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
Additional posts from the blog
Last week the Canadian Government introduced amendments to the Investment Canada Act (ICA) to implement its revised policy towards state-owned enterprises (SOEs) which it announced in December last year. At that time, while it approved the acquisition by Chinese SOE, CNOOC, of Canadian oil and gas company, Nexen, the Government announced its intention to prohibit acquisitions of control of Canadian oil sands businesses by SOEs except on an exceptional basis. It also stated that joint ventures and minority investments were welcome. In addition, the government indicated it would closely monitor SOE acquisitions in other sectors of the economy and would distinguish between SOE and non-SOE investments when setting the ICA review threshold. (See Focus on Foreign Investment Review, December 2012)
The Autorité des marchés financiers Proposes An Alternative Approach to Securities Regulators Intervention in Defensive Tactics
On March 14, 2013, the Autorité des marchés financiers (“AMF”) published for comments a consultation paper (the “AMF Proposal”) pertaining to defensive tactics in response to take-over bids. This consultation is taking place concurrently with the one launched the same day by the Canadian Securities Administrator (“CSA”) with the release of proposed National Instrument 62-105 Security Holder Rights Plans and proposed Companion Policy 62-105CP Security Holder Rights Plans (collectively, “62-105”). Unlike the CSA’s 62-105, the AMF Proposal addresses all defensive tacticsii, not only security holders rights plans.
The Canadian Securities Administrators published for comment a proposed new regulatory framework for rights plans under proposed National Instrument 62-105 Security Holder Rights Plans and proposed Companion Policy 62-105CP Security Holder Rights Plans (collectively, “62-105”). If adopted, 62-105 would provide issuers with a game changing tool to respond to hostile take-over bids, where a target board will be able to use a rights plan as leverage to negotiate with a potential bidder.