Canadian Taxation Framework

Forms of Entity

Treatment of Expenditures in Canada

Flow-Through Shares

Investment Outside of Canada

Mergers & Acquisitions

Provincial Mining Taxes

Other Topics


Mergers & Acquisitions

Executive Summary

Mergers and acquisitions can take many forms, particularly in the mining sector.  While it is not possible to provide a comprehensive discussion of all possible forms of merger and acquisition transactions, the principal issues commonly encountered are reviewed here (including some seen most frequently in the mining sector), and some of the most important factors to consider for Canadian and foreign participants are described.

1.         Form of Transaction

Financing-Type Transactions

In the exploration and development phases of mining ventures, the lines between financing transactions and acquisitions are often blurred.  It is quite common to see a junior mining company with a promising property but short on cash enter into a transaction with a more senior mining company that has stronger financial resources, which from the junior’s perspective constitutes a financing and which the senior mining company sees as the first step of a potential acquisition.  Examples of such transactions include the following:

  • Farm-outs: farm-outs are transactions whereby the owner of a resource property (the “farmor”) grants an interest in an unproven resource property (i.e., one with no proven reserves) to another party (the “farmee”) who agrees to fund and carry out exploration or development work on the property, thereby earning an interest in the property.  The CRA has stated that in certain circumstances, the farmor will be considered to have no proceeds of disposition as a result of the farm-out (and as a result no CCDE reduction or resulting income inclusion) and the farmee’s expenses will be considered CEE rather than CDE.
  • Partnerships & Joint Ventures: two parties may pool specific resources (property, cash, expertise, etc.) in a partnership or joint venture so as to advance development of (and ultimately production from) mining concessions.  Partnership and joint ventures are discussed here
  • Royalties & Production Off-takes:  where the owner of a property is seeking to raise financing, reduce risk or simply monetize a portion of a mine’s present or future production, it may sell a royalty interest in the property to a third party or enter into a contractual agreement to sell several years of production in exchange for an immediate payment and/or a series of future payments (e.g., a forward sale).  The sale of a royalty interest will usually give rise to CDE treatment for both parties. Contractual arrangements such as production off-takes can usually be structured so as not to result in CDE treatment.

In other cases, the transaction will be structured as an outright purchase of property by one party (the purchaser) from another party (the vendor), and the balance of the discussion herein will deal with property purchases.

Buy Assets or the Entity?

One of the principal decisions that the parties must reach relatively early in the process is whether the transaction will be a purchase of assets owned by an entity (an asset sale) or the purchase of the ownership interests of that entity itself (e.g., shares of a corporation that owns the relevant assets).  Quite often the vendor and purchaser have different preferences.  Purchasers usually prefer to acquire assets instead of purchasing an entire entity, since (1) purchasing assets offers more flexibility in terms of which assets to acquire and which liabilities to assume, and (2) the tax recognition for purchased assets (e.g., CCE, CDE, CCA) is typically more advantageous in terms of generating deductions from income for tax purposes than is the tax recognition offered for acquiring shares or partnership interests.

Vendors often prefer to sell shares of a corporation rather than selling particular assets, since:

  • this usually results in capital gains treatment for the vendor rather than creating an income inclusion (such as might occur on a CDE reduction from selling Canadian resource property or recaptured CCA from selling depreciable property); and
  • the vendor is not left with any residual assets or liabilities to deal with (i.e., a share sale is “cleaner”).

The tax attributes of the entity in question (i.e., its CEE/CDE pools and the cost of its assets for tax purposes relative to their fair market value) may also affect the attractiveness of a share acquisition versus an asset purchase.  Significant differences between the cost that shareholders have in their shares of a corporation (“outside basis”) and the cost that the corporation itself has in its own assets (“inside basis”) may be an important factor. Differences in the treatment of asset and share transactions under provincial mining tax laws are also relevant.

A share sale typically takes more time to negotiate (since the purchaser has more work to do understanding the liabilities within the entity being purchased), but is often simpler to complete under the relevant commercial law, in particular where the alternative is selling mining assets that carry environmental or other obligations and possibly require third-party approvals or consents.  Asset sales also involve sales tax and land transfer tax considerations that generally do not exist in a share sale.  Where assets are being purchased, the parties must agree on how to allocate the total consideration payable amongst the various assets, since different types of property have different tax treatment on sale.

In the mining sector, significant asset sales are typically seen only in a domestic context (i.e., Canadian assets and Canadian purchaser and vendor).  The balance of the discussion that follows generally assumes that the transaction is structured as a sale or merger of corporations rather than of assets.  The corporation that is being purchased is referred to as the “target” corporation.


A merger or amalgamation (whereby two or more corporations combine to form a single entity that constitutes the continuation and successor of both of them) is akin to a share acquisition, since the surviving merged entity acquires all of the property and liabilities of all of its predecessors (i.e., the amalgamating corporations).  Typically Canadian corporate law requires that each amalgamating corporation be governed by the same corporate statute in order to amalgamate.  For Canadian tax purposes, an amalgamation of Canadian corporations will not result in a taxable disposition of the property of the amalgamating corporations so long as the resulting amalgamated corporation acquires all of the property and liabilities of each predecessor (excluding shares or debt of one participating corporation held by another participating corporation), and all shareholders of each participating corporation (excluding any other participating corporations) receive shares of the amalgamated corporation.  Shareholders of a participating corporation generally will not realize any gain or loss on the amalgamation if they receive only shares of the amalgamated corporation in exchange for their shares of the predecessor.

2.         Amount and Form of Consideration

Valuation is always a difficult issue in purchases and sales, and this is particularly the case in the mining sector, where the quantity and quality of the underlying resource (and often the pricing of the output) carries a high degree of uncertainty.  Various techniques are often employed in mining acquisitions to bridge the gap between buyers and sellers.  These include earn-out transactions (where the purchase price is linked to post-closing earnings or free cash-flow), contingent value rights, royalties and equity (i.e., shares) in the buyer.  Creative forms of transaction valuation such as these often have unforeseen tax consequences, and require considerable analysis in order to avoid an unfavourable tax result to one party or the other.  Earnouts for example may result in the vendor’s proceeds being deemed to constitute regular income rather than capital gains, in the absence of careful planning.

Where the purchaser is not interested in all of the assets contained within the target corporation or the parties find it difficult to agree on the value of those residual assets, it is often possible to structure the transaction so as to leave the vendor with an interest in a new entity that contains the unwanted assets (a “spin-out”).  Where the target entity is a publicly-traded corporation, that corporation would typically “spin out” shares of that new entity (which themselves are often publicly-listed) to its shareholders, who would then sell the public corporation’s shares to the buyer.  The vendors end up with the spun-out shares of the new entity plus whatever consideration is received for the public corporation’s shares.  The tax implications of such a spin-out to the public corporation and to its shareholders depend on the facts.

The form of payment is also a critical element of the transaction.  As is discussed below, the ability of vendors to defer tax on any accrued gains on the sale and the purchaser’s recognition of the acquisition costs for tax purposes are often dictated by the form of consideration used to pay for the purchase.

3.         Other Target Securities

In the case of corporate acquisitions, there may be other outstanding securities that need to be dealt with in order for the purchaser to acquire 100% equity ownership of the target corporation.  For example, Canadian public companies often have employee stock option plans (ESOPs) granting employees the right to acquire a fixed number of shares of the corporation at a fixed price (usually the fair market value of those shares at the time the stock options were granted to the particular employee).  Planning for the acquisition will have to take into account what to do with these securities, including what is permitted under the terms of the ESOP.  For example, employee stock options could potentially be exercised, surrendered in exchange for a cash payment, or exchanged for new ESOPs for shares of the purchaser.

The key Canadian tax issues associated with ESOPs on an acquisition include:

  1. preserving the favourable tax treatment given to holders of most employee stock options.  While employees who exercise or dispose of their options (other than in exchange for new options in a qualifying exchange) realize a taxable benefit equal to the “in-the-money amount” of their options (the difference between the fair market value of the shares when purchased and the exercise price payable under the option), only 50% of that amount is subject to tax if certain conditions are met;
  2. fulfilling the employer’s legal obligation to withhold the prescribed amount from the employee’s taxable benefit, and remitting the withheld amount to the CRA on account of the employee’s tax liability; and
  3. determining whether there is any scope to create a deductible expense for the employer or a related person in respect of the in-the-money amount, either for income tax or provincial mining tax purposes.

Additional examples of securities that need to be considered in effecting the acquisition of a corporation include other forms of stock-based employee compensation, warrants to acquire shares of the target corporation, and debt convertible into shares of the target corporation.

4.         Acquisition Process

Where a buyer is acquiring all of the shares of a corporation, the process for completing the purchase usually takes a fairly typical sequence:

●          once the parties begin to find agreement on the parameters of a deal, they usually prepare a term sheet which constitutes a non-binding description of the transaction being contemplated and the key terms (e.g., purchase price, timeline, etc.).  The term sheet is often accompanied by a confidentiality agreement to ensure that the purchaser keeps both the negotiations themselves and any information received from the seller confidential.  In some cases the purchaser (who is expending significant time and money investigating the acquisition) will ask for an exclusivity agreement preventing the seller from soliciting or continuing discussions with other potential buyers.

  • the purchaser will then usually have a set amount of time to conduct an investigation of the business, assets and liabilities of the target corporation (called “due diligence”).
  • the purchase and sale transaction will then be set out in a binding, formal agreement (an agreement of purchase and sale), describing the property being purchased and the consideration payable, the representations and warranties each party (primarily the seller) is making as part of the deal, the conditions under which the sale will be completed, and provisions for one party to indemnify the other if its representations and warranties are discovered to be untrue (in acquisitions of widely-held companies there are typically no post-completion indemnities).

During the period between the signing of the agreement of purchase and sale and completion (or “closing”) of the transaction, the parties will obtain any required governmental or third-party consents, secure financing (if necessary), and take whatever other action is required by law or under the purchase agreement in order to fulfill the closing conditions.

Where the target corporation is a Canadian public company there is a further layer of securities law considerations to be observed, and the purchaser will have other important decisions to make such as:

  • whether to try and negotiate a “friendly” transaction with the public company or instead make a “hostile” offer directly to its shareholders (a friendly transaction offers advantages such as greater access to information and potential co-operation on pre-closing tax planning, but constrains the purchaser’s freedom to act); and
  • in the case of a friendly transaction, whether to proceed by way of, (1) a take-over bid to the public company’s shareholders or (2) a “plan of arrangement”, a court-supervised procedure that is often useful when trying to achieve a result not specifically provided for in the relevant corporate law or when trying to complete multiple steps in an all-or-nothing result.  An amalgamation of the target with the purchaser (or a Canadian subsidiary of the purchaser) may also be a viable acquisition structure.

5.         Structuring the Transaction: Tax Planning Considerations for the Seller

Structuring the acquisition requires thought about what tax objectives sellers may have.  By ensuring that the acquisition takes a form that optimizes the tax position of sellers, a purchaser can enhance the likelihood of success and potentially reduce the purchase price.

Capital Gains vs. Dividends

One basic structural issue is the tax character of what the sellers are to receive.  In many cases, it is possible to structure the transaction so that consideration to be received by the sellers takes the form of either a capital gain/loss or a dividend for Canadian tax purposes.  While capital gain/loss treatment is the typical choice, this may be more or less attractive than dividends, depending on various circumstances and the particular situation of each seller.

Deferral of Capital Gains

Where sellers are receiving something other than cash exclusively, a common acquisition strategy is structuring the sale of shares as a tax-deferred exchange in which sellers realize no gain for tax purposes (to the extent possible).  Section 85 ITA provides a mechanism by which a seller can transfer most forms of property to a taxable Canadian corporation on a tax-deferred (or “rollover”) basis.  In order for section 85 to apply, the seller must receive consideration for the transferred property that includes at least one share of the transferee corporation (other forms of consideration (“boot”) may also be received), and the seller and the transferee corporation must jointly elect to have section 85 apply by filing the required forms with the CRA.

The seller and transferee mutually choose an amount that will be deemed to be both the seller’s proceeds of disposition of the property and the transferee corporation’s cost of the property.  There are limitations on this elected amount:

  • it cannot be greater than the fair market value of the transferred property;
  • it cannot be less than the fair market value of any boot received by the seller (e.g., cash, shares of other corporations, etc.); and
  • it cannot be less than the lesser of the transferred property’s fair market value and its cost to the transferor for tax purposes.

The typical result of these rules is that the parties can elect anywhere between the seller’s cost of the transferred property and its fair market value.  If the parties elect at an amount equal to the seller’s cost of the transferred property, no gain will be realized on the transfer (and the transferee corporation will inherit the accrued gain), since the seller’s proceeds of disposition proceeds will equal the property’s cost.  Note however that since the elected amount cannot be less than the amount of any boot received, if the seller does not want to realize any gain then she cannot receive boot in excess of her cost of the transferred property.  In computing the seller’s cost of the consideration received, boot is acquired at a cost equal to its fair market value.  To the extent that the elected amount exceeds the cost of any boot, the difference is deemed to be the seller’s cost of the transferee corporation shares received by the seller, viz., the elected amount is allocated first to the boot and any excess to the shares.

The result of these rules is that it is possible to extract “boot to basis”.  For example, assume that a seller has a property with a fair market value of $100 and a cost of $60.  If that property is transferred to a Canadian corporation in exchange for cash and shares of that corporation under section 85, it is possible for the seller to receive $60 of cash (and $40 worth of transferee shares with zero cost for tax purposes) without realizing any gain by electing under section 85 at $60: there is no requirement to realize a proportionate amount of the $40 accrued gain. This flexibility to extract boot up to the amount of the seller’s basis on a full-deferral basis makes section 85 elections very useful. For more information on section 85 elections, see CRA publication Information Circular IC 76-19R3, available here.

There are other ITA provisions that offer tax deferral in various specific circumstances relevant to mergers and acquisitions:

  • subsection 87(4), which applies where two or more Canadian corporations amalgamate (i.e., merge into a single surviving entity) to form an entity that acquires all of the property and liabilities of the merging corporations, as described above.  This provision deems the exchange of shares in a predecessor corporation exclusively for shares of the amalgamated corporation (and no other property) to occur on a rollover basis;
  • section 85.1, which applies on certain transfers of shares of a Canadian corporation to a purchaser Canadian corporation in exchange for shares of that purchaser.  This provision is generally less advantageous for the purchasing corporation than section 85, so often the purchasing corporation will intentionally structure the acquisition to prevent section 85.1 from applying;
  • section 86, which applies where shareholders of a corporation exchange their shares of the corporation for property that includes (but need not be limited to) new shares of that corporation.  This provision is often very useful in distributing assets of a corporation to its shareholders in a tax-efficient manner, as in a spin-out described above: see here for a discussion of this topic; and
  • paragraph 40(1)(a), which may apply to defer recognition of a portion of the purchase price for up to 5 years where some or all of the purchase price is due after the year of sale and the seller is a Canadian resident.

Where the purchaser is a foreign corporation, it may still be possible to structure the transaction to provide tax deferral to sellers using exchangeable shares, described below at 7, Special Considerations for Non-Resident Pruchasers.

Safe Income

Another tax planning technique that an acquiror can use to make a transaction more attractive to shareholders of the target is offering a “safe income” alternative.  While the details are complicated, essentially a “safe income” transaction gives certain sellers the opportunity to participate in the transaction in a way that reduces the accrued capital gain on their shares of the target, and hence any tax payable.  These sellers first transfer their target shares to a new Canadian holding corporation on a tax-deferred basis under section 85 ITA, and then take certain steps that increase the cost for Canadian tax purposes of their shares of the holding corporation.   They then participate in the transaction by selling all the shares of the Canadian holding corporation (which can usually be merged or wound-up into the purchaser on a tax-deferred basis) for the same consideration that would otherwise be received for the target shares owned by that holding corporation.

A safe income alternative will not be available for all holders in all cases.  Essentially the relevant rules limit the amount of any particular seller’s cost increase for tax purposes to that seller’s pro rata portion of the tax-paid retained earnings of the target corporation during that seller’s period of share ownership.  As such, it will not be of use where the accrued gain on the seller’s target shares is attributable to something other than tax-paid retained earnings of the target corporation (e.g., goodwill or accrued but unrealized gains on the corporation’s property). While safe income alternatives are typically cost-effective only for significant shareholders who are Canadian residents, these shareholders are often the most important to win the support of.

6.         Structuring the Transaction: Tax Planning Considerations for the Purchaser

Purchasers must consider a variety of their own tax issues (separate and apart from the tax position of the sellers) when structuring an acquisition.


Where debt financing is involved for any aspect of the transaction, determining which entity should incur the interest expense and making sure that such interest expense will be deductible for tax purposes is essential.  Interest expense on debt incurred to acquire shares of a target will generally be deductible, subject to various potential limitations (e.g., the reasonableness of the interest rate).  Interest expense is not deductible in all circumstances however, and the deduction may be more useful in one entity than another (Canada does not have a consolidated or group-relief tax system), so it is important to consider how to optimize the use of any financing deductions.  If the objective is to use interest expense from the acquisition financing against income from the target corporation for example, steps will need to be put in place to achieve this result.

There is no interest withholding tax exigible on interest paid to a Canadian resident lender.  Canadian interest withholding tax may apply on interest paid to non-residents of Canada.  No such withholding tax applies if the lender deals at arm’s length with the borrower, as long as the interest is not participating (e.g., computed based on the borrower’s profits or similar criteria).  Moreover, no withholding tax applies even to interest paid to a non-arm’s length U.S. lender, so long as that lender is entitled to claim the benefit of the Canada-U.S. income tax treaty (there are conditions) and the interest is not participating.  Where applicable, Canadian interest withholding tax is 25%, unless reduced by a tax treaty applicable to the non-resident lender (treaty rates are usually 10% or 15%).

Section 116 Withholding

The purchaser will need to satisfy itself that it does not have an obligation to withhold and remit to the CRA 25% of the purchase price under section 116 ITA.  The section 116 withholding regime applies where a non-resident of Canada disposes of most forms of “taxable Canadian property”, which prima facie includes shares of a corporation that have derived their value primarily from Canadian real property or Canadian resource property any time during the preceding 60 months.  There is no section 116 withholding obligation if the shares being purchased are listed on a “recognized stock exchange” (see here for a discussion of this term).

If the purchaser obtains a written representation that an arm’s-length seller is not a resident of Canada and the purchaser has no reason to believe otherwise, this will usually relieve the purchaser of its section 116 obligations.  If the seller may be a non-resident and the shares being purchased are not listed on a recognized stock exchange, the purchaser should either (1) insist that the non-resident produce a waiver of withholding from the CRA or (2) withhold and remit 25% of the purchase price.  The purchaser is liable for amounts that it should have withheld and did not (plus interest and penalties). See here for more on section 116 withholding.

Cost Basis in Target Shares

Purchasers will generally prefer to maximize their cost for tax purposes in the property they are acquiring, since this minimizes future gains (and the related taxation of such gains).  As such, purchasers will generally want to be sure that they obtain the fullest recognition possible for the cost of their target shares for tax purpose.  Where the purchaser is considering offering tax deferral to sellers (e.g., a section 85 ITA election), one of the factors to be taken into account is the fact that this will typically reduce the purchaser’s cost for tax purposes of the property it is acquiring.  In many cases purchasers will for this purpose take steps to ensure that the automatic share-for-share tax deferral in section 85.1 ITA does not apply.

s. 88(1)(d) Bump

The step-up or “bump” in the cost of property for tax purposes afforded by paragraph 88(1)(d) ITA is an extremely useful tax planning tool that is of particular use when acquiring a Canadian mining corporation.  It has been used frequently in mining acquisitions, most notably in Barrick Gold Corp.’s 2006 takeover bid for Placer Dome Inc.  In this transaction Barrick and Goldcorp Inc. agreed that if Barrick could acquire Placer, Barrick would sell to Goldcorp over $1 billion of Placer’s property.  These sale proceeds from Goldcorp effectively funded part of Barrick’s purchase price payable to Placer shareholders, and eliminating tax on accrued gains on this property by increasing its tax cost was a critical element of the bid.

When an acquirer purchases shares of a corporation, the only tax recognition that the acquirer receives for the purchase price is in the basis (adjusted cost base, or “ACB”) of the target corporation’s shares. If that target corporation is later wound up or merged into the acquirer (as often occurs), these shares disappear, and with them the acquirer’s tax recognition of the purchase price.  The purchaser acquires the target’s property on the wind-up, but either inherits the target’s cost for tax purposes of such property (if the wind-up of the target occurs on a rollover basis) or causes the realization of any accrued gains on target’s property (if not a rollover).  Paragraph 88(l)(d) ITA is a relieving provision designed to mitigate some of the harshness of this result.

Essentially, this provision allows a purchaser that is a Canadian corporation to increase the ACB of non-depreciable capital property it acquires when a target Canadian corporation is wound up or merged into it. For example, if Purchaser pays $100 to acquire all the shares of a Canadian target corporation (Target) that has bump-eligible property worth $60 with $20 of ACB to Target, paragraph 88(1)(d) ITA allows Purchaser to liquidate Target on a tax-deferred basis, acquire its property, and potentially increase the ACB in that property to $60 (see Figure 2).  Bumping the ACB of property and eliminating any accrued gain on it allows it to be transferred freely without realizing capital gains (and accompanying tax).


Figure 2: Basic Bump Transaction

While the principle behind the tax cost bump is simple, there are several important requirements that must be observed in order to claim it:

  • Both Purchaser and Target must be taxable Canadian corporations, viz., Canadian incorporated and resident (for non-resident purchasers this means using a Canadian acquisition company).
  • The only property eligible for this step-up in ACB is Target’s non-depreciable capital property. In most cases, this means land and interests in other entities (for example, shares of subsidiaries or partnership interests) but not interests in Canadian or foreign resource properties, buildings, equipment, or inventory.
  • Only property owned by Target at the time that Purchaser acquired control of it is eligible for this increase in ACB.
  • The ACB of an eligible property cannot be increased above its fair market value. In the case of shares of a first-tier foreign affiliate of Target, draft amendments to the ITA designed to prevent duplication in ACB and surplus accounts will reduce the maximum addition to ACB and make the bump less generous.  Essentially, the maximum bump permitted will be the excess of the fair market value of the FA’s shares over the sum of their pre-bump ACB and the FA’s “tax-free surplus balance” (basically the amount that the FA could distribute to Canada tax-free using exempt surplus and credit for underlying foreign tax on taxable surplus).
  • There are a number of complex provisions designed to prevent Purchaser from selling Target property back to former Target shareholders, directly or indirectly, to prevent the use of the bump on what is a ­de facto divisive reorganization.  These rules in particular are overly broad and can add a great deal of complexity to a bump transaction, and prevent selling shareholders from receiving shares of a non-Canadian corporation as consideration (foreign purchasers using the bump are restricted to using cash purchase proceeds).

The paragraph 88(1)(d) bump is particularly useful when some Target assets will be sold immediately following the acquisition of Target, either to a third-party buyer (as in Barrick-Placer) or as part of an intra-group restructuring.  This allows them to be disposed of without any gain being realized for Canadian tax purposes.There are often helpful planning strategies available where Target is willing to co-operate with Purchaser by “pre-packaging” or restructuring its property prior to the acquisition of control in order to maximize the usage of the paragraph 88(1)(d) bump.  For example, under some circumstances it could be desirable prior to the acquisition of control for Target to transfer property that is not bump-eligible into a wholly-owned Canadian subsidiary in exchange for shares of the subsidiary (which are bump eligible).  This would permit the ACB of the subsidiary’s shares to be increased, effectively allowing the underlying property to be sold or moved elsewhere within the group.  See here for more information on the s. 88(1)(d) bump.

7.         Special Considerations for Non-Resident Purchasers

For transactions structured as a purchase of shares of a Canadian corporation, a non-resident will almost always use a Canadian subsidiary as the actual purchaser of the Canadian target’s shares, instead of acquiring those shares directly.  The use of a Canadian acquisition corporation (“Bidco”) has a number of potentially beneficial Canadian tax effects, including:

  • maximizing the paid-up capital (“PUC”, the tax version of corporate law stated capital) of the top-tier Canadian entity, which can be paid out to the foreign parent without incurring Canadian dividend withholding tax;
  • making possible the s. 88(1)(d) step-up or “bump” in the cost for tax purposes of the Canadian target’s property discussed above (but only where the non-resident purchaser is paying exclusively with cash); and
  • permitting consolidation of the tax-deductible interest expense on any acquisition debt  incurred by Bidco with the taxable income earned by the Canadian target, by merging or winding up the Canadian target into Bidco on a tax-deferred basis.

It is important to use Bidco to make the initial acquisition of Canadian target shares, because there are provisions in the ITA that may create adverse tax consequences where a foreign purchaser that has already acquired a Canadian target attempts to interpose Bidco between itself and the Canadian target.  One instance in which a foreign purchaser might consider making a direct acquisition would be where the PUC of the Canadian target exceeded the purchase price payable for its shares.

Exchangeable Shares – Non-resident purchasers acquiring the shares of a Canadian target are at something of a disadvantage compared to a Canadian corporate purchaser, at least as regards Canadian target shareholders, because a Canadian corporate purchaser can offer its own shares as all or part of the purchase price for the target shares on a rollover basis (e.g., by making a section 85 ITA election).  In response to this, foreign purchasers using their shares as consideration in an acquisition and wishing to provide tax deferral to sellers for Canadian tax purposes often use an acquisition structure known as “exchangeable shares”, under which sellers exchange property for shares of a Canadian subsidiary of the foreign purchaser, structured to defer the vendor’s accrued gain (usually via a section 85 ITA election).  These exchangeable shares of the Canadian subsidiary are exchangeable on demand for shares of the foreign purchaser, at which time deferred gains will be realized for Canadian tax purposes.  Exchangeable shares have been used in a number of large inbound Canadian acquisitions, including in the mining sector (Hemlo-Battle Mountain is an example of a mining sector exchangeable share deal, while Vivendi’s acquisition of Seagram and the merger of Molson and Coors were also done via exchangeable shares).  For more on exchangeable shares see here

S. 88(1)(d) Bump – As noted earlier, foreign purchasers have another disadvantage relative to Canadian purchasers in that if vendors receive shares of a foreign purchaser, this will generally render the transaction ineligible for the s. 88(1)(d) tax cost bump described above.  Hence, foreign purchasers wanting to use this provision must use cash for the purchase price.A foreign purchaser will typically want to use the s. 88(1)(d) bump to step up the cost of interests in any foreign entities held by the Canadian target and extract them from the Canadian tax system.  For example, in Figure 3 assume the Canadian Target had owned shares of a foreign subsidiary (US Subco) that have accrued gains and are bump-eligible property.  By using a Canadian acquisition corporation (Bidco), the foreign purchaser (US Parent) is able to have Bidco acquire Target, wind Target up into Bidco and step up the ACB of the shares of US Subco to their fair market value (this may also require the use of surplus balances), as illustrated in Figure 2, above.  Once this is done, US Subco can then be extracted from Canada by causing Bidco to distribute the US Subco shares to US Parent, either as a repayment of acquisition debt or as a PUC reduction (the latter would affect Bidco’s thin capitalization debt/equity ceiling).  Other potential bump planning opportunities exist for foreign purchasers.

Figure 3: Foreign Subsidiary Extraction

Financing & Capitalization

Non-resident purchasers have additional factors to consider in financing and structuring the acquisition.  In particular, the way in which the Canadian acquisition vehicle (Bidco) is capitalized is very important.  To the extent that Bidco is debt-financed from non-arm’s length sources, it is essential to determine (1) whether its ability to deduct interest expense is constrained by Canada’s thin capitalization rules, and (2) as discussed above, whether Canadian interest withholding tax applies in the case of a non-resident lender.

Because interest expense is a relatively simple way of stripping profits out of Canada and reducing Canadian taxes, a thin capitalization regime limits interest expense deductibility on debts owing by a Canadian corporation to certain non-residents if they exceed a specified debt/equity ratio.  If the amount of relevant debt exceeds two times the amount of relevant equity, interest on the excess portion of such relevant debt is deemed not to be deductible (interest on other debt is not affected by this rule).

Relevant debt is debt owing to “specified non-residents”, being non-residents who either are 25%+ shareholders (by votes or value) of the Canadian corporation or who do not deal at arm’s length with any such 25%+ shareholders.  Relevant equity is the sum of the corporation’s total retained earnings and the PUC attributable to shares of the corporation owned by non-residents who are 25%+ shareholders.  No thin capitalization restriction applies to debt owing to other creditors (i.e., Canadians or external bank debt).

More complex techniques may permit enhanced interest deductibility opportunities, particularly where Bidco is being financed by a foreign member of the parent group under an intra-group loan.  This may occur either where the foreign parent already has the necessary funds to finance Bidco or where the foreign parent group is borrowing externally and the proceeds are then being on-loaned to Bidco by a foreign group member.  For example, commonly-used intra-group “hybrid” financing techniques involving U.S. acquisitions into Canada often employ Bidco securities that are considered debt for Canadian purposes and equity for U.S. purposes.

The potential for Canadian interest withholding tax on intra-group debt into Canada typically encourages the use of a foreign group creditor (either the foreign parent or a separate finance company) located in a tax treaty jurisdiction, in order to obtain a reduced 10% rate (or potentially the zero rate applicable under the Canada-U.S. treaty).  The optimal location of the lender also depends on the extent to which Canadian withholding tax gives rise to a foreign tax credit in the lender’s home country.  Because Canadian taxes must generally be computed in Cdn. $ for ITA purposes, consideration should be given to the taxation of potential foreign exchange gains and losses in capitalizing Bidco, for both debtors and creditors.

The equity portion of Bidco’s capital will typically be held by a foreign parent located in a tax treaty country, in order to obtain the lowest possible Canadian dividend withholding tax rate and favourable treatment of capital gains on sale.  Luxembourg is a common choice for many foreign investors into Canada.


It is important to consider at the outset how surplus cash will be repatriated from Canada and whether the use of an entity in a particular country is helpful, in terms of both its local law and the terms of its tax treaty with Canada.  The three basic ways of repatriating cash from a Canadian subsidiary (apart from paying interest on debt) are:

  • the payment of a dividend by the Canadian subsidiary, which gives rise to non-resident withholding tax (reduced to 5% for closely-held subsidiaries under most Canadian tax treaties);
  • a distribution of PUC by the Canadian subsidiary, which does not create Canadian withholding tax but which reduces the shareholder’s basis in its shares for Canadian purposes (and may have tax implications in the recipient’s jurisdiction).  The ability to distribute property out of Canada free of tax as a PUC reduction makes PUC a very valuable attribute: see here for more on the importance of PUC; or
  • a loan by the Canadian subsidiary to the foreign parent. There are a variety of rules dealing with loans to foreign group members, which can be summarized as (1) requiring an arm’s-length rate of interest to be charged, and (2) treating the loan as a dividend unless it is repaid within a specified time frame (for more on this see here.

Note that unlike the U.S., there is no rule deeming equity distributions to come first from earnings and profits so as to be taxed as dividends: a Canadian corporation with sufficient PUC can choose to make a distribution as PUC return or as a dividend.  Depending on the circumstances, intra-group fees for bona fide services rendered to the Canadian entity (e.g., management fees or guarantee fees) may also be a useful means of repatriation that are tax-deductible in Canada.

Sale of Investment

Finally, proper structuring of the investment into Canada involves planning for an eventual sale.  This is because, subject to the critical issue of treaty relief (discussed below), the ITA taxes non-residents on capital gains from the disposition of shares of corporations (Canadian or foreign) as follows:

●          shares of a corporation (whether Canadian or foreign) not listed on a designated stock exchange will be “taxable Canadian property” (“TCP”) at any time only if, at some point during the preceding 60 months, they derived more than 50% of their value, directly or indirectly, from Canadian real property or resource property (the 50%-plus test); and

●          shares of a corporation (whether Canadian or foreign) that are listed on a designated stock exchange would be TCP only if both (1) the 50%-plus test above is met, and (2) 25% or more of any class of the corporation’s shares were owned by the vendor and/or persons dealing non-arm’s-length with the vendor at any time in the preceding 60 months.

Investments in Canadian mining companies are much more susceptible to Canadian capital gains taxation than are investments in most other businesses, because they are more likely to derive their value principally from land or resource interests in Canada.  Publicly traded mining shares are much less likely to constitute TCP however, because they benefit from an extra threshold (the 25%-plus test) before becoming TCP.  For more elaboration on what constitutes TCP, see here.

As discussed elsewhere, tax treaties between Canada and another country may reduce the taxes otherwise payable under the ITA.  This makes the role of tax treaties especially important for mining investments.  Canadian tax treaties approach the taxation of gains on shares that derive their value principally from Canadian real property (which includes mining properties) in different ways:

  • No Relief:  in a relatively small number of treaties there is essentially no relief from Canadian taxation of capital gains (for example, Australia, Chile, Brazil, India, Argentina and Japan);
  • Taxed if Derived Primarily from Canadian Real Property:  in some cases the treaty simply allows Canada to tax a corporation’s shares if the value of such corporation’s assets consists primarily (directly or indirectly) of real property in Canada, or if the corporation’s shares derive their value primarily from real property in Canada (examples include China and the United Arab Emirates);
  • Operating Mines Excluded from Real Property:  a large number of treaties (e.g., Germany, the Netherlands, Kuwait and the U.K.) use the same “primarily derived from Canadian real property” test, but effectively exempt gains on the shares of operating mining companies by excluding property in which the corporation carries on its business from the definition of “real property”. The CRA has confirmed on several occasions that such treaties exclude Canadian taxation of gains on interests in an entity that derive their value principally from mines, mineral reserves, processing mills and related land, buildings and equipment in Canada through which the entity carries on a mining and processing business;
  • Taxation Limited to Canadian Corporations:  several treaties effectively preclude Canada from taxing gains on shares of corporations not resident in Canada, even if deriving their value primarily from Canadian real property.  Canada’s treaties with the U.S., South Africa and Russia are examples of this;
  • Publicly-Listed Shares Excluded:  in a number of treaties (e.g., Luxembourg, the Netherlands, the U.K. and South Africa), Canadian tax is not permitted on gains on shares that are listed on an approved stock exchange either in Canada or in some cases either Canada or the other treaty country; and
  • Ownership Threshold:  some treaties allow Canada to tax gains on shares that derive their value primarily from Canadian real property only when the holder meets a minimum percentage ownership level (often but not always 10% of any class of the corporation’s shares).  Canada’s treaties with Germany, South Africa, Luxembourg and Russia are examples.  Note:  this incremental threshold for real property-based taxation should not be confused with the rule in a few of Canada’s treaties that allows Canada to tax the vendor’s gains on a Canadian corporation’s shares (no matter what they derive their value from) if the vendor (together with non-arm’s-length persons) has owned 25% or more of the corporation’s capital at any time during the preceding 12 months.

As a result, with appropriate planning, gains on shares related to Canadian mining properties may be exempt from Canadian tax by virtue of the underlying mining property being used in the corporation’s business, the relevant corporation being a non-resident of Canada, the shares being publicly listed, or the shareholding not meeting the required ownership threshold.

The foregoing illustrates how important it is to carefully choose the fiscal residence of the shareholder of the Canadian acquisition company (and possibly the shareholder of that shareholder).  The use of one or more foreign holding corporations resident in a suitable tax treaty jurisdiction is an important part of the acquisition planning.  In addition to minimizing Canadian taxation of gains on sale of the investment (and potentially the Canadian reporting requirements accompanying such a sale under the section 116 rules), such planning offers the flexibility to conduct a sale at a level above the Canadian acquisition corporation.

In situations where a Canadian gain cannot be rendered treaty-exempt, the vendor should also consider whether a pre-sale dividend (or deemed dividend) out of Canada to the foreign shareholder makes sense.  As the rate of Canadian dividend withholding tax (often 5% in closely held situations) is typically less than the rate of Canadian tax on capital gains, there may be considerable benefit to such forms of pre-sale planning where circumstances permit, depending of course on the relevant foreign tax treatment.

8.         Target Losses and Resource Pools

A further element of planning for mergers and acquisitions is considering the effect of the transaction on the target corporation.  The Canadian tax system treats the acquisition of control of a corporation as an important event, and contains a number of rules designed to prevent purchasers from effectively buying accumulated losses and similar beneficial tax attributes of unrelated entities.  An acquisition of control of a corporation occurs when there is a change in the direct or indirect shareholdings of the corporation such that a different person or group of persons unrelated to the current controller has de jure control of the corporation (that is, the ability to elect the majority of the corporation’s board of directors).

If control of a corporation is acquired, its tax year is deemed to end, and any accrued but unrealized losses on most forms of its property (including depreciable property) are deemed to be realized immediately before that year-end.  The corporation’s unused non-capital (i.e., operating) losses from a business arising in pre-acquisition of control tax years can be carried forward and used in post-acquisition of control tax years (and vice versa) only if both: (1) throughout the later year in which it seeks to use the loss the corporation continues to carry on with a reasonable expectation of profit the same business that gave rise to the loss, and (2) the income against which the loss is used arises from carrying on either the business that generated the loss or a business of selling similar properties or rendering similar services as were sold or rendered in the loss business. These rules are illustrated in Figure 4.

Thus, for example, a mining company cannot acquire control of a software company and expect to be able to use software-related losses incurred prior to the acquisition of control against future mining income.  The CRA has ruled favourably, however, that different minerals are “similar properties”, so that a corporation’s losses from mining gold, for example, incurred prior to the acquisition of control could be used against income earned after the acquisition of control from mining another mineral such as uranium.  Capital losses of the target and its subsidiaries do not survive an acquisition of control, although a one-time election is permitted to apply them to offset accrued and unrealized capital gains on whatever property they own at the time control is acquired.  Since planning is required to use losses in one entity against accrued gains in another (Canada has no consolidated group relief system), co-operation of the vendor in undertaking such planning prior to the acquisition of control is often very helpful.  See here for more on planning for using losses.

Figure 4: Acquisition of Control Loss Restrictions

Somewhat similar rules apply with respect to CCEE and CCDE of a mining corporation that undergoes a change of control.  Where a corporation (the “successor”) acquires all or substantially all of the Canadian resource properties owned by another person (the “predecessor”) and the parties so elect, the “successor” rules apply in a taxpayer-friendly fashion to allow the successor to inherit the predecessor’s unused CCEE and CCDE balances for use against future income only from the acquired properties.  However, when a corporation undergoes an acquisition of control, the successor rules apply in a restrictive manner: the corporation is deemed to be a successor of itself, such that the future use of its CCEE and CCDE pools is restricted to income  from (or from the sale of) the Canadian resource properties it owned at the time control was acquired. This prevents an acquiror from using the target company’s CCEE/CCDE pools to shelter income from the acquiror’s own properties, and is more restrictive than the rules governing loss carryforwards in that they are tied to income from specific properties.  Various planning techniques exist for managing the practical effects of the successor rules.

  • A variety of key decisions must be made early in the process, such as whether to buy assets of an entity or the entity itself, how to value the property being purchased and what form of consideration will be used to pay for the acquisition.
  • In structuring an acquisition, purchasers should consider that sellers will have various tax objectives, such as a deferral or reduction of any accrued gains and ensuring that the tax character of the consideration is as favourable as possible.
  • Purchasers will normally have a number of important tax considerations, including maximizing the tax recognition of the purchase price, optimizing the financing of the acquisition and ensuring that any tax withholding obligations are met. Non-resident purchasers in particular will want to ensure that taxes on repatriation of income from Canada and a sale of a Canadian investment are minimized.
  • Planning for the effective use of the target corporation’s tax attributes and the impact of the acquisition of control is also an important undertaking.