Cross-border spin-offs – Canadian tax implications

Many Canadian corporations are multinational and deal with numerous cross-border transactions. Adrienne F. Oliver of Ogilvy Renault LLP particularly focuses on cross-border spin-offs and their implications to shareholders.

The defining characteristic of the current Canadian business environment may be its multinational nature. Certain regulated industries aside, most major Canadian corporations have a substantial cross-border component, in that they are either in whole or in part owned by non-Canadian shareholders or have significant non-Canadian subsidiaries. In addition, as Canadian investors have sought to diversify their investment mix, Canadian investment abroad has steadily increased. Recently, the limits on ownership of foreign property by certain tax-deferred investment vehicles have been eliminated, which is providing further incentive for Canadian investment in foreign securities.

This characteristic has important tax implications when market cycles move away from consolidations and acquisitions to ‘pure plays’ and transactions that ‘unlock shareholder value’. Often these types of transactions involve spin-offs or other distributions of corporate assets (typically shares of a subsidiary corporation) to the shareholders of the corporation. Spin-offs can also be important in the M&A context, to permit post-acquisition reorganisations or divestitures of the target’s assets. When the corporation and shareholders are in different jurisdictions, the complexity of the tax planning for the transaction is increased, as the transaction must be tax effective at both the level of the corporation and its shareholders. The balance of this article will focus on public company spin-off transactions, and their implications to shareholders who hold their shares as portfolio investments.

Outbound spin-offs

A recent example of a cross-border spin-off is the January 2005 spin-off by Alcan Inc. of Novelis Inc. This transaction was structured to fit the statutory regime under Canadian tax laws known as a ‘butterfly’ reorganisation. The advantage of this type of spin-off is that it is Canadian tax-deferred to both the distributing corporation and to its shareholders. It may also qualify as a tax-deferred distribution under the laws of other jurisdictions. The disadvantage of this type of distribution is that the technical requirements for implementing the butterfly transaction are onerous and may be difficult to satisfy in particular fact situations.

A somewhat simpler transaction, that is also Canadian tax-deferred to shareholders, involves the distribution of shares of a subsidiary corporation as a return of the capital on the shares of the distributing corporation. The disposition of the shares of the subsidiary is taxable to the distributing corporation and therefore would normally be implemented only when there is little inherent gain in the subsidiary shares being distributed or when the distributing corporation has losses with which to shelter any gain. However, in the M&A setting – when the objective is to have the target distribute shares of its subsidiaries to the purchaser – it may be possible to step up to fair market value the tax cost of the subsidiaries’ shares held by the target, so that no gain is realised by the target on the distribution.

Finally, a distribution of shares of a subsidiary as a dividend-in-kind is generally quite simple to implement, but is a taxable transaction for both the distributing corporation and its shareholders. In such a case, non-Canadian shareholders would be subject to Canadian withholding taxes on the dividend.

Inbound spin-offs

Spin-offs by non-Canadian corporations to Canadian resident shareholders are generally treated as a taxable distribution to the Canadian shareholder, unless specific requirements of a statutory exception are satisfied or if, pursuant to certain jurisprudence, the spin-off transaction does not result in a distribution to, or disposition by, the shareholder, as discussed further below.

The statutory exception is intended to ensure that a spin-off transaction will be tax-deferred to Canadian resident shareholders only in a standard public company spin-off by a corporation resident in a country with which Canada has a bilateral tax treaty. However, the strict criteria mean that there will be transactions taxable to Canadian shareholders that perhaps, from a tax policy perspective, should be tax-deferred.

A recent case suggested that certain transactions that are ‘divisions’ or ‘split-ups’ of a foreign corporation pursuant to the relevant corporate law may also be tax-deferred to Canadian resident shareholders, where such transactions do not involve a distribution by one corporation of shares of another corporation, or a disposition of shares by the Canadian shareholder. The spin-off in the case was governed by Mexican law. Spin-offs effected pursuant to similar provisions in other foreign corporate statutes may also be tax-deferred to Canadian shareholders.

Conclusion

Canadian tax rules may make the structuring of inbound and outbound cross-border spin-offs more complex than in other jurisdictions, but with careful planning these transactions can be implemented in a manner to maximise value to both the corporation and its shareholders.