The acquisition of a privately held Canadian business is generally effected by one of three means:
- The purchase of assets;
- The purchase of shares; or
- Statutory amalgamation.
While privately negotiated acquisitions are generally exempt from the take-over bid provisions of securities legislation, they can still raise securities law concerns, e.g. when they require the issuance of securities as consideration for an acquisition.
The principal features of Canadian asset purchase and share purchase agreements will be discussed below, with uniquely Canadian features noted as appropriate.
Because statutory amalgamations are relatively uncommon in the privately-negotiated context, we will not discuss them at length here. Generally speaking, however, an agreement giving effect to the business terms of such a transaction (whether it is the actual amalgamation or not), would look similar to the share purchase agreement described below. Thus it would include comprehensive representations and warranties concerning each amalgamating corporation, pre-closing covenants, conditions of closing, etc.
Note that the primary focus of this chapter is on the acquiror. It is also generally assumed that both the acquiror and the seller are corporate entities dealing at arm’s length and that the business is located in whole or in part in the province of Ontario.
Asset Purchase or Share Purchase?
Determining whether the acquisition of a privately held Canadian business will be completed by way of a purchase of assets or shares is driven by both tax considerations and non-tax considerations. The weight given to the various factors will depend on the circumstances of the transaction and the bargaining power of the parties.
Setting tax issues aside for a moment, from the point of view of a potential acquiror the greatest advantage of an asset sale is probably that it can pick and choose the assets it will purchase and the liabilities it will assume. Thus it could leave accounts receivable, unwanted inventory, etc. with the seller. However, certain liabilities such as environmental contamination associated with real property, or a collective agreement relating to unionized employees of the business, will flow by operation of law to the buyer in an asset transaction.
While the ability to be selective about what it acquires is a highly attractive aspect of an asset sale, there are numerous respects in which a share sale is advantageous to a buyer. Some of these are as follows:
Share sale is simpler from a conveyancing perspective
A share sale is relatively simple from a conveyancing perspective, as little is required beyond the delivery of share certificates. An asset sale, particularly in larger and more complex transactions, can involve numerous conveyancing, assignment and transfer documents for particular assets, such as real estate, leases, motor vehicles, contracts, intellectual property, etc. However, even in a share sale conveyancing can be complicated if there are “change of control” provisions in contracts or regulatory permits, for example.
Share sale typically requires fewer third-party consents
An asset sale triggers far more third‑party consents for the assignment of leases, licenses and contracts when compared to any consents that might be required in the event of a “change of control” triggered by a sale of shares. Obtaining such consents can be burdensome, time‑consuming and expensive.
Share sale simpler with respect to employment issues
Depending on the province, an asset sale may also entail a number of distinct issues relating to employees. Under Ontario law, for example, it will have to be decided whether some or all of the employees of the seller will be offered employment by the buyer (which party will be responsible for severance costs if employees do not accept offers), how pension benefits are to be dealt with, who will be responsible for accrued vacation pay, etc.
The law in Quebec, however, differs with respect to the treatment of employees in the context of asset sales, so careful analysis should be undertaken with respect to that province where appropriate.
See page B21 below for further information on employment issues.
Share sale avoids difficult bulk sales requirements
(or consequences of bulk sales waiver)
Finally, compliance with bulk sales legislation in Ontario (see page B29, below) often presents considerable difficulties. If the applicable bulk sales legislation requirements are waived, as is often the case, unpaid creditors of the seller may be able to assert claims directly against the buyer.
Tax considerations generally lead sellers to prefer share sales and buyers to prefer asset sales.
Share transactions – seller considerations
Canadian sellers generally prefer share transactions, for a number of reasons:
- Share transactions will generally give rise to capital gains (which are taxed at half the rate of ordinary income);
- An exemption of up to $750,000 of capital gains may be available to Canadian resident individual sellers if the corporation that is disposed of is a “small business corporation” and certain other conditions are met;
- In a share transaction, a seller that is a corporation may be able to reduce its taxable gain by having the target corporation declare “safe income” dividends prior to the transaction (as such inter-corporate dividends are generally non-taxable);
- In a share transaction, the overall tax payable may be reduced if the seller’s tax cost of the shares (“outside basis”) is higher than the corporation’s tax cost of the assets (“inside basis”); and
- In a share transaction, the seller may have the opportunity to claim a reserve for any portion of the sale price that is not payable until a later year.
If the consideration is to include the shares of a buyer that is a Canadian corporation, the seller may be able to take advantage of available tax deferrals or “rollovers”. There may be other tax issues for the seller depending on the nature of the specific share transaction, including issues relating to the proper treatment of payments received under a deferred purchase price arrangement or earn out.
Share transactions – buyer considerations
A buyer might prefer a share transaction if the target corporation has significant non-capital tax-loss carryforwards (i.e. business losses), since the only way for the buyer to acquire the tax losses of the target corporation is to acquire the shares of the target corporation.
However, a share sale may also have certain tax-related drawbacks:
- A share sale will generally result in a “change of control” that triggers a year-end for tax purposes, requiring the corporation to file a tax return; and
- Provisions of the Income Tax Act (Canada) will impose restrictions on the use, after a change of control, of capital and non-capital losses. Non-capital losses are generally “streamed” on a change of control as they may only be used to offset future income from the same or a similar business that generated the losses. Capital losses generally expire on an acquisition of control.
Elections may be available to write up the tax cost of the assets of the corporation immediately prior to the acquisition of control in order to use the losses that might otherwise expire to shelter any resulting gains.
Asset transactions – general considerations
From a tax perspective, an asset transaction is generally more advantageous than a share transaction for the buyer. In an asset transaction, a buyer will generally have the opportunity to write off all or part of the purchase price (i.e. depreciable property, inventory, goodwill, prepaid expenses, etc.). As noted above, a buyer will also be able to purchase only selected assets in an asset transaction, and may be able to choose the liabilities (including tax liabilities) to be assumed.
The seller may also prefer an asset transaction in certain circumstances. For example, if the target corporation has significant tax-loss carryforwards, the seller may wish to engage in an asset sale to generate income or capital gains that can be sheltered with such losses.
Allocation of Purchase Price
In an asset sale, the allocation of the purchase price among the various assets is critical from an income tax perspective. Generally a buyer of assets inCanadawould prefer to allocate the purchase price in the following order:
- Inventory (full deductibility);
- Depreciable capital property with a high rate of capital cost allowance (i.e. “tax depreciation”);
- Eligible capital property (the tax pool for goodwill);
- Depreciable capital property with a low rate of capital cost allowance; and
- Non-depreciable capital property (e.g. land).
In most instances the buyer and the seller engaged in an asset transaction will have conflicting interests in making these allocations. A Canadian asset purchase agreement would typically include provisions dealing with the allocation of the purchase price among the purchased assets and a covenant of the buyer and the seller to prepare their financial statements and prepare and file their tax returns on such a basis.
Exchangeable Shares (Foreign Buyers)
A resident Canadian seller may wish to defer the capital gain that would otherwise arise from the sale of shares to a foreign buyer who wishes to use its stock, in whole or in part, as consideration. In order to obtain such a “rollover”, one of the requirements is that shares of a Canadian corporation be received and, in this context, an “exchangeable share” arrangement is sometimes effected. Exchangeable shares are issued by a Canadian subsidiary or other Canadian affiliate of the buyer and are exchangeable into the publicly-traded shares of the foreign buyer.
The result of such a transaction is that resident Canadian sellers are able to receive shares of a Canadian corporation in return for their shares in the Canadian target and thus take advantage of a tax-free rollover.
Exchangeable share transactions are discussed in more detail in Chapter G of M&A Activity in Canada: “Exchangeable Share Structures”.
Section 116 Certificates (Withholding)
Subject to certain exceptions, Section 116 of the Income Tax Act requires a non-resident seller of “taxable Canadian property” to apply to the CRA for a clearance certificate with respect to the disposition or proposed disposition of such property either before the disposition or within 10 days after the disposition. A clearance certificate will be issued if the non-resident either pays 25% of the (estimated) capital gain on the (proposed) disposition as a pre-payment of the non-resident’s Canadian tax payable, or furnishes security acceptable to the CRA in lieu thereof.
The above requirement does not apply to certain types of excluded property, which includes listed shares, units of a mutual fund trust, bonds, debentures and property any gain from the disposition of which would, because of a tax treaty with another country, be exempt from Canadian tax (provided in certain cases notification is given to the CRA).
In an arm’s length sale of such property, the buyer would generally require the section 116 certificate on the closing date, absent which they would generally withhold 25% of the purchase price until such a certificate is provided (as the failure to obtain a section 116 certificate or, in the alternative to make the required 25% withholding and remittance, will make the buyer liable for the amounts that should have been withheld and remitted).
Goods and Services Tax (GST)
The GST is a value-added 5% federal sales tax imposed under the Excise Tax Act (Canada) on virtually all goods and services consumed in Canada. In recent years, some provinces have replaced their separate and distinct provincial sales taxes (PST) with a higher GST rate in their provinces. In those provinces, all GST collected in excess of the national 5% level is remitted by the federal government to the respective provincial governments as a substitute for their former PST revenues. Note that, in those provinces, GST is called “Harmonized Sales Tax” (HST).
Like most sales and value-added taxes, GST/HST is generally collected by the seller from the buyer. “Exempt” supplies of goods and services are not taxable. The sale of shares falls within the exempt supply category since shares are considered financial instruments. However, absent a rollover, a typical asset sale will attract some GST/HST liability, including on tangible personal property (including inventory), most commercial real property and all intangible property. The most common rollover available is the one under Section 167 of the Excise Tax Act for the sale of a business or part of a business where the parties elect to have the transfer occur at nil consideration. In this context it is important to determine if the buyer and the seller are registered under the Excise Tax Act. There is often a representation and warranty in an acquisition agreement with respect to such registration. The Section 167 rollover is available only if the buyer is acquiring ownership, possession or use of all or substantially all (generally required to by the CRA to be 90%) of the property that can reasonably be regarded as being necessary for it to be capable of carrying on the business or part of a business.The election cannot be made if the seller is registered for GST and the buyer is not.
For a discussion of the effect of provincial sales taxes on an asset sale transaction, see page B30 below.
They are discussed in Chapter C of M&A Activity in Canada: “Acquiring a public company”.