Amalgamation, or corporate merger, refers to two or more taxable corporations forming a new corporation through a compliant merger, with the new corporation being considered a continuation of the predecessor corporations for operational purposes.
This introduces two concepts:
- Predecessor corporations, which refer to the companies before the merger
- New corporation, which refers to the company after the merger
This blog briefly describes the following three aspects of amalgamation:
- Forms
- Process
- Shareholders
Forms
Our firm and client base are in Ontario. Assuming we are only discussing the merger of two companies into one (not discussing the case of three or more companies merging into one for now), there are essentially three scenarios:
- A federal company merges with another federal company
- An Ontario company merges with another Ontario company
- A federal company merges with an Ontario company
From a legislative perspective:
- The amalgamation of federal companies is governed by ss.181-186 of the CBCA
- The amalgamation of Ontario companies is governed by ss.174-178 of the OBCA
- All tax-related matters for company amalgamations are governed by s.87 of the ITA
From a financial and tax perspective:
- s.87(1)(a) ITA provided:
- All of the property (except amounts receivable from any predecessor corporation or shares of the capital stock of any predecessor corporation) of the predecessor corporations immediately before the merger becomes property of the new corporation by virtue of the merger.
- s.87(1)(b) ITA provided:
- All of the liabilities (except amounts payable to any predecessor corporation) of the predecessor corporations immediately before the merger become liabilities of the new corporation by virtue of the merger.
- s.87(1)(c) ITA provided:
- All of the shareholders (except any predecessor corporation), who owned shares of the capital stock of any predecessor corporation immediately before the merger, receive shares of the capital stock of the new corporation because of the merger.
- However, an amalgamation will not be disqualified solely because certain shareholders of a predecessor corporation receive consideration that is not shares of the new corporation, such as cash, by virtue of exercising the statutory right available in certain jurisdictions to dissent to the amalgamation. Further, s.84(3) will not otherwise apply to deem a shareholder of a predecessor corporation to have received a dividend where the shareholder exercises its statutory dissent rights in respect of the amalgamation and receives payment for its shares from the new corporation. In such circumstances, the new corporation is paying the dissenting shareholder for its shares of the predecessor corporation. Therefore the new corporation has not redeemed, acquired or cancelled shares of its capital stock as required for s.84(3) to apply.
- Another less common scenario is: how to deal with shareholders who do not hold shares but are entitled to receive dividends. The definition of a shareholder in s.248(1) ITA is anyone who is entitled to receive dividends is considered a shareholder, but it does not specify that they must hold shares.
- An example would be a policyholder of a mutual insurance corporation. The fact that such a shareholder does not receive any shares of the new corporation because of the amalgamation will not cause the requirement described in s.87(1)(c) not to have been met.
Process
In terms of the structure, corporate amalgamations can primarily be categorized into three types:
- Long-form amalgamation (ordinary merger)
- Short-form amalgamation (simplified merger)
- Triangular amalgamation
Short-form amalgamation is the most prevalent type of corporate amalgamation. This form of amalgamation is fundamentally based on the concept of a “wholly-owned subsidiary”. It mainly manifests in two structures:
- Vertical amalgamation:
- This occurs when a parent company merges with one or more of its subsidiaries. The term ‘vertical’ is used due to the top-down nature of this structure.
- Horizontal amalgamation:
- This involves the merger of two or more wholly-owned subsidiaries of the same parent company. The term ‘horizontal’ is used to denote the lateral nature of this structure.
Triangular amalgamation, on the other hand, is a concept that can be illustrated with an example:
Let’s say we have
- Company A, which owns shares in Company B and Company C.
- Companies B and C merge to form a new entity, Company D.
- Now, Companies B and C are the predecessor companies, and their shareholders would typically hold shares in Company D.
- However, in a triangular amalgamation, the shareholders of Companies B and C end up holding shares in Company A, the parent company.
While the concept of a triangular amalgamation is straightforward, the mechanics of transferring the parent company’s shares to the shareholders of the predecessor companies and the calculation of the Adjusted Cost Base (ACB) of the stock can be complex. For guidance on these aspects, one can refer to s.87(9)(c) ITA, which provides detailed instructions.
Effective date of amalgamations & tax year-end
In Ontario, the effective date of a corporate merger is determined by the date shown on the certificate of amalgamation issued by either Corporation Canada or the Ontario Ministry of Finance.
Furthermore, s.87(2)(a) ITA deems the first tax year of the amalgamated corporation to commence at the time of the amalgamation and the tax years of the predecessor corporations to terminate immediately before the amalgamation.
Since s.87(2)(a) ITA also deems the amalgamated corporation to be a new corporation for purposes of the Act, the amalgamated corporation can select a new fiscal period. Under s.249.1(1)(a) ITA, a fiscal period of a corporation can be up to 53 weeks.
Non-qualifying amalgamations
Where an amalgamation of two or more corporations does not satisfy the conditions in (a), (b), and (c) in s.87(1) ITA, the tax consequences of such a non-qualifying amalgamation to the amalgamated corporation will generally be determined by reference to the legal consequences of the amalgamation under the corporate law governing the amalgamation. Where the applicable corporate law provides that the predecessor corporations involved in the amalgamation cease to exist and that a new corporation is formed on the amalgamation, the predecessor corporations will generally be considered to have disposed of any property held immediately before the amalgamation.
Financial Operations of the New Corporation
The new corporation has been established, but its financial operations do not start from scratch. Given that the predecessor corporations have been in operation for years, the CRA provides detailed guidance on the financial calculation methods for various aspects:
- Methods adopted for computing income with contractors
- Inventory
- Depreciable property
- Cost of capital property
- The concept of “bump amount” is to be noted in the first tax year of the new corporation
- Partnership interests
- Repayment of assistance
- Losses
- Debts and obligations of a predecessor corporation
- Situations where the predecessor corporations are under tax review by the CRA (objections, appeals, refunds, and tax debts)
- Payroll taxes such as CPP and EI of the predecessor corporations
Shareholders
In this section, the CRA provides guidance for new companies on financial operations, not only including “shareholders”, but also regulations on how stock option owners and creditors should operate:
- s.248(1) ITA is important because it provides definitions and explanations for all relevant important tax terms. In the explanation of the term “disposition” (which can be referred to as “sale” or “disposal” of assets), (b)(iii) explicitly states that if a company merges, every shareholder of the predecessor company is considered to have disposed of (sold) their shares in the predecessor company.
- However, s.87(4) states: If this merger is a “qualifying amalgamation”, and the shareholders of the predecessor company have not received any consideration other than the shares of the new company, then this disposition of shares can be rolled over (at its ACB) into the new company. In other words, the act of a company merger will not bring tax burdens to shareholders.
- In specific company mergers, the calculation of the new company’s share value must be based on actual conditions, and specific scenarios must be analyzed specifically, not generalized. For example:
- Where shares of a predecessor corporation are cancelled for no consideration pursuant to a short-form horizontal amalgamation, the adjusted cost base of such cancelled shares to the shareholder will be added to the cost of the common shares of the new corporation which are deemed to have been received by the shareholder on the amalgamation under s.87(1.1).
- In situations where an amalgamation is used to shift all or part of the value of a shareholder’s predecessor corporation shares to a person related to the shareholder whose interest in the new corporation will be enhanced by the shift in value, the rollover provided in s.87(4) will be denied in respect of that shareholder. Specifically, the midamble to s.87(4) provides that no rollover is available to a shareholder of a predecessor corporation if the following two conditions are met : (a) the fair market value of the shareholder’s predecessor corporation shares immediately before the amalgamation exceeds the fair market value of the shareholder’s new corporation shares immediately after the amalgamation; and (b) it is reasonable to regard all or any portion of the excess, which refers to in s.87(4) and in this Chapter as the gift portion as a benefit that the shareholder desired to have conferred on a person related to the shareholder.
- s.116 ITA provides legal regulations for non-residents of Canada selling taxable assets. But in company mergers, when the shareholders of the predecessor company are non-residents of Canada, the guidance provided by s.87(4) is contrary to s.116.
- s.87(4) states: Within 60 months after the merger, the shares received by shareholders from the new company need to be regarded as Canadian taxable assets. At this time, CRA’s view is: s.87 overrides s.116, which means that non-residents do not need to comply with s.116.
- s.87(5) ITA provides regulations for stock options, such as the shareholders of the predecessor company not receiving shares of the new company after the merger, but the option to purchase shares of the new company.
- The key is that the law does not require that the shares that the former shareholders can buy under this option must be similar to the original shares, which gives the former shareholders great flexibility in financial and tax arrangements.
- When one of the merging companies is a debtor corporation and the other is a creditor corporation, s.80.01(3) ITA provides regulations on how to handle debts.
- In the most general terms, at the moment of merger, the debt no longer exists (indebtedness is deemed to have been settled), but the premise is that the debtor must pay off the debt immediately before the merger.
- When the debt is a “foreign currency denominated debt”, the situation and calculation are more complicated.
Others
The CRA has gone to great lengths to explain:
- Where the legal fees and accountant fees for company mergers can be classified, and
- The possibility of involving GAAR (anti-tax avoidance rules)
Due to limited space, these sections are not elaborated in detail here.
