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Published: April 13, 2020

Last Updated: April 13, 2020

Mergers & Acquisitions –Hybrid Transaction Structure – A Canadian Tax Lawyer Analysis

Income Tax Treatment of Share Sale vs. Asset Sale

The classic question when considering an acquisition transaction is whether it will be conducted as a share sale or an asset sale. While the specific circumstances surrounding the transaction can alter the analysis, generally share sales are preferred by vendors, while asset sales are preferred by purchasers. Especially where the vendor is a Qualified Small Business Corporation (QSBC), a share sale is particularly attractive because it allows the individual selling the QSBC shares to utilize his lifetime capital gains exemption of $835,716 (for 2017 but indexed annually). On the other hand, purchasers often prefer an asset sale because they can acquire only the specific assets that they are interested in as well as avoid taking on the obligations and liabilities of the corporation holding the assets. Most importantly for taxes, a purchaser can ‘step-up’ the tax base of an acquired asset that is either depreciable property or eligible capital property, allowing for greater deductions of capital cost allowance (CCA), also known as tax depreciation, and therefore lower income taxes in the future.

The Hybrid Transaction Structure

Hybrid transactions are an alternative transaction structure that can help bridge the competing interests of the vendor and the purchaser. A hybrid transaction typically involves a combination of both a share and an asset sale in order to achieve some or all of the benefits of both structures. In its most simple form, a hybrid structure involves the vendor disposing of shares to the purchaser in order to claim the capital gains exemption, followed by a sale of the assets to the purchaser, followed by a redemption of the shares by the purchaser. Many variations of the hybrid structure also exist that may make them more suitable depending on the circumstances involved. Common variations of the share sale can include utilizing an internal freeze under s.85 of the Income Tax Actto crystallize the capital gains exemption, or incorporating a new corporation and crystallizing the capital gains exemption through a s.85 rollover. Additionally, instead of a direct sale of the target assets from the vendor to the purchaser, the target assets can be spun out into a separate corporation, particularly if a s.85 rollover was used to crystallize the gain, and that separate corporation can be acquired by the purchaser.Call one of our top Canadian tax lawyers and learn how a hybrid transaction structure might be of benefit to you.

Hybrid Transaction Structure Tax Court Decisions – Geransky v The Queen

Hybrid transaction structures are not a well litigated area. One of the only cases that spoke to the effectiveness of hybrid transaction structures was Geransky v The Queenwhich was heard by Justice Bowman in Tax Court in 2001. The structure in Geranskywas one where the taxpayers held shares of the operating company through a holding company. They incorporated a new corporation and crystallized their capital gains exemptions by using s.85 to rollover some of their shares of the holding company into the new corporation and spun out the target asset into the new corporation as a dividend. The holding company then repurchased its shares that were held by the new corporation and the taxpayers sold the new corporation holding the assets to the purchaser.

The CRA argued that various specific anti-avoidance rules applied, such as s.84(2) Income Tax Act, as well as the general anti-avoidance rule (GAAR) under s.245 of the. In his decision, Justice Bowman made it clear that s.84(2) did not apply. S.84(2) operates to deem a dividend to a taxpayer where funds or property of a corporation is appropriated in any manner whatever on windup, discontinuance, or reorganization of a business. However, in this case, Justice Bowman was not convinced that there was windup, discontinuance, or reorganization and even if there was, did not see how s.84(2) could apply as no funds or property of the target corporation had made its way into the taxpayers’ hands – the funds entering the taxpayers’ hands were sourced from the purchaser. Furthermore, Justice Bowman found that GAAR was not applicable as there was no misuse or abuse of any provision of the Income Tax Act.

Canada Revenue Agency’s Position on the Hybrid Transaction Structure

The Canada Revenue Agency (CRA) initially filed an appeal to the Federal Court of Appeal with regards to the Tax Court decision in Geransky, but withdrew before it went to trial. The CRA has since released technical interpretations that indicate hybrid transactions that resemble the Geransky structure are acceptable tax planning and do not run afoul of s.84(2) or the GAAR. However, the CRA has not provided any guidance or input on other variations of the hybrid transaction structure. As such, care must be taken to ensure that any variations avoid the application of any specific or general anti-avoidance provisions while still meeting the requirements of the transacting parties.

Tax Tips–Buying and Selling a Business is Complicated – Get Professional Canadian Tax Lawyer Planning Advice

Beyond the two provisions mentioned in this article, there are a various other provisions of the Income Tax Actthat may come into play depending on the exact details of the transaction structure. It can be easy to implement a hybrid transaction structure without considering all of the possible tax and business implications and end up facing negative tax consequences. The key tax tip is that not every structure is suitable for every transaction, and the hybrid transaction structure is not a one size fits all for mergers and acquisitions and every option, be it asset sale, share sale, or hybrid sale, should be considered in order to optimize tax efficiency when buying or selling a business. Our expert Canadian tax firm can help you maximize your tax efficiency and make sure you are using the right tax structure and that the transaction is done right.


"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."

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