Corporate Amalgamation Under Section 87 of the Income Tax Act –A Canadian Tax Lawyer Analysis
Introduction: Amalgamation and Corporate Law Rules
Under Section 181 of the Canada Business Corporations Act (or Business Corporations Act (Ontario), Section 174), two or more corporations may amalgamate or merge and continue as one corporate entity. Corporate law contemplates the following types of amalgamation:
- Corporate amalgamation is that of two or more corporations with different shareholders;
- Short-form vertical amalgamation is that of a parent corporation with one or more of its wholly owned subsidiaries. In this context, an amalgamation agreement and a shareholder’s vote are not required;
- Short-form horizontal amalgamation is that of two or more wholly owned subsidiaries of one parent corporation. In this context, an amalgamation agreement and a shareholder’s vote are not required; and,
- Triangular amalgamation is where some shareholders of the amalgamating corporations receive shares of the amalgamated corporation’s parent (as opposed to receiving shares of the amalgamated corporation).
A corporate amalgamation requires an amalgamation agreement setting out, among other things, the terms and conditions under which the shares of the predecessor corporations are converted into shares and other securities of the new corporation (Canada Business Corporations Act, Section 182; Business Corporations Act (Ontario), Section 175). An amalgamation agreement is effective when shareholders, of each class or series of shares entitled to vote of each predecessor corporation, have approved the amalgamation by a special resolution (Canada Business Corporations Act, Subsection 183(1); Business Corporations Act (Ontario), Subsection 176(1)). However, special corporate law rules apply to short-form amalgamations, which exempt these types of mergers from requiring a shareholder approval and an amalgamation agreement. A corporate amalgamation is effective upon the filing of articles of amalgamation, the result of which permits the amalgamating corporations to continue as one corporate entity. In this context, the property and liabilities of each amalgamating corporation continue to be the property and liabilities of the new corporation.
Amalgamation and the Income Tax Act
Under Canada’s Income Tax Act, amalgamation is precisely designed to define the tax treatments of the various forms of amalgamation permissible under corporate law. There are two types of amalgamation under the Income Tax Act. First, “qualifying amalgamations” are those that meet the conditions set out in section 87 of the Income Tax Act. Once the section 87 conditions are met, the Income Tax Act provides various tax attributes and comprehensive tax deferral treatments for shareholders and the amalgamated corporation. All other amalgamations, which are referred to as “statutory amalgamations” or “non-qualifying amalgamations”, fall outside the scope of section 87 of the Income Tax Act. As was stated by the Supreme Court of Canada in its leading decision, Envision Credit Union v R, the tax consequences of non-qualifying amalgamations are not clearly specified in the Income Tax Act and therefore their requirements are determined using other provisions in the Income Tax Act (as opposed to section 87), other relevant statutes (such as, the Ontario Business Corporations Act), and the common law.
Reasons for Corporate Amalgamation
Amalgamation is a corporate planning tool that can be used for various reasons including, but not limited to:
- Acquisition of another corporation;
- Achieving corporate and or tax objectives;
- Reducing the tax implications for the amalgamating corporations and shareholders;
- Merging related profitable and loss corporations;
- Simplifying corporate structure;
- Minimizing compliance and administrative costs for related corporations; and
- Eliminating minority shareholders.
Significant Legal Concepts – Predecessor Corporation, New Corporation, and Taxable Canadian Corporation
To better understand the amalgamation rules under the Income Tax Act, this section discusses the following significant concepts: predecessor corporation, new corporation, and taxable Canadian corporation.
In a corporate amalgamation, the taxable Canadian corporations planning to amalgamate are each referred as the “predecessor corporation”. Once two or more taxable Canadian corporations amalgamate and form one new corporate entity, such entity is referred to as the “new corporation”.
Taxable Canadian corporation is defined under subsection 89(1) of the Income Tax Act as a corporation that, at the relevant time, was a Canadian corporation and was not exempt, by virtue of a statutory provision, from Part I tax under the Act.
Amalgamation and Subsection 87(1) of the Income Tax Act
The purpose of section 87 of the Income Tax Act is to provide the applicable rules where two or more Canadian corporations are amalgamated (Guaranty Properties Ltd. v. R.). In particular, a subsection 87(1) amalgamation is achieved upon the merger of two or more corporations each of which must be, immediately before the merger, a taxable Canadian corporation. A qualifying amalgamation under subsection 87(1) of the Income Tax Act must meet the following conditions:
- all of the property (except shares or receivables of another predecessor corporation) of the predecessor corporations, immediately before the merger, becomes property of the new corporation as a result of the amalgamation;
- all of the liabilities (except liabilities payable to another predecessor corporation) of the predecessor corporations, immediately before the merger, becomes liabilities of the new corporation by virtue of the amalgamation; and,
- all of the shareholders (except any predecessor corporation) who owned shares of any predecessor corporation, immediately before the merger, receive shares of the new corporation because of the amalgamation.
Subsection 87(1) of the Income Tax Act does not apply where a corporation acquires property of another corporation by way of purchasing such property or as a result of the distribution of property to a corporation on the winding-up of another corporation.
For income tax purposes, subsection 87(1.1) ensures that a vertical short-form amalgamation and a horizontal short-form amalgamation are treated as qualifying amalgamations under section 87 of the Income Tax Act. In these mergers, either the parent corporation or one of the subsidiary predecessor corporations will continue to exist in its same manner after the merge, without its shares being cancelled or new shares being reissued. Accordingly, the condition under paragraph 87(1)(c) is satisfied by virtue of the rule in subsection 87(1.1).
Tax Consequences for Amalgamated Corporations
Once the subsection 87(1) conditions are met, the merger constitutes a qualifying amalgamation under the Income Tax Act. Subsection 87(2) provides extensive rules for rollovers and carry-forwards. For example, paragraph 87(2)(a) provides that the corporate entity formed as a result of an amalgamation is deemed to be a new corporation, with its first taxation year commencing at the time of the amalgamation, and the taxation year of predecessor amalgamating corporations is deemed to have ended immediately before the amalgamation. However, the new amalgamated corporation can select a taxation year that does not correspond to the taxation year of the predecessor corporations. In addition, paragraph 87(2)(b) deems the inventory of a predecessor corporation to have been acquired by the new corporation at the beginning of its taxation year for an amount equal to its value for inventory purposes by the predecessor corporation.
Further, under subsection 87(2.1), a new corporation is deemed to be the same corporation and a continuation of each predecessor corporation for income tax purposes. In particular, under subsection 87(2.1) the loss carryforwards of predecessor amalgamating corporations can be carried forward through the amalgamation and deducted in computing the taxable income of the new amalgamated corporation, subject to certain loss restriction rules under the Income Tax Act. However, losses realized by the new amalgamated corporation cannot be carried back to predecessor corporations, unless the amalgamated corporation’s losses are carried back to its former parent corporation (subsection 87(2.11)).
Moreover, on an amalgamation of two or more taxable Canadian corporations, subsection 87(3) of the Income Tax Act ensures that the paid-up capital of the issued shares of the new corporation do not exceed the paid-up capital of the issued shares of its predecessors, immediately before the amalgamation. This means that the paid-up capital of shares of an amalgamated corporation cannot exceed the paid-up capital of shares of its predecessors. If the paid-up capital of the amalgamated corporation exceeds such amount (the paid-up capital of shares of its predecessors) subsection 87(3) applies and the paid-up capital of the new amalgamated corporation is reduced by the excess and such reduction is pro-rated to all class of shares in proportion to their paid-up capital.
Tax Consequences for Predecessor Corporations
As previously mentioned, pursuant to subsection 87(2) of the Income Tax act, the taxation year of each predecessor corporation ends immediately before the amalgamation is effective. Since all the property and liabilities of predecessor corporations become property and liabilities of the new corporation by virtue of the merger, there are no gains or losses realized to predecessor corporations with respect to their assets which become assets of the new corporation because of the merger.
Tax Consequences for shareholders
Under subsection 248(1) of the Income Tax Act, “disposition” of any property includes transactions and events “where the property is a share, the share is converted because of an amalgamation or merger”. This means that a conversion of shares because of a section 87 amalgamation constitutes a disposition under subsection 248(1) of the Income Tax Act. Accordingly, when shares of predecessor corporations are exchanged for shares of the new corporation by virtue of amalgamation, shareholders of the predecessor corporations are deemed to have disposed of their predecessor corporate shares.
Subsection 87(4) of the Income Tax Act provides shareholders who hold shares in predecessor corporations as capital property with an automatic rollover of the adjusted cost base of those shares into the new amalgamated shares received. Under paragraph 87(4)(a), a shareholder of a predecessor corporation is deemed to have disposed of the old shares for proceeds equal to the shareholder’s adjusted cost base of the shares in the predecessor corporation immediately before the merger, and is deemed under paragraph 87(4)(b) to have acquired new shares (in the new corporation) at a cost equal to the deemed proceeds (of the old shares). Subsection 87(4) applies to shareholders where: (1) shares are held as capital property; (2) shareholders only receive shares in the amalgamated corporation in exchange of their shares in the predecessor corporation; and, (3) no benefits are conferred on related persons by virtue of the amalgamation. The rollover rules under subsection 87(4) will not apply for non-qualifying amalgamations. Accordingly, a subsection 87(4) rollover will only apply where the subsection 87(1) conditions are met.
Pro Tax Tips – Amalgamation
Amalgamation can be a significant and flexible tool for achieving effective business and tax planning objectives. However, amalgamation is a complex area of law that requires detailed analysis and advice from an experienced Canadian tax lawyer. If you are considering merging or amalgamating two or more taxable Canadian corporations, you should consider obtaining advice from an experienced Canadian tax lawyer on how the above-mentioned rules may impact the predecessor corporations, the new corporation, shareholders and your tax planning objectives. If you have questions pertaining to the corporate amalgamation rules under the Income Tax Act, please contact our tax law office to speak with one of our experienced Certified Specialist in Taxation Canadian tax lawyers.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."