Acquiring a Canadian Business
- more choices as to where to incur expenses (e.g., interest on acquisition debt financing);
- more tax claims on funds repatriated to investors or realized on an eventual sale;
- more post-closing cross-border intra-group payments and the tax issues they create;
- possible tax treaty claims to reduce Canadian and acquirer home country taxation; and
- layering the foreign acquirer’s CFC (controlled foreign corporation) regime on top of the Canadian tax rules.
The ITA has seen several technical amendments in recent years designed to prevent erosion of the Canadian tax base on foreign investment into Canada, such as the following:
- tightening of the “thin capitalization” rules limiting interest expense on debt owing to non-arm’s-length non-residents;
- strengthening of the Canadian withholding tax regime for Canadian-source payments such as interest and royalties, including back-to-back anti-avoidance rules;
- reinforcing of anti-surplus stripping rules such as s. 212.1 (applicable to non-arm’s length transfers of shares of Canadian corporations) and enacting the foreign affiliate dumping (FAD) rules;
- amendments establishing the primacy of Canada’s transfer pricing rules relative to other ITA provisions, as well as aggressive enforcement of those rules by the CRA to protect the Canadian tax base; and
- enactment and ratification in Canada of the OECD Multilateral Instrument (MLI) and the additional constraints it creates on claiming treaty benefits to reduce Canadian tax.
The various Canadian tax issues for a foreign buyer of a Canadian business are discussed at length here. This article reviews issues such as:
- different stages of the acquisition process, allocation of responsibilities for tax issues and tools for identifying and managing tax risks;
- tax structuring considerations for buyers and sellers on share and asset purchases;
- possibilities for non-recognition treatment and gain deferral for sellers;
- the use of earn-outs and the tax issues they create;
- important buyer planning considerations;
- the effect of an acquisition on the target corporation and its tax attributes; and
- typical seller tax planning strategies.
1. Paid-up Capital Maximization
2. The FAD Rules
3. s. 88(1)(d) “Bump” Planning
4. Debt Financing
If external debt is being used to finance the acquisition, a foreign buyer needs to consider in which country that debt should be located (i.e., in Canada or elsewhere). Relevant factors in this analysis include whether:
- interest will be deductible for tax purposes in a particular country (taking into account thin capitalization rules);
- the Canadian entity will have positive taxable income against which to actually use any interest deduction; and
- withholding tax will apply on payments of interest (taking applicable tax treaties into account).Even if no external debt financing is being used, a foreign purchaser may still wish to put intra-group debt into the Canadian entity from a related foreign lender within the group, in order to create tax-deductible interest expense in Canada.
5. Share Consideration for Sellers
6. Bridging Valuation Gaps
7. Canadian Acquisitionco
8. Foreign Exchange
9. Foreign Buyer Repatriation Alternatives
10. Foreign Acquirer Home Country Tax Regime Overlay
various aspects of the foreign acquirer’s home country tax regime (and their interaction with the applicable Canadian tax rules) must be factored into the analysis so as to produce the best overall result, not merely the optimal Canadian one. These include home country tax provisions relating to:
- controlled foreign corporations (i.e., when income earned by CFCs is imputed back to the foreign shareholder, and how that income is taxed in the foreign shareholder’s home country);
- transfer pricing;
- foreign tax credits;
- timing/character mismatches with Canadian rules (e.g., U.S. earnings & profits rules on Canadian equity distributions, hybrid entities/transactions, etc.).
Foreign buyers should obtain Canadian legal advice on these and other matters relating to potential Canadian acquisitions, and do so on a confidential and privileged basis. The CRA routinely demands copies of sensitive and potentially prejudicial tax materials prepared in the context of acquisitions (e.g., tax diligence reports, planning memoranda, etc.), which are only protected from disclosure by lawyer-client privilege if prepared by a lawyer (not accountants or others), as explained here.