Context: M&A transactions often involve new entities that do not have a bank account.  As a result, substantive legal steps to accomplish the end goal of the merger or acquisition often involve multiparty agreements, directions to pay, simultaneous transactions, and agency relationships.  In addition, post-closing restructuring transactions can sometimes involve capital contributions without the movement of cash or other consideration.  Understanding the tax consequences of each such step is of course an important element in the successful completion of any merger or acquisition.          

CRA rules favorably on foreign takeover:  In CRA Ruling 2021-0911211R3 (released January 4, 2023), the parent (Parent) and an operating company (Opco) in a taxpayer group acquired a foreign target corporation (F-Target) involving just such a series of steps and subsequent restructuring – as depicted and summarized below. 

  • Parent established two new foreign subsidiaries (FS-1 and FS-2).  FS-2 then merged with F-Target, resulting in F-Target as the survivor entity and FS-1 as the sole shareholder of F-Target.  On this first merger, the F-Target shareholders (FT-SHs) became entitled to newly issued shares of Parent (Share Consideration) and cash (Cash Consideration) from FS-1, as described further below.  FS-1 and Target then merged in a second merger, with FS-1 being the survivor entity.
  • Under a multiparty funding agreement – and to legally implement the above steps – Parent agreed to issue and deposit the Share Consideration with an exchange agent on behalf of FS-1 and for the benefit of the FT-SHs.  In consideration, FS-1 agreed to issue additional shares of its capital stock to Parent having a fair market value (FMV) equal to the FMV of the Share Consideration.  FS-1 also directed Opco to pay the Cash Consideration and FS-1 agreed that it thereby simultaneously received an equal amount as a loan from Opco.  Parent further directed Opco to deposit the Cash Consideration with the exchange agent on behalf of FS-1 and for the benefit of the FT-SHs.
  • Post-closing, Opco incorporated a foreign holding company (F-Holdco) and a Canadian holding company (Can-Holdco).  Parent then transferred its shares of FS-1 to Opco as a simple capital contribution, and Opco increased the stated capital of its issued shares equal to the FMV of the FS-1 shares.  Opco then transferred these same FS-1 shares to F-Holdco as a simple capital contribution.  Opco thereupon transferred its shares of F-Holdco to Can-Holdco as a simple capital contribution and Can-Holdco increased the stated capital of its issued shares equal to the FMV of the F-Holdco shares.  The liability under the loan owing from FS-1 to Opco was assumed by F-Holdco, in exchange for a promissory note owing from FS-1 to F-Holdco.  F-Holdco then transferred this promissory note back to FS-1 as a contribution of capital – resulting in the end structure depicted above.

The CRA helpfully ruled as follows:

  • Parent’s cost of its additional shares of FS-1 was equal to the FMV of the Share Consideration plus the costs incurred by Parent to acquire these additional shares.  The CRA confirmed that s. 143.3 did not apply to reduce the cost of these additional shares of FS-1.
  • On Parent’s capital contribution of its FS-1 shares to Opco, Parent was deemed to receive sale proceeds equal to their FMV (s. 69).  Parent realized no capital gain because the cost of these shares was (at least) equal to their FMV.  No deemed dividend to Parent arose on Opco’s increase of its stated capital in this step, by reason of the exception in s. 84(1)(b).  The ACB of Parent’s shares of Opco was increased under s. 53(1)(c) by an amount equal to the FMV of the Share Consideration.  Finally, no income arose in Opco on this contribution under s. 9 or s. 12(1)(x), because the contribution was not an amount received by Opco in the course of earning income from a business or property.
  • On Opco’s capital contribution of its FS-1 shares to F-Holdco, Opco did not realize any capital gain.  Implicit in this ruling was a finding that Opco had acquired these FS-1 shares on the above step at a cost equal to their FMV.  This is not surprising, given the CRA’s long-standing position on this point: see CRA Document 2013-0506561I7. 
  • On Opco’s capital contribution of its shares of F-Holdco to Can-Holdco, Opco did not realize a capital gain.  Implicit in this ruling was a finding that the ACB of Opco’s shares of F-Holdco had been increased under s. 53(1)(c) on the above step, by an amount equal to the FMV of the FS-1 shares.  Opco was not deemed to have received a dividend on this contribution, by reason of the exception in s. 84(1)(b).  No income arose in Can-Holdco on the contribution under s. 9 or s. 12(1)(x), because the contribution was not an amount received in the course of earning income from a business or property.
  • None of the taxable benefit provisions in the Act were engaged by these steps (i.e., ss. 15(1), 56(2), 56(4), 69(4) and 246(1)). 

Oddly, two rulings were “intentionally deleted” from the version released to the public (with no reasons given).  Although it is impossible to know, these deleted rulings may have concerned the merger of FS-1 and Target under s. 87(8.2) and the assumption by F-Holdco of the loan owing from FS-1 to Opco.

The takeaway: M&A transactions are seldom as simple as they seem in press releases or newspapers.  The CRA understands that several steps are typically involved and often must be implemented through complex multiparty agreements, directions to pay, simultaneous transactions, and agency relationships.  This ruling provides an excellent example of this and also usefully confirms that simple contributions to capital in these circumstances should not give rise to unexpected tax results.