Managing the Sales of Canadian Businesses A Vendor s Perspective

Transcription

1 , Borden Ladner Gervais LLP, Toronto, CPA, CA, TEP, Cadesky Tax, Toronto 67 th Annual Tax Conference 67e Conférence fiscale annuelle 2015 Our Current Tax and Business Environment Low corporate tax rates even if not a CCPC Top personal tax rates higher than they ve been in 20 years Businesses being sold where succession not an option Capital gains exemptions difficult to use due to purchaser preferences Significant deferrals available if proceeds can be earned corporately Relatively low rates of return on deferred tax 2

2 A New Look at Safe Income 2016 flow through tax rate on dividends paid out of SIOH: 54% (SBD) 55% (No SBD) 2016 flow through tax rate on capital gains paid out of SIOH: 39% (SBD) 45% (No SBD) 10% 15% after-tax cost if defer tax using SIOH Breakeven at 5% pre-tax corporate return is 8/9 years Consider: Capital gain for breakeven period cash needs Safe income for the remainder (If not a U.S. citizen) 3 A New Look at Safe Income Converting Safe Income to Capital Gains A B 25% 75% Opco B wants to buy out A using Opco funds A will require funds for personal use Sale price greater than safe income attributable to A s shares 4

3 A New Look at Safe Income Converting Safe Income to Capital Gains A 100% Holdco B 25% 75% A transfers pursuant to s.85 Opco 5 A New Look at Safe Income Converting Safe Income to Capital Gains A 100% Holdco B 25% 75% Opco Opco redeems Holdcos shares > safe income No 55(5)(f) designation 6

4 A New Look at Safe Income Converting Safe Income to Capital Gains A B 100% 100% Holdco Opco Capital Gain 55(2) creates capital gain to Holdco Holdco has RDTOH and CDA additions 7 A New Look at Safe Income Converting Safe Income to Capital Gains A B Capital dividend Taxable Dividends 100% 100% Holdco Opco Capital Gain, CDA, RDTOH A extracts CDA and use RDTOH against taxable dividend All funded with Opco surplus Result is the same under the proposed new rules 8

5 A New Look at Safe Income Converting Safe Income to Capital Gains Technical Issues: Subsection 55(2) only applies to capital property If redeemed shares are inventory can sections 3 and 9 (profit) apply in addition to subsection 84(3) Does 248(28) preclude this result? Section 54.2 ensures capital treatment on shares of corporation if: Transfer ASA business assets to corp for at least 1 share Applies to any PERSON How do you define the business? 9 A New Look at Safe Income Converting Safe Income to Capital Gains IES5 CRA will seek to apply GAAR Gwartz et al v. The Queen, 2013 TCC 86 No general policy in Act against surplus stripping Notwithstanding Gwartz, CRA feels a general policy against surplus stripping exists and will continue to challenge 2014 Descarries v. The Queen, 2014 OTC 1143 Although (as specified in Gwartz) taxpayers may arrange to distribute surplus as dividends or capital gains, option is not limitless 10

6 A New Look at Safe Income Converting Safe Income to Capital Gains 2015 (October 9, 2015 APFF CRA Roundtable, Q15) Example illustrated above Similar file was referred to GAAR committee GAAR committee recommended GAAR not be applied The CRA has expressed its concerns to Finance 11 Managing Proceeds When Butterfly Not an Option A B Vendor Co. Cash and Pubco shares received from sale of business Life Insurance Can t butterfly out the assets without creating tax on the life insurance policy 12

7 Managing Proceeds When Butterfly Not an Option A wants to dispose of his portion of Pubco shares B wants to hold Separate classes of common shares don t track to underlying assets Tracking shares may be a solution Shareholders Agreement strongly recommended Shareholders tracked losses will be trapped in corporation Mr A s losses may reduce CDA required to extract Mr B s gains Mr A s losses will reduce tax payable on gains realized on Mr B s Pubco shares 13 Managing Proceeds Capital Gains Reserve Under ss.40(1) Provides vendor relief for delayed receipt of proceeds Reserve formula may not equate to 20% per annum inclusion No reserve available Demand promissory note (Pineo) Views# Proceeds consist of shares in escrow Reserve Available Views# I7 - Balance of sale proceeds payable out of future corporate profits, but debtor can prepay balance before due date Views# E5 - New purchaser assumes existing mortgage still payable to original vendor 14

8 Managing Proceeds Earnouts Earnout tax treatment: 1) Concern could be recharacterized under 12(1)(g) 2) Safe harbour if qualify under CRA policy for cost recovery method Problems with the cost recovery method: Not available if proceeds dependent on purchaser s actions e.g., collection of A/R. Not available under asset sale of goodwill (Views# E5) 15 Managing Proceeds Reverse Earnouts Reverse earnout tax treatment Standard view is that proceeds immediately taxable, subject to claim for future capital loss Is a reserve possible under 40(1)(a)(iii)? Per CRA position, no reserve available (Views# E5) Lack of capital gains reserve open to challenge: CRA View may also contradict IT-436R [cancelled] - no principled distinction between an earnout and a conditional promissory note 16

9 Managing Proceeds Earnouts and Reverse Earnouts Does it matter if cost recovery approach gives sufficient flexibility? Working with earnouts Views# E5 - Taxpayer cannot subsequently change method of reporting the capital gains reserve Views # E5 - Non-payment of reverse earnout should not attract debt forgiveness Views # E5 - Cost recovery method must be based on profits of target s assets and not of acquiror 17 Managing Proceeds Issues with Replacement Property Rules Replacement property can defer tax arising on sale of depreciable property (13(4)), CEC (14(6)) and capital property (44(1)) Replacement property must be of same or similar use, and if part of a business the same or similar business as property being sold See Livingston 2015 TCC 24 direct substitution required Flexibility as ITA uses "reasonable to conclude" Former business property must actually be used (Glaxo, 1998 FCA) Be cognizant of timing limitations for replacement property Must be causal connection between disposition and acquisition of the new property, especially if replacement property to be held by Amalco - Views# l7 18

10 Managing Proceeds Issues with Replacement Property Replacement Property can include property in different parts of Canada or outside Canada as long as there is causal connection to former business - Views# E5 and Views# Issues with replacement property: Timing requirement: No deadline extension if construction of replacement property cannot be completed within time limit -Views# E5 PSA generally suggests disposition was voluntary even if vendor pressured to sell - Views# I7 Rental property: generally does not qualify for deferral - Views# E5 and E5 19 Managing Proceeds Issues with Replacement Property Can purchase replacement property before disposal of former business property see IT-259R4 at par. 2 Shares are not a replacement property for ECP Views# E5 Replacement property provisions can apply following for amalgamation 87(2)(l.3) and windup 88(1)(e.2) Deeming rules for replacement of TCP 20

11 21 Managing Proceeds Partition of property under 248(20) and 248(21) Can use partition provisions for tax-free restructuring of property Partition implemented by court order or by mutual agreement Typically used for subdividing land but could apply to other property 248(20) Taxable disposition if change in FMV of co-owners interest 248(21) No disposition if proportional FMV of each owner's interest is the same before and after the partition Can t equalize values by cash contribution or disproportionate debt allocation Views# E5 - Assembly and subdivision of land Managing Proceeds U.S. Citizen Shareholders Standard planning tools don t work for Canadian resident U.S. Capital Dividends; Capital Gains Exemption; Safe Income strips Stock options Consider using a ULC for U.S. Citizens in Canada Capital gain taxed at corp level in Canada - personal level in the U.S. Capital dividend tax free for Canadian tax purposes Capital dividend is a nothing for US tax purposes Credit for corporate capital gains tax against US personal tax No withholding or U.S. tax when taxable dividend paid out 22

12 Negotiating the Sale Rights to Acquire Shares 251(5)(b) for CCPC and related persons deemed exercised 256(1.4) for association purposes rights deemed exercised 110.6(14)(b) for CGE eligibility purposes right under a P&SA NOT deemed exercised (but deemed exercised for CCPC and Association) e.g. Sale contingent on regulatory approval Delayed closing Problems even if deal fails Associated at any time in the year Rights to acquire not relevant for loss restriction event ( AoC ) 23 Negotiating the Sale Letters of Intent - Rights to Acquire Shares Does LOI create an option to acquire, absolutely or contingently? If LOI is binding in a material aspect then the answer likely Yes Binding vs. Non-binding Intention to create legally binding obligations Binding non-essential terms should not be a problem E.g. Break fees, exclusive negotiation terms, termination, etc. If yes, Target Co could lose CCPC status, eligibility for CGE and become associated with Purchaser Even if transaction fails 24

13 Negotiating the Sale Letters of Intent - Rights to Acquire Shares CRA E5 Conditions that need to be met in order for LOI to result in application of s.251(5)(b): LOI must contemplate the exercise of one of the rights provided for in s.251(5)(b) Right provided in LOI can be absolute or contingent, exercisable immediately or in the future LOI must constitute a contract between two or more persons, in equity or otherwise 25 Negotiating the Sale Letters of Intent - Losing CCPC Status Deemed year end 249(3.1) Lose small business deduction No refundable portion of Part I tax (Could be beneficial) No dividend refunds (but keep RDTOH from CCPC period) Lose SBC status so no CGE, ABIL or exception to 74.4 Reassessment period 4 years LRIP rather than GRIP Lose enhanced SR&ED tax credits Negative impact on stock option treatment List not exhaustive 26

14 Negotiating the Sale Letters of Intent - Inadvertent Association Must share small business deduction Lose enhanced SR&ED tax credits May become large corporation Some forms of passive income become active (may be desirable (129(6)) Must share dividend allowance for purposes of Part VI.1 tax (191.1(3)-(5)) 27 Negotiating the Sale Allocation of Proceeds Section 68 CRA can reallocate a portion of proceeds to other properties or services Amount received can reasonably be regarded as being...for disposition of property or provision of services or restrictive covenant Not a FMV test TransAlta Corp v. R., 2012 FCA if a reasonable business person, with business considerations in mind, would have allocated that amount to that particular property an agreement where one of the parties is indifferent, or where both parties' interests are aligned as regards the allocation, will be given less weight Citing Petersen v. MNR (1987), 88 DTC

15 Negotiating the Sale Consulting Contracts Sell shares and provide consulting services If fee is lower than can reasonably be regarded as being reasonable POD may be recharacterized as consulting income If fee higher than reasonable section 67 may preclude deduction but recipient still taxable Even where arm's length parties agree on allocation section 68 may allow Minister to reallocate (2 sided adjustment) 29 Negotiating the Sale Sole Proprietorships Can incorporate prior to sale and use capital gains exemption (14)(f) 24 month test NOT applicable for capital gains exemption if incorporate existing business prior to sale Section 54.2 ensures capital treatment on shares of corporation if: Transfer ASA of business assets into a corporation for consideration that includes shares Applies to any PERSON Section 54.2 can protect from challenge that shares are inventory. Make sure the corp carries on business before sold, to meet QSBC test 30

16 Partnership: Taxable Income Allocation Starting point is income allocation under partnership agreement: a) Matching of taxable income allocations to cash distributions b) Allocation of gains to partner who rolled over property c) Allocation of taxable income to a former partner (96(1.01)) ITA provisions could override anticipated allocations on dissolution 98(1) - Partnership deemed to exist until all property distributed to partners - may affect timing of partnership interest disposition 99(1) now allocates income (and basis bump) before the dissolution No provision to deem a disposition of nil-value partnership unit and 50(1) is unavailable (Views# E5) 31 Partnerships: Strategies For Section 100 If sale to a specified person, vendor taxed on 50% of gain attributable to capital property (except depreciable property) plus 100% of remaining gain ss. 100(1.1) has now expanded category of purchasers to include non-residents and indirect sales through of partnerships and trusts Due diligence required by vendor to validate status of purchaser GAAR will apply if use 97(2) rollover as a preliminary step to admit a non-resident partner (Views# C6) New provisions could create unexpected issues: New money invested by a specified person to redeem a partner New money invested that causes a dilution of existing partner, and consider anti-dilution provisions under 100(1.4) and (1.5) 32

17 Partnerships: Tax-Deferred Windup Evaluate transaction objectives: 1) 98(3) Co-ownership of partnership assets Same partner cannot acquire 100% ownership within 3 month period, though combining ownership with whollyowned sub. may not attract GAAR: Views# R3 Can achieve dissolution on a rollover basis, provided outside basis of partnership interest exceeds inside basis Pre-dissolution planning cash & assumption of liabilities? Election required and no amendments - Views# E5 Available for tiered partnership: Views# Partnerships: Tax-Deferred Windup 2) 98(5) One partner acquires 100% interest in assets Not available for tiered partnerships: Views# Not available if 2 corporate partners amalgamate: Folio S4- F7-C1 at

18 Partnerships: Tax-deferred Windup 3) Rollover to Corporation and Dissolution, 85(2) and 85(3) No gain on asset rollover if tax basis in transferred assets exceeds boot No gain on partnership wind-up, if Partner s ACB in partnership interest exceeds FMV of cash and other property (other than shares of the corporation) 60-day timeline satisfied even if only beneficial ownership transferred: Views# E5 Suspended loss provisions may prevent dissolution of partnership on tax-deferred basis 35 Partnerships: Avoiding Dissolution and 98(6) CRA permits tax-free conversion of limited to general partnership, provided that no dissolution under provincial law Ontario Limited Partnership Act [ss. 23(1)] does not permit automatic conversion to a general partnership Solution under partnership law was to insert a new nominal-value corporation as the GP Consider forming new partnership through 98(1) and 98(6) Also consider whether partnership agreement would impose restrictions on the intended reorganization 36

19 Hybrid Sale Structures Why? Vendors prefer capital gain to extent of capital gains exemption Purchasers prefer assets Hybrid transactions can combine both 37 Hybrid Sale Structures A B 100% 100% Target Co. Acquire Co. Acquire Co. agrees to pay $8,000,000 for Target Co. (Non arm's length) 38

20 Hybrid Sale Structures A $800,000 Note For 10% B 100% 90% Acquire Co 10% Target Co. Business Assets Capital gain to A sheltered by capital gains exemption Acquire Co. and Target Co. are connected 39 Hybrid Sale Structures A $800,000 Note B 100% For 10% Acquire Co 90% Target Co. 10% Business Assets = $8,000,000 $8,000,000 Cash Target Co. sells assets to Acquire Co. for $8,000,000 40

21 Hybrid Sale Structures Cash $800,000 A Repay Note $800,000 B 100% Redeem for $800, % Target Co. 10% Acquire Co Cash $7,200,000 Business Assets = $8,000,000 Target Co. redeems 10% owned by Acquire Co. for $800,000 cash Acquire Co. Repays $800,000 Note 41 Hybrid Sale Structures Cash $800,000 A B 100% 100% Target Co. Acquire Co Cash $7,200,000 Business Assets = $8,000,000 42

22 Hybrid Sale Structures Part IV Tax Part IV tax to Acquire Co if Target Co receives a dividend refund for its taxation year in which it paid the dividend. If companies are connected at any time in Acquire Co s tax year in which the dividend was paid. No need for Acquire Co. to be shareholder at end of Target Co. s year Target Co. likely to receive a dividend refund based on dividend deemed paid to Acquire Co. on redemption. Dividend refund is not optional 43 Sale Structures Public Company Spinoffs By Way of Return PUC Pubco can distribute unwanted assets through PUC return Package assets into Spinco and pay in-kind distribution Consider application of 84(4.1) and 84(2) CRA takes expansive interpretation of 84(2) as per MacDonald (2013 FCA) and Views# C6 CRA disagrees with Descarries (2014 TCC) 44

23 Sale Structures Public Company Spinoffs By Way of Return PUC No deemed dividend to shareholder if FMV of transferred property does not exceed PUC of the distributing company Shareholder must separately evaluate whether capital gain realized per 53(2)(a)(ii) and 40(3) If in-kind distribution, must still rely on CRA admin policy that recipient has basis in property equal to its FMV This legislative omission might motivate continued use of tax rulings 45 Sale Structures Public Company Spinoffs By Way of Share Exchange Spinoff can also be achieved using s.86 share exchange Shareholders must hold shares as capital property Occurs upon reorganization of the capital of a corporation" and consider Views# C6 Similar result to shareholder as with a return of capital, but no ambiguity over tax cost of in-kind distribution Cost of Spinco shares is equal to its FMV Deemed dividend if FMV of Spinco shares exceeds PUC of former Pubco shares Capital gain if FMV of Spinco shares (less deemed dividend) exceeds ACB in former Pubco shares 46

24 Sale Structures Public Company Implications of Spinco Distribution Pubco will have a disposition equal to value of property distributed In-kind distribution attractive if Pubco has high tax cost in assets being distributed or unused tax losses Consider safe income planning before distribution Spinco shares should be listed on designated exchange from date of share issuance Addresses TCP considerations Ensures registered plans do not hold a non-qualified investment May need to adjust exercise price of stock option plans for Pubco 47 Stock Options During acquisition process, preserve Target company shares as prescribed shares (Reg. 6204) and retain access to stock option deduction under 110(1)(d) Quebec deduction is ¼ except for some SBC s Issues with Acquisition Agreement Dividend lock-up Offer by a specified person permitted to acquire all or substantially all of the shares View # R3 Plan of arrangement may constitute an offer for this purpose Cash-out right and application of 110(1.1) 48