Critical Securities and Tax Considerations for Inside Counsel in Canadian Cross-Border Mergers

Transcription

1 Critical Securities and Tax Considerations for Inside Counsel in Canadian Cross-Border Mergers Inside Counsel - Business Insights for Law Department Leaders Jeffrey Roy Partner, Cassels Brock & Blackwell LLP Ken Snider Partner, Cassels Brock & Blackwell LLP November 27, 2012

2 Topics to be Covered This seminar focuses on the acquisition of a Canadian public corporation by a U.S. person. Acquisition of a private Canadian corporation by a U.S. person will generally be very similar to U.S. private M&A except for Canadian tax, employment and specific regulatory considerations. We will attempt to identify issues relevant to counsel at the various stages of the acquisition process including: Pre-transaction acquisition of securities (e.g. acquiring a toehold position ); Selection of the most effective transaction structure: Take over bids vs Plans of Arrangement; Investment Canada Act compliance; Competition Act compliance (Anti-Trust); Canadian tax considerations associated with cross border acquisitions. slide 2

3 Accumulating a Toehold - Canadian Early Warning Requirements Any person who acquires beneficial ownership of voting securities of a Canadian public corporation that represent more than 10% of the voting securities of a particular class of that company must: Promptly issue a press release; File an early warning report within 2 business days of the acquisition. The press release and early warning report must contain prescribed information concerning current ownership, method of acquisition and intentions regarding the acquisition of securities in the future. The report must be updated on the acquisition of an additional 2% of the securities of the Target and/or if there is a material change in the information set out in the early warning report. Holders of 10% or more of the voting securities of a corporation are also reporting insiders and must separately report individual transactions in the securities of the corporation. slide 3

4 Accumulating a Toehold -Acquisitions that Trigger Take Over Bid Rules Acquirors should be careful to avoid inadvertently triggering the formal take over bid requirements. Canadian securities law has a bright line test as to when the acquisition of voting securities constitutes a take over bid that must be made to all securityholders of a class. Under Canadian Securities laws an offer to acquire voting securities of a company which when coupled with the securities already owned by the offeror would constitute more than 20% of the voting securities of a particular class is a take over bid. An offer to acquire is an offer to purchase or acceptance of an offer to sell securities. slide 4

5 Accumulating a Toehold -Acquisitions that Trigger Take Over Bid Rules-Exceptions Exceptions: Offer to acquire securities made to 5 or fewer security holders to acquire securities at not more than 115% of the 20 day average closing price is not a take over bid, regardless of how many securities are purchased. Purchases on normal market terms of not more than 5% of shares in any 12 month period is not a take over bid. All purchases, even purchases of treasury securities within the last 12 months are aggregated for determining compliance. If a purchase of securities would be a take over bid then the offer to purchase must be made to all securityholders of the class via a formal offer. slide 5

6 Accumulating a Toehold -Pre-Bid Integration If an acquiror purchases securities in a private transaction within the 90 day period preceding its launch of a formal take over bid, it must make the take over bid on the same terms. slide 6

7 What Acquisition Structure to Use? Most negotiated public company acquisitions in Canada proceed either by way of: Take over bid (Tender offer); or Plan of Arrangement. Unsolicited change of control transactions are done by way of take over bid. slide 7

8 Take Over Bids-Terms slide 8 Bid must be made to all shareholders in Canada. Exemption from SEC filing if less than 10% of shareholders are U.S. residents; simplified filing if U.S. shareholders hold 10%-40%. Bid cannot conditioned on financing: financing must be in place at the time the bid is made. Bid can be made subject to other conditions. Bid must remain open for acceptance for 35 days; variations in the terms of the Bid must be communicated to shareholders and the Bid cannot expire until ten days following any variation. If conditions to Bid are satisfied, offeror must take up shares tendered to the bid and pay for shares within 3 days of take up. Securities deposited to the bid can be withdrawn by the shareholder at any time prior to being taken up. Under Canadian corporate law, if the offeror acquires 90% of the securities of the class via the Bid, it may compulsorily acquire the remaining shares.

9 Take over Bid-Acquisition of Minority Shares If an offeror acquires less than 90% but more than 66 2/3% of the outstanding shares of the class, may squeeze out the remaining minority shareholders via a second-stage transaction. Second stage transaction is usually an amalgamation or an arrangement; requires that a shareholders meeting of the target company be called. Offeror may vote the securities acquired in the bid in favour of the squeeze out transaction: majority required under corporate law is usually 66 2/3%, so if offeror has acquired more than 66 2/3% through the /Bid it will be assured of success. Consideration provided to securityholders in squeeze-out transaction must be same as the consideration provided in the Bid. slide 9

10 What is an Arrangement? A Plan of Arrangement is a procedure provided for under corporate law that is initiated by the Target company and is subject to shareholder and Court approval. Arrangements are designed to allow a corporation to effect fundamental changes to its corporate structure. Non-exclusively defined in corporate legislation to include: amalgamations (mergers); exchanges of securities for securities of other corporations or property; division of businesses; liquidation. Could consist of an exchange of securities, followed by an amalgamation, followed by a liquidation. slide 10

11 What is an Arrangement? (cont d) The arrangement procedures...flexibility incorporate whatever tools and mechanisms of corporate law the ingenuity of their creator rings to the problems at hand. slide 11

12 Arrangement Procedure slide 12 Target and Acquiror enter into Business Combination Agreement. Target calls meeting of shareholders, prepares proxy circular describing transaction and, if shares of Acquiror are to be issued, containing prospectus-level disclosure regarding Acquiror. Proxy circular is not subject to pr ing review by securities authorities. Target applies to Court for Interim Order setting out procedures for shareholders meeting and setting approval level (usually 66 2/3% of shares voting). Court will require that all stakeholders whose rights are directly affected by the Arrangement be given the right to vote at the shareholders meeting and to appear at the Court hearing at which the Arrangement is to be approved. Target holds shareholders meeting, obtains shareholder approval. Target applies to Court for Final Order approving the Arrangement; Court must find that the Arrangement is fair and reasonable to all affected stakeholders. Shareholders may appear at hearing for final offer. If Final Order is granted, Target files Articles of Arrangement and Arrangement becomes effective.

13 Advantages of Arrangements for Acquirors slide 13 One step transaction: If the Arrangement is approved by the shareholders and the Court, Acquiror acquires 100% of the outstanding shares in a single transaction. Can reduce time required to complete transaction. Shareholder approval requirement can, effectively, be lower for Arrangements than Take over bids: Shareholder approval is usually set at 66 2/3% of the shareholders voting at the Meeting. Very rare to have 100% of shareholders represented at a meeting so an Arrangement can be approved by less than an absolute majority of the shareholders of a Target. Increases deal certainty, particularly if shareholders enter into lock-up agreements. Can be used to effect multi-step transactions: An arrangement can be comprised of a number of separate transactions, all of which are deemed to happen in sequence and none of which happen unless all of them happen: flexible and useful for achieving business or tax planning objectives (e.g. Spin-out of non-core assets).

14 Advantages of Arrangements for Acquirors Can deal with outstanding convertible securities Outstanding warrants and options can be arranged along with the common shares of the target. Financing condition An arrangement can be made subject to a condition that the Acquiror obtain financing; a take over bid cannot. U.S. Registration Exemption If all or a part of the consideration for the transaction is shares of the acquiring company that are to be issued to shareholders in the U.S., an arrangement may provide an exemption from the registration requirements under the Securities Act, slide 14

15 Disadvantages of Arrangements for Acquirors slide 15 All or nothing proposition: if Arrangement is not approved, Acquiror ends up with nothing. Control: Acquiror does not control the process: The Target calls and holds the meeting to approve the Arrangement; Management information (proxy) circular and other meeting materials are prepared by the Target; Certain critical decisions (e.g. waiver of the proxy cut-off deadline) are made by the Target s Board; The Court is responsible for final approval of the Arrangement and must determine that the Arrangement is fair and reasonable ; Target shareholders and other stakeholders affected by the Arrangement are entitled to appear and object at the hearing for the final order approving the Arrangement; Amending the terms of the transaction to counter competing bidders is more difficult, requires the consent of the Target and, possibly, the Court. If shares of a non-canadian corporation are used as consideration: As discussed later, an exchange of shares for shares of a non-resident of Canada will be taxable for Canadian shareholders. Acquiror will become a reporting issuer in Canada, subject to Canadian securities laws and reporting requirements.

16 Regulatory Issues - Investment Canada Act ( ICA ) ICA applies to all acquisitions of control of Canadian businesses by non-canadians. Under the ICA, control can be presumed to have been acquired where the investor acquires 33.3% of the voting shares of a Canadian business. Where a non-canadian acquires control of a Canadian business, the ICA imposes an obligation to either make a pre-closing application for review or a post-closing notification. In either case, the Federal Minister of Industry must be satisfied that the investment is of net benefit to Canada. Where the investor resides in a country that is a member of the World Trade Organization, a pre-closing application for review must be made where the value of the assets of the Canadian business being acquired exceeds CAD $330 million. Net benefit test considers several factors, including the impact of the investment on such things as employment levels, the participation of Canadians in senior management and continued investment in the Canadian economy, among other factors. slide 16

17 Regulatory Approvals - Investment Canada Act On a pre-closing application for review, the Minister of Industry must be satisfied that the investment is of net benefit to Canada before it can be completed. Investors are typically required to enter into a series of binding commitments to secure approval. The most common commitments relate to Canadian employment levels, the number of Canadians involved in senior management and continued investment in Canadian operations. If a pre-closing application is required, the initial review period is 45 calendar days, which can be unilaterally extended by the Minister of Industry for a further 30 calendar days. Any further extensions of the review period require the consent of both the Minister of Industry and the investor. slide 17

18 Regulatory Issues - Competition Act (Anti-Trust) Under the Competition Act, the acquisition of more than 20% of the shares of a publicly-traded company will be subject to mandatory pre-merger notification where: The company whose shares are being acquired has Canadian assets or revenues from sales in or from Canada in excess of CAD$77 million; and The parties to the transaction (including their respective affiliates) have combined Canadian assets or revenues in, from or into Canada in excess of CAD$400 million. If the Transaction is subject to mandatory pre-merger notification, it cannot be completed until the applicable statutory waiting periods have expired or been waived by the Commissioner of Competition. The initial waiting period is 30 calendar days and is triggered by the submission of a merger notification filing. slide 18

19 Regulatory Issues - Competition Act (Anti-Trust) Commissioner can issue a supplemental information request ( SIR ). Transaction cannot be completed until 30 calendar days after SIR has been complied with. Commissioner of Competition can review any transaction within one year of closing where she/he believes it may raise substantive competition law concerns. Substantive concerns are likely to arise where the merged firm will have a market share in excess of 35%, where there are relatively few competitors, or where the merged firm could impact the supply of key inputs to competitors. If the Acquiror does not have a significant presence in the Canadian markets for the products produced by the Target, a transaction is not likely to raise significant competition law issues. slide 19

20 Generally Applicable Canadian Tax Considerations in Cross Border Mergers and Acquisitions slide 20 What are the tax attributes of the Canadian target and its subsidiaries; Is stock of the U.S. parent to be used as consideration and if so, is a tax deferred transaction important for Canadian and specific non-canadian shareholders; How is the acquisition being financed, and should acquisition debt be incurred in Canada; What is the type and location of assets of the Canadian target, and in particular does the Canadian target have foreign affiliates ; Will any gain on a future sale of shares of the Canadian target be taxable in Canada; Can the tax cost of the shares of any non-canadian subsidiaries of the Canadian target be bumped up to fair market value, and repatriated to U.S. parent on a tax efficient basis; What are the post closing arrangements for conduct of business and integration and will there be transfers of property or services between affiliates; Are tax treaty benefits of importance, and is there entitlement of U.S. parent to claim benefits under the Canada-U.S. Tax Convention.

21 Use of a Canadian Acquisition Corporation Generally, a U.S. parent will incorporate a Canadian acquisition corporation ( Canco ) to effect the acquisition of a Canadian target. This is important for numerous reasons (e.g. maximizing repatriation of funds free of Canadian withholding tax, deductibility of interest against income of the Canadian target, and the bump in the tax cost of subsidiaries owned by the Canadian target). In certain situations Canco may be an unlimited liability company ( a ULC ) which is fiscally transparent from a U.S. tax perspective. A ULC is taxed in Canada as a regular corporation. A U.S. parent may wish to use a holding company in another jurisdiction with a favourable tax treaty with Canada to hold the shares of Canco particularly if it optimizes benefits under a tax treaty. slide 21

22 Using Stock of the U.S. Parent as Consideration If stock of U.S. parent is to be used as consideration, there is no tax deferral for Canadian shareholders. A tax deferral for Canadian shareholders may be crucial as there would not be any cash proceeds to pay the tax. The solution to triggering immediate Canadian tax is an exchangeable share structure which has been frequently used. Generally this has been used where the U.S. parent is public and can issue freely tradeable stock. slide 22

23 Using Stock of the U.S. Parent as Consideration (con t) In an exchangeable share transaction, U.S. parent establishes Canco which acquires all the stock of Canadian target. Canco issues shares as consideration which are economically equivalent to the common shares of the U.S. parent. These shares are exchangeable by the shareholder for shares of the U.S. Parent at a fixed ratio by a maturity date. In certain circumstances the U.S. parent can cause the exchange unilaterally, or the shares may get exchanged automatically such as at maturity. A Canadian shareholder (needing a tax deferral) obtains a tax deferral in respect of the sale of the shares to Canco as a result of Canco and the Canadian shareholder filing a joint election under section 85 of the Income Tax Act (Canada) (the ITA ). The gain is deferred until the time of the exchange for shares of the U.S. parent. The shares of the U.S. Parent are generally sold for cash after the exchange. slide 23

24 Financing the Acquisition slide 24 A tax efficient financing structure must take into account both U.S. and Canadian tax considerations. If there is bank financing of any of the purchase price for the Canadian target, it must be decided whether the debt should be incurred by the U.S. parent (which in turn funds Canco) or Canco incurs the debt. This decision can be complex and involves many factors. Generally consideration is given to the expected tax position of the U.S. parent and the Canadian target, Canadian corporate tax rates which are lower than U.S. corporate tax rates, and the cash flow needed to service the debt. As there is no consolidation of a Canadian corporate group for Canadian tax purpose, specific steps must be taken to achieve tax efficiency in regard to the interest. If Canco is the borrower, Canco and the Canadian target must amalgamate after the acquisition by Canco in order for interest expense to be deducted against income of the Canadian target.

25 Financing the Acquisition (cont d) It must be decided whether U.S. parent should fund Canco with some inter-company debt subject to Canadian thin capitalization rules. If non-resident shareholder debt exceeds a debt equity ratio of 1:5 to 1 (as computed under the ITA), the interest on the excess debt will not be deductible and will be treated as a dividend subject to non-resident withholding tax. Withholding tax on interest must be considered. In certain situations hybrid debt should be considered. slide 25

26 Bump in the Tax Cast of Shares of the Subsidiary of the Canadian Target slide 26 Specific rules in the ITA permit a step-up in the tax cost of nondepreciable capital property, such as shares held as an investment. The step up is triggered by certain dissolutions or an amalgamation of Canco and the wholly owned Canadian target after an acquisition of control. The bump is up to a maximum of FMV at the time of the acquisition of control and is made in accordance with a formula. These rules often play a crucial role in many acquisitions. This is particularly important if the Canadian target has non-canadian subsidiaries. It will generally be more tax efficient for these corporations to be repatriated to the U.S. Parent after closing rather than remain owned by a Canadian target. Where there is a bump up to FMV, no capital gain will be realized on the transfer of these shares to the U.S. parent after closing provided FMV does not increase. In addition, there will be no Canadian withholding tax as these shares are distributed on a reduction of paid-up capital provided FMV does not exceed paid-up capital.

27 Bump in the Tax Cast of Shares of the Subsidiary of the Canadian Target (cont d) There is no bump if exchangeable shares are issued. There are complex anti-avoidance rules that can deny the bump. slide 27

28 Example 1 Post Restructuring: Bump Common Situation: In a cash acquisition, Canco will have a FMV tax cost in the shares of the Canadian target. The Canadian target has low tax cost in the shares of its U.S. subsidiary. The problem is that a repatriation of the shares of the U.S. subsidiary to the U.S. parent after the acquisition of control is taxable. Before Bump U.S. Parent FMV tax cost Canco FMV tax cost Target After Bump U.S. Parent FMV tax cost Amalco (formed on amalgamation of Canco and Canadian Target) U.S. Subsidiary FMV tax cost Amalco (formed on amalgamation of Canco and Canadian Target) After Transfer U.S. Parent U.S. Subsidiary U.S. Subsidiary Low tax cost Solution: Tax "bump". A vertical amalgamation of Canco and its wholly owned Canadian target or a winding-up of the wholly owned Canadian target into Canco may allow Canco to increase the tax cost of the shares of the U.S. subsidiary at the time of the acquisition of control and held since then until the time of the bump. A bump will allow for future transfers outside the group or inside the group or other internal reorganizations (e.g. foreign debt push down). slide 28

29 Example 2 Post-Restructuring: Simplified Debt Push Down Structure Common Situation: After acquisition of the Canadian target, Canco and the Canadian target amalgamate, and bump the tax cost of the shares of the foreign subsidiary of the Canadian target to FMV. Idea: Use the high tax cost to shelter operating income in foreign jurisdictions. slide 29 U.S. Parent Amalco (formed on amalgamation of Canco and Canadian Target) Foreign Subsidiary FMV tax cost New Foreign Subsidiary Foreign Subsidiary U.S. Parent Amalco Purchase debt Foreign Financeco Transaction: 1. Amalco sells shares of foreign subsidiary to a new foreign subsidiary for debt (if increase in value sell for debt and shares so there is no Canadian tax). 2. Amalco transfers debt to foreign Financeco for shares. Financeco is a resident of a low tax jurisdiction. 3. New foreign subsidiary and foreign subsidiary merge if necessary. Tax: Tax deduction in jurisdiction of foreign subsidiary. Withholding tax on interest. Interest income in Financeco jurisdiction. Interest not attributed to Amalco. Canadian foreign affiliate and foreign affiliate dumping rules to be considered.

30 Foreign Affiliate Dumping Rules There are proposed amendments to the ITA called the foreign affiliate dumping rules that must be considered when a U.S. Parent is acquiring legal control of a Canadian target through Canco. It must be asked whether Canco has or will have foreign affiliates. Simply put, these rules will apply if a Canadian corporation is legally controlled by a non-resident of Canada, and the Canadian corporation has foreign affiliates. Specifically, subject to certain exemptions, these rules will apply to an investment in a non-resident (a Subject Corporation ) made at any time (the Investment Time ) by a corporation resident in Canada (a CRIC ) if: slide 30 (a) the Subject Corporation is immediately after the Investment Time, or becomes as part of a transaction or event or series of transactions or events that includes the making of the investment, a foreign affiliate of the CRIC;

31 Foreign Affiliate Dumping Rules (cont d) (b) the CRIC is at the investment time, or becomes as part of a transaction or event, or series of transactions or events that includes the making of the investment, controlled by a non-resident corporation. There are very broad rules defining an investment. If applicable there can be material adverse tax consequences subject to mitigation in certain cases. slide 31

32 Canada US Tax Convention ( the Treaty ) There are many potential benefits to the U.S. parent if it can rely on the Treaty. Benefits include: reduced rate of withholding on dividends, exemption from withholding tax on related party interest, protection from Canadian capital gains tax in limited situations, exemption from or reduced rate of Canadian withholding tax on royalties, and protection from Canadian tax on business profits where there is no Canadian permanent establishment. To qualify for benefits, U.S. parent must satisfy certain requirements in regard to U.S. residency and must also qualify under a limitation of benefits provision. slide 32

33 Speaker Profiles Ken Snider Partner, Tax Group Ken Snider is a partner in the Tax Group at Cassels Brock & Blackwell LLP in Toronto. His practice focuses on corporate taxation, with an emphasis on cross-border mergers and acquisitions, reorganizations, inbound and outbound investments, and resource and real estate investments. His clients include multinational corporations, the Canadian federal government, tax-exempt institutions and private equity funds. Ken is recognized by a number of prominent national and international legal directories, and is a frequent speaker and author. ksnider@casselsbro ck.com Jeffrey Roy Partner, Securities Group Jeffrey Roy is a partner in the Securities Group at Cassels Brock & Blackwell LLP in Toronto. His practice focuses on corporate finance and mergers and acquisitions. He regularly advises clients on takeover bids, arrangements and similar transactions. Increasingly, Jeffrey has been involved with cross-border and international mergers and acquisitions and proxy contests. Jeff has been involved in a number of notable transactions and has written and spoken on various topics in securities and banking law. slide 33 jroy@casselsbrock.com

34 Disclaimer This document and the information in it is for illustration only and does not constitute legal advice. The information is subject to changes in the law and the interpretation thereof. This document is not a substitute for legal or other professional advice. Users should consult legal counsel for advice regarding the matters discussed herein. slide 34