse could materially affect future tax expense as recorded in our results of operations. A one percentage point change in our reported effective income tax rate would have the effect of changing the income tax expense by approximately $15 million.

     In addition, Canadian, American and international tax rules and regulations are subject to interpretation and require judgment that may be challenged by taxation authorities. We believe that, to the best of our knowledge, we have adequately provided for our future tax consequences based upon current facts and circumstances and current tax law.

     For the year ended December 31, 2004, we recorded a total net tax recovery of $52 million (recovery of $67 million in 2003), of which $75 million was for future income tax recovery (recovery of $81 million in 2003). Our net future tax liability as at December 31, 2004 was $470 million ($502 million in 2003).

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ASSET RETIREMENT OBLIGATIONS

We recognize asset retirement obligations at fair value in the period in which we incur a legal obligation associated to the retirement of an asset. Our asset retirement obligations are principally linked to landfill capping obligations, asbestos removal obligations and demolition of certain abandoned buildings. The associated costs are capitalized as part of the carrying value of the related asset and depreciated over its remaining useful life. The liability is accreted using a credit adjusted risk-free interest rate.

     The estimate of fair value is based on the results of the expected future cash flow approach, in which multiple cash flow scenarios that reflect a range of possible outcomes are considered. We have established cash flow scenarios for each individual asset retirement obligation. Probabilities are applied to each of the cash flow scenarios to arrive at an expected future cash flow. There is no supplemental risk adjustment made to the expected cash flow. The expected cash flows for each of the asset retirement obligations are discounted using the risk-free interest rate for the corresponding period until the settlement date. The rates used vary, based on the prevailing rate at the moment of recognition of the liability and on its settlement period. The rates used vary between 4.25% and 6.80%.

     Cash flow estimates incorporate assumptions that either marketplace participants would use in their estimates of fair value, whenever that information is available without undue cost and effort, or assumptions developed by internal experts.

     As at December 31, 2004, Domtar has estimated the net present value of its asset retirement obligations at $25 million (2003 — $26 million), based on probability weighted undiscounted cash flows of $37 million (2003 — $41 million).

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Risks and uncertainties

PRODUCT PRICES AND INDUSTRY CONDITIONS

Our financial performance is sensitive to the selling prices of our products that are impacted by supply and demand.

     The markets for most paper, pulp, lumber and packaging products are cyclical and are influenced by a variety of factors beyond our control. These factors include periods of excess product supply due to industry capacity additions, periods of decreased demand due to weak general economic activity in North America or international markets, inventory de-stocking by customers and fluctuations in currency exchange rates. Demand for lumber also depends on the level of housing starts, commercial building activity and the availability and cost of mortgage financing.

     In addition, we may compete with product substitutes which can impact demand for our products. Our paper products compete with electronic transmission and document storage alternatives, as well as grades of paper we do not produce. As the use of these alternatives grows, demand for our paper products may decline or shift to other paper grades. Moreover demand for some of our wood products may decline if customers purchase steel alternatives. Demand for some of our corrugated container products may decline if customers purchase plastic alternatives. Any substantial shift in demand from our products to competing technologies or materials could have a material adverse effect on our business, financial condition and operating results.

     During periods of low prices, we have experienced in the past, and could experience in the future, reduced revenues and margins resulting in substantial declines in profitability and sometimes, net losses. See “Sensitivity Analysis”.

FOREIGN EXCHANGE

The revenues for most of our products are affected by fluctuations in the exchange rate between the Canadian dollar and the U.S. dollar. As a result, any decrease in the value of the U.S. dollar relative to the Canadian dollar reduces our profitability. Our U.S. dollar sales, net of U.S. dollar purchases for our operating activities, represent approximately US$1 billion annually (excluding Norampac). In addition, our sales in Canada are impacted by the exchange rate fluctuations, as the prices for many of our products are generally driven by U.S. prices of similar products. Our exposure to the U.S. dollar is reduced by interest on our U.S. dollar denominated debt (approximately $0.1 billion annually, excluding Norampac). Exchange rate fluctuations are beyond our control and the U.S. dollar may continue to depreciate against the Canadian dollar in the future, which would result in lower revenues and margins.

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OPERATIONAL RISKS

The activities conducted by our businesses are subject to a number of operational risks including competition, performance of key suppliers and distributors, renewal of collective agreements, regulatory risks, successful integration of new acquisitions, retention of key personnel and reliability of information systems. In addition, operating costs for our businesses can be affected by changes in energy prices, fiber prices, other raw material prices and freight costs as a result of changing economic or political conditions or due to particular supply and demand considerations.

Fiber supply

We use hardwood and softwood fiber for the production of our papers and softwood for the production of lumber. Our forestry strategy is to optimize wood flows within our fiber supply area and to maximize value and minimize cost while securing an adequate wood supply. Our hardwood and softwood fiber resources are obtained from harvesting rights on public lands, purchases from third parties and from our owned land.

     Several years ago, the Ontario government reduced the amount of public land available for forestry activities. In Quebec, an independent commission (the Coulombe Commission) is recommending a 20% reduction in allowable harvesting volumes over the next two to three years. This Commission’s report is currently under review by the Quebec government and a decision is expected in 2005.

     There is no assurance that access to fiber will continue at the same levels achieved in the past. The cost of softwood and hardwood fiber and the availability of wood chips may be affected.

ENVIRONMENT

We are subject to U.S. and Canadian environmental laws and regulations for effluent and air emissions, harvesting, silvicultural activities, waste management and groundwater quality, among others. These laws and regulations require us to obtain and comply with the authorization requirements of the appropriate governmental authorities, who exercise considerable discretion for authorization issuances and their timing. Changes to environmental laws and regulations and/or their application may require us to make significant expenditures that could negatively impact our financial results and financial condition.

     Failure to comply with applicable environmental laws, regulations and permit requirements may result in fines, penalties or enforcement actions by the authorities, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of environmental control equipment or remedial actions, any of which could entail significant expenditures and negatively impact our financial results and financial condition.

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We continue to take remedial action under our Care and Control program at a number of former operating sites, especially in the wood preserving sector, due to possible soil, sediment or groundwater contamination. The investigation and remediation process is lengthy and subject to the uncertainties of changes in legal requirements, technological developments and the allocation of liability among potentially responsible parties.

     In addition, the pulp and paper industry in the United States is subject to Cluster Rules and Boiler M.A.C.T. Rules that further regulate effluent and air emissions. We comply with all present regulations.

LUMBER EXPORT DUTIES

The United States Department of Commerce announced that it had imposed cash deposit requirements on the Canadian softwood lumber industry with a final aggregate countervailing and antidumping rate of 27.22%, that is, 18.79% for countervailing and 8.43% for antidumping. Since May 22, 2002, based on a final decision by the United States International Trade Commission, we have made the required cash deposits on our exports of softwood lumber to the United States. The Canadian government has challenged both the countervailing and antidumping rates with the World Trade Organization and the North American Free Trade Agreement. As of January 1, 2005, cash deposits for countervailing and antidumping duties are being made and expensed by Domtar at a new rate of 20.95%, that is, 17.17% for countervailing and 3.78% for antidumping.

     We are currently experiencing, and may continue to experience, reduced revenues and margins in our Wood business as a result of countervailing and antidumping duty applications or any new arrangements between the United States and Canada.

LEGAL PROCEEDINGS

In the normal course of our operations, we become involved in various legal actions mostly related to contract disputes, patent infringements, environmental and product warranty claims and labor issues. While the final outcome with respect to actions outstanding or pending as at December 31, 2004 cannot be predicted with certainty, it is our belief that their resolution will not have a material adverse effect on our financial position, earnings or cash flows.

     In April 2003, the Canadian Competition Bureau (the “Bureau”) began an investigation of Canada’s major distributors of carbonless paper and other fine paper products, including our Paper Merchants in Canada. In March 2004, the Bureau expanded its investigation to include dealings between the Corporation and Xerox Canada Limited. Although the investigation is continuing, we are not able to predict the outcome of this investigation or the impact, if any, it may have on us.

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Sensitivity analysis

Our operating profit, net earnings and earnings per share can be impacted by the following sensitivities:

Note that Domtar may, from time to time, hedge part of its foreign exchange, net pulp, containerboard, interest rate and energy positions, which may therefore impact the above sensitivities.

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