SK3 Group Inc. (SKTO)

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Canadian Acquisition of U.S. Business

http://www.taxanalysts.com/www/features.nsf/Articles/7D5CE15BB915972085257B2C0057342A?OpenDocument

A Canadian corporation may expand in the U.S. by acquiring an existing U.S. business. The issues include whether to structure the acquisition as a share purchase or an asset purchase. The objective would be to reduce Canadian and U.S. taxes on operating the business and the subsequent sale of the business. If the value of the business is not derived primarily from real estate, the subsequent sale of shares of a U.S. company would not be taxable in the U.S.
In the case of a share purchase of a subsidiary in a U.S. consolidated group, the purchaser and the vendor may enter into an election under IRC section 338(h)(10) to step up the basis of the assets in the U.S. subsidiary for U.S. tax purposes. There would be no step-up in basis for Canadian tax purposes. The bump in the cost base of the assets on election may permit losses carried forward to be offset by the gain arising on the asset basis step-up. The vendor would bear the tax. The U.S. company would have a step-up in the tax cost of the assets for U.S. tax purposes.

The U.S. vendor may wish to defer tax on the sale. For example, if real property is sold, a vendor may defer U.S. tax by taking advantage of a like-kind exchange on a sale of real property (that is, an asset sale) and by acquiring a larger property. Alternatively, the U.S. has installment sale rules that may make it attractive for the vendor to have a balance of sale. If the U.S. corporation being acquired has losses, the U.S. imposes limits on loss utilization if more than 50 percent of the shares are acquired, regardless of whether the same business continues to be carried on. The losses of the U.S. company would not be available against the Canadian profits of a Canadian corporate purchaser.

A Canadian corporate purchaser should consider the advantages of forming a U.S. or offshore holding company to acquire shares for the U.S. subsidiary or of forming a U.S. corporation to acquire assets. Care must be exercised in structuring the U.S. entity to avoid U.S. thin capitalization and earnings stripping rules. Creative financing techniques may be available and are outlined below.

A U.S. acquisition company may be used to purchase assets or shares, and it would facilitate consolidated reporting if other U.S. subsidiaries are to be formed in the future. It may also allow the sale of shares of a U.S. operating company owned by a non-Canadian company to be treated as a sale of excluded property for Canadian tax purposes.

The purchase price may be paid in cash or in stock. If a Canadian company is issuing shares to a U.S. vendor, the U.S. vendor would want to structure the transaction to take advantage of a tax-deferred transfer for U.S. tax purposes.

A U.S. tax-deferred transfer may be available for a U.S. vendor that enters into a share-for-share exchange with a Canadian company. The Canadian company must have a value in excess of the U.S. target company and have an operating history. The tax-deferred transfer may take place under IRC sections 367 and 368.

As indicated above, another factor in structuring the transaction is whether the business to be carried on will be an active business for Canadian tax purposes. If the income is likely to give rise to foreign accrual property income in Canada, it may not be advantageous to have a U.S. subsidiary, and the taxpayer should consider having a Canadian corporation acquire the assets. Note that double tax may arise if a U.S. limited liability company is the vehicle to hold assets that produce income that would be treated as FAPI.


Share Sale vs. Asset Sale


There are many factors that should be considered in determining whether to purchase shares or assets of a U.S. corporation.
If the target is a public company, it may be easier to acquire assets than shares to avoid having to make a takeover bid to acquire all the shares of the target.

The tax cost of the shares to the vendor and availability of the long-term capital gains rate to each individual vendor and the tax cost of the assets of the target may affect the pricing for the shares versus assets. An understanding of the tax consequences to the vendor of shares versus an asset sale by the U.S. entity will be relevant. A sale of assets of a C corporation, the shareholders of which are individuals, may result in double taxation (50 percent versus 20 percent federal and state tax if all individuals were to sell the shares when it qualifies as a long-term capital sale).

If an S corporation is the target, an asset sale followed by a liquidation of the S corporation would result in a single level of tax at the shareholder level. Because an S corporation may maintain its U.S. tax status only if purchased by U.S. individuals, an asset sale would be the logical alternative.

A purchaser may prefer an asset sale as a step-up in the tax cost and a tax effective allocation of the purchase price between the assets purchased may be facilitated. However, a share purchase may be easier since no allocation is required. Representations and warranties and a holdback are required as to tax filings and all liabilities (actual and possible litigation, product liability, current and past tax liabilities, environmental liabilities, wrongful dismissal, severance issues, and contingent liabilities) that are not disclosed.

A share purchase will not result in a step-up of the tax cost of the assets, including goodwill, unless an IRC section 338 election is made. An IRC section 338(h)(10) election treats the sale of shares of a U.S. company as an asset purchase.

The target company may have net operating losses that may be accessed by the purchaser on a purchase of shares of the target. NOLs can be carried forward 20 years. The use of the losses is restricted under IRC section 382 on an acquisition of control.

The target may have licenses and leases that are more easily acquired through a share purchase. A share purchase may be attractive if it avoids land transfer taxes or sales tax.

If not all assets of the target are to be sold or are not desired by the purchaser, an asset sale would be the simplest transaction. Alternatively, the purchaser may plan on purchasing the shares or all of the assets, then selling assets that aren't required. A purchase of assets would allow a more favorable price allocation to the assets to be flipped.

If a business is being purchased out of bankruptcy, the assets would be acquired.

If the vendor is to receive shares of the purchaser, a share sale may be appropriate. A tax-deferred transfer or reorganization or an up real estate investment trust structure (exchangeable shares) may be required to enable the U.S. vendor to defer tax.

If an LLC is the target, a Canadian purchaser would prefer an asset purchase or would have to either convert the LLC to a C corporation or use a C corporation to purchase the LLC. Article IV(7)(a) of the Canada-U.S. tax treaty will apply to deny treaty benefits when a Canadian company operates a U.S. business through an LLC. If the LLC is a disregarded entity for U.S. tax purposes, the U.S. will consider it a branch of the Canadian corporation. No treaty relief will be available under Article X of the treaty for U.S. business income earned by the LLC, and it will be subject to 30 percent U.S. branch tax.