PUC offset filing deadline could arise before acquisition of control (p. 19:31)
The policy reasons for implementing a one-year time frame within which acquisitions must be completed are not readily apparent….
…[O]ne can imagine situations…where the PUC offset rules would apply to reduce, at least partially, the deemed dividend with respect to the investment. In such cases, it is conceivable that the deadline for filing the form requiredunder paragraph 212.3(7)(d) could be prior to Parentco's acquiring control of CRIC.
Example of "hollowing out" transaction: subsequent sale of good assets by subject corp. (p. 10)
The explanatory notes issued by Finance with respect to paragraph 212.3(14)(a) specifically indicate that paragraph 212.3(14)(a) is intended to prevent both pre-acquisition "stuffing" of a Canco and post-acquisition "hollowing-out" of a Canco….
[T]he CRIC acquires all of the shares of Canco for a total purchase price of $100. At the acquisition time, Canco owns shares of its wholly-owned foreign affiliate (Subject Corp.) which have a FMV of $50 as well as the IP associated with Canco's operating business ("Canco's IP") which, also has a FMV of $50….[A] series of transactions is carried out to move Canco's IP offshore following which Canco's only assets are shares of Subject Corp….
[C]anco's Bad Assets to Total Assets ratio at the acquisition time is 50% (less than 75%). However, Canco's Bad Assets to Total Assets ratio after the transfer of Canco's IP to IPCo is 100% (greater than 75%). Therefore, if the transfer of Canco's IP is part of the series, paragraph 212.3(14)(a) should apply to deem Canco's Bad Assets to Total Assets ratio at the acquisition time to be greater than 75% and, as a result, CRIC has made an investment in Subject Corp. at the acquisition time for the purposes of the FAD rules.
Second example: collection by 10(f) corp of trade receivable (p. 11)
[T]he CRIC acquires all of the shares of Canco from arm's length parties for a total purchase price of $100. At the acquisition time Canco owns shares of its foreign affiliate (Subject Corp.), business assets, and trade receivables which have an aggregate FMV of $80, $20, and $10 respectively. … Canco has a $10 trade payable to Subject Corp. at the acquisition time for goods previously purchased from Subject Corp. and used in Canco's active business. Shortly after the acquisition Canco collects its accounts receivable from its third party customers and uses the funds to repay its accounts payable to Subject Corp.
In this situation, Canco's Bad Assets to Total Assets ratio at the acquisition time is 72.7% (less than 75%). However, Canco's Bad Assets to Total Assets ratio after Canco repays its indebtedness to Subject Corp. is 80% [fn 33: Bad Assets = ($80 Investment in Subject Corp.) over Total Assets = $100 ($20 in business assets + $80 investment in Subject Corp.) = $80] (greater than 75%). Whether paragraph 212.3(14)(a) applies to deem Canco's Bad Assets to Total Assets ratio at the acquisition time to be greater than 75% (and, as a result, deems CRIC to have made an investment in Subject Corp. at the acquisition time for the purposes of the FAD rules) may rest on whether the repayment by Canco of its indebtedness to Subject Corp. is considered to occur as part of the series of or events that includes the acquisition and a disposition of property described in subparagraph 212.3(14)(a)(i).
s. 212.3(19) can extend to common shares (p. 16)
[C]ommon shares may also be caught if their participation rights are contractually restricted by borrowing terms, shareholders' agreements, or other similar arrangements.
FAD rules apply only to 1st tier FA investments (p. 34)
[A]s a result, certain transactions with similar economic results Can give rise to an investment for the purposes of the FAD Rules when the transaction is between a CRIC and a Subject Corporation but not when the transaction is between a Subject Corporation and a lower tier affiliate.
…[A]ssume a CRIC owns 80% of the common shares of a Subject corp. and an arm's length third party owns the remaining 20%. If the CRIC were to exchange its common shares for preferred shares of the Subject Corp., subsection 212.3 (19) would prevent subsection 212.3(18) from applying to protect the resulting new investment from subsection 212.3(2). As discussed above with respect to debt repayments, whether the disposition of one investment and the making of a new investment give rise to adverse consequences depends on whether the original investment caused a PUC reduction.
A different result arises if the assumptions are changed slightly. Assume the CRIC owns all of the common shares of the Subject Corp. and the Subject Corp. owns 80% of the common shares of a second tier foreign affiliate. The other 20% of the second tier foreign affiliate's shares are owned by an arm's length third party. In this case the Subject Corp. exchanges its common shares of the second tier foreign affiliate for preferred shares….[T]his second scenario should not give rise to a new investment for purposes of the FAD Rules….
FAD rules apply only to 1st tier FA investments (p. 34)
[A]s a result, certain transactions with similar economic results Can give rise to an investment for the purposes of the FAD Rules when the transaction is between a CRIC and a Subject Corporation but not when the transaction is between a Subject Corporation and a lower tier affiliate.
…[A]ssume a CRIC owns 80% of the common shares of a Subject corp. and an arm's length third party owns the remaining 20%. If the CRIC were to exchange its common shares for preferred shares of the Subject Corp., subsection 212.3 (19) would prevent subsection 212.3(18) from applying to protect the resulting new investment from subsection 212.3(2). As discussed above with respect to debt repayments, whether the disposition of one investment and the making of a new investment give rise to adverse consequences depends on whether the original investment caused a PUC reduction.
A different result arises if the assumptions are changed slightly. Assume the CRIC owns all of the common shares of the Subject Corp. and the Subject Corp. owns 80% of the common shares of a second tier foreign affiliate. The other 20% of the second tier foreign affiliate's shares are owned by an arm's length third party. In this case the Subject Corp. exchanges its common shares of the second tier foreign affiliate for preferred shares….[T]his second scenario should not give rise to a new investment for purposes of the FAD Rules….
Two interpretations of subject corporation acquired under earnout agreement: PV all investment obligations at investment time; or succession of property transfers? (p. 24)
One interpretation is that an earnout involves multiple transfers of property by a CRIC for the purposes of paragraph 212.3(2)(a). Under this interpretation, each subsequent payment under the earnout would be a transfer of property that would increase the deemed dividend. Determining the amount of the increase to the deemed dividend would require determining the FMV of the transferred property at the Investment Time, not at the time the property actually was transferred to the Subject Corp….[I]t is possible that a CRlC could make future earnout payments by "transferring property that did not exist at the investment time (such as shares of a corporation that was incorporated after the investment time); it is unclear how such transfers of property would be valued in applying paragraph 212.3(2)(a).
An alternative interpretation is that under an earnout a CRIC agrees to make an initial transfer of property at the Investment Time, and, also at the investment time, incurs a contingent obligation to make future earnout payments. This interpretation would require the contingent obligation to be valued at the investment time and necessitate an analysis of the likelihood of the CRIC being required to make future earnout payments as well as the quantum of such payments….[W]hile both interpretations create potential valuation concerns, the former interpretation should be preferred because in many circumstances, where the subsequent payments are made in cash, the valuation issues should be manageable. If the acquisition was structured as an installment sale with a definite amount payable in future years the CRIC could be viewed as incurring an obligation for the future payments. These amounts are more certain then in a transaction structured with future earnout payments.
Potential conflict between NR parent and 3rd party Cdn. investor re application of s. 212.3(7)(a) (p.29)
Figure 16 illustrates an example where paragraph 212.3(7)(a) potentially could apply. Only Canco (assumed to be a person which deals at arm's length with Parent) owns the class B shares. Further assume that all of the PUC of the class B shares arose on the transfer of property to the CRIC….
…[D]oes the fact that the CRIC did not use $10 of the aggregate amount it received for issuing its shares to make the investment in the Subject Corp. prevent the PUC of the class B shares from being reduced under paragraph 212.3(7)(a). This is a critical point for both the Parent and Canco. From Parent's perspective, the investment was $90 and if the PUC of the class B shares is not available, the Parent should be deemed to receive a dividend of $30. From Canco's perspective, if the PUC of the class B shares is reduced future distributions that otherwise should be returns of capital may give rise to deemed dividends.
If the $10 retained by the CRIC was funded proportionately by the funds received from Parent and Canco, on the precise wording of paragraph 212.3(7)(a), it appears that since less than all of the property received from Canco was transferred to Subject Corp., the PUC of the class B shares will not be reduced….
[C]an the CRIC choose not to "demonstrate" the requirements are satisfied, and essentially choose to maintain PUC in the class of shares owned by the arm's length investors or is a CRIC required to demonstrate once the CRA asks for the relevant information. Could a CRIC contractually agree that it would not demonstrate that the requirements of paragraph 212(7)(a) are satisfied?...
227(6.2) does not eliminate deemed dividend for non-FAD purposes (p.22)
[S]ubsection 227(6.2) requires the CRA to accept late-filed paragraph 212.3(7)(d) forms and refund any Part XIII tax paid with respect to the investment (as long as the written application is filed within two years after the form described in subparagraph 212.3(7)(d)(i) is filed). Interestingly, subsection 227(6.2) does not retroactively rescind the deemed dividend. As a result, the CRIC should be considered, even after the paragraph 212.3(7)(d) form is late-filed, to have paid a dividend to the Parent on the filing-due date for the purposes of other provisions of the Act such as subsection 129(1), subsection 112(3), and Part IV tax….
Email this Content