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Mergers and Acquisitions in Canada

Assets vs. Shares

The decision to acquire the assets of the Canadian business or the shares of the operating company will affect the manner in which the acquisition is completed.

From a commercial perspective, a purchaser would generally prefer to acquire the assets of a business to limit its exposure to the “hidden” liabilities of the target company. It also provides the purchaser with the ability to choose the assets that the purchaser wants in order to carry on the Canadian business. The acquisition of assets could also be advantageous from an income tax perspective, by allowing the purchaser to allocate the purchase price in the most tax-efficient manner (i.e. to the extent permitted, the purchaser should allocate the purchase price to assets which will give rise to the greatest depreciation deductions) under the Act.

In addition, asset acquisitions also provide more flexibility with respect to the choice of carrying on business through a branch or a subsidiary. If a U.S. corporation acquires the assets of a Canadian target business, the U.S. corporation can continue to carry on that business as a Canadian branch. If it later decides to carry on the business through a Canadian subsidiary, it can generally transfer the assets of the business to a Canadian corporation on a tax-deferred basis under section 85 of the Act. In contrast, if a U.S. corporation acquires the shares of a Canadian company, it would be necessary to wind-up the Canadian target or transfer the assets to a U.S. corporation. Neither of these options can be carried out on a tax-deferred basis and could result in significant Canadian income tax consequences.

Commodity taxes, such as GST, QST, HST, PST or land transfer taxes, may be imposed on the sale of assets, whereas transfer taxes will not be imposed on the sale of shares (please see “Commodity Taxes” above). In addition, a purchaser might be interested in acquiring the shares of the operating company where the company has significant non-capital loss carryovers that might be available to reduce taxes payable in respect of future profits of the Canadian operations, subject to the detailed rules in the Act.

Increasing Tax Cost Under ss. 88(1)(d) of the Act

Generally, if the shares of a corporation are acquired, there is a very limited ability to increase the tax cost of the assets of the corporation. However, in certain situations, if the acquisition is by a Canadian corporation, that Canadian corporation can increase the tax cost base of non-depreciable capital properties of the acquired corporation, such as land, shares and partnership interests, through an amalgamation or wind-up. This step-up in cost base is sometimes referred to as the “88(1)(d) bump.” However, it should be noted that the Act imposes significant limitations on when the “bump” can be utilized.

Benefits of Acquiring Canadian Company Using Canadian Holding Company

Perhaps the simplest way of acquiring a Canadian corporation is to purchase the shares of the corporation directly. However, such direct acquisitions by a non-resident corporation may not be the most tax-efficient means of doing so from a Canadian income tax perspective. Consider the following example where the purchase price for all of the issued shares of a Canadian corporation is less than paid-up capital of the corporation.

Example 1: Foreignco acquires all of the issued shares of the Canadian target corporation, Targetco, for $100M. The paid-up capital of Targetco is only $50M. Targetco would only be able to return $50M on a tax-free basis to its parent, Foreignco, although Foreignco paid $100M for the issued shares of the company. Foreignco can improve its Canadian tax position by using a Canadian acquisition corporation.

Example 2: Foreignco subscribes for shares of a new Canco in the amount of $100M. Canco uses the funds to acquire all of the issued shares of the Canadian target corporation, Targetco, for $100M.

In this example, assuming that the foreign affiliate dumping rules (discussed above) do not apply, Canco would have paid-up capital of CA$100M, which could be returned to Foreignco on a tax-free basis. Foreignco’s ability to refinance the equity financing with debt has increased from CA$33.3M to CA$66.6M. Note, however, that this strategy to increase paid-up capital must be executed at the time of the acquisition. Subsequently “rolling over” the shares of Targetco into Canco will not have the desired tax effect.

In addition, if Canco borrows money to finance the acquisition of Targetco, and Targetco and Canco are subsequently combined, the acquisition indebtedness can be converted into operating debt. Interest payments are currently deductible, provided that the amount of interest is reasonable, subject to the thin capitalization rules (discussed above under the section “Thin Capitalization Rules”), and to the potential withholding taxes that may be applicable.

The use of Canco as the acquisition vehicle may also permit an increase in the tax cost of non depreciable assets owned by Targetco (please see “Increasing Tax Cost” under ss. 88(1)(d) of the Act discussed above).

Canadian Capital Gains Exemption

It should be noted that Canadian resident individuals are entitled to a one-time CA$800,000 capital gains exemption in respect of the sale of qualified small business corporation (“QSBC”) shares. For 2015 and subsequent taxation years, the CA$800,00 capital gains exemption will be indexed to inflation. Therefore, if a buyer wishes to purchase shares of a Canadian corporation which qualify as QSBC shares from Canadian resident individuals, the sellers will most likely want to structure the transaction as a share sale, as opposed to an asset sale if they can benefit from the exemption.

Section 116 Notification

As discussed above in the section “Federal Income Taxes,” Canada taxes non-residents on the disposition of taxable Canadian property. Accordingly, if a non-resident sells property which is not taxable Canadian property, there is no Canadian tax payable under the Act. As also discussed above, if the property sold is taxable Canadian property, an applicable tax treaty may exempt the transaction from Canadian tax. It should be noted that if the seller is a non-Canadian resident and the property is taxable Canadian property, in certain situations there is a requirement under section 116 of the Act to notify the CRA and obtain a clearance certificate, even if there is no tax payable under a tax treaty or the sale results in a capital loss. In addition, the purchaser from a non-Canadian resident seller may be required to withhold a portion of the purchase price until the clearance certificate is obtained. (The notification procedure is simplified and the withholding requirement may not apply if the property is “treaty protected property,” as defined in the Act.) In addition to penalties, the Act imposes a joint liability on the purchaser for the non-resident seller’s tax liability if a clearance certificate is not obtained when required under the Act.

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