Imagine you're about to take a big step in the business world: acquiring control of a company. This pivotal moment can transform your business, open up new opportunities, and take your growth to the next level. But before you dive in headfirst, it's important to understand the many tax and strategic implications.
Acquiring control of a company isn't just a financial transaction; it's an event that triggers a series of profound changes in the company's management and operational structure. Whether you're buying shares, merging or reorganizing a holding company, each stage brings its own challenges and legal requirements.
Defining acquisition of control for a better understanding
Acquisition of control occurs when a new person or group of persons acquires more than 50% of the voting shares of a company. This change can occur through the purchase or cancellation of shares, an acquisition, a merger or a liquidation. Once this threshold is crossed, the acquirer assumes control of the target company and makes significant changes to its management and operating structure.
It is important to note that certain related party transactions are not considered to be an acquisition of control under section 256(7) of the Income Tax Act. The relevant control for this definition is legal control, which is the legal ability to direct the affairs of the corporation, not actual control.
Tax consequences of acquiring control
Acquisitions of control have significant tax implications, including deemed year-end, limitations on capital loss and tax credit carryforwards, and the reduction of accumulated capital losses.
Here are some tax considerations to be aware of when acquiring control. You can also download the checklist suggested by the Ordre des CPA du Québec to better plan transactions involving acquisitions of control.
Deemed year-end
In the event of a change of control, the company must end its fiscal year before its official year-end date, known as a deemed year-end. This situation, also known as a “short tax year” requires the corporation to:
- File tax returns within six months after the end of the deemed year.
- Pay taxes due within two or three months of the deemed year-end.
This early year-end can be complex to manage because it must be triggered prior to the date of acquisition and control of the company
Restriction on capital loss carryforwards
Net capital losses resulting from the sale of assets is subject to restrictions following a change in control.
These losses cannot be carried forward to offset future capital gains realized after the change in control. Therefore, they must be used prior to the change in control to reduce capital gains realized in the same year.
Restrictions on the carryforward of tax credits
Investment tax credits acquired prior to a change in control are also subject to restrictions.
These credits can only be used for the same or a similar business after the change of control. This limits the ability of the acquirer to take advantage of tax credits accumulated by the target prior to the acquisition.
Reduction of accumulated capital losses
Capital losses accumulated prior to the change of control are adjusted. The cost of assets with losses is adjusted to their fair market value, which may reduce the amount of loss carryforwards. This reduction is a prophylactic measure to prevent new entities from improperly utilizing capital losses accumulated by the Company prior to the acquisition.
Implement good post-acquisition management
Post-acquisition management is critical to ensuring a smooth transition and maximizing the benefits of the change of control.
Here are some key strategies to adopt:
Reorganize the business
Following an acquisition of control, it is often necessary to reorganize the management structure. This includes redefining roles and responsibilities and implementing new operational strategies.
Effective reorganization can help align the goals of the new entity with those of the target.
Due diligence
Due diligence is essential to assess the financial and tax implications of a change of control. It involves a detailed analysis of financial statements, existing contracts and legal obligations.
Due diligence helps to identify risks and implement measures to mitigate them.
Internal communication
Clear communication with employees is essential to ensure a smooth transition. Employees need to be informed about the upcoming changes and how they will affect their roles and responsibilities.
Good communication can help keep employees motivated and productive during the transition period.
Tax optimization
It is important to implement tax strategies to maximize the benefits and minimize the costs associated with a change in control. This can include the judicious use of tax credits, planning for the use of capital losses, and reviewing ownership structures to optimize tax benefits.
Triggering a capital gain
An election can be made to trigger an unrealized capital gain on a capital asset to prevent capital losses from being lost. This strategy can be complex and requires a thorough understanding of the tax implications.
To do this, the company can establish a deemed PD that is somewhere between the adjusted cost basis (ACB) and the fair market value (FMV). The goal is to find the capital gain necessary to eliminate the PCD and PCN that would otherwise be lost.
The deemed PD results in a depreciation recovery calculated from the undepreciated capital cost (UCC), which is the lesser of the capital cost and the deemed PD. The new capital cost of the asset is equal to the deemed PD, which increases the ACB. The UCC is equal to the original capital cost plus the taxable capital gain (TCG).
Thoroughly plan the acquisition of control of a company
Acquiring control of a business is a critical step that requires careful planning and rigorous management of the tax and strategic implications. Good post-acquisition management, including corporate reorganization, due diligence, internal communications and tax optimization, is essential to ensure a smooth transition and maximize the benefits of the change of control.
If you are planning to sell your business or purchase an existing business, T2inc.ca can assist you with the preparation of your deemed year-end reports. Contact us via our contact form for more information on this topic and we can refer you to trusted partners.
