As a general rule, where a Canadian resident exchanges shares of a corporation for shares of another corporation, that exchange will constitute a “disposition” of the original shares for the purposes of the Income Tax Act (“the Act”), and the “proceeds of disposition” will be equal to the fair market value of the shares received in exchange. Thus, the share exchange will result in the realization, for tax purposes, of any accrued capital gain.
Nevertheless, the Act contains numerous provisions that will result in tax-free “rollover” treatment in such circumstances, under which the gain will be deferred. These provisions include the following:
- Subsection 85(1)-rollover on transfer of property to a Canadian corporation for consideration that includes shares, and joint election filed.
- Subsection 85.1(1)-arm’s length exchange of shares of one Canadian corporation for shares of another Canadian corporation -generally applicable where Canadian public company is the acquirer.
- Subsection 85.1(3)-exchange of shares of one “foreign affiliate” for shares of another “foreign affiliate”
- Subsection 85.1(5)– arm’s length exchange of shares of one foreign corporation for shares of another foreign corporation -generally applicable where foreign public company is the acquirer.
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However, nowhere in the Act is there a provision that allows a tax-free rollover of shares of a Canadian corporation for shares of a foreign corporation.
Years ago, the Ministry of Finance proposed the introduction of such a provision. However, after several years, those proposals were abandoned.
As such, if a Canadian vendor of shares of a Canadian corporation receives shares of a foreign corporation on account of all or a portion of the purchase price, the value of such shares would have to be recognized to the same extent as if cash were received.
Because of this inability to achieve tax-free rollover treatment in such situation, a technique has been developed over the years in situations involving foreign takeovers of a Canadian corporation (“Canco”), particularly where the foreign acquirer is a public corporation.
This technique involves so-called “exchangeable shares”. Normally, the approach that would be followed would be for the foreign acquirer (“Forco”) to form a wholly-owned Canadian subsidiary (“Subco”). Under this type of approach, the shares of Canco would be sold to Subco in exchange for consideration that consists, at least in part, of shares in Subco. This would allow a tax-free rollover, since Subco is a Canadian corporation. However, the attributes of the shares in Subco, as well as various supporting agreements provided by Forco, would result in those Subco shares being the economic equivalent of shares in Forco (which typically will be a foreign public company). For example, the holder of the Subco shares would have the right to exchange them for Forco shares at any time. This exchange will trigger the realization of gains in Canada, but, normally, such exchange would only occur when the holder of those shares wishes to liquidate his/her/its position. In addition, there have been situations where the Subco shares have been listed on a Canadian stock exchange, thereby providing any extra level of liquidity,
ABOUT THE AUTHOR OF THIS ARTICLE
Michael I. Atlas, CPA,CA,CPA(ILL),TEP
Michael Atlas is one of the most prominent international tax experts in Canada. He advises accounting and law firms all across Canada, as well as select private clients (corporate and personal) worldwide. He can be reached by phone (416.860.9175) or email (matlas@TaxCA.com).
