One of the most important considerations for M&A purchasers (especially in cross-border transactions) is managing tax issues. Foreign purchasers of Canadian entities will need to plan around significant changes to the Income Tax Act, which were enacted in 2012.

Revisions were made to Canada's thin capitalisation rules in 2012. These rules limit the extent to which a Canadian-resident corporation (CanCo) can deduct interest expense incurred on debt owing to 'specified non-residents' – non-residents of Canada that either:

  • are 25%+ shareholders of a CanCo; or
  • deal non-arm's length with such 25%+ shareholders.

Effective January 1 2013, a CanCo can deduct only interest expense on an amount of debt owing to specified non-residents equal to 150% of the CanCo's 'equity' (start-of-year unconsolidated retained earnings plus the paid-up capital of CanCo shares owned by a non-resident 25%+ CanCo shareholder). Previously, the limit had been 200% of such equity. In addition, disallowed interest is now treated as a dividend and subject to dividend withholding tax.(1)

Since most foreign purchasers of a Canadian target use a CanCo to make the purchase (for tax and non-tax reasons), a foreign purchaser can now loan only a reduced amount to its Canadian acquisition vehicle to make the purchase, and reduced interest expense deductions must be factored into the purchase price. Going forward, it is expected that CanCos will be financed to a greater extent with equity or with loans from arm's-length lenders (no thin capitalisation limits apply to debt owing to Canadian or arm's-length lenders).

Separately, Canada introduced complex new rules (foreign affiliate dumping rules) in 2012(2) that apply whenever a foreign purchaser acquires shares of a CanCo that itself owns an equity interest in one or more foreign corporations. These rules may apply to either the initial M&A transaction or post-acquisition to any ongoing investment that the CanCo makes in foreign corporations. Where applicable, the rules effectively deem the CanCo to have paid a dividend or effected a capital distribution to its foreign parent. Accelerated or double taxation can arise in various circumstances.

It is advised that foreign purchasers work through these rules carefully whenever the Canadian target has interests in foreign entities.

For further information on this topic please contact Steve Suarez at Borden Ladner Gervais LLP by telephone (+1 416 367 6000), fax (+1 416 367 6749) or email (


(1) For more on changes to these rules, see

(2) For a detailed analysis of these new rules, see