Tax Advice When Making A Cross-Border Canadian Acquisition

Tuesday, November 9, 2004

Kenneth Snider, Blake Cassels & Graydon, Toronto, ON (Canada), http://

Abstracted from: Canadian Tax Considerations Of Acquisitions Of Canadian Businesses By US Persons (Part I)
By: Kenneth Snider Blake Cassels & Graydon, Toronto, ON (Canada)
M&A Tax Report - Vol. 13, No. 2, Pgs. 5-8

Share sale usually cheaper.
Tax considerations play a significant role in any acquisition, but when an American company buys a Canadian target, the tax implications are more complicated because they reflect two countries’ tax rules. Basic guidance for north-of-the-border deals, according to Canadian tax attorney Kenneth Snider, looks at whether the buyer pays in cash or stock, whether it buys assets or stock, and how it finances the deal. The parties then try to coordinate the combined impact of US and Canadian tax rules to minimize the overall tax hit. Canadian tax law generally favors a share purchase over an asset acquisition. The tax on asset sales covers income that will be taxed at ordinary rates; share sales, on the other hand, are generally subject to the lower capital-gains rate. Consequently, buyers contemplating a share sale usually negotiate a discount price, since the seller’s tax will be less.
Form a Canadian buyer. The author recommends that the US purchaser form a Canadian company to implement the purchase. Unlike US law, Canadian tax rules allow a tax-free return of capital for a private company. The buyer thereby avoids Canadian withholding tax, which can range up to 25%, by deferring it. In addition, if the buyer hopes to deduct the interest expense associated with the acquisition, only a Canadian company can do the deal. To achieve a stepup in basis for certain assets, the Canadian company must either merge into the target or wind up its affairs. Another solution is to form an unlimited liability company in Nova Scotia, or NSULC. These entities are recognized as corporations in Canada but can “check the box” for US tax purposes and gain partnership recognition. Advantages include the ability to flow Canadian losses through to the US shareholder (i.e., the partner), take advantage of transfer pricing and planning, and avoid the restrictive US tax rules on controlled foreign corporations.

Create exchangeable shares for share swaps.
Canadian law does not allow tax-free exchanges when a resident company swaps its shares with a nonresident US company. To circumvent this problem, the author suggests that the US purchaser create a Canadian holding company whose shares are equivalent to the American company’s. The two companies exchange shares in a one-time deal and file a joint election allowing the transfer price to equal the tax cost. The Canadian holding company’s shares must have dividend rights and must be redeemable by the holder and exchangeable for equivalent shares of the US company. The shares must also maintain equivalent value to the US shares. The Canadian government announced in 2000 that it would develop legislation which would allow for tax-beneficial share exchanges between American and Canadian companies, but nothing has been enacted yet.

Restructuring may allow stepup.
The US purchaser may want to take advantage of the few exceptions in the Canadian law that allow for a stepup in basis for nondepreciable assets. This basis increase could be important if the Canadian company has US divisions or subsidiaries that will be consolidated with the American company or that have significant growth potential. To achieve the goal, the companies should consider restructuring the Canadian units to bring the basis up to fair value. The US buyer would then distribute the proceeds as a tax-free recapture of the Canadian capital. The parties need to consider the US tax consequences, cautions the author, and should fully understand the limitations in Canadian tax law on stepups. As an alternative to stepping up, consider adopting a deemed disposition of property resulting from the deal and recognizing the capital gain to offset what would otherwise be unused capital losses. Canada does not allow carry-forward losses that emanate from an acquisition.

Abstracted from M&A Tax Report, published by CCH Tax and Accounting, 2700 Lake Cook Road, Riverwoods, IL 60015.

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